R4:M8: Entity / Owners Transactions.

3. Lark contributed $60,000 FMV in assets and received $10,000 in boot. His realized gain is $10,000 ($60,000 FMV - $50,000 basis) and his recognized gain is equal to the $10,000 cash that he received. Amber's basis in the assets received is the $60,000

($50,000 carry-over basis in assets + $10,000 gain recognized by shareholder). Although not asked, Lark's basis in the corporate stock is $50,000 ($50,000 basis contributed + 10,000 gain recognized - $10,000 cash received).

Contributions to a Corp. in Exchange for Stock.

(1). Formation. (2). subsequent transfers of stock.

Corporate Distributions. Distributions from corporations to shareholders are taxable to such shareholders if the distribution are classified as dividends.

(1). dividends defined : earnings and profits = RE. (2). source of distributions. (3). constructive dividends. (4). stock dividends. (5). shareholder taxable amount. (6). Corporation paying dividend: taxable amount. (7). stock redemption.

Small Business Stock.

(1). exclusion amount. (2). Qualifications. (3). taxable portion.

☐ Maximum Ordinary Loss Deduction.

(1). married filing jointly: $100,000. (2). all other individual filers: $50,000.

☐ shareholder: nontaxable.

(1). the reorganization is a nontaxable transaction. (2). the shareholder continues to retain his or her original basis. (3). the shareholder recognizes gain to the extent that he or she receives boot [cash] in the reorganization.

☐ Property Dividends = exception- is taxable event. if a corp. distributes appreciated property, the tax results are as follows: (1). the corp. recognizes gain as if the property had been sold [i.e., FMV less adjusted basis]. FMV property Less: Net Book Value = Corp. gain

(2). the recipient shareholder includes the FMV of property in income as a dividend [to the extent of E&P]. (3). When appreciated property is distributed, the corp. cannot recognize a loss.

☐ Qualifications. (1). cash or property paid to the corp. in exchange for its first $1,000,000 of capital stock.

(2). the stock must have been issued to an individual stockholder [or a partnership] for money or other property, but not stock or securities or services rendered.

(2). source of distributions.

(2.1). order of distribution allocation. (2.2). matching cash dividends to source.

When the CPA Examination has tested on tax issues related to corporations paying property dividends, it normally involves the following sequence of events: (1). corporation has no E&P [dividend would not be taxable income]. (2). corporation distributes appreciated property as a dividend.

(3). corporation has a recognized gain [on property dividend]. (4). corporate gain increases/ creates corporate E&P. (5). Dividend to shareholder is now taxable income [to extent of E&P].

Tax-Free Reorgnizations. (1). reorganization defined. (2). parent/ subsidiary liquidation. (3). nontaxable event.

(4). continuity basis. (5). control requirements. (6). tax status of reorganizations.

(5). shareholder taxable amount. The taxable amount of a dividend from a corp.'s earnings and profits depends on what type of entity the shareholder is.

(5.1). individual shareholder. (5.2). corporate shareholders [subject to the dividends-received deduction].

Corporation Distributes Assets to Shareholders. the result of this transaction is:

(a). corp. recognizes gain or loss as if it sold the assets for the FMV; and (b). Shareholders recognize gain or loss to the extent that the FMV of assets received exceeds the adjusted basis of stock.

Corporation sells assets and distributes cash to shareholders. The result of this transaction is

(a). corporation recognizes gain or loss [as normal] on the sale of the assets; and (b). shareholders recognize gain or loss to the extent that cash exceeds adjusted basis of stock.

☐ corporation: nontaxable.

(a). the reorganization is a nontaxable transaction. (b). all tax attributes remain.

Preliminary taxable income (loss):($20,000). Additional tax return item(s): $200,000 of dividends received from a 25%-owned domestic corporation. Line 8 — $36,000 With respect to the dividends received deduction ("DRD"), unless the exception, discussed below, applies, the DRD is the lesser of

(i) the applicable percentage, defined below, times the domestic dividends received or (ii) the applicable percentage times taxable income without regard to any DRD, any NOL deduction, any capital loss carryback, and the domestic activities production deduction.

With respect to the DRD, unless the exception, discussed below, applies, the DRD is the lesser of (i) the applicable percentage, defined below, times the domestic dividends received or

(ii) the applicable percentage times taxable income without regard to any DRD, any NOL deduction, any capital loss carryback, and the domestic production activities deduction.

The charitable contribution deduction is the lesser of the amount of the charitable contribution or 10% of taxable income before the following deductions: (i) the charitable contribution deduction,

(ii) the dividends received deduction ("DRD"), (iii) any net operating loss carryback (but NOL carry-forwards are deducted), (iv) any capital loss carryback, and (v) the U.S. production activities deduction.

Gain Realized Rule: The realized gain is calculated as the fair market value of the property

...contributed for value in the corporatio less the shareholder's basis of that property.

Distributions from C corporations are considered dividend income (ordinary income) to the extent of the C corporation's current or accumulated earnings and profits. Any excess distribution is treated as a nontaxable return of capital to the extent of a shareholder's basis.

