Chapter 1 C4:Corporate Nonliquidating Distributions
Homework Solution C4-28 a. Gross profit from operations Dividends Interest Net capital gain ($8,000 - $1,200) Gross income Minus: Administrative expenses Bad debt expense Depreciation Charitable contribution [lesser of $8,000 or 0.10 x ($85,800 - $40,000)] Dividends-received deduction (0.80 x $20,000) NOL deduction Taxable income Earnings and profits: Taxable income Plus: Municipal bond interest Life insurance proceeds Excess depreciation ($86,000 - $42,000) NOL carryover Dividends-received deduction Minus: Excess charitable contribution ($8,000 - $4,580) Penalties Taxes ($25,220 x 0.15) Current earnings and profits C4-30 Beginning of 1996: Beginning of 1997: Beginning of 1998: Beginning of 1999: $250,000 20,000 10,000 6,800 $286,800 $110,000 5,000 86,000
-201,000 85,800 -4,580 $81,220 -16,000 -40,000 25,220
$
25,220 12,000 100,000 44,000 40,000 16,000 -3,420 -450 3,783
212,000
-7,653 $229,567
($10,000) (The $2,000 distribution is a return of capital and does not affect E&P.) ($6,000) [($10,000) + ($8,000 - $4,000)] ($11,000) [($6,000) + ($5,000)] $2,000 [($11,000) + ($18,000 - $5,000)] Accumulated Current E&P E&P Stock Cash 10,000 10,000 0 8,000 4,000 4,000 0 6,000 5,000 11,000 5,000 0 13,000 2,000 10,000 10,000 4,000 4,000 2,000 2,000
1995
1996
1997
5,000 5,000 0 18,000 5,000 13,000
1998
2
C4-31 a. $60,000 dividend to Edna. DR Cash 60,000 b. CR Income 60,000 $25,000 is a dividend to Edna. $25,000 is a return of capital which reduces Edna's basis to zero; the excess $10,000 is taxable as a capital gain. DR Cash 60,000 CR Income 25,000 CR Stock 25,000 CR LTCG 10,000 Yellow's accumulated E&P as of March 1 (of a non-leap year) is $65,000 - [($36,500 / 365) x 59] = $59,100. Therefore, $59,100 is taxable as a dividend. $900 is a return of capital which reduces Edna's stock basis to $24,100. DR Cash 60,000 CR Income 59,100 CR Stock 900 $25,000 is a return of capital which reduces Edna's basis to zero; the excess $35,000 is taxable as a capital gain. DR Cash 60,000 CR Stock 25,000 CR LTCG 35,000 Current E&P $16,000 24,000 $40,000 Accumulated E&P $30,000 -0$30,000 Return of Capital $14,000 66,000 $80,000
c.
d.
C4-32
a. Date 3/1 9/1 Amount $ 60,000 90,000 $150,000 Dividend $46,000 24,000 $70,000
Indiv. Charles Donald Total
Thus, Charles has $46,000 of dividend income and a $14,000 return of capital which reduces his basis for the Pearl stock from $80,000 to $66,000. The basis reduction increases Charles's capital gain on the sale to $59,000 [$125,000 - ($80,000 $14,000)]. Donald has a $24,000 dividend and a $66,000 return of capital which reduces his stock basis at year-end from $125,000 to $59,000. b. Current Accumulated Return of Amount Indiv. Date E&P E&P Dividend Capital Charles Donald Total 3/1 9/1 $ 60,000 90,000 $150,000 $ 40,000 60,000 $100,000 $ -0-0$ -0$ 40,000 60,000 $100,000 $20,000 30,000 $50,000
The return of capital distributions reduce Charles' basis in his Pearl stock from $80,000 to $60,000 and Donald's basis from $125,000 to $95,000. This basis reduction, of course, increases Charles's capital gain on the sale to $65,000 [$125,000 ($80,000 - $20,000)]. c. Current Accumulated Return of Indiv. Date Amount E&P E&P Dividend Capital Charles Donald Total
a
3/1 9/1
$ 60,000 90,000 $150,000
$ -0-0$ -0-
$60,000a 35,700b $95,700
$60,000 35,700 $95,700
$ -054,300 $54,300
59/ 365x ($36,500) = ($5,900) E&P deficit for 1/1-2/28. Acc. E&P on 3/1 = $120,000 - $5,900 = $114,100 available.
b
243/365 x ($36,500) = ($24,300) E&P deficit for 1/1-8/31. Acc. E&P on 9/1 = $120,000 - $24,300 - $60,000 = $35,700 Charles reports a $45,000 capital gain ($125,000 - $80,000) on the stock sale since the distribution does not affect the basis for his stock. The return of capital distribution reduces Donald's basis in his stock from $125,000 to $70,700 ($125,000 - $54,300). pp. C4-7 through C4-9.
