Chapter 18 Smartbook
If a noncorporate shareholder receives a distribution from the proceeds of a sale in a partial liquidation of a corporation, the gain or loss recognized from the tax treatment of an exchange is determined by:
the tax basis of the shares that would have been transferred to the corporation had the transaction been a stock redemption.
Yazou, Inc. has property that has become outdated, but still has some value. If Yazou wants to recognize the loss associated with the outdated property, it should
sell the property to minority shareholders Reason: Yazou can recognize the loss on the sale of the property to minority shareholders (<50% owners)
Rules designed to treat shares owned by family members or other related parties as shares owned by the shareholder are known as the _____ ______ rules.
stock attribution constructive ownership
Guenther Corporation has two shareholders: Gene and Asami. Guenther distributes a stock dividend to Asami only. The stock dividend is:
taxable
In a partial liquidation, corporate shareholders generally prefer dividend treatment due to the availability of:
the dividends-received deduction
Candles, Inc. distributes some defective candles to its shareholders. The market value of the candles was $20,000 (adjusted basis = $60,000). What are the tax consequences of the distribution to Candles?
$0 gain or loss recognized Reason: No loss is recognized on the distribution of noncash property by a corporation. E&P is reduced by the E&P basis in the property.
Vebos, Inc. distributes $10,000 cash and a machine with a fair market value of $5,000 (adjusted basis to Vebos of $200 at the time of distribution) to its shareholder Jody. Vebos had current E&P of $100,000 at the distribution. What is the amount and character of the distribution to Jody?
$15,000 dividend Reason: $10,000 cash + $5,000 FMV of property is all paid from E&P.
Which of the following provides an opportunity for a corporation to avoid double taxation on payments to its shareholders?
A reasonable deduction for salaries paid to owner
Shaker, Inc. distributes land to its shareholder, Robbie. The land's fair market value was $36,000 (adjusted basis of $6,000) at the time of the distribution. Robbie assumed the $10,000 mortgage on the land. Shaker has current E&P of $100,000. What is the dividend received by Robbie and the gain or loss recognized by Shaker?
$26,000 dividend for Robbie; $30,000 gain for Shaker Reason: Robbie's dividend is determined by the fair market value of the property received ($36,000) less any liabilities assumed ($10,000). Because the liability assumed was less than the FMV, the gain to Shaker is $36,000 - $6,000 = $30,000.
Amy redeemed all 50 of her shares of Fontaine Corp. for $46,000. This represented one-half of Fontaine's outstanding stock. Just prior to the redemption, Fontaine has E&P of $80,000. What is Fontaine's E&P after the redemption?
$40,000 Reason: In a redemption treated as an exchange, E&P is adjusted by the same percentage as the percentage of stock redeemed, not to exceed the FMV of the property distributed. 50% of stock redeemed x $80,000 =$40,000.
Gopher Inc. has current E&P of $40,000 and accumulated E&P of negative $100,000. Gopher makes a $60,000 distribution. What is the character of the distribution?
$40,000 dividend, $20,000 return of capital to the extent of basis Reason: Since AE&P is negative and the distribution > CE&P, the amount of CE&P is characterized as the dividend, the the remaining ditribution is characterized as return of capital.
Gopher, Inc. has $40,000 of current E&P and $10,000 of accumulated E&P at the start of the year. The sole shareholder, Carl has a basis in his stock of $20,000. If Gopher distributes $100,000 to Carl, it will be treated as a ______.
$50,000 dividend, $20,000 return of capital, and $30,000 capital gain Reason: Distributions treated as a dividend to the extent of E&P ($50,000), return of capital to extent of basis ($20,000) and excess is capital gain ($30,000).
Macadamia Corp. redeems 60 shares of common stock from Patty in exchange for $50,000. Patty held 100 shares of the 150 total outstanding shares in Macadamia for the past 5 years. Patty's basis in the 60 redeemed shares was $10,000. Assuming Patty has a 15% tax rate on both dividends and long-term capital gains, what is Patty's tax liability from this redemption?
