Corporate Tax Notes

True/false
#1 Any distribution in excess of E & P is treated as a tax-free recovery of capital by shareholders.
ANS: F
Distributions in excess of E & P are a tax-free recovery of capital to the extent of stock basis.
Distributions in excess of basis trigger recognition of capital gain.
#21 A corporation that distributes a property dividend must reduce its E & P by the fair market value of the property less any liability on the property.
ANS: F
E & P must be reduced by the greater of the adjusted basis or fair market value of the property, less any liability on the property.
#3 A deferred tax liability represents a potential future tax benefit associated with income reported in the current year GAAP financial statements.
ANS: F
The statement describes a deferred tax asset.
#4 When a corporation makes an installment sale, for E & P purposes the realized gain is recognized as payments are received.
ANS: F
The installment method is not available for E & P purposes. Consequently, the entire gain is recognized in the year of sale.
#5 In a complete liquidation (not a parent-subsidiary liquidation), a shareholder typically recognizes dividend income equal to his or her share (i.e., stock ownership percentage) of the liquidating corporation’s E & P.
ANS: F
Capital gain or loss is the typical result to a shareholder in a complete liquidation, based on the difference between the fair market value of the assets received in the distribution and the basis of the stock surrendered. The liquidating corporation’s E & P is irrelevant for purposes of determining the tax consequences to the shareholder.
#6 “Temporary differences” are book-tax income differences that eventually appear in both the financial statements and the income tax return, but not in the same reporting period.
ANS: T
#7 Tax incentives constitute the primary motivation for most corporations to operate on a consolidated basis.
ANS: F Nontax incentives predominate.
#8 In general, the purpose of ASC 740 (SFAS 109) is to compute and disclose the actual taxes paid by a business entity to state, local, and foreign governments for the current year.
ANS: F
ASC 740 (SFAS 109) requires reporting both current and future tax costs (and benefits).

#9 A shareholder’s basis in property received in a stock redemption is the property’s fair market value.
The basis of the property to the shareholder is the fair market value of the property on the date of the distribution. The basis of the property to the shareholder is the fair market value of the property on the date of the distribution.
#15 ANS: F
The statement describes a temporary difference.
#11
ANS: F
Deferred tax asset is a future tax benefit associated with current book income.
#18 MC
ANS: B
Only the compensation related expenses represent a temporary difference. All the other items are permanent differences.
#12
DRD is added back to taxable income to determine E&P
#16. A partial liquidation can result in sale or exchange treatment to a shareholder even if it results in a pro rata stock redemption. ANS: T A stock redemption pursuant to a partial liquidation can be pro rata with respect to the shareholders
#18 All dividends received by individual shareholders are subject to either a 15% or a 5% tax rate.
ANS: F
To be taxed at the 15%/5% rates, the dividend must be qualifying.
#19
ANS: For a stock redemption to qualify for sale or exchange treatment under § 303, it need not satisfy the § 302 redemption provisions.
#20
ANS: F
If MACRS cost recovery is used for income tax purposes, a positive or negative adjustment equal to the difference between MACRS and ADS must be made each year.
#22 A Federal consolidated group can claim a dividends received deduction for payments among the affiliates.
ANS: F A consolidated group eliminates an intercompany dividend. As a result, no dividends received deduction is available for these payments.
#24 Cash distributions received from a corporation with a positive balance in accumulated E & P at the beginning of the year will always be taxed as dividend income.
ANS: F
A positive balance in accumulated E & P at the beginning of the year does not guarantee dividend treatment for distributions. If there is a deficit in current E & P during the year, it may completely offset the positive accumulated E & P balance. If it does, the distributions will not receive dividend treatment.
#25 A for-profit hospital can remain in the consolidated group after it gains tax-exempt status. Consolidated Tax Returns 8-7 ANS: F Tax-exempt entities are not eligible to join a Federal consolidated group. The rules to qualify to elect as a consolidated group must continue to be met.