Any distribution in excess of both earnings and profits and a shareholder's basis in the stock of the corporation is treated as a capital gain.

(7). stock redemption. Stock redemptions occur when a corporation buys back stock from its stockholders. if the stock redemption qualifies for sale or exchange treatment, gain or loss is recognized by the shareholder.

If not, the redemption is treated as a dividend to the extent of the corporation's E&P. The corp. can recognize gain [but not loss] on any appreciated property distributed as though it had sold the property for its FMV.

(4). continuity basis. A reorganization is treated as a nontaxable transaction because it results in the continuation of a business in a modified form.

In order to meet the "continuity requirement," the acquiring corporation must continue the business of the old entity [or entities] or use a significant portion of the old corporation's assets.

For purposes of the personal holding company rules, a shareholder is considered to own stock held by family members, including brothers, sisters, ancestors and lineal descendants.

In-laws are not considered family members. The number of shares of stock considered owned by Abbie include the 200 shares owned directly by Abbie plus the 45 shares owned by Abbie's brother.

2. 0 | 0 The extension was filed timely and the return was filed during the extension period.

It was not filed late, so there is no failure-to-file penalty.

(1). exclusion amount. a non-corporate shareholder, who holds small business stock for more than five years, may generally exclude 100 percent of the gain on the sale or exchange of the stock.

Maximum exclusion and limited to 100 percent of the greater of ☐ 10 times the taxpayer's basis in the stock; or ☐ $10 million; $5 million if MFS [shareholder by shareholder basis].

For purposes of the personal holding company rules, a shareholder is considered to own stock held by family members, including brothers, sisters, ancestors and lineal descendants.

Neither in-laws nor cousins are considere family members. The number of shares of stock considered owned by Bertha would include only the 160 shares owned directly by Bertha.

(2). parent/ subsidiary liquidation.

No gain or loss is recognized by either the parent corp. or the subsidiary corp. when the parent, who owns at least 80 percent, liquidates its subsidiary. The parent assume the basis of the subsidiary's assets as well as any unused NOL or capital loss or charitable contribution carryovers.

Worthless Stock: Section 1244 Stock [Small business stock]. when a corporation's stock is sold or becomes worthless, an original stockholder can be treated as having an ordinary loss [fully tax deductible] instead of a capital loss, up to $50,000 [$100,000 if married filing jointly].

Any loss in excess of this amount would be a capital loss, which would offset capital gains, and then a maximum $3,000 [$1,500 if MFS] per year would be deductible. ☐ Maximum Ordinary Loss Deduction. ☐ Qualifications.

Realized gain = FMV of assets received less adjusted basis Basis to the corporation in the assets is a substituted basis in that it is generally equal to the transferring shareholder's basis in the asset.

Application to specific task: Our four shareholders are transferring cash or assets equal to 100 percent of the stock, so the control requirement is satisfied.

Cell C8 — $20,000 The facts provide that Carey transferred property with a net book value (tax basis) of $20,000 and that Carey also paid the corporation $30,000 in cash. The tax basis to the corporation would be equal to the $20,000 net book value of the property (No Tax on Transfer means use Net Book Value).

As the corporation received cash from Carey, there is no effect on the tax basis if the property, and the cash is included in the cash line item on the financial statements (GAAP and Tax). Therefore, the corporation's tax basis of the property from Carey is $20,000

Cell C7 — $40,000 The facts provide that Mitchell transferred property with a net book value (tax basis) of $40,000 and that Mitchell also paid the corporation $20,000 in cash. The tax basis to the corporation would be equal to the $40,000 net book value of the property (No Tax on Transfer means use Net Book Value).

As the corporation received cash from Mitchell, there is no effect on the tax basis if the property, and the cash is included in the cash line item on the financial statements (GAAP and Tax). Therefore, the corporation's tax basis of the property from Mitchell is $40,000.

The remaining $3,750 of each dividend will be taxable as follows: February and April: Paid from accumulated earnings and profits [taxable dividend].

August: $2,500 paid from accumulated earnings and profits [taxable dividend]; $1,250 return of capital. November: Entire amount is tax-free return of capital [up to basis of stock; amount in excess of stock basis will be taxed as capital gain].

5. The "solely in exchange" requirement applies only if the contributors are in control of at least 80 percent of the corporate stock immediately after the contribution. Realized gain = FMV of assets received less adjusted basis

Basis to the corporation in the assets is a substituted basis in that it is generally equal to the transferring shareholder's basis in the asset.

Return of Capital: $700 The remaining excess distribution of $1,200 ($18,200 - $17,000) is considered to be a return of capital to the extent of basis in the stock. The basis is given to be $700, so that amount is return of capital.

Capital Gain: $500 The portion of the excess distribution that exceeds stock basis is taxable as a capital gain. Stock basis is $700, so the capital gain is $500 ($1,200 - $700).

Cells B10, C10, and B13 are footed total amounts: B10: $330,000 C10: $260,000 B13: $330,000

Cell B11 — Liabilities on the Balance Sheet: Jones $60,000 Mitchell 50,000 Carey 20,000 Gorman 0 Total liabilities $130,000 The facts provide that the liabilities were "assumed by Arrington Enterprises, Inc."

