Reference no: EM133320485

Assignment: When I think of the tax implications of corporations, it at least appears at face that Section 351 of the Internal Revenue Code (IRC) provides several avenues to actually reduce the overall tax burden for forming a corporations (Cornell Law School, 2022b). Now why would the U.S. Government allow those loopholes for the forming of a corporation, as it applies to providing provisions for non-taxable exchanges of property? My mind immediately goes to the long-game view the U.S. Government see corporate taxation. To this end, if the current corporate income tax rate is 21% compared that of flow-through entities, the government most likely will generate more tax revenue by encouraging business incorporation. However, looking at the long-game view in a The Week article by Cooper (2021) the U.S. Treasury Secretary Janet Yellen has proposed not only an increase in the corporate tax rate to 28 percent (i.e., $10M in corporate taxes under 21 percent would be $13.3M or a $3.3M increase in U.S. Government tax revenues at the proposed 28 percent), but also a global minimum tax to discourage corporations from seeking low tax haven countries around the world. If approved, no matter where in the world a corporation recognizes income they will be taxed at the same minimum rate.

Now in her mind, Secretary Yellen may be thinking of how much more tax revenues may be brought into the U.S. Government coffers for use in funding desired administrative programs, while discouraging corporations from shifting income and assets outside the United States, thus reducing that potential taxable income at the higher 28 percent corporate rate. However, would an unexpected consequence actually discourage incorporation of businesses in order for businesses to prevent paying such high-income taxes on earnings? Furthermore, would it decrease overall industry competition to only those large corporations that could absorb a higher corporate tax rate, where smaller corporations counted on a lower corporate tax rate or competitive international corporate tax rates that allow them to expand and continue business operations. To this end, $3.3M might be a spit in the bucket for a Tesla or Amazon, but to a smaller capitalized corporation that could mean the difference between existence or extinction. As such, could this in turn also discourage or prevent future innovation in those industries that otherwise could be realized at the lower corporate tax rate? Overall, we are called as accountant to follow the tax laws implemented by the U.S. Government and advise our clients accordingly when it comes to the decision to incorporate or consider other more tax advantageous business structures.

Next, looking back again at the concept of non-taxable property exchanges in corporation forming, it is a very simple concept that encourages investors to transfer only cash or property and discourages receipt of anything other than stock in the company in return (Roger CPA Review, 2022). As such, the best advice you might provide to a client seeking forming a corporation would be to avoid transfer of services and consider receiving additional shares of stock as opposed to boot avoid both taxable transactions. I feel this is important advice for a client because: 1) Services provided in exchange for stock will be taxable at the Fair Market Value (FMV) of the stock received and percentage of share in the company subject to FICA or self-employment tax, 2) boot is taxable at the gain recognized, and finally 3) exchanging of services by one shareholder could actually push the overall combined cash and property share below the 80 percent controlling position required to be considered a non-taxable exchange for the other shareholders (Roger CPA Review, 2022). Why this matters to shareholders is that in order to minimize the tax burden of the corporation as well as each individual shareholders, there must be a candid discussion about how the capitalization of the corporation will be structured.

Finally, when considering how to properly conduct distributions either as dividends or gains on sale of stock, it is important to fully understand the concept of stock ownership. Specifically, Section 318 of the Code discusses that general ownership of stock includes the individual, spouses, as well as direct parents and descendants (children, grandchildren) (Cornell Law School, 2022a). Therefore, when conducting a stock redemption in small corporation one must consider how general ownership definitions in Section 318 of the Code impacts redemption of stock from family members in the same company. Now if considered a non-taxable exchange of stock for sale this would be advantageous for corporation, but disadvantageous to the individual shareholder recognizing a taxable capital gain. However, if not meeting the Section 318 criteria and considered a dividend distribution to company shareholders, it would actually cause an increase in gross income for the portion considered a dividend and becomes a taxable event for the corporation depending upon balances of Current Earnings & Profits (CEP) and Accumulated E & P (AEP) (Roger CPA Review, 2022). Overall, the decision to incorporate a business has look beyond just the advantages of access to capital and fund raising for expansion, but most serious consider the various tax implications that can ultimately make or break the corporation financially. This is a decision that should not be made lightly and without professional tax advising before going forward. By doing so, initial investors can fully understand the advantageous way of structuring the corporate capital, as well as conduct distributions to shareholders, all while maintaining the most advantageous tax situation to ensure the long-term longevity of the company.