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Corporate Distributions, Redemptions, and Liquidations
True or False 1. A corporation's accumulated E&P will equal its retained earnings. 2. It is possible for a corporation to pay a taxable dividend even though there is a deficit in accumulated E&P. 3. Corporations can distribute appreciated land held for investment as a dividend without recognizing any income. 4. Normally, a stock dividend is nontaxable as long as it does not change the proportionate interests of the shareholders. 5. T was granted one right for each share of stock that she owned. She was required to allocate basis to the stock rights. T was unwilling to exercise the rights to buy new stock because of the outlook for the company, and consequently they lapsed. Despite her views on the company's future, she continued to hold her original stock. She is not allowed to deduct a loss equal to the basis assigned to the rights. 6. A shareholder must allocate a portion of the basis of stock owned to stock rights received as a dividend when the rights are received. 7. A loss is deductible when stock rights acquired in a tax-free distribution are allowed to expire. 8. Stock redemptions cannot qualify as "not essentially equivalent to a dividend." 9. A redemption of voting common stock that reduces a taxpayer's ownership from 60 percent to 45 percent will qualify as a substantially disproportionate redemption. 10. A distribution in partial liquidation is not considered equivalent to a dividend if it is attributable to a genuine contraction of the corporation's business. A corporation that has ceased operating one of its businesses can redeem stock from any shareholder under the partial liquidation provision.
20-1 11. 20-2 Chapter 20 Corporate Distributions, Redemptions, and Liquidations 12. If a corporation is closely held, the stock attribution rules will prevent a stock redemption from qualifying as a complete termination of ownership. The stock attribution rules do not apply to redemptions that qualify as complete terminations of a shareholder's interest. It is possible to recognize a capital gain on the sale of stock of a corporation that Taxpayer Z controls to another corporation that Taxpayer Z controls. As a general rule, shareholders recognize capital gains and losses on the complete liquidation of a corporation. Section 336 provides that a corporation will not recognize gain on a distribution in complete liquidation. Because the law treats a corporation as having sold its assets when it distributes them in complete liquidation, the corporation will recognize solely capital gains and losses. All losses on property distributed in a complete liquidation will be recognized by the corporation. When a subsidiary is liquidated by its parent corporation, the basis of the assets transferred from the subsidiary to the parent is determined by the amount of the parent's investment in the subsidiary's stock. Section 338 permits a parent corporation to elect to treat the purchase of stock of a subsidiary as a purchase of assets "to obtain the same basis that it would have obtained had it purchased the assets directly" (fair market value). The subsidiary must liquidate if the parent elects 338. 13. 14. 15. 16. 17. 18. 19. 20. Multiple Choice 21. R received a distribution with respect to his stock during the past year. He should treat the amount received a. b. c. d. First as a nontaxable return of capital to the extent of his basis and then as a taxable dividend distribution to the extent that any E&P exist First as a taxable dividend distribution to the extent that any E&P exist and then as a nontaxable return of capital to the extent of his basis As fully taxable ordinary income without regard to his basis or the corporation's E&P As none of the above 22. Which of the following best describes accumulated earnings and profits? a. b. c. d. Retained earnings, as determined for financial accounting purposes and adjusted for distributions Accumulated taxable income of prior years, adjusted for distributions Accumulated net income, as determined for financial accounting purposes for prior years and adjusted for distributions Accumulated economic income that can be distributed without impairing capital 23. This year Q Corporation elects to expense a $10,000 asset under 179. Absent the election, the asset would have been depreciated over a five-year period. Taxable income is the starting point in calculating E&P. What adjustment will have to be made to taxable income in order to calculate E&P for the year of the 179 election? a. b. c. d. e. Increase by $4,000 Increase by $6,000 Increase by $8,000 Increase by $10,000 Taxable income will decrease. Test Bank 20-3 24. K receives a distribution from L, a calendar year corporation, of $10,000 on April 1 of the current year. L Corporation's accumulated E&P at the beginning of the current year was $10,000. L has a deficit in E&P for the current year of $12,000. The amount of dividends that K must report is a. b. c. d. $0 $4,000 $7,000 $10,000 25. JKL Corporation had a balance of $25,000 in accumulated E&P at the beginning of the year. Its current E&P for the year was $10,000. During the year, JKL made two distributions: $30,000 on June 1 and $20,000 on October 1. The distribution on October 1 represents a dividend of a. b. c. d. e. $0 $4,000 $5,000 $14,000 $25,000 26. HIJ Corporation had a balance of $100,000 in accumulated E&P at the beginning of the year. During the current year it had a deficit in current E&P of $73,000, which was attributable to poor performance throughout the year. The corporation made two distributions during the year: $60,000 on March 1 and $40,000 on December 1. How will the distributions be treated? a. b. c. d. e. A maximum of $27,000 of the distributions will be treated as a dividend. A portion of both the first and second distribution will be treated as a dividend. Only the first distribution will give rise to dividend income. Neither of the distributions will give rise to dividend income, since there are no current E&P. None of the above is true. 27. During the year, P&B Construction Corp. distributed a crane used in its business for the last six years to S, who has owned 100 percent of the stock since the corporation's inception nine years ago. The crane was worth $10,000 and had a basis of $19,000. The corporation also distributed land worth $70,000 (basis $40,000). Assuming P&B has substantial E&P, the corporation will report a. b. c. d. e. No gain or loss $30,000 gain $9,000 loss $21,000 gain None of the above 28. Which one of the following can a corporation distribute without recognizing income? a. b. c. d. Patent worth $200,000 (basis $125,000) LIFO inventory worth $30,000 (basis $20,000) Delivery truck worth $10,000 (basis $8,000) None of the above 29. Which one of the following could not be reclassified as a constructive dividend? a. b. c. d. Bargain rental of corporate property by the shareholder Personal use of corporate property by the shareholder Bargain sales of corporate property to the shareholder Bona fide loans to the shareholder from the corporation 20-4 Chapter 20 Corporate Distributions, Redemptions, and Liquidations 30. Constructive dividends arising from a payment for the shareholder's benefit have been found when the corporation paid for a. b. c. d. A shareholder's debt. A shareholder's financial and accounting services. Its own financial and accounting services. Both a. and b. 31. Which one of the following may be a nontaxable stock dividend? a. b. c. d. A dividend of preferred stock to common stockholders A disproportionate stock dividend A stock dividend when the shareholder received stock but had the option to select property or stock A dividend of common stock to preferred shareholders 32. B owns 100 shares of T Corporation common stock, which he acquired on June 1, 1998 for $800. On October 15 of this year he received a stock dividend of 25 shares of preferred worth $4 per share when the common was worth $1 per share. What is B's basis in his preferred stock? a. b. c. d. $800 $640 $400 $100 33. Shareholders who receive stock rights have which one of the following alternatives with respect to their use? a. b. c. d. e. The rights may be sold, in which case the gain or loss is measured using the basis that was assigned to the rights. The rights may be exercised, in which case any basis assigned to the rights is added to the basis of the stock acquired on exercise. The rights may lapse, in which case any basis that may have been assigned to the rights reverts back to the original stock. Both a. and b. All of the above 34. F Corporation has 100 shares of outstanding stock, all owned by J. J bought the shares 10 years ago for $20,000, or $200 per share. During the year, the corporation redeemed 10 shares of J's stock for $30,000. The corporation has current E&P of $75,000 and a deficit in accumulated earnings and profits of $200,000. J must report a. b. c. d. A capital gain of $28,000 A capital gain of $10,000 Dividend income of $28,000 Dividend income of $30,000 35. The holding that a redemption would not be considered equivalent to a dividend if there is a meaningful reduction in the shareholder's interest would most likely determine sale treatment in which of the following situations? a. b. c. d. A shareholder's interest drops from 89 percent to 70 percent. A shareholder's interest drops from 50 percent to 39 percent. A shareholder's interest drops from 59 percent to 50 percent. None of the above Test Bank 20-5 36. X owns 80 percent of the 100 shares of Y common stock outstanding. What is the minimum number of shares that Y must redeem from X for the transaction to qualify as substantially disproportionate? a. b. c. d. 17 31 45 61 37. A redemption is considered substantially disproportionate under 302 and qualifies for sale treatment if certain tests are met immediately after the redemption. These tests include a. b. c. d. The shareholder owns no less than 50 percent of the total combined voting power of all classes