Providing Services in Exchange for Stock in a Corporation
The term property does not include services rendered or to be rendered to the issuing corporation. The value of stock received for services is income to the recipient.
The shareholder's basis in the stock is:
- the value of the services rendered plus
- the value (basis) of property transferred to the corporation in exchange for its stock.
The value of stock received by the shareholder attributable to services is taxed as ordinary income to the shareholder; it is considered compensation.
The corporation gets a deduction equal to the fair market value of the services. The FMV of the services is treated as compensation paid by the corporation.
Services and property exchanged for stock (this is a tax-free exchange):
- You transfer property worth $35,000
- You render services valued at $3,000
- You receive stock valued at $38,000
- You own 85% of the outstanding stock immediately after the exchange
- Since you were in control of at least 80% of all the outstanding stock immediately after the exchange, this is a tax-free exchange (no gain is recognized)
- Your stock basis is $38,000 (property transferred, $35,000, plus services rendered, $3,000).
- You must recognize ordinary income of $3,000 for services rendered to the corporation (the $3,000 is treated as compensation paid by the corporation).
- The corporation gets to deduct the $3,000
A transferor group is a group of people who transfer property to a corporation in exchange for its stock. For example, partners in a partnership.
To be part of a transferor group in a nontaxable Section 351 exchange, be sure to contribute at least 10% of the value of the services rendered in the form of cash or the fair market value of other property.
For example, if the fair market value of services provided is $5,000, you must contribute at least $500 in cash or other property to be part of the transferor group.
- Return to the Tax Basics for Startups Table of Contents to find related links.