ACC 570 Exam 2

Wingate Corporation had the following income and expenses for 2020: Income from operations $70,000 Dividend income (from less-than-20%-owned domestic corporations) 45,000 Expenses of operations 99,000 2019 net operating loss carryover 5,000 What is Wingate Corporation's taxable income for 2020?

$(6,500) A net operating loss is the excess of deductions over gross income, with certain modifications. When a current NOL exists or an NOL results from the DRD, one modification is that the dividends-received deduction is computed without regard to the limitation of 50% of taxable income. Consequently, Wingate's taxable income is computed as follows: Gross income from business operations$ 70,000 Dividends received 45,000 Gross income $115,000 Less: Business expenses (99,000) Dividends-received deduction($45,000 × 50%) (22,500) Taxable Income (NOL)$ (6,500) ch17

On January 1, Year 1, Pearl Corporation owned 90% of the outstanding stock of Seso Corporation. Both companies were domestic corporations. Pursuant to a plan of liquidation adopted by Seso in March Year 1, Seso distributed all of its property in September Year 1 in complete redemption of all its stock, when Seso's accumulated earnings equaled $18,000. Seso had never been insolvent. Pursuant to the liquidation, Seso transferred to Pearl a parcel of land with a basis of $10,000 and a fair market value of $40,000. How much gain must Seso recognize in Year 1 on the transfer of this land to Pearl?

$0 A controlled corporation generally recognizes no gain or loss upon making a liquidating distribution of property to its parent corporation. The control requirement must be met: the parent corporation must own at least 80% of the voting power and 80% of the total value of the stock of the corporation being liquidated. Seso will recognize no gain on the transfer of the land to Pearl. ch20

The following information pertains to treasury stock sold by Lee Corporation to an unrelated broker in the current year: Proceeds received $50,000 Cost 30,000 Par value 9,000 What amount of capital gain should Lee recognize in the current year on the sale of this treasury stock?

$0 A corporation does not recognize gain or loss on the receipt of money or other property in exchange for its stock, including treasury stock. Therefore, no gain or loss is recognized by Lee as a result of the treasury stock sale. ch17

Sky Corp. was a wholly owned subsidiary of Jet Corp. Both corporations were domestic C corporations. Jet received a liquidating distribution of property in cancellation of its Sky stock when Jet's tax basis in Sky stock was $100,000. The distributed property had an adjusted basis of $135,000 and a fair market value of $250,000. What amount of taxable gain did Jet, the parent corporation, recognize on the receipt of the property?

$0 If distributions in complete liquidation are made by a subsidiary to a parent corporation that owns at least 80% of the subsidiary, no gain or loss is recognized by either the parent corporation or the subsidiary. ch20

Mr. Bass transferred a building that had an adjusted basis to him of $300,000 and a fair market value of $500,000, to Corporation C solely in exchange for 100% of C's only class of stock. The building was subject to a mortgage of $100,000, which C assumed for bona fide business purposes. The fair market value of the stock on the date of transfer was $550,000. What is the amount of gain to be recognized by Mr. Bass?

$0 If the requirements of Sec. 351(a) are met, no gain or loss is recognized when property is transferred to a corporation. The requirements are that the transfer be by one or more persons, solely in exchange for stock, and the transferor(s) must be in control of the corporation immediately after the exchange. Section 368(c) defines control as the ownership of at least 80% of the voting and nonvoting stock. Mr. Bass meets these criteria, so the transfer qualifies under Sec. 351(a). No gain or loss is recognized. Note that Sec. 357(a) provides that the transfer of the mortgage on the building does not prevent the exchange from qualifying under Sec. 351(a) because tax avoidance was not the purpose of the liability assumption, which had a valid business purpose, and because the amount of the mortgage did not exceed the adjusted basis of the property. ch18 ch19

Pursuant to a plan of corporate reorganization adopted in July Year 1, Gow exchanged 500 shares of Lad Corp. common stock that he had bought in January Year 1 at a cost of $5,000 for 100 shares of Rook Corp. common stock having a FMV of $6,000. Gow's recognized gain on this exchange was

$0. The exchange of stock for stock in obtaining control of a corporation qualifies as a reorganization. No gain or loss is recognized in a reorganization if stock or securities are exchanged solely for stock or securities in the same corporation or in another corporation that was a party to the reorganization. For Gow, since no boot was received, no gain is recognized. ch20

Nyle Corp. owned 100 shares of Beta Corp. stock that it bought 16 years ago for $9 per share. This year, when the fair market value of the Beta stock was $20 per share, Nyle distributed this stock to a noncorporate shareholder. Nyle's recognized gain on this distribution was

$1,100 A corporation must recognize gain realized on distributions of property. The definition of property excludes stock, but only if issued by the corporation. Thus, Nyle Corp. must recognize gain of $1,100 ($2,000 FMV - $900 basis). ch18 ch19

XYZ, a calendar-year corporation, had accumulated earnings and profits of $5,000 as of January 1, 2020. XYZ's earnings and profits for 2020 were $8,000. During 2020, XYZ distributed one stock right for each of the 10,000 outstanding shares of its only class of stock. The fair market value of each stock right was $15. The corporation gave shareholders the option of receiving the stock rights or cash. No other dividends were paid in 2020. Ms. Y is a 10% shareholder and elects to receive the stock rights. What is the amount of the distribution that is includible in Ms. Y's 2020 gross income as a dividend?

$1,300 When a shareholder has the option of receiving either stock rights or cash, the entire amount of the distribution received by the shareholder will be treated as a taxable dividend under Sec. 305(b)(1). Section 316(a) defines a dividend as a distribution made from current and accumulated earnings and profits. The amount by which the distribution exceeds current and accumulated earnings and profits shall be treated as a return of capital and will reduce the shareholder's basis in the stock. XYZ's total distribution is $150,000 (10,000 shares × $15). The amount considered a dividend would be $13,000 ($8,000 + $5,000), and the remaining $137,000 would be a return of capital. The total amount taxable to Ms. Y would be $1,300 ($13,000 × 10%). Accordingly, Ms. Y would reduce the basis in her 1,000 shares of stock by $13,700 (1,000 shares × $15 per share - $1,300 dividend). Any excess of the $13,700 over Ms. Y's basis is a capital gain. ch18 ch19

Pope, a C corporation, owns 15% of Arden Corporation. Arden paid a $3,000 cash dividend to Pope. What is the amount of Pope's dividends-received deduction?

$1,500 .The DRD is available only to corporations. The deduction is based on the distributee corporation's percentage ownership of the distributing corporation and may be limited to taxable income. The deduction percentage is 50% for corporations with less than 20% ownership in the distributing corporation. Pope's deduction is $1,500 ($3,000 dividend × 50%). ch17

Brown Corp., a calendar-year taxpayer, was organized and actively began operations on July 1, 2020, and incurred the following costs: Legal fees to obtain corporate charter $45,000 Commission paid to underwriter 30,000 Other stock issue costs 15,000 Brown wishes to amortize its organizational costs over the shortest period allowed for tax purposes. In 2020, what amount should Brown deduct for the amortization of organizational expenses (excluding any immediate expensing allowed)?

$1,500 A corporation is deemed to make an election to amortize its organizational expenses over at least 180 months starting with the month in which it begins business. Organizational expenditures are those incurred incidental to the formation of the corporation. Specifically excluded are expenditures connected with issuing or selling stock and with transferring assets to the corporation. Here only the legal fees to obtain corporate charter are organizational costs and are amortized for a half year. The annual amortization is $3,000 [$45,000 × (12/180)]. The amortization expense for 2020 is only for 6 months (July - December) equaling $1,500 ($3,000 annually × 50%). ch17

Mr. Brown transferred property, which had an adjusted basis to him of $40,000 and a fair market value of $50,000, to Corporation B in exchange for 100% of B's only class of stock and $15,000 cash. At the time of the transfer, the stock had a fair market value of $35,000. What is the amount of gain to be recognized by Mr. Brown?

$10,000 This transfer qualifies under Sec. 351 since Mr. Brown transferred property to a corporation for stock and, immediately after the transfer, controlled the corporation. The realized gain on the transfer is $10,000 ($50,000 realized - $40,000 adjusted basis). When property other than stock is received in a Sec. 351 transfer, any gain is recognized to the extent of the lesser of the realized gain or the amount of other property (boot) received [Sec. 351(b)]. Hence, Mr. Brown's gain is limited to the $10,000 realized gain. ch18 ch19

For the year ended December 31, 2020, Maple Corporation's book income before federal income tax was $100,000. Included in this $100,000 were the following: Provision for state income tax expense $1,000 Interest earned on U.S. Treasury bonds 6,000 Interest expense on bank loan to purchase U.S. Treasury bonds 2,000 Maple's taxable income for 2020 was

$100,000 State income taxes are deductible, unlike federal income taxes. There is no exclusion for interest income on U.S. obligations. Relatedly, the interest on debt to carry the U.S. obligations is deductible. Therefore, book income and taxable income are the same: $100,000. ch17

Under a plan of complete liquidation, Len Corporation distributed land, having an adjusted basis to Len of $26,000, to its sole shareholder. The land was subject to a liability of $38,000, which the shareholder assumed for legitimate business purposes. The fair market value of the land on the date of distribution was $35,000. What is the amount of Len Corporation's recognized gain (or loss)?

$12,000 Section 336(a) provides that a corporation should treat a complete liquidation as a sale using the fair market value. However, Sec. 336(b) requires that the fair market value used should not be less than any liability accepted by the distributee. Since Len is transferring property with a liability of $38,000, which is higher than the $35,000 FMV, the $38,000 is used as the new FMV. Therefore, Len Corporation recognizes a $12,000 gain ($38,000 new FMV - $26,000 adjusted basis). ch20

Diane, the sole shareholder of Check Corporation's stock, owns 500 shares, which she purchased in 2009. Diane's basis in Check's stock is $20,000. During 2020, Check, which had earnings and profits of $50,000, redeemed 250 shares of Diane's stock for $12,000. What are the amount and the character of Diane's gain?

$12,000 dividend. If a distribution is not a redemption of all the shareholder's stock, Sec. 302(b)(2) must be applied to determine whether the distribution will be treated as a payment in exchange for the stock or as a dividend. One of the requirements of Sec. 302(b)(2) is that the shareholder must own less than 50% of the total combined voting power of all classes of stock immediately after the redemption. Alternatively, the distribution must not be essentially equivalent to a dividend under Sec. 302(b)(1). This alternative requires a meaningful reduction in the shareholder's interest in the distributing corporation. Since Diane is the sole shareholder, she still owns 100% of the company after redeeming part of her stock. Therefore, the requirements of Secs. 302(b)(2) or 302(b)(1) are not met, and the $12,000 distribution is treated as a dividend since it is less than Check Corporation's earnings and profits (Sec. 301). ch20

What is the current earnings and profits (E&P) of a corporation with taxable income of $10,000 that included the following unadjusted items: Meals $ 200 Capital loss carried over from prior year 3,000

$12,900 Current E&P is the current-year taxable income adjusted for specific items. Positive adjustments include loss carryovers, as they were negative adjustments in the year they occurred. Negative adjustments include the nondeductible portion of meals. Corporations are allowed to deduct 50% of qualifying meal expenses. The corporation's current E&P is $12,900 [$10,000 + $3,000 - ($200 × 50%)]. ch18 ch19

In 2020, Lakeside Corporation had the following results: Gross income from operations $200,000 Dividends from a 25%-owned domestic corporation for which a 65% deduction is allowed 50,000 Operating expenses 340,000 Charitable contributions 20,000 NOL carryforward 30,000 What is the amount of Lakeside's 2020 net operating loss for the current year before NOL carryforward?

$122,500 A net operating loss is the excess of deductions over gross income, with certain modifications. Lakeside may not deduct any of the charitable contributions. One modification is that the dividends-received deduction is computed without regard to the 65% of taxable income limitation (i.e., $0) in Sec. 246(b); therefore, the deduction is the full amount of $32,500. Thus, Lakeside's NOL is $122,500 as computed below. Gross income from operations$ 200,000 Dividend income 50,000 Less: Operating expenses (340,000) Gross income$ (90,000) Less: Dividends-received deduction(65% × $50,000)(32,500) Net operating loss (122,500) CH17

In 2020, its first year of operations, Rowley Corporation, not a dealer in securities, realized taxable income of $128,000 from the operation of its business. In addition to its regular business operations, it realized the following gains and losses from the sale of marketable securities: Short-term capital gain $10,000 Short-term capital loss (4,000) Long-term capital gain 12,000 Long-term capital loss (32,000) What is Rowley's total taxable income for 2020?

$128,000 A corporation may deduct capital losses only to the extent of capital gains (without regard to whether they are short or long term). Therefore, Rowley may deduct only $22,000 of its capital losses since capital gains are $22,000 ($10,000 short term and $12,000 long term). The $14,000 balance of the capital losses may be carried forward 5 years. Rowley's total taxable income is Income from operations $128,000 Capital gains 22,000 Capital losses (22,000) Taxable income $128,000 ch17

The following information for 2020 pertains to Bartley Corporation: Capital contributions by shareholders$50,000 Realized loss on sale of treasury stock(10,500) Income from rental property in a sinking fund (in the hands of a trustee)5,500 Rent paid directly to a bond holder on a lease of corporate property8,000 What is the amount of gross income to Bartley Corporation for 2020?

$13,500 Gross income of a corporation includes all income, unless specifically excluded. Excluded from a corporation's gross income are capital contributions by shareholders and any gain or loss realized by a corporation on the sale or exchange of its own stock (including treasury stock). Included in a corporation's gross income are income from property in a sinking fund and income that has been assigned by the corporation to another. Thus, Bartley Corporation's gross income is $13,500 ($5,500 sinking fund income + $8,000 assignment of income). CH17

For the year ended December 31, 2020, Dodd Corp. had net income per books of $100,000. Included in the computation of net income were the following items: Provision for federal income tax$27,000 Net long-term capital loss5,000 Key employee life insurance premiums(Corporation is beneficiary.)3,000 Dodd's 2020 taxable income was

$135,000 None of the items are deductible in computing taxable income even though they decrease book income. Therefore, they must be added back to book income to find taxable income. ch17

The following information pertains to Lamb Corp.: Accumulated earnings and profits at January 1, 2020 $ 60,000 Earnings and profits (E&P) for the year ended December 31, 2020 80,000 Cash distributions to individual shareholders during 2020 180,000 What is the total amount of distributions taxable as dividend income to Lamb's shareholders in 2020?

$140,000 A corporate distribution is a dividend that must be included in the recipient's gross income to the extent it comes from current or accumulated earnings and profits (E&P). To the extent the distribution exceeds current and accumulated E&P, it is treated as a return of capital to the shareholder. Since Lamb had only $140,000 ($80,000 + $60,000) of E&P, the distribution will be taxed as a dividend only to that extent. The remaining $40,000 will be treated as a return of capital or capital gain. ch18 ch19

Core Corporation reported current earnings and profits of $250,000. Core distributed a building with an adjusted basis of $170,000 and a fair market value of $230,000 to its sole shareholder. The building had a mortgage of $90,000, which the shareholder will assume. What is the amount of the dividend received by the shareholder?

$140,000 Section 301(b)(1) provides that the distribution to a shareholder is equal to the fair market value of the property distributed. Under Sec. 301(b)(2)(A), this amount must be decreased by any liabilities assumed by the shareholder or to which the property is subject. The distribution to the shareholder is $140,000 ($230,000 FMV - $90,000 liability). Under Sec. 316, a distribution is a dividend to the extent that it comes from earnings and profits. The earnings and profits would be increased by the gain (net of tax) on the distribution. Gain is recognized to the extent the FMV of the building exceeds the adjusted basis [Sec. 311(b)], or $60,000. In any event, the corporation has at least $250,000 of earnings and profits. Therefore, the entire $140,000 is a dividend. ch18 ch19

Agress Corporation, a calendar-year taxpayer reporting on the accrual basis, showed the following balances on its books for 2020: Sales $130,000 Cost of sales 70,000 Operating expenses 40,000 Contributions 6,000 Net life insurance premiums on officer with Agress as the beneficiary 4,000 Accrued federal income tax 3,230 Book income$ 6,770 What is the amount of Agress Corporation's taxable income as it would be shown on Schedule M-1 of its 2020 corporate income tax return?

$15,000 Schedule M-1 reconciles income or loss per books with income or loss per tax return. Taxable income before the charitable contribution is $20,000 ($130,000 - $70,000 - $40,000). The charitable contribution is limited to $5,000 ($20,000 × 25%). Net income per books $ 6,770 Add back:Federal income taxes 3,230 Excess contributions 1,000 Life insurance premiums 4,000 Taxable income $15,000 ch17

Agress Corporation, a calendar-year taxpayer reporting on the accrual basis, showed the following balances on its books for 2020: Sales $130,000 Cost of sales 70,000 Operating expenses 40,000 Contributions 6,000 Net life insurance premiums on officer with Agress as the beneficiary 4,000 Accrued federal income tax 3,230 Book income $ 6,770 What is the amount of Agress Corporation's taxable income as it would be shown on Schedule M-1 of its 2020 corporate income tax return?

$15,000 Schedule M-1 reconciles income or loss per books with income or loss per tax return. Taxable income before the charitable contribution is $20,000 ($130,000 - $70,000 - $40,000). The charitable contribution is limited to $5,000 ($20,000 × 25%). Net income per books$ 6,770 Add back:Federal income taxes 3,230 Excess contributions 1,000 Life insurance premiums 4,000 Taxable income $15,000 CH17

Elm Corp. is an accrual-basis, calendar-year C corporation with 100,000 shares of voting common stock issued and outstanding as of December 30, Year 1. On December 31, Year 1, Hall surrendered 2,000 shares of Elm stock to Elm in exchange for $33,000 cash. Hall had no direct or indirect interest in Elm after the stock surrender. Additional information follows: Hall's adjusted basis in 2,000 shares of Elm on December 31, Year 1 ($8 per share) $16,000 Elm's accumulated earnings and profits at January 1, Year 1 25,000 Elm's Year 1 net operating loss (7,000) What amount of income did Hall recognize from the stock surrender?

$17,000 capital gain. In the case of a stock redemption in complete liquidation of a shareholder's interest, the redemption is treated as a sale or exchange of a capital asset. Therefore, Hall's income from the redemption is a $17,000 capital gain ($33,000 - $16,000 basis). ch20

Kent Corp. is a calendar-year, accrual-basis C corporation. In Year 1, Kent made a nonliquidating distribution of property with an adjusted basis of $150,000 and a fair market value of $200,000 to Reed, its sole shareholder. The following information pertains to Kent: Reed's basis in Kent stock at January 1, Year 1 $500,000 Accumulated earnings and profits at January 1, Year 1 125,000 Current earnings and profits for Year 1 (includes any gain recognized as a result of the distribution, but not reduced for the distribution amount) 60,000 What was taxable as dividend income to Reed for Year 1?

$185,000 A distribution is a dividend that is included in the recipient's gross income to the extent that it is made from the current or accumulated earnings and profits (E&P) of a corporation. Any additional distribution is treated by the shareholder as a nontaxable return of capital to the extent of the shareholder's basis in the stock. A property distribution is valued at FMV, and the corporation recognizes gain as if the property were sold. Since the shareholder receives a $200,000 distribution, $185,000 ($125,000 + $60,000) is taxable as dividend income. ch18 ch19

In 2020, Aca Corp. adopted a plan of complete liquidation. Under this plan of complete liquidation, distributions to shareholders in 2020 included marketable securities purchased in 2010, with a basis of $100,000 and a fair market value (FMV) of $120,000 at the date of distribution. On June 30, 2020, the date this plan of complete liquidation was adopted, Aca had 100 equal shareholders, and the FMV of all of Aca's outstanding stock was $12 million. In Aca's 2020 return, what amount should be reported as long-term capital gain?