#25 MC
Beige Corporation (a calendar year taxpayer) has taxable income of $150,000, and its financial records reflect the following for the year. Federal income taxes paid Net operating loss carryforward deducted currently Gain recognized this year on an installment sale from a prior year Depreciation deducted on tax return (ADS depreciation would have been $5,000) Interest income on Iowa state bonds Beige Corporations current E & P is: a. $68,000. b. $77,000. c. $103,000. d. $107,000. e. None of the above. ANS: D To determine E & P, the Federal income tax is subtracted from taxable income and the net operating loss carryforward is added. The gain recognized currently from the prior years installment sale is subtracted. The excess of depreciation deducted on the tax return over ADS depreciation and the interest from Iowa state bonds are added.
#5 MC
Wendy and David, equal shareholders in Loon Corporation, receive $300,000 each in distributions on December 31 of the current year. Loons current year E & P is $500,000 and it has no accumulated E & P. Last year, Loon sold an appreciated asset for $600,000 (basis of $200,000). Payment for one half of the sale of the asset was made this year. How much of Wendys distribution will be taxed as a dividend? a. $0. b. $150,000. c. $250,000. d. $300,000. e. None of the above. ANS: B Loon Corporation increased its E & P last year for the entire amount of the deferred gain on the installment sale. Since one-half of the $400,000 gain is included in taxable income in the current year, E & P should be reduced by this amount. Therefore, Loon Corporations current year E & P is $300,000 ($500,000 taxable income $200,000 of installment sale gain). Because one-half of the current E & P is allocated to Wendys distribution, she has a $150,000 dividend.
#14 MC
Maria and Christopher each own 50% of Cockatoo Corporation, a calendar year taxpayer. Distributions from Cockatoo are: $750,000 to Maria on April 1 and $250,000 to Christopher on May 1. Cockatoos current E & P is $300,000 and its accumulated E & P is $600,000. How much of the accumulated E & P is allocated to Christophers distribution? a. $0. b. $75,000. c. $150,000. d. $300,000. e. None of the above. ANS: B Current E & P is allocated on a pro rata basis to each distribution made during the year. Cockatoo Corporation made $1 million of distributions and Christophers distribution represents 25% ($250,000/$1,000,000) of that amount. Consequently, Christopher receives 25% of Cockatoos current year E & P, or $75,000 ($300,000 25%). Accumulated E & P is applied in chronological order beginning with the earliest distribution. Since Marias distribution is made first, how much current and accumulated E & P belong to her? Maria should receive 75% of Cockatoos current year E & P because she received 75% of the distributions made during the year ($750,000/$1,000,000). Consequently, $225,000 of current E & P is sourced to Maria ($300,000 75%). The remainder of Marias distribution, $525,000 ($750,000 distribution $225,000 of current E & P), is made from accumulated E & P, leaving $75,000 of accumulated E & P ($600,000 $525,000) for Christophers distribution.

#23 MC
Goose Corporation makes a property distribution to its sole shareholder, Michael. The property distributed is a hunting cabin (fair market value of $270,000; basis of $220,000) that is subject to a $350,000 mortgage which Michael assumes. Before considering the consequences of the distribution, Gooses current E & P is $50,000 and its accumulated E & P is 200,000. Goose makes no other distributions during the current year. What is Gooses taxable gain on the distribution of the cabin? a. $0. b. $30,000. c. $50,000. d. $130,000. e. None of the above. Corporations: Earnings and Profits and Dividend Distributions 5-23 ANS: D If distributed property is subject to a liability in excess of basis, for purposes of determining gain on the distribution, the fair market value of the property is treated as being not less than the amount of the liability. Goose has a gain of $130,000 ($350,000 liability treated as fair market value $220,000 basis).
#1 MC
Navy Corporation makes a property distribution to its sole shareholder, Troy. The property distributed is a car (fair market value of $10,000; basis of $15,000) that is subject to a $2,000 liability which Troy assumes. Navy makes no other distributions during the current year. Navy has no accumulated E & P and $15,000 of current E & P from other sources during the year. What is Navys E & P after taking into account the distribution of the car? a. $2,000. b. $3,000. c. $5,000. d. $7,000. e. None of the above. ANS: A E & P is reduced by the greater of the adjusted basis or the fair market value of the property distributed, net of any liabilities. Losses on distribution are not taken into account when determining E & P. As a result, Navys $15,000 E & P is reduced by $13,000 ($15,000 basis of the car less the amount of the liability). The remaining E & P after the distribution is $2,000.
