Summary: Case Study
Chapter 19.
10. Distributing automobile A would trigger a taxable gain of $7,000 for Crimson, whiledistributing C produces a nondeductible loss of $5,000. To preserve the loss on C and avoid recognizing a gain on A, Crimson should consider selling C and then distributing cash to the second shareholder. Crimson should also distribute automobile B because there will be no gain on distribution and no nondeductible loss.10.
14.
a. The determination of the reasonableness of compensation paid to an employee who is not a shareholder but is related to the sole owner of the corporate-employer should be made in the same manner as that for salary paid the shareholder-employee. The degree of relationship between the sole owner of the corporation and the employee should be …show more content…
considered initially to determine if, in essence, the salary could be considered as having been paid to the owner. If so, the same factors used to determine the reasonableness of salary paid to the owner should be used to determine the reasonableness of salary paid to the related employee
b.
That the employee-shareholder never completed high school should be relevant only with respect to the nature and scope of the employee’s work.
c. The fact that the employee-shareholder is a full-time college student might wellcause any salary paid to be deemed excessive
d. If the employee-shareholder was underpaid during the formative period of thecorporation, this is evidence of reasonableness of the compensation if a portionthereof is for service rendered in prior years.
e. If a corporation has substantial E & P and pays only a nominal dividend eachyear, a constructive dividend may be found
f. Year-end bonuses would be vulnerable to constructive dividend treatment, particularly if they are related to profit for the year, are paid only to shareholder-employees, and are determined at year-end on an arbitrary basis. 31.
a. Capon reports the $600,000 dividend as gross income but claims a dividends received deduction under § 243 of $420,000 (70% × $600,000). None of the other items affect taxable income. Thus, taxable income is $1,380,000 ($1,200,000 taxable income
before dividends + $600,000 dividend – $420,000 dividends received deduction).
b. Capon Corporation’s E & P as of December 31 is $2,240,000, computed as follows:
$400,000 (beginning balance in E & P) + $1,380,000 (taxable income) + $420,000
(dividends received deduction) + $90,000 (tax-exempt interest) – $50,000 (interest on indebtedness to purchase tax-exempt bonds)
35.
a. Bunting Corporation and Jennifer each have a taxable dividend of $30,000. Sparrow
Corporation’s current E & P is $65,000; thus, the entire distribution is a taxable dividend even though Sparrow has no accumulated E & P. Assuming the taxable income limitation does not apply, Bunting Corporation is entitled to a dividends received deduction of
$24,000 (80% × $30,000). Thus, Bunting is only taxed on $6,000 ($30,000 distribution –
$24,000 dividends received deduction). Because Jennifer is an individual, she pays tax on the entire dividend, subject to the preferential 15%/0% tax rates if the dividend is qualifying. b. To determine Sparrow Corporation’s accumulated E & P at the end of the year, its current
E & P ($65,000) is reduced by the amount of the distributions ($60,000). The remaining
$5,000 is then netted against the deficit in accumulated E & P of $150,000, leaving a net deficit of $145,000
51.
a. With respect to the distribution, Lori would have ordinary dividend income of $400,000 and Swan
Corporation would reduce its E & P by $400,000. As a resultof the stock transaction, Lori would have a basis of $400,000 in the newlyacquired 100 shares and become the sole shareholder of Swan. Roberta wouldhave a capital gain of $375,000 [$400,000 (amount realized) – $25,000 (basis instock)] on the sale.
The stock transaction would not affect Swan.
b. The transaction would constitute a complete termination redemption and result ina capital gain of
$375,000 [$400,000 (amount realized) – $25,000 (basis in stock)]to Roberta. Lori would become the sole shareholder as a result of the redemption.Swan would reduce its E & P by $350,000 [$700,000 (E & P at time of redemption) X 50% (interest redeemed)]
50.
a. The redemption cannot qualify as a complete termination redemption. Jacque is deemed to own
Monique’s 800 shares or 67% (800/1,200) of the remaining shares outstanding. The family attribution waiver does not apply because Jacque holds a prohibited interest in Thrush Corporation (i.e., directorship) immediately after theredemption
b. The redemption can qualify as a complete termination redemption. Monique’s position as a director does not constitute a prohibited interest for Jacque. Thus, if the other requirements for the family attribution waiver are satisfied (e.g., Jacquefiles the required agreement with the IRS), the redemption completely terminatesJacque’s ownership interest in Thrush.
c. The redemption cannot qualify as a complete termination redemption. To qualifyfor the family attribution waiver, the former shareholder cannot acquire a stock ownership interest in the corporation
(other than by bequest or inheritance) duringthe 10 years following the redemption
10. Distributing automobile A would trigger a taxable gain of $7,000 for Crimson, whiledistributing C produces a nondeductible loss of $5,000. To preserve the loss on C and avoid recognizing a gain on A, Crimson should consider selling C and then distributing cash to the second shareholder. Crimson should also distribute automobile B because there will be no gain on distribution and no nondeductible loss.10.