(5). control requirements. In addition to the continuity requirement, there is a control test.

Control is defined as at least 80 percent of the total voting power of all classes of stock and at least 80 percent of all other classes of stock. this is the same requirement as that of a tax-free incorporation.

(1). dividends defined : earnings and profits = RE. a dividend is defined by the internal revenue code as a distribution of property by a corp. out of its earnings and profits [E&P]:

Current E&P [by year end]- taxable dividend. Accumulated E&P [distribution date] - taxable dividend. return of capital [no E&P] -tax free and reduces basis of common stock. capital gain distribution [no E&P / no basis]- taxable income as a capital gain.

Any distribution in excess of earnings and profits ["E&P," accumulated and current] is treated as a nontaxable return of capital that reduces the shareholder's basis in the stock.

Distributions in excess of basis are capital gain distributions taxable as capital gains instead of dividends.

The applicable percentage is 70% if the corporation owns less than 20% of the domestic investee corporation; the applicable percentage is 80% if the corporation owns at least 20% of, but less than 80% of, the domestic investee corporation.

EXCEPTION: "the applicable percentage times taxable income" limitation does not apply if, after taking into account the full DRD, the result is a net operating loss.

(a). corp. recognizes gain or loss as if it sold the assets for the FMV; and

Fair Market Value Less: Basis. = Taxable gain / loss. [1st tax]

(b). Shareholders recognize gain or loss to the extent that the FMV of assets received exceeds the adjusted basis of stock.

Fair Market Value. Less: Stock Basis. = Taxable gain / loss.

Cells B4 and C4: Jones ($10,000) Mitchell 20,000 Carey 30,000 Gorman (20,000) Total cash $20,000

For the cash contributed, the Balance Sheet amount and the Tax Basis are the SAME.

For purposes of the personal holding company rules, a shareholder is considered to own stock held by family members, including brothers, sisters, ancestors and lineal descendants.

Former spouses are not considered famil members. The number of shares of stock considered owned by Demetrius would include the 260 shares owned directly by Demetrius plus the 40 shares owned by Demetrius' child.

Rule: As discussed in the Financial and Regulation textbook and presented in the lectures,

GAAP financial statements generally record the assets and liabilities at their Fair Market Values (i.e., Financials use Fair Market Value).

Multiple Distributions in a Year. in Year 1, Linda Corp. had current earnings and profits of $15,000 and accumulated earnings and profits of $10,000. It paid four cash dividends in February, April, August, and November of $7,500 each for a total of $30,000.

Half of each dividend [$3,750] will be treated as having been made from current earnings and profits taxable to the shareholder to that extent.

General Netting Rules.

However, if current E&P is negative and accumulated E&P is positive, the two amounts are netted and distributions are dividends if the net is positive.

General Netting Rules. the general rule is that current and accumulated E&P are not netted. dividends come from current E&P and then from accumulated E&P. if both are positive, there are no issues; distributions are dividends to the extent of the total of current and accumulated E&P.

If current E&P is positive and accumulated E&P is negative, distributions are dividends to the extent of current E&P only. if current and accumulated E&P are negative, distributions are not dividends at all.

The DRD is $14,000: the lesser of (i) 70% times $20,000 dividends from less-than-20%-owned domestic corporations = $14,000 or (ii) 70% times $210,000 = $147,000. $210,000 is $200,000 preliminary taxable income plus $20,000 dividends less $10,000 charitable contribution deduction.

Note that the "exception" does not apply here. As such, line 30 is $196,000: $200,000 preliminary taxable income plus $20,000 dividends received less the $10,000 allowable charitable contribution deduction less $14,000 DRD.

The DRD is $144,000: the lesser of (i) 80% times $200,000 dividends from at-least-20%-but-less-than-80%-owned domestic corporations = $160,000 or (ii) 80% times $180,000 = $144,000. $180,000 is ($20,000) preliminary taxab income (loss) plus $200,000 dividends received.

Note that the "exception" does not apply here. As such, line 30 is $36,000: ($20,000) preliminary taxable income (loss) plus $200,000 dividends received less $144,000 DRD.

Corporation Liquidation. If a corp. is liquidated, the transaction is subject to double taxation [that is, the corporation and the shareholders must generally recognize gain or loss].

Note that the corp. generally deducts its liquidation expenses [e.g., filing fees and professional fees] on its final tax return. Corp. liquidation takes two general forms.

(b). shareholders recognize gain or loss to the extent that cash exceeds adjusted basis of stock.

Proceeds Less: stock basis. = Taxable gain / loss. [2nd tax]

Tax Basis in Shares Rule: The shareholder's tax basis in the shares is generally equal to the shareholder's net book value of the property immediately before the contribution plus any cash contributed.

Remember, the transfer of property is generally is a non-taxable event, which means that the basis is the net book value to the shareholder (recall the Pass Keys from the tax lectures).

To distinguish the liquidation and reorganization rules, review the following: Liquidation. Business activity: completely ceases. Corporate consequence: taxable. Shareholder Consequence: taxable.

