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Corporate Distributions, Redemptions, and Liquidations
Solutions to Problem Materials DISCUSSION QUESTIONS
20-1 A dividend is a distribution of cash or property by a corporation to its shareholders out of current or accumulated E&P. (See p. 20-2.) Basically, E&P equals taxable income increased by nontaxable income and decreased by nondeductible expenses. Earnings and profits is similar to retained earnings, but has significant differences caused by the differences in the treatment of various items for financial accounting purposes as opposed to the items' tax treatment. (See pp. 20-2 and 20-3.) Non-taxable items, distributions, taxes, and adjustments to more closely reflect economic income also affect E&P. (See pp. 20-2 through 20-5.) Only depreciation computed under the straight-line method reduces E&P. (See p. 20-3.) Only 1=5 of the amount expensed reduces E&P. The remaining pp. 20-3 through 20-5.)
4 =5 20-2 20-3 20-4 20-5 reduces E&P at a rate of 1 =5 per year. (See 20-6 A distribution can be taxable as a dividend, even if there is a deficit in accumulated E&P, as long as there is current E&P equal to or greater than the distribution. (See p. 20-5.) The distribution amount is the face amount of cash. (See p. 20-8.) Both corporate and noncorporate shareholders report the fair market value of the property as the distribution. (See p. 20-8.) If property is distributed subject to a liability, the amount of the distribution is reduced by the liability. The basis of the property is unaffected. (See p. 20-8.) Constructive dividends are transactions between a corporation and a shareholder which are reclassed as a dividend. They arise on audit by the IRS. (See p. 20-9.) A corporation recognizes gain when it distributes property that has a value exceeding its basis. (See p. 20-8.) 20-7 20-8 20-9 20-10 20-11 20-1 20-2 Chapter 20 Corporate Distributions, Redemptions, and Liquidations 20-12 First, E&P is increased by the realized gain. Then E&P is reduced by the fair market value of the property. [See p. 20-8 and 312(b).] A stock dividend is a distribution of the issuing corporation's own stock. (See p. 20-9.) A stock dividend is taxable if the shareholder has a choice between stock and property, if it is disproportionate, or if it is paid to preferred shareholders. Distributions of convertible preferred stock also may be taxable. All other cases are nontaxable. [See pp. 20-9 and 20-10 and 305(b).] In a nontaxable dividend, the shareholder's basis is determined by an allocation of the basis of the old stock between the old and the new stock, based on relative fair market values. If the dividend is taxable, its basis equals its fair market value. (See pp. 20-10 and 20-11 and Reg. 1.307-1.) Nontaxable stock dividends do not affect E&P. Taxable stock dividends are treated as property distributions. [See p. 20-11 and 312(d)(1).] Stock rights provide the holder with the right to purchase stock at a set price during a set time period. They are treated as a stock dividend except that basis is not allocated unless the fair market value of the rights exceeds 15 percent of the value of the stock. Taxpayers may elect to allocate basis in these cases. [See p. 20-11 and 307(b)(2).] A corporation may not deduct dividends paid. (See p. 20-13.) A stock redemption is the acquisition by a corporation of its own stock. It is immaterial if the stock is canceled or held as treasury stock. [See pp. 20-13 and 20-14 and 317(b).] Redemptions will be treated as sales if they are not equivalent to a dividend, are substantially disproportionate, terminate a shareholder's interest, qualify as a partial liquidation, or are used for death taxes under 303. (See p. 20-14 and 302 and 303.) Constructive ownership is the situation in which a person is deemed to own stock owned by a related party. Related parties are family members and entities controlled by the taxpayer. (See pp. 20-18 and 20-19 and 318.) A stock redemption is a nontaxable event to the corporation. The corporation, however, must recognize gain if it uses appreciated property. The reduction in E&P depends on whether the distribution qualifies for sale treatment or is a dividend. If the redemption qualifies for sale treatment, E&P is reduced by the redeemed stock's proportionate share of E&P but not to exceed the amount of the redemption distribution. (See pp. 20-21 and 20-22 and 311 and 312.) A complete liquidation is the redemption of all of its stock by a corporation. (See p. 20-22.) Section 331 treats a liquidation as a sale of stock by the shareholders. The shareholder must recognize gain or loss equal to the difference between the net fair market value of the property received and the basis of the stock surrendered. (See p. 20-22.) A corporation generally must recognize gain and loss on the