Prentice Hall's Federal Taxation 2011: Corporations, 24e (Pope) Chapter 4 Corporate Nonliquidating Distributions

1) Corporate distributions that exceed earnings and profits are always capital gains. Answer: FALSE
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$) Corporations %ay always use retained earnings as a substitute for earnings and profits. Answer: FALSE
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') (hen co%puting E) * Section 1+, property %ust be expensed ratably o-er a fi-e#year period starting with the %onth in which it is expensed for Sec. 1+, purposes. Answer: .!/E
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") A shareholders basis in property distributed as a di-idend is its fair %ar0et -alue. Answer: .!/E
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&) (hen appreciated property is distributed in a nonli1uidating distribution* the net effect on the distributing corporation2s E) is that it is reduced by the F34 of the property distributed and increased by the gain 5net of federal inco%e taxes) recogni6ed due to the property distribution. Answer: .!/E
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8) Corporations recogni6e gain and losses on the distribution of property to shareholders if the property2s fair %ar0et -alue differs fro% its basis. Answer: FALSE
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+) 9n a nontaxable distribution of stoc0 rights* when the -alue of the rights is less than 1&: of the -alue of the stoc0 with respect to which the rights were distributed* the basis of the rights is 6ero unless the shareholder elects to allocate stoc0 basis to the rights. Answer: .!/E
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;) 9n a taxable distribution of stoc0* the recipient shareholder ta0es a basis e1ual to the F34 of the stoc0 recei-ed. Answer: .!/E
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,) A stoc0 rede%ption is always treated as if the shareholder sold his stoc0 to the corporation. Answer: FALSE
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17) .he Sec. '1; fa%ily attribution rules can be wai-ed for purposes of the Sec. '7$5b)5') co%plete ter%ination rules e-en though the redee%ing shareholder is a creditor of the corporation. Answer: .!/E
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11) A partial li1uidation of a corporation is treated as a di-idend in the case of a corporate shareholder. Answer: .!/E
age !ef.: C:"#$"* C:"#$&

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1$) .wo corporations are considered to be brother#sister corporations for purposes of the Sec. '7" rede%ption rules if one shareholder owns %ore than &7: of each corporation. Answer: .!/E
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1') 9dentify which of the following state%ents is false. A) For E) di-idend distribution purposes* property as defined in Sec. '1+5a) includes %oney. <) .he function of E) is to pro-ide a %easure of a corporation2s econo%ic ability to pay di-idends. C) At for%ation* a corporation2s E) depends on the a%ount of capital contributed by the shareholders. =) Ad>ust%ents to taxable inco%e when co%puting E) do not include tax exe%pt interest. Answer: C
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1") 9dentify which of the following increase Earnings ) rofits. A) a capital contribution <) life insurance proceeds payable to the spouse C) tax#exe%pt interest inco%e =) all of the abo-e increase E) of a corporation Answer: C
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1&) Current E) does not include A) tax#exe%pt interest inco%e. <) life insurance proceeds where the corporation is the beneficiary. C) federal inco%e tax refunds fro% prior years. =) all of the abo-e are included Answer: =
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18) ?rant Corporation sells land 5a nonin-entory ite%) with a basis of @&+*777 for @177*777. Aichole will be paid on an install%ent basis in fi-e e1ual annual pay%ents starting in the current year. .he E) for the year of sale will be increased as a result of the sale 5excluding federal inco%e taxes) by A) @7. <) @;*877. C) @"'*777. =) @177*777. Answer: C Explanation: C) .he entire gain on the install%ent sale %ust be used to increase E) in the year of sale
age !ef.: C:"#&B Exa%ple C:"#&

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1+) <oxer Corporation buys e1uip%ent in Canuary of the current year with a se-en#year class life for @1&*777. .he corporation expensed the @1&*777 under Sec. 1+,. .he deduction in the year of purchase for E) purposes due to the ac1uisition and expensing of the e1uip%ent is A) @1*&77. <) @'*777. C) @1"*777. =) @1&*777. Answer: < Explanation: <) roperty expensed under Sec. 1+, is expensed ratably using the straight# line %ethod o-er fi-e years co%%encing with the %onth in which it is deductible for Sec. 1+, purposes when co%puting E) regardless of the nu%ber of years in its class life. @1&*777D& yrs. E @'*777
age !ef.: C:"#&B Exa%ple C:"#8

1;) For purposes of deter%ining current E) * which of the following ite%s cannot be deducted in the year incurredF A) Charitable contribution in excess of the 17: li%itation. <) Capital losses in excess of capital gains. C) Life insurance pre%iu%s 5in excess of the increase in cash surrender -alue for the policy) paid on the li-es of 0ey e%ployees. =) =i-idends#recei-ed deduction Answer: =
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1,) 9dentify which of the following state%ents is true. A) Section 1+, property %ust be expensed ratably o-er a fi-e#year period when co%puting E) . <) Losses on property sales to related parties are not deductible when co%puting E) . C) =istributions %ade out of accu%ulated E) are allocated ratably between %ultiple distributions %ade during the tax year. =) All are false. Answer: A
age !ef.: C:"#&* C:"#8

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$7) oppy Corporation was for%ed three years ago. oppy2s E) history is as follows: Year $77& $778 $77+ Current E&P @8*777 &*777 1*777 Distributions @"*777 1*777 #7#

oppy Corporation2s accu%ulated E) on Canuary 1 will be A) @7. <) @+*777. C) @&*777. =) @1$*777. Answer: < Explanation: <) 5@8*777 # @"*777) G 5@&*777 # @1*777) G @1*777 E @+*777
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$1) =ixie Corporation distributes @'1*777 to its sole shareholder* Sally. At the ti%e of the distribution* =ixie2s E) is @$&*777 and Sally2s basis in her =ixie stoc0 is @17*777. Sally2s basis in her =ixie stoc0 after the distribution is A) @"*777. <) @17*777. C) @$&*777. =) @'1*777. Answer: A Explanation: A) @'1*777 # @$&*777 E @8*777 distribution in excess of E) . @17*777 basis # @8*777 excess distribution E @"*777
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$$) Crossroads Corporation distributes @87*777 to its sole shareholder Harley. Crossroads has earnings and profits of @&&*777 and Harley2s basis in her stoc0 is @$7*777. After the distribution* Harley2s basis is A) @&*777. <) @1&*777. C) @$7*777. =) @87*777. Answer: < Explanation: <) @&&*777 of the distribution reduces E) to @7* and @&*777 is a reduction in the basis of Harley2s stoc0
age !ef.: C:"#+

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$') .o%i0a Corporation has current and accu%ulated earnings and profits of @7. .o%i0a distributes @17*777 to its sole shareholder* Alana. (hat are .o%i0a2s earnings and profits after the distributionF A) @7. <) 5@17*777). C) @17*777. =) Aone of the abo-e. Answer: A Explanation: A) =istributions cannot create an E) deficit
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$") Exit Corporation has accu%ulated E) of @$"*777 at the beginning of the current tax year. Current E) is @$7*777. =uring the year the corporation %a0es the following distributions to its sole shareholder who has a @$$*777 basis for her stoc0. =ate A%ount =istributed April 1 @$7*777 Cune 1 $7*777 August 1 1&*777 Ao-e%ber 1 &*777 .he treat%ent of the @1&*777 August 1 distribution would be A) @1&*777 is taxable as a di-idendB @&*777 fro% current E) and the balance fro% accu%ulated E) . <) @1&*777 is taxable as a di-idend fro% accu%ulated E) . C) @"*777 is taxable as a di-idend fro% accu%ulated E) * and @11*777 is tax#free as a return of capital. =) @&*777 is taxable as a di-idend fro% current E) and @17*777 is tax#free as a return of capital. Answer: = Explanation: =) Date of Distributio Amount n Distributed April Cune August Ao-e%ber @$7*777 $7*777 1&*777 &*777 @87*777 Current E&P @ 8*88+ 8*88+ &*777 1*888 @$7*777 Accumulat ed E&P @1'*''' 17*88+ #7# #7# @$"*777 eturn of Capital @ #7# $*888 17*777 '*''" @18*777

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$&) Ireo Corporation has accu%ulated E) of @;*777 at the beginning of the current year. =uring the year 5a non#leap year)* the corporation incurs a current E) deficit of @1;*$&7. .he corporation distributes @11*777 on 3arch $7th to 3orris* its sole shareholder* who has a @,*777 basis for his stoc0. 9f the exact loss cannot be deter%ined as of the date of distribution* the treat%ent of the distribution will be A) @"*177 di-idend and a @8*,77 capital gain. <) @11*777 return of capital. C) @"*177 di-idend and a @8*,77 tax free return of capital. =) @;*777 di-idend and a @'*777 return of capital. Answer: C Explanation: C) '1 G $; G 1, E +;D'8& J @1;*$&7 E @'*,77 reduction in accu%ulated E) @;*777 # @'*,77 loss accrued to distribution date E @"*177 E) a-ailable for distribution. @8*,77 5@11*777 # @"*177) balance of the distribution is a return of capital
age !ef.: C:"#;B Exa%ple C:"#1'

$8) 9dentify which of the following state%ents is true. A) 9f both the current and accu%ulated E) ha-e deficit balances* a corporate distribution cannot be characteri6ed as a di-idend. <) .he shareholder2s basis in property recei-ed in a nonli1uidating distribution is the property2s F34 reduced by liabilities assu%ed by the shareholder. C) A corporation recogni6es gain when distributing %oney as a di-idend to its shareholders. =) All are false. Answer: A
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$+) 9dentify which of the following state%ents is true. A) .he holding period for property recei-ed by a shareholder in a nonli1uidating distribution begins on the day after the distribution. <) (hen %a0ing a nonli1uidating distribution* a corporation recogni6es gains and losses. C) (hen %a0ing a nonli1uidating distribution* the corporation2s E) is reduced by the property2s F34 e-en though the property2s basis is greater than its F34. =) All are false. Answer: A
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$;) Hogg Corporation distributes @'7*777 to its sole shareholder* 9%a. At the ti%e of the distribution* Hoggs2 E) is @1"*777 and 9%a2s basis in her stoc0 is @17*777. 9%a2s gain fro% this transaction is A) @8*777 capital gain. <) @1"*777 capital gain. C) @$7*777 capital gain. =) @'7*777 capital gain. Answer: A Explanation: A) @'7*777 distribution # @1"*777 E) 5di-idend) # @17*777 return of capital E @8*777
age !ef.: C:"#,