$20,000 A corporation recognizes gain or loss upon making a liquidating distribution of its assets as if the property had been sold for its fair market value immediately before the distribution. The character of this gain depends upon the nature of the assets (in the hands of the distributing corporation) distributed. Aca's recognized gain is $20,000 ($120,000 FMV of distributed property - $100,000 AB in that property). ch20

In a bona fide transaction, Jesse transferred land worth $50,000 to his 80%-controlled corporation for stock of the corporation worth $20,000 and cash of $20,000. The basis of the property to him was $15,000 and was subject to a $10,000 mortgage, which the corporation assumed. Jesse must report a gain of

$20,000 Immediately after the exchange, Jesse is in control of the corporation. Gain realized by Jesse is recognized to the extent of money plus the FMV of other property received. Section 351 will apply if its conditions are met even when there is no corporate formation. Jesse's reportable gain is Proceeds ($20,000 stock + $20,000 cash +$10,000 liabilities assumed by the corporation) $50,000 Less adjusted basis of land transferred (15,000) Realized gain $35,000 Gain recognized (limited to cash received) $20,000 ch18 ch19

Pursuant to a plan of reorganization adopted in Year 1, Summit Corporation exchanged 1,000 shares of its common stock and paid $40,000 cash for Hansen Corporation's assets with an adjusted basis of $200,000 (fair market value of $300,000). Hansen Corporation was liquidated shortly after the exchange, with its shareholders receiving the Summit stock and cash. The 1,000 shares of Summit common stock had a fair market value of $260,000 on the date of the exchange. What is the basis to Summit of the assets acquired in the exchange?

$200,000 .Summit Corporation's exchange of 1,000 shares of common stock and $40,000 cash for the assets of Hansen Corporation is a qualified reorganization, assuming that all or substantially all of Hansen's assets are acquired and that Hansen distributes the stock, securities, and other property it receives, as well as the other property it has retained, as part of the reorganization. Since it is a qualified reorganization, Hansen, the transferor corporation, will have a realized gain of $100,000 ($300,000 received - $200,000 adjusted basis). In a qualifying reorganization, the transferor corporation recognizes no gain if the assets other than stock or securities received are distributed immediately to its shareholders or creditors. The basis of the assets to Summit equals the transferor's adjusted basis in the assets ($200,000) increased by any gain recognized by the transferor ($0). ch20

Pursuant to a plan of reorganization adopted in Year 1, Summit Corporation exchanged 1,000 shares of its common stock and paid $40,000 cash for Hansen Corporation's assets with an adjusted basis of $200,000 (fair market value of $300,000). Hansen Corporation was liquidated shortly after the exchange, with its shareholders receiving the Summit stock and cash. The 1,000 shares of Summit common stock had a fair market value of $260,000 on the date of the exchange. What is the basis to Summit of the assets acquired in the exchange?

$200,000 Summit Corporation's exchange of 1,000 shares of common stock and $40,000 cash for the assets of Hansen Corporation is a qualified reorganization, assuming that all or substantially all of Hansen's assets are acquired and that Hansen distributes the stock, securities, and other property it receives, as well as the other property it has retained, as part of the reorganization. Since it is a qualified reorganization, Hansen, the transferor corporation, will have a realized gain of $100,000 ($300,000 received - $200,000 adjusted basis). In a qualifying reorganization, the transferor corporation recognizes no gain if the assets other than stock or securities received are distributed immediately to its shareholders or creditors. The basis of the assets to Summit equals the transferor's adjusted basis in the assets ($200,000) increased by any gain recognized by the transferor ($0). ch20

For the year ended December 31, 2020, Taylor Corp. had a net operating loss (NOL) of $200,000. Taxable income for the earlier years of corporate existence, computed without reference to the net operating loss, was as follows: Taxable Income 2015 $ 5,000 2016 10,000 2017 20,000 2018 30,000 2019 40,000 What amount of net operating loss will be available to Taylor for the year ended December 31, 2021, if Taylor's taxable income for that year is $300,000?

$200,000 The NOL arising in tax years 2018 and later is carried forward indefinitely and limited to 80% of the taxable income for the year it is carried to. Since the loss of $200,000 in 2020 is less than 80% of $300,000, which is the taxable income in 2021, all of the loss in 2020 can be deducted in 2021. ch17

In 2020, Cape Co. reported book income of $140,000. Included in that amount was $50,000 for meals expense and $40,000 for federal income tax expense. In Cape's Schedule M-1 of Form 1120, which reconciles book income and taxable income, what amount should be reported as taxable income?

$205,000 Federal income tax is not deductible. Only 50% of meal expense is allowed. Cape's taxable income is $140,000 + $40,000 + (50% × $50,000). ch17

Net income per books of Pat Jordan's psychology clinic was $140,825 for the year ended September 30 of the current year. Select from the following account information those items that would be necessary to reconcile book income to the income to be reported on the return, and compute taxable income per return. Capital gains $ 3,600 Capital losses 8,200 Entertainment expenses 5,425 Federal income tax expense 62,225 Tax-exempt interest income 5,000 Net income 140,825 Cash distribution to shareholders 20,000

$208,075 Schedule M-1 reconciles income or loss per books with income or loss per tax return. Net income per books $140,825 Add back: Federal income taxes 62,225 Excess net capital losses 4,600 Entertainment 5,425 $213,075 Subtract: Tax-exempt interest (5,000) Taxable income $208,075 ch17

Mr. Fox owns 500 shares of stock in Ocean Corporation, which represents 52% of Ocean's only class of stock issued and outstanding. Mr. Fox's basis in the stock is $50,000 ($100 per share). Ocean redeems 250 shares of Mr. Fox's stock for $40,000. The redemption is properly treated as a distribution of cash in exchange for the stock. What is Mr. Fox's basis in his remaining shares of stock?

$25,000 The shareholder's basis in his remaining stock depends on the treatment of the distribution. If the distribution is essentially equivalent to a dividend, the shareholder's basis in the remaining stock will be increased by the basis of the stock that is redeemed [Reg. 1.302-2(c)]. If the distribution is treated as payment for the shareholder's redeemed stock, the basis of the redeemed stock offsets the amount received by the shareholder, and the basis of the remaining shares is unchanged. Section 302 governs the determination of the distribution's character. Since Fox still owns Ocean stock after the redemption, a complete termination under Sec. 302(b)(3) did not occur. The best choice from the remaining alternatives is the substantially disproportionate redemption test of Sec. 302(b)(2), which requires that, immediately after the redemption, the shareholder own less than 50% of the total combined voting power of all classes of voting stock. Since approximately 962 shares are outstanding before redemption (500 ÷ 52% = 961.5), 35% of the Ocean stock is owned by Fox after the redemption [(500 - 250) ÷ (962 - 250) = 35%]. A second requirement for Sec. 302(b)(2) treatment is that the percentage of stock ownership after the redemption be less than 80% of the percentage of ownership immediately before the redemption (80% × 52% = 41.6%; 35% < 41.6%). Therefore, the redemption is substantially disproportionate and is considered a sale. Hence, the basis is $25,000 (250 remaining shares × $100 per share). ch20

The minimum Accumulated Earnings Credit is

$250,000 for non-personal service corporations. The Accumulated Earnings Credit is defined as the increase in the reasonable needs of a business during the tax year. Without showing a reason for the accumulation, the minimum Accumulated Earnings Credit is $250,000 for corporations other than personal service corporations. ch17

The following information pertains to Dahl Corp.: Accumulated earnings and profits at January 1, 2020 $120,000 Earnings and profits for the year ended December 31, 2020 160,000 Cash distributions to individual shareholders during 2020 360,000 What is the total amount of distributions taxable as dividend income to Dahl's shareholders in 2020?

$280,000 A taxable dividend for purposes of taxable income is, generally, any distribution of money or property made by a corporation to its shareholders with respect to their stock out of the corporation's earnings and profits. The earnings and profits (both current and accumulated) total $280,000, and this amount represents the taxable dividends. The remainder is a return of capital. ch18 ch19

Mr. X purchased stock in Corporation Y in 2016 for $5,000. In 2017, he received a distribution of $1,200, when Corporation Y had no current or accumulated earnings and profits. In 2020, Mr. X received a $400 dividend, when Corporation Y had earnings and profits in excess of its dividend distribution. There has been no other activity on this stock. What is Mr. X's basis in his stock of Corporation Y as of December 31, 2020?

$3,800 A corporate distribution is taxable to the recipient to the extent that it comes from accumulated or current earnings and profits [Sec. 301(c)(1)]. Any remaining distribution is treated as a return of capital. Since there were not any current or accumulated E&P when the first distribution was made in 2017, Mr. X's basis was reduced by the amount of the $1,200 distribution. Since the 2020 E&P was in excess of the $400 distribution, the $400 is a taxable dividend to Mr. X. Thus, Mr. X's adjusted basis in his stock of Y Corporation at year-end 2020 is $3,800 ($5,000 - $1,200). ch18 ch19

Vernon receives a truck from Berry Trucking Company as a distribution in complete liquidation. Vernon's basis in the stock of Berry Trucking Company is $2,000. The fair market value of the truck on the date of the distribution is $30,000. There is a $15,000 loan on the truck, which Vernon assumed. What is the basis of the truck to Vernon?

$30,000 If a shareholder assumes a liability of the liquidating corporation or receives property that is subject to a liability, then the liability reduces the amount realized by the shareholder, thus reducing the shareholder's gain or increasing the shareholder's loss. Nevertheless, the shareholder's basis for the property is the property's fair market value, in this case $30,000. ch20

Mr. Brown transferred an office building to Corporation J in exchange for 100% of Corporation J's stock and $30,000 in cash. The building had an adjusted basis of $150,000 and a fair market value of $250,000. The building was subject to a mortgage of $120,000, which Corporation J assumed for a valid business reason. The fair market value of Corporation J's stock on the date of the transfer was $100,000. What is Mr. Brown's recognized gain?

$30,000 If the requirements of Sec. 351(a) are met, no gain or loss is recognized when property is transferred to a corporation. There are three primary exceptions to Sec. 351(a). Gain can be recognized when Property other than stock (e.g., cash) is received [Sec. 351(b)], A liability is assumed by the corporation for tax avoidance or nonbusiness purposes [Sec. 351(b)], or A liability is assumed in excess of the adjusted basis of the property transferred [Sec. 357(c)]. Since the mortgage is assumed for a valid business reason and does not exceed the $150,000 adjusted basis, none of the mortgage that is assumed is treated as boot property [Sec. 357(a)]. The recognized gain is the lesser of the cash received by the transferor ($30,000) or the realized gain of $100,000 [($100,000 FMV of stock + $120,000 mortgage release + $30,000 cash) - $150,000 adjusted basis]. ch18 ch19

For the year ended December 31, 2020, Kelly Corp. had net income per books of $300,000 before the provision for federal income taxes. Included in the net income were the following items: Dividend income from a 5%-owned domestic taxable corporation (Taxable income limitation does not apply, and there is no portfolio indebtedness.) $50,000 Bad debt expense (represents the increase in the allowance for doubtful accounts) 80,000 If no bad debt was written off, what is Kelly's taxable income for the year ended December 31, 2020?

$355,000 .First, a 50% dividends-received deduction (DRD) is allowed if the corporation owns less than 20% of the distributing corporation. Thus, there is a $25,000 DRD ($50,000 × 50%). Second, the deductibility of bad debts is limited to the direct write-off method. The allowance method is not allowed except for certain financial institutions. Therefore, $80,000 must be added back to the financial net income. Thus, the taxable income for 2020 is $355,000 ($300,000 - $25,000 + $80,000). ch17

Dahl Corp. was organized and commenced operations in 1946. At December 31, 2020, Dahl had accumulated earnings and profits of $9,000 before a dividend declaration and distribution. On December 31, 2020, Dahl distributed cash of $9,000 and a vacant parcel of land to Mr. Green, Dahl's only shareholder. At the date of distribution, the land had a basis of $5,000 and a fair market value of $40,000. What was Mr. Green's taxable dividend income in 2020 from these distributions assuming a 21% corporate tax rate?

$36,650 The amount of a distribution is the amount of money plus the FMV of other property received. Dahl Corp. recognizes gain on the distribution of appreciated property of $35,000 ($40,000 FMV - $5,000 adjusted basis). The total amount of Dahl's distribution is Cash$ 9,000 Basis of property plus gain (equal to FMV)40,000 Total distribution$49,000 A distribution is a dividend to the extent it comes from E&P. Dahl's $9,000 in E&P is increased by the gain on the distribution and decreased by taxes on the gain. E&P - 12/31/20 $ 9,000 Gain on land distribution 35,000 Taxes on gain ($35,000 × 21%)(7,350) E&P after adjustment $36,650 The $36,650 of the total $49,000 paid is taxable as a dividend. The remaining $12,350 is either return of capital or capital gain, depending on Mr. Green's stock basis. ch18 ch19

Fox, the sole shareholder in Fall, a C corporation, has a tax basis of $60,000. Fall has $40,000 of accumulated positive earnings and profits at the beginning of the year and $10,000 of current positive earnings and profits for the current year. At year end, Fall distributed land with an adjusted basis of $30,000 and a fair market value (FMV) of $38,000 to Fox. The land has an outstanding mortgage of $3,000 that Fox must assume. What is Fox's tax basis in the land?

$38,000 In a nonliquidating distribution, the shareholder's basis in property received is the FMV at the date of distribution. If the shareholder also assumes a liability with the property distribution, it must be compared to the property's FMV. In the event the liability exceeds the FMV, the liability is the shareholder's basis in the property. If the liability is less, as this situation indicates ($3,000 < $38,000), the basis will remain equal to the FMV. ch18 ch19

Mr. X owned 40% of Corporation B's only class of stock outstanding. The remaining 60% of B's stock was owned by Mr. Y (not related to Mr. X). Corporation B redeemed all of X's stock for $75,000 and one-half of Y's stock for $50,000. Mr. X's and Mr. Y's basis in their stock of Corporation B was $30,000 and $25,000, respectively. B's earnings and profits (E&P) were $200,000. Assuming that no partial liquidation occurred, what are the amount and the character of X's and Y's recognized gains? Mr. X Mr. Y

$45,000 capital gain $50,000 dividend Under Sec. 302(b)(3), if a corporation redeems all of its stock owned by a shareholder, the shareholder is treated as having sold his stock to the corporation and will report a capital gain to the extent that the distribution exceeds his basis in the stock. Therefore, Mr. X has a capital gain of $45,000 ($75,000 distribution - $30,000 basis). If the distribution is not a redemption of all the shareholder's stock, Sec. 302(b)(2) must be applied to determine whether the distribution will be treated as a payment in exchange for the stock or as a dividend. One of the requirements of Sec. 302(b)(2) is that the shareholder must own less than 50% of the total combined voting power of all classes of stock immediately after the redemption. Alternatively, the distribution must not be essentially equivalent to a dividend under Sec. 302(b)(1). This alternative requires a meaningful reduction in the shareholder's interest in the distributing corporation. Since all of Mr. X's stock was redeemed, Mr. Y owns 100% of the voting stock. Therefore, the requirements of Secs. 302(b)(2) or 302(b)(1) are not met, and the $50,000 distribution is treated as a dividend since it is less than B Corporation's earnings and profits. ch20

Bridge, a C corporation, had $15,000 in accumulated earnings and profits at the beginning of the current year. During the current year, Bridge reported earnings and profits of $10,000 and paid $20,000 in cash distributions to its shareholders in both March and July. What amount of the July distribution should be classified as dividend income to Bridge's shareholders?

$5,000 A distribution is a dividend that is included in the recipient's gross income to the extent that it is made from the current or accumulated earnings and profits (E&P) of a corporation. Any additional distribution is treated by the shareholder as a nontaxable return of capital to the extent of the shareholder's basis in the stock. When distributions during the year exceed current E&P, pro rata portions of each distribution are deemed to be from current E&P. Therefore, current E&P of $5,000 [$10,000 × ($20,000 distribution ÷ $40,000 total distributions for the year)] is allocated to each distribution. Accumulated E&P is then allocated to distributions in chronological order. The first distribution is allocated $15,000 of accumulated E&P, and the second distribution is not allocated any accumulated E&P because none remains after the allocation to the first distribution. Hence, the total dividend for July equals $5,000 from current E&P and a return of capital of $15,000. ch18 ch19

In a Sec. 351 transaction, Mr. Biller transferred assets with an adjusted basis of $76,000 and a fair market value of $80,000 to Bay View Corporation in exchange for its capital stock with a fair market value of $72,000. Bay View Corporation also assumed a liability from Mr. Biller of $81,000 [not a trade account payable under Sec. 357(c)(3)]. What is Mr. Biller's recognized gain?

$5,000 Section 351(a) provides for nonrecognition of gain or loss if a person transfers property to a corporation solely in exchange for stock in the corporation and if, immediately after the exchange, such person is in control (owns at least 80% of the stock). Also, Sec. 357(c) provides that, if the liabilities transferred or assumed ($81,000) are greater than the basis of all the property transferred ($76,000), the excess is treated as a gain from the sale or exchange of property. Thus, Mr. Biller's recognized gain equals $5,000 ($81,000 liability assumed - $76,000 basis in property transferred). ch18 ch19

Marvel Corporation's operating income for 2020 was $200,000 before a reduction of $60,000 for charitable contributions. What is the maximum allowable deduction for contributions on Marvel's 2020 federal income tax return?

$50,000 The charitable contribution deduction for corporations is limited to 25% of the taxable income computed before the charitable contribution deduction, dividends-received deduction, and capital loss carryback. Marvel's charitable contribution deduction should be $50,000 ($200,000 × 25%). ch17

Krol Corporation distributed marketable securities in redemption of its stock in a complete liquidation. On the date of distribution, these securities had a basis of $100,000 and a fair market value of $150,000. What gain does Krol have as a result of the distribution?

$50,000 capital gain. .Gain or loss is recognized when a corporation distributes property as part of a complete liquidation. Krol recognizes a $50,000 gain ($150,000 FMV - $100,000 AB). It is a capital gain because the marketable securities are a capital asset. ch20

John Budd is the sole shareholder of Ral Corp., an accrual-basis taxpayer engaged in wholesaling operations. Ral's retained earnings at January 1, 2020, amounted to $1 million. For the year ended December 31, 2020, Ral's book income, before federal income tax, was $300,000. Included in the computation of this $300,000 was the following: Dividends received on 500 shares of stock of a taxable domestic corporation that had 1,000,000 shares of stock outstanding (Ral had no portfolio indebtedness.) $1,000 What portion of the dividend revenue net of the dividends-received deduction should be included in Ral's 2020 taxable income?

$500 A corporation may deduct an applicable percentage of dividends received from a domestic taxable corporation. The applicable percentage depends on the value and percentage of voting stock of the distributing corporation owned by the distributee ch17

In order for Corporation X, a calendar-year taxpayer, to be required to make estimated tax payments in 2020, its expected tax liability will have to be

$500 or more. All corporations must make estimated tax payments, except those which have an estimated tax liability of less than $500. ch17

For the year ended December 31, 2020, Atkinson, Inc., a calendar-year corporation, had gross income of $260,000 including dividend income of $100,000 from 25%-owned unaffiliated domestic corporations. Business deductions for 2020 amounted to $170,000. The dividends were not from debt-financed portfolio stock. What is Atkinson's dividends-received deduction for 2020?