of voting stock. The shareholder's percentage ownership of voting stock is less than 80 percent of the shareholder's percentage ownership immediately before the redemption. The shareholder's percentage ownership of common stock is at least 80 percent of the shareholder's percentage ownership immediately before the redemption. None of the above 38. For purposes of the dividend equivalency test for partial liquidations, to meet the safe harbor provision, there must be a termination of one of two or more "qualified businesses" in which a corporation is actively engaged. A "qualified business" is a business that satisfies certain conditions. They include which one of the following? a. b. c. d. e. The corporation engages in business or investment activities. The business is conducted throughout a five-year period ending one year from the date of the distribution. None of the businesses was acquired in a taxable transaction in the five-year period before the date of the distribution. Both a. and c. Choices a., b. and c. 39. Which one of the following redemptions will not be treated as a sale? a. b. c. d. A partial liquidation with the stock redeemed from a corporate shareholder A redemption from an estate to provide cash to pay death taxes A redemption that reduces taxpayer ownership from 30 percent to 20 percent A redemption of all the stock that the taxpayer owns 40. Which one of the following is not a related party for stock attribution purposes? a. b. c. d. A controlled corporation A sister A partnership in which the taxpayer owns 20 percent A trust of which taxpayer is the sole beneficiary 41. Which one of the following statements concerning a qualified 303 redemption to pay death taxes is true? a. b. c. d. Under specified circumstances, the stock of two corporations can be aggregated to meet the 35 percent requirement. The redemption proceeds must be used for taxes, administration, or funeral expenses. Any redemptions in excess of the maximum allowed by 303 will be treated as dividends. All the above statements are false. 42. H directly owns 40 percent of X Corporation and nothing of Z Corporation. W, his wife, directly owns 30 percent of X Corporation and 15 percent of Z Corporation. X Corporation owns 20 percent of Z Corporation. How much of Z is H deemed to own? a. b. c. d. 0 percent 15 percent 29 percent 35 percent 20-6 Chapter 20 Corporate Distributions, Redemptions, and Liquidations 43. J purchased 100 shares of C Corporation's common stock in 1997 for $1,000. J purchased another 100 shares in 1999 for $10,000. In the current year, C adopts a plan of liquidation and distributes $8,000 to J as the first installment ($4,000 for each block). J's recognized gain or loss on the distribution is a. b. c. d. $3,000 loss $0 gain or loss $3,000 gain $8,000 gain 44. K Corporation has the following information for the current year. On January 15 the board of directors of K Corporation voted to adopt a plan of liquidation on February 1. On January 25 they sell land and realize a $400,000 loss. On February 15 they sell a building acquired in 1983 and depreciated under ACRS at a $200,000 gain (total depreciation recapture potential of $380,000). Both sales are to non-related parties at fair market value. K distributes all of its assets pro rata to its shareholders on December 31. On K's final tax return, it will report a. b. c. d. $400,000 loss on sale of land only No gain or loss on sale of land and building $400,000 loss on sale of land and $200,000 ordinary income on sale of building $200,000 ordinary income on sale of building only 45. R purchases all the stock of T Corporation on January 1, 2002 for $20,000. On January 1, 2011 T adopts a plan of liquidation. On January 20, 2011 T sells land with a basis of $60,000 for $45,000. On January 31, 2011 T distributes the $45,000 cash plus its only other asset, FIFO inventory with a basis of $40,000 and a fair market value of $48,000, to R. Which of the following statements is true? a. b. c. d. e. T recognizes a loss of $15,000; R recognizes a gain of $73,000 and takes inventory with a basis of $48,000. Neither T nor R recognize gain. T recognizes neither gain nor loss; R recognizes a $73,000 gain and has a basis for the inventory of $48,000. T recognizes a $15,000 loss on the sale and an $8,000 gain on the distribution; R recognizes a gain of $73,000 and has inventory with a basis of $48,000. T recognizes a $15,000 loss on the sale and an $8,000 gain on the distribution; R recognizes neither gain nor loss and has inventory with a basis of $40,000. 46. Which one of the following may a corporation distribute in complete liquidation and recognize a loss on the distribution? a. b. c. d. Land to the majority shareholder, if the land was contributed to the corporation by the recipient the previous year. Equipment to the majority shareholder that was contributed immediately before the liquidation. Inventory that is distributed pro rata. The inventory was contributed by the majority shareholder 18 months before the liquidation, when its basis exceeded its fair market value. No loss is recognized on any of the above distributions. 