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$,) Ine conse1uence of a property distribution by a corporation to a shareholder is A) the a%ount of the distribution is increased by any liability assu%ed by the shareholder. <) the holding period of the distributed property includes the holding period of the distributing corporation. C) the shareholder2s basis in the distributed property is the sa%e as the distributing corporation2s basis. =) any liabilities assu%ed by the shareholder do not reduce the shareholder2s basis. Answer: =
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'7) (ills Corporation* which has accu%ulated and current E) totaling @8&*777* distributes land to its sole shareholder* an indi-idual. .he land has a F34 of @+&*777 and an ad>usted basis of @&&*777. .he shareholder assu%es a @1&*777 liability associated with the land. .he shareholder will recogni6e A) @87*777 of di-idend inco%e and ha-e a @87*777 basis in the land. <) @8&*777 of di-idend inco%e and ha-e a @+&*777 basis in the land. C) @87*777 of di-idend inco%e and ha-e a @+&*777 basis in the land. =) @8&*777 of di-idend inco%e and ha-e a @8&*777 basis in the land. Answer: C Explanation: C) =i-idend e1uals @+&*777 F34 # @1&*777 liability assu%ed E @87*777. <asis e1uals the @+&*777 F34 of the property
age !ef.: C:"#,B Exa%ple C:"#1"

'1) (ills Corporation* which has accu%ulated and current E) totaling @+7*777* distributes land to its sole shareholder* an indi-idual. .he land has a F34 of @+&*777 and an ad>usted basis of @87*777. .he shareholder assu%es a @1&*777 liability associated with the land. .he transaction will ha-e the following tax conse1uences. A) .he corporation will recogni6e a @1&*777 gainB the shareholder will recogni6e di-idend inco%e of @+&*777. <) .he corporation will recogni6e no gainB the shareholder will recogni6e di-idend inco%e of @+&*777. C) .he corporation will recogni6e a @1&*777 gainB the shareholder will recogni6e di-idend inco%e of @87*777. =) .he corporation will recogni6e no gainB the shareholder will recogni6e di-idend inco%e of @87*777. Answer: C Explanation: C) .he corporation will recogni6e @1&*777 5@+&*777 F34 # @87*777 basis) of gain as if it had sold the property i%%ediately preceding the distribution. .he shareholder has di-idend inco%e e1ual to the @+&*777 F34 %inus the @1&*777 of liabilities assu%ed* or @87*777* 5but not in excess of the E) )
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'$) A corporation distributes land and the related liability to 3eg* its sole shareholder. .he land has a F34 of @87*777 and is sub>ect to a liability of @+7*777. .he corporation has current and accu%ulated E) of @;7*777. .he corporation2s ad>usted basis for the property is @+7*777. (hat effect does the transaction ha-e on the corporationF A) A recogni6ed loss of @17*777 and its E) is reduced by @+7*777. <) A recogni6ed loss of @17*777 and its E) is unchanged. C) Ao recogni6ed gain or loss and its E) is reduced by @87*777. =) Ao recogni6ed gain or loss and its E) is unchanged by the distribution. Answer: =
age !ef.: C:"#17B Exa%ple C:"#1&

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'') A corporation distributes land and the related liability in a nonli1uidating distribution to a shareholder. .he land 5a capital asset) has an ad>usted basis of @+7*777 and a F34 of @177*777 and is sub>ect to a %ortgage of @1$7*777. .he corporation %ust recogni6e A) @$7*777 capital loss. <) @&7*777 capital gain. C) @+7*777 capital gain. =) no gain or loss. Answer: < Explanation: <) .he property2s F34 is dee%ed to be at least e1ual to the liability assu%ed or ac1uired 5Sec. '115b)). .herefore a @&7*777 capital gain 5@1$7*777 liability # @+7*777 basis) is recogni6ed
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'") 9dentify which of the following state%ents is true A) .he F34 of an obligation is used to deter%ine the E) reduction when a corporation distributes the obligation to its shareholders. <) (hen appreciated property is distributed to shareholders* E) %ust be increased by any gain 5net of taxes) recogni6ed due to the property distribution. C) (hen appreciated property is distributed in a nonli1uidating distribution* the net effect on the distributing corporation2s E) is that it is reduced by the net of the F34 of the property distributed %inus the gain 5net of federal inco%e taxes) recogni6ed due to the property distribution. =) < and C abo-e are true. Answer: A
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'&) (hich of the following transactions does not ha-e the potential of creating a constructi-e di-idendF A) Co%pensation paid by corporation to a shareholder#e%ployee. <) urchase of corporate property by the shareholder. C) Shareholder2s rental of corporate property. =) All of the abo-e can result in a constructi-e di-idend. Answer: =
age !ef.: C:"#11#C:"#1'

'8) 9dentify which of the following state%ents is true. A) Loans %ade to shareholders in proportion to their stoc0 ownership in the corporation is e-idence that the loans are disguised di-idends. <) Corporate pay%ents for the shareholder2s benefit %ay be a taxable di-idend. C) 9f the shareholder can elect to recei-e distributing corporation stoc0 or %oney* the receipt of distributing corporation stoc0 will be a taxable di-idend. =) All are true. Answer: =
age !ef.: C:"#1$#C:"#1"

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'+) An indi-idual shareholder owns '*777 shares of <axter Corporation co%%on stoc0 with a basis of @17 per share. She recei-es a nontaxable &: stoc0 di-idend. .he basis per share of the co%%on stoc0 after the stoc0 di-idend is A) @,. 77. <) @,. &7. C) @,. &$. =) @17. 77. Answer: C Explanation: C) @'7*777DK'*777 shares G 57.7& J '*777 shares)L E @,. &$
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';) .ia owns $*777 shares of <ass Corporation co%%on stoc0 with a @;7*777 basis. <ass distributes a nontaxable preferred stoc0 di-idend. (hen the preferred stoc0 is distributed* it has a F34 of @87*777 and the F34 of the $*777 co%%on stoc0 shares is @1;7*777. .he basis of the preferred stoc0 is A) @#7#. <) @$7*777. C) @87*777. =) @;7*777. Answer: < Explanation: <) K@87*777 5F34)D@$"7*777 5total F34)L J @;7*777 5basis) E @$7*777. <asis is allocated based on relati-e F34s
age !ef.: C:"#1"B Exa%ple C:"#$7

',) <at Corporation distributes stoc0 rights with a @$7*777 F34 to its co%%on stoc0 shareholders. .he @$7*777 -alue of the stoc0 rights at the ti%e of distribution is less than 1&: of the -alue of the underlying stoc0. A) A shareholder %ust allocate basis to the rights based on the relati-e F34s of the stoc0 and the rights. <) A shareholder cannot allocate any basis to the rights. C) .he basis in the rights is 6ero unless a shareholder %a0es a -alid election to allocate basis to the rights. =) .he holding period for the rights begins on the day the rights are distributed in all cases. Answer: C
age !ef.: C:"#1&B Exa%ple C:"#$1

"7) 9dentify which of the following state%ents is false. A) .he distribution of stoc0 rights will be taxable if the -alue of the stoc0 rights is %ore than 1&: of the -alue of the underlying stoc0. <) .he distribution of stoc0 rights is generally tax free under Sec. '7&. C) 9f the -alue of stoc0 rights is less than 1&: of the -alue of the underlying stoc0* the basis of the rights is 6ero unless the shareholder elects to allocate basis to the rights. =) .he holding period for stoc0 rights includes the holding period for the underlying stoc0. Answer: A
age !ef.: C:"#1"* C:"#1&

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"1) <ruce recei-es $7 stoc0 rights in a nontaxable distribution. .he stoc0 rights ha-e a F34 of @&*777. .he co%%on stoc0 with respect to which the rights are issued has a basis of @"*777 and a F34 of @1$7*777. <ruce allows the stoc0 rights to lapse. He can deduct a loss of A) @7. <) @1*777. C) @&*777. =) none of the abo-e Answer: A
age !ef.: C:"#1&B Exa%ple C:"#$'

"$) 9dentify which of the following state%ents is true. A) .he distributing corporation2s E) %ust be reduced by the F34 of nontaxable stoc0 rights distributed to shareholders. <) A stoc0 rede%ption can be used to withdraw so%e assets fro% a corporation prior to a sale of the business. C) A shareholder can redee% part of his stoc0 and recogni6e a capital gain if the corporation has only one shareholder. =) All are false. Answer: <
age !ef.: C:"#18

"') (hich of the following is not a reason for a stoc0 rede%ptionF A) desire by re%aining shareholders to retain control <) desire by shareholders to reduce the corporate tax liability C) !ede%ption of shares is a good corporate in-est%ent. =) Ao outside %ar0et exists for the stoc0. Answer: <
age !ef.: C:"#18

"") Eli>ah owns $7: of ar0 Corporation2s single class of stoc0. Eli>ah2s basis in the stoc0 is @;*777. ar02s E) is @$;*777. 9f ar0 redee%s all of Eli>ah2s stoc0 for @";*777* Eli>ah %ust report di-idend inco%e of A) @7. <) @$;*777. C) @"7*777. =) @";*777. Answer: A Explanation: A) .he rede%ption will be treated as a co%plete ter%ination under Sec. '7$5b) 5')
age !ef.: C:"#1+B Exa%ple C:"#$&

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"&) Coshua owns 177: of Steeler Corporation2s stoc0. Coshua2s basis in the stoc0 is @;*777. Steeler Corporation has E) of @"7*777. 9f Steeler Corporation redee%s 87: of Coshua2s stoc0 for @&7*777* Coshua %ust report di-idend inco%e of A) @7. <) @;*777. C) @"7*777. =) @&7*777. Answer: C Explanation: C) .he entire a%ount of the distribution is di-idend inco%e to the extent of E) . Here E) of @"7*777 is the %axi%u% di-idend distribution. .he re%aining @17*777 of the distribution reduces the basis of his stoc0 to 6ero* and causes a @$*777 capital gain to be recogni6ed
age !ef.: C:"#1+B Exa%ple C:"#$"

"8) (hich of the following is not a condition that per%its a stoc0 rede%ption to be treated as a saleF A) ro-ides funds for pay%ent of inco%e taxes. <) 9t is not essentially e1ui-alent to a di-idend. C) .he rede%ption is substantially disproportionate. =) .he rede%ption co%pletely ter%inates the shareholder2s interest. Answer: A
age !ef.: C:"#1+

"+) 9dentify which of the following state%ents is false. A) A stoc0 rede%ption is treated as a sale or exchange only if the shareholder2s ownership of one particular class of stoc0 is ter%inated. <) An indi-idual is not considered to own stoc0 owned by a brother under the fa%ily attribution rules of Sec. '1;. C) An indi-idual is considered to own the stoc0 owned by his parents* children* spouse* and grandchildren under the fa%ily attribution rules of Sec. '1;. =) A person who has an option to purchase stoc0 is considered to own the stoc0 Answer: A
age !ef.: C:"#1+#C:"#$7