$58,500 A corporation is allowed a deduction for 65% of dividends received from unaffiliated domestic corporations of which it owns at least 20% of the stock. The dividends-received deduction is limited to 65% of taxable income before inclusion of the dividends-received deduction, qualified business income deduction, net operating loss deduction, capital loss carrybacks, and certain adjustments for extraordinary dividends. Gross income (including dividends) $260,000 Less: Business deductions (170,000) Taxable income without dividends-received deduction $ 90,000 Deduction is lesser of: 65% of dividend income, or $ 65,000 65% of taxable income without dividends-received deduction $ 58,500 Note that if there is a net operating loss after the dividends-received deduction, the deduction is not limited by taxable income. ch17

Mintee Corp., an accrual-basis, calendar-year C corporation, had no corporate shareholders when it liquidated in Year 1. In cancellation of all their Mintee stock, each Mintee shareholder received in Year 1 a liquidating distribution of $2,000 cash and land with a tax basis of $5,000 and a fair market value of $10,500. Before the distribution, each shareholder's tax basis in Mintee stock was $6,500. What amount of gain should each Mintee shareholder recognize on the liquidating distribution?

$6,000 The amount realized on the liquidation of a corporation is the amount of money received plus the FMV of property received. The recognized gain is the amount by which this exceeds adjusted basis of the corporation's stock. The recognized gain on this distribution is Amount realized $12,500 Less: Adjusted basis (6,500) Gain recognized $ 6,000 ch20

During 2020, Anna transferred land with an adjusted basis to her of $20,000 and a fair market value of $56,000 to Elm Corporation in exchange for 100% of Elm Corporation's only class of stock. The land was subject to a liability of $26,000, which Elm assumed for legitimate business purposes. The fair market value of Elm's stock at the time of the transfer was $30,000. What is the amount of Anna's recognized gain?

$6,000 The general rule of Sec. 351 is that no gain is recognized if a shareholder transfers property in exchange for stock of a corporation as long as the shareholder(s) involved in the transaction control(s) the corporation immediately after the exchange. Control is defined in Sec. 368(c) as 80% of the voting power and 80% of all classes of nonvoting stock. Anna received 100% of Elm Corporation's stock and therefore has control immediately after the exchange. But Sec. 357(c) provides that gain must be recognized by the shareholder to the extent that liabilities assumed, or taken subject to, by the corporation exceed the adjusted basis of all property transferred. The liability on the land exceeded the adjusted basis of the land Anna transferred by $6,000 ($26,000 liability assumed - $20,000 adjusted basis). Thus, Anna must recognize a gain of $6,000. CH18 ch19

In April, A and B formed X Corp. A contributed $50,000 cash, and B contributed land worth $70,000 (with an adjusted basis of $40,000). B also received $20,000 cash from the corporation. A and B each receive 50% of the corporation's stock. What is the tax basis of the land to X Corp.?

$60,000 .The basis of land to X Corp. is the adjusted basis to B ($40,000) increased by B's recognized gain ($20,000). B's realized gain is $30,000. Recognized gain is the lesser of boot received ($20,000) and realized gain. ch18 ch19

Potter Corp. and Sly Corp. file consolidated tax returns. In January of Year 1, Potter sold land, with a basis of $60,000 and a fair value of $75,000, to Sly for $100,000. Sly sold the land in December of Year 2 for $125,000. In the consolidated group's Year 1 and Year 2 tax returns, what amount of gain should be reported for these transactions in the consolidated return? Year 2 Year 1

$65,000 $0 A sale or exchange of property between members of the consolidated group is a deferred intercompany transaction. In the case of nondepreciable property (e.g., land) not sold on the installment basis, the gain is not reported until the property is sold outside the group. Therefore, Potter should report no income in the consolidated return for Year 1 as a result of the sale. For Year 2, however, Potter should recognize the full amount of the $65,000 gain ($125,000 - $60,000). ch17

Since 2009, Ben has owned all 100 outstanding shares of N and M Corporation's stock. Ben's basis for the stock is $50,000. In 2020, N and M have earnings and profits of $100,000. The corporation redeemed 25 shares of Ben's stock for $75,000 in 2020. How will Ben report this?

$75,000 dividend. Because Ben owns 100% of the stock before and after the redemption, the transaction is a dividend to the extent that N and M Corporation has earnings and profits. Because the distribution ($75,000) is less than earnings and profits ($100,000), the entire amount is taxable as a dividend. ch20

Emerald Corporation and Sound Corporation file a consolidated return on a calendar-year basis. In Year 1, Emerald sold land to Sound for its fair market value of $50,000. At the date of sale, Emerald had an adjusted basis in the land of $40,000 and had held the land for several years as an investment. Sound held the land primarily for sale to its customers in the ordinary course of its business and sold it to a customer early in Year 2 for $120,000. As a result of the sale of the land in Year 2, the corporations should report on their consolidated return

$80,000 ordinary income. A sale or exchange of property between members of an affiliated group is a deferred intercompany transaction. In the case of nondepreciable property (e.g., land) not sold on the installment basis, the gain is not reported until the property is sold outside the group. Under the single-entity approach, the character and amount of the gain are determined with reference to the consolidated group. Therefore, the sale to the outside customer results in $80,000 of ordinary income ($120,000 amount realized - $40,000 adjusted basis) to be reported on the Year 2 consolidated return. ch17

A C corporation has gross receipts of $150,000, $35,000 of other income, and deductible expenses of $95,000. In addition, the corporation incurred a net long-term capital loss of $25,000 in the current year. What is the corporation's taxable income?

$90,000 Net capital gains (NCGs) constitute gross income. However, a corporation's capital losses are deductible only to the extent of capital gains, whether they are short- or long-term. Therefore, a net capital loss is not deductible in the tax year incurred. The corporation has taxable income of $90,000 ($150,000 + $35,000 - $95,000). ch17

Finbury Corporation's taxable income for the year ended December 31, 2019, was $2 million. For Finbury to escape the estimated tax underpayment penalty for the year ending December 31, 2020, its total 2020 estimated tax payments must equal at least

100% of its 2020 tax liability. A large corporation will not be considered to have underpaid its income tax if it pays 100% of the tax shown on the return for the tax year. A large corporation is one having $1 million or more taxable income during any of its 3 preceding tax years. Large corporations are not able to avoid underpaying their taxes by relying on the 100% of the tax shown on the return for the preceding year exception. CH17

Finbury Corporation's taxable income for the year ended December 31, 2019, was $2 million. For Finbury to escape the estimated tax underpayment penalty for the year ending December 31, 2020, its total 2020 estimated tax payments must equal at least

100% of its 2020 tax liability. A large corporation will not be considered to have underpaid its income tax if it pays 100% of the tax shown on the return for the tax year. A large corporation is one having $1 million or more taxable income during any of its 3 preceding tax years. Large corporations are not able to avoid underpaying their taxes by relying on the 100% of the tax shown on the return for the preceding year exception. ch17

John Budd is the sole shareholder of Ral Corp., an accrual-basis taxpayer engaged in wholesaling operations. Ral's retained earnings at January 1, 2020, amounted to $1 million. For the year ended December 31, 2020, Ral's book income, before federal income tax, was $300,000. Included in the computation of this $300,000 was the following: On 12/1/20, Ral received prepaid rent of $27,000 from a tenant for a 3-year lease commencing 1/1/21 to cover rents for the years 2021, 2022, and 2023. In conformity with GAAP, Ral did not include any part of this rental in its income statement for the year ended 12/31/20. What amount should Ral include in its 2020 taxable income for rent revenue?

27,000 Both cash- and accrual-basis taxpayers must include in gross income amounts actually or constructively received if the taxpayer has an unrestricted claim to the amounts. Ral has an unrestricted claim to the rent received under the lease. The full amount is gross income in 2020. ch17

Mr. Oleaner owns 600 shares of the voting stock of Clarkson Corporation. The remaining 350 shares of the voting stock outstanding are held by persons unrelated to Mr. Oleaner. Mr. Oleaner wants a proposed redemption of part of the stock to qualify under Sec. 302(b)(2). What is the maximum number of shares that Mr. Oleaner can own after the redemption to qualify as a sale or an exchange?

349 Section 302 determines whether a redemption is considered a distribution equivalent to a dividend or payment for the stock eligible for capital gain or loss treatment. Under Sec. 302(b)(2), a substantially disproportionate redemption qualifies for capital gain or loss treatment. For a redemption to be substantially disproportionate, the shareholder must own less than 50% of all outstanding voting stock immediately after the redemption, and his or her total percentage of ownership must be less than 80% of his or her ownership percentage immediately before the redemption. Mr. Oleaner holds approximately 63% (600 ÷ 950 shares) of the stock before the transfer and, if he holds 349 shares, he meets the 50%-ownership rule (349 ÷ 699 = 49.9%). The second requirement is also met because ownership after the redemption is less than 80% of the percentage ownership immediately before the redemption (80% × 63% = 50.4%; 49.9% < 50.4%). Thus, the redemption is substantially disproportionate and is considered a sale. ch20

Bob owns 250 shares of Rice Corporation. Rice Corporation plans on redeeming 100 shares of its 500 shares of common stock outstanding. Below what percentage must Bob's interest be reduced if the redemption is to be substantially disproportionate?

40% Substantially disproportionate means that the amount received by shareholders is not in the same proportion as their stock holdings. To qualify, immediately after redemption, the shareholder must own (1) less than 50% of the voting power of outstanding voting stock and (2) less than 80% each of both the common stock and voting stock owned before the redemption by the shareholder. Bob owns 50% of Rice Corporation before the redemption (250 ÷ 500). Thus, Bob must reduce his interest below 40% (50% × 80%). ch20

Mary, an individual shareholder, owns 125 shares of West Corporation. West Corporation has 500 shares of common stock outstanding. If West Corporation redeems 100 shares of common stock from its shareholders, what is the least number of Mary's shares that will need to be redeemed in order for the redemption to be substantially disproportionate to Mary?

46 Substantially disproportionate means that the amount received by shareholders is not in the same proportion as their stock holdings. In order for a redemption to qualify as substantially disproportionate, immediately after the redemption, the shareholder must own less than 50% of the voting power of outstanding voting stock and less than 80% each of both the common stock and voting stock owned before the redemption by the shareholder. Mary owned 25% of West Corporation before the redemption (125 ÷ 500). Mary must reduce her interest to below 20% for the redemption to be substantially disproportionate (80% × 25%). Mary needs to own less than 80 shares after the redemption (20% × 400). Thus, more than 45 shares need to be redeemed to reduce Mary's interest below 20% (125 - 80). Accordingly, Mary needs to have a minimum of 46 shares redeemed for the redemption to be substantially disproportionate. ch20

Corporation H has 1,000 shares of stock issued and outstanding. Mr. K, the founder, owns 40% of the stock, his wife owns 10%, his son owns 20%, and the balance is owned by unrelated parties. Under the constructive ownership rules of the stock redemption provisions, what percentage of stock is Mr. K considered to own?

70% The stock redemption provisions found in Sec. 302 use the constructive ownership (attribution) rules of Sec. 318. Under the Sec. 318(a)(1) rules, an individual is considered to own the stock owned by members of his or her family including his or her spouse, children, grandchildren, and parents. Therefore, Mr. K owns 40% of the stock directly, and he indirectly owns the stock owned by his wife and son. Mr. K has direct and indirect ownership of 70% (40% + 20% + 10%) of Corporation H. For that matter, so do his wife and son. ch20

Dana Corporation owns stock in Seco Corporation. For Dana and Seco to qualify for the filing of consolidated returns, at least what percentage of Seco's total voting power and total value of stock must be directly owned by Dana? Total Voting Power Total Value of Stock

80% 80% A corporation must own 80% of the total voting power and 80% of the total value of the stock (excluding certain preferred stock issues) in order to file a consolidated return. ch17

On July 1 of the current year, Rich, sole proprietor of Kee Nail, transferred all of Kee's assets to Merit, Inc., a new corporation, solely for a certain percentage of Merit's stock. Dee, who is not related to Rich, also bought some of Merit's stock on July 1. Merit's outstanding capital stock consisted of 1,000 shares of common stock with a par value of $100 per share. For the transfer of Kee Nail's assets to be tax-free, what is the minimum number of shares of Merit's stock that must be owned by Rich and Dee immediately after the exchange?

800 A transfer of assets for stock of a corporation is tax-free if the transferors are in control of the corporation immediately after the exchange. A person who transfers appreciated property will receive the benefit if another transferor transfers property and together they meet the control test. Property includes money. Control is ownership of stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation. At a minimum, Rich and Dee must own 800 shares (1,000 shares × 80%). ch18 ch19

Nancy owns 10% interest in ABC Corporation and 20% of the outstanding shares of XYZ Corporation. Her son Nick owns 60% of the outstanding shares of XYZ Corporation. XYZ Corporation owns 50% interest in ABC Corporation. Denise, Nancy's mother, owns 40% interest in ABC Corporation. Under the constructive ownership rules of Sec. 318, Nancy is considered to own how much of ABC Corporation?

90% An individual is treated as owning the stock owned by his or her spouse, children, grandchildren, and parents. If 50% or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, that person is considered to own the stock, directly or indirectly, by or for his or her corporation in the proportion that the value of the stock (s)he owns bears to the value of all the stock in the corporation. Nancy is considered to own 90% of ABC: 10% direct ownership, plus 40% indirect ownership (made up of her 20% ownership of XYZ plus her son's 60% ownership of XYZ times the 50% corporate ownership of ABC), plus 40% indirect ownership from her mother. ch20

Pitkin Theatres, Inc., distributes land to its sole shareholder. The land is valued at $30,000 and has a basis of $10,000. The land is subject to a $16,000 mortgage, which the shareholder assumes. Pitkin has $20,000 in earnings and profits. Ignoring any potential effect of any taxes on the distribution, the net effect of the transaction on earnings and profits (E&P) is

An increase by $6,000. E&P are increased by current E&P and decreased by the corporation's distributions to its shareholders. A distribution of appreciated property increases E&P by the gain recognized on the distribution ($20,000) and decreases E&P by the FMV of the property ($30,000) net of any liability assumed by the shareholder ($16,000). Therefore, Pitkin's E&P will have a net increase of $6,000 ($20,000 - $30,000 + $16,000). ch18 ch19

From the perspective of the parent corporation, there are tax consequences of a subsidiary liquidation under the general nonrecognition rules with a subsidiary liquidation that follows a § 338 election. Complete the statements below that define these tax consequences. Under the general nonrecognition rules, the parent corporation recognizes ______ on liquidating distributions from the subsidiary, _________ and _________ in the assets received. The parent's basis in the stock of the subsidiary ________ . With a § 338 election, the parent corporation recognizes ________ on liquidating distributions from the subsidiary. Also, the parent's basis in the assets received will reflect the ________ basis resulting from the subsidiary's deemed asset sale and repurchase under § 338. The holding period of the assets ________ . The parent's basis in the stock of the subsidiary _________

Answers: no gain or loss; takes a carryover basis; carryover holding period; disappears; no gain or loss; stepped-up (or stepped-down) basis; will begin on the date of the qualified stock purchase; is eliminated. The liquidation of a subsidiary generally is a nontaxable transaction resulting in the nonrecognition of gain or loss for both the parent and the subsidiary corporations and the carryover of the subsidiary's asset bases (and other tax attributes). This treatment reflects the fact that such a liquidation often is merely a change in corporate structure and not a change in substance. This is particularly the case when the parent has owned the stock of the subsidiary since the subsidiary's inception. In such cases, the carried-over bases are comparable to what the parent would have in the subsidiary's assets if the parent, and not the subsidiary, had originally acquired the assets. Specifically, the tax consequences to a parent corporation in a subsidiary liquidation that follows a § 338 election are governed by the same rules as above, but substantive differences will result due to the § 338 election. The parent corporation still recognizes no gain or loss on liquidating distributions from the subsidiary. Also, the parent takes a carryover basis and holding period in the assets received. However, these bases will reflect the stepped-up (or -down) basis resulting from the subsidiary's deemed asset sale and repurchase under § 338. Further, the holding period of the assets will begin on the date of the qualified stock purchase. The parent will acquire the other tax attributes (e.g., net operating loss carryover, E & P) of the subsidiary, but those attributes are likely to be nominal in amount since the subsidiary is treated as a new corporation as of the day following the qualified stock purchase date. The parent's basis in the stock of the subsidiary disappears. ch20

Goyo Corporation, a calendar year taxpayer, incurs a long-term net capital loss of $12,000 for 2020. It has ordinary income of $10,000 in 2020. Goyo had long-term capital gains of $2,500 in 2017 and $5,000 in 2019. If an amount is zero, enter "0". As a result, Goyo may deduct _____ of the net long-term capital loss in 2020. Goyo may carryback and use ______ of the losses. In addition, Goyo has a ______ carryover of ______ to 2021.

Answers: $0; $7,500; short-term; $4,500. Significant differences exist in the treatment of capital losses for income tax purposes. Individuals can annually deduct up to $3,000 of net capital losses against ordinary income. If an individual has both net short-term and net long-term capital losses, the short-term capital losses are used first in arriving at the $3,000 ordinary loss deduction. While corporations may not use net capital losses to offset ordinary income, they may use net capital losses to offset past or future capital gains. Unlike individuals, corporations are not allowed an unlimited carryover period for capital losses. Instead, they may carry back excess capital losses to the three preceding years, applying the losses initially to the earliest year. If not exhausted by the carryback, remaining unused capital losses may be carried forward for a period of five years from the year of the loss. When carried back or forward, both short-term capital losses and long-term capital losses are treated as short-term capital losses by corporate taxpayers. For noncorporate taxpayers, carryovers of capital losses retain their identity as short or long-term. None of the capital loss may be deducted in 2020. Goyo may, however, carry the loss back to years 2017, 2018, and 2019 (in this order) and offset any capital gains recognized in these years. Therefore, $2,500 and $5,000 are used up by the carryback, leaving the balance of $4,500 ($12,000 - $7,500) to be carried forward to 2021, 2022, 2023, 2024, and 2025 (in this order). Such capital loss carrybacks or carryovers are treated as short-term capital losses. CH17

Rebecca holds 100 shares of Gotchas stock that she purchased for $1,000 several years ago. In a merger of Gotchas into Solis, Inc., Rebecca exchanges her 100 Gotchas shares for 1,000 Solis shares and $500. Gotchas is valued at $40 per share and Solis at $3.50 per share. a. What is Rebecca's realized and recognized gain/loss from the reorganization?Assuming that this exchange qualifies for tax-free treatment under § 368, Rebecca's realized gain is __________, her recognized gain is ________ b. What is Rebecca's basis in her Solis stock?

Answers: $3,000; $500; $1,000. Corporations meeting the § 368 requirements do not recognize gains or losses on restructurings. However, an exception to the nonrecognition rule occurs when other property is transferred by the acquiring corporation in the reorganization. Other property, also called boot, is any asset other than stock or securities exchanged in the reorganization. If boot is transferred, gain but not loss may be recognized. Generally, the shareholders of corporations involved in a tax-free reorganization do not recognize gain or loss when exchanging their stock unless they receive boot in addition to stock. a. Rebecca's Gotchas stock is valued at $4,000 ($40 per share × 100 shares). She receives $4,000 ($3.50 per share x 1,000 shares = $3,500 + $500) in stock and cash (boot). Because she received boot, part of her gain realized is recognized. The exchange of Rebecca's stock has no tax consequences for Gotchas or Solis. Assuming that this exchange qualifies for tax-free treatment under § 368, Rebecca's recognized gain and basis in her Solis stock are computed as follows using the four-column template of Concept Summary 20.3. *Rebecca received: $3.50 per share x 1,000 shares = $3,500 + $500 = $4,000. The exchange of Rebecca's stock has no tax consequences for Gotchas or Solis. b. Rebecca's basis in Solis stock is $1,000. ch20

Larry, the sole shareholder of Brown Corporation, sold his Brown stock to Ed on July 30 for $270,000. Larry's basis in the stock was $200,000 at the beginning of the year. Brown had accumulated E & P of $120,000 on January 1 and has current E & P of $240,000. During the year, Brown made the following distributions: $450,000 of cash to Larry on July 1 and $150,000 of cash to Ed on December 30. If an amount is zero, enter "0". a. How will Larry and Ed be taxed on the distributions?Larry will have the following: Dividend income: ________ Return of capital: ________ Capital gain: ________ Ed will have the following: Dividend income: ________ Return of capital: _________ Capital gain: ________ b. How much gain will Larry recognize on the sale of his stock to Ed? Larry recognizes a capital gain of ________ on the sale of the stock.

