ch19

COMPREHENSIVE VOLUME--CHAPTER

19--CORPORATIONS: DISTRIBUTIONS NOT IN

COMPLETE LIQUIDATIONS

Student: ___________________________________________________________________________

1. Distributions by a corporation to its shareholders are presumed to be a dividend unless the parties can prove

otherwise.

True False

2. A distribution from a corporation will be taxable to the recipient shareholders only to the extent of the

corporations E & P. True False

3. Distributions that are not dividends are a return of capital and decrease the shareholders basis. True False

4. Cash distributions received from a corporation with a positive balance in accumulated E & P at the beginning

of the year will be taxed as dividend income.

True False

5. A distribution in excess of E & P is treated as capital gain by shareholders.

True False

6. The terms earnings and profits and retained earnings are identical in meaning. True False

7. To determine E & P, some (but not all) previously excluded income items are added back to taxable income.

True False

8. When computing E & P, taxable income is not adjusted for 179 expense.

True False

9. When computing current E & P, taxable income must be adjusted for the deferred gain in a 1031 like-kind

exchange.

True False

10. An increase in the LIFO recapture amount must be added to taxable income to determine E & P.

True False

11. Use of MACRS cost recovery when computing taxable income does not require an E & P adjustment.

True False

12. No E & P adjustment is required for regular tax gains under the installment method.

True False

13. A corporation borrows money to purchase State of Texas bonds. The interest on the loan has no impact on

either taxable income or current E & P.

True False

14. Federal income tax paid in the current year must be subtracted from taxable income to determine E & P.

True False

15. To determine current E & P, taxable income must be increased for any domestic production activities

deduction.

True False

16. Nondeductible meal and entertainment expenses must be subtracted from taxable income to determine

current E & P.

True False

17. The dividends received deduction has no impact on E & P.

True False

18. A realized gain from an involuntary conversion under 1033 that is not recognized for income tax purposes

has no effect on E & P.

True False

19. In the current year, Carnation Corporation has a 179 expense of $60,000. As a result, in the current year,

taxable income must be increased by $48,000 to determine current E & P.

True False

20. A deficit in current E & P is treated as occurring ratably during the year, unless the taxpayer can show

otherwise.

True False

21. When current E & P has a deficit and accumulated E & P is positive, the two accounts are netted at the date

of the distribution. If a positive balance results, the distribution is a dividend to the extent of the balance.

True False

22. When current E & P is positive and accumulated E & P has a deficit balance, the two accounts are netted for

dividend determination purposes.

True False

23. Regardless of any deficit in current E & P, distributions during the year are taxed as dividends to the extent

of accumulated E & P.

True False

24. Corporate distributions are presumed to be paid out of E & P and are treated as dividends unless the parties

to the transaction can show otherwise.

True False

25. Dividends paid to shareholders who hold both long and short positions do not qualify for the reduced tax

rate available to individuals in certain years.

True False

26. Dividends taxed as ordinary income are considered investment income for purposes of the investment

interest expense limitation.

True False

27. Certain dividends from foreign corporations can be qualified dividends for purposes of the preferential rate

available to individuals.

True False

28. During the year, Blue Corporation distributes land to its sole shareholder. If the fair market value of the land

is less than its adjusted basis, Blue will not be able to recognize a loss on the distribution.

True False

29. In a property distribution, the amount of dividend income recognized by a shareholder is always reduced by

the amount of liability assumed by a shareholder.

True False

30. Property distributed by a corporation as a dividend is subject to a liability in excess of its basis. For purposes

of determining gain on the distribution, the basis of the property is treated as being not less than the amount of

liability.

True False

31. A corporation that distributes a property dividend must reduce its E & P by the adjusted basis of the

property less any liability on the property.

True False

32. Under certain circumstances, a distribution can generate (or add to) a deficit in E & P.

True False

33. Constructive dividends do not need to satisfy the legal requirements for a dividend as set forth by applicable

state law.

True False

34. Constructive dividends have no effect on a distributing corporations E & P. True False

35. If a stock dividend is taxable, the shareholders basis in the newly received shares is equal to the fair market value of the shares received in the distribution.

True False

36. A corporate shareholder that receives a constructive dividend cannot apply a dividends received deduction

to the distribution.

True False

37. If a distribution of stock rights is taxable and their fair market value is less than 15 percent of the value of

the old stock, then either a zero basis or a portion of the old stock basis may be assigned to the rights, at the

shareholders option. True False

38. The rules used to determine the taxability of stock dividends also apply to distributions of stock rights.

True False

39. If stock rights are taxable, the recipient has income to the extent of the fair market value of the rights.

True False

40. The Code treats corporate distributions that are a return of a shareholders investment as sales or exchanges and corporate distributions that are a return from a shareholders investment as dividends. True False

41. In general, if a shareholders ownership interest is not diminished as a result of a stock redemption, the Code will treat the transaction as a sale or exchange.

True False

42. Corporate shareholders generally receive less favorable tax treatment from a qualifying stock redemption

than from a dividend distribution.

True False

43. Yolanda owns 60% of the outstanding stock of Amber Corporation. In a qualifying stock redemption,

Amber distributes $20,000 to Yolanda in exchange for one-half of her shares (basis of $35,000). As a result of

the redemption, Yolanda has a recognized capital loss of $15,000.

True False

44. A shareholders basis in property acquired in a stock redemption is the propertys fair market value as of the date of redemption.

True False

45. Vireo Corporation redeemed shares from its sole shareholder pursuant to a written agreement between the

parties that clearly identified the transaction as a stock redemption (and not a dividend distribution). Since the

agreement is binding under state law, the shareholder will receive sale or exchange treatment with respect to the

redemption.

True False

46. In applying the 318 stock attribution rules to a stock redemption, a shareholder is treated as owning the

stock of her spouse, children, grandchildren, parents, and siblings.

True False

47. A redemption will qualify as a not essentially equivalent redemption only if the shareholders interest in the redeeming corporation has been meaningfully reduced.

True False

48. As a result of a redemption, a shareholders interest (direct and indirect) in the corporation decreased from 80% to 55%. The redemption qualifies for sale or exchange treatment as a disproportionate redemption.

True False

49. Puffin Corporations 2,000 shares outstanding are owned as follows: Paul, 800 shares; Sandra (Pauls sister), 800 shares; and Greta (Pauls granddaughter), 400 shares. During the current year, Puffin (E & P of $1 million) redeemed 600 shares of Pauls stock for $100,000. If Paul had acquired the 600 shares five years ago for $30,000, he will have a long-term capital gain of $70,000 from the redemption.

True False

50. For purposes of the waiver of the family attribution rules in a complete termination redemption, the former

shareholder must notify the IRS within 30 days of acquiring a prohibited interest in the corporation during the

10-year period following the redemption.

True False

51. Reginald and Roland (Reginalds son) each own 50% of the stock of Robin Corporation. Reginalds stock interest is entirely redeemed by Robin Corporation. Two years later, Reginald loans Robin Corporation

$250,000. The loan to Robin Corporation does not constitute a prohibited interest for purposes of the family

attribution waiver.

True False

52. Six years ago, Ronald and his mom each owned 50% of the stock of Bronze Corporation. At such time,

Bronze redeemed all of Ronalds stock. For the redemption year, Ronald filed the agreement required of the family attribution waiver and reported the transaction as a complete termination redemption (i.e., sale or

exchange). In the current year, the mom passed away and willed her entire stock interest in Bronze to

Ronald. The inheritance of Bronze stock by Ronald is a prohibited interest for purposes of the family

attribution waiver.

True False

53. In determining whether a distribution qualifies as a 303 redemption to pay death taxes, the stock

attribution rules must be applied.

True False

54. Bettys adjusted gross estate is $9 million. The death taxes and funeral and administration expenses of her estate total $1.2 million. Included in Bettys gross estate is stock in Heron Corporation, valued at $3.3 million as of the date of her death in 2013. Betty had acquired the stock six years ago at a cost of $810,000. If Heron

Corporation redeems $1.2 million of Heron stock from the estate, the transaction will qualify under 303 as a

redemption to pay death taxes and receive sale or exchange treatment.

True False

55. At the time of her death, Janice owned (in terms of the value of the stock outstanding) the following

stock: 18% of Heron Corporation and 21% of Hawk Corporation. The value of these stocks is included in

Janices gross estate. For purposes of applying the 35% of the value of adjusted gross estate requirement under 303 (i.e., redemption to pay death taxes), the Heron and Hawk stocks are aggregated.

True False

56. Grackle Corporation (E & P of $600,000) distributes cash of $200,000 and land (fair market value of

$400,000; basis of $250,000) to a shareholder in a qualifying stock redemption. The land distributed is subject

to a mortgage of $460,000. Grackle will recognize a gain of $210,000 as a result of the distribution.