distribution of property in complete liquidation as if the property were sold for its fair market value. (See pp. 20-23 through 20-25 and 336.) The parent corporation must own at least 80 percent of the voting power and at least 80 percent of the total value of the subsidiary's stock. All property of the subsidiary must be distributed in complete cancellation of the subsidiary's stock within three years following the close of the tax year of the first distribution. (See p. 20-25.) Generally, the subsidiary's basis carries over to the parent corporation. [See pp. 20-25 and 20-26 and 334(b)(1).] The Kimbell-Diamond exception permitted the purchase of stock followed by a liquidation to be treated as the purchase of assets. Thus, the basis of the assets was the cost of the stock rather than the carryover basis. It was repealed in 1982. (See p. 20-26.) 20-13 20-14 20-15 20-16 20-17 20-18 20-19 20-20 20-21 20-22 20-23 20-24 20-25 20-26 20-27 20-28 Solutions to Problem Materials 20-3 20-29 Section 338 applies if 80 percent control is purchased within 12 months, and the Section is elected within nine and one-half months of the acquisition of control. The basis of the assets will equal the deemed purchase price of the stock. [See pp. 20-27 through 20-30 and 338(d).] PROBLEMS
20-30 Dividend Return of basis Long-term capital gain Total distribution $3,500 3,000 1,500 $8,000 A has ordinary income on the distribution only to the extent of his pro rata share of E&P. Since the distribution exceeds his share of E&P, A must reduce his basis, but not below zero. Any distribution in excess of basis is taxed as capital gain. (See Example 1 and p. 20-2.) 20-31 Taxable income Plus: Tax-exempt income Dividends-received deduction Excess depreciation NOL carryover Capital loss carryover Sub-total Less: Federal income tax Current E&P (See Exhibit 20-1 and pp. 20-2 through 20-5.) 20-32 Charitable contribution Dividends-received deduction Excess depletion Four-fifths of 179 amount Excess depreciation [$1,500 ($10,000/12 1=2)] Change $(8,000) 8,000 3,200 1,600 1,083 $ 5,883 $103,000 $ 5,000 16,000 80,000 9,000 7,000 117,000 $220,000 (23,420) $196,580 All charitable contributions are deductible in determining E&P. Therefore, the $8,000 deduction is the contribution in excess of the 10 percent limit. Only cost depletion is allowed, so percentage depletion in excess of cost must be added back: $4,000 $800 $3,200. Only 1=5 of the amount immediately expensed may be deducted under 179, therefore, 4=5 must be added back: $2,000 4=5 $1,600. Only depreciation taken under the straight-line method is allowed, so the excess must be added back. The useful life for fiveyear ACRS property is 12 years and half the annual amount is allowed in the year of purchase. Therefore, the excess depreciation would be $1,500 ($10,000 / 12 yr. 1=2) $1,083. (See Exhibit 20-1 and pp. 20-2 through 20-5.) 20-33 a. b. c. d. e. f. g. Dividend -- $10,000 all from current Dividend -- $18,000 ($15,000 from current, $3,000 from accumulated) Dividend -- $6,000 all from current Dividend -- $8,000 all from accumulated Dividend -- $8,000 all from accumulated Dividend -- $1,000 ($600 April distribution plus $400 October distribution) all from current Dividend -- $1,000 April, from accumulated [$8,000 AE&P (3 months/12 months $6,000 current loss) $6,500 AE&P] $2,500 October [$8,000 $1,000 distributed $4,500 allocated current loss ($6,000 current loss 9 months/12 months)] Note that current E&P is allocated pro rata to the distributions, whereas accumulated E&P is considered distributed chronologically. (See pp. 20-5 through 20-7.) 20-4 Chapter 20 Corporate Distributions, Redemptions, and Liquidations 20-34 a. b. c. d. B--$10,000 J--$10,000 J--$10,000 B--10,000 Recognize a $4,000 gain on the distribution of property. Increased by the corporation's recognized gain on the distribution of the press and reduced by $20,000 dividend. (See p. 20-8.) Fair market value Minus: Basis of obligation Face value of notes Less: Gross profit (20% $20,000) Basis of the obligation Gain $ 18,000 $20,000 (4,000) (16,000) $ 2,000 20-35 The note is treated as sold for its fair market value. To determine the basis of the note, the face value of the note must be reduced by the deferred gross profit. (See p. 20-8.) 20-36 a. b. c. None. $25. $5;000 (original basis divided by total shares owned). 200 Sales price Less: Basis Gain $ 7,500 (1,250) $ 6,250 (50 $150) (50 $25) Long-term* *The gain is long-term because the old shares' holding period tacks on for the new shares. (See pp. 20-9 and 20-11.) 