#12 MC
Green Corporation has accumulated E & P of $50,000 on January 1, 2009. In 2009, Green has current E & P of $65,000 (before any distribution). On December 31, 2009, the corporation distributes $125,000 to its sole shareholder, Maxwell (an individual). Green Corporations E & P as of January 1, 2010 is: Corporations: Earnings and Profits and Dividend Distributions a. b. c. d. e. $0. ($10,000). $50,000. $65,000. None of the above. 5-25 ANS: A The $125,000 distribution will reduce the $115,000 balance in E & P to zero. A distribution may not generate a deficit in E & P.
#31 MC
The stock in Lark Corporation is owned equally by Olaf and his son Pete. In a liquidation of the corporation, Lark Corporation distributes to Olaf land that it had purchased three years ago for $550,000. The property has a fair market value on the date of distribution of $400,000. Later, Olaf sells the land for $420,000. What loss will Lark Corporation recognize with respect to the distribution of the land? a. $20,000. b. $75,000. c. $130,000. d. $150,000. e. None of the above. ANS: E Olaf is deemed to own 100% of the stock of Lark Corporation--50% directly and 50% indirectly from Pete. As a result, there is a distribution of loss property to a related party and the distribution is not pro rata. The related-party loss limitation therefore applies to disallow the entire $150,000 loss realized on the distribution ($400,000 fair market value $550,000 basis).
#2 MC
On April 11, 2008, Crow Corporation acquired land in a transaction that qualified under 351. The land had a basis of $350,000 to the contributing shareholder and a fair market value of $200,000. Assume that the shareholder also transferred equipment (basis of $30,000, fair market value of $180,000) in the same 351 exchange. Crow Corporation adopted a plan of liquidation on October 6, 2009. On December 4, 2009, Crow Corporation distributes the land to Ali, a shareholder who owns 20% of the stock in Crow Corporation. The land's fair market value was $130,000 on the date of the distribution to Ali. Crow Corporation acquired the land to use as security for a loan it had hoped to obtain from a local bank. In negotiating with the bank for a loan, the bank required the additional capital investment as a condition of its making a loan to Crow Corporation. How much loss can Crow Corporation recognize on the distribution of the land? a. $0. b. $70,000. c. $150,000. d. $220,000. e. None of the above. ANS: D Crow Corporation had a business reason for acquiring the land. Further, the land was not distributed to a related party. Thus, the loss limitation provisions do not apply and the entire loss of $220,000 [$130,000 (fair market value) $350,000 (land basis)] is allowed. [Note that the 362(e)(2) basis step-down rules for loss properties acquired in carryover basis transactions does not apply to the land, as there was no net built-in loss on the two properties transferred by shareholder. Section 362(e)(2) is discussed in Chapter 4.]
#17 MC
Skylark Corporation owns 90% of the outstanding stock of Quail Corporation, having purchased the stock five years ago for $550,000. Pursuant to a plan of liquidation adopted by Quail Corporation on March 4, 2009, Quail distributes all its property on December 1, 2009, to its shareholders. Quail Corporation had never been insolvent and had E & P of $830,000 on the date of liquidation. Pursuant to the liquidation, Quail distributed property worth $690,000 (basis $580,000) to Skylark Corporation. How much gain must the parties recognize in 2009 on the transfer of this property to Skylark Corporation? a. $140,000 as to Skylark and $110,000 as to Quail. b. $0 as to Skylark and $110,000 as to Quail. c. $140,000 as to Skylark and $0 as to Quail. d. $30,000 as to Skylark and $110,000 as to Quail. e. None of the above. ANS: E Pursuant to 332 and 337, neither Skylark Corporation nor Quail Corporation recognizes gain as result of the liquidating distribution.
