 Hello, and welcome to the session in which we will account for contributed services, however, from the corporation's perspective. What is the big idea for this session? We have shareholders that they combine older resources and they form a corporation by contributing cash and property to form this corporation. In return, the corporation will issue stocks of the company and these individuals become corporate shareholders or investors. And what we learn about this, if this transaction falls under section 351, which we learn about this in a separate recording, then this transaction is tax-free for both the shareholders as well as the property, as well as the corporation. Now, sometime what happens, some shareholders, rather than contributing money, they don't have money to contribute, they will contribute services. What are services? For example, a CPA, a lawyer, a person that don't have money to contribute, they would say, we will work for the company and as a result, we will get some stocks, we will become owners while they're contributing their services. And there are specific rules that we learn about. How does this contribution of services affect the shareholder? And we learn that this service is considered compensation for shareholder and because it's compensation, the transaction is taxable. So we already learned about this. We also learned that sometime they contribute services and property and under those circumstances, we may or may not count this individual part of the section transaction 351. Everything that I talked about to this point, we already know. We already learned in prior recording. In this session, we are going to determine how would the corporation account for those services. So how would the corporation treat those services? Let's go ahead and get started. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead, start your free trial today. There are two types of services as far as the corporation is concerned. Legal and accounting services to form the corporation and all other services. Simply put, we have to differentiate what type of a service this individual is contributing. Is he or she contributing services, accounting and legal in nature to form the corporation or is it some other services? If they are contributing accounting and legal services, the amount is capitalized as an organizational expenditure. It's part of corporate formation. It is recognized as an intangible asset. Simply put, what is that? That's an asset. It's an intangible asset. The corporation has basis in the asset. For example, if this individual contributed $20,000 worth of services, accounting and legal to form the corporation, we debit $20,000 of an intangible asset. Now the law allows us of that $20,000 to expense up to $5,000, not up to the $20,000, from the $20,000. It will allow us to expense up to $5,000 and the remainder is deducted over $180 a month in form of amortization. Now the reason I said it doesn't have to be of the $20,000, $5,000 is allowed to be deducted as an expense in the current year as long as the expenditure don't exceed, you know, don't exceed $55,000 and it's between $50,000 and $55,000. Simply put, there's a limitation. Once those contribution exceeds $55,000, you can no longer expense. You have to amortize the whole thing. If they are below $50,000, you can expense up to $5,000 of those expenditure. If they are in between, if they are in between $50,000 and $55,000, you would lose $1,000 or $4,000. So if they are $52,000, then you can expense. So let's assume the total expenditure were $52,000. They're $2,000 within the range. The range is $5,000. Well, therefore, we would lose $2,000 out of the $5,000. Therefore, we can deduct $3,000. And what happened to the remaining? What happened to the remaining? Because we have $49,000 remaining. They will be amortized, expense over $180 a month, which is $5,000. How about if you provide services other than accounting and legal services? Well, like personal managerial services, something that you do for the company. Well, what you do is this. The company will expense it as compensation. Basically, they're paying you your salary. That's what it's considered. Therefore, it's deductible. It's deductible to the corporation. And it's a current deduction. So it has more value because the option is if it's not a current deduction, it's an intangible asset. It's a future deduction. Companies prefer to have a current deduction. A deduction now. They like this because you'll get a tax benefit today. Let's take a look at an example to illustrate this concept. We're going to see if this transaction is a 351 and answer a few questions about it. And how do the company treat contribution of services? We have Elizabeth and Catherine, E and K, E and K established Falcon Enterprises. Elizabeth contributed an asset with a basis of 25, basis 25, fair market value of 200 in exchange for 50 shares of the company. So they got 50 shares of the stock. On the other hand, Catherine provide an asset with a basis of 50. The basis is 50 and the fair market value of 165. So notice, first