True False

57. At a time when Blackbird Corporation had E & P of $700,000 and 1,000 shares of stock outstanding, the

corporation distributed $300,000 to redeem 400 shares of its stock. The transaction qualified as a

disproportionate redemption for the shareholder. Blackbirds E & P is reduced by $300,000 as a result of the distribution.

True False

58. Tan Corporation paid interest expense on a debt incurred in financing a redemption of its stock. The

interest expense is not deductible since it was incurred in connection with a stock redemption.

True False

59. The tax treatment of corporate distributions at the shareholder level does not depend on:

A. The character of the property being distributed.

B. The earnings and profits of the corporation.

C. The basis of stock in the hands of the shareholder.

D. Whether the distributed property is received by an individual or a corporation.

E. None of the above.

60. Rose Corporation (a calendar year taxpayer) has taxable income of $300,000, and its financial records

reflect the following for the year.

Federal income taxes paid $110,000

Net operating loss carryforward deducted currently 70,000

Gain recognized this year on an installment sale from a prior year 44,000

Depreciation deducted on tax return (ADS depreciation would have been $10,000) 40,000

Interest income on Iowa state bonds 8,000

Rose Corporations current E & P is:

A. $254,000.

B. $214,000.

C. $194,000.

D. $104,000.


61. Tern Corporation, a cash basis taxpayer, has taxable income of $500,000 for the current year. Tern elected

$100,000 of 179 expense. It also had a related party loss of $20,000 and a realized (not recognized) gain from

an involuntary conversion of $75,000. It paid Federal income tax of $150,000 and paid a nondeductible fine of

$10,000. Terns current E & P is: A. $400,000.

B. $410,000.

C. $320,000.

D. $475,000.


62. Silver Corporation, a calendar year taxpayer, has taxable income of $550,000. Among its transactions for

the year are the following:

Collection of proceeds from insurance policy on life of corporate

officer (in excess of cash surrender value) $82,500

Realized gain (not recognized) on an involuntary conversion 11,000

Nondeductible fines and penalties 44,000

Disregarding any provision for Federal income taxes, Silver Corporations current E & P is:

A. $500,500.

B. $588,500.

C. $599,500.

D. $687,500.


63. Which of the following statements is incorrect with respect to determining current E & P?

A. All tax-exempt income should be added back to taxable income.

B. Dividends received deductions should be added back to taxable income.

C. Charitable contributions in excess of the 10% of taxable income limit should be subtracted from taxable

income.

D. Federal income tax refunds should be added back to taxable income.

E. None of the above statements are incorrect.

64. Aaron and Michele, equal shareholders in Cavalier Corporation, receive $25,000 each in distributions on

December 31 of the current year. During the current year, Cavalier sold an appreciated asset for $60,000 (basis

of $15,000). Payment for the sale of the asset will be made as follows: 50% next year and 50% in the

following year, with interest payable at a rate of 6 percent. Before considering the effect of the asset sale,

Cavaliers current year E & P is $40,000 and it has no accumulated E & P. How much of Aarons distribution will be taxed as a dividend?

A. $0.

B. $20,000.

C. $25,000.

D. $42,500.


65. Tracy and Lance, equal shareholders in Macaw Corporation, receive $600,000 each in distributions on

December 31 of the current year. Macaws current year taxable income is $1 million and it has no accumulated E & P. Last year, Macaw sold an appreciated asset for $1,200,000 (basis of $400,000). Payment for one-half

of the sale of the asset was made this year. How much of Tracys distribution will be taxed as a dividend? A. $0.

B. $300,000.

C. $500,000.

D. $600,000.


66. Falcon Corporation ended its first year of operations with taxable income of $250,000. At the time of

Falcons formation, it incurred $50,000 of organizational expenses. In calculating its taxable income for the year, Falcon claimed an $8,000 deduction for the organizational expenses. What is Falcons current E & P? A. $200,000.

B. $208,000.

C. $250,000.

D. $258,000.


67. During the current year, Hawk Corporation sold equipment for $600,000 (adjusted basis of $360,000). The

equipment was purchased a few years ago for $760,000 and $400,000 in MACRS deductions have been

claimed. ADS depreciation would have been $300,000. As a result of the sale, the adjustment to taxable income

needed to determine current E & P is:

A. No adjustment is required.

B. Subtract $100,000.

C. Add $100,000.

D. Add $80,000.


68. On January 2, 2013, Orange Corporation purchased equipment for $300,000 with an ADS recovery period

of 10 years and a MACRS useful life of 7 years. Section 179 was not elected. MACRS depreciation properly

claimed on the asset, including depreciation in the year of sale, totaled $79,6019. The equipment was sold on

July 1, 2014, for $290,000. As a result of the sale, the adjustment to taxable income needed to arrive at current

E & P is:

A. No adjustment is required.

B. Decrease $49,6019.

C. Increase $49,6019.

D. Decrease $79,6019.


69. Tungsten Corporation, a calendar year cash basis taxpayer, made estimated tax payments of $800 each

quarter in 2013, for a total of $3,200. Tungsten filed its 2013 tax return in 2014 and the return showed a tax

liability $4,200. At the time of filing, March 15, 2014, Tungsten paid an additional $1,000 in Federal income

taxes. How does the additional payment of $1,000 impact Tungstens E & P? A. Increase by $1,000 in 2013.

B. Increase by $1,000 in 2014.

C. Decrease by $1,000 in 2013.

D. Decrease by $1,000 in 2014.


70. Cedar Corporation is a calendar year taxpayer formed in 2009. Cedars E & P for each of the past 5 years is listed below.

2013 $28,000

2012 $40,000

2011 $39,000

2010 $68,000

2009 $16,000

Cedar Corporation made the following distributions in the previous 5 years.

2012 Land (basis of $70,000, fair market value of $80,000)

2009 $20,000 cash

Cedars accumulated E & P as of January 1, 2014 is:

A. $91,000.

B. $95,000.

C. $101,000.

D. $105,000.


71. 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

Parakeets current E & P is $60,000, how much is allocated to Andrews distribution? A. $5,000.

B. $10,000.

C. $18,000.

D. $30,000.


72. 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.


73. Robin Corporation, a calendar year taxpayer, has a deficit in current E & P of $200,000 and a $580,000

positive balance in accumulated E & P. If Robin determines that a $700,000 distribution to its shareholders is

appropriate at some point during the year, what is the maximum amount of the distribution that could potentially

be treated as a dividend?

A. $0.

B. $380,000.

C. $480,000.

D. $580,000.


74. Pheasant Corporation, a calendar year taxpayer, has $400,000 of current E & P and a deficit in accumulated

E & P of $180,000. If Pheasant pays a $600,000 distribution to its shareholders on July 1, how much dividend

income do the shareholders report?

A. $0.

B. $20,000.

C. $220,000.

D. $400,000.


75. Glenda is the sole shareholder of Condor Corporation. She sold her stock to Melissa on October 31 for

$150,000. Glendas basis in Condor stock was $50,000 at the start of the year. Condor distributed land to Glenda immediately before the sale. Condors basis in the land was $20,000 (fair market value of $25,000). On December 31, Melissa received a $75,000 cash distribution from Condor. During the year, Condor has $20,000

of current E & P and its accumulated E & P balance on January 1 is $10,000. Which of the following statements

is true?

A. Glenda recognizes a $110,000 gain on the sale of her stock.

B. Glenda recognizes a $100,000 gain on the sale of her stock.

C. Melissa receives $5,000 of dividend income.

D. Glenda receives $20,000 of dividend income.


76. Blue Corporation has a deficit in accumulated E & P of $300,000 and has current E & P of $225,000. On

July 1, Blue distributes $250,000 to its sole shareholder, Sam, who has a basis in his stock of $52,500. As a

result of the distribution, Sam has:

A. Dividend income of $225,000 and reduces his stock basis to $27,500.

B. Dividend income of $52,500 and reduces his stock basis to zero.

C. Dividend income of $225,000 and no adjustment to stock basis.

D. No dividend income, reduces his stock basis to zero, and has a capital gain of $250,000.


77. Renee, the sole shareholder of Indigo Corporation, sold her stock to Chad on July 1 for $180,000. Renees stock basis at the beginning of the year was $120,000. Indigo made a $60,000 cash distribution to Renee

immediately before the sale, while Chad received a $120,000 cash distribution from Indigo on November 1. As

of the beginning of the current year, Indigo had $26,000 in accumulated E & P, while current E & P (before

distributions) was $90,000. Which of the following statements is correct?

A. Renee recognizes a $60,000 gain on the sale of the stock.

B. Renee recognizes a $64,000 gain on the sale of the stock.

C. Chad recognizes dividend income of $120,000.

D. Chad recognizes dividend income of $30,000.


78. Tangelo Corporation has an August 31 year-end. Tangelo had $50,000 in accumulated E & P at the

beginning of its 2014 fiscal year (September 1, 2013) and during the year, it incurred a $75,000 operating loss.

It also distributed $65,000 to its sole shareholder, Cass, on November 30, 2013. If Cass is a calendar year

taxpayer, how should she treat the distribution when she files her 2013 income tax return (assuming the return is

filed by April 15, 2014)?

