VJ Corporation is to be owned equally by Vic and Joe. The corporation will be formed by exchanging the assets and liabilities of the V & J Manufacturing Partnership for all the corporation's stock on September 1 of the current year. Both shareholders use the calendar year as their tax year and desire to make an S election. What tax issues should Vic and Joe consider with respect to the

Question

incorporation?

What will be an ideal response?

Answer 1

• Does the incorporation transaction qualify as tax-free under Sec. 351?
• Are there advantages to be gained by transferring the partnership's assets to the corporation in exchange for its stock and then liquidating the partnership?
• Are there advantages to be gained by first liquidating the partnership and then transferring the assets to the corporation in exchange for its stock?
• What are the amount and character of the gain or loss recognized on the incorporation by the partnership? The S corporation? The partners?
• What is the basis of the assets to the S corporation?
• What is the basis of the S corporation stock to each shareholder?
• When does the holding period start for the assets? The S corporation's stock?
• What tax year should the corporation elect? Does this tax year have to be the same tax year used by the partnership?
• What accounting methods should the corporation elect? Do these accounting methods have to be the same accounting methods used by the partnership?
• What procedures must be followed to make an S election?
• By what date must the corporation make the election?
• What format does the election take?
• What consents are required of the shareholders?

One underlying question that might be brought up is: Should the tax practitioner and the transferor consider using an LLC instead of an S corporation?

The method of incorporation does matter. In fact, the entity making the selection does not have to be a corporation. Under the check-the-box regulations, a noncorporate entity can elect to be taxed as a corporation and then make a selection. The tax consequences (gain recognized, basis amounts, etc.) can be different depending on which of the three basic methods are used to terminate the partnership and transfer the assets to the corporation. The three methods are: (1) the partnership transfers assets to the corporation in exchange for stock, and the partnership transfers the stock to its partners in liquidation; (2) the partnership transfers assets to its partners in liquidation, and the former partners transfer the assets to the corporation in exchange for stock; and (3) the partners transfer their partnership interests to the corporation in exchange for stock, and the partnership transfers the assets to the corporation in liquidation.

Without further information, the gain and basis amounts cannot be determined, nor can we say which of the three ways is best. The S corporation can use a tax year different from the partnership, but it does have to be a required year. Likewise, the S corporation can elect any accounting method that it chooses, without regard to the method employed by the partnership. The corporation must file an S election (Form 2553) in a timely manner and the appropriate consents must be obtained from the shareholders. A transfer of assets from a partnership to an LLC is covered by rules different from a corporate formation