Answers: $300,000; $150,000; $0; $60,000; $90,000; $0; $220,000. When a positive balance exists in both the current and the accumulated E & P accounts, corporate distributions are deemed to be made first from current E & P and then from accumulated E & P. When distributions exceed the amount of current E & P, it becomes necessary to allocate current and accumulated E & P to each distribution made during the year. Current E & P is applied on a pro rata basis (using dollar amounts) to each distribution. Accumulated E & P is applied in chronological order, beginning with the earliest distribution. Click here to view Concept Summary 19.2, Allocating E & P to Distributions. a. Brown Corporation has $240,000 in current E & P, and this amount is allocated on a pro rata basis to the two distributions made during the year (based on the total distributions made during the tax year). Thus, $180,000 of current E & P is allocated to Larry's distribution [$240,000 current E & P x ($450,000 distribution to Larry/$600,000 total distributions)] and $60,000 is allocated to Ed's distribution [$240,000 current E & P x ($150,000 distribution to Ed/$600,000 total distributions)]. Accumulated E & P is applied in chronological order beginning with the earliest distribution. When Brown Corporation distributes $450,000 to Larry on July 1, its dividend-paying capacity is $300,000 (the entire accumulated E & P balance of $120,000 + $180,000 from current E & P). As a result, $300,000 of Larry's July 1 distribution is treated as dividend income. The remaining $150,000 of the distribution reduces Larry's stock basis to $50,000 ($200,000 basis - $150,000 return of capital). Of the $150,000 distributed to Ed, $60,000 is treated as a dividend and the remaining $90,000 reduces his stock basis to $180,000 [$270,000 (original cost) - $90,000 (reduction in basis from the distribution)]. b. Larry recognizes a $220,000 capital gain on the sale of his stock to Ed [$270,000 (sales price) - $50,000 (remaining stock basis)]. CH19

Complete the statements below that outline when C corporations are required to make estimated tax payments and how the payments are calculated. Assume the preceding year was a 12-month tax year, the return filed showed a tax liability, and the corporation is not a large corporation. Estimated tax payments are required if the corporation's tax liability is expected to be $_____ or more. The required annual payment is the ______ of (1) _____ of the corporation's tax for the current year or (2) ______% of the corporation's tax for the preceding year. Estimated tax payments, if required, are made_________ .

Answers: $500; lesser; 100%; 100%; quarterly. A corporation must make payments of estimated tax unless its tax liability can reasonably be expected to be less than $500. The required annual payment (which includes any estimated alternate minimum tax (AMT) liability) is the lesser of: 100% of the corporation's tax for the current yearor 100% of the tax for the preceding year (if that was a 12-month tax year and the return filed showed a tax liability). A large corporation (one with $1,000,000 or more of taxable income in any of its three preceding tax years) cannot base its installment payments on its previous year's tax liability, except for its first installment payment. For a calendar year corporation, the estimated tax payment due dates are April 15, June 15, September 15, and December 15. Estimated payments can be made in four installments due on or before the fifteenth day of the fourth month, the sixth month, the ninth month, and the twelfth month of the corporate taxable year. For a calendar year corporation, the payment dates are as follows: April 15; June 15; September 15; and December 15. The full amount of the unpaid tax is due on the due date of the return. A corporation failing to pay its required estimated tax payments will be subjected to a nondeductible penalty on the amount by which the installments are less than the tax due. However, the underpayment penalty will not be imposed if the estimated payments are timely and are equal to the tax liability of the corporation for the prior year or equal to the tax due computed on an annualized basis. If the annualized method is used for one installment and the corporation does not use this method for a subsequent installment, any shortfall from using the annualized method for a prior payment(s) must be made up in the subsequent installment payment. The penalty is imposed on each installment; that is, a corporation must pay one-fourth of its required annual payment by the due date of each installment. A large corporation cannot base its installment payments on its previous year's tax liability except for its first installment payment. A corporation is considered large if it had taxable income of $1,000,000 or more in any of its three preceding years. CH17

In the current year, Pelican, Inc., a calendar year C corporation, incurs $10,000 of meals and entertainment expenses that it deducts in computing net income per the corporation's financial statements. Assume all of the meals and entertainment expenditures are subject to the 100% disallowance rule applicable to such expenditures. Complete the statements below that outline how this information is reported on Schedule M-3. If your answer is zero, enter "0". Pelican, Inc., reports the meals and entertainment expenditures on ________, Part III . The corporation reports book expense of ________ in column (a), permanent difference of ________ in column (c), and tax return deduction of ________ in column (d).

Answers: 11; Part III; $10,000; $10,000; $0. Corporations with total assets of $10 million or more are required to report greater detail relative to differences between income (loss) reported for financial purposes and income (loss) for tax purposes. This expanded reconciliation of book and taxable income (loss) is reported on Schedule M-3. Schedule M-3 is a response, at least in part, to financial reporting scandals such as Enron and WorldCom. One objective of Schedule M-3 is to create greater transparency between corporate financial statements and tax returns. Another objective is to identify corporations that engage in aggressive tax practices by requiring that transactions that create book/tax differences be disclosed on corporate tax returns. Corporation that are not required to file Schedule M-3 may do so voluntarily. Any corporation that files Schedule M-3 is not allowed to file Schedule M-1. The starting point on Schedule M-1 is net income per books. Additions and subtractions are entered for items that affect net income per books and taxable income differently. An example of an addition is Federal income tax expense, which is deducted in computing net income per books but is disallowed in computing taxable income. An example of a subtraction is a charitable contributions carryover that was deducted for book purposes in a prior year but deducted in the current year for tax purposes. Part I requires information about the corporation's source of the financial income (loss) used in the reconciliation. Part II reconciles income and loss items of includible corporations. Part III lists 36 reconciling items related to expenses and deductions. For these items, taxpayers must reconcile differences between income statement amounts (column a) and tax return amounts (column d) and then classify these differences as temporary (column b) or permanent (column c) differences. Pelican, Inc., reports the meals and entertainment expenditures on line 11, Part III as follows: book expense of $10,000 in column (a), permanent difference of $10,000 in column (c), and tax return deduction of $0 in column (d). This problem illustrates reporting procedures when book expenses are greater than tax return deductions. It also illustrates the reporting of permanent differences. CH17

On July 15, 2019, Lilac Corporation purchased 25% of the Coffee Corporation stock outstanding. Lilac Corporation purchased an additional 40% of the stock in Coffee on March 24, 2020, and an additional 20% on May 5, 2020. On September 25, 2020, Lilac Corporation purchased the remaining 15% of Coffee Corporation stock outstanding. For purposes of the § 338 election, on what date does a qualified stock purchase occur? For purposes of Lilac Corporation, a qualified stock purchase occurs with the ________ purchase. What is the due date for making the § 338 election?The election must be filed by __________ .

Answers: May 5, 2020; February 15, 2021. A qualified stock purchase occurs when one corporation acquires, in a taxable transaction, stock representing at least 80% of the total voting power and at least 80% of the value of another corporation within a 12-month period. The stock must be acquired in a taxable transaction (i.e., § 351 and other nonrecognition provisions do not apply). An acquisition of stock by any member of an affiliated group that includes the parent corporation is considered to be an acquisition by the parent. The § 338 election must be made by the fifteenth day of the ninth month beginning after the month in which a qualified stock purchase occurs. If made, the election is irrevocable. For purposes of Lilac Corporation, a qualified stock purchase occurs with the May 5, 2020, purchase [85% = 25% (July 15, 2019) + 40% (March 24, 2020) + 20% (May 5, 2020)]. The § 338 election must be made by the fifteenth day of the ninth month beginning after the month in which a qualified stock purchase occurs. Since Lilac's qualified stock purchase date is May 5, 2020, the election must be filed by February 15, 2021. ch20

In the current year, Woodpecker, Inc., a C corporation with $8,500,000 in assets, deducted amortization of $40,000 on its financial statements and deducted amortization of $55,000 on its Federal tax return. Is Woodpecker required to file a Schedule M-3? If Woodpecker is required to file a Schedule M-3, the difference in amortization amounts treated on that schedule is reported on line 28, Part III as follows: _____ in column (a) book amortization . ______ in column (b) temporary difference . ______ in column (d) tax amortization

Answers: No; $40,000; book amortization; $15,000; temporary difference; $55,000; tax amortization. Corporations with total assets of $10,000,000 or more are required to report greater detail relative to differences between income (loss) reported for financial purposes and income (loss) for tax purposes. This expanded reconciliation of book and taxable income (loss) is reported on Schedule M-3. Corporation that are not required to file Schedule M-3 may do so voluntarily. Any corporation that files Schedule M-3 is not allowed to file Schedule M-1. The starting point on Schedule M-1 is net income per books. Additions and subtractions are entered for items that affect net income per books and taxable income differently. An example of an addition is Federal income tax expense, which is reported in computing net income per books but is disallowed in computing taxable income. An example of a subtraction is a charitable contributions carryover that was deducted for book purposes in a prior year but deducted in the current year for tax purposes. In summary, corporations with total assets of $10,000,000 or more are required to file Schedule M-3; thus, Woodpecker, with $8,500,000 of assets, is not required to file the form. If a Schedule M-3 is filed by Woodpecker, the amortization is reported on line 28, Part III as follows: $40,000 book amortization in column (a). $15,000 temporary difference in column (b). $55,000 tax return amortization in column (d). CH17

Indicate whether the following statements are "True" or "False" regarding the filing a consolidated return for affiliated groups. a.Losses of one group member can be used to shelter the income of other members. b. Generally, an election is binding for subsequent years. c. Members of an affiliated group must file a consolidated return. d. An affiliated group exists when one corporation owns at least 80 percent of the voting power and stock value of another corporation.

Answers: True; True; False; True. True. One of the advantages of a consolidated return is that losses of one group member can be used to shelter the income of other members True. An election is binding for subsequent years and can be avoided only if the makeup of the affiliated group changes or the IRS consents to the revocation of consolidated return status. False. Members of an affiliated group need not file a consolidated return, and absent an election to consolidate, each corporation files its own Form 1120. True. The stock ownership test must be met on every day of the tax year. Multiple tiers and chains of corporations are allowed as long as the group has an identifiable parent corporation (i.e., at least 80 percent of one corporation must be owned by another). CH17

Indicate the type of tax-free reorganization for each of the following statements. a. A transfer by a corporation of all or a part of its assets to another corporation in a bankruptcy or receivership proceeding. b. A statutory merger or consolidation. c. The acquisition by a corporation of substantially all of the property of another corporation in exchange for voting stock (voting-stock-for-asset exchange). d. A mere change in identity, form, or place of organization. e. The acquisition by a corporation of another using solely stock of each corporation (voting-stock-for-stock exchange). f. The transfer of all or part of a corporation's assets to another corporation when the original corporation's shareholders are in control of the new corporation immediately after the transfer (acquisitive or divisive exchange: spin-off, split-off, or split-up). g. A recapitalization.

Answers: Type G; Type A; Type C; Type F; Type B; Type D; Type E. To qualify as a tax-free reorganization, a corporate restructuring must meet not only the specific requirements of § 368 but also several general requirements. These requirements include the following: There must be a plan of reorganization. The reorganization must meet the continuity of interest and the continuity of business enterprise tests provided in the Regulations. The restructuring must meet the judicial doctrine of having a sound business purpose. The court-imposed step transaction doctrine should not apply to the reorganization.The initial and most important consideration, however, is whether the reorganization qualifies for nonrecognition status under § 368. Section 368(a) specifies seven corporate restructurings or reorganizations that will qualify as nontaxable exchanges. If the transaction fails to qualify as a reorganization, it will not receive the special tax-favored treatment. Therefore, a corporation considering a business reorganization must determine in advance whether the proposed transaction specifically falls within one of these seven types. The Code states, in § 368(a)(1), that the term reorganization applies to any of the following: A statutory merger or consolidation. The acquisition by a corporation of another using solely stock of each corporation (voting-stock-for-stock exchange). The acquisition by a corporation of substantially all of the property of another corporation in exchange for voting stock (voting-stock-for-asset exchange). The transfer of all or part of a corporation's assets to another corporation when the original corporation's shareholders are in control of the new corporation immediately after the transfer (acquisitive or divisive exchange: spin-off, split-off, or split-up). A recapitalization. A mere change in identity, form, or place of organization. A transfer by a corporation of all or a part of its assets to another corporation in a bankruptcy or receivership proceeding.These seven types of tax-free reorganizations typically are designated by their identifying letters: "Type A," "Type B," "Type C," etc. ch20

In a qualifying reorganization, Cato Corporation exchanges $1,200,000 worth of stock and property valued at $500,000 ($245,000 basis) for all of Firestar Corporation's assets, which have a value of $1,700,000 and a $500,000 basis. Firestar distributes the property received from Cato. The exchange meets the § 368 requirements. If an amount is zero, enter "0". a. What is Cato's recognized gain/loss from the reorganization?Cato recognizes a gain of __________ b. What is Firestar's recognized gain/loss from the reorganization?Firestar recognizes no gain or loss of ________.

Answers: a gain; $255,000; no gain or loss; $0. The tax treatment for the parties involved in a tax-free reorganization almost parallels the treatment under the like-kind exchange provisions of § 1031. In the simplest like-kind exchange, neither gain nor loss is recognized on the exchange of like-kind property. The general rule is that when an investor exchanges stock in one corporation for stock in another, the exchange is a taxable transaction. If the transaction qualifies as a reorganization under § 368, the tax treatment, in substance, is similar to a nontaxable exchange of like-kind property. When "boot" (non-like-kind property) is received, gain may be recognized. The four-column template of Concept Summary 20.3 computes the amount of gain recognized and the adjusted basis in the new asset received in the like-kind exchange. Corporations meeting the § 368 requirements do not recognize gains or losses on restructurings. There are exceptions to the nonrecognition rule, however. As shown in Concept Summary 7.1, if the acquiring corporation transfers other property to a target corporation along with its stock and securities, gain, but not loss, may be recognized. When the target receives the other property in the restructuring and fails to distribute it, or distributes its own appreciated property to its shareholders, gain, but not loss, is recognized. Other property (called boot) for restructurings is any asset other than stock or securities exchanged in the reorganization. a. Due to the boot (property) it used in the transfer, Cato recognizes a $255,000 gain ($500,000 - $245,000) on the reorganization. b. Since Firestar distributes the property to its shareholders, it does not recognize gain. Note: However, if Firestar retains the property it recognizes a gain to the extent of the other property received, $500,000. ch20

In January 2020, Pelican, Inc., established an allowance for uncollectible accounts (bad debt reserve) of $70,000 on its books and increased the allowance by $120,000 during the year. As a result of a client's bankruptcy, Pelican, Inc., expensed the allowance by $60,000 in November 2020. Pelican, Inc., deducted the $190,000 of increases to the allowance on its 2020 income statement but was not allowed to deduct that amount on its tax return. On its 2020 tax return, the corporation was allowed to deduct the $60,000 actual loss sustained because of its client's bankruptcy. On its financial statements, Pelican, Inc., treated the $190,000 increase in the bad debt reserve as an expense that gave rise to a temporary difference. On its 2020 tax return, Pelican, Inc., took a $60,000 deduction for bad debt expense. How is this information reported on Schedule M-3? Click here to access Form 1120, Schedule M-3. These amounts are reported on Schedule M-3, line 32, Part III as follows: the $190,000 book bad debt expense is reported in column (a) , the ________ temporary difference is reported in column (b) , and the ________ tax return bad debt expense is reported in column (d) .

Answers: column (a); $130,000; column (b); $60,000; column (d). Corporations that are not required to file Schedule M-3 may do so voluntarily. Any corporation that files Schedule M-3 is not allowed to file Schedule M-1. Schedule M-3 is a response, at least in part, to financial reporting scandals such as Enron and WorldCom. One objective of Schedule M-3 is to create greater transparency between corporate financial statements and tax returns. Another objective is to identify corporations that engage in aggressive tax practices by requiring that transactions that create book/tax differences be disclosed on corporate tax returns. Part I requires information about the corporation's source of the financial income (loss) used in the reconciliation. Part II reconciles income and loss items of includible corporations. Part III lists 36 reconciling items related to expenses and deductions. For these items, taxpayers must reconcile differences between income statement amounts (column a) and tax return amounts (column d) and then classify these differences as temporary (column b) or permanent (column c) differences. These amounts must be reported on line 32, Part III as follows: $190,000 book bad debt expense in column (a), $130,000 temporary difference in column (b), and $60,000 tax return bad debt expense in column (d). This problem illustrates reporting procedures when book expenses are greater than tax return deductions. It also illustrates the reporting of temporary differences. CH17

Pink Corporation acquired land and securities in a § 351 tax-free exchange. On the date of the transfer, the land had a basis of $720,000 and a fair market value of $630,000, and the securities had a basis of $110,000 and a fair market value of $250,000. Pink Corporation has two shareholders, Maria and Paul, who are unrelated. Maria owns 85% of the stock in the corporation, and Paul owns 15%. Pink adopts a plan of liquidation in the current year. On the date of the liquidation, the land's fair market value has decreased to $500,000. What is the effect of each of the following on Pink Corporation? a. If Pink Corporation distributes all the land to Maria, the corporation has a realized loss _________ of which _________ will be recognized. b. Assume there is no business reason for the transfer of the property. If all the land is distributed to Paul, then the property had a built-in loss of ___________ which is disallowed . Therefore, Pink Corporation will recognize a loss of ________. c. Assume there is no business reason for the transfer of the property. If the land is distributed 85% to Maria and 15% to Paul, Pink Corporation has a disallowed loss of ________ due to the distribution of disqualified property. In addition, _________ is disallowed due to the built-in loss rules. As a result, only _________ of the loss will be recognized d. Assume there is no business reason for the transfer of the property. If the land is distributed 50% to Maria and 50% to Paul, the _________ loss on the distribution to Maria, is disallowed. Of the _________ loss on the distribution to Paul, __________ will be disallowed. e. If the land is sold and the proceeds of $500,000 are distributed proportionately to Maria and to Paul but Pink Corporation cannot show a business purpose for the transfer, the built-in loss of __________ will be disallowed. f. Indicate which one of the following options should be selected to achieve the best tax consequence for Pink. Select "Yes" or "No", whichever is applicable. a.Distribute all the land to Maria. b.Distribute 85% of the land to Maria and 15% to Paul. c.Distribute 50% of the land to Maria and 50% to Paul. d.Distribute all the land to Paul, or sell the land and distribute the proceeds of $500,000 proportionately.