A. $65,000 of dividend income.

B. $60,000 of dividend income and $5,000 recovery of capital.

C. $50,000 of dividend income and $15,000 recovery of capital.

D. The distribution has no effect on Cass in the current year.


79. As of January 1, Cassowary Corporation has a deficit in accumulated E & P of $100,000. For the tax year,

current E & P (accrued ratably) is $240,000 (prior to any distributions). On July 1, Cassowary Corporation

distributes $275,000 to its sole shareholder. The amount of the distribution that is a dividend is:

A. $20,000.

B. $140,000.

C. $240,000.

D. $275,000.


80. At the beginning of the current year, Doug and Alfred each own 50% of Amaryllis Corporation (a calendar

year taxpayer). In July, Doug sold his stock to Kevin for $140,000. At the beginning of the year, Amaryllis

Corporation had accumulated E & P of $240,000 and its current E & P is $280,000 (prior to any distributions).

Amaryllis distributed $300,000 on February 15 ($150,000 to Doug and $150,000 to Alfred) and distributed

another $300,000 on November 1 ($150,000 to Kevin and $150,000 to Alfred). Kevin has dividend income of:

A. $150,000.

B. $140,000.

C. $110,000.

D. $70,000.


81. On January 1, Eagle Corporation (a calendar year taxpayer) has accumulated E & P of $300,000. During the

year, Eagle incurs a net loss of $420,000 from operations that accrues ratably. On June 30, Eagle distributes

$180,000 to Libby, its sole shareholder, who has a basis in her stock of $112,500. How much of the $180,000 is

a dividend to Libby?

A. $0.

B. $90,000.

C. $112,500.

D. $180,000.


82. Which of the following is not a consequence of the double tax on dividends?

A. Corporations have an incentive to retain earnings and structure distributions to avoid dividend treatment.

B. Corporations have an incentive to invest in noncorporate rather than corporate businesses.

C. The cost of capital for corporate investments is increased.

D. Corporations have an incentive to finance operations with debt rather than equity.

E. All of the above are consequences of the double tax on dividends.

83. Which one of the following statements is false?

A. Most countries that trade with the U.S. do not impose a double tax on dividends.

B. Tax proposals that include corporate integration would eliminate the double tax on dividends.

C. The double tax on dividends may make corporations more financially vulnerable during economic

downturns.

D. Many of the arguments in support of the double tax on dividends relate to fairness.


84. In June of the current year, Marigold Corporation declares a $4 dividend out of E & P on each share of

common stock to shareholders of record on August 1. Ellen and Tim each purchase 100 shares of Marigold

stock on July 1. On July 15, Ellen also purchases a short position in Marigold. Tim sells 50 of his shares on

August 10 and continues to hold the remaining 50 shares through the end of the year. Ellen closes her short

position in Marigold on October 119. With respect to the dividends, which of the following is correct?

A. Ellen will have $400 of qualifying dividends subject to reduced tax rates and $400 of ordinary income (from

dividends paid on the short position of Marigold stock).

B. Tim will have $200 of qualifying dividends subject to reduced tax rates and $200 of ordinary income.

C. All $800 of Ellens dividends will qualify for reduced tax rates. D. All $400 of Tims dividends will qualify for reduced tax rates. E. None of the above.

85. In the current year, Warbler Corporation (E & P of $250,000) made the following property distributions to

its shareholders (all corporations):

Adjusted Fair Market

Basis Value

Pink Corporation stock (held for investment) $150,000 $120,000

Non-LIFO inventory 80,000 110,000

Warbler Corporation is not a member of a controlled group. As a result of the distribution:

A. The shareholders have dividend income of $200,000.

B. The shareholders have dividend income of $260,000.

C. Warbler has a recognized gain of $30,000 and a recognized loss of $30,000.

D. Warbler has no recognized gain or loss.


86. Purple Corporation makes a property distribution to its sole shareholder, Paul. The property distributed is a

house (fair market value of $189,000; basis of $154,000) that is subject to a $245,000 mortgage that Paul

assumes. Before considering the consequences of the distribution, Purples current E & P is $35,000 and its accumulated E & P is $140,000. Purple makes no other distributions during the current year. What is Purples taxable gain on the distribution of the house?

A. $0.

B. $21,000.

C. $35,000.

D. $91,000.


87. Puffin Corporation makes a property distribution to its sole shareholder, Bonnie. The property distributed

is a car (basis of $30,000; fair market value of $20,000) that is subject to a $6,000 liability which Bonnie

assumes. Puffin has no accumulated E & P and $30,000 of current E & P from other sources during the year.

What is Puffins E & P after taking into account the distribution of the car? A. $4,000.

B. $6,000.

C. $10,000.

D. $14,000.


88. Navy Corporation has E & P of $240,000. It distributes land with a fair market value of $70,000 (adjusted

basis of $25,000) to its sole shareholder, Troy. The land is subject to a liability of $55,000 that Troy assumes.

Troy has:

A. A taxable dividend of $15,000.

B. A taxable dividend of $25,000.

C. A taxable dividend of $45,000.

D. A taxable dividend of $70,000.

E. A basis in the machinery of $55,000.

89. Which one of the following statements about property distributions is false?

A. When the basis of distributed property is greater than its fair market value, a deficit may be created in E & P.

B. When the basis of distributed property is less than its fair market value, the distributing corporation

recognizes gain.

C. When the basis of distributed property is greater than its fair market value, the distributing corporation does

not recognize loss.

D. The amount of a distribution received by a shareholder is measured by using the propertys fair market value. E. All of the above statements are true.

90. Brett owns stock in Oriole Corporation (basis of $100,000) as an investment. Oriole distributes property

(fair market value of $375,000; basis of $187,500) to him during the year. Oriole has current E & P of $25,000

(which includes the E & P gain on the property distribution), accumulated E & P of $100,000, and makes no

other distributions during the year. What is Bretts capital gain on the distribution? A. $0.

B. $100,000.

C. $150,000.

D. $187,500.


91. Rust Corporation distributes property to its sole shareholder, Andre. The property has a fair market value of

$350,000, an adjusted basis of $205,000, and is subject to a liability of $220,000. Current E & P is $500,000.

With respect to the distribution, which of the following statements is correct?

A. Rust has a gain of $15,000 and Andre has dividend income of $350,000.

B. Rust has a gain of $145,000 and Andres basis in the distributed property is $130,000. C. Rust has a gain of $130,000 and Andres basis in the distributed property is $350,000. D. Rust has a gain of $145,000 and Andre has dividend income of $130,000.


92. Purple Corporation has accumulated E & P of $100,000 on January 1, 2013. In 2013, Purple has current

E & P of $130,000 (before any distribution). On December 31, 2013, the corporation distributes $250,000 to its

sole shareholder, Cindy (an individual). Purple Corporations E & P as of January 1, 2014 is: A. $0.

B. ($20,000).

C. $100,000.

D. $130,000.


93. Starling Corporation has accumulated E & P of $60,000 on January 1, 2013. In 2013, Starling Corporation

had an operating loss of $80,000. It distributed cash of $40,000 to Zoe, its sole shareholder, on December 31,

2013. Starling Corporations balance in its E & P account as of January 1, 2014, is: A. $60,000 deficit.

B. $20,000 deficit.

C. $0.

D. $60,000.


94. Robin Corporation distributes furniture (basis of $40,000; fair market value of $50,000) as a property

dividend to its shareholders. The furniture is subject to a liability of $55,000. Robin Corporation recognizes

gain of:

A. $55,000.

B. $15,000.

C. $10,000.

D. $0.


95. Ten years ago, Carrie purchased 2,000 shares in Osprey Corporation for $20,000. In the current year, Carrie

receives a nontaxable stock dividend of 20 shares of Osprey preferred. Values at the time of the dividend are:

$8,000 for the preferred stock and $72,000 for the common. Based on this information, Carries basis in the stock is:

A. $20,000 in the common and $8,000 in the preferred.

B. $2,000 in the common and $18,000 in the preferred.

C. $18,000 in the common and $2,000 in the preferred.

D. $19,802 in the common and $198 in the preferred.


96. Which of the following statements regarding constructive dividends is not correct?

A. Constructive dividends do not need to be formally declared or designated as a dividend.

B. Constructive dividends need not be paid pro rata to the shareholders.

C. Corporations that receive constructive dividends may not use the dividends received deduction.

D. Constructive dividends are taxable as dividends only to the extent of earnings and profits.

E. All of the above.

97. Pink Corporation declares a nontaxable dividend payable in rights to subscribe to common stock. Each right

entitles the holder to purchase one share of stock for $219. One right is issued for every two shares of stock

owned. Jack owns 100 shares of stock in Pink, which he purchased three years ago for $3,000. At the time of

the distribution, the value of the stock is $45 per share and the value of the rights is $2 per share. Jack receives

50 rights. He exercises 25 rights and sells the remaining 25 rights three months later for $2.50 per right.