Reorganization: Business activity: continues. Corporate consequence: nontaxable. Shareholder Consequence: nontaxable.

(a). corporation recognizes gain or loss [as normal] on the sale of the assets; and

Sale price Less: Basis = taxable gain / loss. [1st tax].

☐ Complete Buyout of Shareholder:

Shareholder's entire interest is redeemed, and the transaction is treated as an exchange of stock.

The General Rule for taxable events and basis applies to reorganizations: Taxpayer: corporation. Event: nontaxable. Income: NONE. Basis: NBV. Tax attributes: No change

Taxpayer: Shareholder. Event: nontaxable. Income: NONE. Basis: NBV. Tax attributes: No change

(3). constructive dividends. Note: Corporations may have an incentive to not classify the above as dividends since the transactions listed above could create a deductible expense or a loss, while a dividend payment is not a deduction to the corp.

The IRS may classify these as dividends to avoid giving the deduction to the corp. and to count them as income to the recipients.

Alaska, Inc. is an accrual-basis C corporation that was incorporated on January 1, Year 1. At the end of Year 2, the corporation is considering converting to an S corporation. Alaska is required to determine its accumulated earnings and profits prior to conversion.

The company has already calculated book net income, taxable income, and prior-year accumulated earnings and profits, and is now attempting to calculate the company's current earnings and profits.

Rule: As discussed in the Regulation textbook and presented in the lectures, for tax purposes, there is generally no tax on the transfer of assets to a corporation (i.e., No Tax means use Net Book Value).

The corporation's tax basis in the asset is generally equal to the tax basis of the shareholder upon transfer to the corporation plus any cash the corporation had to pay to complete the transfer of the asset.

Cell B11 — Stockholders' Equity on the Balance Sheet: Jones $50,000 Mitchell 50,000 Carey 50,000 Gorman 50,000 Total liabilities $200,000

The facts provide that each shareholder contributed "sufficient assets to become a 25% shareholder with a total stock equity of $50,000 each.

Distributions in complete liquidation of a corporation are subject to two levels of taxation. First, the corporation must recognize gain or loss as if it sold the assets for the fair market value.

The gain on the sale would be the fair market value of $162,000 less $90,000 basis for a gain of $72,000. Secondly, the shareholders would report gain or loss determined by the difference between the fair market value of the assets received and the shareholders' adjusted basis of the stock.

☐ General Rule.

The general rule is the payment of a dividend does not create a taxable event. A dividend is a reduction of earning and profits [retained earnings].

4. 30,000 | 900 All amounts paid after the initial due date are subject to interest. The interest is 1 percent for each month or fraction of a month.

The payment on June 24 is 2 full months and part of a third month late. Therefore the interest is 1% × 3 × 30,000 = 900

1. 0 | 0 This is not an electing large corporation. Therefore, they may use the 100% of prior year method for paying estimated taxes as long as the prior year was not zero.

The prior year was 35,000. Because the estimated tax payments of 80,000 (20,000 × 4) were at least 35,000, there will be no penalty for underpayment of estimated taxes.

Clay, Finch, Lark and Token formed Amber Co., a C corporation.

The shareholders made the following contributions to the corporation in exchange for stock on January 2, Year 1.

Cell C9 — $70,000 The facts provide that Gorman transferred property with a net book value (tax basis) of $50,000 and that the corporation had to pay Gorman $20,000 to complete the transfer.

The tax basis to the corporation would, therefore be equal to the $50,000 net book value of the property (No Tax on Transfer means use Net Book Value) plus the $20,000 cash the corporation paid Jones to complete the transfer, or a tax basis for the corporation of $70,000.

Cell C6 — $110,000 The facts provide that Jones transferred property with a net book value (tax basis) of $100,000 and that the corporation had to pay Jones $10,000 to complete the transfer.

The tax basis to the corporation would, therefore, be equal to the $100,000 net book value of the property (No Tax on Transfer means use Net Book Value) plus the $10,000 cash the corporation paid Jones to complete the transfer, or a tax basis for the corporation of $110,000.

In the Table below, please indicate how much tax each of the following penalties and interest would be based on.

Then calculate the penalty and interest in the last column. Assume that the interest rate is 1% per month or part of month that the payment is late.

The table below shows the assets contributed by each shareholder. In all cases, the liabilities are recourse and are assumed by Arrington Enterprises, Inc.

There are no tax avoidance purposes inherent in the assumption of shareholder liabilities.

4. Token contributed $10,000 cash and property worth $40,000. His gain realized is $35,000 ($40,000 FMV - $5,000 basis). The liability relieved of $20,000 exceeds the basis of all property contributed (including cash) by $5,000 ($20,000 liability - $10,000 cash - $5,000 property basis = $5,000 excess).

Therefore, the recognized gain is $5,000. Although it is not asked for in the question, the corporation's basis in the asset is equal to the carryover basis of $5,000 plus the $5,000 gain recognized by Token, or $10,000.

For purposes of the personal holding company rules, a shareholder is considered to own stock held by family members, including brothers, sisters, ancestors and lineal descendants.