$6,000 Reason: After the exchange Patty owns 40/90 shares (44%) which is less than 50% and also less than 80% of her ownership percentage before the redemption. As a result, her redemption qualifies as an exchange. $50,000 less $10,000 basis = $40,000 x 15% = $6,000.
Gopher, Inc. has negative $40,000 current E&P and $100,000 of accumulated E&P. Gopher made a $70,000 distribution at the end of the year. What is the character of the distribution?
$60,000 dividend and $10,000 return of capital to the extent of basis Reason: Total E&P at time of distribution is $60,000 ($100,000 - $40,000). Distribution in excess of total E&P is return of capital.
At the end of 2020, Gopher, Inc. has current E&P of negative $40,000. Accumulated E&P at the beginning of the year was $100,000. Gopher made a $70,000 distribution on January 1, 2020. What is the character of the distribution?
$70,000 dividend Reason: Total E&P at time of distribution is $100,000 (no current E&P at start of year) and thus entire distribution is dividend from accumulated E&P.
Storrs-It Corporation distributes land to its shareholder, Jim, that has a fair market value of $36,000 and an attached mortgage of $10,000 (which Jim assumes). Storrs-It has tax and E&P basis of $6,000 in the land. Storrs-It has $100,000 of current E&P (excluding the net of tax gain on the property distribution). What is the total net effect on Storrs-It's E&P from the distribution, assuming a 21% tax rate on the gain?
($2,300) Reason: The FMV of the property exceeds its basis; thus the FMV of the land is a $36,000 reduction of E&P. The liabilities assumed ($10,000) by Jim increase E&P. The gain is $36,000 - $6,000 = $30,000 increase in E& P less taxes of $6,300 ($30,000 x 21%). Net change = ($36,000) + $10,000 + $30,000 - $6,300 = ($2,300)
GW Corp. has two shareholders; Devana owns 40 shares and Alpine Corp. owns the other 60 shares. Devana is a 40% shareholder in Alpine Corp. Under the attribution rules for the change in stock ownership tests in a redemption, how many shares of GW Corp. are attributed to Devana? Multiple choice question.
40 Reason: Devana owns 40 shares directly. Because her ownership in Alpine is less than 50%, none of those shares are attributed to her.
Chuck owns 200 shares of Walnut Corporation. Chuck wishes to redeem some shares in exchange for property and would like exchange treatment for his redemption. If there are 500 common shares of Walnut outstanding (the only class of stock) before any redemption, what is the minimum number of shares Chuck must exchange?
59 Shares Reason: In order to meet the 80% test, Chuck needs his ownership percentage to drop below 32%. Walnut must redeem 59 shares (200-x/500-x > 32%) in order to meet the 80% test.
Kevin directly owns 50 shares of Sharon Company stock. He is a 50% partner in AMI Partnership which also owns 50 shares of Sharon. Prior to any stock redemption, how many shares of stock are attributed to Kevin?
75 Reason: The 50 shares Kevin holds directly + 25 shares (50% x 50) of the shares held by AMI.
Marcie and her husband, Franklin, each own 50 shares of Chestnut, Inc. Sally, Marcie's old high school friend, owns the remaining 50 shares (150 total shares outstanding). Chestnut redeems 40 of Marcie's shares for $38,000 (her adjusted basis was $5,000). What is the tax treatment of the basis of the shares redeemed?
Add the $5,000 basis to Marcie's remaining 10 shares. Reason: As her spouse, Franklin's shares are attributed to Marcie. Thus Marcie owns 60 (her remaining 10 + Franklin's 50) shares of Chestnut's total 110 (150 - 40) outstanding. Because 60 ÷ 110 > 50%, Marcie fails the 50% test and the redemption is treated as a dividend. As a result, the unused basis is added to the basis of Marcie's remaining shares.
Distributions come out of E&P in the following order.
Current, then accumulated
Corporate distributions to shareholders are treated in the following order.