47. Z Corporation purchases 90 percent of B Corporation's outstanding common stock for $1 million on January 1, 1997. On June 15 of this year, B adopts a plan of liquidation and distributes assets with a fair market value of $1.2 million and a basis of $900,000 to Z. B distributes assets with a fair market value of $133,333 and a basis of $90,000 to the minority shareholders. Which one of the following is true? a. b. c. d. Z Corporation recognizes neither gain nor loss and has a basis in the assets received of $900,000. Z Corporation recognizes neither gain nor loss and has a basis in the assets received of $1 million. Z Corporation recognizes $20,000 gain and has a basis in the assets of $1 million. Z Corporation recognizes a gain of $34,333 and has a basis in the assets received of $1 million. Test Bank 20-7 48. Q Corporation had assets with a basis of $800,000 and no liabilities. P Corporation bought all the stock of Q Corporation for $1 million. Three years later, when Q Corporation's assets had shrunk to a basis of $600,000, P Corporation liquidated Q Corporation in a tax-free liquidation under 332. What is P Corporation's basis in the assets received from Q Corporation? (Assume that P Corporation's basis in its assets not received from Q Corporation at the time of liquidation of Q was $750,000.) a. b. c. d. $400,000 $800,000 $1 million $600,000 49. A Corporation owns 90 percent of the outstanding stock of B Corporation; the remaining 10 percent is owned by unrelated parties. In a liquidation pursuant to 332, B distributed and transferred property to A Corporation with a fair market value of $80,000 (basis $30,000). In addition, B distributed and transferred property to the minority shareholders worth $11,000 (basis $9,000). How much gain does B recognize? a. b. c. d. $50,000 $52,000 $2,000 $0 50. Which one of the following is a true statement concerning a valid 332 liquidation of a subsidiary? a. b. c. d. Parent corporation may own as little as 51 percent of the subsidiary's stock. Subsidiary recognizes no gain or loss on any distribution of property. The parent's basis of assets transferred from the subsidiary equals the basis of the parent's stock in the subsidiary immediately before the liquidation. All the statements are false. 51. What are the provisions of 338 for avoiding the abuses under Kimbell-Diamond? a. b. c. d. Stock purchases must be treated as a purchase of assets. A subsidiary must be acknowledged to have been acquired with the intent to obtain its assets. It is required that the subsidiary actually be liquidated. None of the above 52. Which one of the following statements about a 338 (Kimbell-Diamond exception) election is false? a. b. c. d. It is not necessary for the subsidiary to liquidate. The subsidiary will be required to recognize gains and losses. The subsidiary will adjust the basis of its assets to equal the adjusted cost of its stock to parent corporation. All the statements are true. 53. If 338 is elected, assets are grouped into five classes to allocate the deemed purchase price. The method of establishing the value of Class V--intangible assets in the nature of goodwill or going concern value--is a. b. c. d. e. To determine the fair market value by appraisal on election date To assign 20 percent of fair market value to intangible assets according to the 20 percent allocation rule To assign what remains, after fair market value allocations to the three other classes, to intangible asset value None of the above All of the above 20-8 Chapter 20 Corporate Distributions, Redemptions, and Liquidations 54. The term grossed-up basis a. b. Refers to adjustment of the deemed price of a subsidiary corporation for a minority interest when a parent corporation owns less than 100 percent of the subsidiary and elects 338 Is obtained by the following formula: Grossed up basis Parent corporation's basis in subsidiary's stock on the acquisition date % of subsidiary's stock held by parent on the acquisition date 100% c. d. 55. Requires that the parent corporation purchase at least 90 percent of the subsidiary's stock (except nonvoting, nonparticipating, preferred stock) Is characterized by all of the above H Corporation purchased 55 percent of J Corporation's stock on April 5, 2011 and the remaining 45 percent on July 28, 2011. The time known as the consistency period under provisions of 338 runs from April 5, 2010 through July 28, 2012. If H purchases any assets of J during this period, other than in the ordinary course of business, a. b. c. d. Their value is deemed to be determined by carryover of the subsidiary's basis to the parent corporation. Under the consistency rule, provisions of 332 must govern the determination of their value. H is deemed to have made a 338 election to treat the stock purchase as an acquisition of assets, thus precluding a carryover basis. None of the above apply. 20
Corporate Distributions, Redemptions, and Liquidations