A. Jack must allocate a part of the basis of his original stock in Pink to the rights.

B. If Jack does not allocate a part of the basis of his original stock to the rights, his basis in the new stock is

zero.

C. Sale of the rights produces ordinary income to Jack of $62.50.

D. If Jack does not allocate a part of the basis of his original stock to the rights, his basis in the new stock is

$6219.


98. On January 30, Juan receives a nontaxable distribution of stock rights from Platinum Corporation. Each

right entitles the holder to purchase one share of stock for $40. One right is issued for every share of stock

owned. Juan owns 100 shares of stock purchased two years ago for $4,000. At the date of distribution, the rights

are worth $1,000 (100 rights at $10 per right) and Juans stock in Platinum is worth $5,000 (or $50 per share). On December 1, Juan sells all 100 stock rights for $12 per right. How much gain does Juan recognize on the

sale?

A. $1,200.

B. $533.

C. $400.

D. $0.


99. Seven years ago, Eleanor transferred property she had used in her sole proprietorship to Blue Corporation

for 2,000 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 $700,000 on the date of the transfer. In the current year, Blue

Corporation (E & P of $1 million) redeems 600 shares from Eleanor for $260,000 in a transaction that does not

qualify for sale or exchange treatment. With respect to the redemption, Eleanor will have a:

A. $140,000 dividend.

B. $260,000 dividend.

C. $140,000 capital gain.

D. $260,000 capital gain.


100. Seven years ago, Eleanor transferred property she had used in her sole proprietorship to Blue Corporation

for 2,000 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 $700,000 on the date of the transfer. In the current year, Blue

Corporation ( E & P of $1 million) redeems 600 shares from Eleanor for $260,000 in a transaction that qualifies

for sale or exchange treatment. With respect to the redemption, Eleanor will have a:

A. $140,000 dividend.

B. $260,000 dividend.

C. $140,000 capital gain.

D. $260,000 capital gain.


101. Finch Corporation distributes property (basis of $225,000, fair market value of $300,000) to a shareholder

in a distribution that is a qualifying stock redemption. The property is subject to a liability of $160,000, which

the shareholder assumes. The basis of the property to the shareholder is:

A. $0.

B. $140,000.

C. $225,000.

D. $300,000.


102. Coffee Corporation has 2,000 shares of common stock outstanding. John owns 700 of the shares, Johns grandfather owns 100 shares, Johns father owns 100 shares, Johns ex-wife owns 700 shares, and Redbird Partnership owns 400 shares. John is a 50% partner in Redbird Partnership. How many shares is John deemed

to own in Coffee Corporation under the 318 attribution rules?

A. 700.

B. 1,000.

C. 1,100.

D. 1,700.


103. Kite Corporation has 1,000 shares of stock outstanding. Kent owns 300 shares, Kents father owns 200 shares, Kents daughter owns 100 shares, and Kents aunt owns 200 shares. Plover Corporation owns the other 200 shares in Kite Corporation. Kent owns 75% of the stock in Plover Corporation. Applying the 318 stock

attribution rules, how many shares does Kent own in Kite Corporation?

A. 500.

B. 600.

C. 750.

D. 950.


104. Keshia owns 200 shares in Parakeet Corporation. Keshia has a 30% beneficiary interest in her deceased

grandmothers estate. The estate owns 400 shares in Parakeet Corporation. None of the other beneficiaries of the estate own stock in Parakeet. In applying the 318 attribution rules:

A. The estate owns 400 shares.

B. Keshia owns 320 shares.

C. Keshia owns 600 shares.

D. The estate owns 460 shares.


105. Which of the following is an incorrect statement regarding the application of the 318 stock attribution

rules?

A. An individual is not deemed to own the shares owned by his or her siblings.

B. Stock owned by an estate is deemed to be owned in full by a beneficiary.

C. Stock owned by any shareholder owning 50% or more of a corporations stock is deemed to be owned in full by the corporation.

D. Stock owned by a partnership is deemed to be owned proportionately by a partner.


106. Bristlebird Corporation (E & P of $700,000) has 3,000 shares of common stock outstanding. Juan owns

1,500 shares and his wife, Roberta, owns 1,500 shares. Juan and Roberta each have a basis of $90,000 in their

Bristlebird stock. In the current year, Bristlebird Corporation redeems 1,000 shares from Juan for

$250,000. With respect to the distribution in redemption of the Bristlebird stock:

A. Juan has dividend income of $250,000.

B. Juan has dividend income of $190,000.

C. Juan has a capital gain of $250,000.

D. Juan has a capital gain of $190,000.


107. Hazel, Emily, and Frank, unrelated individuals, own all of the stock in Wren Corporation (E & P of $1.2

million) as follows: Hazel, 1,500 shares; Emily, 300 shares; and Frank, 200 shares. Wren redeems 900 of

Hazels shares (basis of $210,000) for $625,000. With respect to the distribution in redemption of the stock: A. Hazel has a capital gain of $415,000.

B. Hazel has a capital gain of $625,000.

C. Hazel has dividend income of $415,000.

D. Hazel has dividend income of $625,000.


108. Lucinda owns 1,100 shares of Blackbird Corporation stock at a time when Blackbird has 2,000 shares of

stock outstanding. The remaining shareholders are unrelated to Lucinda. What is the minimum number of

shares Blackbird must redeem from Lucinda so that the transaction will qualify as a disproportionate

redemption?

A. 220.

B. 393.

C. 484.

D. 880.


109. Hannah, Greta, and Winston own the stock in Redpoll Corporation (E & P of $900,000) as follows:

Hannah, 600 shares; Greta, 400 shares; and Winston, 1,000 shares. Greta is Hannahs daughter, and Winston is Hannahs brother. Redpoll Corporation redeems 400 of Hannahs shares (basis of $55,000) for $240,000. Hannah purchased the stock three years ago as an investment. With respect to the stock

redemption, Hannah has:

A. Long-term capital gain of $185,000.

B. Long-term capital gain of $240,000.

C. Dividend income of $185,000.

D. Dividend income of $240,000.


110. Ethel, Hannah, and Samuel, unrelated individuals, own the stock in Broadbill Corporation (E & P of

$700,000) as follows: Ethel, 300 shares; Hannah, 300 shares; and Samuel, 400 shares. Broadbill redeems 200

of Samuels shares (basis of $175,000) for $250,000. If Samuels stock is a capital asset and has been held for over three years, Samuel has:

A. A long-term capital gain of $75,000.

B. A short-term capital gain of $75,000.

C. Ordinary income of $250,000.

D. Ordinary income of $75,000.


111. Julian, Berta, and Maria own 400 shares, 400 shares, and 200 shares, respectively, in Caramel Corporation

(E & P of $750,000). Berta is Julians sister, and Maria is Julians aunt. Caramel Corporation redeems all of Julians stock for $420,000. Julian paid $200 a share for the stock five years ago. Julian continued to serve on Caramels board of directors after the redemption. With respect to the redemption: A. Dividend income of $340,000.

B. Dividend income of $420,000.

C. Long-term capital gain of $340,000.

D. Long-term capital gain of $420,000.


112. Lupe and Rodrigo, father and son, each own 50% of the stock outstanding of Heron Corporation (E & P of

$400,000). During the current year, Heron redeems all of Lupes shares for $250,000. The transaction cannot qualify as a complete termination redemption if:

A. Lupe received a $250,000 note receivable from Heron in the stock redemption.

B. Lupe loaned Heron Corporation $50,000 two years following the redemption.

C. Rodrigo continued to serve on Heron Corporations board of directors for two years following the redemption.

D. Three years after the redemption, Lupe inherited Rodrigos shares in Heron as a result of his sons death. E. None of the above.

113. The gross estate of John, decedent, includes stock in Crimson Corporation and Jade Corporation valued at

$1.3 million and $2 million, respectively. Johns adjusted gross estate is $9 million. He owned 23% of the Crimson stock and 31% of the Jade stock. Immediate members of Johns family own the remaining shares of both Crimson and Jade. Those individuals are also the sole beneficiaries of Johns estate. Death taxes and funeral and administration expenses for Johns estate are $1.3 million. John had a basis of $475,000 in the Crimson stock and $510,000 in the Jade stock. Crimson Corporation (E & P of $3 million) distributed land

worth $1.3 million (basis of $800,000) to Johns estate in redemption of all of the Crimson stock. Which of the following is a correct statement regarding the tax consequences of this redemption?

A. The estate recognizes dividend income of $1.3 million on the redemption.

B. Crimson Corporation recognizes no gain on the distribution of the land.

C. The estate recognizes no gain or loss on the redemption.

D. The estate has a basis of $800,000 in the land.


114. The adjusted gross estate of Keith, decedent, is $12 million. Included in the gross estate is stock in Gold

Corporation (E & P of $1.3 million), a closely held corporation, valued at $4.6 million as of the date of Keiths death in 2013. Keith had acquired the stock twelve years ago at a cost of $900,000. Death taxes and funeral and

administration expenses for Keiths estate are $2.3 million. Gold Corporation redeems one-half of the stock from Keiths estate in a 303 redemption to pay death taxes using property with a fair market value of $2.3 million (adjusted basis of $1.9 million). Which of the following is a correct statement regarding the tax

consequences of this redemption?