These 40 shareholders are all unrelated, so none of the 10 shares owned by each of them will count towards the PHC ownership test.

In addition to the skills that each brings to the new entity, the owners will contribute assets that will enhance the company's ability to provide quality technical design and planning services.

These assets include a building, land, lawn care equipment, office furniture and equipment, and cash for initial operating expenses.

Jones, Mitchell, Carey, and Gorman are knowledgeable about landscape design. They have decided to pool their knowledge and resources to form Arrington Enterprises, Inc., a C corporation.

They will provide professional services to area businesses and homeowners. All participants expect to work full time for Arrington Enterprises, and each expects to contribute sufficient assets to become a 25% shareholder with a total stock equity of $50,000 each.

*Note that principal repayments are not taxable as they do not represent income; instead, they are a return of capital.

Thus, the after-tax cash flow from the principal payment is equal to the principal payment of $46,000.

For purposes of the personal holding company rules, a shareholder is considered to own stock held by family members, including brothers, sisters, ancestors and lineal descendants.

Uncles, aunts, and cousins are not considered family members. The number of shares of stock considered owned by Clyde would include only the 18 shares owned directly by Clyde.

The amount for utilities ($12,000) and office supplies ($7,000) are directly input from the given information. The amount of the organization expenses ($5,707) is also given in the facts; however, it is made up of two components the portion that was expensed ($5,000 maximum)

and the portion that was amortized over 180 months beginning with the month of doing business ($15,600 total expense - $5,000 expensed = $10,600 to amortize; $10,600/180 × 12 months = $707 amortization expense).

In Year 4, Alaska is still a C corporation. Accumulated earnings and profits at the end of Year 3 were $61,000. Current earnings and profits for Year 4 are $24,000. During Year 4, Alaska made two distributions on the dates indicated in the table below.

Underwood, a 20% shareholder in Alaska, has a stock basis of $700 at the beginning of Year 4. Complete the following table to indicate the characterization of the Alaska distributions to Underwood during Year 4. Round all answers to the nearest dollar.

In this case, the examiners have included the amortization expense with the amount that was directly expensed to total $5,707.

[Note: In practice, the amounts are generally separately stated as "Amortization Expense" ($707) and "Organization Expenses" ($5,000); although, they would both still be reported as part of the total $24,707 on Line 26.]

☐ accumulated earnings and profits.

accumulated earnings and profits are applied in chronological order, beginning with the earliest distribution.

General rule under Sec, 351(a): "No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately

after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation."

(2). subsequent transfers of stock. unlike the initial formation of a corporation, it is very likely that subsequent contributions will not result in 80 percent control of the corp. [e.g., only one member of the original contributing control group

is now transferring assets for stock, or a new shareholder is admitted]. in this case, the control test will not be met and the contribution is treated as a sale to the corporation for fair market value, resulting in gain / loss recognized by the contributing shareholder.

Distributions are deemed to come from earnings and profits first. Any distribution in excess of earnings and profits ("E&P," accumulated and current)

is treated as a nontaxable return of capital that reduces the shareholder's basis in the stock. Distributions in excess of basis are capital gain distributions taxable as capital gains instead of dividends.

As such, line 30 is ($37,000): ($40,000) preliminary taxable income plus $10,000 dividends received

less -0- charitable contribution deduction less $7,000 DRD.

☐ Disproportional [substantially disproportionate]: Sale by shareholder subject to taxable capital gain / loss to shareholder. Disproportional means that there has been a meaningful reduction in the shareholder's ownership interest. The percentage ownership after the redemption

must be less than 50 percent and must be less than 80 percent of the percentage ownership before the redemption. Percentage ownership includes what is owned by certain family members [only spouse, children, grandchildren, and parents].

The amount of the taxable dividend is limited to the lesser of the actual amount distributed ($30,000, in this case),

or the amount of earnings and profits (the greater of current year earnings and profits or cumulative earnings and profits).

Amounts that are reported on Line 26, Other Deductions, include all expenses that are not given their own line item. The only expenses that have not been directly entered from the facts are federal tax expense (not a deductible expense for tax purposes),

organization expenses, utilities, and office supplies. Generally, these are reported on a Statement that supports the Form 1120 (note that the instructions for the line item on the Form 1120 indicate "Attach Schedule"). In this case, let's assume this statement is called "Statement 1."

Amounts that are reported on Line 26, Other Deductions, include all expenses that are not given their own line item. The only expenses that have not been directly entered from the facts are federal tax expense (not a deductible expense for tax purposes),

organization expenses, utilities, and office supplies. Generally, these arereported on a Statement that supports the Form 1120 (note that the instructions for the line item on the Form 1120 indicate "Attach Schedule"). In this case, let's assume this statement is called "Statement 1."

Cell B8 — $40,000 The facts provide that Carey transferred property with a fair market value of $40,000, which is the amount that

would appear for the asset on the financial statements of the corporation (Financials use Fair Market Value).

(4). stock dividends. ☐ Determination of value. the value of the taxable stock dividend is the fair market value on the distribution date.