Solutions to Test Bank
True or False 1. False. Accumulated E&P will differ from retained earnings due to the different treatment of various items for financial accounting purposes as opposed to an item's tax treatment. (See pp. 20-2 and 20-3 and 312.) 2. True. The distribution is treated as coming out of current E&P first. [See p. 20-5 and Reg. 1.316-2(a).] 3. False. Under 311, corporations will recognize gain. (See p. 20-8 and 311.) 4. True. Since the shareholder's interest after the stock dividend remains unchanged, he has received nothing, and consequently the transaction is not taxable. (See pp. 20-9 and 20-10.) 5. True. The basis allocated to the rights is returned to the original stock. [See p. 20-11 and Reg. 1.307-1(a).] 6. False. The allocation is not necessary if the fair market value of the rights is less than 15 percent of the value of the stock. [See pp. 20-11 and 20-12 and Reg. 1.307-1(a).] 7. False. No loss is recognized because basis is not allocated unless the rights are sold or exercised. [See Example 15, p. 20-11, 307(a), and Reg. 1.307-1(a).] 8. False. The "not essentially equivalent to a dividend" exception seemed to have been effectively canceled because of the decision handed down by the Supreme Court in U.S. v. Davis. However, some taxpayers in subsequent litigation not involving a sole shareholder have been able to demonstrate that a "meaningful reduction" in their interest in the corporation occurred. [See p. 20-14 and 302(b)(1).] 9. True. The reduction brings the taxpayer's ownership to less than 80 percent of her former ownership (45/60 75%) and less than 50 percent of the total voting control. [See pp. 20-15 through 20-17 and 302(b)(2), especially subsections (B) and (C).] 10. True. Sale treatment is apparently justified in this case on the theory that the redemption proceeds represent a portion of the shareholder's capital that was formerly employed in the business (before the contraction) rather than a return on capital. (See p. 20-17.) False. Partial liquidations apply only to redemptions from noncorporate shareholders. [See p. 20-17 and 302(b)(4).]
20-9 11. 20-10 Chapter 20 Corporate Distributions, Redemptions, and Liquidations 12. False. The stock attribution rules will not apply if the individual files and qualifies for a waiver of the attribution rules. [See pp. 20-19 and 20-20, and 302(c)(2).] False. The attribution rules do apply. In selected cases, a taxpayer can elect to waive the family attribution rules. [See pp. 20-19 and 20-20, and 302(c)(2).] True. Section 304 will convert the sale to a stock redemption. If the transaction meets one of the tests contained in 302(b), capital gains can still result. (See pp. 20-20 and 20-21.) True. Section 331 treats the shareholders as if they sold their stock for the property received. (See p. 20-22.) False. The general rule is that the corporation recognizes gain or loss on the distribution of property as part of a complete liquidation as if sold for its fair market value. [See Example 34, p. 20-23 and 336(a).] False. Sections 1245, 1250, 291, 453B, and others will convert some or all of the gain into ordinary income. (See pp. 20-23 through 20-25.) False. Certain losses will not be recognized. [See p. 20-24 and 336(d)-(1) and (2).] False. The parent's basis for assets transferred from the liquidating subsidiary to the parent is determined solely by that subsidiary's basis in the assets. [See pp. 20-25 and 20-26 and 334(b)(1).] False. A 338 election does allow the parent to treat the purchase of stock as the purchase of assets. However, it is not necessary to liquidate the subsidiary. (See pp. 20-27 through 20-30.) 13. 14. 15. 16. 17. 18. 19. 20. Multiple Choice 21. b. The Code creates an irrefutable presumption that all distributions are treated as dividends to the extent that any E&P exist at the date of distribution. The remainder is treated as a nontaxable return of capital to the extent of the shareholder's basis in his stock. (See Example 1, p. 20-2.) Accumulated E&P is designed to be a measure of the amount that a corporation can distribute without impairing its capital. The calculation attempts to measure the corporation's capacity to pay dividends. The starting point is taxable income. However, this amount is generally adjusted to determine the amount that the corporation could actually distribute without dipping into capital. (See pp. 20-2 and 20-3.) The $10,000 must be deducted for E&P in equal installments over a five-year period. Therefore, fourfifths of the expensing deduction--or $8,000--must be added to taxable income in the calculation of E&P. (See Example 3 and pp. 20-3 and 20-4.) The distribution is deemed to be from accumulated E&P as of April 1, that is, $10,000 minus onefourth of the deficit for the year. (See Example 8 and pp. 20-6 and 20-7.) Current E&P is allocated pro rata to all distributions during the year, while accumulated E&P is allocated chronologically. The first distribution of $30,000 represents a distribution of $6,000 of