";) (hat are the conse1uences of a stoc0 rede%ption to the distributing corporationF A) .he corporation recogni6es gain or loss as if it had sold the distributed property for its F34 i%%ediately before the rede%ption. <) 9f the rede%ption is treated as a di-idend* E) is reduced in the sa%e %anner as for a regular di-idend. C) 9f the rede%ption is treated as a sale* only accu%ulated earnings and profits is reduced. =) All of the abo-e are correct. Answer: <
age !ef.: C:"#1;

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",) 9dentify which of the following state%ents is true. A) ?enerally in a stoc0 rede%ption if the shareholder2s ownership percentage is substantially reduced the rede%ption is treated as a sale. <) .he fa%ily attribution rules of Sec. '1; are as inclusi-e as the fa%ily attribution rules of Sec. $8+. C) A 17: shareholder of a corporation is considered to own 17: of any stoc0 that is owned by the corporation under the Sec. '1; attribution rules. =) All are false. Answer: A
age !ef.: C:"#$7* C:"#$1

&7) (hich of the following re1uire%ents %ust be %et for a rede%ption to be treated as substantially disproportionateF A) .he shareholder %ust own less than &7: of the outstanding stoc0 5in ter%s of -oting power) after the rede%ption. <) After the rede%ption* the shareholder %ust own less than ;7: of his percentage ownership of -oting stoc0 prior to the rede%ption. C) After the rede%ption* the shareholder %ust own less than ;7: of his percentage ownership of co%%on stoc0 5-oting and non-oting) prior to the rede%ption. =) all of the abo-e Answer: =
age !ef.: C:"#$7

&1) 9dentify which of the following state%ents is true. A) Stoc0 ownership attributed to a corporation fro% one of its shareholders cannot be attributed to another of the corporation2s shareholders under the Sec. '1; attribution rules. <) /nder the attribution rules relating to stoc0 rede%ptions* a person who has an option to purchase stoc0 is considered to own the stoc0. C) A stoc0 rede%ption that 1ualifies as substantially disproportionate is a safe harbor for capital gain treat%ent. =) All are true. Answer: =
age !ef.: C:"#$7* C:"#$1

&$) 9dentify which of the following state%ents is true. A) .he Sec. '1; fa%ily attribution rules can be wai-ed for purposes of the Sec. '7$5b)5') co%plete ter%ination rules e-en though the redee%ing shareholder is a creditor of the corporation. <) (ai-er of the Sec. '1; fa%ily attribution rules is per%itted for all related party stoc0 transactions. C) For a rede%ption to be essentially e1ui-alent to a di-idend* the shareholder %ust not ha-e control of the corporation i%%ediately following the rede%ption. =) All are false. Answer: A
age !ef.: C:"#$$

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&') Fa%ily Corporation* a corporation controlled by <uddy2s fa%ily* redee%s all of <uddy2s stoc0. For the rede%ption to be treated as a sale* which one of the following conditions %ust be %etF A) <uddy cannot be a creditor of the corporation after the rede%ption. <) <uddy cannot be an officer of the corporation after the rede%ption. C) <uddy cannot ac1uire an interest* e-en by inheritance* for 17 years unless the be1uest was %ade prior to the rede%ption. =) <uddy %ust ha-e purchased the redee%ed stoc0 fro% a person whose stoc0 ownership would be attributed to <uddy. Answer: <
age !ef.: C:"#$$

&") All of Sphere Corporation2s single class of stoc0 is owned by four unrelated indi-iduals in the following %anner: Mac0 $+:* Nu $". '':* O-onne $". '':* and (in $". '':. So%e of Mac02s stoc0 holdings are redee%ed by Sphere Corporation* resulting in Mac02s interest being reduced to $$.$+:. Nu* O-onne* and (in owned e1ually the re%aining ++. +': of the Sphere stoc0. How should the rede%ption of Mac02s stoc0 be treated by Mac0F A) di-idend inco%e <) sale transaction C) return of capital =) so%e other treat%ent Answer: <
age !ef.: C:"#$'B Exa%ple C:"#'&

&&) 9dentify which of the following state%ents is true. A) .o ha-e a bona fide partial li1uidation* a fir% %ust continue to conduct a 1ualified trade or business* which it had conducted for a period of %ore than three years prior to the rede%ption. <) .o 1ualify as a partial li1uidation* a distribution %ust result in a bona fide contraction of the corporate business at the corporate le-el. C) A partial li1uidation of a corporation %ust be pro rata. =) All are false. Answer: <
age !ef.: C:"#$"

&8) <last Corporation %anufactures purses and %a0e#up 0its. .he corporation decides to 1uit %anufacturing purses and distributes the assets associated with this di-ision to its shareholders. .he distribution of the these assets will be treated as a partial li1uidation if A) the corporation so elects. <) the corporation discontinues the line of business and the transaction is Pessentially e1ui-alent to a di-idend.P C) the distribution is %ade within $" %onths of the adoption of a plan of li1uidation and the transaction is Pnot essentially e1ui-alent to a di-idend.P =) the distribution is Pnot essentially e1ui-alent to a di-idendP and is %ade within the year a plan of li1uidation is adopted or within the succeeding year. Answer: =
age !ef.: C:"#$"

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&+) erch Corporation has %ade paint and paint brushes for the past ten years. erch Corporation is owned e1ually by Arnold* an indi-idual* and Acorn Corporation. erch Corporation has @177*777 of accu%ulated and current E) . <oth Arnold and Acorn Corporation ha-e a basis in their stoc0 of @17*777. erch Corporation discontinues the paintbrush operation and distributes assets worth @17*777 each to Arnold and Acorn Corporation in rede%ption of $7: of their stoc0. =ue to the distribution* Arnold and Acorn Corporation %ust report A) Arnold Acorn Corporation @;*777 capital gain @;*777 capital gain <) Arnold Acorn Corporation @;*777 capital gain @17*777 di-idend C) Arnold Acorn Corporation @17*777 di-idend @;*777 capital gain =) Arnold Acorn Corporation @17*777 di-idend @17*777 di-idend Answer: < Explanation: <) Acorn Corporation is a corporate shareholder and not eligible for the partially li1uidating distributions to be treated as a sale since the distribution is pro rata. Arnold is eligible for sale treat%ent under the Sec. '7$5b)5") partial li1uidation rules
age !ef.: C:"#$" and C:"#$&B Exa%ple C:"#'+

&;) .he gross estate of a decedent contains @$*777*777 cash and 177: of =a-is Corporation stoc0 worth @877*777. Funeral and ad%inistrati-e expenses and state death taxes allowable as estate tax deductions a%ount to @"77*777. .he estate owes no other liabilities. .he decedent2s =a-is stoc0 can be A) redee%ed to the extent of the death taxes and the estate2s funeral and ad%inistrati-e costs with sale or exchange treat%ent. <) redee%ed with di-idend treat%ent. C) redee%ed in full with sale or exchange treat%ent only if the proceeds are used to pay the death taxes and funeral and ad%inistrati-e costs. =) redee%ed to the extent of the death taxes and the funeral and ad%inistrati-e costs with sale or exchange treat%ent only if the proceeds are used to pay the death taxes and funeral and ad%inistrati-e costs. Answer: <
age !ef.: C:"#$&B Exa%ple C:"#';

&,) 9dentify which of the following state%ents is true. A) 9f a stoc0 rede%ption is %ade by an estate following the decedent2s death* the rede%ption %ay recei-e capital gains treat%ent only if the %oney is actually used to pay the death taxes. <) Attribution rules do not apply to 1ualified Sec. '7' stoc0 rede%ptions. C) .he -alue of decedent2s stoc0 satisfies the Sec. '7' %ini%u% if it is less than '&: of the decedent2s gross estate. =) All are false. Answer: <
age !ef.: C:"#$&

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87) 9dentify which of the following state%ents is true. A) Inly stoc0 included in the decedent2s gross estate can be redee%ed under the Sec. '7' pro-isions. <) 9f the stoc0 rede%ption proceeds are used to pay either the estate2s funeral and ad%inistrati-e expenses or death taxes* the rede%ption can 1ualify for capital gains treat%ent under Sec. '7'. C) /sually* a stoc0 rede%ption 1ualifying under Sec. '7' as a rede%ption to pay death taxes will result in little or no gain to the redee%ing shareholder. =) All are true. Answer: =
age !ef.: C:"#$&

81) Cac0 Corporation redee%s $77 shares of its stoc0 for @177*777 fro% Cunior* who inherited the stoc0 fro% his father* Qen. .he stoc02s F34 on Qen2s date of death was @,7*777. Qen2s basis in the stoc0 was @"7*777. Cac0 Corporation had an E) balance of @'77*777. 9f the rede%ption 1ualifies under Sec. '7'* Cunior will A) recogni6e a capital gain of @17*777. <) recogni6e a capital gain of @87*777. C) recogni6e @177*777 in di-idend inco%e. =) recogni6e di-idend inco%e of @&7*777 and a capital gain of @17*777. Answer: A
age !ef.: C:"#$8B Exa%ple C:"#"1

8$) 9dentify which of the following state%ents is false. A) .he rules for the recognition of gain or loss by a corporation that distributes property in rede%ption of its stoc0 are the sa%e as the rules for property distributions that are not in rede%ption of stoc0. <) ?enerally little or no gain is recogni6ed by the redee%ing shareholder in a 1ualified Sec. '7' rede%ption. C) (hen a stoc0 rede%ption is considered a sale of stoc0 by the shareholder* the E) of the redee%ing corporation is reduced by the F34 of the property used to redee% the stoc0. =) /nder Sec. '11* a corporation does not recogni6e a loss when it distributes property that has declined in -alue. Answer: C
age !ef.: C:"#$+

8') Circle Corporation has 1*777 shares of co%%on stoc0 outstanding. Circle redee%s "&7 shares owned by =ennis for @+&*777 in co%plete rede%ption of =ennis2s interest. .he rede%ption 1ualifies as a sale. (hen the rede%ption is %ade* Circle Corporation has @1&7*777 of current and accu%ulated E) and paid#in capital of @&7*777. .he distribution reduces paid#in capital by A) @8+*&77. <) @$$*&77. C) @+*&77. =) @7. Answer: C Explanation: C) @1&7*777 J 7."& E @8+*&77 E) reduction* lea-ing @+*&77 to reduce paid#in capital. .he distribution first reduces E) by the percentage reduction in stoc0 ownershipB the balance reduces paid#in capital
age !ef.: C:"#$+B Exa%ple C:"#"$