3
C4-33 a. b. c. d. Barbara receives a taxable dividend of $52,000 ($60,000 - $8,000). Barbara's basis for the land is $60,000, its FMV. Ruby Corporation recognizes a $30,000 [($52,000 net FMV + $8,000 release from liability) - $30,000] capital gain on the distribution. Ruby Corporation's E&P is increased by the $30,000 gain and decreased by the $52,000 ($60,000 FMV - $8,000 mortgage) net amount of the distribution plus the $10,200 (0.34 x $30,000) of federal income taxes imposed on the gain, or a net reduction of $32,200. pp. C4-9 through C4-11. The $20,000 cash received by Arlene is taxable as a dividend. The FMV of the land is deemed to be at least equal to the mortgage assumed by Arlene. Therefore, Arlene has received a property distribution of -0- ($60,000 FMV $60,000 liability assumed). Arlene's basis for the land is $60,000 Stowe Corporation must recognize a $45,000 ($60,000 FMV - $15,000 basis) capital gain on the distribution. Stowe Corporation's E&P is increased by the $45,000 gain and reduced by the zero ($60,000 - $60,000) net amount of the property distribution resulting in a net increase of $45,000. This increase is offset by $15,300 (0.34 x $45,000) of federal income taxes imposed on the gain and the $20,000 cash distribution for a net increase of $9,700 [$45,000 -($15,300 + $20,000)]. pp. C4-9 through C4-11. S's basis 200,000 200,000 25,000 450,000 Z Corp gain Net effect on E&P 75,000 1231 <125,000 + taxes> 75,000 1231 + (15,000 - taxes) 7,000 OI <18,000 + taxes> 300,000 <150,000 + taxes> 1250 0 291 15,000 1231 285,000 2,240 1245 <5,760 + taxes> 35,000 10,500 <24,500 + taxes> Character depends on prop underlying installment oblig. S/H Land 200,000 Div Inc 200,000
C4-34
a.
b. c. e.
C4-36. GI to Susan a) 200,000 b) 60,000 c) 25,000 d)450,000
e) 8,000 f) 35,000
8,000
JOURNAL ENTRIES Corp a) R/E 200,000 Land 1231 Gain b) R/E 60,000 Mtg 140,000 Land 1231 Gain c) R/E 25,000 Inventory OI d) R/E 450,000 Acc dep 75,000 Bldg Gain
125,000 75,000
125,000 75,000
Land 200,000 Mtg 140,000 Div. Inc 60,000
18,000 7,000
Asset 25,000 Div Inc 25,000
Bldg 450,000 Div Inc 450,000 225,000 300,000 (291 15,000 1231 285,000) Car 8,000 Div. Inc 8,000 12,000 2,240 A/R 35,000 Div Inc 35,000
e) R/E 8,000 Acc Dep 6,240 Car 1245 Gain f) R/E 35,000 A/R Gain
24,500 10,500 1231
4
C4-37 a. b. c. $220,000 ($500,000 paid - $280,000 reasonable compensation) would be nondeductible to the corporation and be a constructive dividend to Wilma. $400,000 would likely be a dividend to Harry. The net FMV of the property that was sold is $290,000 ($350,000 - $60,000). Since Wilma paid only $150,000, she has a constructive dividend of $140,000 ($290,000 - $150,000). King Corporation must recognize a total gain of $260,000 ($350,000 FMV - $90,000 basis) on the sale of a portion of the building and distribution the of the remainder of the building. Harry has a constructive dividend of $15,000 per year. King's rent expense is reduced by $15,000. Wilma has a constructive dividend of $65,000 ($250,000 - $185,000). King's basis in the land is reduced from $250,000 to $185,000. Harry and Wilma have a constructive dividend of $8,000. King's deductions for its airplane use are reduced by $8,000. pp. C4-12 through C4-14. The $200,000 in disallowed salary and bonuses will be nondeductible for Forward Corporation and taxable as a dividend to Alvin. The repayment will be deductible by Alvin. The dividend income and deduction items would represent offsetting amounts reported in the year in which the initial "salary" payment was made and the year of repayment, respectively. The hedge agreement prevents the monies from being paid to Alvin out of after-tax dollars. pp. C4-12, C4-13, C4-34 and C4-35. The stock dividend is nontaxable under Sec. 305(a). Robert's basis in each share is $909.09 ($100,000 110 shares). His gain on the sale is computed as follows: Amount received on sale $7,000.00 Minus: Basis of 5 shares (5 x $909.09) (4,545.45) Recognized gain $2,454.55 Robert's basis in his remaining shares is $909.09 each. Basis for the shares is $95,454.55 ($100,000 - $4,545.45). Robert's holding period for all shares begins in 1992 when he acquired the original 100 shares. pp. C4-14 and C4-15. Tillie recognizes no income when she receives the preferred stock. Tillie's basis in her common and preferred stock is: Basis for 100 preferred shares: $100,000 x $ 10,000 = $ 5,263.16 $190,000 Basis for 1,000 common shares: $100,000 x $180,000 = $94,736.84 $190,000 Tillie must recognize a long-term capital gain of $2,368.42 ($5,000 - $2,631.58) on the sale of one-half of the preferred stock. Tillie's basis in her common stock is $94,736.84. Tillie's basis in her remaining preferred stock is $2,631.58. Her holding period begins in 1994 when she purchased the common stock. pp. C4-14 and C4-15.
d. e. f.
C0-1
a. b.