20-37 a. b. c. None. $1,250 ($25 per share) (See computation below.) Common: Sales price Less: Basis Gain Preferred: Sales price Less: Basis Gain 11$ 4,375 (1,875) $ 2,500 $ 1,875 (625) $ 1,250 (25 $175) (25 $75) Long-term (25 $75) (25 $25) Long-term R's basis in the preferred stock is determined by the following ratio: [FMV of preferred stock/(FMV of preferred stock FMV of common stock)] the total basis in the common stock FMV preferred FMV common 50 sh $50 50 sh $150 $ 2,500 7,500 $10,000 11- $2;500 $5,000 basis $1,250 basis allocated to preferred. $10;000 The remaining $3,750 ($5,000 $1,250) is allocated to common. (See pp. 20-9 through 20-11.) Solutions to Problem Materials 20-5 20-38 a. b. c. $15,000 (100 $150). $15,000. Old: Sales price Less: Basis Loss New: Sales price Less: Basis Gain $4,500 (5,000) $ 500 $4,500 (3,750) $ 750 (25 $180) (25 $200) Long-term (25 $150) Short-term Since the stock dividend is issued on preferred stock, the dividend is taxable, using the value at date of distribution. Since she is being taxed on the FMV of the dividends, the FMV also is her basis. She now has two different holding periods and bases for the stock. (See pp. 20-9 through 20-11.) 20-39 a. b. None. Sales price Less: Basis Loss $175 (500)* $325 Long-term 11- c. d. *[(100 rights sold/1,000 rights owned) ((FMV of rights $500/FMV stock and stock rights FMV of rights $1,500 $500 1/4) $20,000 stock basis $5,000 basis allocated to the rights)] $0.50 basis per right $500 basis of rights sold. None. $19,000 [$20,000 $1,000 ($500 allocated to rights sold $500 allocated to rights exercised)] A would have no dividend income since the stock rights issued were nontaxable. When the rights were sold, A must allocate some of his basis in the stock to the rights. The basis in the rights sold would be determined as follows: Value of rights Value of stock Total $0.50 1.50 $2.00 $0:50 $5,000 basis in rights $2:00 $20,000 basis in stock ($5,000/1,000 rights $5 basis per right) 100 rights $500 basis. Basis is not allocated to rights that lapse. (See pp. 20-11 through 20-13.) 20-40 a. b. The redemption is treated as a dividend since it does not qualify as a sale under 302 (b). $3,000. Since this was not a substantially disproportionate redemption, no gain or loss is recognized and the distribution is treated as a dividend. (See pp. 20-13 through 20-17.) The redemption qualifies as a sale under 302 (b)(2). After the redemption, the shareholder owns: (1) less than 50% of the stock, and (2) less than 80% of his prior ownership. Percent owned after the redemption is 38 percent (300/800). Sales price Less: Basis Gain $800 (600) $200 (200 $3) Long-term 20-41 a. b. 11- 20-6 Chapter 20 Corporate Distributions, Redemptions, and Liquidations c. $900 (300 shares $3 per share). Since the shareholder owned 500/1,000 50% before the redemption and 300/800 38% after the redemption, he has met the 80 percent test under substantially disproportionate distributions. Therefore, the distribution will be treated as a sale. (See pp. 20-13 through 20-17.) Percentage after is 44% (400/900). Therefore it does not qualify as a sale under 302(b) and will be treated as a dividend. Dividend income of $800, assuming sufficient E&P. $1,500 (500 $3 original cost). Percentage reduction requirement: 500/1,000 50% 80% 40%, and 400/900 44%, which is greater than the required 40 percent. Now, the 80 percent test is not met, so the distribution is treated as a dividend. (See pp. 20-13 through 20-17.) 20-42 a. b. c. 20-43 The transaction will qualify as a sale under 302(b)(2). After the redemption K owns less than 50% of the stock and less than 80% of her former ownership. (See pp. 20-13 through 20-17.) Percent owned after is 50/70 71%. Since K owns actually and constructively more than 50 percent of the stock, it is treated as a dividend. (See pp. 20-13 through 20-17 and 20-18 and 20-19.) Ownership of A Directly From wife From daughter Total Ownership of BC 20% 60% 10% 90% From wife From daughter Total 50% 30% 80% 20-44 20-45 (See pp. 20-18 and 20-19 and 318.) 20-46 Percent of F Percent of DE Percent of F owned by D (See pp. 20-18 and 20-19 and 318.) 20-47 20-48 All 200 shares (See pp. 20-18 and 20-19.) a. Deemed sales price Less: Basis Gain 11b. c. Fair market value. B Corporation will be treated as if it sold its assets for $1.2 million. Since its basis is $750,000, it will recognize a gain of $450,000. The deemed sale of the equipment will be covered by 1245, resulting in $50,000 of the gain being ordinary income. $1,200,000 (300,000) $ 900,000 10% 30% 3% (See pp. 20-20 through 20-25.) 20-49 a. b. c. None. Carryover of B's basis. None. (See pp. 20-25 and 20-26.) Solutions to Problem Materials 20-7 20-50 a. b. c. None. Under 338, B is deemed to have sold its assets to itself for their fair market value. Therefore, B will have a recognized gain of $450,000. The basis is $1 million plus the tax liability that S has on the deemed sale of its assets of $153,000, for a total basis for the assets of $1,153,000. (See pp. 20-27 through 20-30.) ...
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- Spring '11