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8") 9dentify which of the following state%ents is true. A) .he distribution of preferred stoc0 as a stoc0 di-idend will result in inco%e or a taxable gain being recogni6ed by the shareholder on the date of the distribution if the stoc0 is Sec. '78 stoc0. <) Corporations without E) can distribute preferred stoc0 as a stoc0 di-idend that is Sec. '78 stoc0. C) .wo corporations are considered to be brother#sister corporations for purposes of the Sec. '7" rede%ption rules if one shareholder owns %ore than &7: of each corporation. =) All are false. Answer: C
age !ef.: C:"#'7

8&) Cohn owns +7: of the 3ay Corporation stoc0 and 87: of the Cune Corporation stoc0. Cohn sells one#half of his interest in 3ay Corporation to Cune Corporation for @"&*777. .he E) accounts of 3ay and Cune are @$&*777 and @'&*777* respecti-ely. .he result would be A) Cohn has sold his stoc0 and reports a capital gain or loss. <) Cohn has sold his stoc0 and reports a capital gain but no loss. C) the transaction is treated as a contribution to 3ay2s capital and a rede%ption of Cune stoc0. =) the sale is recast as a di-idend paid to Cohn* first by Cune and then by 3ay. Answer: =
age !ef.: C:"#'7* C:"#'1

88) <oris owns 87 of the 177 shares outstanding of <read Corporation stoc0 and ;7 of the 177 shares of <utter Corporation stoc0. His basis in the <read shares is @17*777 and his basis in his <utter shares is @&*777. <oris sells '7 of his <read Corporation shares to <utter Corporation for @$&*777. <read Corporation has E) of @$7*777 and <utter Corporation has E) of @"7*777. 9n applying the substantially disproportionate test to deter%ine if this is a sale or a di-idend* <oris is treated as owning how %any shares of <read after the saleF A) '7 shares <) &" shares C) 87 shares =) ;7 shares Answer: < Explanation: <) <oris owned 87 shares and sold '7. Since he owns ;7: of the corporation that ac1uired the '7 shares* he is treated as owning ;7: of their '7* or $" shares. He owns in total &" K587 # '7) G $"L shares
age !ef.: C:"#'1B Exa%ple C:"#"&

8+) !ose has a @$7*777 basis in the 87: of the arent Corporation stoc0 that she owns. arent Corporation owns a +7: interest in Child Corporation. arent and Child ha-e current and accu%ulated E) balances of @$&*777 and @"7*777* respecti-ely. 9n return for @1&*777 !ose sells 17: of the arent Corporation stoc0 to Child Corporation. (hat is the i%pact of the transaction on !oseF A) !ose will recogni6e a @&*777 capital gain. <) !ose will be treated as ha-ing recei-ed a @1&*777 di-idend distribution fro% Child Corporation. C) !ose will be treated as ha-ing sold stoc0 to arent Corporation and recogni6e a @1&*777 capital gain. =) !ose will be treated as ha-ing recei-ed a @1&*777 di-idend fro% arent Corporation. Answer: <
age !ef.: C:"#'$

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8;) (hich of the following state%ents is not true about rede%ptionsF A) !ede%ptions of Sec. '78 stoc0 are generally treated as di-idends to the shareholder. <) A sale of stoc0 fro% one controlled corporation to another controlled corporation is treated as a rede%ption. C) !ede%ptions to pay death taxes are treated as di-idends to the shareholder. =) A distribution in rede%ption of stoc0 is generally a di-idend. Answer: C
age !ef.: C:"#''

8,) 3arie owns one#half of the stoc0 of Star0e Corporation and ser-es as its resident. .he re%aining stoc0 is owned by 17 in-estors* none of who% owns %ore than 17: of the outstanding shares. 3arie entered a hedge agree%ent with the corporation three years ago about salary pay%ents that are declared unreasonable co%pensation by the 9!S. .wo years ago* the Corporation paid 3arie a salary and bonus of @&77*777. .he 9!S subse1uently held that @$77*777 of the salary is unreasonable co%pensation. Last year Star0e Corporation and the 9!S agreed that @1&7*777 of the co%pensation is* in fact* unreasonable. .his year the @1&7*777 is repaid by 3arie to the corporation. A) .he entire @&77*777 is taxable to 3arie in the year of receipt and @1&7*777 of the co%pensation is deductible by 3arie last year. <) 3arie %ust a%end the return of two years ago to ad>ust her taxable co%pensation to the agreed upon reasonable a%ount. C) .he entire @&77*777 is taxable to 3arie in the year of receipt and @1&7*777 of the co%pensation is deductible by 3arie this year. =) 3arie %ust not include the agreed upon a%ount in her return since it is not deductible. Answer: C
age !ef.: C:"#'"B Exa%ple C:"#",

+7) 4an owns all 1*777 shares of 4alley 3etal Corporation stoc0. .he stoc0 has a @177*777 F34. Qaren wants to purchase the stoc0 fro% 4an but has only @+7*777. 4alley 3etal has a%ple cash* which is not needed for operations. (hich of the following best 1ualifies for bootstrap rede%ption treat%ent and no constructi-e di-idends to the purchaserF A) Qaren contracts to ac1uire all the stoc0 of the corporation on an install%ent plan and then uses corporate funds to pay the install%ent obligations. <) Qaren buys +7 shares fro% 4an for @+7*777 and 4an causes 4alley 3etal Corporation to redee% his re%aining shares for @'7*777. C) Qaren buys +7 shares fro% 4an for @+7*777 and then contracts to buy the re%aining '7 shares fro% 4an. She then causes 4alley 3etal Corporation to redee% 4an2s '7 shares. =) Qaren buys +7 shares fro% 4an for @+7*777 and obtains an option to purchase 4an2s re%aining stoc0 for @&7*777. Qaren then assigns the option to 4alley 3etal Corporation. .he corporation subse1uently exercises the option. Answer: <
age !ef.: C:"#'"B Exa%ple C:"#&7

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+1) (hich of the following state%ents best describes a bootstrap ac1uisitionF A) .he shareholder sells part of his or her stoc0 to a purchaser and then the corporation redee%s the original shareholder2s re%aining stoc0. <) .he shareholder sells his stoc0 in exchange for cash and debt. C) .he shareholder exchanges his stoc0 for stoc0 of a different corporation. =) Aone of the abo-e. Answer: A
age !ef.: C:"#'"

+$) ?ood .i%es Corporation has a @87*777 accu%ulated E) balance at the beginning of the year and incurs a @177*777 deficit during the year. <ecause of its poor operating perfor%ance* ?ood .i%es pays only three of its usual @17*777 1uarterly di-idend pay%ents to its sole shareholder: those ordinarily paid 3arch '1* Cune '7* and Septe%ber '7. How are the 3arch '1* Cune '7* and Septe%ber '7 pay%ents of @17*777 treatedF A) di-idendB di-idendB return of capital <) di-idendB return of capitalB return of capital C) return of capitalB di-idendB di-idend =) return of capitalB return of capitalB di-idend Answer: <
age !ef.: C:"#'&B Exa%ple C:"#&$

+') In April 1* =elta Corporation distributes @1$7*777 in cash to each of its two e1ual shareholders* Sarah and 3att. At the ti%e of the distribution* =elta2s E) is @187*777. Sarah2s basis in her stoc0 is @&7*777 and 3att2s basis in his stoc0 is @$7*777. How are the distributions characteri6ed to Sarah and 3attF <e specific. Answer: Sarah and 3att %ust each recogni6e @;7*777 57.&7 J @187*777) of di-idend inco%e. .his portion of the distribution reduces =elta2s E) to 6ero. .he additional @"7*777 that each shareholder recei-es is treated as a return of capital or capital gain as su%%ari6ed in the table below. Ellen !ob "otal =istribution @1$7*777 @1$7*777 @$"7*777 =i-idend inco%e 5 ;7*777) 5 ;7*777) 5187*777) !e%aining distribution @ "7*777 @ "7*777 @ ;7*777 !eturn of capital 5 "7*777) 5 $7*777) 5 87*777) Capital ?ain @ 7 @ $7*777 @ $7*777
age !ef.: C:"#$ and C:"#'* Exa%ple C:"#1

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+") I%ega Corporation is for%ed in $77". 9ts current E) and distributions for each year through $77+ are as follows: Oear Current E) 5deficit) =istributions $77& @5$7*777) #7# $778 '7*777 #7# $77+ '8*777 @1;*777 $77; 18*777 #7# 9s the distribution %ade fro% current or accu%ulated E) F At the beginning of $77,* what is accu%ulated E) F Answer: .he @1;*777 distribution is %ade fro% $77+2s current E) . At the beginning of $77;* I%ega2s accu%ulated E) is @$;*777* 5#@$7*777 G @'7*777 G @'8*777 # @1;*777). At the beginning of $77,* I%ega2s accu%ulated E) is @""*777* 5@$;*777 G @18*777).
age !ef.: C:"#'

+&) 9n $77;* .ru Corporation deducted @&*777 of bad debts. 9t recei-ed no tax benefit fro% the deduction because it had an AIL in $77; that it was unable to carry bac0 or forward. 9n $77,* .ru reco-ered @"*777 of the a%ount due. a. (hat a%ount %ust .ru include in inco%e in $77,F b. (hat affect does the @"*777 ha-e on E) in $77,* if anyF Answer: a. .ru excludes the @"*777 fro% gross inco%e in $77, because it recei-ed no tax benefit fro% the bad debt deduction in $77;. b. .ru %ust add the @"*777 to its inco%e for purposes of deter%ining current E) since it was deducted in a prior year.
age !ef.: C:"#"B Exa%ple C:"#'

+8) 9n the current year* Ho Corporation sells land that has a @8*777 basis and a @17*777 F34 to Henry* an unrelated indi-idual. Henry %a0es a @$&*777 down pay%ent this year and will pay Ho @$&*777 per year for the next three years* plus interest on the unpaid balance at a rate acceptable to the 9!S. Ho2s reali6ed gain is @"*777. Since Ho is not in the business of selling land* it will use the install%ent %ethod of accounting. How does this transaction effect Ho2s E) in the current year and the three subse1uent yearsF Answer: 9n the current year* Ho recogni6es @1*777 of gain K5@"*777D@17*777 J @$*&77L in co%puting taxable inco%e. Ho will also recogni6e @1*777 of gain in co%puting taxable inco%e in each of the next three years. All @"*777 of Ho2s reali6ed gain %ust be included in current E) . As Ho collects the install%ents* E) will need to be reduced by @1*777 in each of those years since all @"*777 was included in E) in the current year.
age !ef.: C:"#"B Exa%ple C:"#&

++) (hen co%puting E) and taxable inco%e* different depreciation %ethods are often used. (hat happens when the taxpayer sells such assetsF Answer: .he taxpayer %ust calculate a gain or loss separately for taxable inco%e and E) purposes.
age !ef.: C:"#&