#8 MC
Five years ago, Eleanor transferred property she had used in her sole proprietorship to Blue Corporation for 1,000 shares of Blue Corporation in a transaction that qualified under 351. The assets had a tax basis to her of $400,000 and a fair market value of $550,000 on the date of the transfer. In the current year, Blue Corporation (E & P of $1 million) redeems 100 shares from Eleanor for $290,000 in a transaction that does not qualify for sale or exchange treatment. With respect to the redemption, Eleanor will have a: a. $250,000 capital gain. b. $290,000 capital gain. c. $250,000 dividend. d. $290,000 dividend. e. None of the above. ANS: D The transaction is treated as a return from her investment, and she has dividend income to the extent of the entire distribution.
#10 MC
Five years ago, Eleanor transferred property she had used in her sole proprietorship to Blue Corporation for 1,000 shares of Blue Corporation in a transaction that qualified under 351. The assets had a tax basis to her of $400,000 and a fair market value of $550,000 on the date of the transfer. In the current year, Blue Corporation (E & P of $1 million) redeems 100 shares from Eleanor for $290,000 in a transaction that qualifies for sale or exchange treatment. With respect to the redemption, Eleanor will have a: a. $250,000 capital gain. b. $290,000 capital gain. c. $250,000 dividend. d. $290,000 dividend. e. None of the above. ANS: A The transaction is treated as a return of a portion of her investment. She is treated as having sold 100 of her shares in Blue (basis of $40,000) for $290,000. Therefore, Eleanors capital gain from the sale or exchange is $250,000 ($290,000 $40,000).
#20 MC
Orange Corporation distributes property worth $300,000, basis of $340,000, to a shareholder in a distribution that is a qualifying stock redemption. The property is subject to a liability of $110,000, which the shareholder assumes. The basis of the property to the shareholder is: a. $190,000. b. $230,000. c. $300,000. d. $340,000. e. None of the above. ANS: C The shareholders basis in property received in a qualifying stock redemption is the fair market value of the property.
#16 MC
Crow Corporation has 800 shares of stock outstanding. Ted owns 300 shares, Teds mother owns 100 shares, Teds sister owns 80 shares, and Teds granddaughter owns 120 shares. Bluebird Corporation owns the remaining 200 shares of stock in Crow. Ted owns 30% of the stock in Bluebird Corporation. In applying the 318 stock attribution rules, how many shares does Ted own in Crow Corporation? a. 300. b. 400. c. 520. d. 550. e. None of the above. ANS: C Ted owns 520 shares, 300 shares directly and 220 shares constructively, in Crow Corporation. Ted owns the shares of his mother (100 shares) and his granddaughter (120 shares). Ted is not deemed to own the stock of his sister or Bluebird Corporation (in which he owns less than 50%).
#19 MC
Meadowlark Corporation has 1,000 shares of stock outstanding. Harvey owns 400 shares, Gabriella (Harveys cousin) owns 400 shares, and Black Partnership owns 200 shares. Harvey is a 50% partner of Black Partnership. In applying the 318 attribution rules: a. Black Partnership owns 300 shares. b. Gabriella owns 800 shares. c. Harvey owns 500 shares. d. Harvey owns 900 shares. e. None of the above. ANS: C Harvey owns 400 shares directly and 100 shares indirectly from Black Partnership (50% partnership interest 200 shares owned by Black). There is no attribution from cousins under 318. Black Partnership owns 600 shares: 200 shares directly and 400 shares indirectly from Harvey (a partnership is deemed to own the stock of its partners in full). Gabriella owns 400 shares, as none of the other shares are attributed to her under the 318 attribution rules.
#22 MC
Domingo and Juan, brothers, each own 300 shares in White Corporation (E & P of $700,000). Heron Partnership owns the remaining 400 shares of stock in White Corporation, and Juan has a 25% interest in Heron Partnership. White Corporation redeems 200 shares of Juans stock for $120,000. Juan paid $150 a share for the stock five years ago. With respect to the redemption: a. Juan has dividend income of $120,000. b. Juan has a long-term capital gain of $120,000. c. Juan has dividend income of $90,000. d. Juan has a long-term capital gain of $90,000. e. None of the above. ANS: D Corporations: Redemptions and Liquidations 6-19 The redemption meets both tests of 302(b)(2) and qualifies for sale or exchange treatment. Before and after the redemption, Juan is deemed to own a proportionate number of the White shares owned by Heron Partnership, but none of the shares owned by Domingo. (The family attribution rules do not include siblings.) Thus, before the redemption, Juan has a 40% interest in White: 300 shares directly plus 100 shares indirectly from Heron (25% 400). After the redemption, Juan owns 25% of the stock in White Corporation: [200 shares (100 directly plus 100 indirectly from Heron) 800 postredemption shares outstanding]. The 25% ownership interest is less than 50% of the total voting power and less than 80% of Juans original ownership [25% is less than 32% (80% 40%)]. Thus, the distribution is a disproportionate redemption and Juan has a long-term capital gain of $90,000 [$120,000 (amount realized) $30,000 (stock basis)].