A. The estate will have a basis of $2.3 million in the property received from Gold Corporation in redemption of

the estates stock. B. Gold Corporation will not reduce its E & P as a result of the distribution of the property to Keiths estate. C. The estate will recognize a $1.4 million long-term capital gain on the redemption.

D. Gold Corporation recognizes no gain (or loss) on the distribution of the property to Keiths estate. E. None of the above.

115. The adjusted gross estate of Debra, decedent, is $8 million. Debras estate will incur death taxes and funeral and administration expenses of $1 million. Debras gross estate includes stock in Silver Corporation that she had purchased twelve years ago for $600,000 (date of death fair market value of $3 million). At the time of

her death in 2013, Debra owned 80% of the stock in Silver Corporation. Silver Corporation (E & P of $4

million) redeems all of the estates stock in the corporation for $3 million. Debras will names her daughter, Dena, who owns the remaining 20% interest in Silver Corporation, as her sole heir. With respect to this

redemption, Debras estate has the following income: A. $0.

B. $2.4 million long-term capital gain.

C. $2 million dividend.

D. $3 million dividend.


116. 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 318 stock attribution rules do not apply to the redemption.

C. The value of the stock in the decedents gross estate must exceed 40% of the value of the adjusted gross estate.

D. A corporation recognizes gains and losses on the distribution of property in the redemption.


117. Copper Corporation (E & P of $1.2 million) distributes land (basis of $410,000, fair market value of

$650,000) to Lauren, a shareholder, to carry out a qualifying stock redemption. Lauren had a basis of $90,000

in the shares redeemed. Which of the following is an incorrect statement regarding the redemption?

A. If the land is distributed subject to a $500,000 liability, Copper Corporation will recognize a gain of

$240,000.

B. If the land is distributed subject to a $500,000 liability, Lauren will have a basis in the land of $650,000.

C. If the land is distributed subject to a $500,000 liability, Lauren will recognize a gain of $60,000.

D. If the land is distributed subject to a $700,000 liability, Copper Corporation will recognize a gain of

$290,000.


118. To carry out a qualifying stock redemption, Turaco Corporation (E & P of $800,000) transfers land held

for investment purposes to Aida, a shareholder. The land had a basis of $250,000, a fair market value of

$400,000, and is subject to a $300,000 liability. Aida has a basis of $70,000 in the shares redeemed. Which of

the following is a correct statement regarding the tax consequences of this redemption?

A. Aida will have $400,000 of dividend income.

B. Aida will have a $100,000 basis in the land.

C. Turaco Corporation will recognize a gain of $50,000.

D. Aida will recognize a gain of $30,000.


119. Canary Corporation has 5,000 shares of stock outstanding. It redeems in a qualifying stock redemption

1,200 shares for $475,000 at a time when it has paid-in capital of $300,000 and E & P of $1.5 million. What

would be the charge to Canarys E & P as a result of the redemption? A. $72,000.

B. $300,000.

C. $432,000.

D. $475,000.


120. In the current year, Quail Corporation distributed installment notes payable in redemption of some of its

shares. Quail incurred the following expenditures in connection with the redemption: accounting fees of $7,000

and legal fees of $8,000. In addition, Quail paid $10,000 of interest expense on the installment notes

payable. The distribution was a qualifying stock redemption. How much of the $25,000 is deductible in the

current year?

A. $0.

B. $7,000.

C. $10,000.

D. $25,000.


121. On January 1, Gold Corporation (a calendar year taxpayer) has E & P of $30,000 and generates no

additional E & P during the year. On March 31, the corporation distributes $40,000 to its sole shareholder,

Wyatt (basis in stock of $8,000). Determine the effect of the distribution on Wyatts taxable income and stock basis.

122. On January 1, Tulip Corporation (a calendar year taxpayer) has accumulated E & P of $300,000. Its current

E & P for the year is $90,000 (before considering dividend distributions). During the year, Tulip distributes

$600,000 ($300,000 each) to its equal shareholders, Anne and Tom. Anne has a basis in her stock of $65,000,

while Toms basis is $120,000. What is the effect of the distribution by Tulip Corporation on Anne and Tom?

123. Daisy Corporation is the sole shareholder of Ostrich Corporation, which it hopes to sell within the next

three years. The Ostrich stock (basis of $25 million) is currently worth $30 million, but Daisy believes that it

would be easier to find a buyer if it was worth less. To lower the value of its stock, Ostrich distributes $4

million cash to Daisy (sufficient E & P exists to cover the distribution). At a later date, Daisy sells Ostrich for

$26 million.

a. What are the tax consequences to Daisy on the sale?

b. What would be the tax consequences if Ostrich had not first distributed the $4 million in cash and Daisy sold the Ostrich stock for $30

million?

124. Ashley, the sole shareholder of Hawk Corporation, has a stock basis of $200,000 at the beginning of the

year. On July 1, she sells all of her stock to Matt for $1 million. On January 1, Hawk has accumulated E & P of

$90,000 and during the year, current E & P of $160,000. Hawk makes the following cash distributions:

$270,000 to Ashley on March 31 and $90,000 to Matt on December 1. How are the distributions taxed to

Ashley and Matt? What is Ashleys recognized gain on the sale to Matt?

125. Brown Corporation, an accrual basis corporation, has taxable income of $150,000 in the current year.

Included in its determination of taxable income are the following transactions.

Brown incurred a $65,000 capital loss from the sale of stock. Because Brown had no capital gains this year, none of the loss is deductible.

The corporations Federal income tax liability is $41,750. Brown incurred $18,000 in nondeductible meal and entertainment expenses.

Brown uses the LIFO method when accounting for inventory. This year, the companys LIFO recapture amount increased by $3,000. Brown claimed a domestic production activities deduction under 199 of $1,500.

What is Browns current E & P for the year?

126. Finch Corporation (E & P of $400,000) distributed machinery ($10,000 adjusted basis, $150,000 fair

market value) to its sole shareholder, Kathleen. The property is subject to a $50,000 mortgage, which Kathleen

assumed. How much dividend income does Kathleen recognize as a result of the distribution and what is her

basis in the machinery?

127. Sylvia owns 25% of Cormorant Corporation. Cormorant sells diamonds to retail jewelry businesses. While

Cormorant has a deficit in accumulated E & P of $56,000 at the beginning of the year, its current E & P is

$500,000. Since the company had a successful year, Cormorant pays a $36,000 distribution to each of the

companys four shareholders on December 119. Three shareholders receive cash, but Cormorant distributes a diamond (adjusted basis of $40,000 and a fair market value of $36,000) to Sylvia in lieu of cash. Determine the

effect of distributing the diamond on Cormorants and on Sylvias taxable income. What is Sylvias basis in the diamond? Was the distribution good tax planning on the part of Cormorant? Why or why not?

128. Thrush, Inc., is a calendar year, accrual basis corporation with Henry as its sole shareholder (basis in his

stock is $90,000). On January 1 of the current year, Thrush Corporation has accumulated E & P of $200,000.

Before considering the effect of the distribution described below, the corporations current E & P is $50,000. On November 1, Thrush distributes an office building to Henry. The office building has an adjusted basis of

$80,000 (fair market value of $100,000) and is subject to a mortgage of $110,000. Assume that the building

has been depreciated using the ADS method for both income tax and E & P purposes. What are the tax

consequences of the distribution to Thrush and to Henry? (In your answer, be sure to describe the effects on

taxable income for both Thrush and Henry, the impact of the distribution on Thrushs E & P, and Henrys basis in the building.)

129. Scarlet Corporation is an accrual basis, calendar year corporation. Scarlet distributes inventory (basis of

$20,000; fair market value of $40,000) to Frank, its shareholder. Assuming that Scarlet has $500,000 of current

E & P, what is the impact of the distribution on Scarlet Corporation and on Frank?

130. Puce Corporation, an accrual basis taxpayer, has struggled to survive since its formation, six years ago. As

a result, it has a deficit in accumulated E & P at the beginning of the year of $340,000. This year, however,

Puce earned a significant profit; taxable income was $240,000. Consequently, Puce made two cash distributions

to Martha, its sole shareholder: $150,000 on July 1 and $200,000 December 31. The following information

might be relevant to determining the tax treatment of the distributions.

This years taxable income included a net operating loss carryover of $50,000.

The corporations Federal income tax liability is $72,000 for the year.

Puce paid nondeductible fines and kickbacks of $10,000. The company also paid nondeductible life insurance premiums of $22,000.

The cash surrender value of the corporate-owned life insurance policies increased by $11,000 during the year.

