Reference no: EM132950832

Facts:

• P and S are both U.S. corporations classified as "C" corporations for federal income tax purposes. P owns 100% of S's stock. However, P and S do not file their federal income tax returns as a consolidated group (they file as separate corporations).
• To fund its operations, four years ago S borrowed $500,000 from P. The transaction was structured with five payments of $100,000 plus market interest. S has been making the required payments of interest and principal on the debt, and the amount outstanding is now $100,000. Also, P's basis in the outstanding note receivable from S is $100,000.
• Although S is solvent (i.e., the fair market value of its assets is just barely in excess of its debts), it is experiencing cash flow problems and is now unable to repay the debt. Accordingly, S proposes to issue additional S stock to P in satisfaction of the debt. The fair value of this additional stock would be $5,000.
• S has determined that Code section 108(e) is the authority that governs the taxation of its proposed transaction.

Issues:

Problem 1) What are the tax consequences to S of the proposed transaction?

Problem 2) If the transaction could be treated as a capital contribution (instead of a stock issuance), what would be the tax consequences to S?

Problem 3) Is it possible for S to characterize the issuance as a capital contribution?