#7 MC
Flamingo Corporation (E & P of $700,000) has 1,000 shares of stock outstanding. Jaime owns 400 shares, Lupe (Jaimes daughter) owns 400 shares, and the remaining 200 shares are owned by unrelated individuals. In an effort to raise funds for another investment, Jaime convinces Flamingo to redeem all of his shares for $380,000. Jaime acquired the stock seven years ago for $60,000. After the redemption, Jaime continued to serve as Flamingos controller but Gabriella assumed his role as a member of the corporations board of directors. As a result of the transaction, Jaime must recognize: a. $320,000 long-term capital gain. b. $380,000 dividend income. c. $380,000 long-term capital gain. d. $320,000 dividend income. e. None of the above. ANS: B The distribution does not qualify for sale or exchange treatment. While Jaime has terminated his direct ownership interest in Flamingo, Lupes 400 shares are attributed to him under the family attribution rules. The waiver of the family attribution rules does not apply as Jamies continued employment as the corporations controller is a prohibited interest. Further, as a result of his deemed ownership of Lupes shares, Jaime owns 67% of the shares outstanding after the redemption, thereby failing the other qualifying redemption provisions.
#4 MC
Leon owns 600 shares of the 1,000 outstanding shares of Crane Corporation (E & P of $500,000). None of the other shareholders of Crane are related to Leon. Leon acquired his Crane shares ten years ago for $90,000. Crane has operated several trades or businesses for more than five years. In the current year, Crane sells the assets of one of those trades or businesses and distributes the proceeds from the asset sale to the shareholders in a pro rata stock redemption. In this transaction, Leon receives $200,000 in redemption of 200 shares of Crane. As a result of this transaction, Leon will recognize: a. No gain or loss. b. $170,000 dividend income. c. $200,000 dividend income. d. $200,000 long-term capital gain. e. None of the above. ANS: E Corporations: Redemptions and Liquidations 6-21 The transaction qualifies as a partial liquidation under the termination of a business test. Crane Corporation operates two or more qualified trades or businesses, the distribution relates to the proceeds from the sale of one of the qualified trades or businesses, and Crane is actively engaged in the conduct of a qualified trade or businesses after the distribution. As such, sale or exchange treatment applies and Leon has a long-term capital gain of $170,000 [$200,000 (amount realized) $30,000 (stock basis)]. It is not relevant that the distribution is pursuant to a pro rata stock redemption.
#6 On January 1, Tanager Corporation (a calendar year taxpayer) has accumulated E & P of $190,000.
During the year, Tanager incurs a net loss of $240,000 from operations that accrues ratably. On June 30,
Tanager distributes $100,000 to Sharisa, its sole shareholder, who has a basis in her stock of $40,000.
How much of the $100,000 is a dividend to Sharisa?
a. $0.
b. $70,000.
c. $60,000.
d. $50,000.
e. None of the above.

ANS: B
The deficit in current E & P equals $120,000 on June 30, the date of distribution. Subtracting this from accumulated E & P yields a net accumulated E & P balance on June 30 of $70,000 ($190,000 accumulated E & P at the beginning of the year – $120,000 current E & P deficit on June 30). Of the
$100,000 distribution, $70,000 will be taxed as a dividend to Sharisa.
