Chap018
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Chap018

Course Number: BUS 167, Fall 2012

College/University: UC Riverside

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Chapter 18 - Corporate Taxation: Nonliquidating Distributions Chapter 18 Corporate Taxation: Nonliquidating Distributions True / False Questions 1. The "double taxation" of corporate income refers to the fact that corporate income is taxed at both the entity-level and the shareholder-level. True False 2. A distribution from a corporation to a shareholder will always be treated as a dividend for tax...

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18 Chapter - Corporate Taxation: Nonliquidating Distributions Chapter 18 Corporate Taxation: Nonliquidating Distributions True / False Questions 1. The "double taxation" of corporate income refers to the fact that corporate income is taxed at both the entity-level and the shareholder-level. True False 2. A distribution from a corporation to a shareholder will always be treated as a dividend for tax purposes. True False 3. A corporation's "earnings and profits" account is equal to the company's "retained earnings" account on its balance sheet. True False 4. A distribution from a corporation to a shareholder will only be treated as a dividend for tax purposes if the distribution is paid out of current or accumulated earnings and profits. True False 5. Green Corporation has current earnings and profits of $100,000 and negative accumulated earnings and profits of $(200,000). A $50,000 distribution from Green to its sole shareholder will not be treated as a dividend because total earnings and profits is a negative $100,000. True False 6. Green Corporation has negative current earnings and profits of $100,000 and positive accumulated earnings and profits of $200,000. A $50,000 distribution from Green to its sole shareholder will be treated as a dividend because total earnings and profits is a positive $100,000. True False 18-1 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 7. The term "earnings and profits" is well-defined in the Internal Revenue Code. True False 8. Only income and deductions included on a corporation's income tax return are included in the computation of current earnings and profits. True False 9. Cedar Corporation incurs a net capital loss of $20,000 in 20X3 that cannot be deducted on its income tax return but must be carried forward to 20X4. Cedar will deduct the net capital loss in the computation of current earnings and profits for 20X3. True False 10. Terrapin Corporation incurs federal income taxes of $250,000 in 20X3. Terrapin deducts the federal income taxes in computing its current earnings and profits for 20X3. True False 11. Evergreen Corporation distributes land with a fair market value of $200,000 to its sole shareholder. Evergreen's tax basis in the land is $50,000. Assuming sufficient earnings and profits, the amount of dividend reported by the shareholder is $200,000. True False 12. Evergreen Corporation distributes land with a fair market value of $200,000 to its sole shareholder. Evergreen's tax basis in the land is $50,000. Evergreen will report a gain of $150,000 on the distribution regardless of whether its earnings and profits is positive or negative. True False 18-2 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 13. Evergreen Corporation distributes land with a fair market value of $50,000 to its sole shareholder. Evergreen's tax basis in the land is $200,000. Evergreen will report a loss of $150,000 on the distribution regardless of whether its earnings and profits is positive or negative. True False 14. Compensation recharacterized by the IRS as a dividend because it was considered "unreasonable" will affect only the income tax liability of the corporation paying the compensation. True False 15. Unreasonable compensation issues are more likely to arise in audits of privately-held corporations rather than publicly-traded corporations. True False 16. Stock dividends are always tax-free to the recipient. True False 17. The recipient of a tax-free stock dividend will have a zero tax basis in the stock. True False 18. The recipient of a taxable stock dividend will have a tax basis in the stock equal to the fair market value of the stock received. True False 19. A stock redemption is always treated as a sale or exchange for tax purposes. True False 18-3 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 20. Tammy owns 60 percent of the stock of Huron Corporation. Unrelated individuals own the remaining 40 percent. For a stock redemption to be treated as an exchange under the "substantially disproportionate" rule, Tammy must reduce her stock ownership to below 48 percent. True False 21. Brothers and sisters are considered "family" under the stock attribution rules that apply to stock redemptions. True False 22. Diego owns 30 percent of Azul Corporation. Azul Corporation owns 50 percent of Verde Corporation. Under the attribution rules applying to stock redemptions, Diego is treated as owning 15 percent of Verde Corporation. True False 23. The "family attribution" rules are automatically waived in a complete redemption of a shareholder's stock. True False 24. Battle Corporation redeems 20 percent of its stock for $100,000 in a stock redemption that is treated as an exchange by the shareholders. Battle's E&P at the date of the redemption is $200,000. Battle will reduce its earnings and profits by $100,000 as a result of the redemption. True False 25. A distribution in partial liquidation of a corporation is always treated as a sale or exchange by an individual shareholder. True False 18-4 Chapter 18 - Corporate Taxation: Nonliquidating Distributions Multiple Choice Questions 26. Which statement best describes the concept of the "double taxation" of corporation income? A. Corporate income is subject to two levels of taxation: the regular tax and the alternative minimum tax. B. Corporate income is taxed twice at the corporate level: first when earned and then a second time if appreciated property is distributed to a shareholder. C. Corporate income is taxed when earned by a C corporation and then a second time at the shareholder level when distributed as a dividend. D. Corporate income is subject to two levels of taxation: at the federal level and a second time at the state level. 27. Which of the following forms of earnings distributions would not be subject to double taxation at the corporate and shareholder level? A. Dividend B. Stock redemption C. Partial liquidation D. Compensation paid to a shareholder/employee of the corporation 28. Which of the following statements best describes the priority of the tax treatment of a distribution from a corporation to a shareholder? A. The distribution is a dividend to the extent of the corporation's earnings and profits, then a return of capital, and finally gain from sale of stock. B. The distribution is a return of capital, then a dividend to the extent of the corporation's earnings and profits, and finally gain from sale of stock. C. The distribution is a return of capital, then gain from sale of stock, and finally a dividend to the extent of the corporation's earnings and profits. D. The shareholder can elect to treat the distribution as either a dividend to the extent of the corporation's earnings and profits or a return of capital, followed by gain from sale of stock. 18-5 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 29. Which of the following statements best describes earnings and profits? A. Earnings and profits is another name for a corporation's retained earnings on its balance sheet. B. Earnings and profits is a precisely defined tax term in the Internal Revenue Code and represents a corporation's economic income. C. Earnings and profits is a partially defined tax concept in the Internal Revenue Code and represents a corporation's economic income. D. Earnings and profits is a conceptual tax concept with no definition in the Internal Revenue Code. 30. Which of the following statements best describes the role of current and accumulated earnings and profits in determining if a distribution is a dividend? A. A distribution will only be a dividend if total earnings and profits (current plus accumulated) is positive at the time of the distribution. B. A distribution can never be a dividend if current earnings and profits is negative. C. A distribution will be a dividend if current earnings and profits for the year is positive, even if accumulated earnings and profits is negative. D. A distribution will never be a dividend if current earnings and profits for the year is negative, even if accumulated earnings and profits is positive. 31. A calendar-year corporation has positive current E&P of $500 and accumulated negative E&P of $1,200. The corporation makes a $400 distribution to its sole shareholder. Which of the following statements is true? A. The distribution will not be a dividend because total earnings and profits is a negative $700. B. The distribution may be a dividend, depending on whether total earnings and profits at the date of the distribution is positive. C. The distribution will be a dividend because current earnings and profits is positive and exceeds the distribution. D. A distribution from a corporation to a shareholder is always a dividend, regardless of the balance in earnings and profits. 18-6 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 32. A calendar-year corporation has negative current E&P of $500 and accumulated positive E&P of $1,000. The corporation makes a $600 distribution to its sole shareholder. Which of the following statements is true? A. $500 of the distribution will be a dividend because total earnings and profits is $500. B. $0 of the distribution will be a dividend because current earnings and profits is negative. C. $600 of the distribution will be a dividend because accumulated earnings and profits is $1,000. D. Up to $600 of the distribution could be a dividend depending on the balance in accumulated earnings and profits on the date of the distribution. 33. Which of these items is not an adjustment to taxable income or net loss to compute current E&P? A. Dividends received deduction B. Tax-exempt income C. Net capital loss carryforward from the prior year tax return D. Refund of prior year taxes for an accrual method taxpayer 34. Grand River Corporation reported taxable income of $500,000 in 20X3 and paid federal income taxes of $170,000. Not included in the computation was a disallowed meals and entertainment expense of $2,000, tax exempt income of $1,000, and deferred gain on an installment sale of $25,000. The corporation's current earnings and profits for 20X3 would be: A. $524,000 B. $500,000 C. $354,000 D. $331,000 35. Au Sable Corporation reported taxable income of $800,000 in 20X3 and paid federal income taxes of $272,000. Not included in the computation was a disallowed penalty of $25,000, life insurance proceeds of $100,000, and an income tax refund from 20X2 of $50,000. Au Sable is an accrual basis taxpayer. The corporation's current earnings and profits for 20X3 would be: A. $875,000 B. $653,000 C. $603,000 D. $553,000 18-7 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 36. Oakland Corporation reported a net operating loss of $500,000 in 20X3 and elected to carry the loss forward to 20X4. Not included in the computation was a disallowed meals and entertainment expense of $20,000, tax exempt income of $10,000, and deferred gain on an installment sale of $250,000. The corporation's current earnings and profits for 20X3 would be: A. $(500,000) B. $(720,000) C. $(510,000) D. $(260,000) 37. Packard Corporation reported taxable income of $1,000,000 in 20X3 and paid federal income taxes of $340,000. Included in the computation was a dividends received deduction of $5,000, a net capital loss carryover from 20X2 of $10,000, and gain of $50,000 from an installment sale that took place in 20X1. The corporation's current earnings and profits for 20X3 would be: A. $1,015,000 B. $965,000 C. $675,000 D. $625,000 38. Abbot Corporation reported a net operating loss of $400,000 in 20X3, which the corporation elected to carry forward to 20X4. Included in the computation was regular depreciation of $100,000 (E&P depreciation is $40,000), first year expensing under 179 of $50,000, and a dividends received deduction of $10,000. The corporation's current earnings and profits for 20X3 would be: A. $(290,000) B. $(330,000) C. $(400,000) D. $(490,000) 18-8 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 39. Madison Corporation reported taxable income of $400,000 in 20X3 and accrued federal income taxes of $136,000. Included in the computation was regular depreciation of $200,000 (E&P depreciation is $60,000), first year expensing under 179 of $100,000, and a net capital loss carryover of $20,000 from 20X2. The corporation's current earnings and profits for 20X3 would be: A. $504,000 B. $484,000 C. $460,000 D. $424,000 40. Greenwich Corporation reported a net operating loss of $800,000 in 20X3, which the corporation elected to carry forward to 20X4. Not included in the computation was a disallowed fine of $50,000, life insurance proceeds of $500,000, and a current year charitable contribution of $10,000 that will be carried forward to 20X4. The corporation's current earnings and profits for 20X3 would be: A. $(250,000) B. $(260,000) C. $(300,000) D. $(360,000) 41. Bruin Company reports current E&P of $200,000 in 20X3 and accumulated E&P at the beginning of the year of $100,000. Bruin distributed $400,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $400,000 B. $300,000 C. $200,000 D. $100,000 42. Aztec Company reports current E&P of $200,000 in 20X3 and accumulated E&P at the beginning of the year of negative $100,000. Aztec distributed $300,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $300,000 B. $200,000 C. $100,000 D. $0 18-9 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 43. Inca Company reports current E&P of negative $100,000 in 20X3 and accumulated E&P at the beginning of the year of $200,000. Inca distributed $300,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $0 B. $100,000 C. $200,000 D. $300,000 44. Wildcat Corporation reports current E&P of negative $200,000 in 20X3 and accumulated E&P at the beginning of the year of $100,000. Wildcat distributed $300,000 to its sole shareholder on December 31, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $0 B. $100,000 C. $200,000 D. $300,000 45. Beaver Company reports current E&P of $100,000 in 20X3 and accumulated E&P at the beginning of the year of $200,000. Beaver distributed $400,000 to its sole shareholder on January 1, 20X3. The shareholder's tax basis in her stock in Beaver is $200,000. How is the distribution treated by the shareholder in 20X3? A. $400,000 dividend B. $100,000 dividend, $200,000 tax-free return of basis, and $100,000 capital gain C. $200,000 dividend and $200,000 tax-free return of basis D. $300,000 dividend and $100,000 tax-free return of basis 46. Longhorn Company reports current E&P of $100,000 in 20X3 and accumulated E&P at the beginning of the year of negative $200,000. Longhorn distributed $300,000 to its sole shareholder on January 1, 20X3. The shareholder's tax basis in his stock in Longhorn is $100,000. How is the distribution treated by the shareholder in 20X3? A. $300,000 dividend B. $100,000 dividend, $100,000 tax-free return of basis, and $100,000 capital gain C. $100,000 dividend and $200,000 tax-free return of basis D. $0 dividend, $100,000 tax-free return of basis, and $200,000 capital gain 18-10 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 47. Husker Corporation reports current E&P of negative $200,000 in 20X3 and accumulated E&P at the beginning of the year of $300,000. Husker distributed $200,000 to its sole shareholder on December 31, 20X3. The shareholder's tax basis in her stock in Husker is $50,000. How is the distribution treated by the shareholder in 20X3? A. $200,000 dividend B. $100,000 dividend, $50,000 tax-free return of basis, and $50,000 capital gain C. $100,000 dividend and $100,000 tax-free return of basis D. $0 dividend, $50,000 tax-free return of basis, and $150,000 capital gain 48. Tar Heel Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, William Roy. The land's fair market value was $100,000 and its tax and E&P basis to Tar Heel was $25,000. William assumed a mortgage attached to the land of $10,000. The tax consequences of the distribution to William in 20X3 would be: A. $100,000 dividend and a tax basis in the land of $100,000 B. $100,000 dividend and a tax basis in the land of $90,000 C. Dividend of $90,000 and a tax basis in the land of $100,000 D. Dividend of $90,000 and a tax basis in the land of $90,000 49. Cavalier Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Tom Jefferson. The land's fair market value was $200,000 and its tax and E&P basis to Cavalier was $50,000. The tax consequences of the distribution to Cavalier in 20X3 would be: A. No gain recognized and a reduction in E&P of $200,000 B. $150,000 gain recognized and a reduction in E&P of $200,000 C. $150,000 gain recognized and a reduction in E&P of $50,000 D. No gain recognized and a reduction in E&P of $50,000 18-11 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 50. Montclair Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Molly Pitcher. The land's fair market value was $200,000 and its tax and E&P basis to Montclair was $50,000. Molly assumed a liability of $25,000 attached to the land. The tax consequences of the distribution to Montclair in 20X3 would be: A. No gain recognized and a reduction in E&P of $200,000 B. $150,000 gain recognized and a reduction in E&P of $200,000 C. $150,000 gain recognized and a reduction in E&P of $175,000 D. No gain recognized and a reduction in E&P of $175,000 51. Catamount Company had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Caroline West. The land's fair market value was $200,000 and its tax and E&P basis to Catamount was $250,000. The tax consequences of the distribution to Catamount in 20X3 would be: A. No loss recognized and a reduction in E&P of $250,000 B. $50,000 loss recognized and a reduction in E&P of $250,000 C. $50,000 loss recognized and a reduction in E&P of $150,000 D. No loss recognized and a reduction in E&P of $200,000 52. Paladin Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Maria Mendez. The land's fair market value was $200,000 and its tax and E&P basis to Paladin was $250,000. Maria assumed a liability of $25,000 attached to the land. The tax consequences of the distribution to Paladin in 20X3 would be: A. No loss recognized and a reduction in E&P of $200,000 B. $50,000 loss recognized and a reduction in E&P of $200,000 C. $50,000 loss recognized and a reduction in E&P of $225,000 D. No loss recognized and a reduction in E&P of $225,000 53. Which of the following payments could be treated as a constructive dividend by the IRS? A. End-of-year bonus payment to a shareholder/employee B. Rent paid to a shareholder/lessor C. Interest paid to a shareholder/creditor D. All of the above payments could be treated as a constructive dividend by the IRS 18-12 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 54. Which of the following factors would not be considered in determining if compensation paid to a shareholder/employee is reasonable? A. The individual's duties and responsibilities B. What individuals performing in comparable capacities at other companies are paid C. Whether the corporation has a formal compensation policy D. The individual's marginal income tax rate 55. Which of the following statements is not considered a potential answer to the dividend puzzle (why do corporations pay dividends)? A. Paying dividends avoids the double taxation of corporate income B. Demanding that managers pay out dividends restricts their investment activities and forces them to adopt more efficient investment policies C. Paying dividends is a source of investor goodwill D. Dividends are a signal to the capital markets about the health of a corporation's activities 56. Which of the following stock dividends would be tax-free to the shareholder? A. A 2-for-1 stock split to all holders of common stock B. A stock dividend where the shareholder could choose between cash and stock C. A stock dividend to all holders of preferred stock D. Both A and C are tax-free to the shareholder 57. El Toro Corporation declared a common stock dividend to all shareholders of record on June 30, 20X3. Shareholders will receive 1 share of El Toro stock for each 2 shares of stock they already own. Raoul owns 300 shares of El Toro stock with a tax basis of $60 per share. The fair market value of the El Toro stock was $100 per share on June 30, 20X3. What are the tax consequences of the stock dividend to Raoul? A. $0 dividend income and a tax basis in the new stock of $100 per share B. $0 dividend income and a tax basis in the new stock of $60 per share C. $0 dividend income and a tax basis in the new stock of $20 per share D. $15,000 dividend and a tax basis in the new stock of $100 per share 18-13 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 58. Wonder Corporation declared a common stock dividend to all shareholders of record on September 30, 20X3. Shareholders will receive three shares of Wonder stock for each five shares of stock they already own. Diana owns 300 shares of Wonder stock with a tax basis of $90 per share (a total basis of $27,000). The fair market value of the Wonder stock was $180 per share on September 30, 20X3. What are the tax consequences of the stock dividend to Diana? A. $0 dividend income and a tax basis in the new stock of $180 per share B. $0 dividend income and a tax basis in the new stock of $67.50 per share C. $0 dividend income and a tax basis in the new stock of $56.25 per share D. $10,800 dividend and a tax basis in the new stock of $180 per share 59. Which of the following individuals is not considered "family" for purposes of applying the stock attribution rules to a stock redemption? A. Parents B. Grandchildren C. Grandparents D. Spouse 60. Which of the following statements is true? A. All stock redemptions are treated as exchanges for tax purposes. B. A stock redemption not treated as an exchange will automatically be treated as a taxable dividend. C. All stock redemptions are treated as dividends if received by an individual. D. A stock redemption is treated as an exchange only if it meets one of three stock ownership tests described in the Internal Revenue Code. 61. Sam owns 70 percent of the stock of Club Corporation. Unrelated individuals own the remaining 30 percent. For a stock redemption of Sam's stock to be treated as an exchange under the "substantially disproportionate" test, what percentage of Club stock must Sam own after the redemption? A. Any percentage less than 70 percent B. Any percentage less than 56 percent C. Any percentage less than 50 percent D. All stock redemptions involving individuals are treated as exchanges 18-14 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 62. Sara owns 60 percent of the stock of Lea Corporation. Unrelated individuals own the remaining 40 percent. For a stock redemption of Sara's stock to be treated as an exchange under the "substantially disproportionate" test, what percentage of Lea stock must Sara own after the redemption? A. Any percentage less than 60 percent B. Any percentage less than 50 percent C. Any percentage less than 48 percent D. All stock redemptions involving individuals are treated as exchanges 63. Comet Company is owned equally by Pat and his sister Pam, each of whom hold 100 shares in the company. Pam wants to reduce her ownership in the company, and it was decided that the company will redeem 50 of her shares for $1,000 per share on December 31, 20X3. Pam's income tax basis in each share is $500. Comet has total E&P of $250,000. What are the tax consequences to Pam as a result of the stock redemption? A. $25,000 capital gain and a tax basis in each of her remaining shares of $500. B. $25,000 capital gain and a tax basis in each of her remaining shares of $100. C. $50,000 dividend and a tax basis in each of her remaining shares of $100. D. $50,000 dividend and a tax basis in each of her remaining shares of $50. 64. Comet Company is owned equally by Pat and his sister Pam, each of whom hold 100 shares in the company. Comet redeems 50 of Pam's shares on December 31, 20X3, for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes. Comet has total E&P of $250,000 on December 31, 20X3. What are the tax consequences to Comet as a result of the stock redemption? A. No reduction in E&P as a result of the exchange. B. A reduction of $50,000 in E&P as a result of the exchange. C. A reduction of $62,500 in E&P as a result of the exchange. D. A reduction of $125,000 in E&P as a result of the exchange. 18-15 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 65. Comet Company is owned equally by Pat and his sister Pam, each of whom hold 100 shares in the company. Comet redeems 50 of Pam's shares on December 31, 20X3, for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes. Comet has total E&P of $160,000 on December 31, 20X3. What are the tax consequences to Comet as a result of the stock redemption? A. No reduction in E&P as a result of the exchange. B. A reduction of $50,000 in E&P as a result of the exchange. C. A reduction of $40,000 in E&P as a result of the exchange. D. A reduction of $80,000 in E&P as a result of the exchange. 66. Viking Corporation is owned equally by Sven and his wife Olga, each of whom hold 100 shares in the company. Viking redeemed 75 shares of Sven's stock in the company on December 31, 20X3. Viking paid Sven $2,000 per share. His income tax basis in each share is $1,000. Viking has total E&P of $500,000. What are the tax consequences to Sven as a result of the stock redemption? A. $75,000 capital gain and a tax basis in each of his remaining shares of $1,000. B. $75,000 capital gain and a tax basis in each of his remaining shares of $2,000. C. $150,000 dividend and a tax basis in each of his remaining shares of $1,000. D. $150,000 dividend and a tax basis in each of his remaining shares of $4,000. 67. Viking Corporation is owned equally by Sven and his wife Olga, each of whom hold 100 shares in the company. Viking redeemed 75 shares of Sven's stock for $2,000 per share on December 31, 20X3. Viking has total E&P of $500,000. What are the tax consequences to Viking as a result of the stock redemption? A. No reduction in E&P as a result of the exchange. B. A reduction of $150,000 in E&P as a result of the exchange. C. A reduction of $187,500 in E&P as a result of the exchange. D. A reduction of $375,000 in E&P as a result of the exchange. 