A manufacturer reports $4,200,000 of book income, receives $300,000 of dividends from three different domestic corporations, donates $500,000 to charity, and carries a $1,800,000 net operating loss (NOL) into the year. The CFO needs the federal tax bill before the board meeting. Six rules sit between book income and the final number, and each one is a high-frequency CPA-REG question.
Congress defers tax on incorporation because forcing recognition would block entrepreneurs from pooling capital and risk. Below the 80% control line, Congress treats the transfer as a sale to a separate entity. Above it, the transferors have just rearranged their own wealth into corporate form, so tax waits until they actually cash out.
HIGH-FREQUENCY: §351 defers gain or loss when you transfer property to a corporation solely in exchange for stock, provided the transferors as a group own at least 80% of voting power and 80% of each class of nonvoting stock immediately after the exchange.
Three requirements, all required: property is transferred (not services), the transfer is solely for stock, and the transferring group holds 80% control post-transfer.
Common mistakes
- Treating services as property under §351. A consultant contributes only services for 30% of the stock. Services are always compensation income at FMV, and those shares do not count toward 80% control.
- Equating boot to total cash received. Boot is cash + other property + debt relief exceeding basis. A transferor who receives $30,000 cash and has $100,000 of debt assumed by the corporation on property with $80,000 basis has $30,000 cash boot plus $20,000 excess-liability boot (the $100,000 debt assumed exceeds the $80,000 basis by $20,000)...
- Defaulting to 50% DRD regardless of ownership. A corporation with 30% ownership that takes a 50% DRD instead of the correct 65% understates the deduction by 15 percentage points. On a $300,000 dividend that is a $45,000 error, which at 21% is $9,450 of overpaid tax.
Bottom line
- §351 formation defers gain when transferors control 80% of voting power and each nonvoting class immediately after the exchange; boot triggers gain up to realized gain, never loss
- Flat 21% rate on all taxable income; no preferential capital gains rate; net capital losses offset only capital gains, carrying back 3 years and forward 5
- DRD ladder: under 20% = 50%, 20-80% = 65%, 80%+ affiliated = 100%; the cap is waived when the full DRD creates an NOL
- Charitable cap = 10% of modified taxable income (computed before the charitable deduction itself); 5-year carryforward
Exam shortcut
When a question describes forming a corporation, run three checks: transfer for stock (not debt), property (not services), and group with 80% control immediately after. All three pass → §351 deferral; boot triggers gain up to realized gain. When ownership shows 25% or 30%, the DRD is 65%, not 50%. That is the middle-tier trap.
The full lesson (about 6,162 words, 41 min read) adds 10 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- V.B1
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