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+;) !i-er Corporation2s taxable inco%e is @$&*777* after deducting a @&*777 AIL carryo-er fro% last year and after clai%ing a @17*777 di-idends#recei-ed#deduction. (hat is current E) F Answer: !i-er %ust add bac0 the @17*777 =!= and the @&*777 AIL. .herefore* current E) is @"7*777 5@$&*777 G @17*777 G @&*777).
age !ef.: C:"#8

+,) (hite Corporation is a calendar year taxpayer. (ilhel%ina owns all of its stoc0. Her basis for the stoc0 is @$&*777. In 3arch 1 of the current year 5not a leap year)* (hite Corporation distributes @87*777 to (ilhel%ina. =eter%ine the tax conse1uences of the cash distribution to (ilhel%ina in each of the following independent situations. a. Current E) @1&*777* accu%ulated E) @&7*777. b. Current E) @$&*777* accu%ulated E) @5$&*777). c. Current E) 5@'8*&77)* accu%ulated E) @8&*777. d. Current E) 5@17*777)* accu%ulated E) @5$&*777) Answer: a. @87*777 di-idend to (ilhel%inaB @1&*777 out of current E) and @"&*777 out of accu%ulated E) . b. @$&*777 is a di-idend to (ilhel%inaB @$&*777 is a return of capital that reduces (ilhel%ina2s basis to 6eroB the excess @17*777 is taxable as a capital gain. c. (hite2s accu%ulated E) as of 3arch 1 5of a non#leap year) is @8&*777 # K5@'8*&77 R '8&) J &,L E @&,*177. .herefore* @&,*177 is taxable as a di-idend. @,77 is a return of capital that reduces (ilhel%ina2s stoc0 basis to @$"*177. d. @$&*777 is a return of capital that reduces (ilhel%ina2s basis to 6eroB the excess @'&*777 is taxable as a capital gain.
age !ef.: C:"#8 through C:"#;

;7) Splash Corporation has @&7*777 of taxable inco%e before any charitable contribution deduction. Splash contributed @$7*777 to a 1ualified charitable organi6ation. =ue to the 17: of taxable inco%e li%itation on charitable contribution deductions* Splash2s contribution deduction is li%ited to @&*777. (hat effect does the charitable contribution ha-e on current and future E) F Answer: Splash deducts the entire @$7*777 in co%puting current E) . .herefore* @1&*777 %ust be deducted fro% taxable inco%e of @"&*777 5@&7*777 # @&*777) to co%pute current E) . 9n future years* when the @1&*777 carryo-er is deducted in deter%ining taxable inco%e* it %ust be added to taxable inco%e in arri-ing at current E) .
age !ef.: C:"#+B Exa%ple C:"#,

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;1) each Corporation was for%ed four years ago. 9ts current E) 5or E) deficit) and distributions for the %ost recent four years are as follows: Current E&P (Deficit) 5@$7*777) ;*777 5 &*777) $&*777

Year $77& $778 $77+ $77;

Distributions @ $*777 "*777 #7# "*777

(hat is each2s accu%ulated E) at the beginning of $778* $77+* $77;* and $77,F Answer: $778: 5@$7*777)a $77+: 5@18*777)b $77;: 5@$1*777)c $77,: #7#d a A distribution does not reduce a current E) deficit. b 5@$7*777) G 5@;*777 # @"*777) E 5@18*777). c 5@18*777) G 5@&*777) E 5@$1*777). d 5@$1*777) G 5@$&*777 # @"*777) E @7.
age !ef.: C:"#+

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;$) ay%ent Corporation has accu%ulated E) of @1,*777 and current E) of @$;*777. =uring the year the corporation %a0es the following distributions to its sole shareholder.

Date April 1 Cune 1 August 1 Ao-e%ber 1

Amount Distributed @$7*777 $7*777 1&*777 &*777

.he sole shareholder2s basis in her stoc0 is @"&*777. (hat are the tax conse1uences of the Cune 1 distributionF Answer: .he current E) is allocated ratably to each distribution. Accu%ulated E) is allocated to the four distributions in chronological order starting with the April 1 distribution. .he taxability of the distributions is as follows: Amount Distribute d @$7*777 $7*777 1&*777 &*777 @87*777

Date April 1 Cune 1 August 1 Ao-e%ber 1

Current E&P @ ,*''' ,*''" +*777 $*''' @$;*777

Accum# E&P @17*88+ ;*''' #7# #7# @1,*777

eturn Capital of Capital $ain #7# @ $*''' ;*777 $*88+ @1'*777 #7# #7# #7# #7# #7#

age !ef.: C:"#+

;') ?reen Corporation is a calendar#year taxpayer. All of the stoc0 is owned by E-an. His basis for the stoc0 is @'&*777. In 3arch 1 5of a non#leap year)* ?reen Corporation distributes @1$7*777 to E-an. =eter%ine the tax conse1uences of the cash distribution to E-an in each of the following independent situations: Current E) Accu%ulated E) a. @'7*777 @177*777 b. &7*777 5 &7*777) c. 5+'*777) "7*777 d. 5$7*777) 5 &7*777) Answer: a. @1$7*777 is a di-idend to E-an. b. @&7*777 is di-idend. @'&*777 is a return of capital* which reduces E-an2s basis to 6ero. .he re%aining @'&*777 is taxable as a capital gain. c. ?reen2s accu%ulated E) as of 3arch 1 is @$;*$77 S@"7*777 # K@+'*777 J 5&, ) '8&)LT. .herefore* @$;*$77 is taxable as a di-idend. @'&*777 is a return of capital and the re%aining @&8*;77 is taxable as a capital gain. d. @'&*777 is a return of capital which reduces E-an2s basis to 6ero and the re%aining @;&*777 is a capital gain.
age !ef.: C:"#+ and C:"#;

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;") (hen is E) %easured for purposes of deter%ining whether a distribution is a di-idendF Answer: /sually at year#end. Howe-er* if a current deficit exists* the E) a-ailable for %easuring di-idend inco%e is deter%ined at the distribution date.
age !ef.: C:"#;

;&) 9n the current year* earl Corporation has @'77*777 of current and accu%ulated E) . In Cune '* earl Corporation distributes a parcel of land 5a capital asset) worth @1$7*777 to <etty* a shareholder. .he land has a @87*777 ad>usted basis to earl Corporation and is sub>ect to a @18*777 %ortgage* which <etty assu%es. Assu%e a '": %arginal corporate tax rate. a. (hat are the a%ount and character of the inco%e recogni6ed by <etty as a result of the distributionF b. (hat is <etty2s basis for the landF c. (hat are the a%ount and character of earl2s gain or loss as a result of the distributionF d. (hat effect does the distribution ha-e on earl2s E) F Answer: a. <etty has a taxable di-idend of @17"*777 5@1$7*777 # @18*777). b. <etty2s basis for the land is @1$7*777* its F34. c. earl Corporation recogni6es a @87*777 5@1$7*777 F34 # @87*777 basis) gain on the distribution. d. earl Corporation2s E) is increased by the @87*777 gain and decreased by the @17"*777 5@1$7*777 # @18*777) net a%ount of the distribution plus the @$7*"77 57.'" J @87*777) of federal inco%e taxes i%posed on the gain* or a net reduction of @8"*"77.
age !ef.: C:"#;#C:"#11

;8) 9n the current year* !ed Corporation has @177*777 of current and accu%ulated E) . In 3arch $* !ed Corporation distributes to !andy* a shareholder* a parcel of land 5a capital asset) ha-ing a @87*777 F34. .he land has a @'7*777 ad>usted basis 5for both tax and E) purposes) to !ed Corporation and is sub>ect to an @;*777 %ortgage* which !andy assu%es. Assu%e a '": %arginal corporate tax rate. a. (hat are the a%ount and character of the inco%e !andy recogni6es as a result of the distributionF b. (hat is !andy2s basis for the landF c. (hat are the a%ount and character of !ed Corporation2s gain or loss as a result of the distributionF d. (hat effect does the distribution ha-e on !ed Corporation2s E) F Answer: a. !andy recei-es a taxable di-idend of @&$*777 5@87*777 # @;*777). b. !andy2s basis for the land is @87*777* its F34. c. !ed Corporation recogni6es a @'7*777 K5@&$*777 net F34 G @;*777 release fro% liability) # @'7*777L capital gain on the distribution. d. !ed Corporation2s E) is increased by the @'7*777 E) gain* which is the excess of the land2s F34 o-er its E) ad>usted basis. 5Aote that the E) gain and the tax gain are the sa%e in this proble%. ) E) is decreased by the @&$*777 5@87*777 F34 # @;*777 %ortgage) net a%ount of the distribution and by the @17*$77 57.'" J @'7*777) of federal inco%e taxes i%posed on the gain* or a net reduction of @'$*$77.
age !ef.: C:"#;#C:"#11

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;+) =igger Corporation has @&7*777 of current and accu%ulated E) . In 3arch 1* =igger distributes land with a @'7*777 F34 and a @1+*&77 ad>usted basis to =a-e* its sole shareholder. .he land is sub>ect to a @&*777 liability which =a-e assu%es: a. (hat is the a%ount and character of the distributionF b. (hat is =a-e2s basis in the propertyF c. (hen does his holding period for the property beginF Answer: a. .he distribution a%ount is @$&*777 5@'7*777 # @&*777)* all of which is a di-idend to =a-e as it does not exceed =igger2s E) balance. b. =a-e2s basis in the property is @'7*777* its F34. c. =a-e2s holding period starts on 3arch $.
age !ef.: C:"#,B Exa%ple C:"#1"

;;) ?ould Corporation distributes land 5a capital asset) worth @,7*777 to ?erry* a shareholder. .he land as a @'7*777 basis to ?ould. (hat is the a%ount and character of the gain or loss recogni6ed by ?ouldF Answer: ?ould recogni6es a @87*777 5@,7*777 # @'7*777) capital gain* as though ?ould had sold the property.
age !ef.: C:"#17B Exa%ple C:"#1&

;,) Strong Corporation is owned by a group of $7 shareholders. =uring the current year* Strong Corporation pays @$$&*777 in salary and bonuses to Sted%an* its president and controlling shareholder. .he 9!S audits Strong2s tax return and deter%ines that reasonable co%pensation for Sted%an would be @1$&*777. Strong Corporation agrees to the ad>ust%ent. a. (hat effect does the disallowance of part of the deduction for Sted%an2s salary and bonuses ha-e on Strong Corporation and Sted%anF b. (hat tax sa-ings could ha-e been obtained by Strong Corporation and Sted%an if an agree%ent had been in effect that re1uired Sted%an to repay Strong Corporation any a%ounts deter%ined by the 9!S to be unreasonableF Answer: a. .he @177*777 in disallowed salary and bonuses will be nondeductible by Strong Corporation and taxable as a di-idend to Sted%an. How the 9!S will treat this is unclear. Since salary reclassified as di-idend inco%e will be taxed at a %axi%u% of 1&:* the 9!S is not li0ely to allow an offsetting ordinary deduction upon repay%ent. b. .he repay%ent %ay be deductible by Sted%an. How the 9!S will treat this is unclear. Since salary reclassified as di-idend inco%e will be taxed at a %axi%u% of 1&:* the 9!S is not li0ely to allow an offsetting ordinary deduction upon repay%ent.
age !ef.: C:"#1$* C:"#1'* C:"#''* C:"#'"

