Greetings Ms. Cherie Logan,
The purpose of this document is to provide you with the legal background of the scenario that you and the corporation that you are a part of, Cincinnati Commercial Design Associates Inc., is facing.
Facts
Starting with the facts, it has to be stated and clarified that you started the business—which is now running as a corporation, as a sole proprietorship or a privately owned business for an undisclosed number of years and that the main reason behind the recent step to incorporate it was to minimize potential liabilities as a business owner. The petition for Cincinnati Commercial Design Associates’ incorporation was filed on the 1st of July 2015.
Tax Issue
The main federal tax issue here is whether all the appropriate accounting figures were reported. Corporations are taxed differently from privately owned businesses. Corporations are taxed as an entity. Therefore, the owners of the corporation (i.e. shareholders) cannot be deemed liable to the tax and other financial and non-financial obligations of this already-independent taxable entity. This is opposed to how privately owned businesses are taxed where the owner of the business is the one made liable for the business’ financial and non-financial obligations to the government.
It is important to note, however, that corporations, despite the more complex and diluted distribution of tax and other obligations, are taxed more heavily compared to their privately-owned counterparts. It also carries over a higher level of costs.
Discussion
In terms of the question that is going to be taxed, the corporation would be the entity that the IRS will tax upon the completion of the incorporation process. However, there are still certain taxes (although greatly minimized in number) that may still apply to Ms. Logan. When the corporation pays the trade accounts payable, it has to be properly deducted from Ms. Logan because such transactions happened when the company was still privately owned, unless certain special arrangements would be made.
Applicable Authorities and Analysis
The stockholders of the soon to be incorporated business would have to work with the Internal Revenue Service, which is the federal government-mandated entity responsible for collecting taxes from individuals and businesses throughout the incorporation process. The main objective here is to be able to successfully and legally declare all of the assets and liabilities that Commercial Design Associates may have had prior to its incorporation in order for the IRS to determine what assets and incomes are going to be taxed and what are not. It is important to note that it would be the IRS who will do the assessment and not the company’s internal representatives although certain disputes and clarifications may be filed should any of the parties involved (i.e. Ms. Logan) think there is a need to do so. In such cases, they would have to raise their concerns to their legal representatives (e.g. corporate tax law department) before raising their position to the IRS. These arguments are supported by the following parts of the Internal Revenue Code Section 351 in verbatim:
“No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation” .
2) “Receipt of property If subsection (a) would apply to an exchange but for the fact that there is received, in addition to the stock permitted to be received under subsection (a), other property or money, then no loss to such recipient shall be recognized” .
“In general, in determining control for purposes of this section, the fact that any corporate transferor distributes part or all of the stock in the corporation which it receives in the exchange to its shareholders shall not be taken into account” .
Now, according to these three specified parts, there may be cases where the debts and other liabilities may be transferred to the corporation but it would be safe to assume that any debt issued prior to the incorporation may still be under the previous owner’s name especially if the shareholders or investors would vote against the transfer of such liabilities to the corporation.
Conclusions and Recommendations
There are many recorded cases wherein a formerly privately owned business that has recently filed a petition for incorporation failed to declare all of the business’ taxable assets. The IRS is strict when it comes to declaration of assets especially for businesses because it basically exists to make sure that all taxable entities are taxed appropriately. Some companies, on the other hand, intentionally or unintentionally, hide their assets in order to minimize the taxes that they have to pay. It makes sense to do so because a lower tax rate would translate to a higher bottom line (i.e. net income) for the business. However, the IRS would sooner or later find out about such measures and the company may get slapped with tax evasion charges. This is something that Commercial Design Associates should avoid.
Works Cited
Legal Information Institute. "26 U.S.Code S 351 - Transfer to Corporatin Controlled by Transferor." (2016): https://www.law.cornell.edu/uscode/text/26/351. 01. Web.