Dividend to the extent to E&P included in gross income Non-taxable return of capital that reduces the shareholders basis Gain from sale or exchange of stock
True or false: Depreciation deducted when calculating E&P is the generally same as depreciation deducted when calculating taxable income.
False
True or false: Under no circumstances will a shareholder who has shares redeemed be able to treat the stock redemption as an exchange unless the shareholder meets the bright line change-in-stock-ownership tests.
False Reason: The not essentially equivalent to a dividend test is still available.
Which of the following forms of tax exempt income is NOT included in E&P?
Gifts
Which of the following reduces accumulated E&P?
Market value of noncash property with market value > E&P basis E&P basis of noncash property with fair market value < E&P basis Cash distributed
Mitt redeems his entire ownership of stock in Dawn Key Corp. However, Mitt's sons, Rick and Newt, own all of the remaining shares of Dawn Key Corp. after the redemption. What are the requirements that Mitt must meet to waive the family attribution rules for this redemption?
Mitt must notify the IRS if he acquires a prohibited interest within 10 years of the redemptions. Mitt may NOT serve as a shareholder, director, officer or consultant for Dawn Key.
Cashews Corp. had 200 outstanding shares of its only class of stock when it redeemed 30 of Linus' shares in exchange for land worth $50,000. The exchange reduced Linus' ownership from 180 shares to 150 shares. Is Linus' redemption substantially disproportionate?
No Reason: Linus owns 88% (150 ÷ 170) of Cashews after the redemption and fails the stock ownership tests.
Aztec Corp. is calculating its current E&P and is considering the following items: Federal income taxes paid $50,000 Political contributions to the state governor's race $5,000 Fines and penalties $1,000 Ordinary and necessary business expenses $50,000 Salaries paid to owner/employees $30,000 Which of the items above should Aztec deduct when adjusting its taxable income to get to E&P?
Political contributions Federal income taxes Fines and penalties
Which of the following is one of the bright line tests of a substantially disproportionate redemption?
The shareholder owns less than 50% of the voting power of the corporation after the redemption.
True or false: The family attribution rules can be waived in a complete redemption of stock by a shareholder.
True Reason: The family attribution rules can we waived in a complete redemption subject to restrictions.
The potential tax consequences of a corporate distribution of cash or other tangible property to a shareholder are ______.
a dividend included in gross income a gain from the sale of stock a non-taxable return of the shareholder's capital
When current E&P is negative, the tax status of a distribution is determined by the
accumulated E&P on the date of distribution Reason: total E&P = current E&P + accumulated E&P
A stock redemption is
an acquisition by a corporation of its own stock from a shareholder in exchange for property
In a partial liquidation of a corporation, corporate shareholders are subject to the _____-_____-_____-_____ rules that apply to stock redemptions.
change-in-stock-ownership
When a corporation pays a distribution that is characterized as a dividend, the corporation _____ the dividend from taxable income.
does NOT deduct
When noncash property subject to liabilities is distributed by a corporation to shareholders, the amount of the distribution is
equal to the FMV of the property minus the liability assumed by the shareholder
In a partial liquidation, noncorporate shareholders receive _____ treatment.
exchange
The amount of a corporate distribution to a shareholder of property, other than cash, is determined by its
fair market value
When a corporation distributes property to a shareholder in a redemption, it is required to recognize _____, but may NOT recognize _____.
gains: losses
The _____ of the shareholder dictates the tax treatment of a distribution from a partial liquidation.
identity
In order for a stock distribution to be non-taxable, it must be
made pro-rata with respect to all shareholders made with respect to the corporation's common stock
Individuals prefer exchange treatment for redemptions due to the
reduction in the amount of income for the adjusted basis. increased ability to deduct capital losses.
In order to qualify for exchange treatment as a redemption that is NOT essentially equivalent to a dividend, the redemption must ______
result in a meaningful reduction of the shareholder's proportionate interest in the corporation. result in the shareholder's voting power being below 50%.