Answers: loss; $220,000; $0. There are four exceptions to the general rule of gain and loss recognition by a liquidating corporation. Losses are disallowed on distributions to related parties in either of the following cases: (1) The distribution is not pro rata or (2) the property distributed is disqualified property. A corporation and a shareholder are considered related if the shareholder owns (directly or indirectly) more than 50% in value of the corporation's outstanding stock. A pro rata distribution is one where each shareholder receives his or her proportionate share of the corporate assets distributed. Disqualified property is property that is acquired by the liquidating corporation in a § 351 or contribution to capital transaction during the five-year period ending on the date of the distribution. The land is disqualified property that is distributed to a related party; thus, the entire $220,000 loss realized is disallowed under the related-party loss limitation. b. Answers: built-in loss; $90,000; disallowed; loss; $130,000. Losses are disallowed on distributions to related parties in either of the following cases: (1) The distribution is not pro rata or (2) the property distributed is disqualified property. A corporation and a shareholder are considered related if the shareholder owns (directly or indirectly) more than 50% in value of the corporation's outstanding stock. The built-in loss limitation applies when the following conditions are met: (1) The property was acquired by the corporation in a § 351 or contribution to capital transaction, and (2) such acquisition was part of a plan whose principal purpose was to recognize a loss on that property by the liquidating corporation. A tax avoidance purpose is presumed in the case of transfers occurring within two years of the adoption of a plan of liquidation. This disallowance rule applies only to the extent that a property's built-in loss at transfer is not eliminated by a stepped-down basis. The built-in loss limitation applies when the following conditions are met: (1) The property was acquired by the corporation in a § 351 or contribution to capital transaction, and (2) such acquisition was part of a plan whose principal purpose was to recognize a loss on that property by the liquidating corporation. A tax avoidance purpose is presumed in the case of transfers occurring within two years of the adoption of a plan of liquidation. This disallowance rule applies only to the extent that a property's built-in loss at transfer is not eliminated by a stepped-down basis. The property had a built-in loss of $90,000 [$630,000 (fair market value) - $720,000 (basis)] when it was transferred to Pink Corporation. Further, the transfer occurred within two years of the date the plan of liquidation was adopted. Unless Pink can rebut the presumption of a tax avoidance purpose for the transfer, the built-in loss of $90,000 is disallowed. The remaining $130,000 loss will be recognized. Because Paul is an unrelated party, the related-party loss limitation does not apply to a distribution to him. If Pink Corporation can establish a business reason for the transfer of the property to the corporation and rebut the two-year presumption rule, the entire $220,000 loss will be recognized. c. Answers: $187,000; $13,500; $19,500. The loss on the property distributed to Maria, or $187,000 will be disallowed entirely, because it is a distribution of disqualified property to a related party. Unless Pink Corporation can rebut the presumption of a tax avoidance purpose for the transfer, an additional $13,500 of the loss [$90,000 (built-in loss from above) x 15% (Paul's interest)] will be disallowed. As a result, $19,500 of the loss will be recognized [$130,000 (post-transfer loss) x 15% (Paul's interest)]. If Pink Corporation can rebut the two-year presumption rule, $33,000 of loss will be recognized [$220,000 (total loss) x 15% (Paul's interest)]. d. Answers: $110,000; disallowed; $110,000; $45,000. Losses are disallowed on distributions to related parties in either of the following cases: (1) The distribution is not pro rata or (2) the property distributed is disqualified property. A corporation and a shareholder are considered related if the shareholder owns (directly or indirectly) more than 50% in value of the corporation's outstanding stock. The loss on the distribution of disqualified property to Maria, or $110,000, will be disallowed. Of the remaining $110,000 loss, 50% of the built-in loss of $90,000, or $45,000, will be disallowed unless Pink Corporation can demonstrate a business purpose for the transfer. If Pink can rebut the two-year presumption rule, $110,000 of the loss, or the portion pertaining to the distribution to Paul, will be recognized. e. Answers: built-in loss; $90,000. Losses are disallowed on distributions to related parties in either of the following cases: (1) The distribution is not pro rata or (2) the property distributed is disqualified property. The limitation does not apply to sales of loss property. Under the built-in loss limitation, the disallowance rule applies only to the extent that a property's built-in loss at transfer is not eliminated by a stepped-down basis. The built-in loss limitation applies to a broader range of transactions than the related-party exception, which disallows losses only on certain distributions to related parties (i.e., more-than-50 percent shareholders). The built-in loss limitation can apply to distributions of property to any shareholder, including an unrelated party, and to a sale or exchange of property by a liquidating corporation. If Pink Corporation cannot show a business purpose for the transfer, the built-in loss of $90,000 will be disallowed. The remaining $130,000 loss will be recognized. If Pink can rebut the two-year presumption rule, the entire $220,000 loss will be recognized. The related-party loss limitation does not apply to a sale of property. f. No. The entire loss will not be recognized. No. $90,000 of the $220,000 realized loss will not be recognized. No. $187,000 of the $220,000 realized loss will not be recognized. Yes. $110,000 of the $220,000 realized loss will be recognized. ch20

The accumulated earnings tax is not imposed on corporations that

Are personal holding companies. Any corporation, unless expressly exempt, may incur AET liability. PHCs are expressly exempt from the AET but may be subject to the PHC tax. ch17

Which of the following statements correctly represents the tax effect of the liquidation of an 80% or more owned subsidiary?

Assets transferred to the parent of the liquidating corporation generally have a carryover basis. Basis in property distributed to the parent is transferred to the parent. ch20

In a Type B reorganization as defined by the Internal Revenue Code, the I. Stock of the target corporation is acquired solely for the voting stock of either the acquiring corporation or its parent. II. Acquiring corporation must have control of the target corporation immediately after the acquisition.

Both I and II. A Type B, or stock-for-stock, reorganization requires that shareholders acquire stock of a corporation solely for the voting stock of the acquiring corporation or its parent. In addition, the acquiring corporation must control the target corporation immediately after the exchange. ch20

In the reconciliation of income per books with income per return,

Both temporary and permanent differences are considered. Reconciling income per books with income per return considers both temporary differences (i.e., differences expected to be eliminated in the future, such as an accelerated method of depreciation for tax purposes and a straight-line method for financial reporting purposes) and permanent differences (i.e., differences not expected to be eliminated in the future, such as that caused by the deduction of federal income tax for financial reporting purposes). ch17

The accumulated earnings tax

Can be avoided by sufficient dividend distributions. The accumulated earnings tax is imposed by Sec. 531 on unreasonably large accumulations of earnings in a corporation. If the corporation pays out sufficient dividends, it will not have unreasonably large accumulations of earnings and will not be subject to the tax. ch17

Which of the following items is not an adjustment to taxable income when determining a corporation's current earnings and profits amount?

Capital contributions. Section 312 provides a partial definition of earnings and profits. Capital contributions are excluded from the corporation's gross income under Sec. 118. They are also excluded from earnings and profits since they do not represent an increase in corporate earnings that are available to be paid out in the form of a dividend. As a result, no adjustment to taxable income is made for capital contributions. ch18 ch19

Sparrow Corporation (a calendar year, accrual basis taxpayer) had the following transactions in 2020, its second year of operation: Taxable income $330,000 Federal income tax liability paid 69,300 Tax-exempt interest income 5,000 Business meals expense (total) 3,000 Premiums paid on key employee life insurance 3,500 Increase in cash surrender value attributable to life insurance premiums 700 Proceeds from key employee life insurance policy 130,000 Cash surrender value of life insurance policy at distribution 20,000 Excess of capital losses over capital gains 13,000 MACRS deduction 26,000 Straight-line depreciation using ADS lives 16,000 Section 179 expense elected in 2019 25,000 Dividends received from domestic corporations (less than 20% owned) 35,000 Sparrow uses the LIFO inventory method, and its LIFO recapture amount increased by $10,000 during 2020. In addition, Sparrow sold property on installment during 2019. The property was sold for $40,000 and had an adjusted basis at sale of $32,000. During 2020, Sparrow received a $15,000 payment on the installment sale. Finally, assume that no additional first-year depreciation was claimed. Click here for the Dividend Received Deduction Table. Indicate whether each item (or part of the item) is "Added" to, "Deducted" from taxable income, or "No effect" when computing current E & P. Federal income tax liability paid Tax-exempt interest income Non-deductible meals and entertainment expenses Life insurance premiums paid, net of increase in cash surrender value Proceeds from life insurance policy, net of cash surrender value Excess of capital losses over capital gains Excess MACRS deduction Section 179 expense elected in 2019 Dividends received deduction from domestic corporations LIFO adjustment Installment sale In your computations, if required, round amounts to the nearest dollar. Sparrow Corporation's current E & P is _______

Deducted. The expense is not deductible for purposes of calculating taxable income. However, it reduces the corporation's economic income and its ability to pay dividends. Added. The income is not taxable. However, it increases the corporation's economic income and its ability to pay dividends. Deducted. 50% of the expense is not deductible for purposes of calculating taxable income. However, the nondeductible portion reduces the corporation's economic income and its ability to pay dividends. Deducted. The expense is not deductible for purposes of calculating taxable income. However, the expenses less the increase in the policy's cash surrender value reduces the corporation's economic income and its ability to pay dividends. Added. The income is not taxable. However, the proceeds less the cash surrender value increases the corporation's economic income and its ability to pay dividends. Deducted. The excess capital losses over capital gain are not deductible for purposes of calculating taxable income. However, the excess capital losses reduce the corporation's economic income and its ability to pay dividends. Added. The additional MACRS tax depreciation is deducted for purposes of calculating taxable income. The alternative depreciation system (ADS) must be used for purposes of computing E & P. This method requires straight-line depreciation with a half-year convention over a recovery period equal to the Asset Depreciation Range (ADR) midpoint life. The MACRS depreciation in excess of ADS is added back to taxable income to determine E & P. Deducted. The E & P rules impose limitations on the deductibility of § 179 expense. In particular, this expense must be deducted over a period of five years. Thus, in any year that § 179 is elected, 80 percent of the resulting expense must be added back to taxable income to determine current E & P. In each of the following four years, a subtraction from taxable income equal to 20 percent of the § 179 expense must be made. Added. The dividend received deduction is allowed for purposes of calculating taxable income. However, the dividends received deduction which do not decrease the corporation's assets, are added back to taxable income to determine E & P. Added. To account for income deferral under the LIFO inventory method, the E & P computation requires an adjustment for changes in the LIFO recapture amount (the excess of FIFO over LIFO inventory value) during the year. Increases in LIFO recapture are added to taxable income, and decreases are subtracted. Deducted. The installment method is not permitted for E & P purposes. Thus, an adjustment is required for the deferred gain from property sales made during the year under the installment method. All principal payments are treated as having been received in the year of sale. Taxable income $330,000 Less: Federal income tax liability (69,300) Add: Tax-exempt interest income 5,000 Less: disallowed portion of non-deductible meal expense (1,500) Less: life insurance premiums paid, net of increase in cash surrender value ($3,500 - $700) (2,800) Add: proceeds from life insurance policy, net of cash surrender value ($130,000 - $20,000) 110,000 Less: excess capital losses (13,000) Add: excess of MACRS depreciation over E & P depreciation ($26,000 - $16,000) 10,000 Less: allowable portion of 2019 § 179 expenses (20% x $25,000) (5,000) Add: dividends received deduction (50% x $35,000) 17,500 Add: LIFO recapture adjustment10,000Less: installment sale gain (3,000)* Equals: current E & P $387,900 *[($40,000 sales price - $32,000 adjusted basis) / $40,000 sales price] x $15,000 CH19

Which of the following is a positive adjustment for calculating current earnings and profits (E&P)?

Deferred gain on installment sales. Current E&P is the current year taxable income adjusted for specific items. Some adjustments are positive and some are negative. Deferred gain on installment sales for taxable income is recognized in the year of sale (i.e., the current year) for E&P. ch18 ch19

Which of the following is not taken into account when determining if a gain or loss should be recognized on the transfer of property to a corporation in exchange for a controlling interest in stock of the corporation?

Holding period of contributed assets. Section 351(a) provides that no gain or loss is recognized if one person or more transfers property to a corporation solely in exchange for stock in such corporation and if, immediately after the exchange, such person(s) is(are) in control of the corporation. Control is defined in Sec. 368(c) as the ownership of stock possessing at least 80% of the total combined voting power of all classes of voting stock and at least 80% of the total number of shares of all other classes of stock. In a Sec. 351 exchange, the holding period of property transferred is not taken into account when determining the amount of the recognized gain or loss (although it may determine character if gain or loss is recognized). ch18 ch19

When a corporation has an unused net capital loss that is carried back or carried forward to another tax year,

It is treated as a short-term capital loss whether or not it was short term when sustained. A net capital loss for the corporation may be carried back 3 years and forward 5 years. A capital loss carried back or forward to other taxable years is treated as a short-term capital loss in each such taxable year. ch17

Zeb, an individual shareholder, owned 25% of Towne Corporation stock. Pursuant to a series of stock redemptions, Towne redeemed 10% of the shares of stock Zeb owned in exchange for land having a fair market value of $30,000 and an adjusted basis of $10,000. Zeb's basis for all of his Towne stock was $200,000. Zeb reported the redemption transaction as if it were a dividend. Zeb's basis in the land and his Towne stock (immediately after the redemption) is

Land, $30,000; stock, $200,000. If a redemption of shares does not qualify as a sale or exchange, it is treated as a dividend. The amount of a dividend distribution is the amount of money received plus the fair market value of the property received. Zeb has a $30,000 dividend. The basis of property received in a distribution is the FMV of such property. Therefore, Zeb's basis in the land is $30,000. A dividend distribution does not affect the basis in a shareholder's stock, so Zeb's stock basis remains $200,000. ch20

The costs of organizing a corporation in 2020

May be amortized over a period of 180 months, even if these costs are capitalized on the company's books. A corporation is deemed to elect to deduct $5,000 of organizational expenses (subject to a phase-out) and amortize the remaining expenditures over a period of 180 months, beginning with the month in which the corporation starts business. ch17

If a corporation's charitable contributions exceed the limitation for deductibility in a particular year, the excess

May be carried forward to a maximum of 5 succeeding years. A corporation may carry unused charitable contributions forward for 5 years. Current contributions are deducted before carryovers. Carryovers are applied on a FIFO basis. Carrybacks of excess charitable contributions are not permitted. ch17

During 2020, Mr. Hill and Mr. Dale formed a corporation to which Hill transferred a patent right that had a fair market value to him of $25,000 and a zero adjusted basis. Dale transferred a building that had a fair market value of $100,000 and an adjusted basis to him of $75,000. In return, Hill received 250 shares and Dale 750 shares of the corporation's 1,000 outstanding shares of its only class of stock. As a result of this transaction, what should Mr. Dale report?

Neither a gain nor a loss. If the requirements of Sec. 351(a) are met, no gain or loss is recognized when property is transferred to a corporation. The requirements are that the transfer be by one or more persons, solely in exchange for stock, and the transferor(s) must be in control of the corporation immediately after the exchange. Section 368(c) defines control as the ownership of at least 80% of both the voting and nonvoting stock. Since Hill and Dale collectively received all the shares, the control requirement is met. Hill and Dale meet these criteria so the transfer qualifies under Sec. 351(a). No gain or loss is recognized. The difference in value of property contributed for equal shares may cause other tax consequences depending on the underlying facts; e.g., Dale may have made a gift to Hill, or Hill may have received compensation from Dale or the corporation. ch18 ch19

Gar purchased 1,000 shares of Pat Corporation common stock at $5 per share in Year 1. On September 19, Year 4, he received 1,000 stock rights entitling him to buy 250 additional shares of Pat Corporation common stock at $10 per share. On the day that the rights were issued, the fair market value of the stock was $12 per share ex-rights and that of the rights was $1 each. Gar did not exercise the rights; he let them expire on November 28, Year 4. What should be the loss that Gar can report for Year 4?

No gain or loss. When a taxpayer receives nontaxable stock rights, the cost basis of the rights is determined by allocating part of the basis of the stock on which the distribution was made. If the fair market value of the rights at the time of the distribution is less than 15% of the fair market value of the stock held at that time, the allocation is elective, but no allocation is made unless the stock rights are sold or exercised. ch18 ch19

The income tax treatment of individual and corporate taxpayers agrees in which of the following respects? Excess capital losses retain their identity as either long-term or short-term losses in the year to which they are carried. Excess capital losses may be carried forward 5 years and losses may not be carried back. None of the answers are correct. Excess capital losses may be offset against income from other sources but only to a limited extent.

None of the answers are correct. None of the statements are true (Secs. 1211 and 1212.) The only similarities between corporate and individual treatment of capital losses is that the capital loss definition is the same. Corporate capital gains do not have the multiple long-term baskets like individual capital gains do. CH17

When a parent corporation completely liquidates its 80%-owned subsidiary, the parent (as shareholder) will ordinarily

Not recognize gain or loss on the liquidating distribution(s). When a subsidiary corporation is liquidated into the parent corporation in a Sec. 332 transaction, no gain or loss is recognized on the liquidation. ch20

In 2020, Aaron transferred property worth $75,000 and services worth $25,000 to the BJ Corporation. In exchange, he received stock in BJ valued at $100,000. Immediately after the exchange, Aaron owned 80% of the only class of outstanding stock. Which of the following is true with regard to Aaron's treatment of this transaction in 2020?

Ordinary income of $25,000. The general rule of Sec. 351 is that no gain or loss is recognized if one person or more transfers property to a corporation solely for stock and if, immediately after the exchange, such person(s) is(are) in control of the corporation (i.e., own at least 80% of the stock). Section 351(d) states, however, that stock issued for services is not issued in return for property. Stock issued for services falls outside the general rule, and income must be recognized on such a transfer. The fair market value of stock received for services ($25,000) must be included in Aaron's income. All other stock received was in exchange for property, and no gain or loss is recognized on its transfer. ch18 ch19

A distribution of stock or stock rights is generally considered a taxable dividend (to the extent of E&P) unless it is which of the following?

Proportionate distribution. A proportionate distribution of stock or stock rights would not be considered a dividend under Sec. 305(a) and would not be included in the gross income of the distributee. ch18 ch19

Houston Corporation distributed marketable securities to Sam Alamo, a shareholder owning 90% of Houston, in redemption of Alamo's stock. This distribution took place as part of the complete liquidation of Houston. Alamo had contributed the securities 3 years before in a Sec. 351 transaction. On the day the securities were distributed, their adjusted basis was $340,000, and their fair market value was $210,000. What is the tax result to Houston on the distribution date?

Realized capital loss of $130,000 and recognized capital loss of $0. A corporation generally recognizes any losses realized on liquidating distributions. Certain realized losses are not recognized when the distributee shareholder is related to the corporation. Applicable distributions include those of assets acquired within 5 years by a contribution to capital or a Sec. 351 exchange. Permanent disallowance of the loss results. Since Sam Alamo owns 90% of Houston Corporation, he is a related party. The distribution to him of securities contributed in a Sec. 351 transaction within 5 years results in the permanent disallowance of the loss. The realized loss is $130,000 ($340,000 - $210,000), but the recognized loss must be $0. ch20

he stock in Ivory Corporation is owned by Gold Corporation (80%) and Imelda (20%). Gold Corporation purchased its shares in Ivory nine years ago at a cost of $650,000, and Imelda purchased her shares in Ivory four years ago at a cost of $175,000. Ivory Corporation has the following assets that are distributed in complete liquidation: Adjusted Basis Fair Market Value Cash $600,000 $600,000 Inventory 80,000 200,000 Equipment 350,000 200,000 a. Assume that Ivory Corporation distributes the cash and inventory to Gold Corporation and the equipment to Imelda. Indicate whether the following statements are "True" or "False" regarding the tax consequences of the distributions to Ivory Corporation, to Gold Corporation, and to Imelda. •Section 332 applies to the liquidation, and Ivory Corporation recognizes no gain on the distribution of the cash and inventory to Gold Corporation. •Ivory recognizes the $150,000 loss realized on the distribution of the equipment to Imelda. •Gold Corporation recognizes no gain or loss on the liquidation and takes a basis of $80,000 in the inventory. •Gold's basis in its Ivory Corporation stock is eliminated. •Imelda recognizes a gain of $25,000. b. Assume that Ivory Corporation distributes the cash and equipment to Gold Corporation and the inventory to Imelda. Indicate whether the following statements are "True" or "False" regarding the tax consequences of the distributions to Ivory Corporation, to Gold Corporation, and to Imelda. •§ 332 applies, and Ivory recognizes no gain or loss on the distribution of the cash and equipment to Gold Corporation •Imelda recognizes a gain of $25,000. •Ivory Corporation recognizes the gain of $120,000 on the distribution of the inventory to Imelda. •Gold Corporation recognizes no gain or loss on the liquidation and takes a basis of $200,000 in the equipment. •Gold's basis in its Ivory Corporation stock is eliminated.