The company sold a piece of equipment during the year and reported a 1231 gain of $105,000 and recapture income under 1245 of

$35,000. There were no other 1231 transactions during the year, but the corporation did have a capital loss carryforward of $30,000.

MACRS depreciation exceeds E & P depreciation by $14,000. In addition, an election under 179 was made this year for $18,000 of

assets.

a. Compute Puces E & P for the year.

b. What are the tax consequences of the two distributions made during the year to Martha (her stock basis is $74,000)?

131. Stephanie is the sole shareholder and president of Hawk Corporation. She feels that she can justify at least

a $220,000 bonus this year because of her performance. However, rather than a bonus in the form of a salary,

she plans to have Hawk pay her a $220,000 dividend. Because Stephanies marginal tax rate is 35%, she prefers to receive a dividend taxed at 15%. Her accountant, however, suggests a $310,000 bonus in lieu of the $220,000

dividend since Hawk Corporation is in the 34% tax bracket. Should Stephanie take the $220,000 dividend or the

$310,000 bonus? Support your answer by computing the after-tax cost of the two alternatives to Hawk and to

Stephanie.

132. Albatross Corporation acquired land for investment purposes in 1999 at a cost of $100,000. Albatross sold

the land to Monty on December 30, 2013, and did not elect out of the installment method of accounting. The

selling price of the property was $400,000. Monty made a cash down payment of $50,000 on the date of sale

and executed a $350,000 note, payable in seven annual installments of $50,000 each plus interest at the rate of

6% per annum. The first installment of $50,000 was due in 2014 which Monty paid, plus interest of

$21,000. Discuss the effect of this sale on Albatrosss taxable income and its E & P account in 2013 and 2014.

133. Kite Corporation, a calendar year taxpayer, has taxable income of $360,000 for 2014. Among its

transactions for the year are the following:

Collection of proceeds from insurance policy on life of corporate

officer (in excess of cash surrender value) $ 9,000

Realized gain (not recognized) on an involuntary conversion 10,000

Nondeductible fines and penalties 21,000

Disregarding any provision for Federal income taxes, determine Kite Corporations current E & P for 2014.

134. Maria owns 75% and Christopher owns 25% of Cockatoo Corporation, a calendar year

taxpayer. Cockatoo makes a $600,000 distribution to Maria on April 1 and a $200,000 distribution to

Christopher on May 1. Cockatoos current E & P is $120,000 and its accumulated E & P is $500,000. What are the tax implications of the distributions to Maria and Christopher?

135. Jen, the sole shareholder of Mahogany Corporation, sold her stock to Jason on July 1 for $90,000. Jens 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) is $30,000. What are the tax consequences of these transactions to Jen and Jason?

136. At the beginning of the current year, Paul and John each own 50% of Apple Corporation. In July, Paul sold

his stock to Sarah for $110,000. At the beginning of the year, Apple Corporation had accumulated E & P of

$200,000 and its current E & P is $250,000 (prior to any distributions). Apple distributed $260,000 on March 1

($130,000 to Paul and $130,000 to John) and distributed another $260,000 on October 1 ($130,000 to Sarah and

$130,000 to John). What are the tax implications of the $130,000 distribution to Sarah?

137. Tanya is in the 33% tax bracket. She acquired 1,000 shares of stock in Swan Corporation seven years ago

for $100 a share. In the current year, Swan Corporation (E & P of $1.2 million) redeems all of her shares for

$160,000. What are the income tax consequences to Tanya if:

a. The redemption qualifies for sale or exchange treatment, and Tanya has no other transactions in the current year involving capital assets?

b. The redemption does not qualify for sale or exchange treatment?

138. Steve has a capital loss carryover in the current year of $30,000. He owns 3,000 shares of stock in

Carmine Corporation, which he purchased six years ago for $20 per share. In the current year, Carmine

Corporation (E & P of $750,000) redeems all of his shares for $140,000. Steve is in the 33% tax

bracket. What is his income tax liability with respect to the corporate distribution if:

a. The redemption qualifies for sale or exchange treatment, and Steve has no other transactions in the current year involving capital assets?

b. The redemption does not qualify for sale or exchange treatment?

139. Hawk Corporation has 2,000 shares of stock outstanding: Marina owns 800 shares, Russell owns 500

shares, Velvet Partnership owns 400 shares, and Yellow Corporation owns 300 shares. Marina and Russell,

unrelated individuals, are equal partners of Velvet Partnership. Marina owns 35% of the stock in Yellow

Corporation.

a. Applying the 318 stock attribution rules, determine how many shares in Hawk Corporation each shareholder owns, directly and

indirectly:

Marina:

Russell:

Velvet Partnership:

Yellow Corporation:

b. Assume, instead, that Marina owns 60% of Yellow Corporation. How many shares does Marina own, directly and indirectly, in Hawk

Corporation?

140. Sams gross estate includes stock in Tern Corporation and Wren Corporation, valued at $1.4 million and $980,000, respectively. At the time of Sams death in 2013, the stock represented 22% of Terns outstanding stock and 27% of Wrens outstanding stock. Sams adjusted gross estate equals $6,500,000. Death taxes and funeral and administration expenses for Sams estate total $980,000. Sam had a basis of $350,000 in the Tern stock and $190,000 in the Wren stock at the time of his death. None of the beneficiaries of Sams estate own (directly or indirectly) any stock in Tern Corporation, but some of the beneficiaries own stock of Wren

Corporation. Consider the following independent questions.

a. What are the tax consequences to the estate if all of its Wren stock is redeemed by Wren Corporation for $980,000?

b. What are the tax consequences to the estate if all of its Tern stock is redeemed by Tern Corporation for $1.4 million?

141. Rauls gross estate includes 1,500 shares of stock of Orange Corporation (basis to Raul of $600,000, fair market value on date of death of $4.1 million). The estate will incur $2.2 million of death taxes and funeral and

administration expenses, and the adjusted gross estate is $9 million. Denise, Rauls daughter and sole heir of his estate, owns the remaining 500 shares of Orange Corporations (2,000) shares outstanding. In the current year, Orange (E & P of $5 million) redeems all of the estates 1,500 shares for $4.1 million. What are the tax consequences of the redemption to Rauls estate?

142. Ivory Corporation (E & P of $1 million) has 2,000 shares of common stock outstanding owned by

unrelated parties as follows: Veronica, 1,000 shares, and Tommie, 1,000 shares. Veronica and Tommie each

paid $150 per share for the Ivory stock 12 years ago. In May of the current year, Ivory distributes land held as

an investment (basis of $180,000, fair market value of $390,000) to Veronica in redemption of 350 of her

shares.

a. What are the tax results to Veronica on the redemption of her Ivory stock?

b. What are the tax results to Ivory Corporation on the distribution of the land?

143. Gold Corporation has accumulated E & P of $2 million as of January 1 of the current year. During the

year, it expects to have earnings from operations of $1,680,000 and to distribute $900,000 in cash to

shareholders. Gold Corporation also expects to sell an asset for a loss of $2 million. Thus, it anticipates

incurring a deficit of $320,000 for the year. What can Gold do to minimize the amount of dividend income to its

shareholders?

144. Timothy owns 100% of Forsythia Corporations stock. Corporate employees and annual salaries include Timothy ($300,000); Richard, Timothys son ($80,000); Rita, Timothys daughter ($100,000); and Sandy ($120,000). The operation of Forsythia Corporation is shared about equally between Timothy and Sandy (an

unrelated party). Richard and Rita are full-time college students at a university about 150 miles away. Forsythia

Corporation has substantial E & P but has not distributed a dividend for the past five years. Discuss problems

related to the salary arrangement for Forsythia Corporation.

145. Briefly describe the reason a corporation might distribute a property dividend to a shareholder in lieu of a

cash distribution. Describe the tax effects of the property distribution on the shareholder and on the

corporation.

146. How does the definition of accumulated E & P differ from the definition of current E & P?

147. How does the payment of a property dividend affect E & P?

148. Goldfinch Corporation distributes stock rights to its shareholders. How is the basis of the stock rights

received by Goldfinchs shareholders determined?

149. Briefly describe the rationale for the reduced tax rate on dividends for individual taxpayers.

150. Christian, the president and sole shareholder of Venture Corporation, is paid an annual salary of

$150,000. Christian would like to draw additional funds from the corporation but is concerned that increased

salary might cause the IRS to contend his salary is unreasonable. Further, Christian does not want the

corporation to pay any dividends. He would like to contribute $40,000 to his alma mater to establish

scholarships for needy students. If Christian makes a pledge to the university to provide $40,000 for

scholarships, would there be a problem if Venture Corporation paid the pledge on his behalf? Explain.

151. Briefly define the term earnings and profits.

152. Provide a brief outline on computing current E & P.

153. In general, how are current and accumulated earnings and profits allocated to corporate distributions?

154. Briefly discuss the rules related to distributions of non-cash property.

155. What is a constructive dividend? Provide several examples of the term.

156. Do noncorporate and corporate shareholders typically have the same preference for the tax treatment of a

stock redemption? Explain.

