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Monday, June 22, 2015

The Tax Consequences of Capital Contributions in a Business

The Tax Consequences of Capital Contributions in a Business



When you decide to start a business venture, there are a myriad of things to consider.  We regularly assist small business owners, especially start-up businesses, walking them through the steps that need to be taken in order to make the business official and legal.  There are many ways a business can be organized and there are both non-tax and tax factors as well as state and local statutory requirements that need to be taken into consideration when embarking on this exciting journey of starting a business.

I previously wrote an article regarding the non-tax factors that should be considered when starting a business.  This article is one of a series of articles that focuses on the tax implications of certain business activities and things you should consider when choosing your business entity.  The most prominent federal tax considerations in choosing a business entity include:



The first tax consideration I will address is the tax consequence of a capital contribution.

cashCASH CONTRIBUTIONS

When cash is contributed, no gain or loss is recognized, and the contributor's basis for the stock or interest received in the business equals the the amount of cash contributed.

PROPERTY CONTRIBUTIONS

Partnership or LLC

If property is contributed to the business, any gain or loss inherent in the contributed property is deferred until the partnership or LLC sells the asset or the contributing partner/member sells his interest.  The contributing partner/member does not recognize gain or loss at the time of contribution, regardless of his percentage of ownership.  The contributor's basis in the property carries over to the partnership/LLC and it also becomes the basis for the membership/partnership interest the contributor receives for the contribution.  When the contributed property is sold, the gain or loss that was not recognized at the time of the contribution is recognized and allocated to the contributing partner/member.  If the contributed property is distributed to another partner/member within five years of the contribution date, the contributing partner/member recognizes gain or loss on the property.

Corporations

The transfer of appreciated property to a regular or S corporation in exchange for stock is a taxable transaction unless the transferor, together with other parties making contributions at the same time, control the corporation through ownership of at least 80% of its stock.  No gain or loss is recognized if this control requirement is met.  The contributing shareholder's basis for the property carries over to the corporation and also becomes the basis for the stock the shareholder receives in return.

In an S corporation, gain or loss the corporation recognizes when it disposes of the property passes through to the shareholders in proportion to their stock ownership.  Unlike a partnership, the gain or loss is not allocated to the contributing shareholder.

In a C corporation, the corporation is taxable on any gain or loss when the contributed property is disposed of.  There are no current tax consequences to the shareholders.

For a complete analysis of the tax implications of C Corporations, Partnerships, and S Corporations click here for the Joint Committee on Taxation's publication entitled "Choice of Business Entity: Present Law and Data Relating to C Corporations, Partnerships, and S Corporations."

Attorney Angel Oliver / McGrath and Spielberger, PLLC assists clients with all sorts of tax matters, both federal and state (including but not limited to North Carolina and South Carolina). Click here to contact Ms. Oliver about your tax matter.