The Liability-Offset Theory of Peracchi
Bradley T. Borden
Brooklyn Law School
Douglas L. Longhofer
Ernst & Young LLP - Washington, D.C. Office
Tax Lawyer, Vol. 64, 2011
Brooklyn Law School, Legal Studies Paper No. 199
Peracchi v. Commissioner is a lightning rod for commentators and the bane of students of corporate income tax. In short, the decision makes no sense because it grants the maker of a note a section 1012 basis in the note, violating a fundamental principle of income taxation. Nonetheless, the decision helped preserve a fundamental aspect of corporate taxation - the tax-free formation of and contributions to controlled corporations. Because of its unorthodox application of the section1012 basis rules, the Peracchi decision is the subject of severe criticism. Unfortunately, commentators who criticize Peracchi generally fail to offer an alternative that recognizes general income tax principles, concepts of corporate income tax, and the economic realities of corporate formation and contributions to corporations.
This Article reviews the evolution of the corporate formation rules governing contributions of self-created notes. It discovers that Congress did not intend to impose taxable gain on shareholders who contribute self-created notes. It also reveals how the court in Peracchi reached the right conclusions (from an economic and corporate-tax-policy perspective) using the wrong analytical framework. After assessing current theories of Peracchi, the Article presents the liability-offset theory. Under this theory, the contributed self-created note would offset the liabilities assumed by the corporation in a manner similar that used in section 357(d). The Article illustrates that this theory adheres to general principles of income tax, honors concepts of corporate income tax, and recognizes the economic realities of corporate formation and contributions to corporations. The theory could therefore help resolve problems that stem from Peracchi and its progenitors.
Number of Pages in PDF File: 32
Keywords: Peracchi, IRC 357(c), IRC 357(d), corporate formation, contribution of note to corporation
JEL Classification: H25, K34, M41
Date posted: August 4, 2010 ; Last revised: September 22, 2010