Section 332, is exception to the general rule of § 331. In a § 332 parent-subsidiary liquidation, up to 20 percent of the subsidiary's stock can be owned by minority shareholders. a. True. Section 332, an exception to the general rule of § 331, provides that a parent corporation does not recognize gain or loss on a liquidation of a subsidiary. In addition, the subsidiary corporation recognizes neither gain nor loss on distributions of property to its parent. False. In a § 332 parent-subsidiary liquidation, up to 20 percent of the subsidiary's stock can be owned by minority shareholders. In such liquidations, a distribution of property to a minority shareholder is treated in the same manner as a nonliquidating distribution. That is, the subsidiary corporation recognizes gain (but not loss) on the property distributed to the minority shareholder. Thus, Ivory does not recognize the $150,000 loss realized on the distribution of the equipment to Imelda (minority shareholder). True. The liquidation of a subsidiary generally is a nontaxable transaction resulting in the nonrecognition of gain or loss for both the parent and the subsidiary corporations and the carryover of the subsidiary's asset bases (and other tax attributes). True. Under § 334(b)(1)—Property has the same basis as it had in the hands of the subsidiary. Parent's basis in the stock disappears. True. Under § 331—The general rule provides for gain or loss treatment on the difference between the FMV of property received and the basis of the stock in the corporation. b. True. Section 332, an exception to the general rule of § 331, provides that a parent corporation does not recognize gain or loss on a liquidation of a subsidiary. In addition, the subsidiary corporation recognizes neither gain nor loss on distributions of property to its parent. True. Under § 331—The general rule provides for gain or loss treatment on the difference between the FMV of property received and the basis of the stock in the corporation. True. In a § 332 parent-subsidiary liquidation, up to 20 percent of the subsidiary's stock can be owned by minority shareholders. In such liquidations, a distribution of property to a minority shareholder is treated in the same manner as a nonliquidating distribution. That is, the subsidiary corporation recognizes gain (but not loss) on the property distributed to the minority shareholder. Thus, Ivory does not recognize the $120,000 gain realized on the distribution of the inventory to Imelda (minority shareholder). False. Section 332, an exception to the general rule of § 331, provides that a parent corporation does not recognize gain or loss on a liquidation of a subsidiary. In addition, the subsidiary corporation recognizes neither gain nor loss on distributions of property to its parent. Under § 334(b)(1)—Property has the same basis as it had in the hands of the subsidiary. The carryover basis would be $350,000. True. Under § 334(b)(1)—Property has the same basis as it had in the hands of the subsidiary. Parent's basis in the stock disappears. ch20

Which one of the following is not a corporate reorganization as defined in the Internal Revenue Code?

Stock redemption. A stock redemption is normally a taxable transaction to the shareholder(s). It is not a taxable transaction to the corporation unless appreciated property is used to make the redemption. However, stock redemptions do not fall under the corporate reorganization rules defined in Sec. 368(a)(1). ch20

Rose Corporation, a calendar-year corporation, had accumulated earnings and profits of $40,000 as of January 1, 2020. Rose Corporation had an operating loss for tax year 2020 of $55,000. Rose Corporation distributed $15,000 to its shareholders on July 1, 2020. Which of the following is correct?

The part of the distribution that is a dividend is $12,500. When a distribution is made during the course of the year, the E&P must be prorated to reflect the accumulated E&P balance on the date of the distribution (unless the actual deficit at the date of distribution is shown). Because the distribution occurred on July 1, the accumulated E&P were $12,500 {$40,000 - [(6 months ÷ 12 months) × $55,000]}. A corporate distribution is a "dividend" that must be included in the recipient's gross income under Sec. 301(c)(1) to the extent that it comes from current or accumulated E&P of a corporation. To the extent the distribution exceeds current and accumulated E&P, it is treated as a return of capital to the shareholder. Once the basis of the stock has been reduced to zero, any distributions received are treated as a gain from the sale of the stock. Therefore, the shareholders will recognize $12,500 of dividend income. ch18 ch19

All of the following statements regarding stock redemptions are true except

The stock that is redeemed by a corporation may not be held as treasury stock. Section 317(b) states that stock is treated as redeemed by a corporation if the corporation acquires its stock from a shareholder in exchange for property, whether or not the acquired stock is canceled, retired, or held as treasury stock. ch20

Which one of the following statements is true regarding the complete liquidation of a subsidiary corporation under Sec. 332?

The tax attributes of the subsidiary corporation carry over to the parent. When a subsidiary corporation is liquidated into the parent corporation in a Sec. 332 transaction, no gain or loss is recognized by either corporation on the liquidation. The tax attributes of the subsidiary corporation carry over to the parent corporation under Sec. 381. ch20

Jaxson Corp. has 200,000 shares of voting common stock issued and outstanding. King Corp. has decided to acquire 90% of Jaxson's voting common stock solely in exchange for 50% of its voting common stock and retain Jaxson as a subsidiary after the transaction. Which of the following statements is true?

The transaction will qualify as a tax-free reorganization. A Type B, or stock-for-stock, acquisition qualifies as a tax-free reorganization if the shareholders of one company acquire the stock of the target company solely in exchange for stock of their company. The acquiring company must control at least 80% of the stock of the target company after the exchange. ch20

Corporations A and B combine in a qualifying reorganization and form Corporation C, the only surviving corporation. This reorganization is tax-free to the Shareholders Corporation

Yes Yes A shareholder does not recognize any gain or loss in a reorganization on an exchange of stock or securities in a corporation solely for stock or securities in the same or another corporation that is a party to the reorganization. A (transferor/acquired) corporation that is a party to a reorganization recognizes no gain or loss on exchange of property solely for stock or securities of another corporate party. The transferee (acquiring) corporation also recognizes no gain or loss on its own stock or securities exchanged. ch20

Par Corp. acquired the assets of its wholly owned subsidiary, Sub Corp., under a plan that qualified as a tax-free complete liquidation of Sub. Which of the following of Sub's unused carryovers may be transferred to Par? Excess CharitableContributions Net OperatingLoss

Yes Yes No gain or loss is recognized by either corporation on the liquidation of a controlled subsidiary. The tax attributes of the subsidiary corporation carry over to the parent corporation. Both the subsidiary's excess charitable contributions and NOLs are transferred to the parent, together with other tax attributes, such as basis in property, Sec. 1245 and Sec. 1250 potential, capital loss carryovers, and E&P. ch20

Ace Corp. and Bate Corp. combine in a qualifying reorganization and form Carr Corp., the only surviving corporation. This reorganization is tax-free to the Shareholders Corporation

Yes Yes This exchange represents a Type A statutory consolidation wherein neither the shareholders nor the corporations involved will recognize income, provided no boot is exchanged. ch20

Shonda owns 1,000 of the 1,500 shares outstanding in Rook Corporation (E & P of $1,000,000). Shonda paid $50 per share for the stock seven years ago. The remaining stock in Rook is owned by unrelated individuals. a. What are the tax consequences to Shonda when Rook Corporation redeems 450 shares of Shonda's stock for $225,000? Select "Yes" or "No", whichever is applicable. • Shonda owns 52.4% of the Rook shares outstanding after the redemption. • Shonda has $225,000 of dividend income. • Shonda's basis in the 450 shares redeemed attaches to the basis in the remaining Rook shares. • The transaction qualifies as a not essentially equivalent redemption. • Shonda has a $225,000 basis in the remaining 550 shares b. What are the tax consequences to Shonda when Rook Corporation redeems 600 shares of Shonda's stock for $300,000? Select "Yes" or "No", whichever is applicable. • Shonda has a recognized long-term capital gain of $270,000. • Shonda has an ownership interest in Rook of 44.4%. • The distribution does not qualify as a disproportionate redemption. • Shonda has recognized dividend income of $300,000.

a. Yes. Like its predecessor, the not essentially equivalent redemption lacks an objective test. Instead, each case must be resolved on a facts and circumstances basis. In determining whether the meaningful reduction test has been met, the stock attribution rules apply. A decrease in the redeeming shareholder's voting control appears to be the most significant indicator of a meaningful reduction, but reductions in the rights of redeeming shareholders to share in corporate earnings or to receive corporate assets upon liquidation are also considered. The meaningful reduction test is applied whether common stock or preferred stock is being redeemed. After the redemption, Shonda owns 52.4% of the Rook shares outstanding [550 (postredemption shares owned) ÷ 1,050 (postredemption shares outstanding)]. Yes. The distribution does not satisfy the qualifying stock redemption provisions. This postredemption ownership interest fails the requirements for a disproportionate redemption (i.e., the less-than-50% test) or a complete termination redemption. Also, there has not been a "meaningful reduction" of ownership interest. Thus, the transaction fails to qualify as a not essentially equivalent redemption. Shonda has $225,000 of dividend income. Yes. When a redemption fails to satisfy any of the qualifying stock redemption rules, the basis of the redeemed shares does not disappear. Typically, the basis will attach to the basis of the redeeming shareholder's remaining shares in the corporation. If, however, the redeeming shareholder has terminated his or her direct stock ownership and the redemption is nonqualified due to the attribution rules, the basis of the redeemed shares will attach to the basis of the constructively owned stock. In this manner, a nonqualified stock redemption can result in stock basis being shifted from one taxpayer (the redeeming shareholder) to another taxpayer (the shareholder related under the attribution rules). The distribution does not satisfy the qualifying stock redemption provisions. Shonda's basis in the 450 shares redeemed attaches to the basis in her remaining Rook shares. No. Since Shonda still has dominant control of Rook, there has not been a "meaningful reduction" of her ownership interest in Rook. Thus, the transaction fails to qualify as a not essentially equivalent redemption. No. The distribution does not satisfy the qualifying stock redemption provisions. Shonda's basis in the 450 shares redeemed attaches to the basis in her remaining Rook shares. Thus, Shonda has a $50,000 basis in her remaining 550 shares. b. Yes. The distribution qualifies as a disproportionate redemption. Shonda has a recognized long-term capital gain of $270,000 [$300,000 (amount realized) - $30,000 (basis in shares redeemed)]. Yes. This ownership interest is less than 80% of her original ownership [44.4% < 53.4% (80% × 66.7%)] and less than 50% of the total combined voting power. No. A stock redemption qualifies for sale or exchange treatment under § 302(b)(2) as a disproportionate redemption if the following conditions are met: (1) After the distribution, the shareholder owns less than 80% of the interest owned in the corporation before the redemption [e.g., if a shareholder owns a 60% interest in a corporation that redeems part of the stock, the shareholder's ownership interest after the redemption must be less than 48% (80% of 60%)]; and (2) After the distribution, the shareholder owns less than 50% of the total combined voting power of all classes of stock entitled to vote. No. The distribution qualifies as a disproportionate redemption; thus, Shonda has a recognized long-term capital gain of $270,000 [$300,000 (amount realized) - $30,000 (basis in shares redeemed)]. CH19

The following information for 2020 relates to Sparrow Corporation, a calendar year, accrual method taxpayer: Net income per books (after-tax) $205,050 Federal income tax expense per books 55,650 Tax-exempt interest income 4,500 MACRS depreciation in excess of straight-linedepreciation used for financial statement purposes 7,200 Excess of capital losses over capital gains 9,400 Nondeductible meals and entertainment 5,500 Interest on loan to purchase tax-exempt bonds 1,100 a. Regarding items that would be added back on the M-1 schedule, label either "Yes" (it would be added back to net income per books) or "No" (it would not be). • Federal income tax per books • Excess of capital loss over capital gains • Tax-exempt interest income • Excess of MACRS over book depreciation • Interest on loan to purchase tax-exempt bonds • Nondeductible meals and entertainment b. Sparrow's taxable income for 2020 is _________

a. Yes. If a company takes an expense for Federal income taxes in their book income, this would be added back as Federal income taxes is not an allowable expense when computing taxable income. Yes. The excess of capital losses over capital gains (deducted for financial accounting purposes but not deductible by corporations for income tax purposes) would be added back to book income. No. Although included in book income, tax-exempt interest income is not taxable; thus not included in taxable income No. Many assets are depreciated quicker for tax than for book purposes. Consequently, an additional expense (a subtraction from / reduction in) in book income adjustment is necessary. Yes. Interest on loan to purchase tax-exempt bonds is deducted for financial accounting purposes but not deductible by corporations for income tax purposes and therefore, added back to book income. Yes. Although an expense for meals and entertainment is taken per book income, the nondeductible portion of meals and entertainment is not deductible for tax purposes. This expense would be added back to book income. b. $265,000. CH17

Alice and Jane form Osprey Corporation. Alice transfers property (basis of $25,000 and value of $200,000) for 50 shares in Osprey Corporation. Jane transfers property (basis of $5,000 and value of $15,000) and agrees to serve as manager of Osprey for one year; in return, Jane receives 50 shares in Osprey. The value of Jane's services to Osprey is $185,000. a. Jane has income of $________ from the services, and $________ on the transfer of her property. b. Alice has income of $________ on the transfer of her property.

a. 185,000; 10,000 b. 175,000 Because neither asset is <10% of the services so no Property is transfered and NO 351 allowed for either person because they do not qualify for 80%. SO Each person's transaction is taxable. CH18

Goose Corporation, a C corporation, incurs a net capital loss of $12,000 for 2020. It also has ordinary income of $10,000 in 2020. Goose had net capital gains of $2,500 in 2016 and $5,000 in 2019. If an amount is zero, enter "0". a. Determine the amount, if any, of the net capital loss of $12,000 that is deductible in 2020. b. Determine the amount, if any, of the net capital loss of $12,000 that is carried forward to 2021.

a. Answer: $0. Unlike individuals, corporate taxpayers are not permitted to deduct any net capital losses against ordinary income. Capital losses can be used only as an offset against capital gains. As a result, if the current capital gains are insufficient to offset the current capital losses, the corporation has no current deduction for the excess capital loss. Because Goose Corporation has no current capital gains to offset the capital loss, none of the $12,000 can be deducted in 2020. b. Answer: $7,000. For corporate taxpayers, any excess net capital losses may be used to offset past or future capital gains. However, corporations may only carry back net capital losses to three preceding years, applying them first to the earliest year. Carryforwards are allowed for a period of five years from the year of the loss. When carried back or forward, a long-term capital loss is treated as a short-term capital loss. Goose Corporation is required to carry back the capital loss to three preceding years. Of the $12,000 net capital loss, $5,000 is carried back to 2019 and deductible against the $5,000 net capital gain of that year. The remaining $7,000 ($12,000 - $5,000) of the net capital loss is carried forward to 2021. Note: Since a net capital loss is carried back only three years, the 2020 loss cannot be carried back to tax year 2016. ch17

Target Corporation holds assets with a fair market value of $4,000,000 (adjusted basis of $2,200,000) and liabilities of $1,500,000. It transfers assets worth $3,700,000 to Acquiring Corporation in a "Type C" reorganization, in exchange for Acquiring voting stock and the assumption of $1,400,000 of Target's liabilities. Target retained a building worth $300,000 (adjusted basis of $225,000). Target distributes the Acquiring voting stock and the building with an associated $100,000 mortgage to Wei, its sole shareholder, for all of her stock in Target. Wei's basis in her stock is $2,100,000. If an amount is zero, enter "0". a. The value of stock transferred from Acquiring to Target: b. What is the amount of gain (loss) recognized by Wei, Target, and Acquiring in this reorganization? Wei has a realized gain of __________, of which _________ is recognized. Target has a realized gain of _________, of which __________ is recognized. Acquiring has no gain or loss of which ___________ is recognized. c. What is Wei's basis in the stock and building she received? Wei's basis in the stock is __________. Wei's basis in the building is __________. In addition, she acquired a _________ liability.

a. Answer: $2,300,000. When the acquiring corporation gives solely voting stock for the target corporation's assets, the target corporation's liabilities assumed by the acquiring corporation are not considered other property (i.e., boot) in the exchange. The transaction is a voting-stock-for-assets exchange, and the 80 percent-of-property requirement is met. However, liabilities assumed by the acquiring corporation are treated as other property if the target corporation receives any property other than voting stock in the reorganization. Target liabilities assumed by the acquiring corporation are likely to exceed 20 percent of the fair market value of the target assets acquired and, consequently, destroy the "Type C" reorganization. The value of stock transferred from Acquiring to Target is $2,300,000, computed as follows: $3,700,000 - $1,400,000 liabilities = $2,300,000 stock. b. Answers: a realized gain; $400,000; $200,000; a realized gain; $75,000; $75,000; no gain or loss; $0. Generally, the shareholders of corporations involved in a tax-free reorganization do not recognize gain or loss when exchanging their stock unless they receive cash or other property in addition to stock. The cash or other property is considered boot, and the gain recognized by the stockholder is the lesser of the boot received or the realized gain. This is analogous to the treatment of boot in a like-kind exchange. The only instance when shareholders may recognize losses in reorganizations is when they receive solely boot and no stock. Wei receives $2,300,000 in stock and a building valued at $300,000 with a $100,000 mortgage for her Target stock. Thus, Wei receives $2,500,000 for her Target stock ($2,300,000 + $300,000 - $100,000). Since her basis is $2,100,000, Wei realizes a $400,000 ($2,500,000 - $2,100,000) gain. However, she only recognizes gain to the extent of the boot received, which is $200,000 ($300,000 building - $100,000 mortgage). See part c. for computation of gain using the four-column approach. Target has a $75,000 ($300,000 - $225,000) recognized gain on the reorganization due to the building distributed to Wei. Acquiring has no gain or loss on the reorganization. c. Answers: $2,100,000; $300,000; $100,000. The assets transferred from the target corporation to the acquiring corporation retain their basis. The acquiring corporation's carryover basis is increased by any gain recognized by the target corporation on the reorganization. Wei's basis in the building is $300,000 and has a $100,000 liability she acquired. Her basis in the stock is computed as follows. ch20

Gull Corporation, a cash method, calendar year C corporation, was formed and began business on November 1, 2020. Gull incurred the following expenses during its first year of operations (November 1, 2020-December 31, 2020): Expenses of temporary directors and organizational meetings $21,000 Fee paid to state of incorporation 3,000 Expenses for printing and sale of stock certificates 11,000 Legal services for drafting the corporate charter and bylaws(not paid until January 2021) 19,000 Round the per-month amount to two decimal places. Round the final answer to the nearest dollar. a. Assuming that Gull Corporation elects under § 248 to expense and amortize organizational expenditures, what amount may be deducted in 2020? Gull Corporation's deduction for 2020 is $_____ b. Assume the same facts as above, except that the amount paid for the legal services was $28,000 (instead of $19,000). What amount may be deducted as organizational expenditures in 2020?