C4-39
a. b.
c. C0-2 a.
b. c.
C4-43
Lara owns:
60 shares directly, 10 shares through LMN Partnership (0.20 x 50 shares) 70 shares through LST Partnership (0.70 x 100 shares) -0- shares through Lemon Corporation 54 shares through Lime Corporation (0.60 x 90 shares) for a total deemed shareholding of 194 shares. pp. C4-19 through C4-21. Since Paul still owns 100% of Presto Corporation's stock, the redemption is treated as a dividend under Sec. 301. Paul has a $30,000 dividend to be taxed as ordinary income. His $2,500 ($10,000 x 25/100) basis in the redeemed shares is added to his $7,500 ($10,000 - $2,500) basis in his remaining 75 shares so that his basis in the remaining 75 shares is $10,000. Presto Corporation's E&P is reduced by the amount distributed, or $30,000.
C4-44
5
C4-45 a. Ann owns 25% of the Moore stock before the redemption and 10% (30/300) after the redemption. Therefore Ann treats the redemption as a sale of stock under Sec. 302(b)(2) and must recognize a long-term capital gain of $29,400 [70 x ($600 - $180)]. Ann's remaining 30 shares have a basis of $180 per share. Beth owns 25% of the Moore stock before the redemption and 26-2/3% (80 300) after the redemption. Therefore Beth treats the redemption as a dividend distribution and must recognize dividend income of $12,000 (20 shares x $600). Beth's remaining 80 shares have a total basis of $18,000 (100 shares x $180 each), or $225 per share. Carol owns 25% of the Moore stock before the redemption and 30% (90 300) after the redemption. Therefore Carol treats the redemption as a dividend distribution and must recognize dividend income of $6,000 (10 shares x $600). Carol's remaining 90 shares have a total basis of $18,000 (100 shares x $180 each), or $200 per share. Post % < 80 % Pre Ann 30/300 < 80% * 100/400 Yes Beth 80/300 < 80% * 100/400 No Carol 80/300 < 80% * 100/400 No Ann 42000 <12600> 29,400 LTCG 5400 Beth Carol
A/R A/B Gain
Stock Basis b.
12000 Dividend OI 18000
6000 Dividend OI 18000
Ann is considered to own 50% of the Moore stock (200 400) before the redemption and 40% (120 300) after the redemption. Therefore Ann might have to treat the redemption distribution as a dividend. (It is no longer substantially disproportionate since the post-redemption ownership interest for Ann is exactly 80% of her pre-redemption ownership interest.) If so, Ann must recognize dividend income of $42,000 (70 shares x $600). Ann's remaining 30 shares have a total basis of $18,000, or $600 per share. Carol is also considered to own 50% before the redemption and 40% after the redemption and will be considered to have a dividend. Thus, the tax consequences for Beth and Carol do not change from part a. If the distribution is instead considered to be not essentially equivalent to a dividend under Sec. 302(b)(1), Ann and Carol will each report the transaction as a sale or exchange. The tax consequences to Ann will not change from part a. Carol will recognize a $4,200 long-term capital gain [($600 - $180) x 10]. Carol's basis in her remaining shares is $180 per share. pp. C4-16 through C4-24. 120/300 < 50% 120/300 < 80% * 200/400 No
Ann
Ann's distribution would be treated as a 42,000 dividend. Basis in stock = 18,000. Beth Carol - same as (a), report 12,000 dividend - 120/300 < 50% 120/300 < 80% * 200/400 No report 12,000 dividend
6
C4-50 a) Andrew Bea Carl Carl Jr Tetra Corp Pre-redemption Direct Indirect Total 20 0 20 30 7.5 37.5 25 15 40 15 25 40 10 30 40 100 S/H effect 30000 <5000> 25000 LTCG 12000 dividend 30000 <4000> 26000 LTCG 24000 <3000> 21000 LTCG Corp effect decrease E & P by 25000 25% * 100,000 decrease PIC by 5000 decrease E & P by 12000 decrease E & P by 25000 decrease PIC by 5000 24000 <6000> 18000 decrease E & P by 20,000, 20% of 100,000 decrease PIC by 4000 increase 18,000 - taxes Before redemption: 20 shares (out of 100) (20%) After redemption: -0- shares (out of 80) (0%) The redemption is either a complete termination or substantially disproportionate. (No stock is attributed from Tetra Corporation to Andrew since Andrew owns less than 50% of the Tetra stock.) Andrew must recognize a $21,000 ($24,000 - $3,000) capital gain. Excel Corporation must recognize an $18,000 gain on the distribution of the land. Its E&P is increased by $18,000 minus the $6,120 ($18,000 x 0.34) of federal income taxes attributable to the gain. The reduction for the distribution is the lesser of (1) 20% of the E&P balance [$22,376 = 0.20 x ($100,000 + $18,000 - $6,120)], or (2) the amount of the redemption distribution [$24,000]. pp. C4-16 through C429.
a)
12.5/75 < 80% * 37.5/100 Yes
b) c)
27.5/90 < 80% * 37.5/100 No 15/75 < 80% * 40/100 Yes
d) SKIP e) complete termination