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Corporation Tax Case Analysis

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This research paper investigates the literature on tax laws. It examines Joel’s situation in which he wants to convert from a sole proprietorship into a corporation. According to the literature, Joel’s situation has been worsened by the fact that his liabilities exceed his assets in the sole proprietorship by a huge margin. As such, he has to forge an alternative plan that would enable him avoid gaining recognition for purposes of taxation. A sole proprietorship is the kind of business whereby the business and the owner are regarded as a single entity. As such, the owner pays personal tax on all the profits made by the business. A corporate business, on the other hand, has the business and the owners as separate entities (Bittker B. I. & Eustice J. S. 2009).

The relative complexity of tax laws especially with regards to sole proprietorship and the corporation has always restricted expansion of businesses. These laws are imposed at federal level for all corporations in the United States. There is a legal requirement that all corporations file their tax returns on an annual basis to the revenue authorities. However, they are accorded an opportunity to make quarterly tax estimates. Besides, their shareholders are not subject to direct taxation on their dividends. This makes corporate businesses more lucrative as compared to sole proprietorship. This is confounded by the fact that the law treats a corporation and its individual owners as separate entities. As such, personal assets of corporate business owners are more secure as they cannot be confiscated to pay for the debts of the business. This is why Joel was considering changing into a corporate business (Momburn, et al. 2011).

However, things got complicated due to the fact that his liabilities in the business exceeded his basis by a large margin. According to the manner in which the court handled Donald Peracchi’s tax case of 1996, there could be some reprieve for Joel’s new adventure. For instance, Donald was also required to contribute an additional capital to their corporation in order to act in compliance with Nevada’s tax laws. Indeed, he gave up his parcels of real estate that were found to be riddled with liabilities which together outdid his basis in the properties. According to the United States corporate tax code, his actions could easily trigger recognition of gain on the excess amounts. That is why Peracchi had to make every attempt to execute a promissory note to the corporation on the argument that such a note had an equal basis to its face value. As such, it would raise his total contributions to a value greater than his total liabilities in the sole proprietorship. However, this was not as easy as it may have looked, especially if the corporation decided to write off the note. Ideally, such a move would put Peracchi in a worse situation as he would have to face a discharge which is often regarded as an ordinary income (Bittker B. I. & Eustice J. S. 2009).

According to section 351 of the federal tax laws, a shareholder reserves the right to contribute a sum in capital without necessarily being required to recognize gain on its exchange. This is in recognition of the fact that the said transaction merely amounted to a change in the form of business ownership. Ideally, the corporation after the exchange ought to apply, since the shareholders who were making the contributions would essentially remain in control of the corporation after the changes. According to Peracchi, it should not have been a big deal whether the contribution of the capital took place at the initial creation of the business or when it was already operational. The ideal issue that should have been considered is the very fact that Peracchi could make his contributions to the business without any requirements to recognize gains on the capital exchange (Momburn, et al. 2011).

On the issue of gain deferral, Peracchi’s forms of contributions were strictly within the law. This is in respect of the fact that the law allows any kind of contributions to corporations so long as it is an asset. Although the consequential taxation may get complicated due to the fact that Peracchi’s basis slightly differed from its initial market value, the law still holds because his contributions were typical of a non-recognition transaction. This slightly contradicts the general rule that the basis of contributed assets should match the initial cost of the property. As such, he was duty bound to substitute the basis for a value equal to the cost basis of the property. As a matter of fact, deferral of gains cannot entirely diminish the significance of issues relating to the overall basis and its eventual timing of recognition. Ideally, it is an undisputable fact that any tax payer would prefer to be taxed on their property contributions at a later date rather than on an immediate basis. This reasoning would certainly benefit Joel as it would allow his gains to be recognized only after he disposes his stock in entirety. There was a real possibility of applying the law of assumption of liabilities. Ideally, Peracchi’s contributions would make taxation a tricky affair, especially with regards to the constitutional provision that a corporation assumes the debts of the contributed property. As such, his basis in the corporation could be viewed from the perspective of receipt of money which would definitely attract taxes (Bittker B. I. & Eustice J. S. 2009).

In pursuing his alternative plan, Joel would have to contend with the idea that depositing a promissory note technically amounts to making an empty promise on a piece of paper and have it included in corporate books. Although there is no chance that the corporation will at any time enforce the promissory note against Joel for as long as he remains in tight control of the corporation, the IRS could opt to ignore the possibility of the corporation’s bankruptcy and give the note some significance. Ideally, it is only the note that would make corporation’s creditors seize Joel’s personal assets. As such, his alternative plan has a potential of exposing him to far worse economic situations in future. This line of reasoning conspicuously appears in the other court cases, especially the one involving William Christopher. As a matter of fact, it becomes very prudent to stop and consider whether bankruptcy should be that significant to the point of economically affecting Joel’s transaction. If indeed the risk of bankruptcy is that significant, then Joel should be quick in obtaining basis in his note. However, if it doesn’t attract such magnitude of significance, then the potential economic effects posed by the note should be dismissed as inconsequential (Momburn, et al. 2011).

In conclusion, Joel’s attempt to cushion his personal assets from confiscation on the occasion of business debts proves a difficult task. This is basically due to the complex tax laws that apply in cases similar to this one. As a matter of fact, it is evident from the court cases relating to Donald Peracchi and William Christopher. As such, Joel would need to seek more expert opinion to determine if there are possible ways of navigating through the uncertain adventure. Although this could prove expensive, considering the fact that he is already financially strained, it is certainly worth it because the eventualities could see him lose all his property in the long run (Momburn et al. 2011).

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