Structuring A Non-Taxable Transaction For Messina Properties Inc. Using Section 351

Facts

Metro Culinaria Inc. owns several restaurants in Metro Area. The company is a closely held company with 100% of its ownership belonging to Tony Messina (80%) and his youngest son Martin Messina (20%) with market value of stock of Metro Culinaria estimated to be $4,000,000.  Elder son of Tony also owns a popular restaurant in that has an estimated market value of $1,500,000 and runs the restaurant as sole-proprietorship business. With the intention of merging all these restaurants under single umbrella the family decided to incorporate Messina Properties Inc.

Subsequent to the formation of Messina Properties Inc. the stock Metro Culinaria and the properties of Tony’s elder son’s restaurant shall be vested in the company. Subsequent to the vesting of Metro Culinaria’s stock and properties of Tony Jr.’s restaurant in the new formed Messina Properties Inc. it is estimated that the stock of the company would have a market value of $5.5 million. The stock of new formed company would be held between Tony Sr., Tony Jr. and Martin in the proportion of 58.2%, 27.2% and 14.6% respectively.     

Issue:

There are number of issues associated with the above facts, these are as following:

1. The tax implications of vesting the stock of Metro in the new company to the stock holders of Metro.
2. The tax implications for Tony Jr. of vesting the properties of his sole proprietorship restaurant business to the Messina Properties Inc (Burton, 2017).

• Tax implications of converting Tony Sr.’s common stock into preferred stock in Messina Properties.

1. Impact on taxation income of Tony Sr. for receiving annual cumulative preferred dividend of 6% on his preferred stock from Messina Properties.

Discussion:

Section 351 of the Internal Revenue Code provides for the tax implications to the transferor of assets to an entity. Section 351 (a) specifies that a person/ persons would not be required to recognize the gain or loss from transfer of property to an entity if the transferor received only stock of the transferee entity in exchange of transferring such property or assets if the persons are in control of the transferee entity subsequent to the transfer of such properties or assets (Davis, 2015).

As per section 368(c) of the code if a person or persons have combined voting power of 80% or more in an entity then it can be defined as the person or persons have controlled of such entity. In this case, the stock of Metro Culinaria Inc. and the properties of Tony Jr.’s restaurant have been transferred to the Messina Properties Inc. has resulted in complete control of the new entity in the hands of Messina families. Hence, as per section 368 (c) of Internal Revenue Code the transferors namely, Tony Sr., Tony Jr. and Martin need not recognize the gain or loss immediately subsequent to the transfer of stock and properties of Metro and Tony Jr.’s restaurant respectively (Ganor, 2018). The basis of Tony Sr., Tony Jr. and Martin in the newly formed company in accordance with the market value of stock in the company will be as following:

Particulars	Amount ($)	Amount ($)
Market value of stock of Messina Properties Inc.	5.50 Million
Basis of Tony Sr. (5.5 x 58.2%)		3,201,000.00
Basis of Tony Jr. (5.5 x 27.2%)		1,496,000.00
Basis of Martin (5.5 x 14.6%)		803,000.00

No gain or loss shall be recognized from the transfer of property of Tony Sr., Tony Jr. and Martin as the control in newly formed company has been vested in the transferors completely subsequent to the transfer of stock and assets (McDaniel, Repetti & Ring, 2014).  

The gain or loss from conversion of common stock into preferred stock also need not be recognized by the transferor if the conditions of section 351 (a) of Internal Revenue Code are satisfied. In this case it is clear that immediately subsequent to the transfer of the properties and stock of sole proprietorship business of Tony Jr. and Metro Culinaria have resulted in complete control of the new formed incorporation by the Messina family hence, no gain or loss from such transfers need to be recognized for income tax purposes in the country (Decker & Ray, 2017).   

Summary:          

Taking into consideration the above discussion and as per the income tax regulations in the country it is clear that Tony Sr., Tony Jr. and Martin need not recognize any gain or loss from the transfer of their properties to the newly formed Messina Properties Inc. as the transferors hold more than 80% of the ownership of the company subsequent to the transfer of such properties and stock.     

References:

Burton, D. (2017). The Tax Code as a Barrier to Entrepreneurship.

Davis, T. R. (2015). Mapping the Families of the Internal Revenue Code. Va. J. Soc. Pol’y & L., 22, 179.

Decker, J., & Ray, R. (2017). Tax Strategies for US Farmers: Tax Reduction and Averting Risk.

Ganor, M. (2018). Recoupling Founders with Their IP–Improving Innovation by Rationalizing IRC Section 351 (Licensing vs. Assignment of Founders’ IP in VC Backed Start-Ups).

McDaniel, P. R., Repetti, J. R., & Ring, D. M. (2014). Aspen student treatise for introduction to united states international taxation. Wolters Kluwer Law & Business.