current E&P [$30,000/($30,000 $20,000) $10,000] and $24,000 of accumulated E&P. The second distribution represents a distribution of $4,000 of current E&P (40% current E&P of $10,000) and $1,000 of accumulated E&P ($25,000 $24,000 allocated to first distribution). (See Examples 6 and 7 and p. 20-6.) The deficit in current E&P is prorated on a daily basis against any accumulated E&P. The balance in accumulated E&P before the first distribution is $88,200 [$100,000 ($73,000/365 days 59 days)]. Thus, all of the $60,000 distribution is a dividend. The balance in accumulated E&P before the second distribution is zero, because the $100,000 beginning E&P is eliminated by the $60,000 distribution and the deficit that has occurred through November 30 of $66,800 ($73,000/365 334). (See Example 9 and p. 20-7.) 22. d. 23. c. 24. c. 25. c. 26. c. Solutions to Test Bank 20-11 27. b. The corporation recognizes gain--but not loss--on the distribution of property. Thus, the corporation recognizes the gain on the distribution of the land, $30,000. The loss on the distribution of the crane, $9,000, is not recognized. (See p. 20-8 and 311.) Under the current rules, corporations recognize gain on the distribution of all appreciated property. (See p. 20-8 and 311.) Bona fide loans to shareholders with intent to repay should not be reclassified. (See p. 20-9.) Constructive dividends arising from a payment for the shareholder's benefit have been found by the IRS where the corporation paid the shareholder's debt, the shareholder's expenses for financial and accounting services, or the shareholder's travel and entertainment expenses. (See p. 20-9.) Preferred stock can be issued tax-free on common stock provided it is proportionate and no shareholder has the option to select cash or other property. Any distribution to a preferred shareholder is taxable. (See pp. 20-9 and 20-10.) The $800 basis is allocated based on the relative fair market values of the aggregate values of the stock, or $200 [(100 $1) (25 $4)]. Since the preferred stock is worth $100, or 50 percent of the value of the total value of the stock, 50 percent of the basis is allocated to the preferred, or $400 (50% $800). (See Example 12 and pp. 20-10 and 20-11.) A shareholder who receives stock rights has all three alternatives with respect to their use. (See Example 14 and pp. 20-11 and 20-12.) The effect of this $30,000 distribution to J is the same as a dividend: J's ownership interest and control of the corporation remain unchanged after the stock redemption. Because the distribution is within the amount of current E&P, dividend treatment applies--not sale treatment. (See Example 18 and p. 20-15.) The shareholder went from majority interest to mere equality. In choice a. the shareholder is still a majority stockholder (89% 80% 71%). In choice b., the redemption qualifies as substantially disproportionate. (See pp. 20-14 and 20-15.) X must end up with less than 80 percent of his former ownership as well as less than 50 percent of the voting power. The shares redeemed reduce the outstanding stock for computational purposes. [See Examples 19 and 20; pp. 20-15 through 20-17; and 302(b)(2).] Choice a. is wrong because the shareholder must own less than 50 percent of the total combined voting power to disprove dividend equivalency. Choice c. is wrong because the shareholder's percentage ownership of common stock must be less than 80 percent of the shareholder's ownership immediately before the redemption. Only choice b. correctly states one of the tests that must be met to obtain sale treatment for the shareholder redeeming her or his stock. (See pp. 20-15 through 20-17.) Investment activities are not considered business activities. Business must have been conducted throughout the five-year period ending on the date of the distribution. (See p. 20-17.) A partial liquidation will qualify as a sale only if the redemption is of stock from a noncorporate shareholder. [See p. 20-17 and 302(b)(4).] The only family members considered to be relatives are spouses, children, grandchildren, and parents. [See Examples 22 and 23, pp. 20-18 through 20-20, and 318(a)(1).] Two corporations can be aggregated provided the decedent owned 20 percent or more of each one and the stock of each is included in the decedent's estate. (See pp. 20-17 and 20-18.) H owns all the stock that his wife owns (15 shares). He is deemed to own 70 percent of X; therefore, he is deemed to own 70 percent of the 20 shares that X owns. (See pp. 20-18 and 20-19.) 28. d. 29. 30. d. d. 31. a. 32. c. 33. e. 34. d. 35. c. 36. d. 37. b. 38. 39. c. a. 40. b. 41. a. 42. c. 20-12 Chapter 20 Corporate Distributions, Redemptions, and Liquidations 43. c. $3,000 gain. The gain or loss is calculated separately for each block of stock, using the cost recovery method: 1997 purchase: Received Less: Basis Gain Basis Less: Received Unrecovered basis $ 4,000 (1,000) $ 3,000 $10,000 (4,000) $ 6,000 1999 purchase: Note that subsequent installments made to J will produce only gain for the 1997 block. There remains $6,000 of basis to recover before any gain will be reportable for the 1999 block. (See p. 20-20.) 