157. Explain the stock attribution rules that apply in the case of stock redemptions.

158. When does a redemption qualify as a not essentially equivalent redemption under 302(b)(1)?

159. What are the requirements that must be satisfied for a distribution to qualify under 302(b)(2) as a

disproportionate redemption?

160. When is a redemption to pay death taxes under 303 most advantageous?

COMPREHENSIVE VOLUME--CHAPTER

19--CORPORATIONS: DISTRIBUTIONS NOT IN COMPLETE

LIQUIDATIONS Key

1. TRUE

2. FALSE

3. FALSE

4. FALSE

5. FALSE

6. FALSE

7. FALSE

8. FALSE

9. FALSE

10. TRUE

11. FALSE

12. FALSE

13. FALSE

14. TRUE

15. TRUE

16. TRUE

17. FALSE

18. TRUE

19. TRUE

20. TRUE

21. TRUE

22. FALSE

23. FALSE

24. TRUE

25. TRUE

26. TRUE

27. TRUE

28. TRUE

29. TRUE

30. FALSE

31. FALSE

32. FALSE

33. TRUE

34. FALSE

35. TRUE

36. FALSE

37. FALSE

38. TRUE

39. TRUE

40. TRUE

41. FALSE

42. TRUE

43. FALSE

44. TRUE

45. FALSE

46. FALSE

47. TRUE

48. FALSE

49. TRUE

50. TRUE

51. TRUE

52. FALSE

53. FALSE

54. TRUE

55. FALSE

56. TRUE

57. FALSE

58. FALSE

59. A

60. A

61. A

62. B

63. E

64. C

65. B

66. D

67. B

68. B

69. D

70. B

71. C

72. B

73. D

74. D

75. A

76. A

77. B

78. A

79. C

80. C

81. B

82. E

83. E

84. B

85. E

86. D

87. B

88. A

89. A

90. C

91. D

92. A

93. B

94. B

95. C

96. C

97. D

98. B

99. B

100. C

101. D

102. B

103. C

104. B

105. B

106. A

107. D

108. B

109. A

110. A

111. C

112. E

113. C

114. A

115. C

116. B

117. E

118. D

119. E

120. C

121. Wyatt recognizes dividend income of $30,000 (the amount of E & P distributed). In addition, he reduces his stock basis from $8,000 to zero and

recognizes a taxable capital gain of $2,000 (the excess of the distribution over the stock basis).

122. Anne and Tom each have dividend income of $195,000 {[$300,000 (Tulips accumulated E & P) + $90,000 (Tulips current E & P)] 2}. The remaining $210,000 distributed reduces the basis in Tulip stock, with the excess treated as capital gain. Thus, Anne reduces her stock basis to zero

and has a capital gain of $40,000 [($210,000 distribution in excess of E & P 2) $65,000 basis]. Tom reduces his stock basis to $15,000 [$120,000

basis ($210,000 distribution in excess of E & P 2)].

123.

a. Because Daisy is the sole shareholder of Ostrich, it has a 100% dividends received deduction on the $4 million cash distribution. Thus,

Daisy Corporation is not taxed on the $4 million distribution, and it has a gain on the sale of its stock in Ostrich of $1 million [$26 million

(sales price) $25 million (stock basis)].

b. If Daisy had sold the stock for $30 million, Daisy would have a taxable gain on the sale of $5 million [$30 million (sales price) $25 million (stock basis)].

124. The $160,000 in current E & P is allocated pro rata to the two distributions made during the year; thus, $120,000 is allocated to Ashley and

$40,000 is allocated to Matt. As accumulated E & P is applied in chronological order, it is allocated entirely to Ashley. Consequently, of the

$270,000 distribution to Ashley on March 31, $210,000 is taxed as dividend income [$90,000 (accumulated E & P) + $120,000 (current E & P)] and

the remaining $60,000 reduces her stock basis to $140,000. She then recognizes a capital gain of $860,000 on the sale of her stock [$1 million (sales

price) $140,000 (remaining stock basis)]. As to the $90,000 distribution to Matt, $40,000 is taxed as a dividend (from current E & P) and the remaining $50,000 reduces his basis to $950,000 [$1 million (original basis) $50,000 (return of capital)].

125.

Taxable income $150,000

Current year capital loss (65,000)

Federal income tax (41,750)

Nondeductible meals and entertainment expenses (18,000)

LIFO recapture adjustment 3,000

Domestic production activities deduction 1,500

Current E & P $ 29,750

126. As a result of the distribution, Kathleen has a taxable dividend of $100,000 [$150,000 (fair market value) $50,000 (liability)].The basis of the property to Kathleen is its fair market value, or $150,000.

127. Losses on distributed property are not recognized at the corporate level, so there is no impact on Cormorants taxable income. Because there is sufficient current E & P to cover the distribution, Sylvia has a taxable dividend of $36,000 and her basis in the diamond is also $36,000. The

distribution reflects poor tax planning by Cormorant because the built-in $4,000 loss on the diamond ($36,000 fair market value $40,000 adjusted basis) has been wasted. If Cormorant had sold the diamond for its $36,000 fair market value, it could have recognized the loss. The $36,000 cash

received from the sale would be distributed to Sylvia instead.

128. The corporation recognizes gain of $30,000 [$110,000 (liability) $80,000 (adjusted basis)]. The $30,000 gain increases the corporations current E & P from $50,000 to $80,000. Because the liability exceeds the fair market value of the property, the distribution itself will not impact

E & P. Henry has no taxable income because the liability exceeds the fair market value of the property received. Henrys basis in the office building is its fair market value, or $100,000.

129. Scarlets E & P is increased by the $20,000 gain [$40,000 (fair market value) $20,000 (adjusted basis)] and decreased by the $40,000 fair market value of the distribution. Frank has dividend income of $40,000.

130.

a. Taxable income $240,000

Net operating loss carryover 50,000

Federal income tax (72,000)

Fines and kickbacks (10,000)

Life insurance premiums (22,000)

Cash surrender value of life insurance 11,000

Capital loss carryforward 30,000

Excess of MACRS depreciation over E & P depreciation 14,000

Section 179 expense (80% $18,000) 14,400

Current E & P $255,400

b. Martha has a dividend of $255,400 (the amount of the current E & P). The distributions during the year exceed current E & P by $94,600

($350,000 $255,400). Consequently, Marthas stock basis is reduced to $0 and she has a capital gain equal to the extent to which the $94,600 exceeds her stock basis ($74,000), or $20,600.

131. Stephanie should choose the $310,000 bonus instead of the $220,000 dividend because the after-tax benefit to her is greater and the after-tax

cost for Hawk is less. Stephanies after-tax benefit for the bonus is $201,500 [$310,000 (1 .35)], while her after-tax benefit for the dividend is $187,000 [$220,000 (1 .15)]. Hawk Corporations after-tax cost for the bonus is $204,600 [$310,000 bonus ($310,000 .34) taxes saved], while its after-tax cost for the dividend is $220,000 (the dividend is not deductible).

132. The gross profit percentage on the sale is 75%, computed as follows: $300,000 (gross profit) $400,000 (selling price). In 2013, Albatross

includes a long-term capital gain of $37,500 in its taxable income (75% of the $50,000 cash down payment). However, the entire gain of $300,000

increases E & P in 2013. Thus, to compute E & P, taxable income will be increased by the $262,500 gain not already recognized ($300,000 total

gain less $37,500 gain recognized in 2013). In 2014, Albatross Corporation again includes a long-term capital gain of $37,500 in taxable income

(75% of the $50,000 installment), plus ordinary interest income of $21,000. In determining its 2014 E & P, it reduces taxable income by $37,500.

133.

Taxable Income $360,000

Plus: Life insurance proceeds in excess of CSV 9,000

Less: Fines and penalties (21,000)

Current Earning & Profits $348,000

The realized gain (not recognized) on the involuntary conversion has no effect on E & P.

134. Current E & P is allocated on a pro rata basis to each distribution made during the year. Cockatoo Corporation made $800,000 of distributions

during the year. Christophers distribution represents 25% ($200,000/$800,000) of that amount. Consequently, 25% of Cockatoos current E & P, or $30,000 ($120,000 25%), is allocated to Christophers distribution. Marias distribution represents 75% ($600,000/$800,000) of total distributions. Consequently, 75% of Cockatoos current E & P, or $90,000 ($120,000 75%), is allocated to Marias distribution.

Accumulated E & P is applied in chronological order beginning with the earliest distribution.

When Marias distribution is made, Cockatoo has $590,000 of dividend-paying capacity ($500,000 of accumulated E & P plus $90,000 of current E & P). Therefore, $590,000 of Marias distribution is treated as a dividend with the balance ($10,000) being a return of capital (to the extent of her stock basis) and then a capital gain. After this distribution, Cockatoo has no accumulated E & P remaining.

