## Facts

- Sol Lessinger operated a sole proprietorship, Universal Screw and Bolt Co., and separately owned all shares of Universal Screw & Bolt Co., Inc.
- In 1976, the proprietorship’s lender refused to continue lending unless the business operated in corporate form.
- In 1977, Lessinger transferred the proprietorship’s business into the existing corporation in an informal consolidation; no new stock was issued.
- The proprietorship had negative net worth; its liabilities exceeded the adjusted basis of its transferred assets by roughly $255,000.
- Corporate books reflected an approximately $255,500 entry showing Lessinger’s personal indebtedness to the corporation, corresponding to the excess liabilities the corporation assumed.
- After the consolidation, Lessinger made payments toward this obligation; a bank later required a promissory note that was used as collateral.
- The Commissioner asserted taxable gain under I.R.C. § 357(c) and determined deficiencies for 1977 and 1978; the Tax Court agreed, disregarding the shareholder debt entry.
- Sol and Edith Lessinger appealed; Edith also asserted innocent-spouse relief, contingent on the existence of an underpayment.

## Issues

1. Whether I.R.C. § 357(c) requires gain recognition when liabilities assumed exceed asset basis in a § 351 transfer, if the shareholder simultaneously incurs a genuine, enforceable debt to the corporation that is recorded as an asset.
2. Whether the corporation’s basis in the shareholder’s obligation should be included among the “total adjusted basis of the property transferred” for § 357(c) purposes.
3. Whether Edith Lessinger’s innocent-spouse defense matters if no taxable gain arises from the incorporation transaction.

## Decision

- The Second Circuit reversed the Tax Court.
- The court held that Lessinger recognized no gain under § 357(c) because his personal obligation to the corporation was bona fide and should be treated as an asset with basis to the corporation.
- With that asset included, the assumed liabilities did not exceed the total adjusted basis of assets received, so § 357(c) did not apply.
- Because no deficiency remained, Edith Lessinger’s innocent-spouse claim was effectively moot.

## Legal Principles

- In a § 351 incorporation, § 357(c) applies only when the liabilities assumed exceed the total adjusted basis of the assets transferred as properly computed.
- A shareholder’s genuine, enforceable indebtedness to the transferee corporation can constitute “property” received by the corporation (a receivable) and must be accounted for as an asset in the § 357(c) comparison.
- A shareholder note or equivalent obligation is not automatically assigned zero basis; the analysis turns on whether the obligation has real economic substance and is enforceable.
- § 357(c) should not be applied to impose tax where the transaction creates no economic gain and merely shifts creditor position, absent the type of equity-withdrawal concern the provision targets.

## Conclusion

The Second Circuit held that a bona fide shareholder debt to the transferee corporation is an asset with basis that can offset assumed liabilities in a § 351 transfer, preventing § 357(c) gain where the transaction does not produce real economic income.


Lessinger v. Commissioner, 872 F.2d 519 (2d Cir. 1989)