Reference no: EM132480918

Point 1: What will be the tax and nontax implications relating to the formation of Transformation, Inc.? Emily has operated her startup venture as a sole proprietorship since launching the business two years ago. David, a friend from college, has been collaborating with Emily, and together they have developed an innovative software app. They were overjoyed that as soon as the app was introduced into the market, it was an immediate hit-and it has gained increasing recognition and market traction as sales continue to rise. After only a short period of success though, Emily becomes convinced that the upside potential for even more growth is significant. However, she realizes that a leap to that level of growth and market penetration can only be achieved with a large infusion of capital that she is unable to fund from her resources.

Point 2: Fortunately, Emily's friend Ethan, who is a venture capitalist, is enthusiastic about making a large investment in the business in exchange for an equity stake. Ethan agrees that Emily's startup easily will enjoy remarkable success once it has the necessary additional resources. To integrate Ethan's capital into the venture, the sole proprietorship will be incorporated with Emily and Ethan each contributing assets in exchange for stock in newly formed Transformation, Inc. Emily also has asked David, an invaluable employee and a major contributor to the app's development, if he would be interested in becoming a shareholder in Transformation. He was given the option of transferring either property or services in exchange for stock.

Point 3: However, at this point, David is undecided about what he will do. Emily receives 200 shares of Transformation stock in exchange for the transfer of the following sole proprietorship assets to the new corporation as follows:

                                       Adjusted Basis                          Fair Market Value

Accounts receivable         $             -0-                      $ 50,000

Building                          100,000                                400,000

Proprietary information-app   300,000                            1,550,000

                                       $400,000                            $2,000,000

Ethan will contribute $48 million of cash for 4,800 shares of Transformation stock.

Question 1: What will be the tax and nontax implications relating to the formation of Transformation, Inc.?