68. Corona Company is owned equally by Maria, her sister Carlita, her mother Gabriella, and her grandmother Olivia, each of whom hold 100 shares in the company. Under the family attribution rules, how many shares of Corona stock is Maria deemed to own? A. 100 B. 200 C. 300 D. 400 18-16 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 69. Panda Company is owned equally by Min, her husband Bin, her sister Xiao, and her grandson, Han, each of whom hold 100 shares in the company. Under the family attribution rules, how many shares of Panda stock is Min deemed to own? A. 100 B. 200 C. 300 D. 400 70. Beltway Company is owned equally by George, his brother Thomas, and a partnership owned 50 percent by George and his father Abe. Each of the three shareholders holds 100 shares in the company. Under the 318 stock attribution rules, how many shares of Beltway stock is George deemed to own? A. 100 B. 150 C. 200 D. 300 71. Lansing Company is owned equally by Jennifer, her husband Dan, and DeWitt Corporation, which is owned 50 percent by Jennifer and her sister Jane. Each of the three shareholders holds 100 shares in the company. Under the 318 stock attribution rules, how many shares of Lansing stock is Jennifer deemed to own? A. 100 B. 200 C. 250 D. 300 72. Lansing Company is owned equally by Jennifer, her husband Dan, and DeWitt Corporation, which is owned 50 percent by Jennifer and her sister Jane. Each of the three shareholders holds 100 shares in the company. Under the 318 stock attribution rules, how many shares of Lansing stock is DeWitt Corporation deemed to own? A. 100 B. 200 C. 250 D. 300 18-17 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 73. Tammy owns 100 shares in Star Struck Corporation. The other 100 shares are owned by her husband Tommy. Which of the following statements is true? A. A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as an exchange for tax purposes. B. A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as a dividend for tax purposes if Tammy waives the family attribution rules and files a "triple i" agreement with the IRS. C. A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as an exchange if Tammy waives the family attribution rules and files a "triple i" agreement with the IRS. D. A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as a dividend if Tammy waives the family attribution rules and files a "triple i" agreement with the IRS. 74. General Inertia Corporation made a distribution of $50,000 to Henry Tiara in partial liquidation of the company on December 31, 20X3. Henry owns 500 shares (50%) of General Inertia. The distribution was in exchange for 250 shares of Henry's stock in the company. After the partial liquidation, Henry continued to own 50% of the remaining stock in General Inertia. At the time of the distribution, the shares had a fair market value of $200 per share. Henry's income tax basis in the shares was $100 per share. General Inertia had total E&P of $800,000 at the time of the distribution. What are the tax consequences to Henry as a result of the transaction? A. Henry has dividend income of $50,000 and a tax basis in his remaining shares of $100 per share. B. Henry has capital gain of $25,000 and a tax basis in his remaining shares of $100 per share. C. Henry has dividend income of $50,000 and a tax basis in his remaining shares of $200 per share. D. Henry has capital gain of $25,000 and a tax basis in his remaining shares of $200 per share. 18-18 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 75. General Inertia Corporation made a pro rata distribution of $50,000 to Tiara, Inc. in partial liquidation of the company on December 31, 20X3. Tiara, Inc. owns 500 shares (50%) of General Inertia. The distribution was in exchange for 250 shares of Tiara's stock in the company. After the partial liquidation, Tiara continued to own 50% of the remaining stock in General Inertia. At the time of the distribution, the shares had a fair market value of $200 per share. Tiara's income tax basis in the shares was $100 per share. General Inertia had total E&P of $800,000 at the time of the distribution. What amount of dividend or capital gain does Tiara recognize as a result of the transaction? A. Tiara does not recognize any dividend income or capital gain. B. Tiara recognizes capital gain of $50,000. C. Tiara recognizes dividend income of $50,000. D. Tiara recognizes capital gain of $25,000. Essay Questions 76. Superior Corporation reported taxable income of $1,000,000 in 20X3. Superior paid a dividend of $100,000 to its sole shareholder, Mary Yooper. Superior Corporation is subject to a flat rate tax of 34%. The dividend meets the requirements to be a "qualified dividend" and Mary is subject to a tax rate of 15% on the dividend. What is the total federal income tax imposed on the corporate income earned by Superior and distributed to Mary as a dividend? 18-19 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 77. Erie Corporation reported taxable income of $2,200,000 in 20X3 before any deduction for any payment to its sole shareholder and employee, LaBron Cleveland. Erie paid a bonus of $200,000 to LaBron at year-end. Erie Corporation is subject to a flat-rate tax of 34%. The bonus meets the requirements to be "reasonable" and is therefore deductible by Erie. LaBron is subject to a marginal tax rate of 35% on the bonus. What is the total federal income tax imposed on the corporate income earned by Erie and paid to LaBron as a bonus? 78. St. Clair Company reports positive current E&P of $500,000 in 20X3 and positive accumulated E&P at the beginning of the year of $400,000. St. Clair Company distributed $600,000 to its sole shareholder, Danielle Brush on December 31, 20X3. Danielle's tax basis in her St. Clair stock is $120,000. How much of the $600,000 distribution is treated as a dividend to Danielle and what is her basis in St. Clair stock after the distribution? 79. Austin Company reports positive current E&P of $200,000 and negative accumulated E&P of $300,000. Austin distributed $250,000 to its sole shareholder, Betsy Bevo, on December 31, 20X3. Betsy' tax basis in her stock is $125,000. How much of the $250,000 distribution is treated as a dividend to Betsy and what is her tax basis in Austin stock after the distribution? 18-20 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 80. Elk Company reports negative current E&P of $200,000 and positive accumulated E&P of $300,000. Elk distributed $200,000 to its sole shareholder, Barney Rubble, on December 31, 20X3. Barney's tax basis in his Elk stock is $75,000. What is the tax treatment of the distribution to Barney and what is his tax basis in Elk stock after the distribution? 81. Houghton Company reports negative current E&P of $(500,000) and negative accumulated E&P of $(800,000). Houghton distributed $100,000 to its sole shareholder, Blossom Applegate, on December 31, 20X3. Blossom's tax basis in her Houghton stock is $50,000. What is the tax treatment of the distribution to Blossom and what is her tax basis in Houghton stock after the distribution? 82. Loon, Inc. reported taxable income of $600,000 in 20X3 and paid federal income taxes of $202,000. Not included in the company's computation of taxable income is tax-exempt interest of $30,000, disallowed meals and entertainment expenses of $15,000, and disallowed expenses related to the tax-exempt income of $4,000. Loon deducted depreciation of $200,000 on its tax return. Under the alternative (E&P) depreciation method, the deduction would have been $80,000. Compute the company's current E&P for 20X3. 18-21 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 83. Orchard, Inc. reported taxable income of $800,000 in 20X3 and paid federal income taxes of $272,000. Included in the company's computation of taxable income is gain from sale of a depreciable asset of $200,000. The income tax basis of the asset was $50,000. The E&P basis of the asset using the alternative depreciation system was $75,000. Compute the company's current E&P for 20X3. 84. Walloon, Inc. reported taxable income of $1,000,000 in 20X3 and paid federal income taxes of $340,000. The company reported a capital gain from sale of investments of $150,000, which was partially offset by a $40,000 net capital loss carryover from 20X2, resulting in a net capital gain of $110,000 included in taxable income. Compute the company's current E&P for 20X3. 85. Otter Corporation reported taxable income of $400,000 from operations for 20X3. The company paid federal income taxes of $136,000 on this taxable income. During the year, the company made a distribution of land to its sole shareholder, Emmet Jugg. The land's fair market value was $50,000 and its tax and E&P basis to Otter was $30,000. Emmet assumed a mortgage attached to the land of $10,000. Any gain from the distribution will be taxed at 34%. The company had accumulated E&P of $900,000 at the beginning of the year. Compute Otter's total taxable income and federal income tax paid as a result of the distribution (assume a tax rate of 34%). Using your solution, compute Otter's current E&P for 20X3. 18-22 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 86. Ozark Corporation reported taxable income of $500,000 from operations for 20X3. During the year, the company made a distribution of land to its sole shareholder, Marcus Twain. The land's fair market value was $100,000 and its tax and E&P basis to Ozark was $125,000. Marcus assumed a mortgage attached to the land of $25,000. Ozark's tax rate is 34%. The company had accumulated E&P of $850,000 at the beginning of the year. Compute Ozark's total taxable income and federal income tax paid as a result of the distribution. Using your solution, compute Otter's accumulated E&P at January 1, 20X4. 87. Sherburne Corporation reported current earnings and profits for 20X3 of $500,000. During the year, the company made a distribution of land to its sole shareholder, Ted Bozeman. The land's fair market value was $150,000 and its tax and E&P basis to Sherburne was $100,000. Ted assumed a mortgage attached to the land of $25,000. What amount of dividend income does Ted report as a result of the distribution and what is Ted's income tax basis in the land received from Sherburne? 88. Sunapee Corporation reported taxable income of $700,000 from operations for 20X3. During the year, the company made a distribution of land to its sole shareholder, Jean McCarthy. The land's fair market value was $125,000 and its tax and E&P basis to Sunapee was $75,000. Jean assumed a mortgage attached to the land of $25,000. Sunapee's tax rate is 34%. Compute Sunapee's total taxable income and federal income tax paid as a result of the distribution. Using your solution, compute Sunapee's current E&P for 20X3. 18-23 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 89. Tappan Company pays its sole shareholder, Carlita Hill, a salary of $200,000. At the end of each year, the company pays Carlita a "bonus" equal to the difference between the corporation's taxable income for the year (before the bonus) and $75,000. For 20X3, Tappan reported pre-bonus taxable income of $800,000 and paid Carlita a bonus of $725,000. On audit, the IRS determined that individuals working in Carlita's position earned on average $300,000 per year. The company had no formal compensation policy and never paid a dividend. How much of Carlita's compensation (salary plus bonus) might the IRS recharacterize as a dividend? Assuming the IRS recharacterizes $500,000 of Carlita's bonus as a dividend, what additional income tax liability does Tappan Company face? (Ignore payroll taxes) 90. Townsend Corporation declared a 1-for-1 stock split to all common stock shareholders of record on December 31, 20X3. Townsend reported current E&P of $400,000 and accumulated E&P of $1,000,000. The total fair market value of the stock distributed was $500,000. Regina Williams owned 1,000 shares of Townsend common stock with a tax basis of $200 per share ($2,000,000 total). The fair market value of the common stock was $300 per share on December 31, 20X3. What is Regina's income tax basis in the new and existing common stock she owns in Townsend, assuming the distribution is tax-free? 18-24 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 91. Sweetwater Corporation declared a stock dividend to all common stock shareholders of record on December 31, 20X3. Shareholders will receive 1 share of Sweetwater common stock for each 5 shares of common stock they already own. Pierre Dorgan owns 500 shares of Sweetwater common stock with a tax basis of $150 per share. The fair market value of the Sweetwater common stock was $90 per share on December 31. What is Pierre's income tax basis in his new and existing common stock in Sweetwater, assuming the distribution is nontaxable? 92. Buckeye Company is owned equally by James and his brother Terrelle, each of whom own 500 shares in the company. Terrelle wants to reduce his ownership in the company, and it was decided that the company will redeem 200 of his shares for $5,000 per share on December 31, 20X3. Terrelle's income tax basis in each share is $1,000. Buckeye has current E&P of $10,000,000 and accumulated E&P of $20,000,000. What is the amount and character (capital gain or dividend) recognized by Terrelle as a result of the stock redemption? 93. Pine Creek Company is owned equally by Bob and his sister Samantha, each of whom own 1,000 shares in the company. On December 31, 20X3, Pine Creek redeemed 200 of Samantha's shares for $5,000,000 in a transaction treated as an exchange by Samantha. Pine Creek has current E&P of $10,000,000 and accumulated E&P of $30,000,000 (computed without regard to the stock redemption). Assuming Pine Creek did not make any dividend distributions during 20X3, by what amount does the company reduce its E&P as a result of the redemption? 18-25 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 94. Goose Company is owned equally by Val and her sister Eugenia, each of whom own 500 shares in the company. Val wants to reduce her ownership in the company and have the transaction treated as an exchange for tax purposes. Determine the minimum amount of stock that Goose must redeem from Val for her to treat the redemption as being "substantially disproportionate with respect to the shareholder" and receive exchange treatment. 95. Crystal, Inc. is owned equally by John and his wife Arlene, each of whom own 500 shares in the company. Arlene wants to reduce her ownership in the company, and it was decided that the company will redeem 200 of her shares for $5,000 per share on December 31, 20X3. Arlene's income tax basis in each share is $1,000. Crystal has current E&P of $1,000,000 and accumulated E&P of $3,000,000. What is the amount and character (capital gain or dividend) recognized by Arlene as a result of the stock redemption, assuming only the "substantially disproportionate with respect to the shareholder" test is applied? 96. Crescent Corporation is owned equally by George and his daughter Olympia, each of whom own 100 shares in the company. George wants to retire from the company, and it was decided that the company will redeem all 100 of his shares for $10,000 per share on December 31, 20X3. George's income tax basis in each share is $2,000. Crescent has current E&P of $1,000,000 and accumulated E&P of $5,000,000. What must George do to ensure that the redemption will be treated as an exchange? 18-26 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 97. Tiger Corporation, a privately-held company, has one class of voting common stock, of which 1,000 shares are issued and outstanding. The shares are owned as follows: How many shares of stock is Mark deemed to own under the family attribution rules in a stock redemption? 