#11 MC
Which of the following corporate distributions would qualify as a partial liquidation? a. A distribution to an individual shareholder of excess inventory by a clothing retailer who has been in the business for seven years. The corporation continues to operate a car wash business it has owned for six years. b. A distribution to an individual shareholder of stock held for investment for more than five years. The corporation continues to operate three businesses it has owned for more than five years. c. A distribution to a corporate shareholder of the proceeds from the sale of the assets of a business owed and operated for the last eight years. The (distributing) corporation continues to operate a business it has owned for the last seven years. d. A distribution to an individual shareholder of the assets of a business owned and operated by the corporation for the last six years. The distribution was pursuant to a pro rata redemption of stock from the shareholders. The corporation continues to operate another business it has owned for the last ten years. e. None of the above. ANS: D A partial liquidation requires a distribution that is not essentially equivalent to a dividend. This requires a distribution that results in a genuine contraction of the corporations business or the termination of a business (option d.). A distribution of excess inventory (option a.) or investment property (option b.) does not satisfy either of these requirements. The partial liquidation rules of 302(b)(4) do not apply to corporate shareholders (option c).
#13 MC
Which of the following is a correct statement regarding a redemption to pay death taxes under 303? a. An estate recognizes gain on the redemption equal to the excess of the distribution proceeds over the decedents basis in the stock. b. The value of the stock in the decedents gross estate must exceed 40% of the value of the adjusted gross estate. c. The redemption must satisfy one of the 302 qualifying stock redemption provisions. d. A corporation recognizes gains but not losses on the distribution of property in the redemption. e. None of the above. ANS: D A corporation recognizes gains but not losses on the distribution of property in a redemption. An estate recognizes gain (or loss) on a redemption equal to the excess of the distribution proceeds over the estates basis in the stock. Because the stock basis is stepped up to the fair market value on the date of death, no gain (or loss) generally occurs. The value of the stock must exceed 35% of the adjusted gross estate. Redemptions qualifying under 303 need not also qualify under 302.
#21 MC
Three years ago, Loon Corporation purchased 100% of the stock of Pelican Corporation for $720,000.
Pelican Corporation has a basis of $500,000 in its assets, but the assets currently have a fair market value of $800,000. If Loon liquidates Pelican, what basis will Loon have in the assets it acquires from Pelican
Corporation?
a. $0.
b. $500,000.
c. $720,000.
d. $800,000.
e. None of the above.

ANS: B
Property received by a parent corporation in a complete liquidation of its subsidiary under § 332 has the same basis the property had in the hands of the subsidiary, or $500,000. The parent’s basis in the stock of the liquidated subsidiary disappears.
# 32 MC
Jen, the sole shareholder of Mahogany Corporation, sold her stock to Jason on July 1 for $90,000. Jen's stock basis at the beginning of the year was $60,000. Mahogany made a $30,000 cash distribution to Jen immediately before the sale, while Jason received a $60,000 cash distribution from Mahogany on November 1. As of the beginning of the current year, Mahogany had $16,000 in accumulated E & P, while current E & P (before distributions) was $30,000. Which of the following statements is correct? a. Jen recognizes a $30,000 gain on the sale of the stock. b. Jen recognizes a $34,000 gain on the sale of the stock. c. Jason recognizes dividend income of $60,000. d. Jen recognizes dividend income of $30,000. e. None of the above. ANS: B The $30,000 in current E & P is allocated on a pro rata basis to the two distributions made during the year; thus, $10,000 of current E & P is allocated to Jen and $20,000 is allocated to Jason. Accumulated E & P is allocated in chronological order, so that all $16,000 is allocated to Jen. Therefore, the distribution to Jen is treated as a $26,000 dividend and a $4,000 reduction in stock basis. Jason's distribution consists of a $20,000 dividend and a $40,000 reduction in stock basis. Since Jen sells her stock for $90,000 and her basis immediately after the distribution is $56,000 ($60,000 original basis $4,000 recovery of capital), she has a $34,000 gain on sale.