☐ Allocation of basis. the basis of a nontaxable stock dividend, where old and new shares are identical, is determined by dividing the basis of the old stock by the number of old and new shares.

(2). Qualifications. Qualified corp. and must have the following: ☐ stock issued after August 10, 1993. ☐ Acquired at the original issuance.

☐ C Corp. only [not an S corp.]. ☐ less than 50 million of capital as of the date of stock issuance. ☐ 80 percent [or more] of the value of the corp.'s assets used in the active conduct of one or more qualified trades or businesses.

(6). Corporation paying dividend: taxable amount.

☐ General Rule. ☐ Property Dividends.

(4). stock dividends. ☐ Definition. A stock dividend is a distribution by a corp. of its own stock to its shareholders.

☐ Generally Not Taxable. Stock dividends are generally not taxable unless the shareholder has a choice of receiving cash or other property.

(7). stock redemption. ☐ Proportional: ☐ Disproportional [substantially disproportionate]: ☐ Partial Liquidation of Corporation [Stock held by a non-corporate shareholder]:

☐ Partial Liquidation of Corporation [Stock Held by a Non-corporate Shareholder]: ☐ Complete Buyout of Shareholder: ☐ Redemption Not Essentially Equivalent to a Dividend: ☐ Redemption to Pay Estate Taxes or Expenses:

(1). reorganization defined. reorganization includes the following: ☐ mergers or consolidations [Type A]. ☐ the acquisition by one corp. of another corp.'s stock, stock for stock [type B].

☐ The acquisition by one corp. of another corp.'s assets, stock for assets [Type C]. ☐ Dividing of the corp. into separate operating corporations [Type D]. ☐ Recapitalizations [Type E]. ☐ A mere change in identity, form, or place of organization [Type F].

(5.1). individual shareholder.

☐ cash dividends: amount received. ☐ property dividends: FMV of property received.

(5.2). corporate shareholders [subject to the dividends-received deduction].

☐ cash dividends: amount received. ☐ property dividends: FMV of property received.

(3). nontaxable event.

☐ corporation: nontaxable. ☐ shareholder: nontaxable.

(3). constructive dividends. = hidden / disguised dividends [trying to get a tax deduction when giving money to shareholder]. Same transactions, although not in the form of dividends, are treated as such when the payments are not in proportion to stock ownership. Examples include:

☐ excessive salaries paid to shareholder employees. ☐ excessive rents and royalties. ☐ "Loans" to shareholders where there is no intent to repay. ☐ Sale of assets below fair market value.

Distribution Allocation. At December 31, Year 1, the Julie Corp. had $20,000 of accumulated E&P. For the taxable year, Year 1, Julie had current E&P [before distributions] of $25,000.

☐ if Julie makes distributions in Year 2 of $25,000 or less, the distribution would be a dividend out of current E&P.

Distribution Allocation. ☐ if the distribution is greater than $25,000, but less than or equal to $45,000 , the distribution would be a dividend as follows: $25,000 out of current E&P and up to $20,000 out of accumulated E&P.

☐ if the distribution is greater than $45,000, the distribution would be a dividend of $45,000, and the excess over $45,000 is a nontaxable return of capital.

The amount for utilities ($12,000) and office supplies ($7,000) are directly input from the given information. The amount of the organization expenses ($5,707) is also given in the facts; however, it is made up of two components the portion that was expensed

($5,000 maximum) and the portion that was amortized over 180 months beginning with the month of doing business ($15,600 total expense - $5,000 expensed = $10,600 to amortize; $10,600/180 × 12 months = $707 amortization expense).

Cell B9 — $70,000 The facts provide that Gorman transferred property with a fair market value of $70,000,

which is the amount that would appear for the asset on the financial statements of the corporation (Financials use Fair Market Value).

Basis Allocation After Stock Dividend. In Year 1, Linda purchased 100 shares of Conduf stock for $18,000 [$180 per share].

in year 2, the corp. declared a 50 percent stock dividend and Linda received 50 new shares. after the stock dividend, the basis of each new share is $120 [$18,000 / 150 shares].

Preliminary taxable income (loss): ($40,000). Additional tax return item(s): $5,000 of charitable contributions and $10,000 of dividends received from a 15%-owned domestic corporation. Line 7 — ($37,000) The charitable contribution deduction is the lesser of the amount of the charitable contribution or

10% of taxable income before the following deductions: (i) the charitable contribution deduction, (ii) the dividends received deduction ("DRD"), (iii) any net operating loss carryback (but NOL carry-forwards are deducted), (iv) any capital loss carryback, and (v) the U.S. production activities deduction.

Exceptions under Sec. 351(b): If the contributor receives other property or "money" in addition to the stock, then: 1. The recipient must recognize gain not in excess of a) the amount of "money" received (including debt transferred in excess of basis); plus b) the fair market value of such other property ("boot") received.

2. No loss on the transfer can be recognized. 3. Note: Debt is only considered "boot" when it is in excess of basis.

Exceptions under Sec. 351(b): If the contributor receives other property or "money" in addition to the stock, then: 1. The recipient must recognize gain not in excess of a) the amount of "money" received (including debt transferred in excess of basis); plus b) the fair market value of such other property ("boot") received.