24 Copyright 2011 Pearson Education, Inc.

,7) Chec0ers Corporation has a single class of co%%on stoc0 outstanding. <ert owns 177 shares* which he purchased fi-e years ago for @$77*777. 9n the current year* when the stoc0 is worth @$*&77 per share* Chec0ers Corporation declares a 17: stoc0 di-idend payable in co%%on stoc0. <ert recei-es ten additional shares on =ece%ber 17 of the current year. In Canuary $& of next year* he sells all ten shares for @'7*777. a. How %uch inco%e %ust <ert recogni6e when he recei-es the stoc0 di-idendF b. How %uch gain or loss %ust <ert recogni6e when he sells the ten shares he recei-ed as a stoc0 di-idendF Answer: a. .he stoc0 di-idend is nontaxable 5Sec. '7&5a)). b. <ert2s basis in each share is @1*;1;. 1; 5@$77*777D117 shares). .herefore his gain on the sale is @11*;1;.$7 K@'7*777 # 517 J @1*;1;.1;)L.
age !ef.: C:"#1"

,1) Ace Corporation has a single class of stoc0 outstanding. Alan owns $77 shares of the co%%on stoc0* which he purchased for @&7 per share two years ago. In April 17* of the current year* Ace Corporation distributes to its shareholders one right to purchase a share of co%%on stoc0 at @87 per share for each share of co%%on stoc0 held. At the ti%e of the distribution* the co%%on stoc0 is worth @+& per share* and the rights are worth @1& per right. In Septe%ber 17* Alan sells 177 rights for @$*777 and exercises the re%aining 177 rights. He sells 87 of the shares ac1uired with the rights for @;7 each on Ao-e%ber 17. a. (hat are the a%ount and character of inco%e Alan recogni6es when he recei-es the rightsF b. (hat are the a%ount and character of gain or loss Alan recogni6es when he sells the rightsF c. (hat are the a%ount and character of gain or loss Alan recogni6es when he exercises the rightsF d. (hat are the a%ount and character of gain or loss Alan recogni6es when he sells the new co%%on stoc0F e. (hat basis does Alan ha-e in his re%aining sharesF Answer: a. Alan recogni6es no inco%e when he recei-es the rights. b. Since the -alue of the rights 5@1&) is %ore than 1&: of the -alue of the underlying stoc0 5@+&)* the basis of the stoc0 %ust be allocated to the stoc0 and the right. Alan2s basis in his stoc0 is: @17*777 J 5@+&D@,7) E @;*'''. '' 5@"1. 8+ per share). Alan2s basis in his rights is @17*777 J 5@1&D@,7) E @1*888. 8+ 5@;. '' per right). Alan recogni6es a long#ter% capital gain of @1*188. 8+ 5@$*777 # @;''. '') when he sells the 177 rights. c. Alan recogni6es no gain when he exercises the rights. .heir basis is added to the basis of the stoc0 purchased with the rights 5@8*777 G @;''. '' E @8*;''. ''). d. Alan recogni6es a gain of @+77 K587 J @;7) # 587 J @8;. '')L on the stoc0 sale. .he gain is a short#ter% capital gain since the holding period begins on the Septe%ber 17 exercise date. e. Alan2s basis in his re%aining shares is as follows: Alan2s original $77 shares: @;*'''. '' 5@17*777 # @1*888. 8+). Alan2s "7 re%aining shares purchased with the rights: @$*+''. '' 5"7 shares J @8;. '').
age !ef.: C:"#1&* C:"#18

,$) eter owns all 177 shares of ar0er Corporation2s stoc0. His basis in the stoc0 is @'7*777. ar0er Corporation has @'77*777 of E) . ar0er Corporation redee%s $& of eter2s shares for @,7*777. (hat are the conse1uences to eter and to ar0er CorporationF Answer: Since eter still owns 177: of ar0er Corporation2s stoc0* the rede%ption is treated as a di-idend. eter has a @,7*777 di-idend taxed at a %axi%u% of 1&:. His basis in his re%aining +& shares re%ains at @'7*777. ar0er Corporation2s E) is reduced by @,7*777.
age !ef.: C:"#18#C:"#1;

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,') 3aury Corporation has $77 shares of stoc0 outstanding as follows: Aa%e Shares A%y 5an indi-idual) '7 A < artnership 5A%y is a $7: partner) $& A<C artnership 5A%y is a +7: partner) &7 Sil-er Corporation 5A%y is a '7: shareholder) &7 ?old Corporation 5A%y is a 87: shareholder) "& .otal $77 How %any shares is A%y dee%ed to own under the Sec. '1; attribution rulesF Answer: A%y owns: '7 shares directly & shares through A < artnership 57.$7 J $& shares) '& shares through A<C artnership 57.+7 J &7 shares) #7# shares through Sil-er Corporation $+ shares through Li%e Corporation 57.87 J "& shares) .hus* total dee%ed constructi-e ownership is ,+ shares.
age !ef.: C:"#1;#C:"#$7

,") =a-e* Erica* and Faye are all unrelated. Each has owned 177 shares of Aews Corporation stoc0 for fi-e years and each has a @1;7*777 basis in those 177 shares. Aews Corporation2s E) is @+$7*777. Aews redee%s all 177 of =a-e2s shares for @'77*777* their F34. a. (hat are the a%ount and character of =a-e2s recogni6ed gain or lossF (hat basis do Erica and Faye ha-e in their re%aining sharesF (hat effect does the rede%ption ha-e on Aews2s E) F b. Assu%ing instead that =a-e is Erica2s son* answer the 1uestions in art a again. Answer: a. .his is a co%plete ter%ination of interest and therefore Sec. '7$5b)5') applies. =a-e recogni6es a gain of @1$7*777 5@'77*777 # @1;7*777 basis). Erica and Faye each retain a basis of @1;7*777 in their shares. Aews2s E) is reduced by @$"7*777 K5177D'77 shares) J @+$7*777L. b. 9f Erica is =a-e2s %other and a wai-er of the fa%ily attribution rules is not elected* =a-e is considered to own $77D'77 or 88 $D': before the rede%ption and 177D$77 or &7: after the rede%ption. .herefore* the rede%ption is treated as a di-idend of @'77*777 to =a-e. Erica2s @1;7*777 basis is increased by =a-e2s @1;7*777 basis in the shares surrendered to @'87*777. Faye2s basis re%ains the sa%e at @1;7*777. Aews2 E) is reduced by @'77*777* the a%ount of the di-idend paid to =a-e. Alternati-ely* =a-e could elect under Sec. '7$5c) to wai-e the fa%ily attribution rules. 9f such an election is %ade* the Sec. '7$5b)5') rules that applied in deter%ining the answer in part 5a) will pro-ide capital gain treat%ent.
age !ef.: C:"#$1#C:"#$'

26 Copyright 2011 Pearson Education, Inc.

,&) <art* a &7: owner of Atlas Corporation2s co%%on stoc0* recei-es a distribution of a new class of Atlas preferred stoc0 ha-ing a @"7*777 F34. <art2s basis in the Atlas co%%on stoc0 is @'7*777. 9ts F34 is @;7*777 on the distribution date. Ine year later the corporation redee%s the preferred stoc0 for @+&*777. At the ti%e the stoc0 was issued* the corporation2s current and accu%ulated E) was @;7*777. At the end of the year of rede%ption the current and accu%ulated E) is @$&*777. Ao other distributions out of E) were %ade in the year of rede%ption. (hat are the tax conse1uences of the transactionF Answer: .he basis allocated of the co%%on stoc0 is: @'7*777 J K@"7*777D5@"7*777 G @;7*777)L E @17*777 .he rede%ption of <art2s preferred stoc0 is treated as a di-idend under Sec. '71. <art2s di-idend inco%e under Sec. '78 is li%ited to Atlas Corporation2s E) at the ti%e of the stoc0 rede%ption* or @$&*777. Conse1uently* <art has @$&*777 of di-idend inco%e* @17*777 treated as a return of capital* and @"7*777 of capital gain K@+&*777 # 5@$&*777 G @17*777)L.
age !ef.: C:"#$;#C:"#'7

,8) Susan owns 1&7 of the $77 outstanding shares of arent Corporation2s stoc0. arent owns 187 of the $77 outstanding shares of Subsidiary Corporation2s stoc0. Susan sells &7 shares of her arent stoc0 to Subsidiary for @"7*777. Susan2s basis in her arent shares is @1&*777. 5@177 pear share). Subsidiary Corporation and arent Corporation ha-e E) of @87*777 and @$&*777* respecti-ely* at the end of the year in which the rede%ption occurs. a. (hat are the a%ount and character of Susan2s gain or loss on the saleF b. (hat is Susan2s basis in her re%aining shares of arent stoc0F c. How does the sale affect the E) of arent and Subsidiary CorporationF d. (hat basis does Subsidiary Corporation ta0e in the arent shares it purchasesF e. How would your answer to art a change it Susan instead sells 177 of her arent shares to Subsidiary Corporation for @;7*777F Answer: a. .he sale is recast as a rede%ption. Since Susan still owns %ore than &7: of arent after the rede%ption* K177 shares directly and $7 5&7: J ;7: J &7) shares indirectly out of $77 outstanding sharesL* or 87: of arent2s stoc0* the @"7*777 is taxed as a di-idend to Susan. b. Susan2s basis in her re%aining 177 shares of arent stoc0 is @1&*777. c. Subsidiary Corporation2s E) is reduced to @$7*777 5@87*777 # @"7*777). d. Subsidiary Corporation2s basis in the arent shares is @"7*777. e. .he recast rede%ption is substantially disproportionate S+&: before the rede%ption and +7 K&7 G $7 5$&: J ;7: J 177)L shares* or '&:* after the rede%ptionT. .herefore* Susan has a capital gain of @+7*777 K@;7*777 # 5177D1&7 J @1&*777)L.
age !ef.: C:"#'7#C:"#''