#33 MC
In August, Sunglow Corporation declares a $4 dividend out of E & P on each share of common stock to shareholders of record on October 1. Elaine and Tom each purchase 100 shares of Sunglow stock on September 1. On September 15, Elaine also purchases a short position in Sunglow. Tom sells 50 of his shares on October 15 and continues to hold the remaining 50 shares through the end of the year. Elaine closes her short position in Sunglow on December 15. With respect to the dividends, which of the following is correct? a. Tom will have $200 of qualifying dividends subject to reduced tax rates and $200 of ordinary income. b. Elaine will have $400 of qualifying dividends subject to reduced tax rates and $400 of ordinary income (from dividends paid on the short position of Sunglow stock). c. All $800 of Elaine's dividends will qualify for reduced tax rates. d. All $400 of Tom's dividends will qualify for reduced tax rates. e. None of the above. ANS: A Dividends received on stock that is held in both long and short positions do not qualify for reduced tax rates. Thus, none of Elaine's stock qualifies. In addition, to qualify, stock must be held for 60 days during the 121 day period beginning 60 days before the ex-dividend date. Tom sells 50 of his shares prematurely, so only 50 of his shares qualify. Given a $4 dividend per share, $200 of Tom's dividends will qualify for the reduced rates.

#35 MC
Stacey and Andrew each own one-half of the stock in Parakeet Corporation, a calendar year taxpayer. Cash distributions from Parakeet are: $350,000 to Stacey on April 1 and $150,000 to Andrew on May 1. If Parakeet's current E & P is $60,000, how much is allocated to Andrew's distribution? a. $5,000. b. $10,000. c. $18,000. d. $30,000. e. None of the above. ANS: C Current E & P is allocated on a pro rata basis to distributions made during the year. Parakeet Corporation made $500,000 of distributions and Andrew's distribution represented 30% ($150,000/$500,000) of that amount. Consequently, Andrew receives 30% of Parakeet's current year E & P, or $18,000 ($60,000 30%).
#1 PROBLEMS
Rosie, the sole shareholder of Eagle Corporation, has a stock basis of $100,000 at the beginning of theyear. On July 1, she sells all of her stock to Manuel for $500,000. On January 1, Eagle has accumulated E& P of $45,000 and during the year, current E & P of $80,000. Eagle makes the following cashdistributions: $90,000 to Rosie on March 31 and $90,000 to Manuel on November 1. How are thedistributions taxed to Rosie and Manuel? What is Rosie’s recognized gain on the sale to Manuel?ANS:The $80,000 in current E & P is allocated pro rata to the two distributions made during the year; thus,$40,000 is allocated to Rosie and $40,000 is allocated to Manuel. As accumulated E & P is applied inchronological order, it is allocated entirely to Rosie. Consequently, of the $90,000 distribution to Rosie onMarch 31, $85,000 is taxed as dividend income [$45,000 (accumulated E & P) + $40,000 (current E & P)]and the remaining $5,000 reduces her stock basis to $95,000. She then recognizes a capital gain of $405,000 on the sale of her stock [$500,000 (sales price) – $95,000 (remaining stock basis)]. As to the$90,000 distribution to Manuel, $40,000 is taxed as a dividend (from current E & P) and the remaining$50,000 reduces his basis to $450,000 [$500,000 (original basis) – $50,000 (return of capital)].
#2 PROBLEMS
Ali, a corporate executive, is in the 35% tax bracket. He acquired 1,000 shares of stock in Cardinal Corporation seven years ago for $300 a share. In the current year, Cardinal Corporation redeems all of his shares for $700,000. Cardinal Corporation has adequate E & P to cause any distribution to be dividend income. What are the tax consequences to Ali if: a. The redemption qualifies for sale or exchange treatment, and Ali has no other transactions in the Corporations: Distributions Not in Complete Liquidation current year involving capital assets? b. The redemption does not qualify for sale or exchange treatment? 19-35 ANS: a. If the redemption qualifies for sale or exchange treatment, Ali will have a long-term capital gain of $400,000 [$700,000 (amount realized) $300,000 (stock basis)]. His income tax liability on the $400,000 gain will be $60,000 ($400,000 X 15%). b. If the corporate payment of $700,000 does not qualify as a sale or exchange, it will be treated as dividend income and his tax liability will be $105,000 ($700,000 X 15%). (The entire $700,000 will be subject to tax at the 15% rate; Ali will have no basis offset.)