44. c. The sale of the land and building at fair market value to non-related parties produces recognized loss and gain for the corporation, respectively. This is true whether inside or outside of liquidation. Note that any property distributed to shareholders (other than parent) in liquidation will result in recognition of gains and losses at both the corporate and shareholder levels. (See p. 20-22.) T will recognize the loss on the sale and the gain on the deemed sale under 336. R will recognize gain under 331. (See pp. 20-22 through 20-25.) Answers a through c suggest tax-avoidance motives. Section 336(d) denies a loss deduction on property distributed in potentially abusive situations. (See pp. 20-23 through 20-25.) Under 332, a parent does not recognize gain or loss on the liquidation of a subsidiary. The basis of the assets carry over to the parent. The cost of the stock is ignored. (See pp. 20-25 and 20-26.) When a subsidiary is liquidated, the basis of assets transferred is the same for the parent corporation as it had been for the subsidiary, on a carryover basis. The amount of the parent's investment in the subsidiary's stock is ignored; the parent's basis is determined solely by the subsidiary's basis, or $600,000 in this case. [See pp. 20-25 and 20-26 and 334(b)(1).] B recognizes no gain on the distribution to A Corporation because 332 exempts a subsidiary from gain or loss recognition on distributions of property to its parent. However, B must recognize a gain of $2,000 ($11,000 $9,000) on the distribution to the minority shareholders. (See p. 20-25.) The parent must own at least 80 percent. The subsidiary will recognize gain on distribution of property to minority shareholders. Parent corporation uses the carryover basis for the assets. (See p. 20-25.) If a parent corporation purchases the stock of a subsidiary, it may elect to treat the stock purchase as a purchase of assets. This election enables the parent to obtain the same basis that it would have obtained had it purchased the assets directly. However, there is no requirement that the subsidiary be acquired with the intent to obtain its assets, or that it actually be liquidated. (See pp. 20-27 through 20-30 and 338.) All the statements are true. (See pp. 20-27 through 20-30.) The purchase price is allocated to assets in the first four classes in turn; the amount allocated to the asset cannot exceed the fair market value. Any portion of the purchase price that remains after allocations to the first three classes is allotted to Class V, in what is known as the residual value approach. [See p. 20-28, 338, and Temp. Reg. 1.338(b)-2T.] The adjustment for a minority interest results in a deemed purchase price called the grossed-up basis, obtained by multiplying the actual purchase price of the stock by a ratio, where the numerator is 100 percent and the denominator equals the percentage of the subsidiary stock owned by the parent. And, just as in any 338 liquidation, the parent corporation is required to own at least 80 percent of the subsidiary's stock. (See pp. 20-29 and 20-30 and 338.) To prohibit the acquiring corporation from effectively selecting the basis that is most desirable, the Code contains the "consistency" provisions. According to these provisions, an acquiring corporation is required to use a carryover basis for purchased assets unless a 338 election is made for the acquired corporation. (See Example 43, p. 20-30, and 338.) 45. 46. 47. 48. d. d. a. d. 49. c. 50. 51. d. d. 52. 53. d. c. 54. a. 55. a. 20
Corporate Distributions, Redemptions, and Liquidations
1. B Corporation has 200 shares issued and outstanding stock. One hundred shares are owned by R and the other 100 are owned by T Corporation. R's basis is $1,000 and T Corporation's basis is $10,000. B Corporation will be restructured due to a fight between R and T Corporation concerning the future of B Corporation. B Corporation will declare and pay a cash dividend to R of $15,000 as part of the restructuring agreement. It also will declare a property dividend to T Corporation. The property and equipment has a fair market value of $15,000 and a basis to B Corporation of $11,000. B Corporation will redeem 50 shares of stock owned by T Corporation. B will distribute all the assets of its real estate division in exchange for the stock. The assets have a fair market value of $100,000 and a basis of $75,000. a. b. c. d. e. Assuming sufficient E&P, how much dividend income will R report? Assuming sufficient E&P, how much dividend income will T Corporation report as a result of the receipt of the equipment? What would the answers to (a) and (b) be if B Corporation's E&P were $22,000 before the distributions? How should T Corporation report the stock redemption? How much income should B Corporation report as a result of these transactions? 2. D Corporation's Balance Sheet dated December 31, 2011 appears below.
