Sergio and Chris Agree to Combine Their Sole Proprietorships and Form

question 41

Multiple Choice

Sergio and Chris agree to combine their sole proprietorships and form a corporation. Sergio will contribute cash of $20,000 and business property worth $120,000 (adjusted basis of $50,000) for a 25% interest. Chris will contribute cash of $200,000 and business property worth $220,000 (adjusted basis of $200,000) for a 75% interest. Which of the following statements concerning the tax treatment of Sergio and Chris's exchange of assets is/are correct?
I.Because neither owner owns more than 80% of the stock in the corporation, the transfers do not qualify for tax-free treatment.
II.Based on the wherewithal-to-pay concept, each owner is taxed on the cash they contributed to the corporation.
III.Sergio will recognize a $70,000 gain and Chris will recognize a $20,000 gain.
IV.No gain or loss is recognized on the exchange.
​

• A)Only statement IV is correct.
• B)Statements I and III are correct.
• C)Only statement II is correct.
• D)Only statement III is correct.
• E)None of the statements are correct.

---

Definitions:

Cash Flows

The total sum of cash and cash-equivalent assets moving in and out of a company.

Income Tax Payable

The amount of income tax a company owes to the government but has not yet paid.

Direct Method

A way to prepare the cash flow statement, where operating cash receipts and payments are listed directly to calculate net cash from operating activities.

Cash Payments

Financial transactions that involve the transfer of cash from one entity to another.