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,+) !ich owns 87 of the 177 outstanding shares of !ainbow Corporation2s stoc0 and ;7 of the 177 outstanding shares of I6 Corporation2s stoc0 !ich2s basis in his !ainbow shares is @1$*777* and his basis in his I6 shares is @;*777. !ich sells '7 of his !ainbow shares to I6 Corporation for @&7*777. At the end of the year of the sale* !ainbow and I6 Corporations ha-e E) of @$&*777 and @"7*777* respecti-ely. a. (hat are the a%ount and character of !ich2s gain or lossF b. (hat is !ich2s basis in his re%aining shares of the !ainbow and I6 stoc0F c. How does the sale affect the E) of !ainbow and I6 CorporationsF d. (hat basis does I6 Corporation ta0e in the !ainbow shares it purchasesF e. How would your answer to art a change if !ich owns only &7 shares of the 177 outstanding shares of I6 Stoc0F Answer: a. .he sale is recast as a rede%ption of I6 stoc0 issued as a result of !ich2s capital contribution of the !ainbow stoc0 to I6. .he Sec. '7$ stoc0 ownership is tested by loo0ing at !ich2s ownership of the !ainbow stoc0. U !ich2s ownership of !ainbow stoc0 before the rede%ption: 87: of !ainbow stoc0. U !ich2s ownership after the rede%ption: '7 shares directly and ;7: J '7 shares indirectly E &" shares E &": of !ainbow stoc0. .he rede%ption is treated as a @&7*777 di-idend to !ich since the co%bined E) of !ainbow and I6 Corporations is @8&*777 5@$&*777 G @"7*777). b. !ich2s basis in his re%aining !ainbow stoc0 is @8*777 5'7D87 J @1$*777). !ich2s basis in his I6 stoc0 is increased to @1"*777 by his @8*777 basis in the redee%ed I6 stoc0. c. I62s E) is reduced by the first @"7*777 of the distribution* and !ainbow2s E) is reduced by the re%aining @17*777 5@&7*777 # @"7*777) of the distribution. d. I62s basis in its !ainbow shares is @8*777* the sa%e as !ich2s pre#sale basis. e. 9f !ich owned only &7: of the I6 stoc0 before the sale* !ich owns 87: of the !ainbow stoc0 before and "&: after the sale K'7 shares G 5&7: J '7 shares)L* so the rede%ption is treated as a sale under Sec. '7$5b)5$). !ich has a capital gain of @""*777 5@&7*777 # @8*777 basis).
age !ef.: C:"#'1#C:"#''

,;) How does a shareholder classify a distribution for tax purposesF Answer: =istributions are treated as follows: 51) di-idends to the extent of corporate E) * 5$) return of capital to the extent of the shareholders stoc0 basis* and 5') gain fro% the sale of stoc0.
age !ef.: C:"#$

,,) Iutline the co%putation of current E) including two exa%ples for each ad>ust%ent. Answer: .axable inco%e lus: 9nco%e excluded fro% taxable inco%e 5e. g. * tax#exe%pt interest* life insurance proceeds) lus: 9nco%e deferred to a later year when co%puting taxable inco%e 5e. g. * install%ent sales* inco%e reported on percentage of co%pletion %ethod) lus or %inus: 9nco%e and deduction ite%s that %ust be reco%puted when co%puting E) 5e. g. * excess depreciation o-er straight#line* percentage depletion in excess of cost depletion). lus: =eductions not allowed in co%puting E) 5e. g. * AIL deduction* di-idends#recei-ed deduction) 3inus: Expenses and losses not deductible in co%puting taxable inco%e 5e. g. federal inco%e taxes* nondeductible political contributions) Current E) 5or E) deficit).
age !ef.: C:"#"

2 Copyright 2011 Pearson Education, Inc.

177) 3aple Corporation distributes land to a noncorporate shareholder. Explain how the following ite%s are co%puted: a. .he a%ount of the distribution. b. .he a%ount of the di-idend c. .he basis of the land to the shareholder d. .he start of the holding period for the land How would your answers change if the distribution were %ade to a corporate shareholderF Answer: a. .he distribution a%ount is the F34 of all property recei-ed. 9f the shareholder assu%es or ac1uires a liability in connection with the distribution* it reduces the a%ount of the distribution 5but not below 6ero). b. .he distribution a%ount is a di-idend to the extent it is paid out of the current and accu%ulated E) of the corporation. c. .he basis of any property recei-ed is its F34. Any liability assu%ed or ac1uired by the shareholder in connection with the distribution does not reduce the property2s basis. d. .he holding period for the property begins on the day after the distribution date. .he answers would not change if they were %ade to a corporate shareholder because Sec. '715c) applies the sa%e di-idend rules to each type of shareholder. Howe-er* a corporation shareholder %ay be eligible for the di-idend#recei-ed deduction.
age !ef.: C:"#;* C:"#,

171) (hat is a constructi-e di-idendF /nder what circu%stances are constructi-e di-idends %ost li0ely to ariseF Answer: A constructi-e di-idend 5or undeclared distribution) is an indirect pay%ent %ade to a shareholder without a for%al declaration. Such di-idends are %ost li0ely to arise in the context of a closely held corporation. Exa%ples of constructi-e di-idends include excess co%pensation paid to a shareholder#e%ployee or excess lease pay%ents %ade to a shareholder#lessor.
age !ef.: C:"#11#C:"#1'

17$) (hy are stoc0 di-idends generally nontaxableF /nder what circu%stances are stoc0 di-idends taxableF Answer: Stoc0 di-idends generally are nontaxable because they do not add anything to the property the shareholder already owns* nor do they reduce the property of the corporation. As a general rule* the distribution is taxable whene-er a stoc0 di-idend changes or has the potential to change the shareholder2s proportionate interest in the distributing corporation.
age !ef.: C:"#1'#C:"#1&

17') (hat is a stoc0 rede%ptionF (hat are so%e of the reasons for %a0ing a stoc0 rede%ptionF (hy are so%e rede%ptions treated as sales and others as di-idendsF Answer: A stoc0 rede%ption is the ac1uisition by a corporation of its own stoc0. So%e reasons for a rede%ption are listed on pages C:"#18. So%e rede%ptions that substantially change the shareholder2s proportionate interest closely rese%ble a sale of stoc0 to a third party and are treated as a sale or exchange* while others that do not produce such a change are essentially e1ui-alent to a di-idend and are taxed as a di-idend.
age !ef.: C:"#18

2! Copyright 2011 Pearson Education, Inc.

17") =efine Sec. '78 stoc0. Answer: Sec. '78 stoc0 is stoc0* other than co%%on stoc0 issued with respect to co%%on stoc0 that is recei-ed in a nontaxable stoc0 di-idend. 9t can also be stoc0* other than co%%on stoc0* ac1uired in an exchange to which Sec. '&1 applies if the receipt of %oney 5in lieu of stoc0) would ha-e been treated as a di-idend. Sec. '78 stoc0 also includes stoc0* other than co%%on stoc0* recei-ed in a tax#free corporate reorgani6ation or corporate di-ision if the effect of the transaction was substantially the sa%e as the receipt of a stoc0 di-idend or if the stoc0 was recei-ed in exchange for Sec. '78 stoc0. Finally* Sec. '78 stoc0 is any stoc0 whose basis is deter%ined by reference to the basis of Sec. '78 stoc0 5i. e. * a substituted or transferred basis). Sec. '78 stoc0 can only be issued by a corporation ha-ing E) in the year of issuance. .he Sec. '78 stoc0 designation lapses upon inheritances since the basis of such stoc0 is its F34 on date of death 5or alternati-e -aluation date).
age !ef.: C:"#$;

17&) Alice owns &8: of =aisy Corporation2s stoc0 and &7: of 3ay Corporation2s stoc0. Alice sells one#half of her interest in 3ay Corporation to =aisy Corporation for @'7*777. .he E) balances of =aisy and 3ay are @$&*777 and @'&*777* respecti-ely. Alice2s basis in her =aisy stoc0 is @"7*777 and her basis in the 3ay stoc0 is @';*777. (hat are the tax conse1uences of the transactionF Answer: .he transaction is recast as a rede%ption by =aisy Corporation of Alice2s =aisy stoc0 that was recei-ed as a result of the capital contribution of the 3ay stoc0. .o test for exchange treat%ent* the Sec. '7$5b) rules are applied to Alice2s interest in 3ay Corporation. Alice2s interest in 3ay Corporation after the distribution is ',: K$&: direct ownership G 1": 5&8: J $&:) indirect ownershipL. Since this is less than ;7: of her pre#rede%ption ownership 5&7: J 7.;7 E "7:)* the transaction is treated as a substantially disproportionate rede%ption that is taxed as an exchange. .his results in an @11*777 K@'7*777 # 57.&7 J @';*777)L capital gain being recogni6ed by Alice.
age !ef.: C:"#'1 and C:"#'$B Exa%ples C:"#"&* C:"#"8

178) A%eriparent Corporation owns a +7: interest in Flag Corporation. .he corporations ha-e current and accu%ulated E) of @$&*777 and @"7*777* respecti-ely. .axpayer* who has a @$7*777 basis in her "7: ownership interest of A%eriparent Corporation* sells sufficient stoc0 to Flag to reduce her interest in A%eriparent fro% "7: to $7:. .axpayer recei-es @$7*777 for the stoc0 she surrenders. (hat are the tax conse1uences of the transaction for .axpayerF Answer: .he transaction is recast under Sec. '7" as a distribution fro% A%eriparent in rede%ption of .axpayer2s stoc0. .he @$7*777 purchase is a di-idend under Sec. '71 since .axpayer2s interest was not less than ;7: of what it was prior to the rede%ption K$7: direct G 1": indirect E '": which is not less than the '$: 5"7: J ;7: E '$:) %ini%u% needed for substantially disproportionate treat%entL. .he rede%ption %ight be eligible for capital gain treat%ent if the distribution is considered to be not essentially e1ui-alent to a di-idend. 9t is possible that this interpretation will be accepted since .axpayer goes fro% one %inority position to another %inority position.
age !ef.: C:"#'1

30 Copyright 2011 Pearson Education, Inc.

17+) (hat %ust be reported to the 9!S by corporations when nondi-idend distributions are %ade to its shareholdersF Answer: .he basic purpose of For% &"&$* Corporate !eport of Aondi-idend =istributions* is to report the E) of the distributing corporation so that the 9!S can deter%ine whether the distributions are indeed nontaxable to shareholders. .he corporation %ust include its current and accu%ulated E) * the a%ounts paid to shareholders during the year and the percentage of each pay%ent that is taxable and nontaxable* and a detailed co%putation of the corporation2s E) since incorporation.
age !ef.: C:"#'8

