Do services in exchange for stock create ordinary income at corporate formation?

Yes. Stock received in exchange for services is taxable as ordinary compensation income equal to the fair market value of the stock at the time of receipt. This is true whether the entity is a corporation, partnership, or limited liability company classified as a corporation.

The treatment under Section 83:

• The service provider includes the FMV of the stock in compensation income in the year the stock is no longer subject to a substantial risk of forfeiture.
• If the stock is vested at issuance, the income is recognized immediately.
• If the stock is subject to vesting, the service provider can elect under Section 83(b) to recognize income at grant on the value at that time. This is risky if the stock could later be forfeited, but it locks in the basis.

The service provider's basis in the stock equals the amount included in income. So 10,000 dollars of stock means 10,000 dollars of basis. If the stock later doubles in value and the provider sells, the gain is computed against that 10,000 dollar basis.

The corporation gets a corresponding compensation deduction in the year the service provider recognizes income (subject to Section 162 ordinary and necessary requirements).

For the Section 351 control test, the service provider's stock does not count toward the 80 percent unless the service provider also contributes more than a de minimis amount of property.