2. No loss on the transfer can be recognized. 3. Note: Debt is only considered "boot" when it is in excess of basis. 4. Qualifying transfers apply only to shareholders contributing money or property, not services.

4. Qualifying transfers apply only to shareholders contributing money or property, not services.

5. The "solely in exchange" requirement applies only if the contributors are in control of at least 80 percent of the corporate stock immediately after the contribution.

EXCEPTION: "the applicable percentage times taxable income" limitation does not apply if, after taking into account the full DRD, the result is a net operating loss. Because taxable income before the five deductions listed above is negative, there is no charitable contribution deduction. The DRD is $7,000:

70% times $10,000 dividends from less-than-20%-owned domestic corporations. Because the "exception'' applies, "the applicable percentage times taxable income" limitation does not apply.

Common shareholders are residual owners of a corp. and share in the retained earnings ["earnings and profits" is the tax term] of the corporation as well as the net assets. A "dividend" distribution to a common shareholder may or may not be classified as a taxable dividend.

A dividend is defined by the Internal Revenue Code as a distribution of property by a corporation out of its earnings and profits [E&P]. Dividends come first from current E&P and then from accumulated E&P.

Widgets, Inc., which is not a large corporation, paid income tax in Year 1 in the amount of $35,000. For Year 2, their total income tax is $110,000. They made 4 timely estimated tax payments for Year 2 in the amounts of $20,000 each.

A timely extension was filed for the Year 2 Tax Return on April 13, Year 3 and no additional money was sent with the return. The additional 30,000 tax owed was paid when the return was filed during the extension period on June 24, Year 3.

Rules: Distributions from corporations to shareholders are taxable to such shareholders if the distributions are classified as dividends. A dividend is defined by the IRC as a distribution of property by a corporation out if its earnings and profits.

An individual shareholder will be taxed on dividends in cash for the amount received and on dividends of property for the fair market value of the property received.

Rules: Distribution from corporations to shareholders are taxable to such shareholders if the distributions are classified as dividends. A dividend is defined by the IRC as a distribution of property by a corporation out if its earnings and profits.

An individual shareholder will be taxed on dividends in cash for the amount received and on dividends of property for the fair market value of the property received. Distributions are deemed to come from earnings and profits first.

General rule under Sec, 351(a): "No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock

in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation."

3. 30,000 | 450 Although there is no penalty for underpayment of estimated taxes and an extension was timely filed, the final 30,00 was paid after the initial due date of the return. Extensions filed are for the period to file and not to pay. Any payment made after the initial due date of the return is subject to the failure-to-pay penalty. There is an exception 90% of the tax was paid on time

and the remaining amount is paid by the extended due date, but that does not apply to the facts here. The penalty is half of a percent for each month or fraction of a month up to a maximum 25%. The payment on June 24 is 2 full months and part of a third month late. Therefore the penalty is 0.5% × 3 × 30,000 = 450.

In a liquidating distribution, the shareholder recognizes a capital gain to the extent that the fair market value of the assets received exceeds the shareholder's basis in the stock. In this case, the fair market value of the machinery was $5,000

and the shareholder's basis was $2,000, resulting in a $3,000 capital gain. In a liquidating distribution, the shareholder is essentially selling his or her stock, which is a capital asset. Thus, the gain is a capital gain, not ordinary income.

With respect to the DRD, unless the exception discussed below applies, the DRD is the lesser of (i) the applicable percentage, defined below, times the domestic dividends received or (ii) the applicable percentage times taxable income without regard to any DRD, any NOL deduction,

any capital loss carryback, and the domestic production activity deduction. The applicable percentage is 70% if the corporation owns less than 20% of the domestic investee corporation; the applicable percentage is 80% if the corporation owns at least 20% of, but less than 80% of, the domestic investee corporation.

Any distributions in excess of current or accumulated E&P

are first return of capital [up to the basis of the common stock] and then capital gain distribution.

Preliminary taxable income (loss): $200,000 Additional tax return item(s): $10,000 of charitable contributions, and $20,000 of dividends from less-than-20%-owned domestic corporations. Line 4 — $196,000 The charitable contribution deduction is the lesser of the amount of the charitable

contribution or 10% of taxable income before the following deductions: (i) the charitable contribution deduction, (ii) the dividends received deduction ("DRD"), (iii) any net operating loss carryback (but NOL carry-forwards are deducted), (iv) any capital loss carryback, and (v) the U.S. production activities deduction.

☐ current earnings and profits.

current earnings and profits are allocated on a pro rata basis to each distribution, regardless of the actual date of the distributions.

[Note: Do not get this concept confused with the concept presented in the beginning of the R3 lecture. In neither of these cases

did the debt exceed the basis of the contributed property, so there was no taxable boot stemming from the debt relief on the contribution.]

(2.1). order of distribution allocation.

distributions are deemed to come from current E&P first and then from accumulated E&P. Any distribution in excess of both current and accumulated E&P is treated as a nontaxable return of capital that reduces the shareholder's basis in the stock.