When Christophers distribution is made, Cockatoo has $30,000 remaining in current E & P. Therefore, $30,000 of Christophers distribution is treated as a dividend with the balance ($170,000) being a return of capital (to the extent of his stock basis) and then a capital gain. After the

distribution to Christopher, Cockatoo has no remaining current or accumulated E & P.

135. 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 ($30,000 $30,000/$90,000) and $20,000 is allocated to Jason ($30,000 $60,000/$90,000).

As accumulated E & P is allocated in chronological order, all of Mahoganys $16,000 of accumulated E & P is allocated to Jens distribution.

Therefore, the distribution to Jen is treated as a $26,000 dividend and a $4,000 reduction in stock basis. Jasons distribution consists of a $20,000 dividend and a $40,000 reduction in stock basis. Because 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 the sale.

136. As current E & P is allocated on a pro rata basis to distributions made during the year, one-half, or $125,000 ($250,000 $260,000/$520,000), is

allocated to the March 1 distribution and one-half ($125,000) is allocated to the October 1 distribution.

The $200,000 of accumulated E & P is allocated chronologically. As a result, on March 1, Apple has $325,000 of dividend-paying capacity

($125,000 of current E & P and $200,000 of accumulated E & P). Therefore, the March 1 distribution is entirely treated as a dividend and Apple has

$65,000 of accumulated E & P remaining after the distribution.

On October 1, Apple has $190,000 of dividend-paying capacity ($125,000 of current E & P and $65,000 of accumulated E & P). So of the $260,000

distribution, $190,000 is treated as a dividend and, as a 50% shareholder, Sarahs share of this is $95,000.

Thus, of the $130,000 received by Sarah, $95,000 is a dividend distributed from E & P ($62,500 current E & P + $32,500 accumulated E & P), while

the remaining $35,000 is a nontaxable recovery of capital. Consequently, her stock basis is reduced to $75,000 ($110,000 $35,000).

137.

a. If the redemption qualifies for sale or exchange treatment, Tanya will have a long-term capital gain of $60,000 [$160,000 (amount

realized) $100,000 (stock basis)]. Her income tax liability on the $60,000 gain will be $9,000 ($60,000 15%).

b. If the redemption distribution of $160,000 does not qualify as a sale or exchange, it will be treated as dividend income and her tax liability

will be $24,000 ($160,000 15%). (The entire $160,000 will be subject to tax at the 15% rate; Tanya will have no basis offset.)

138.

a. Steve will have a capital gain of $80,000 on the redemption [$140,000 (amount realized) $60,000 (stock basis)]. Steve can offset the $30,000 capital loss carryover against the $80,000 of capital gain. His income tax liability on the remaining $50,000 gain will be

$7,500 ($50,000 15%).

b. If the redemption distribution does not qualify for sale or exchange treatment, the entire $140,000 will be taxed as a dividend at 15%,

producing a tax of $21,000. With no other capital gain transactions in the current year, Steve can deduct only $3,000 of the $30,000

capital loss carryover to offset his other (ordinary) income.

139.

a. Marina owns 1,000 shares [800 shares directly and 200 shares indirectly from Velvet Partnership (400 shares 50% partnership

interest)]. The stock attribution rules do not apply to stock held by a corporation if the shareholder owns less than 50% of the stock

in that corporation. Russell owns 700 shares [500 shares directly and 200 shares indirectly from Velvet Partnership (400 shares 50%

partnership interest)]. Velvet Partnership owns 1,700 shares (400 shares directly plus 800 shares indirectly from Marina plus 500

shares indirectly from Russell). Stock owned by a partner is deemed to be owned in full by a partnership. Yellow Corporation owns

300 shares in Hawk Corporation. There is no attribution to Yellow Corporation from Marina, a less than 50% shareholder.

b. Marina owns 1,180 shares [800 shares directly plus 200 shares indirectly from Velvet Partnership (400 shares 50% partnership

interest) plus 180 shares indirectly from Yellow Corporation (300 shares 60% shareholder interest)]. Stock owned by a corporation is

deemed to be owned proportionately by any shareholder owning 50% or more of the corporations stock.

140.

a. The redemption qualifies under 303 as a sale or exchange. The combined value of the stock in Tern Corporation and Wren Corporation

exceeds 35% of the value of the adjusted gross estate [($1.4 million + $980,000) $6,500,000 = 36.6%]. Tern and Wren stock are

combined for purposes of the 35% test since Sam owned at least 20% of the stock of each corporation. There would be no gain recognized

by Sams estate because 1014 would apply to give the stock a stepped-up basis to the date of death value [$980,000 (redemption distribution) $980,000 (stepped-up basis) = $0].

b. The estate will receive sale or exchange treatment under 303 to the extent of the death taxes and funeral and administration expenses of

$980,000. The remaining portion of the distribution would qualify as a complete termination redemption, as none of the beneficiaries own

Tern stock that could be attributed to the estate. There would be no gain recognized by the estate because 1014 would apply to give the

stock a stepped-up basis to the date of death value [$1.4 million (redemption distribution) $1.4 million (stepped-up basis) = $0].

141. The redemption qualifies under 303 as a sale or exchange. The value of the stock in Orange Corporation exceeds 35% of the value of the

adjusted gross estate [($4.1 million $9 million) = 45.6%]. A redemption to pay death taxes applies to the extent of the sum of the death taxes and funeral and administration expenses, or $2.2 million. The estates basis in the shares redeemed under 303 is $4.1 million (stepped-up basis); thus, this portion of the redemption results in no gain or loss to the estate. The remainder of the distribution ($1.9 million) must be tested under the

qualifying stock redemption provisions of 302 for sale or exchange treatment. For purposes of 302, the stock attribution rules of 318 apply and

the shares owned by Denise, the estates sole beneficiary, are deemed to be owned by the estate. As such, the estate owns (directly and indirectly) 100% of the Orange shares outstanding after the redemption and none of the 302 provisions are satisfied. The $1.9 million therefore is treated as a

dividend distribution to the estate. The estates basis in the shares not qualifying for sale or exchange treatment ($1.9 million stepped-up basis) attaches to the basis of Denises shares in Orange Corporation.

142.

a. Veronica has a long-term capital gain of $337,500 [$390,000 (amount realized) $52,500 (stock basis)]. The distribution qualifies as a disproportionate redemption under 302(b)(2). Veronica has a 50% (1,000 shares 2,000 shares) ownership interest in Ivory Corporation

before the redemption and a 39.4% (650 shares 1,650 postredemption shares) ownership interest after the redemption. Both the 50% and

the 80% [i.e., 39.4% < 40% (80% 50%)] tests are met. Veronica will have a basis of $390,000 in the land.

b. Ivory Corporation has a recognized capital gain of $210,000 [$390,000

(fair market value) $180,000 (adjusted basis)] on the distribution of the land. Gains (but not losses) are recognized in nonliquidating

distributions. In a qualifying stock redemption, E & P is reduced by no

more than the ratable share of the E & P attributable to the stock

redeemed; thus, Ivory reduces its E & P by $175,000 [$1 million E & P

17.5% (percentage of stock redeemed)].

143. Gold should recognize the loss as soon as possible and immediately thereafter make the cash distribution. For example, assume these two steps

took place on January 2. Because current E & P is a deficit, accumulated E & P is brought up to date. At the time of the distribution, the combined

E & P balance is zero [$2 million (beginning balance in E & P) $2 million (existing deficit in current E & P)], and the entire $900,000 is a return of capital. Current deficits are allocated pro rata throughout the year unless the parties can provide otherwise. Here they can.

144. The salaries paid to Richard and Rita are vulnerable to constructive dividend treatment. Neither appears to earn their salaries. Although they are

not shareholders, their relationship to Timothy is enough of a tie-in to raise the unreasonable compensation issue. There is also a problem regarding

the $300,000 salary payment to Timothy. Why is he receiving $180,000 more than Sandy when it appears they share equally in the operation of the

corporation? Forsythia Corporation has not distributed a dividend for the past five years although it has substantial E & P. The IRS might be

successful in contending the entire salaries paid to Richard and Rita are unreasonable compensation and that $180,000 of the salary paid to Timothy

is unreasonable.

145. A corporation could distribute property to a shareholder because a shareholder may want a particular piece of property held by the corporation.

Another reason might be that the corporation has low cash reserves but still wants to make a distribution to its shareholders.

The amount distributed to the shareholder is measured by the fair market value of the property on the date of distribution. Like cash, the portion of a

property distribution covered by existing E & P is a dividend, and any excess is treated as a return of capital. If the market value of the property

distributed exceeds the corporations E & P and the shareholders basis in the stock investment, a capital gain usually results. The amount distributed is reduced by any liabilities to which the distributed property is subject immediately before and immediately after the distribution and by any

liabilities of the corporation assumed by the shareholder. The basis of the distrib

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Documents

current e p

accumulated e p

computing e p

e p adjustment

excess of e p

corporations e

taxable income

extent of accumulated