Case study: excluding assets from a tax-free incorporation to avoid double taxation later.

• Author: Ellentuck, Albert B.

When incorporating an ongoing business, the organizer must transfer enough assets to the corporation to allow it to operate the business for which it was organized. However, it may be wise to avoid the transfer of all the assets to the newly formed corporation. For example, vital business real estate may be best left in the hands of the organizer and leased to the corporation. This avoids double taxation from a future distribution or sale of the real estate and allows the organizer to withdraw funds from the corporation as deductible rent instead of nondeductible dividends. There are several commonly cited reasons for retaining assets outside a corporation

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This case study has been adapted from PPC's Tax Planning Guide--Closely Held Corporations, 24th Edition, by Albert L. Grasso, R. Barry Johnson, Lewis A. Siegel, Mary C. Danylak,Timothy Fontenot, James A. Keller, Brian B. Martin, and Robert Popovitch, published byThomson Tax & Accounting, Ft. Worth,TX, 2011 ((800) 323-8724; ppc.thomson.com).

Avoiding double taxation: When an incorporator transfers an asset to a corporation under Sec. 351, the adjusted tax basis of the asset generally carries over from the incorporator to the corporation. For a C corporation, there is a double tax cost if the corporation sells the asset or distributes it out of the corporation to the shareholders. Sec. 336 triggers gain (as if an asset were sold at its fair market value, or FMV) if property is distributed in a corporate liquidation, and Sec. 311(b) triggers gain to a distributing corporation if property is distributed to a shareholder in a nonliquidating situation. While this may be less of an issue in today's economy, in general assets such as land and buildings, which tend to appreciate in value and may not be disposed of if the operating business is sold or fails, may be better owned outside the corporation.

Distributing cash in a form other than compensation: When assets are retained outside a corporation, the corporation must pay rents or royalties for the use of the assets. These rental or royalty payments can serve as a method of withdrawing corporate cash in a way that is tax deductible to the corporation but also without incurring the FICA tax costs or reasonable compensation issues associated with drawing compensation from the corporation. Furthermore, rents and royalties can be paid into the shareholder/ lessor's retirement years with the reasonableness of the payment...