No, the original partners don't pay the tax. The new corporation pays the tax when it collects the money. The court said that unpaid bills are considered 'property,' so they can be part of a tax-free business creation under a tax rule called Section 351. There's a conflict between that rule (which says 'no tax now') and another general idea that 'whoever earns it, pays tax on it.' The court decided that the specific rule from Congress to help businesses change their legal structure is more important. Forcing the partners to pay a big tax bill just for creating a corporation would make it too hard for businesses to grow and change, which isn't what lawmakers wanted. The court also said the new company couldn't claim the supplies as a new expense because the old partnership already got a tax break for them; the company started with those supplies having a tax value of zero.

Yes, the partnership does not have to pay taxes on the gain or loss from transferring the IOUs and inventory to the corporation. A special tax law, Section 351, says transfers of property for corporate stock can be made without immediate tax consequences. The purpose is to make it easier for businesses to incorporate. Customer IOUs count as 'property' under this law. A special tax rule that could change the value of the inventory for the corporation's taxes does not apply here, because the tax value stays the same when property is transferred this way. Normally, the partnership would have to pay taxes when it transfers the right to receive the IOU payments, but Section 351 overrides that in this situation to allow the tax-free transfer.

No. The assignment of income doctrine does not require the transferor to recognize income; rather, the transferee corporation is taxed when it collects the receivables. The court found that accounts receivable qualify as 'property' under the broad definition used for § 351, as they are a normal asset of an ongoing business and a key source of working capital for a new corporation. The court then addressed the direct conflict between the non-recognition purpose of § 351 and the judicial assignment of income doctrine, which holds that income should be taxed to the one who earns it. It concluded that the specific Congressional intent behind § 351—to facilitate changes in business form without immediate adverse tax consequences—must prevail over the more general, judicially-created doctrine. To hold otherwise would hamper the incorporation of ongoing businesses by forcing the transferor to either recognize a large amount of income immediately or withhold the receivables, which is economically and practically unsound. The court also rejected the taxpayer's argument that the tax benefit rule entitled it to a stepped-up basis in the transferred inventory, holding that under § 362, the corporation takes a carryover basis from the transferor, which in this case was zero because the partnership had already expensed the inventory costs.

Yes, the transfer of accounts receivable and inventory from the partnership to the corporation does not require the recognition of gain or loss because Section 351(a) expresses Congressional intent to postpone such recognition during the transfer of property for stock in a corporation. The term 'property' in Section 351 includes accounts receivable. The tax benefit rule does not apply to adjust the basis of the transferred inventory because the basis of property exchanged under Section 351(a) remains the same in the hands of the transferee as it was in the hands of the transferor. The purpose of Section 351 is to facilitate the incorporation of ongoing businesses and eliminate technical constructions that are economically unsound. While the assignment of income doctrine would normally require the partnership to recognize income upon the transfer, Section 351 takes precedence in this case to allow for nonrecognition treatment.

Hempt Bros., Inc. v. United States

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