Note: Generally, the corporation takes the carryover basis from the transferor shareholder. The rule that allows a corporation to take a higher amount of liability assumed as the basis is a special rule that only applies if the shareholder recognizes gain due to liabilities being in

excess of basis of all property contributed. Mitchell contributed $20,000 in addition to the property. The liabilities did not exceed the basis of all basis contributed, including the cash. Therefore, Mitchell does not recognize any gain and the corporation takes the carryover basis of $40,000 for the property.

Gain Recognized Rule: The recognized gain is the gain that is reported (recognized) on the tax return of the taxpayer. If there is realized gain and boot (e.g., cash) received,

gain may be recognized, but only to the extent of the boot. If there is no boot received, no gain is recognized for tax purposes.

EXCEPTION: "the applicable percentage times taxable income" limitation does not apply if, after taking into account the full DRD, the result is a net operating loss. So, the charitable contribution deduction here is $10,000: t

he lesser of (i) the $10,000 charitable contribution or (ii $22,000 which is 10% of the sum of the $200,000 preliminary taxable income plus the $20,000 dividends received from domestic corporations.

Dividends to Preferred vs. Common Shareholders. a dividend to a preferred shareholder is based on that shareholder's fixed percentage at purchase. preferred shareholders are not common equity owners of a corp., and they only get paid based on their preferred percentage; therefore, any dividend

pmts to a preferred shareholder are considered dividend income to the shareholder. preferred shareholders are paid in full before common shareholders receive dividends. Common shareholders are residual owners of a corp. and share in the earnings and profits of the corp. as well as the net assets.

☐ Disproportional [substantially disproportionate]:

regardless of family ownership, a complete 100 percent termination of shareholder's interest is considered disproportional.

(6). tax status of reorganizations.

reorganizations are nontaxable [except to the extent of boot received] because the shareholders have not liquidated their investment but have continued operations in a modified form.

Underwood's Total Distribution: $18,200 Total distributions from the facts are $91,000. Underwood is a 20% shareholder. Thus, the total distribution is $18,200 ($91,000 × 20%). Dividend Income: $17,000 According to the first chart, $85,000 of the total distributions of $91,000

represent current and accumulated E&P.The remaining $6,000 is classified as excess distributions. All distributions will be considered to be taxable dividends to the extent of this ratio. Therefore, dividend income is $17,000 ($18,200 × $85,000 / $91,000).

If a property's fair market value is less than the amount of the liability assumed, the property's fair market value is assumed to be the amount of the liability assumed by the shareholder,

so in this case the fair market value is assumed to be $70,000. The recognized gain is calculated as $70,000 less $20,000, which equals $50,000.

☐ Proportional:

taxable dividend income [to shareholder-ordinary income]. Generally, the corporation either redeems or cancels the stock pro rata for all shareholders.

The applicable percentage is 70% if the corporation owns less than 20% of the domestic investee corporation;

the applicable percentage is 80% if the corporation owns at least 20% of, but less than 80% of, the domestic investee corporation.

(1). Formation. as previously covered in module 1, gains and losses are generally not recognized by shareholders and corporations upon contribution of property in exchange for stock at formation when immediately after the transfer,

the contributing shareholders, in aggregate, control the corporation to which they transferred the property.

(3). taxable portion. [amount of gain that exceeds $10,000,000].

the includable portion of the gain is taxed at regular tax rates.

a dividend to a preferred shareholder is based on that shareholder's fixed percentage at purchase. Preferred shareholders are not common equity owners of a corporation, and they only get paid based on their preferred percentage;

therefore, any dividend payments to a preferred shareholder are considered dividend income to the preferred shareholder. Preferred shareholders are paid in full before common shareholders receive dividends.

With respect to the DRD, unless the exception discussed below applies, the DRD is the lesser of (i) the applicable percentage, defined below,

times the domestic dividends received or (ii) the applicable percentage times taxable income without regard to any DRD, any NOL deduction, any capital loss carryback, and the domestic production activity deduction.

☐ Partial Liquidation of Corporation [Stock Held by a Non-corporate Shareholder]:

treated as an exchange of stock, not as a dividend.

☐ Partial Liquidation of Corporation [Stock held by a non-corporate shareholder]:

treated as an exchange of stock, not as a dividend.

☐ Redemption Not Essentially Equivalent to a Dividend:

treated as an exchange of stock.

☐ Redemption to Pay Estate Taxes or Expenses:

treated as an exchange when the corporation redeems stock that has been included in the decedent's gross estate [subject to dollar and time limitations].

(2.2). matching cash dividends to source. it is sometimes necessary to allocate separate cash dividends paid during the year between current and accumulated earnings and profits in order to determine the taxable income for each payment.

when dividends are in excess of earnings and profits, the following allocation applies: ☐ current earnings and profits. ☐ accumulated earnings and profits.

Cell B6 — $120,000 The facts provide that Jones transferred property with a fair market value of $120,000,

which is the amount that would appear for the asset on the financial statements of the corporation (Financials use Fair Market Value).