Taxation & Estate Planning

THIRD PARTY CAPITAL CONTRIBUTIONS

By Charles Rubin

A basic tenet of federal income tax is that all accessions to wealth are income to the recipient, absent a statutory exclusion. What happens if a for-profit corporation receives funds by the government ? is that income? It would seem silly ? the government giving money away with one hand, and then taking some of it back in tax with the other. However, it happens all the time. For example, Social Security payments can be taxable to recipients.

This issue came up in regard to grants to broadband communications companies under the American Recovery and Reinvestment Act of 2009, and reminds us of an advantageous characterization of such payments if the recipient is a corporation. Revenue Procedure 2010-34 recently provided a safe harbor interpretation for the communications companies, using Code Section 118.

Code Section 118 permits corporations to receive contributions to capital in a nontaxable manner. Most capital contributions come from shareholders of a corporation, and the Code Section 118 clearly avoids income to the corporation on its receipt. Further, Code Section 118 will also apply to contributions received from non-shareholders. However, in that situation, the corporation must reduce its tax basis in assets acquired within 12 months of the contribution (or other property of the taxpayer if such assets are not purchased in that period), pursuant to the rules of Code Section 362(c)(2)(B).  Thus, the reduction in basis does impose a tax cost to the recipient corporation by way of reduced depreciation or increased gains/reduced losses in regard to corporate property.

The Revenue Procedure confirmed the application of these provisions to most of the grants, but did not apply them to reimbursement for pre-application expenses and certain specified grants. The Procedure is silent as to why some of the grants do not qualify.

Code Section 118 only applies to corporations. The Revenue Procedure confirms this when it excludes noncorporate taxpayers from the coverage of the Procedure.

An interesting question is what happens if the recipient corporation does not acquire enough property within 12 months of a grant, and has insufficient basis in its other property, to apply a full basis reduction equal to the capital contribution.

Revenue Procedure 2010-34

Full post as published by Rubin on Tax on October 24, 2010 (boomark / email).