How does the 80 percent control test work in a Section 351 transfer?

Question

AcadiFi · Accepted Answer

No. A service provider does not count as a property transferor for purposes of the 80 percent control test under Section 368(c).

The mechanics: the transferors as a group must own at least 80 percent of the combined voting power and 80 percent of each class of nonvoting stock immediately after the exchange. Stock issued in exchange for services does not count toward that 80 percent.

```mermaid
flowchart TD
  A["All transferors contribute"] --> B["Identify property contributors"]
  A --> C["Identify service contributors"]
  B --> D["Sum their stock from property only"]
  C --> E["Exclude their stock from the test"]
  D --> F["Compare to total stock outstanding"]
  F --> G{"At least 80%?"}
  G -->|Yes| H["Section 351 applies"]
  G -->|No| I["Taxable exchange"]
```

Worked example. Three founders. Property contributors A and B each receive 100 shares for property. Service contributor C receives 50 shares for services. Total: 250 shares. Property contributors own 200 of 250, which is 80 percent. Test passes.

If C had received 75 shares for services, property contributors would own 200 of 275, or 72.7 percent. The transaction would fail Section 351 and A and B would recognize their full realized gain.

Note that if the service provider also contributes property that is more than a de minimis amount of the total contribution, the IRS may count their property-related shares toward the 80 percent. This is a common exam trap. The mere fact that a person contributed both services and property does not automatically include all their stock.

How does the 80 percent control test work in a Section 351 transfer?

Master REG with our CPA Course

Related Questions

Related Articles

Practice Questions