a. Answer: $5,422. Organizational expenditures include the following: Legal services incident to organization. Necessary accounting services. Fees paid to the state of incorporation. Under § 248, a corporation may elect to amortize organizational expenditures over the 180-month period beginning with the month in which the corporation begins business. Organizational expenditures include the following: Legal services incident to organization (e.g., drafting the corporate charter, bylaws, minutes of organizational meetings, and terms of original stock certificates) Necessary accounting services Expenses of temporary directors and of organizational meetings of directors or shareholders Fees paid to the state of incorporation. Expenditures that do not qualify as organizational expenditures include those connected with issuing or selling shares of stock or other securities (e.g., commissions, professional fees, and printing costs) or with the transfer of assets to a corporation. These expenditures reduce the amount of capital raised and are not deductible at all. The first $5,000 of organizational costs can be immediately expensed, with any remaining amount of organizational costs amortized over a 180-month period. However, this $5,000 expensing amount is phased out on a dollar-for-dollar basis when these costs exceed $50,000. Startup expenditures include various investigation expenses involved in entering a new business (e.g., travel, market surveys, financial audits, and legal fees) and operating expenses such as rent and payroll that are incurred by a corporation before it actually begins to produce any gross income. At the election of the taxpayer, such expenditures are deductible in the same manner as organizational expenditures. In summary, for 2020, the deduction for organizational expenditures is $5,422 {$5,000 (amount immediately expensed) + [($43,000 - $5,000) ÷ 180 months x 2 months]}. Except for the expenses related to the printing and sale of the stock certificates, all other expenses qualify for the § 248 amortization election. Thus, organizational expenditures total $43,000 ($21,000 + $3,000 + $19,000). To qualify for the election, the expenditure must be incurred before the end of the taxable year in which the corporation begins business. Since the legal fees were incurred in 2020, the $19,000 qualifies as organizational expenditures. b. Answer: $3,544. At the election of the taxpayer, such expenditures are deductible in the same manner as organizational expenditures. Thus, up to $5,000 can be immediately expensed (subject to the phaseout) and any remaining amounts amortized over a period of 180 months. The $5,000 expensing amount is phased out on a dollar-for-dollar basis when these costs exceed $50,000. For example, a corporation with $52,000 of organizational or start-up costs would expense $3,000 [$5,000 - ($52,000 - $50,000)] of this amount and amortize the $49,000 balance ($52,000 - $3,000) over 180 months. In summary, Gull Corporation's organizational expenditures now total $52,000 ($21,000 + $3,000 + $28,000). Since organizational expenditures exceed $50,000, the $5,000 first-year expensing limit is reduced to $3,000 [$5,000 - ($52,000 - $50,000)]. Thus, the 2020 deduction for organizational expenditures is $3,544 {$3,000 (amount that can be immediately expensed) + [($52,000 - $3,000) ÷ 180 months x 2 months]}. CH17

Gigi transfers real estate (basis of $60,000 and fair market value of $40,000) to Monarch Corporation in exchange for shares of § 1244 stock. Assume that the transfer qualifies under § 351. a. What is the basis of the stock to Gigi? (Gigi and Monarch do not make an election to reduce her stock basis.)The basis of the stock to Gigi is b. What is the basis of the stock to Gigi for purposes of § 1244?The basis of the stock to Gigi for purposes of § 1244 is c. If Gigi sells the stock for $38,000 two years later, how will the loss be treated for tax purposes? Gigi would have a capital loss of __________ and an ordinary loss of ________ for tax purposes.

a. Answer: $60,000. Section 351(a) postpones gain or loss until the transferor-shareholder disposes of the stock in a taxable transaction. The postponement of shareholder gain or loss has a corollary effect on the basis of the stock received by the shareholder and the basis of the property received by the corporation. This procedure ensures that any gain or loss postponed under § 351 ultimately will be recognized when the affected asset is disposed of in a taxable transaction. For a taxpayer transferring property to a corporation in a § 351 transaction, the stock received in the transaction is given a substituted basis. Essentially the stock's basis is the same as the basis the taxpayer had in the property transferred, increased by any gain recognized on the exchange of property and decreased by boot received. The basis of the stock to Gigi is $60,000 ($60,000 - $0 gain). b. Answer: $40,000. Special treatment applies if § 1244 stock is issued by a corporation in exchange for property that has an adjusted basis above its fair market value immediately before the exchange. For purposes of determining ordinary loss upon a subsequent sale, the stock basis is reduced to the fair market value of the property on the date of the exchange. Therefore, the basis of the stock for purposes of § 1244 is only $40,000, the fair market value. For purposes of § 1244 only, the basis of § 1244 stock is the fair market value when the fair market value is less than the adjusted basis of property received in exchange for the stock. c. Answers: $20,000; $2,000. In an exception to the capital treatment that generally results, § 1244 permits ordinary loss treatment for losses on the sale or worthlessness of stock of so-called small business corporations. The amount of ordinary loss deductible in any one year from the disposition of § 1244 stock is limited to $50,000 (or $100,000 for spouses filing a joint return). For purposes of determining ordinary loss upon a subsequent sale, the stock basis is reduced to the fair market value of the property on the date of the exchange. Gigi's total loss is $22,000 ($38,000 sales price - $60,000 basis). To determine how much of the total loss is § 1244, the fair market value on the date of the exchange is used. Therefore, Gigi will have a $2,000 ordinary loss ($38,000 sales price - $40,000 basis reduced to fair market value at the date of exchange). The remaining $20,000 loss would be a capital loss. CH18

Silver Corporation has 2,000 shares of common stock outstanding. Howard owns 600 shares, Howard's grandfather owns 300 shares, Howard's mother owns 300 shares, and Howard's son owns 100 shares. In addition, Maroon Corporation owns 500 shares. Howard owns 70% of the stock in Maroon Corporation. a. Applying the § 318 stock attribution rules, how many shares does Howard own in Silver Corporation?Howard constructively owns fill in the ________ shares in Silver Corporation. b. Assume that Howard owns only 40% of the stock in Maroon Corporation. How many shares does Howard own, directly and indirectly, in Silver Corporation? _________ shares. c. Assume the same facts as in (a) above, but in addition, Howard owns a 25% interest in Yellow Partnership. Yellow owns 200 shares in Silver Corporation. How many shares does Howard own, directly and indirectly, in Silver Corporation? _______ shares.

a. Answer: 1,350. The stock attribution rules must be considered in applying the stock redemption provisions. Under these rules, related parties are defined to include the following family members: spouses, children, grandchildren, and parents. An individual is deemed to own the stock owned by his or her spouse, children, grandchildren, and parents (not siblings or grandparents). Attribution also takes place from and to partnerships, estates, trusts, and corporations (50 percent or more ownership required in the case of regular corporations). Stock owned by a corporation is deemed to be owned proportionately by any shareholder owning 50% or more of the corporation's stock. Stock owned by a shareholder who owns 50% or more of a corporation is deemed to be owned in full by the corporation. A partner is deemed to own the stock owned by a partnership to the extent of the partner's proportionate interest in the partnership. Stock owned by a partner is deemed to be owned in full by a partnership. Howard owns 1,350 shares, 600 shares directly and 750 shares indirectly, in Silver. Howard constructively owns the stock of his mother (300 shares) and his son (100 shares) and 70% of the 500 shares, or 350 shares, owned by Maroon Corporation. Howard is not deemed to own his grandfather's stock. Siblings are not related parties under the § 318 stock attribution rules, and the attribution rules do not apply to the stock held by a corporation if the shareholder owns less than 50% of the stock in the corporation. b. Answer: 1,000. An individual is deemed to own the stock owned by his or her spouse, children, grandchildren, and parents (not siblings or grandparents). The stock attribution rules do not apply to stock held by a regular corporation if the shareholder owns less than 50% of the stock in that corporation. Thus, Howard would only own 1,000 shares, 600 shares directly and 400 shares indirectly, owned by his mother (300 shares) and son (100 shares). c. Answer: 1,400. An individual is deemed to own the stock owned by his or her spouse, children, grandchildren, and parents (not siblings or grandparents). Attribution also takes place from and to partnerships, estates, trusts, and corporations (50 percent or more ownership required in the case of regular corporations). Stock owned by a corporation is deemed to be owned proportionately by any shareholder owning 50% or more of the corporation's stock. In addition, a partner is deemed to own the stock owned by a partnership to the extent of the partner's proportionate interest in the partnership. Howard would now own 1,400 shares in Silver, the 1,350 shares as computed in part a. above plus 50 shares as a result of his 25% partnership interest [200 (shares owned by Yellow Partnership) × 25% (Howard's interest in the partnership)]. CH19

uciana, Jon, and Clyde incorporate their respective businesses and form Starling Corporation. On March 1 of the current year, Luciana exchanges her property (basis of $50,000 and fair market value of $150,000) for 150 shares in Starling Corporation. On April 15, Jon exchanges his property (basis of $70,000 and fair market value of $500,000) for 500 shares in Starling. On May 10, Clyde transfers his property (basis of $90,000 and fair market value of $350,000) for 350 shares in Starling. a. If the three exchanges are part of a pre-arranged plan, who will recognize a gain on the exchanges? b. Now assume that Luciana and Jon exchanged their property for stock four years ago, while Clyde transfers his property for 350 shares in the current year. Clyde's transfer is not part of a pre-arranged plan with Luciana and Jon to incorporate their businesses. What gain will Clyde recognize on the transfer? Clyde will recognize a gain of ______ on the transfer. c. Returning to the original facts, assume the property that Clyde contributes has a basis of $490,000 (instead of $90,000). Why would it be better from a tax perspective for Clyde to wait to transfer his property rather than be a part of Luciana's and Jon's transfers?

a. Answer: None of the parties. For the transaction to qualify as nontaxable under § 351, the property transferors must be in control of the corporation immediately after the exchange. Control means that the person or persons transferring the property must have at least an 80 percent stock ownership in the corporation. Immediately after the exchange, the property transferors must control the corporation. Control can apply to a single person or to several taxpayers if they are all parties to an integrated transaction. When more than one person is involved, the exchange does not necessarily require simultaneous exchanges by those persons. However, the rights of those transferring property to the corporation must be previously set out and determined as in a pre-arranged plan. Also, the agreement to transfer property should be executed "with an expedition consistent with orderly procedure." Therefore, if two or more persons transfer property to a corporation for stock and want to defer gain, it is helpful if the transfers occur close together in time and are made in accordance with an agreement among the parties. None of the three individuals will recognize gain in this case. The nonrecognition provisions of § 351 apply to all the exchanges. b. Answer: $260,000. Clyde will have a taxable gain of $260,000 on the transfer because he does not have control of the corporation after his transfer and because his transaction cannot be integrated with Luciana's and Jon's transfer for purposes of the control requirement. Clyde will recognize gain of $260,000 on the exchange, computed as follows: $350,000 fair market value of property - $90,000 basis of property. c. Answer: To allow the recognition of a loss by Clyde. Since the same principles govern the nonrecognition of gain or loss under § 351, Clyde would be well advised to avoid having his transfer treated as a part of an integrated plan that also includes Luciana's and Jon's transfers. If his transfer is considered independent, it will not fall under the mandatory nonrecognition treatment for gains and losses. Not only will Luciana and Jon be able to benefit from § 351 (i.e., realized gains would not be recognized), Clyde's loss of $140,000 ($350,000 - $490,000) will be recognized. CH18

In the current year, Tanager Corporation (a calendar year C corporation) had operating income of $480,000 and operating expenses of $390,000. In addition, Tanager had a long-term capital gain of $55,000 and a short-term capital loss of $40,000. a. Compute Tanager's taxable income and tax for the year. Taxable income: Income tax: b. Assume the same facts except that Tanager's long-term capital gain was $15,000. Compute Tanager's taxable income and tax for the year. Taxable income: Income tax:

a. Answers: $105,000; $22,050. Gains and losses from property transactions are handled in a similar fashion for both individual and corporate taxpayers. For example, whether a gain or loss is capital or ordinary depends upon the nature of the asset in the hands of the taxpayer making the taxable disposition. In defining what is not a capital asset, § 1221 makes no distinction between corporate and noncorporate taxpayers. Capital gains and losses result from the taxable sales or exchanges of capital assets. Whether these gains and losses are long-term or short-term depend upon the holding period of the assets sold or exchanged. Individuals generally pay a preferential tax rate of 15 or 20% on net capital gains (i.e., excess of net long-term capital gain over net short-term capital loss). Capital gains of corporations are included in taxable income and are not subject to the preferential rate applicable to individuals. Net capital losses of corporate and individual taxpayers receive different income tax treatment. Generally, individual taxpayers can deduct up to $3,000 of such net losses against other income. Unlike individuals, corporate taxpayers are not permitted to claim any net capital losses as a deduction against ordinary income. Capital losses, therefore, can be used only as an offset against capital gains. Corporations, however, carry back net capital losses to three preceding years, applying them first to the earliest year in point of time. Carryforwards are allowed for a period of five years from the year of the loss. When carried back or forward, a long-term capital loss is treated as a short-term capital loss. Taxable income is computed as follows: $105,000 = $480,000 (operating income) - $390,000 (operating expenses) + $55,000 (LTCG) - $40,000 (STCL). The tax on $105,000 of taxable income is $22,050 ($105,000 × 21%). Corporations include LTCGs in taxable income and do not receive a preferential tax rate with respect to such income. b. Answers: $90,000; $18,900. Taxable income is computed as follows: $90,000 = $480,000 (operating income) - $390,000 (operating expenses) + $15,000 (LTCG) - $15,000 (STCL). No deduction is allowed for the $25,000 net capital loss. Instead, the net capital loss is carried back 3 years and forward 5 years. The tax on $90,000 of taxable income is $18,900 ($90,000 × 21%). CH17

Iris Corporation owns 30% of Fresia Corporation's stock. On November 15, Fresia Corporation, with current E & P of $320,000, distributes land (fair market value of $100,000; basis of $160,000) to Iris. The land is subject to a liability of $80,000, which Iris assumes. Click here to view the Dividend Received Deduction Table. a. How is Iris Corporation taxed on the distribution? Iris Corporation has dividend income of _________ and a dividends received deduction of ________. Iris Corporation has a basis of $fill in the _______ in the land. b. What is Fresia Corporation's E & P after the distribution?

a. Answers: $20,000; $13,000; $100,000. When a corporation distributes property rather than cash to a shareholder, the amount distributed is measured by the fair market value of the property on the date of distribution. As with a cash distribution, the portion of a property distribution covered by existing E & P is a dividend, and any excess is treated as a return of capital. If the fair market value of the property distributed exceeds the corporation's E & P and the shareholder's basis in the stock investment, a capital gain usually results. The amount distributed is reduced by any liabilities to which the distributed property is subject immediately before and immediately after the distribution and by any liabilities of the corporation assumed by the shareholder. The basis of the distributed property for the shareholder is the fair market value of the property on the date of the distribution. Per the dividend received deduction table, Iris Corporation, with 30% ownership of Fresia Corporation, is entitled to a deduction of 65% or $13,000 ($20,000 × 65%) under § 243. Iris Corporation has dividend income of $20,000 [$100,000 (fair market value of the land) - $80,000 (liability on the land)]. Along with the dividend received deduction, only $7,000 of the dividend is subject to tax. Iris Corporation has a basis of $100,000 in the land. b. Answer: $240,000. All distributions of appreciated property generate gain to the distributing corporation. In effect, a corporation that distributes gain property is treated as if it had sold the property to the shareholder for its fair market value. However, the distributing corporation does not recognize loss on distributions of property. If the distributed property is subject to a liability in excess of basis or the shareholder assumes such a liability, a special rule applies. For purposes of determining gain on the distribution, the fair market value of the property is treated as not being less than the amount of the liability. Corporate distributions reduce E & P by the amount of money distributed or by the greater of the fair market value or the adjusted basis of property distributed, less the amount of any liability on the property. E & P is increased by gain recognized on appreciated property distributed as a property dividend. Fresia Corporation may not deduct the $60,000 loss on the land ($100,000 fair market value less $160,000 adjusted basis). Its E & P is reduced by $80,000 [the $160,000 basis of the land (which is greater than the fair market value) - the $80,000 liability on the land]. As a result, Fresia Corporation's E & P after the distribution is $240,000 (current E & P of $320,000 less the $80,000 reduction). CH19

In terms of the rules applying to a § 332 parent-subsidiary liquidation, complete the statement for each of the following: a. The parent corporation's ownership interest in the subsidiary. The parent corporation must own ________ of the subsidiary's voting stock and _________ in value of all its other stock. b. The period of time in which the subsidiary must liquidate. The subsidiary must distribute all its property in complete cancellation of all its stock within the taxable year in which the first distribution is made or within _________ from the close of the tax year. c. The solvency of the subsidiary. The subsidiary _________ for § 332 to apply.

a. Answers: 80% or more; 80% or more. Section 332, an exception to the general rule of § 331, provides that a parent corporation does not recognize gain or loss on a liquidation of a subsidiary. In addition, the subsidiary corporation recognizes neither gain nor loss on distributions of property to its parent. The requirements for applying § 332 are as follows: (1) The parent must own at least 80 percent of the voting stock of the subsidiary and at least 80 percent of the value of the subsidiary's stock; (2) The subsidiary must distribute all of its property in complete cancellation of all of its stock within the taxable year or within three years from the close of the tax year in which the first distribution occurred; (3) The subsidiary must be solvent. If these requirements are met, nonrecognition of gains and losses becomes mandatory. However, if the subsidiary is insolvent, the parent corporation will have an ordinary loss deduction under § 165(g). Therefore the parent corporation must own 80% or more of the subsidiary's voting stock and 80% or more in value of all its other stock (other than nonvoting preferred) at the time the plan of liquidation is adopted and until all property is distributed. Otherwise, the liquidation will not qualify under § 332. b. Answer: three. The subsidiary must distribute all its property in complete cancellation of all its stock within the taxable year in which the first distribution is made or within three years from the close of the tax year in which the first distribution occurred pursuant to the adoption of a plan by the corporation. Otherwise, the liquidation will not qualify under § 332. c. Answer: must be solvent. The subsidiary must be solvent, or § 332 will not apply. If the subsidiary is insolvent, the parent corporation will have an ordinary loss deduction for its worthless stock in the subsidiary. ch20

John (a sole proprietor) and Eagle Corporation (a C corporation) each recognize a long-term capital gain of $10,000 and a short-term capital loss of $18,000 on the sale of capital assets. Neither taxpayer had any other property transactions during the year. a. Regarding John's gains and losses, label each of the following as "True", a tax consequence or "False", not a tax consequence. • John reports the capital transactions on his individual tax return and deducts a $18,000 net capital loss in the current year. • John reports the capital transactions on his individual tax return but is limited to a $3,000 net capital loss deduction in the current year • John nets the $10,000 LTCG against the $18,000 STCL. b. Regarding Eagle Corporation's gains and losses, label each of the following as "True", a tax consequence or "False", not a tax consequence. • Eagle Corporation nets the $10,000 LTCG against the $18,000 STCL, resulting in a $8,000 net capital loss. • Eagle is limited to a $8,000 net capital loss deduction in the current year. • All of the $18,000 net capital loss is deductible in the current year. • Eagle carries back a $8,000 STCL 3 years and, if necessary, forward 5 years, to be offset against capital gains in such years.

a. Answers: False; True; True. False. Taxpayers must net capital gains and losses first. Generally, individual taxpayers can deduct up to $3,000 of such net losses against other income. True. Generally, individual taxpayers can deduct up to $3,000 of such net losses against other income. Any remaining capital losses can be carried forward to future years until absorbed by capital gains or by the $3,000 deduction. Therefore, John reports the capital transactions on his individual tax return, deducts $3,000 of the net capital loss in the current year, and carries forward to next year a $5,000 STCL for the remainder of the net capital loss. True. Each year, a taxpayer's short-term gains and losses are combined, and long-term gains and losses are combined. The result is a net short-term capital gain or loss and a net long-term capital gain or loss. b.Answers: True; False; False; True. True. Each year, a taxpayer's short-term gains and losses are combined, and long-term gains and losses are combined. The result is a net short-term capital gain or loss and a net long-term capital gain or loss. False. Capital losses can be used only as an offset against capital gains. Eagle reports the capital transactions on its corporate tax return, but none of the $8,000 net capital loss is deductible in the current year. Instead, Eagle carries back a $8,000 STCL three years and, if necessary, forward five years, to be offset against capital gains in such years. False. See answer above. True. Unlike individuals, corporate taxpayers are not permitted to claim any net capital losses as a deduction against ordinary income. Capital losses, therefore, can be used only as an offset against capital gains. Corporations may, however, carry back net capital losses to three preceding years. Any remaining net operating losses may be carried forward. CH17

Broadbill Corporation (E & P of $650,000) has 1,000 shares of common stock outstanding. The shares are owned by the following individuals: Tammy, 300 shares; Yvette, 400 shares; and Jeremy, 300 shares. Each of the shareholders paid $50 per share for the Broadbill stock four years ago. In the current year, Broadbill Corporation distributes $75,000 to Tammy in redemption of 150 of her shares. Determine the tax consequences of the redemption to Tammy and to Broadbill under the following independent circumstances. a. If Tammy and Jeremy are grandmother and grandson:The transaction does not qualify for sale or exchange treatment. Tammy will recognize dividend income of ________ . Broadbill Corporation's E & P is reduced by ________ b. If the three shareholders are siblings:The transaction does qualify for sale or exchange treatment. Tammy will recognize a long-term capital gain of ________ . Broadbill Corporation's E & P is reduced by _________ as a result of the distribution.

