A proposed regulation, designed to increase compliance by corporate taxpayers, could create both tax planning opportunities and pitfalls for companies.
The existing regulation under IRC section 1032 allows a corporation to issue its own stock, or options to buy its stock, in exchange for cash or property without recognizing either gain or loss. Previously, the Treasury had extended the section 1032 rules to stock issued in a tax-free triangular reorganization (a series of transactions in which a parent creates a subsidiary to acquire a target company) and certain consolidated return transactions. The proposed regulation would extend the nonrecognition treatment to additional transactions, thereby further liberalizing the tax-free nature of section 1032.
Under the proposed regulation, no gain or loss would be recognized when a corporation (the transferor) receives property in exchange for stock, or options to acquire stock, it obtained from another corporation (the issuer) in a nontaxable transaction. The transferor corporation would be treated as having purchased the stock from the issuer for its fair market value immediately before the disposition.
The regulation would also extend this treatment to stock a company transfers in exchange for services. There is a corresponding amendment to the regulations under IRC section 83. In other words, the transferor can issue the stock of its parent to one of its employees in exchange for services without recognizing a gain on the transaction.
Observation. The proposed regulation has exceptions and does not apply to all transactions of this type. It applies only if the corporation that receives the stock immediately transfers the stock to acquire money or property. A transfer of stock that is not used until a later date is not covered by the regulation and, therefore, might result in gain recognition.
In addition, if the stock were issued with a forfeiture provision, upon forfeiture the stock would revert to the transferring corporation. The transferring corporation would have to recognize a gain or loss as if it had sold the stock for value. If the stock reverted to the issuing corporation, however, the transferor would receive nonrecognition treatment.
Corporations should remember these drawbacks as well as the advantages of this proposed regulation when analyzing and planning a transaction involving the issuance of stock.
—Edward J. Schnee, CPA, PhD, Joe
Lane Professor of Accounting and director,
MTA program, Culverhouse School of Accountancy,
University of Alabama, Tuscaloosa.