tax-law corporate-law shareholders incorporation equity
How exactly is founder stock created?
<p>Suppose that I found a C corporation, Superlative Widgets Inc., <strong>within the U.S.</strong>  I would like to both fund the corporation and issue myself 100,000 shares in a way that avoids or minimizes my personal tax liability.  However achieving this seems to require a clear understanding of how founder shares are created.  What exactly is the nature of this process?</p>

<p>Here are two possibilities:</p>

<ol>
<li><p>I file forms to create Superlative Widgets Inc. as a new legal entity, with myself as its incorporator.  Then, operating as the company's board of directors (?), I approve the company to issue 100,000 shares.  Next, I obtain a <a href="https://www.capshare.com/409a-valuation-report" rel="nofollow noreferrer">409A valuation</a>, using average numbers and probabilities common in studies on startups, and compute the "fair market value" per share, which&mdash;say&mdash;turns out to be $0.25.  Finally, I purchase all shares at this price, opening a company bank account and depositing $25,000 into it.</p></li>
<li><p>I file forms to create Superlative Widgets Inc. as a new legal entity, with myself as its incorporator.  I then create a company bank account and deposit $1000 in this account.  Next, operating as the company's board of directors or other custodian, I approve the company to issue 100,000 shares.  Since I am the incorporator of the company, I become its sole shareholder, owning all shares, as an immediate implication of issuing the shares.</p></li>
</ol>

<p>Oddly, neither of the above seems entirely sensible.  In the first case, it appears that I must fund the corporation with at least $25,000 or pay income taxes on the difference if I buy the shares at a lower price &ndash; this conclusion seems absurd given that the company is newborn and contains no actual content.  In the second case, there is no attempt to compute fair market value at all, which seems like it may be at odds with tax law (see <a href="https://medium.com/rough-draft-ventures/a-rough-draft-of-the-legal-basics-part-3-issuing-equity-to-the-founders-important-tax-and-ab93ce623517" rel="nofollow noreferrer">this</a> article for example).  What then is the right way to think about creation of founder shares in a new company?</p>

<h2>Companys limited by shares<sup>1</sup> <em>always</em> have shareholders</h2>

<p>When you apply to create a company it is created with the number and types of shares specified and are owned by the people nominated in the application form.</p>

<h2>Tax</h2>

<p>Shares in a newly founded company can be set at any value and their acquisition does not create a taxable event for either the founder(s) or the company. </p>

<p>Where the purchase of the shares is for other than cash, there are actually more transactions happening than just the issue of shares and some of those may be taxable events. </p>

<p>For example, lets imagine I have a great idea and my potential partner has $50 to fund the start-up (it's a great but <em>cheap</em> idea OK) and another potential partner has a second-hand truck that they are willing to contribute that we all reckon is worth $50. We form a corporation with 150 $1 shares split 3 ways; no tax happens here. However, there are two <em>other</em> transactions here:</p>

<ul>
<li>I have sold my idea to the company for $50 - that's taxable income in some jurisdictions .</li>
<li>The 3rd partner has sold his truck to the company for $50. The disposal of that truck is a taxable event in some jurisdictions if the truck was a business asset - there may be a profit or a loss on this sale depending on the written-down value of the truck.</li>
</ul>

<p><sup>1</sup>There are ways of forming companies that don't use shares.</p>

<p>Given the statutory reference in the question, I assume that this question is about U.S. income tax laws.</p>

<p>When you contribute property (money or in kind) to a corporation and receive initially offered or treasury shares in exchange from the corporation, under U.S. tax law, the transaction is a non-taxable contribution to capital.</p>

<p>In the case of a cash contribution, your "basis" in your shares (i.e. the deemed purchase price for capital gains tax purposes), is the amount of cash you contributed. In the case of an in kind contribution of property, your "basis" in your shares  would be a carryover of the basis you have in the property contributed "in kind." Your basis in your shares is used to determine your taxable capital gain income if you later sell or redeem your shares or if you received a return of capital distribution from the corporation.</p>

<p>In the case of a C-corporation, this tax free treatment of contributions to capital does not work in the opposite direction for money or property distributed from the corporation.</p>

<p>Money distributed from the corporation without changing your proportionate share of ownership is treated as a dividend to the extent of the corporation's undistributed profits (called "earnings and profits" or "e &amp; p" for short) and otherwise a return of capital, which is tax free to the extent of the basis in your shares and a capital gain to the extent the distribution exceeds your basis in your shares. If the distribution is made "in kind" rather than in cash, the transaction is deemed to be a sale of the property by the corporation at fair market value, followed by a cash distribution of the sales proceeds. </p>

<p>Equity is established by the company acquiring value. If the only value the company has is in its ability to sell stock, then the fair market value of the stock is quite easy to calculate: it's whatever you say it is. If you buy 100,000 shares of stock for $0.25 each, then the total assets of the company consists of the $25,000 that you paid to the company for the stock, so the value of the stock is $25,000.</p>

<p>A share is just that: a share of the company. If there are 100,000 shares, then each share is worth 1/100,000 of the company. If the only assets that the company has is money from the sale of stock, then each share is worth the corresponding fraction of that money, which by definition is the share price.</p>