17;) .ia recei-es a @1&*777 cash distribution fro% 3ain Corporation in 3arch of the current year. 3ain has @8*777 of accu%ulated E) at the beginning of the year and @1$*777 of current E) . 3ain also distributed @1&*777 in cash to <etty* who purchased all '77 shares of 3ain stoc0 fro% .ia in Cune of the current year. (hat tax issues should be considered with respect to the distributions paid to .ia and <ettyF Answer: U Since the two cash distributions exceed E) * what portion of each distribution co%es out E) F U (hat portion of each shareholder2s distribution is a return of capitalF U (hat portion of the return of capital distribution5s) reduces the basis of the shareholder2s stoc0F U (hat portion of each shareholder2s return of capital distribution is a capital gainF U 9s the capital gain recogni6ed long#ter% or short#ter%F .he issue is to what extent .ia2s distribution is a di-idend. 3ain Corporation has @1;*777 of current and accu%ulated E) * so only @1;*777 can be a di-idend to either <etty or .ia. Current E) is allocated ratably to <etty and .ia 5@8*777 each)* and accu%ulated E) is allocated on a first#in* first#out basis so the re%aining @8*777 of E) is allocated to .ia. .herefore* .ia has a @1$*777 di-idend and a @'*777 return of capital. <etty has a @8*777 di-idend and a @,*777 return of capital. Any a%ount recei-ed by .ia or <etty after reco-ering their stoc0 basis is a capital gain. .he return of capital distribution reduces the basis of .ia2s stoc0 in-est%ent and will cause a corresponding increase 5decrease) in the capital gain 5capital loss) reported on her sale of the 3ain stoc0 to <etty.
age !ef.: C:"#'#C:"#;

31 Copyright 2011 Pearson Education, Inc.

17,) Qiara owns 177: of the shares of Lion Corporation. Qiara2s basis in @+7*777 and the F34 of the shares is @$77*777. Qiara is willing to sell all of the stoc0 to .ia* but .ia is unwilling to pay %ore than @1&7*777 for the stoc0 because the corporation currently has excess cash balances. .hey ha-e agreed that Qiara can withdraw @&7*777 in cash fro% Lion before the stoc0 sale. (hat tax issues should be considered with respect to Qiara and .ia2s agree%entF Answer: U (hat is Lion2s E) balance i%%ediately preceding the distributionF U 9f @&7*777 in cash is withdrawn fro% the business* will it be treated as a di-idend to QiaraF U Can the @&7*777 withdrawn fro% the business be considered to ha-e been recei-ed as part of Qiara2s stoc0 saleF U Can the tax results for the transaction be i%pro-ed if Qiara has so%e of her stoc0 redee%ed for the @&7*777 cashF U Are the tax conse1uences of the transaction different if the @&7*777 is withdrawn fro% the business either before or as part of the stoc0 saleF U Can the @&7*777 pay%ent be classified as pay%ent of bac0 wages to QiaraF (ould such an a%ount be deductible by the corporationF U (hat is the a%ount and character of the gain recogni6ed on Qiara2s sale of the stoc0F .he pri%ary issue is whether the @&7*777 Qiara recei-es fro% Lion2s is a di-idend or is part of the a%ount she recei-es for her stoc0. 9f Lion redee%s $&: of her stoc0 for @&7*777 in cash as part of the sa%e transaction in which her re%aining stoc0 is sold to .ia for @1&7*777* 1uite li0ely she can treat the entire @$77*777 as being recei-ed in exchange for her stoc0 under the bootstrap rede%ption rules. 9n such case* she has a @1'7*777 5@$77*777 # @+7*777) capital gain. Howe-er* if she recei-es @&7*777 fro% Lion before entering into the sale agree%ent with .ia* she will ha-e a @&7*777 di-idend and then an @;7*777 5@1&7*777 # @+7*777) capital gain on a later sale of her stoc0 to .ia. 9t is not li0ely that Lion can treat the @&7*777 pay%ent as additional co%pensation 5e. g. * a bonus or pay%ent %ade because of lower#than#nor%al salary pay%ents %ade in prior years) and then deduct the pay%ent in co%puting its corporate tax liability. A possibility %ight be to treat the @&7*777 pay%ent as being paid to Qiara in exchange for a co-enant not to co%pete for a certain period of ti%e. Such pay%ent generally is ordinary inco%e for the recipient but is deductible by the payer o-er 1& years in accordance with Sec. 1,+.
age !ef.: C:"#'#C:"#;* C:"#''

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117) Cerry purchased land fro% (inter Harbor Corporation* his 177:#owned corporation* for @$+&*777. .he corporation purchased the land three years ago for @'77*777. Si%ilar tracts of land located nearby ha-e sold for @"77*777 in recent %onths. (hat tax issues should be considered with respect to the corporation2s sale of the landF Answer: U (hat reasons %ight cause the sale to be @1$&*777 below the apparent pre-ailing %ar0etF U (hat gain or loss does (inter Harbor recogni6e on the saleF U (hat is (inter Harbor Corporation2s E) balanceF U =o the related party sale rules apply to the saleF U 9f the @1$&*777 shortfall is a di-idend* U (hat gain or loss does (inter Harbor recogni6e on the distributionF U (hat is the shareholder2s gross inco%eF U (hat is the shareholder2s basis for the landF U (hat is the shareholder2s holding period for the landF U (hat is the distributing corporation2s gain or loss on the distributionF U (hat effect does the distribution ha-e on the distributing corporation2s E) F Ine issue is whether (inter Harbor can recogni6e a @$&*777 loss on the sale of the land to Cerry for @$+&*777 5@$+&*777 sale. # @'77*777 ad>usted basis). 9t appears that Sec. $8+ will pre-ent the recognition of the loss since Cerry and (inter Harbor Corporation are related parties under Sec. $8+5b). An additional issue is whether Cerry has a constructi-e di-idend. 9f si%ilar land has sold recently for @"77*777* it appears that the sale should ha-e been @"77*777 instead of @$+&*777. .he @1$&*777 difference between the actual sales and the a%ount paid for si%ilar land therefore should be considered a constructi-e di-idend. Classifying the difference as a constructi-e di-idend causes (inter Harbor to recogni6e a @177*777 5@"77*777 # @'77*777) capital gain on the dee%ed land sale that occurs under Sec. '115b) when appreciated property is distributed. 9t also will trigger a @'"*777 5@177*777 J 7.'") inco%e tax liability that will reduce E) . Cerry will ta0e a @"77*777 basis in the land. .he distribution will reduce E) by @1$&*777.
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111) Cohn* the sole shareholder of hoto Specialty Corporation has had an exceptional year. He is considering issuing hi%self a large bonus in lieu of a di-idend. Oou are concerned about unreasonable co%pensation. (hat issues %ust be consideredF Answer: U .he e%ployee2s 1ualifications U .he nature* extent* and scope of the e%ployee2s wor0 U .he si6e of the business U .he co%plexities of the business U A co%parison of the salaries paid with the corporation2s gross and net inco%e U .he pre-ailing general econo%ic conditions U (hether the corporation has paid any di-idends U Co%pensation for co%parable positions in co%parable concerns U .he corporation2s salary policy to its e%ployees U .he a%ount of co%pensation paid to the particular e%ployees in pre-ious years U .he a%ount of co%pensation -oted by the board of directors.
age !ef.: C:"#1$* C:"#1'

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11$) Stone Corporation redee%s 1*777 share of its stoc0 fro% Ste-e for @177*777. Ste-e2s basis in those shares is @;7*777. (hat tax issues should Ste-e consider with respect to the transactionF Answer: U 9s the rede%ption a saleF U 9s the rede%ption not a saleF 9f the rede%ption is treated as a sale* Ste-e has a @$*777 capital gain 5@17*777 # @;*777). 9f the rede%ption is not treated as a sale* Ste-e has a @17*777 distribution that is a di-idend to the extent of Stone Corporation2s current and accu%ulated E) . 9n the di-idend case* Ste-e2s @;*777 basis in the redee%ed stoc0 is added to his basis in his re%aining stoc0.
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11') Aichol Corporation has 177 shares of co%%on stoc0 outstanding. Aichol repurchased all of Aed2s '7 shares for @'&*777 cash during the current year. Aed recei-ed the shares as a gift fro% his %other three years ago. .hey ha-e a basis to hi% of @18*777. Aichol Corporation has @177*777 in current and accu%ulated E) . Aed2s %other owns "7 of the re%aining sharesB unrelated indi-iduals own the other '7 shares. (hat tax issues should be considered with respect to the corporation 2s purchase of Aed2s sharesF Answer: U (hat is Aed2s stoc0 ownership before and after the rede%ptionF U Are any shares attributed to Aed fro% his %otherF U Can Aed elect to wai-e the fa%ily stoc0 attribution rulesF U (hat is the a%ount and character of Aed2s gain or inco%e on the stoc0 rede%ptionF U (hat is Aed2s basis in the '7 shares of stoc0 he recei-ed as a gift fro% his %otherF U 9f the transaction is a di-idend* what happens to Aed2s basis in his stoc0F U (hat is Aed2s %other2s basis for her stoc0 after the rede%ption 5i. e. * is any of Aed2s re%aining basis transferred to his %other)F U =oes the corporation recogni6e any gain on the repurchase of the sharesF U (hat is its basis for the shares repurchasedF U (hat effect does the rede%ption ha-e on Aichol Corporation2s E) F .he issue is whether the rede%ption should be treated as a sale or a di-idend. Aed is dee%ed to own the shares owned by his %other. .herefore* he is dee%ed to ha-e owned +7 shares before the rede%ption 5+7D177 E +7: of the Aichol stoc0) and "7 shares after the rede%ption 5"7D+7 E &+: of the Aichol stoc0). .hus* the rede%ption is not substantially disproportionate under Sec. '7$5b)5$). .he second issue is whether Aed can sign a wai-er to ha-e the fa%ily attribution rules wai-ed under Sec. '7$5b)5'). .he proble% is that he recei-ed his shares as a gift fro% his %other. 9f Aed can show that tax a-oidance was not the principal purpose for the gift of the Aichol stoc0* he can sign a wai-er* and the rede%ption will be treated as a sale. 9n such case* he has a @1,*777 5@'&*777 # @18*777) L.C?. E) will be reduced by '7: of the current and accu%ulated E) * or @'7*777 57.'7 J @177*777). 9f a wai-er of the fa%ily attribution rules is not possible* Aed will %ost li0ely ha-e a @'&*777 di-idend. 9t is not li0ely that the Sec. '7$5b)51) Vnot essentially e1ui-alent to a di-idendW rules will apply since Aed still %aintains a %a>ority stoc0 ownership position in Aichol following the rede%ption. 9f the transaction is a di-idend* his basis for all '7 shares will be reallocated to his %other since she is the indi-idual whose stoc0 ownership pre-ented the rede%ption fro% recei-ing capital gain treat%ent. E) will be reduced by the @'&*777 distributed to Aed. .he corporation2s basis for the redee%ed shares is not i%portant since it recogni6es no gain or loss when it issues new or treasury stoc0 5Sec. 17'$).
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