18-27 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 98. Geneva Corporation, a privately-held company, has one class of voting common stock, of which 1,000 shares are issued and outstanding. The shares are owned as follows: Madison has a 20 percent interest in the partnership. The remaining 80 percent is owned by unrelated individuals. Madison owns 40% of Packer Corporation. The other 60 percent is owned by her father. How many shares of stock is Madison deemed to own under the family attribution rules in a stock redemption? 99. Half Moon Corporation made a distribution of $300,000 to Arnold Swartz in partial liquidation of the company on December 31, 20X3. Arnold owns 100% of Half Moon Corporation (1,200 shares). The distribution was in exchange for 50% of Arnold's stock in the company (600 shares). At the time of the distribution, the shares had a fair market value of $500 per share. Arnold's income tax basis in the shares was $250 per share. Half Moon had total E&P of $2,000,000 at the time of the distribution. What is the amount and character (capital gain or dividend) of any income or gain recognized by Arnold as a result of the partial liquidation? 18-28 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 100. Yellowstone Corporation made a distribution of $300,000 to Cheney, Inc. in partial liquidation of the company on December 31, 20X3. Cheney, Inc. owns 50 percent of Yellowstone Corporation (1,000 shares). The other 50 percent is owned by an unrelated corporation. The distribution was in exchange for 50% of Cheney's stock in the company (500 shares). At the time of the distribution, the shares had a fair market value of $800 per share. Cheney's income tax basis in the shares was $500 per share. Yellowstone had total E&P of $5,000,000 at the time of the distribution. What is the amount and character (capital gain or dividend) of any income or gain recognized by Cheney as a result of the partial liquidation? 18-29 Chapter 18 - Corporate Taxation: Nonliquidating Distributions Chapter 18 Corporate Taxation: Nonliquidating Distributions Answer Key True / False Questions 1. The "double taxation" of corporate income refers to the fact that corporate income is taxed at both the entity-level and the shareholder-level. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-01 Explain the basic tax law framework that applies to property distributions from a corporation to a shareholder. Level of Difficulty: Easy 2. A distribution from a corporation to a shareholder will always be treated as a dividend for tax purposes. FALSE It could also be a return of capital or gain from sale of the stock. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Easy 3. A corporation's "earnings and profits" account is equal to the company's "retained earnings" account on its balance sheet. FALSE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Easy 18-30 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 4. A distribution from a corporation to a shareholder will only be treated as a dividend for tax purposes if the distribution is paid out of current or accumulated earnings and profits. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Easy 5. Green Corporation has current earnings and profits of $100,000 and negative accumulated earnings and profits of $(200,000). A $50,000 distribution from Green to its sole shareholder will not be treated as a dividend because total earnings and profits is a negative $100,000. FALSE The distribution will be a dividend because Green has positive current E&P. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 6. Green Corporation has negative current earnings and profits of $100,000 and positive accumulated earnings and profits of $200,000. A $50,000 distribution from Green to its sole shareholder will be treated as a dividend because total earnings and profits is a positive $100,000. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-31 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 7. The term "earnings and profits" is well-defined in the Internal Revenue Code. FALSE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Easy 8. Only income and deductions included on a corporation's income tax return are included in the computation of current earnings and profits. FALSE The computation also includes tax exempt income and nondeductible expenses. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 9. Cedar Corporation incurs a net capital loss of $20,000 in 20X3 that cannot be deducted on its income tax return but must be carried forward to 20X4. Cedar will deduct the net capital loss in the computation of current earnings and profits for 20X3. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-32 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 10. Terrapin Corporation incurs federal income taxes of $250,000 in 20X3. Terrapin deducts the federal income taxes in computing its current earnings and profits for 20X3. TRUE E&P is an after-tax computation AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 11. Evergreen Corporation distributes land with a fair market value of $200,000 to its sole shareholder. Evergreen's tax basis in the land is $50,000. Assuming sufficient earnings and profits, the amount of dividend reported by the shareholder is $200,000. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Easy 12. Evergreen Corporation distributes land with a fair market value of $200,000 to its sole shareholder. Evergreen's tax basis in the land is $50,000. Evergreen will report a gain of $150,000 on the distribution regardless of whether its earnings and profits is positive or negative. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-33 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 13. Evergreen Corporation distributes land with a fair market value of $50,000 to its sole shareholder. Evergreen's tax basis in the land is $200,000. Evergreen will report a loss of $150,000 on the distribution regardless of whether its earnings and profits is positive or negative. FALSE losses are not recognized on distributions of property. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 14. Compensation recharacterized by the IRS as a dividend because it was considered "unreasonable" will affect only the income tax liability of the corporation paying the compensation. FALSE The recipient will be eligible for a lower tax rate on the dividend and not be subject to payroll tax on the recharacterized amount. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-03 Identify situations in which a corporation may be deemed to have paid a "constructive dividend" to a shareholder. Level of Difficulty: Hard 15. Unreasonable compensation issues are more likely to arise in audits of privately-held corporations rather than publicly-traded corporations. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-03 Identify situations in which a corporation may be deemed to have paid a "constructive dividend" to a shareholder. Level of Difficulty: Medium 18-34 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 16. Stock dividends are always tax-free to the recipient. FALSE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-04 Explain the basic tax rules that apply to stock dividends. Level of Difficulty: Easy 17. The recipient of a tax-free stock dividend will have a zero tax basis in the stock. FALSE The recipient must allocate a portion of the basis from existing stock. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-04 Explain the basic tax rules that apply to stock dividends. Level of Difficulty: Easy 18. The recipient of a taxable stock dividend will have a tax basis in the stock equal to the fair market value of the stock received. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-04 Explain the basic tax rules that apply to stock dividends. Level of Difficulty: Easy 19. A stock redemption is always treated as a sale or exchange for tax purposes. FALSE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Easy 18-35 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 20. Tammy owns 60 percent of the stock of Huron Corporation. Unrelated individuals own the remaining 40 percent. For a stock redemption to be treated as an exchange under the "substantially disproportionate" rule, Tammy must reduce her stock ownership to below 48 percent. TRUE Tammy's stock ownership must be reduced below 50 percent and be less than 80 percent of her existing ownership (80% x 60% = 48%). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 21. Brothers and sisters are considered "family" under the stock attribution rules that apply to stock redemptions. FALSE Only a spouse, children, grandchildren, and parents are considered "family". AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Easy 22. Diego owns 30 percent of Azul Corporation. Azul Corporation owns 50 percent of Verde Corporation. Under the attribution rules applying to stock redemptions, Diego is treated as owning 15 percent of Verde Corporation. FALSE The corporation to shareholder attribution rule only applies if Diego owns 50 percent or more of Azul Corporation. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Hard 18-36 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 23. The "family attribution" rules are automatically waived in a complete redemption of a shareholder's stock. FALSE The shareholder must sign a "triple i" agreement with the IRS to waive the family attribution rules in a complete redemption. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 24. Battle Corporation redeems 20 percent of its stock for $100,000 in a stock redemption that is treated as an exchange by the shareholders. Battle's E&P at the date of the redemption is $200,000. Battle will reduce its earnings and profits by $100,000 as a result of the redemption. FALSE Battle reduces its E&P by the lesser of $100,000 or 20% of E&P at the date of the redemption ($40,000). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Hard 25. A distribution in partial liquidation of a corporation is always treated as a sale or exchange by an individual shareholder. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-06 Describe a partial liquidation from a stock redemption and the difference in tax consequences to the shareholders. Level of Difficulty: Medium 18-37 Chapter 18 - Corporate Taxation: Nonliquidating Distributions Multiple Choice Questions 26. Which statement best describes the concept of the "double taxation" of corporation income? A. Corporate income is subject to two levels of taxation: the regular tax and the alternative minimum tax. B. Corporate income is taxed twice at the corporate level: first when earned and then a second time if appreciated property is distributed to a shareholder. C. Corporate income is taxed when earned by a C corporation and then a second time at the shareholder level when distributed as a dividend. D. Corporate income is subject to two levels of taxation: at the federal level and a second time at the state level. The double taxation of corporate income refers to the taxation of such income at the corporate level and then at the shareholder level when such income is distributed as a dividend. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-01 Explain the basic tax law framework that applies to property distributions from a corporation to a shareholder. Level of Difficulty: Easy 27. Which of the following forms of earnings distributions would not be subject to double taxation at the corporate and shareholder level? A. Dividend B. Stock redemption C. Partial liquidation D. Compensation paid to a shareholder/employee of the corporation Compensation is deductible at the corporate level. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-01 Explain the basic tax law framework that applies to property distributions from a corporation to a shareholder. Level of Difficulty: Easy 18-38 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 28. Which of the following statements best describes the priority of the tax treatment of a distribution from a corporation to a shareholder? A. The distribution is a dividend to the extent of the corporation's earnings and profits, then a return of capital, and finally gain from sale of stock. B. The distribution is a return of capital, then a dividend to the extent of the corporation's earnings and profits, and finally gain from sale of stock. C. The distribution is a return of capital, then gain from sale of stock, and finally a dividend to the extent of the corporation's earnings and profits. D. The shareholder can elect to treat the distribution as either a dividend to the extent of the corporation's earnings and profits or a return of capital, followed by gain from sale of stock. The tax treatment is specified in 301(c). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Easy 29. Which of the following statements best describes earnings and profits? A. Earnings and profits is another name for a corporation's retained earnings on its balance sheet. B. Earnings and profits is a precisely defined tax term in the Internal Revenue Code and represents a corporation's economic income. C. Earnings and profits is a partially defined tax concept in the Internal Revenue Code and represents a corporation's economic income. D. Earnings and profits is a conceptual tax concept with no definition in the Internal Revenue Code. Earnings and profits is partially defined in the Internal Revenue Code. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Easy 18-39 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 30. Which of the following statements best describes the role of current and accumulated earnings and profits in determining if a distribution is a dividend? A. A distribution will only be a dividend if total earnings and profits (current plus accumulated) is positive at the time of the distribution. B. A distribution can never be a dividend if current earnings and profits is negative. C. A distribution will be a dividend if current earnings and profits for the year is positive, even if accumulated earnings and profits is negative. D. A distribution will never be a dividend if current earnings and profits for the year is negative, even if accumulated earnings and profits is positive. Distributions are first treated as paid out of current earnings and profits. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 31. A calendar-year corporation has positive current E&P of $500 and accumulated negative E&P of $1,200. The corporation makes a $400 distribution to its sole shareholder. Which of the following statements is true? A. The distribution will not be a dividend because total earnings and profits is a negative $700. B. The distribution may be a dividend, depending on whether total earnings and profits at the date of the distribution is positive. C. The distribution will be a dividend because current earnings and profits is positive and exceeds the distribution. D. A distribution from a corporation to a shareholder is always a dividend, regardless of the balance in earnings and profits. Distributions are first treated as paid out of current earnings and profits. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Easy 18-40 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 32. A calendar-year corporation has negative current E&P of $500 and accumulated positive E&P of $1,000. The corporation makes a $600 distribution to its sole shareholder. Which of the following statements is true? A. $500 of the distribution will be a dividend because total earnings and profits is $500. B. $0 of the distribution will be a dividend because current earnings and profits is negative. C. $600 of the distribution will be a dividend because accumulated earnings and profits is $1,000. D. Up to $600 of the distribution could be a dividend depending on the balance in accumulated earnings and profits on the date of the distribution. When current E&P is negative, the status of a distribution is determined based on accumulated E&P at the date of the distribution. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Easy 33. Which of these items is not an adjustment to taxable income or net loss to compute current E&P? A. Dividends received deduction B. Tax-exempt income C. Net capital loss carryforward from the prior year tax return D. Refund of prior year taxes for an accrual method taxpayer Refunds of prior year taxes are included in the computation of current E&P under the cash method of accounting. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-41 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 34. Grand River Corporation reported taxable income $500,000 of in 20X3 and paid federal income taxes of $170,000. Not included in the computation was a disallowed meals and entertainment expense of $2,000, tax exempt income of $1,000, and deferred gain on an installment sale of $25,000. The corporation's current earnings and profits for 20X3 would be: A. $524,000 B. $500,000 C. $354,000 D. $331,000 $500,000 - $170,000 - $2,000 + $1,000 + $25,000 = $354,000. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 35. Au Sable Corporation reported taxable income of $800,000 in 20X3 and paid federal income taxes of $272,000. Not included in the computation was a disallowed penalty of $25,000, life insurance proceeds of $100,000, and an income tax refund from 20X2 of $50,000. Au Sable is an accrual basis taxpayer. The corporation's current earnings and profits for 20X3 would be: A. $875,000 B. $653,000 C. $603,000 D. $553,000 $800,000 - $272,000 - $25,000 + $100,000 = $603,000. The refund is not added back because Au Sable is on the accrual method. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-42 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 36. Oakland Corporation reported a net operating loss of $500,000 in 20X3 and elected to carry the loss forward to 20X4. Not included in the computation was a disallowed meals and entertainment expense of $20,000, tax exempt income of $10,000, and deferred gain on an installment sale of $250,000. The corporation's current earnings and profits for 20X3 would be: A. $(500,000) B. $(720,000) C. $(510,000) D. $(260,000) $(500,000) - $20,000 + $10,000 +250,000 = $(260,000). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 37. Packard Corporation reported taxable income of $1,000,000 in 20X3 and paid federal income taxes of $340,000. Included in the computation was a dividends received deduction of $5,000, a net capital loss carryover from 20X2 of $10,000, and gain of $50,000 from an installment sale that took place in 20X1. The corporation's current earnings and profits for 20X3 would be: A. $1,015,000 B. $965,000 C. $675,000 D. $625,000 $1,000,000 - $340,000 + $5,000 + $10,000 - $50,000 = $625,000. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Hard 18-43 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 38. Abbot Corporation reported a net operating loss of $400,000 in 20X3, which the corporation elected to carry forward to 20X4. Included in the computation was regular depreciation of $100,000 (E&P depreciation is $40,000), first year expensing under 179 of $50,000, and a dividends received deduction of $10,000. The corporation's current earnings and profits for 20X3 would be: A. $(290,000) B. $(330,000) C. $(400,000) D. $(490,000) $(400,000) + $60,000 + $40,000 + $10,000 = $(290,000). The first year expensing under 179 must be capitalized and amortized over 5 years ($10,000 per year). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Hard 39. Madison Corporation reported taxable income of $400,000 in 20X3 and accrued federal income taxes of $136,000. Included in the computation was regular depreciation of $200,000 (E&P depreciation is $60,000), first year expensing under 179 of $100,000, and a net capital loss carryover of $20,000 from 20X2. The corporation's current earnings and profits for 20X3 would be: A. $504,000 B. $484,000 C. $460,000 D. $424,000 $400,000 - $136,000 + $140,000 + $80,000 + $20,000= $504,000. The first year expensing under 179 must be capitalized and amortized over 5 years ($20,000 per year). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Hard 18-44 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 40. Greenwich Corporation reported a net operating loss of $800,000 in 20X3, which the corporation elected to carry forward to 20X4. Not included in the computation was a disallowed fine of $50,000, life insurance proceeds of $500,000, and a current year charitable contribution of $10,000 that will be carried forward to 20X4. The corporation's current earnings and profits for 20X3 would be: A. $(250,000) B. $(260,000) C. $(300,000) D. $(360,000) $(800,000) - $50,000 + $500,000 - $10,000 = $(360,000). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Hard 41. Bruin Company reports current E&P of $200,000 in 20X3 and accumulated E&P at the beginning of the year of $100,000. Bruin distributed $400,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $400,000 B. $300,000 C. $200,000 D. $100,000 The distribution is a dividend to the extent of current and accumulated E&P. The tax status of the dividend is determined based on current E&P for the full year. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-45 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 42. Aztec Company reports current E&P of $200,000 in 20X3 and accumulated E&P at the beginning of the year of negative $100,000. Aztec distributed $300,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $300,000 B. $200,000 C. $100,000 D. $0 The distribution is a dividend to the extent of current and accumulated E&P. The tax status of the dividend is determined based on current E&P for the full year. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 43. Inca Company reports current E&P of negative $100,000 in 20X3 and accumulated E&P at the beginning of the year of $200,000. Inca distributed $300,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $0 B. $100,000 C. $200,000 D. $300,000 When current E&P is negative, the tax status of the dividend is determined by calculating accumulated E&P on the date of the distribution. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-46 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 44. Wildcat Corporation reports current E&P of negative $200,000 in 20X3 and accumulated E&P at the beginning of the year of $100,000. Wildcat distributed $300,000 to its sole shareholder on December 31, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $0 B. $100,000 C. $200,000 D. $300,000 When current E&P is negative, the tax status of the dividend is determined by calculating accumulated E&P on the date of the distribution. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 45. Beaver Company reports current E&P of $100,000 in 20X3 and accumulated E&P at the beginning of the year of $200,000. Beaver distributed $400,000 to its sole shareholder on January 1, 20X3. The shareholder's tax basis in her stock in Beaver is $200,000. How is the distribution treated by the shareholder in 20X3? A. $400,000 dividend B. $100,000 dividend, $200,000 tax-free return of basis, and $100,000 capital gain C. $200,000 dividend and $200,000 tax-free return of basis D. $300,000 dividend and $100,000 tax-free return of basis The distribution is a dividend to the extent of current and accumulated E&P at December 31, 20X3. The excess distribution is a tax-free return of basis because the shareholder's tax basis in her stock exceeds the distribution. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Hard 18-47 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 46. Longhorn Company reports current E&P of $100,000 in 20X3 and accumulated E&P at the beginning of the year of negative $200,000. Longhorn distributed $300,000 to its sole shareholder on January 1, 20X3. The shareholder's tax basis in his stock in Longhorn is $100,000. How is the distribution treated by the shareholder in 20X3? A. $300,000 dividend B. $100,000 dividend, $100,000 tax-free return of basis, and $100,000 capital gain C. $100,000 dividend and $200,000 tax-free return of basis D. $0 dividend, $100,000 tax-free return of basis, and $200,000 capital gain The distribution is a dividend to the extent of current E&P at December 31, 20X3. The excess $200,000 distribution is first a tax-free return of basis to the extent of the shareholder's tax basis and then capital gain. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Hard 47. Husker Corporation reports current E&P of negative $200,000 in 20X3 and accumulated E&P at the beginning of the year of $300,000. Husker distributed $200,000 to its sole shareholder on December 31, 20X3. The shareholder's tax basis in her stock in Husker is $50,000. How is the distribution treated by the shareholder in 20X3? A. $200,000 dividend B. $100,000 dividend, $50,000 tax-free return of basis, and $50,000 capital gain C. $100,000 dividend and $100,000 tax-free return of basis D. $0 dividend, $50,000 tax-free return of basis, and $150,000 capital gain When current E&P is negative, the tax status of the dividend is determined by calculating accumulated E&P on the date of the distribution. Accumulated E&P at 12/31/03 is $100,000. The remaining distribution is a tax-free return of basis, with the excess treated as capital gain. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Hard 18-48 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 48. Tar Heel Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, William Roy. The land's fair market value was $100,000 and its tax and E&P basis to Tar Heel was $25,000. William assumed a mortgage attached to the land of $10,000. The tax consequences of the distribution to William in 20X3 would be: A. $100,000 dividend and a tax basis in the land of $100,000 B. $100,000 dividend and a tax basis in the land of $90,000 C. Dividend of $90,000 and a tax basis in the land of $100,000 D. Dividend of $90,000 and a tax basis in the land of $90,000 The dividend amount is the fair market value less the liability assumed. The tax basis of the land is the fair market value. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 49. Cavalier Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Tom Jefferson. The land's fair market value was $200,000 and its tax and E&P basis to Cavalier was $50,000. The tax consequences of the distribution to Cavalier in 20X3 would be: A. No gain recognized and a reduction in E&P of $200,000 B. $150,000 gain recognized and a reduction in E&P of $200,000 C. $150,000 gain recognized and a reduction in E&P of $50,000 D. No gain recognized and a reduction in E&P of $50,000 The distributing corporation recognizes gain on the distribution, which is included in E&P, net of tax, and reduces E&P by the land's fair market value. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-49 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 50. Montclair Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Molly Pitcher. The land's fair market value was $200,000 and its tax and E&P basis to Montclair was $50,000. Molly assumed a liability of $25,000 attached to the land. The tax consequences of the distribution to Montclair in 20X3 would be: A. No gain recognized and a reduction in E&P of $200,000 B. $150,000 gain recognized and a reduction in E&P of $200,000 C. $150,000 gain recognized and a reduction in E&P of $175,000 D. No gain recognized and a reduction in E&P of $175,000 The distributing corporation recognizes gain on the distribution, which is included in E&P, net of tax, and reduces E&P by the land's fair market value less the liability assumed by the shareholder. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Hard 51. Catamount Company had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Caroline West. The land's fair market value was $200,000 and its tax and E&P basis to Catamount was $250,000. The tax consequences of the distribution to Catamount in 20X3 would be: A. No loss recognized and a reduction in E&P of $250,000 B. $50,000 loss recognized and a reduction in E&P of $250,000 C. $50,000 loss recognized and a reduction in E&P of $150,000 D. No loss recognized and a reduction in E&P of $200,000 The distributing corporation does not recognize loss on the distribution and reduces E&P by the land's E&P basis. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-50 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 52. Paladin Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Maria Mendez. The land's fair market value was $200,000 and its tax and E&P basis to Paladin was $250,000. Maria assumed a liability of $25,000 attached to the land. The tax consequences of the distribution to Paladin in 20X3 would be: A. No loss recognized and a reduction in E&P of $200,000 B. $50,000 loss recognized and a reduction in E&P of $200,000 C. $50,000 loss recognized and a reduction in E&P of $225,000 D. No loss recognized and a reduction in E&P of $225,000 The distributing corporation does not recognize loss on the distribution and reduces E&P by the land's E&P basis less the liability assumed by the shareholder. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Hard 53. Which of the following payments could be treated as a constructive dividend by the IRS? A. End-of-year bonus payment to a shareholder/employee B. Rent paid to a shareholder/lessor C. Interest paid to a shareholder/creditor D. All of the above payments could be treated as a constructive dividend by the IRS All of the payments are deductible by the corporation and could be treated as a nondeductible dividend by the IRS. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-03 Identify situations in which a corporation may be deemed to have paid a "constructive dividend" to a shareholder. Level of Difficulty: Easy 18-51 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 54. Which of the following factors would not be considered in determining if compensation paid to a shareholder/employee is reasonable? A. The individual's duties and responsibilities B. What individuals performing in comparable capacities at other companies are paid C. Whether the corporation has a formal compensation policy D. The individual's marginal income tax rate The IRS and courts do not list the individual's marginal tax rate as a factor in determining if compensation is reasonable. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-03 Identify situations in which a corporation may be deemed to have paid a "constructive dividend" to a shareholder. Level of Difficulty: Easy 55. Which of the following statements is not considered a potential answer to the dividend puzzle (why do corporations pay dividends)? A. Paying dividends avoids the double taxation of corporate income B. Demanding that managers pay out dividends restricts their investment activities and forces them to adopt more efficient investment policies C. Paying dividends is a source of investor goodwill D. Dividends are a signal to the capital markets about the health of a corporation's activities Dividends result in the double taxation of corporate income. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-03 Identify situations in which a corporation may be deemed to have paid a "constructive dividend" to a shareholder. Level of Difficulty: Medium 18-52 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 56. Which of the following stock dividends would be tax-free to the shareholder? A. A 2-for-1 stock split to all holders of common stock B. A stock dividend where the shareholder could choose between cash and stock C. A stock dividend to all holders of preferred stock D. Both A and C are tax-free to the shareholder To be tax-free, the stock dividend must be on common stock and made pro rata to all shareholders. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-04 Explain the basic tax rules that apply to stock dividends. Level of Difficulty: Medium 57. El Toro Corporation declared a common stock dividend to all shareholders of record on June 30, 20X3. Shareholders will receive 1 share of El Toro stock for each 2 shares of stock they already own. Raoul owns 300 shares of El Toro stock with a tax basis of $60 per share. The fair market value of the El Toro stock was $100 per share on June 30, 20X3. What are the tax consequences of the stock dividend to Raoul? A. $0 dividend income and a tax basis in the new stock of $100 per share B. $0 dividend income and a tax basis in the new stock of $60 per share C. $0 dividend income and a tax basis in the new stock of $20 per share D. $15,000 dividend and a tax basis in the new stock of $100 per share The stock dividend is nontaxable because it is pro rata. The tax basis of the new stock is pro rated from the tax basis of the stock on which it was paid. The tax basis = 150/450 x $60 = $20 per share. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-04 Explain the basic tax rules that apply to stock dividends. Level of Difficulty: Medium 18-53 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 58. Wonder Corporation declared a common stock dividend to all shareholders of record on September 30, 20X3. Shareholders will receive three shares of Wonder stock for each five shares of stock they already own. Diana owns 300 shares of Wonder stock with a tax basis of $90 per share (a total basis of $27,000). The fair market value of the Wonder stock was $180 per share on September 30, 20X3. What are the tax consequences of the stock dividend to Diana? A. $0 dividend income and a tax basis in the new stock of $180 per share B. $0 dividend income and a tax basis in the new stock of $67.50 per share C. $0 dividend income and a tax basis in the new stock of $56.25 per share D. $10,800 dividend and a tax basis in the new stock of $180 per share The stock dividend is nontaxable because it is pro rata. The tax basis of the new stock is pro rated from the tax basis of the stock on which it was paid. The tax basis = $27,000/480 shares = $56.25 per share. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-04 Explain the basic tax rules that apply to stock dividends. Level of Difficulty: Medium 59. Which of the following individuals is not considered "family" for purposes of applying the stock attribution rules to a stock redemption? A. Parents B. Grandchildren C. Grandparents D. Spouse Children also are considered "family" under the 318 attribution rules. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Easy 18-54 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 60. Which of the following statements is true? A. All stock redemptions are treated as exchanges for tax purposes. B. A stock redemption not treated as an exchange will automatically be treated as a taxable dividend. C. All stock redemptions are treated as dividends if received by an individual. D. A stock redemption is treated as an exchange only if it meets one of three stock ownership tests described in the Internal Revenue Code. To be an exchange, one of the stock ownership tests described in 302(b) must be satisfied. Stock redemptions not treated as exchanges are tested under 301 and could be a tax-free return of capital or gain from sale of stock. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 61. Sam owns 70 percent of the stock of Club Corporation. Unrelated individuals own the remaining 30 percent. For a stock redemption of Sam's stock to be treated as an exchange under the "substantially disproportionate" test, what percentage of Club stock must Sam own after the redemption? A. Any percentage less than 70 percent B. Any percentage less than 56 percent C. Any percentage less than 50 percent D. All stock redemptions involving individuals are treated as exchanges Under 302(b)(2), Sam must own less than the lesser of 1) 80% x 70% = 56% or 2) 50%. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 18-55 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 62. Sara owns 60 percent of the stock of Lea Corporation. Unrelated individuals own the remaining 40 percent. For a stock redemption of Sara's stock to be treated as an exchange under the "substantially disproportionate" test, what percentage of Lea stock must Sara own after the redemption? A. Any percentage less than 60 percent B. Any percentage less than 50 percent C. Any percentage less than 48 percent D. All stock redemptions involving individuals are treated as exchanges Under 302(b)(2), Sara must own less than the lesser of 1) 80% x 60% = 48% or 2) 50%. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 63. Comet Company is owned equally by Pat and his sister Pam, each of whom hold 100 shares in the company. Pam wants to reduce her ownership in the company, and it was decided that the company will redeem 50 of her shares for $1,000 per share on December 31, 20X3. Pam's income tax basis in each share is $500. Comet has total E&P of $250,000. What are the tax consequences to Pam as a result of the stock redemption? A. $25,000 capital gain and a tax basis in each of her remaining shares of $500. B. $25,000 capital gain and a tax basis in each of her remaining shares of $100. C. $50,000 dividend and a tax basis in each of her remaining shares of $100. D. $50,000 dividend and a tax basis in each of her remaining shares of $50. The redemption will be treated as an exchange because Pam meets the substantially disproportionate test (her 25% ownership after the redemption is less than 50% and less than 40%). Her remaining shares retain a basis of $500 per share. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 18-56 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 64. Comet Company is owned equally by Pat and his sister Pam, each of whom hold 100 shares in the company. Comet redeems 50 of Pam's shares on December 31, 20X3, for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes. Comet has total E&P of $250,000 on December 31, 20X3. What are the tax consequences to Comet as a result of the stock redemption? A. No reduction in E&P as a result of the exchange. B. A reduction of $50,000 in E&P as a result of the exchange. C. A reduction of $62,500 in E&P as a result of the exchange. D. A reduction of $125,000 in E&P as a result of the exchange. In a stock redemption treated as an exchange, the distributing corporation reduces E&P by the lesser of the amount paid in the redemption or the % of stock redeemed times E&P at the date of the redemption. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 65. Comet Company is owned equally by Pat and his sister Pam, each of whom hold 100 shares in the company. Comet redeems 50 of Pam's shares on December 31, 20X3, for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes. Comet has total E&P of $160,000 on December 31, 20X3. What are the tax consequences to Comet as a result of the stock redemption? A. No reduction in E&P as a result of the exchange. B. A reduction of $50,000 in E&P as a result of the exchange. C. A reduction of $40,000 in E&P as a result of the exchange. D. A reduction of $80,000 in E&P as a result of the exchange. In a stock redemption treated as an exchange, the distributing corporation reduces E&P by the lesser of the amount paid in the redemption or the % of stock redeemed times E&P at the date of the redemption. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 18-57 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 66. Viking Corporation is owned equally by Sven and his wife Olga, each of whom hold 100 shares in the company. Viking redeemed 75 shares of Sven's stock in the company on December 31, 20X3. Viking paid Sven $2,000 per share. His income tax basis in each share is $1,000. Viking has total E&P of $500,000. What are the tax consequences to Sven as a result of the stock redemption? A. $75,000 capital gain and a tax basis in each of his remaining shares of $1,000. B. $75,000 capital gain and a tax basis in each of his remaining shares of $2,000. C. $150,000 dividend and a tax basis in each of his remaining shares of $1,000. D. $150,000 dividend and a tax basis in each of his remaining shares of $4,000. The redemption will be treated as a dividend because Sven is treated as owning 100% of the corporation's stock after the redemption through his wife Olga. The exchange will be treated as a dividend of $150,000. Sven's stock basis in his redeemed shares is transferred to his remaining 25 shares ($100,000/25 = $4,000). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Hard 67. Viking Corporation is owned equally by Sven and his wife Olga, each of whom hold 100 shares in the company. Viking redeemed 75 shares of Sven's stock for $2,000 per share on December 31, 20X3. Viking has total E&P of $500,000. What are the tax consequences to Viking as a result of the stock redemption? A. No reduction in E&P as a result of the exchange. B. A reduction of $150,000 in E&P as a result of the exchange. C. A reduction of $187,500 in E&P as a result of the exchange. D. A reduction of $375,000 in E&P as a result of the exchange. The redemption will be treated as a dividend because Sven is treated as owning 100% of the corporation's stock after the redemption through his wife Olga. As a result, Viking reduces its E&P by the amount distributed. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 18-58 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 68. Corona Company is owned equally by Maria, her sister Carlita, her mother Gabriella, and her grandmother Olivia, each of whom hold 100 shares in the company. Under the family attribution rules, how many shares of Corona stock is Maria deemed to own? A. 100 B. 200 C. 300 D. 400 Maria is treated as owning the shares of her mother, but not those of her sister or grandmother. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 69. Panda Company is owned equally by Min, her husband Bin, her sister Xiao, and her grandson, Han, each of whom hold 100 shares in the company. Under the family attribution rules, how many shares of Panda stock is Min deemed to own? A. 100 B. 200 C. 300 D. 400 Min is treated as owning the shares of her husband and her grandson, but not her sister. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 18-59 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 70. Beltway Company is owned equally by George, his brother Thomas, and a partnership owned 50 percent by George and his father Abe. Each of the three shareholders holds 100 shares in the company. Under the 318 stock attribution rules, how many shares of Beltway stock is George deemed to own? A. 100 B. 150 C. 200 D. 300 George is treated as owning his pro rata shares in Beltway owned by the partnership. Under the family attribution rules, George is treated as owning 100% of the partnership. He owns his own shares plus 100% of the stock owned by the partnership. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Hard 71. Lansing Company is owned equally by Jennifer, her husband Dan, and DeWitt Corporation, which is owned 50 percent by Jennifer and her sister Jane. Each of the three shareholders holds 100 shares in the company. Under the 318 stock attribution rules, how many shares of Lansing stock is Jennifer deemed to own? A. 100 B. 200 C. 250 D. 300 Jennifer is treated as owning her husband's shares and 50% of the shares owned by the corporation. Under the family attribution rules, Jennifer is not treated as owning any of her sister's stock in the corporation. Because she owns 50% of DeWitt's stock, she is treated as owning 50 shares of Lansing through DeWitt. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Hard 18-60 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 72. Lansing Company is owned equally by Jennifer, her husband Dan, and DeWitt Corporation, which is owned 50 percent by Jennifer and her sister Jane. Each of the three shareholders holds 100 shares in the company. Under the 318 stock attribution rules, how many shares of Lansing stock is DeWitt Corporation deemed to own? A. 100 B. 200 C. 250 D. 300 DeWitt is treated as owning the stock of its 50%-or-more shareholders. DeWitt owns its own stock, Jennifer's stock, and Dan's stock attributed to Jennifer under the family attribution rules. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Hard 73. Tammy owns 100 shares in Star Struck Corporation. The other 100 shares are owned by her husband Tommy. Which of the following statements is true? A. A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as an exchange for tax purposes. B. A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as a dividend for tax purposes if Tammy waives the family attribution rules and files a "triple i" agreement with the IRS. C. A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as an exchange if Tammy waives the family attribution rules and files a "triple i" agreement with the IRS. D. A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as a dividend if Tammy waives the family attribution rules and files a "triple i" agreement with the IRS. To be treated as an exchange, Tammy must waive the family attribution rules and file a "triple i" agreement with the IRS. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 18-61 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 74. General Inertia Corporation made a distribution of $50,000 to Henry Tiara in partial liquidation of the company on December 31, 20X3. Henry owns 500 shares (50%) of General Inertia. The distribution was in exchange for 250 shares of Henry's stock in the company. After the partial liquidation, Henry continued to own 50% of the remaining stock in General Inertia. At the time of the distribution, the shares had a fair market value of $200 per share. Henry's income tax basis in the shares was $100 per share. General Inertia had total E&P of $800,000 at the time of the distribution. What are the tax consequences to Henry as a result of the transaction? A. Henry has dividend income of $50,000 and a tax basis in his remaining shares of $100 per share. B. Henry has capital gain of $25,000 and a tax basis in his remaining shares of $100 per share. C. Henry has dividend income of $50,000 and a tax basis in his remaining shares of $200 per share. D. Henry has capital gain of $25,000 and a tax basis in his remaining shares of $200 per share. Under the partial liquidation rules, an individual receives exchange treatment in the transaction. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-06 Describe a partial liquidation from a stock redemption and the difference in tax consequences to the shareholders. Level of Difficulty: Medium 18-62 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 75. General Inertia Corporation made a pro rata distribution of $50,000 to Tiara, Inc. in partial liquidation of the company on December 31, 20X3. Tiara, Inc. owns 500 shares (50%) of General Inertia. The distribution was in exchange for 250 shares of Tiara's stock in the company. After the partial liquidation, Tiara continued to own 50% of the remaining stock in General Inertia. At the time of the distribution, the shares had a fair market value of $200 per share. Tiara's income tax basis in the shares was $100 per share. General Inertia had total E&P of $800,000 at the time of the distribution. What amount of dividend or capital gain does Tiara recognize as a result of the transaction? A. Tiara does not recognize any dividend income or capital gain. B. Tiara recognizes capital gain of $50,000. C. Tiara recognizes dividend income of $50,000. D. Tiara recognizes capital gain of $25,000. Under the partial liquidation rules, a corporate shareholder tests the tax status of the distribution under the section 302(b) rules. In a pro rata distribution, Tiara's ownership in General Inertia does not change. As a result, the distribution will be treated as a dividend and eligible for the dividend received deduction. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-06 Describe a partial liquidation from a stock redemption and the difference in tax consequences to the shareholders. Level of Difficulty: Medium 18-63 Chapter 18 - Corporate Taxation: Nonliquidating Distributions Essay Questions 76. Superior Corporation reported taxable income of $1,000,000 in 20X3. Superior paid a dividend of $100,000 to its sole shareholder, Mary Yooper. Superior Corporation is subject to a flat rate tax of 34%. The dividend meets the requirements to be a "qualified dividend" and Mary is subject to a tax rate of 15% on the dividend. What is the total federal income tax imposed on the corporate income earned by Superior and distributed to Mary as a dividend? $355,000 Feedback: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-01 Explain the basic tax law framework that applies to property distributions from a corporation to a shareholder. Level of Difficulty: Easy 18-64 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 77. Erie Corporation reported taxable income of $2,200,000 in 20X3 before any deduction for any payment to its sole shareholder and employee, LaBron Cleveland. Erie paid a bonus of $200,000 to LaBron at year-end. Erie Corporation is subject to a flat-rate tax of 34%. The bonus meets the requirements to be "reasonable" and is therefore deductible by Erie. LaBron is subject to a marginal tax rate of 35% on the bonus. What is the total federal income tax imposed on the corporate income earned by Erie and paid to LaBron as a bonus? $750,000 Feedback: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-01 Explain the basic tax law framework that applies to property distributions from a corporation to a shareholder. Level of Difficulty: Easy 78. St. Clair Company reports positive current E&P of $500,000 in 20X3 and positive accumulated E&P at the beginning of the year of $400,000. St. Clair Company distributed $600,000 to its sole shareholder, Danielle Brush on December 31, 20X3. Danielle's tax basis in her St. Clair stock is $120,000. How much of the $600,000 distribution is treated as a dividend to Danielle and what is her basis in St. Clair stock after the distribution? $600,000 dividend and a tax basis of $120,000. Feedback: All $600,000 is treated as a dividend because the distribution is less than the company's total earnings and profits of $900,000. Danielle's tax basis in her Erie stock remains $120,000. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Easy 18-65 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 79. Austin Company reports positive current E&P of $200,000 and negative accumulated E&P of $300,000. Austin distributed $250,000 to its sole shareholder, Betsy Bevo, on December 31, 20X3. Betsy' tax basis in her stock is $125,000. How much of the $250,000 distribution is treated as a dividend to Betsy and what is her tax basis in Austin stock after the distribution? $200,000 dividend and a tax basis in Austin stock of $75,000. Feedback: Betsy has dividend income of $200,000, an amount equal to the company's current E&P. She reduces her tax basis in the Austin stock by $50,000, the excess of the distribution over the dividend amount. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 80. Elk Company reports negative current E&P of $200,000 and positive accumulated E&P of $300,000. Elk distributed $200,000 to its sole shareholder, Barney Rubble, on December 31, 20X3. Barney's tax basis in his Elk stock is $75,000. What is the tax treatment of the distribution to Barney and what is his tax basis in Elk stock after the distribution? $100,000 dividend income, $75,000 tax-free return of capital, $25,000 capital gain. His tax basis in the Elk stock is $0. Feedback: Barney reports a dividend of $100,000, the accumulated E&P at December 31, 20X3. The excess $100,000 distribution first reduces his basis in Elk stock, and the excess is treated as capital gain from sale of the stock. His tax basis in Elk stock is $0. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-66 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 81. Houghton Company reports negative current E&P of $(500,000) and negative accumulated E&P of $(800,000). Houghton distributed $100,000 to its sole shareholder, Blossom Applegate, on December 31, 20X3. Blossom's tax basis in her Houghton stock is $50,000. What is the tax treatment of the distribution to Blossom and what is her tax basis in Houghton stock after the distribution? $0 dividend to Blossom, $50,000 tax free return of capital, and $50,000 capital gain. Her tax basis in Houghton stock is $0. Feedback: No part of the distribution is treated as a dividend because both current and accumulated E&P are negative. The first $50,000 of the distribution is a tax free return of capital and the remaining $50,000 is treated as gain from sale of stock. Her tax basis in Houghton stock is $0. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-67 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 82. Loon, Inc. reported taxable income of $600,000 in 20X3 and paid federal income taxes of $202,000. Not included in the company's computation of taxable income is tax-exempt interest of $30,000, disallowed meals and entertainment expenses of $15,000, and disallowed expenses related to the tax-exempt income of $4,000. Loon deducted depreciation of $200,000 on its tax return. Under the alternative (E&P) depreciation method, the deduction would have been $80,000. Compute the company's current E&P for 20X3. $529,000 Feedback: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-68 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 83. Orchard, Inc. reported taxable income of $800,000 in 20X3 and paid federal income taxes of $272,000. Included in the company's computation of taxable income is gain from sale of a depreciable asset of $200,000. The income tax basis of the asset was $50,000. The E&P basis of the asset using the alternative depreciation system was $75,000. Compute the company's current E&P for 20X3. $503,000 Feedback: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-69 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 84. Walloon, Inc. reported taxable income of $1,000,000 in 20X3 and paid federal income taxes of $340,000. The company reported a capital gain from sale of investments of $150,000, which was partially offset by a $40,000 net capital loss carryover from 20X2, resulting in a net capital gain of $110,000 included in taxable income. Compute the company's current E&P for 20X3. $700,000 Feedback: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Easy 18-70 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 85. Otter Corporation reported taxable income of $400,000 from operations for 20X3. The company paid federal income taxes of $136,000 on this taxable income. During the year, the company made a distribution of land to its sole shareholder, Emmet Jugg. The land's fair market value was $50,000 and its tax and E&P basis to Otter was $30,000. Emmet assumed a mortgage attached to the land of $10,000. Any gain from the distribution will be taxed at 34%. The company had accumulated E&P of $900,000 at the beginning of the year. Compute Otter's total taxable income and federal income tax paid as a result of the distribution (assume a tax rate of 34%). Using your solution, compute Otter's current E&P for 20X3. $277,200 Feedback: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-71 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 86. Ozark Corporation reported taxable income of $500,000 from operations for 20X3. During the year, the company made a distribution of land to its sole shareholder, Marcus Twain. The land's fair market value was $100,000 and its tax and E&P basis to Ozark was $125,000. Marcus assumed a mortgage attached to the land of $25,000. Ozark's tax rate is 34%. The company had accumulated E&P of $850,000 at the beginning of the year. Compute Ozark's total taxable income and federal income tax paid as a result of the distribution. Using your solution, compute Otter's accumulated E&P at January 1, 20X4. $500,000 taxable income, $170,000 federal income tax, $1,080,000 accumulated E&P at the beginning of 20X3. Feedback: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Hard 18-72 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 87. Sherburne Corporation reported current earnings and profits for 20X3 of $500,000. During the year, the company made a distribution of land to its sole shareholder, Ted Bozeman. The land's fair market value was $150,000 and its tax and E&P basis to Sherburne was $100,000. Ted assumed a mortgage attached to the land of $25,000. What amount of dividend income does Ted report as a result of the distribution and what is Ted's income tax basis in the land received from Sherburne? $125,000 dividend and a tax basis of $150,000 in the land. Feedback: Ted reports dividend income of $125,000, computed as the fair market value of the land received of $150,000 less the mortgage he assumes of $25,000. Ted's income tax basis in the land equals its fair market value of $150,000. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-73 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 88. Sunapee Corporation reported taxable income of $700,000 from operations for 20X3. During the year, the company made a distribution of land to its sole shareholder, Jean McCarthy. The land's fair market value was $125,000 and its tax and E&P basis to Sunapee was $75,000. Jean assumed a mortgage attached to the land of $25,000. Sunapee's tax rate is 34%. Compute Sunapee's total taxable income and federal income tax paid as a result of the distribution. Using your solution, compute Sunapee's current E&P for 20X3. Taxable income of $750,000, federal income tax of $255,000, and current E&P of $495,000. Feedback: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount received by a shareholder. Level of Difficulty: Medium 18-74 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 89. Tappan Company pays its sole shareholder, Carlita Hill, a salary of $200,000. At the end of each year, the company pays Carlita a "bonus" equal to the difference between the corporation's taxable income for the year (before the bonus) and $75,000. For 20X3, Tappan reported pre-bonus taxable income of $800,000 and paid Carlita a bonus of $725,000. On audit, the IRS determined that individuals working in Carlita's position earned on average $300,000 per year. The company had no formal compensation policy and never paid a dividend. How much of Carlita's compensation (salary plus bonus) might the IRS recharacterize as a dividend? Assuming the IRS recharacterizes $500,000 of Carlita's bonus as a dividend, what additional income tax liability does Tappan Company face? (Ignore payroll taxes) The IRS could recharacterize $625,000 as a dividend. If the IRS recharacterizes $500,000 as a dividend, Tappan's tax liability would increase by $181,750. Feedback: The IRS could treat Carlita as receiving a constructive dividend to the extent the "bonus" is considered unreasonable compensation. The IRS could argue that the total "compensation" in excess of what an individual in Carlita's position typically receives as compensation should be recharacterized as a dividend. Carlita's compensation would be $300,000. She would report the disallowed compensation of $625,000 ($200,000 + $725,000 - $300,000) as a dividend. Tappan would be denied a deduction for the $500,000, increasing the company's taxable income from $75,000 to $575,000. The company's tax on $575,000 is $195,500. The company's tax on $75,000 is $13,750. The company would owe additional taxes of $181,750. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-03 Identify situations in which a corporation may be deemed to have paid a "constructive dividend" to a shareholder. Level of Difficulty: Medium 18-75 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 90. Townsend Corporation declared a 1-for-1 stock split to all common stock shareholders of record on December 31, 20X3. Townsend reported current E&P of $400,000 and accumulated E&P of $1,000,000. The total fair market value of the stock distributed was $500,000. Regina Williams owned 1,000 shares of Townsend common stock with a tax basis of $200 per share ($2,000,000 total). The fair market value of the common stock was $300 per share on December 31, 20X3. What is Regina's income tax basis in the new and existing common stock she owns in Townsend, assuming the distribution is tax-free? $100 per share Feedback: The new common stock is allocated part of the tax basis of the old common stock based on relative fair market value. In a 1 for 1 stock split, Regina would allocate half of the basis of the old common stock of $200 to the new common stock, making her tax basis in the old and new common stock $100 per share. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-04 Explain the basic tax rules that apply to stock dividends. Level of Difficulty: Medium 91. Sweetwater Corporation declared a stock dividend to all common stock shareholders of record on December 31, 20X3. Shareholders will receive 1 share of Sweetwater common stock for each 5 shares of common stock they already own. Pierre Dorgan owns 500 shares of Sweetwater common stock with a tax basis of $150 per share. The fair market value of the Sweetwater common stock was $90 per share on December 31. What is Pierre's income tax basis in his new and existing common stock in Sweetwater, assuming the distribution is nontaxable? $125 per share Feedback: The new stock is allocated part of the tax basis of the existing common stock based on relative fair market value. After the common stock dividend, Pierre will own 600 shares of Sweetwater common stock (500 + 500/5), each with the same fair market value. His basis in each share of common stock will be $125, computed as (500 shares x $150 basis)/600. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-04 Explain the basic tax rules that apply to stock dividends. Level of Difficulty: Medium 18-76 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 92. Buckeye Company is owned equally by James and his brother Terrelle, each of whom own 500 shares in the company. Terrelle wants to reduce his ownership in the company, and it was decided that the company will redeem 200 of his shares for $5,000 per share on December 31, 20X3. Terrelle's income tax basis in each share is $1,000. Buckeye has current E&P of $10,000,000 and accumulated E&P of $20,000,000. What is the amount and character (capital gain or dividend) recognized by Terrelle as a result of the stock redemption? $800,000 capital gain Feedback: Terrelle reduces his ownership in Buckeye Company from 50% to 37.5% (300/800). Terrelle meets the "substantially disproportionate" test to treat the redemption as an exchange. He reduces his ownership below 50%, and his ownership percentage after the redemption is less than 80% of his ownership before the redemption (80% x 50% = 40%). As a result, Terrelle recognizes a capital gain of $800,000 ($1,000,000 - $200,000). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 93. Pine Creek Company is owned equally by Bob and his sister Samantha, each of whom own 1,000 shares in the company. On December 31, 20X3, Pine Creek redeemed 200 of Samantha's shares for $5,000,000 in a transaction treated as an exchange by Samantha. Pine Creek has current E&P of $10,000,000 and accumulated E&P of $30,000,000 (computed without regard to the stock redemption). Assuming Pine Creek did not make any dividend distributions during 20X3, by what amount does the company reduce its E&P as a result of the redemption? $4,000,000 Feedback: Pine Creek reduces its accumulated E&P by the lesser of the cash distributed ($5,000,000) or the percentage of stock redeemed times accumulated E&P at the date of the redemption, after reduction by any dividends paid during the year (200/2,000 x $40,000,000 = $4,000,000). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 18-77 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 94. Goose Company is owned equally by Val and her sister Eugenia, each of whom own 500 shares in the company. Val wants to reduce her ownership in the company and have the transaction treated as an exchange for tax purposes. Determine the minimum amount of stock that Goose must redeem from Val for her to treat the redemption as being "substantially disproportionate with respect to the shareholder" and receive exchange treatment. 167 shares Feedback: Val must reduce her stock ownership in Goose below 40% as a result of the exchange. The algebraic equation to solve for the number of shares to have redeemed is (500 X)/(1,000 - X) < 40%, where X equals the number of shares redeemed. Solving for X, the number of shares to be redeemed equals 167. After a redemption of 167 shares, Val will own 333 out of 833 shares of Goose stock. 333/833 = 39.98%, which is below the required 40% threshold to have the redemption treated as an exchange for tax purposes. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Hard 95. Crystal, Inc. is owned equally by John and his wife Arlene, each of whom own 500 shares in the company. Arlene wants to reduce her ownership in the company, and it was decided that the company will redeem 200 of her shares for $5,000 per share on December 31, 20X3. Arlene's income tax basis in each share is $1,000. Crystal has current E&P of $1,000,000 and accumulated E&P of $3,000,000. What is the amount and character (capital gain or dividend) recognized by Arlene as a result of the stock redemption, assuming only the "substantially disproportionate with respect to the shareholder" test is applied? $1,000,000 dividend Feedback: Arlene reduces her direct ownership in Crystal, Inc. from 50% to 37.5% (300/800). However, under the family attribution rules, she is deemed to own the 500 shares owned by her husband, John. Her stock ownership before the exchange is 100%, and her ownership after the exchange is still 100% (800/800). Arlene fails the "substantially disproportionate" test to treat the redemption as an exchange. As a result, she recognizes a dividend of $1,000,000 ($5,000 x 200 shares). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Easy 18-78 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 96. Crescent Corporation is owned equally by George and his daughter Olympia, each of whom own 100 shares in the company. George wants to retire from the company, and it was decided that the company will redeem all 100 of his shares for $10,000 per share on December 31, 20X3. George's income tax basis in each share is $2,000. Crescent has current E&P of $1,000,000 and accumulated E&P of $5,000,000. What must George do to ensure that the redemption will be treated as an exchange? George must file a "triple i agreement" with the IRS, in which he agrees he will not acquire a prohibited interest in the next 10 years. By filing such an agreement, George can waive the family attribution rules and be treated as having a complete termination of his interest in Crescent Corporation. Feedback: A prohibited interest includes being an employee, consultant, or director. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 18-79 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 97. Tiger Corporation, a privately-held company, has one class of voting common stock, of which 1,000 shares are issued and outstanding. The shares are owned as follows: How many shares of stock is Mark deemed to own under the family attribution rules in a stock redemption? 750 Feedback: Mark is deemed to own his shares, his wife's shares, and his daughter's shares. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Medium 18-80 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 98. Geneva Corporation, a privately-held company, has one class of voting common stock, of which 1,000 shares are issued and outstanding. The shares are owned as follows: Madison has a 20 percent interest in the partnership. The remaining 80 percent is owned by unrelated individuals. Madison owns 40% of Packer Corporation. The other 60 percent is owned by her father. How many shares of stock is Madison deemed to own under the family attribution rules in a stock redemption? 800 Feedback: Madison is deemed to own her shares, her percentage ownership in the partnership's shares (50), her granddaughter's shares, and 100 percent of the corporation's shares (300). Under the family attribution rules, she is treated as owning 100 percent of the corporation. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions. Level of Difficulty: Hard 18-81 Chapter 18 - Corporate Taxation: Nonliquidating Distributions 99. Half Moon Corporation made a distribution of $300,000 to Arnold Swartz in partial liquidation of the company on December 31, 20X3. Arnold owns 100% of Half Moon Corporation (1,200 shares). The distribution was in exchange for 50% of Arnold's stock in the company (600 shares). At the time of the distribution, the shares had a fair market value of $500 per share. Arnold's income tax basis in the shares was $250 per share. Half Moon had total E&P of $2,000,000 at the time of the distribution. What is the amount and character (capital gain or dividend) of any income or gain recognized by Arnold as a result of the partial liquidation? $150,000 capital gain. Feedback: An individual receives exchange treatment on distributions in partial liquidation of stock. As a result, Arnold reports capital gain of $150,000 on the stock exchanged ($300,000 $150,000). AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-06 Describe a partial liquidation from a stock redemption and the difference in tax consequences to the shareholders. Level of Difficulty: Medium 100. Yellowstone Corporation made a distribution of $300,000 to Cheney, Inc. in partial liquidation of the company on December 31, 20X3. Cheney, Inc. owns 50 percent of Yellowstone Corporation (1,000 shares). The other 50 percent is owned by an unrelated corporation. The distribution was in exchange for 50% of Cheney's stock in the company (500 shares). At the time of the distribution, the shares had a fair market value of $800 per share. Cheney's income tax basis in the shares was $500 per share. Yellowstone had total E&P of $5,000,000 at the time of the distribution. What is the amount and character (capital gain or dividend) of any income or gain recognized by Cheney as a result of the partial liquidation? $300,000 dividend Feedback: A corporation receives dividend treatment on distributions in partial liquidation of stock. As a result, Cheney, Inc. reports a dividend of $300,000, which is eligible for an 80% dividends received deduction. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 18-06 Describe a partial liquidation from a stock redemption and the difference in tax consequences to the shareholders. Level of Difficulty: Medium 18-82
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