14.
a. The determination of the reasonableness of compensation paid to an employee who is not a shareholder but is related to the sole owner of the corporate-employer should be made in the same manner as that for salary paid the shareholder-employee. The degree of relationship between the sole owner of the corporation and the employee should be …show more content…
considered initially to determine if, in essence, the salary could be considered as having been paid to the owner. If so, the same factors used to determine the reasonableness of salary paid to the owner should be used to determine the reasonableness of salary paid to the related employee
b.
That the employee-shareholder never completed high school should be relevant only with respect to the nature and scope of the employee’s work.
c. The fact that the employee-shareholder is a full-time college student might wellcause any salary paid to be deemed excessive
d. If the employee-shareholder was underpaid during the formative period of thecorporation, this is evidence of reasonableness of the compensation if a portionthereof is for service rendered in prior years.
e. If a corporation has substantial E & P and pays only a nominal dividend eachyear, a constructive dividend may be found
f. Year-end bonuses would be vulnerable to constructive dividend treatment, particularly if they are related to profit for the year, are paid only to shareholder-employees, and are determined at year-end on an arbitrary basis. 31.
a. Capon reports the $600,000 dividend as gross income but claims a dividends received deduction under § 243 of $420,000 (70% × $600,000). None of the other items affect taxable income. Thus, taxable income is $1,380,000 ($1,200,000 taxable income
before dividends + $600,000 dividend – $420,000 dividends received deduction).
b. Capon Corporation’s E & P as of December 31 is $2,240,000, computed as follows:
$400,000 (beginning balance in E & P) + $1,380,000 (taxable income) + $420,000
(dividends received deduction) + $90,000 (tax-exempt interest) – $50,000 (interest on indebtedness to purchase tax-exempt bonds)
35.
a. Bunting Corporation and Jennifer each have a taxable dividend of $30,000. Sparrow
Corporation’s current E & P is $65,000; thus, the entire distribution is a taxable dividend even though Sparrow has no accumulated E & P. Assuming the taxable income limitation does not apply, Bunting Corporation is entitled to a dividends received deduction of
$24,000 (80% × $30,000). Thus, Bunting is only taxed on $6,000 ($30,000 distribution –
$24,000 dividends received deduction). Because Jennifer is an individual, she pays tax on the entire dividend, subject to the preferential 15%/0% tax rates if the dividend is qualifying. b. To determine Sparrow Corporation’s accumulated E & P at the end of the year, its current
E & P ($65,000) is reduced by the amount of the distributions ($60,000). The remaining
$5,000 is then netted against the deficit in accumulated E & P of $150,000, leaving a net deficit of $145,000
51.
a. With respect to the distribution, Lori would have ordinary dividend income of $400,000 and Swan
Corporation would reduce its E & P by $400,000. As a resultof the stock transaction, Lori would have a basis of $400,000 in the newlyacquired 100 shares and become the sole shareholder of Swan. Roberta wouldhave a capital gain of $375,000 [$400,000 (amount realized) – $25,000 (basis instock)] on the sale.
The stock transaction would not affect Swan.
b. The transaction would constitute a complete termination redemption and result ina capital gain of
$375,000 [$400,000 (amount realized) – $25,000 (basis in stock)]to Roberta. Lori would become the sole shareholder as a result of the redemption.Swan would reduce its E & P by $350,000 [$700,000 (E & P at time of redemption) X 50% (interest redeemed)]
50.
a. The redemption cannot qualify as a complete termination redemption. Jacque is deemed to own
Monique’s 800 shares or 67% (800/1,200) of the remaining shares outstanding. The family attribution waiver does not apply because Jacque holds a prohibited interest in Thrush Corporation (i.e., directorship) immediately after theredemption
b. The redemption can qualify as a complete termination redemption. Monique’s position as a director does not constitute a prohibited interest for Jacque. Thus, if the other requirements for the family attribution waiver are satisfied (e.g., Jacquefiles the required agreement with the IRS), the redemption completely terminatesJacque’s ownership interest in Thrush.
c. The redemption cannot qualify as a complete termination redemption. To qualifyfor the family attribution waiver, the former shareholder cannot acquire a stock ownership interest in the corporation
(other than by bequest or inheritance) duringthe 10 years following the redemption