Assets Basis Fair Market Value Cash Inventory Land Total Capital Common stock Retained earnings $ 10,000 100,000 90,000 $200,000 $ 10,000 130,000 150,000 $290,000 $ 50,000 150,000 $200,000 $290,000 $290,000 20-13 20-14 Chapter 20 Corporate Distributions, Redemptions, and Liquidations All the stock of D Corporation is owned by J. She purchased the stock three years ago for $75,000. On January 1, 2012, D Corporation adopts a plan of liquidation. As part of the plan, D Corporation immediately sells the land to an unrelated third party for $150,000. D Corporation receives $50,000 cash and an installment note for $100,000. In February, 2012, D Corporation distributes cash of $30,000 (the remaining $30,000 in cash retained to pay corporate income taxes), the inventory, and the installment note to J in complete liquidation. a. b. c. What is the tax effect of the sale of the land by D Corporation? How much gain or loss must D Corporation recognize on the liquidation? How much gain must J report in 2012? Solutions to Comprehensive Problems 20-15 Solutions to Comprehensive Problems
1. a. b. c. R will report the full $15,000 as dividend income. T Corporation will report the fair market value of the equipment, $15,000, as a dividend. R will report the following: Dividend (1=2 of E&P) Return of capital Capital gain $11,000 1,000 3,000 $15,000 T Corporation will report Dividend (1=2 of E&P) Return of capital $11,000 4,000 $15,000 d. This redemption cannot be a partial liquidation since it involves a corporate shareholder. It can be a substantially disproportionate redemption. The post redemption ownership by T Corporation is 50 shares owned 33% 150 outstanding This is less than the 80 percent of the former ownership (80% 50% 40%). Therefore, T Corporation will treat the redemption as a sale. Sale price Less: Basis Gain $100,000 (5,000) $ 95,000 This redemption could also qualify as a sale under the "not essentially equivalent to a dividend" rule of 302(b)(1). e. B Corporation will treat both the property dividend and the redemption as sales. Equipment Sale price Less: Basis Gain Real Estate Sale price Less: Basis Gain $ 15,000 (11,000) $ 4,000 $100,000 (75,000) $ 25,000 20-16 Chapter 20 Corporate Distributions, Redemptions, and Liquidations 2. a. D Corporation will report the gain on the installment method. Sale price Less: Basis Realized gain $150,000 (90,000) $ 60,000 11- Cash received $ 50,000 1 3 Sale price $150; 000 Recognized gain is b.
1 3 $60,000 $20,000. D Corporation will be treated as if it sold both the inventory and installment note for their fair market value. Inventory Sale price Less: Basis Gain Note Sale price Less: Basis Gain Total $ 130,000 (100,000) $30,000 $ 100,000 (60,000) 40,000 $ 70,000 11c. J will be treated as if she sold her stock. She received: Installment note Plus other property: Cash* Inventory Total $100,000 $ 30,000 130,000 38% 160,000 $260,000 *Total cash $60,000 less $30,000 retained for corporate income taxes. 11J is treated as if she received the other property for stock in a current sale. The installment note will be treated as future receipts in liquidation. Other property Sale price Less: Basis** Gain recognized $160,000 (46,500) $113,500 **Basis of stock allocated to other property $75,000 62% $46,500 11The remaining $27,500 basis of the stock is allocated to the installment note. It will be used to calculate gain on the receipt of the installment note. / 62% ...
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This note was uploaded on 02/05/2012 for the course ACCT 112 taught by Professor Smith during the Spring '11 term at Adrian College.
- Spring '11