of all, we have no built-in loss. So there's no built-in loss. There's no built-in loss. That's out. And because the asset that they contributed has a gain, which is fair market value greater than the basis. And agree to manage Falcon Enterprise for a year. So Catherine, she did not only contributed the fair market value. She's going to provide some services. And she also received 50 shares of stock. The value of Catherine managerial services to the enterprise is estimated to be, and I did not give you the estimate. I did not give you this number. The reason I did not give you this number, I want you to figure out this number. Well, if Elizabeth received 50 shares of stock and Catherine received 50 shares of stock, it means they together they own 100%, 50% and 50%. Elizabeth contributed 200,000 worth of goods. Catherine contributed 165 worth of goods plus services. So now we know what are the services. What is the value of those services? They must have been 35. Why? Because for the exchange to make sense, she has to contribute 200,000 worth of value. She has to contribute 2,000 worth of value. Therefore, they own the company 50% to 50%. So that's why I kept estimated to be, and I did not give you the number, which I should have, but I wanted to show you that services could be figured out. So does the economics make sense? Yes, because 200,000, 50%, 200,000, 50%. Is there any built-in loss? And the answer is no. Is this a section 351? Why do we have to ask this question? Well, because we contributed services. And definitely it's section 351, because Catherine is counted. Why is Catherine counted as part of 351? Although she contributed services, the property she contributed also property. So the property contributed is more than 10% of the services. The services are 35,000. 10% is 3,500. She contributed 165,000. Therefore, this is section 351. Now, what is the gain recognized? Well, what's the gain recognized? Well, let's see first what's the gain realized. For Elizabeth, she contributed an asset worth 200,000 with a basis of 25. The gain is 175 realized. And Catherine contributed an asset worth 165, and her basis in the asset is 50. Therefore, the realized gain is 115. Those are the realized gain. The question is how much of it is recognized? And the answer is none. Why? Because if we have section 351, which we do already determine that Catherine is part of it, and Elizabeth together, they control 100%, more than 80%. Now, what is the basis for the shareholders? What's the basis for Elizabeth? What are the basis for Catherine? Starting with Elizabeth, how do we compute the basis? Well, it's the adjusted basis of property contributed, 50,000 plus any gain. There was no gain, any taxable services for Elizabeth. There is no taxable services, minus fair market value received. There are none. Minus liability, that's not a boot. There are none. So Elizabeth, the basis is 25,000. What about the basis for Catherine? The basis for Catherine, we use the same formula, starting with the adjusted basis of property contributed, plus any taxable gain. Actually, we do have taxable gain. What's the taxable gain? The taxable gain is the services of 35, minus fair value of boot received, which is non minus liability. Therefore, her basis is 85,000. And Catherine will have an ordinary income that's taxable of 35,000. Why? For the services provided, that's what? That's taxable income. Now, let's look at the basis for the corporation. The basis for the corporation is the transferred basis, plus any gain that was recognized for the corporation. Well, guess what? There was no gain. Therefore, the basis for the corporation is the basis of Catherine and Elizabeth. Remember, gain for the corporation, gain on the property. They did not recognize any gain on the property. Therefore, 25 for Elizabeth, the asset for Elizabeth, and 50 for the asset contributed by Catherine. Let's switch the scenario a little bit and let's assume Catherine perform accounting services that help form the corporation rather than managerial services. So those are accounting services to form the corporation. All the answers will be the same except how we handle the accounting services expenditure, which was the 35,000. We're going to treat the 35,000 for accounting services by expensing 5,000 up front. So of the 35,000 of accounting services to form the corporation, the company can deduct 5,000 up front and the remainder is 30,000 will be amortized over 5 years as an intangible asset. So this is how we account for services contributed to a corporation. What should you do now? You've got to go to Farhat Lectures and look at additional MCQs, true-folds, additional exercises that's going to help you. Section 351 implication for shareholders as well as corporation, whether they contributed property or whether they contributed section 351 services. We have to know how to handle services under section 351 for both shareholders as well as corporation, whether you are a CPA exam candidate, enrolled agent, accounting student, study hard, invest in yourself. Good luck and stay safe.