Question

A is a research pharmacologist. He has been pursuing a patent a patent on a formula which when developed into a commercial product will dramatically decrease reliance on opioids following surgery.

In an exchange qualifying for Sec. 351 IRC tax-free treatment, A received 1000 shares of Painless Corporation stock plus a contingent right to receive an additional 250 shares. The contingent shares will be awarded upon the valuation of his patent application. Because the patent license is pending, the patent cannot be usefully valued for several months.

Prepare a memorandum for your tax manager explaining whether the contingent shares are considered “stock” for purposes of Section 351 IRC and what tax consequences ensue from A’s receipt or non-receipt of the actual and contingent shares of stock.

A is a technological genius but is inexperienced in the business arena. He also asks that your memorandum with respect to the Section 351 IRC treatment of his contingent shares also discuss Sections 1244 IRC & 1202 IRC and their possible application to this issue.

Answer 1

Section 351(a) provides that 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 § 368(c)) of the corporation

Section 1244 IRC

Section 1244 of the Internal Revenue Code is the small business stock provision enacted to allow shareholders of domestic small business corporations to deduct a loss on the disposal of such stock as an ordinary loss rather than as a capital loss, which is limited to only $3,000 annually.

1202 IRC

Section 1202, also called the Small Business Stock Gains Exclusion, is a portion of the Internal Revenue Code (IRC) that allows capital gains from select small business stock to be excluded from federal tax. Section 1202 of the IRS Code only applies to qualified small business stock acquired after September 27, 2010, that is held for more than five years.

• Points to remember..
• Under Section 1202, capital gains from select small business stocks are excluded from federal tax.
• It provides an incentive for non-corporate taxpayers to invest in small businesses.
• Not all business stock quality.