a. Answers: does not; dividend income; $75,000; reduced; $75,000. Currently, the following five types of stock redemptions qualify for sale or exchange treatment: (1) Distributions not essentially equivalent to a dividend ("not essentially equivalent redemptions"). (2) Distributions substantially disproportionate in terms of shareholder effect ("disproportionate redemptions"). (3) Distributions in complete termination of a shareholder's interest ("complete termination redemptions"). (4) Distributions to noncorporate shareholders in partial liquidation of a corporation ("partial liquidations"). (5) Distributions to pay a shareholder's death taxes ("redemptions to pay death taxes"). To qualify for sale or exchange treatment, a stock redemption generally must result in a substantial reduction in the shareholder's ownership interest in the corporation. In determining whether a stock redemption has sufficiently reduced a shareholder's interest, the stock owned by certain related parties is attributed to the redeeming shareholder. Thus, the stock attribution rules must be considered in applying the stock redemption provisions. Under these rules, related parties are defined to include the following family members: spouses, children, grandchildren, and parents. Attribution also takes place from and to partnerships, estates, trusts, and corporations (50 percent or more ownership required in the case of regular corporations). A stock redemption qualifies for sale or exchange treatment under § 302(b)(2) as a disproportionate redemption if the following conditions are met: (1) After the distribution, the shareholder owns less than 80 percent of the interest owned in the corporation before the redemption and (2) After the distribution, the shareholder owns less than 50 percent of the total combined voting power of all classes of stock entitled to vote. In determining a shareholder's ownership interest before and after a redemption, the attribution rules apply. The transaction does not qualify for sale or exchange treatment. As a result of the stock attribution rules, Tammy is deemed to own the shares owned by Jeremy, her grandson. Tammy's postredemption ownership interest of 52.9% [450 (150 postredemption shares owned directly + Jeremy's 300 shares) ÷ 850 (postredemption shares outstanding)] fails to satisfy any of the qualifying stock redemption provisions. Therefore, Tammy will recognize dividend income equal to the amount of the distribution, or $75,000. The $7,500 basis in the stock redeemed attaches to the basis of Tammy's remaining shares of Broadbill stock. Broadbill Corporation's E & P is reduced by $75,000, the amount of the dividend distribution. b. Answers: does; a long-term capital gain; $67,500; reduced; $75,000. A stock redemption qualifies for sale or exchange treatment under § 302(b)(2) as a disproportionate redemption if the following conditions are met: (1) After the distribution, the shareholder owns less than 80% of the interest owned in the corporation before the redemption. For example, if a shareholder owns a 60% interest in a corporation that redeems part of the stock, the shareholder's ownership interest after the redemption must be less than 48% (80% of 60%). (2) After the distribution, the shareholder owns less than 50% of the total. In determining whether a stock redemption has sufficiently reduced a shareholder's interest, the stock owned by certain related parties is attributed to the redeeming shareholder. Thus, the stock attribution rules must be considered in applying the stock redemption provisions. Under these rules, related parties are defined to include the following family members: spouses, children, grandchildren, and parents. In a qualifying stock redemption, the E & P of the distributing corporation is reduced by an amount not in excess of the ratable share of the corporation's E & P attributable to the stock redeemed. The transaction qualifies for sale or exchange treatment as a disproportionate redemption. There is no attribution under § 318 for stock owned by siblings. Tammy's postredemption ownership interest of 17.6% [150 (postredemption shares owned by Tammy) ÷ 850 (postredemption shares outstanding)] satisfies both the 80% test [17.6% is less than 24% (80% × 300/1,000)] and the 50% test. As a result, Tammy will recognize a long-term capital gain of $67,500 [$75,000 (amount realized) - $7,500 (basis in shares redeemed)]. Broadbill Corporation's E & P is reduced by $75,000, the amount of the distribution {$75,000 is less than the limitation of $97,500 [15% (percentage of shares outstanding redeemed from Tammy) × $650,000 (E & P as of the date of distribution)]}. CH19

Rafael transfers the following assets to Crane Corporation in exchange for all of its stock. Assume that neither Rafael nor Crane plans to make any special tax elections at the time of incorporation. Assets Rafael's Adjusted Basis Fair Market Value Inventory $60,000 $100,000 Equipment 150,000 105,000 Shelving 80,000 65,000 If an amount is zero, enter "0". Do not round any division in your computations. a. What is Rafael's recognized gain or loss? Rafael's realized loss is _________. Of this amount, ________ is recognized. b. What is Rafael's basis in the stock?Assuming no election is made, Rafael's basis in the stock is ________ c. What is Crane's basis in the inventory, equipment, and shelving?Inventory; Equipment: Shelving: d. If Rafael has no intentions of selling his Crane stock for at least 15 years, what action would you recommend that Rafael and Crane Corporation consider? If Rafael plans to hold his stock for a substantial period of time, he and Crane may elect to allow Crane to take a carryover basis in the assets received. If they so elect, Rafael's stock basis would be _______

a. Answers: loss; $20,000; $0. Section 351, which deals with transfers to controlled corporations, provides that gain or loss is not recognized upon the transfer of property to a corporation when certain conditions are met. For example, when a business is incorporated, the owner's economic status remains the same; only the form of the investment has changed. Section 351 exists because Congress believes that tax rules should not impede the exercise of sound business judgment (e.g., a choice of the corporate form of doing business). For example, a taxpayer would think twice about forming a corporation if gain recognition (and the payment of a tax) would always be a consequence. In a like-kind exchange, the recognition of gain is avoided only to the extent the taxpayer receives like-kind property. However, the taxpayer must recognize some or all of the realized gain when receiving "boot" (i.e., property of an unlike kind, such as cash). Rafael's transfer of property to Crane Corporation is subject to § 351. Therefore, the $20,000 realized loss ($270,000 - $290,000) is not recognized. b. Answer: $290,000. For a taxpayer transferring property to a corporation in a § 351 transaction, the stock received in the transaction is given a substituted basis. Essentially, the stock's basis is the same as the basis the taxpayer had in the property transferred, increased by any gain recognized on the exchange and decreased by boot received. Rafael's basis in the Crane stock is $290,000. Note that Rafael's basis exceeds the $270,000 value of his stock. Thus, a $20,000 built-in loss exists for his stock. c. Answers: $60,000; $135,000; $75,000. When a corporation receives property in a § 351 transaction, the basis for that property is carried over from the shareholder. As a result, the corporation's basis for the property has no correlation with its fair market value. However, in certain situations when built-in loss property is contributed to a corporation, its aggregate basis in the property may have to be stepped down so that the basis does not exceed the fair market value of the property transferred. When this built-in loss situation exists, the basis in the loss properties is stepped down. The step-down in basis is allocated proportionately among the assets with the built-in loss. Because the aggregate basis of the assets transferred to Crane exceeds their fair market value, the basis of the loss assets must be stepped down. After the step-down, the aggregate basis of the assets will equal their fair market value. The basis of each of the assets is as follows: inventory, $60,000; equipment, $135,000; shelving, $75,000. d. Answers: a carryover basis; $270,000. In the event a corporation is subject to the built-in loss adjustment, an alternative approach is available. If both the shareholder and the corporation elect, the basis reduction can be made to the shareholder's stock rather than to the corporation's property. If Rafael plans to hold his stock for a substantial period of time, he and Crane may elect to allow Crane to take a carryover basis in the assets received. If they so elect, Rafael will reduce his stock basis to $270,000 [$290,000 (stock basis under § 358) - $20,000 (built-in loss)]. To Crane's advantage, its basis in the assets would be as follows: inventory, $60,000; equipment, $150,000; shelving, $80,000. The election has no effect on the application of § 351 on the formation of Crane. In addition, electing to reduce Rafael's stock basis results in higher future capital gain (or lower capital loss), subject to lower capital gain rates if held sufficiently long. In contrast, retaining a higher basis in the equipment and shelving will produce lower ordinary gains and/or depreciation deductions. On balance, it is likely that the benefit to Crane will exceed the cost to Rafael. CH18

Last year Pink Corporation acquired land and securities in a § 351 tax-free exchange. On the date of the transfer, the land had a basis of $720,000 and a fair market value of $1,000,000 and the securities had a basis of $110,000 and a fair market value of $250,000. Pink Corporation has two shareholders, Maria and Paul, who are unrelated. Maria owns 85% of the stock in the corporation, and Paul owns 15%. Pink adopts a plan of liquidation in the current year. On this date, the value of the land has decreased to $500,000. What is the effect of each of the following on Pink Corporation? If an amount is zero, enter "0". a. If Pink Corporation distributes all the land to Maria, the corporation has a realized loss of _________ of which ______ will be recognized. b. If all the land is distributed to Paul, Pink Corporation will have a realized loss of _________ of which _________ is recognized. c. If 85% of the land is distributed to Maria and 15% to Paul:On the distribution to Maria, Pink Corporation has a ________ realized loss on the distribution of which ________ is recognized. On the distribution to Paul, Pink Corporation has a _________ realized loss on the distribution of which ___________ is recognized. d. If 50% of the land is distributed to Maria and 50% to Paul, Pink Corporation has a ________ realized loss of which ________ is disallowed. e. If the land is sold and the proceeds of $500,000 are distributed proportionately to Maria and to Paul, Pink Corporation would recognize a loss of _________. f. Indicate which one of the following options should be selected to achieve the best tax consequence for Pink. Select "Yes or No", whichever is applicable. a.Distribute all the land to Maria. b.Distribute 85% of the land to Maria and 15% to Paul. c.Distribute 50% of the land to Maria and 50% to Paul. d.Distribute all the land to Paul, or sell the land and distribute the proceeds proportionately.

a. Answers: loss; $220,000; $0. There are four exceptions to the general rule of gain and loss recognition by a liquidating corporation. Losses are disallowed on distributions to related parties in either of the following cases: (1) The distribution is not pro rata or (2) the property distributed is disqualified property. A corporation and a shareholder are considered related if the shareholder owns (directly or indirectly) more than 50% in value of the corporation's outstanding stock. A pro rata distribution is one where each shareholder receives his or her proportionate share of the corporate assets distributed. Disqualified property is property that is acquired by the liquidating corporation in a § 351 or contribution to capital transaction during the five-year period ending on the date of the distribution. If Pink Corporation distributes all the land to Maria, none of the $220,000 loss realized [$500,000 (fair market value) - $720,000 (basis)] on the distribution will be recognized, since Maria is a related party and the land is disqualified property. b. Answers: $220,000; $220,000. Losses are disallowed on distributions to related parties in either of the following cases: (1) The distribution is not pro rata or (2) the property distributed is disqualified property. A corporation and a shareholder are considered related if the shareholder owns (directly or indirectly) more than 50% in value of the corporation's outstanding stock. The built-in loss limitation applies when the following conditions are met: (1) The property was acquired by the corporation in a § 351 or contribution to capital transaction, and (2) such acquisition was part of a plan whose principal purpose was to recognize a loss on that property by the liquidating corporation. A tax avoidance purpose is presumed in the case of transfers occurring within two years of the adoption of a plan of liquidation. This disallowance rule applies only to the extent that a property's built-in loss at transfer is not eliminated by a stepped-down basis. If all the land is distributed to Paul, Pink Corporation will have a recognized loss of $220,000. The land was valued at more than its basis on the date of the § 351 transfer to Pink; thus, the built-in loss limitation does not apply. Because Paul is an unrelated party, the related-party loss limitation does not apply. c. Answers: $187,000; loss; $0; $33,000; loss; $33,000. Losses are disallowed on distributions to related parties in either of the following cases: (1) The distribution is not pro rata or (2) the property distributed is disqualified property. A corporation and a shareholder are considered related if the shareholder owns (directly or indirectly) more than 50% in value of the corporation's outstanding stock. The built-in loss limitation applies when the following conditions are met: (1) The property was acquired by the corporation in a § 351 or contribution to capital transaction, and (2) such acquisition was part of a plan whose principal purpose was to recognize a loss on that property by the liquidating corporation. A tax avoidance purpose is presumed in the case of transfers occurring within two years of the adoption of a plan of liquidation. This disallowance rule applies only to the extent that a property's built-in loss at transfer is not eliminated by a stepped-down basis. Even though the distribution is pro rata, the property is disqualified property; thus, the $187,000 loss on the distribution to Maria (i.e., 85% x $220,000), a related party, would be disallowed. Of the $220,000 loss, 15% (Paul's interest), or $33,000, would be allowed. If all the land is distributed to Paul, Pink Corporation will have a recognized loss of $220,000. The land was valued at more than its basis on the date of the transfer to Pink; thus, the built-in loss limitation does not apply. Because Paul is an unrelated party, the related-party loss limitation does not apply. d. Answers: $220,000; loss; $110,000. Losses are disallowed on distributions to related parties in either of the following cases: (1) The distribution is not pro rata or (2) the property distributed is disqualified property. A corporation and a shareholder are considered related if the shareholder owns (directly or indirectly) more than 50% in value of the corporation's outstanding stock. In this case, 50% of the $220,000 realized loss, or $110,000, would be disallowed. The property is disqualified property; thus, the loss on the distribution to Maria, a related party, would be disallowed. The remaining $110,000 loss will be recognized. The loss limitations do not apply to the distribution to Paul. e. Answers: loss; $220,000. Losses are disallowed on distributions to related parties in either of the following cases: (1) The distribution is not pro rata or (2) the property distributed is disqualified property. The limitation does not apply to sales of loss property. Under the built-in loss limitation, the disallowance rule applies only to the extent that a property's built-in loss at transfer is not eliminated by a stepped-down basis. The built-in loss limitation applies to a broader range of transactions than the related-party exception, which disallows losses only on certain distributions to related parties (i.e., more-than-50 percent shareholders). The built-in loss limitation can apply to distributions of property to any shareholder, including an unrelated party, and to a sale or exchange of property by a liquidating corporation. Because the property does not have a built-in loss on the date of the transfer to the corporation, the built-in loss limitation does not apply. Further, the related-party loss limitation does not apply to a sale of property. Upon the sale, Pink Corporation would recognize the entire $220,000 loss. f. No. The loss would not be recognized. No. $187,000 of the $220,000 realized loss would not be recognized. No. $110,000 of the $220,000 realized loss would not be recognized. Yes. The entire $220,000 realized loss would be recognized. ch20

Ann and Bob form Robin Corporation. Ann transfers property worth $420,000 (basis of $150,000) for 70 shares in Robin Corporation. Bob receives 30 shares for property worth $165,000 (basis of $30,000) and for legal services (worth $15,000) in organizing the corporation. If there is no gain or loss, enter "0" for the amount. a. What gain or income, if any, will the parties recognize on the transfer? Ann recognizes no gain or loss of _________. Bob recognizes ordinary income of ________. b. What basis do Ann and Bob have in the Robin Corporation stock? Ann has a basis of _______, and Bob has a basis of ________ in the stock. c. What is Robin Corporation's basis in the property and services it received from Ann and Bob? Robin Corporation has a basis of ______ in the property Ann transferred and a basis of ________ in the property Bob transferred.

a. Answers: no gain or loss; $0; ordinary income; $15,000. Section 351, which deals with transfers to controlled corporations, provides that gain or loss is not recognized upon the transfer of property to a corporation when certain conditions are met. For example, when a business is incorporated, the owner's economic status remains the same; only the form of the investment has changed. Section 351 exists because Congress believes that tax rules should not impede the exercise of sound business judgment (e.g., a choice of the corporate form of doing business). For example, a taxpayer would think twice about forming a corporation if gain recognition (and the payment of a tax) would always be a consequence. In a like-kind exchange, the recognition of gain is avoided only to the extent the taxpayer receives like-kind property. However, the taxpayer must recognize some or all of the realized gain when receiving "boot" (i.e., property of an unlike kind, such as cash). In general, the definition of property under § 351 is comprehensive. Along with plant and equipment, unrealized receivables of a cash basis taxpayer and installment obligations are considered property. However, the Code specifically excludes "services rendered" from the definition of property. Services are not considered to be property under § 351 for a critical reason. A taxpayer must report as income the fair market value of any consideration received as compensation for services rendered. Consequently, when a taxpayer receives stock in a corporation as consideration for rendering services to the corporation, taxable income results. Ann does not recognize a gain. Bob recognizes ordinary income of $15,000, the value of the services he rendered to the corporation. Bob does not recognize gain on the transfer of property to the corporation. b. Answers: $150,000; $45,000. For a taxpayer transferring property to a corporation in a § 351 transaction, the stock received in the transaction is given a substituted basis. Essentially, the stock's basis is the same as the basis the taxpayer had in the property transferred, increased by any gain recognized on the exchange of property and decreased by boot received. Ann has a basis of $150,000 in her stock, and Bob has a basis of $45,000 in his stock [$30,000 (basis in property transferred) + $15,000 (income recognized) - $0 (boot received)]. c. Answers: $150,000; $30,000. The basis of property received by the corporation generally is determined under a carryover basis rule. This rule provides that the property's basis to the corporation is equal to the basis in the hands of the transferor, increased by the amount of any gain recognized on the transfer by the transferor-shareholder. Robin Corporation has a basis of $150,000 in the property Ann transferred and a basis of $30,000 in the property Bob transferred. However, Robin Corporation capitalizes $15,000 as organizational expenditures for the legal services that Bob provided. CH18

Schedule M-1 of Form 1120 is used to reconcile financial accounting net income with taxable income reported on the corporation's income tax return as follows: Net income per books + Additions - Subtractions = Taxable income. Classify each of the following items as an "Addition" or a "Subtraction" in the Schedule M-1 reconciliation. a. Life insurance proceeds received upon death of covered executive. b. Tax depreciation in excess of book depreciation. c. Federal income tax per books. d. Capital loss in excess of capital gain. e. Charitable contributions in excess of taxable income limitation. f. Premiums paid on life insurance policies covering executives (corporation is beneficiary).

a. Subtraction. Although included in book income, life insurance proceeds are not taxable; thus not included in taxable income. b. Subtraction. Many assets are depreciated quicker for tax than for book purposes. Consequently, an additional expense (a subtraction from / reduction in) in book income adjustment is necessary. c. Addition. If a company takes an expense for Federal income taxes in their book income, this would be added back as Federal income taxes is not an allowable expense when computing taxable income. d. Addition. The excess of capital losses over capital gains (deducted for financial accounting purposes but not deductible by corporations for income tax purposes) would be added back to book income. e. Addition. Charitable contributions in excess of the 10% ceiling application to corporations would be added back to book income. f. Addition. Although an expense taken per book income, the premiums paid on life insurance policies of executives where the corporation is the beneficiary is not deductible for tax purposes. This expense would be added back to book income. CH17

The gross estate of Raul, decedent, includes stock in Iris Corporation (E & P of $8,000,000) valued at $6,000,000. At the time of his death, Raul owned 60% of the Iris stock outstanding and he had a basis of $840,000 in the stock. The death taxes and funeral and administration expenses related to Raul's estate amount to $2,000,000, and the adjusted gross estate is $16,000,000. The remainder of the Iris stock is owned by Monica, Raul's daughter and sole heir of his estate. Indicate whether the following are tax consequences to Raul's estate if Iris Corporation distributes $6,000,000 to the estate in redemption of all of its stock in the corporation. Select "Yes" or "No", whichever is applicable. a. As to the Iris stock redeemed, the estate recognizes no gain or loss. b. $4,000,000 portion of the distribution is treated as dividend distribution. c. Under the § 318 stock attribution rules, shares owned by an heir are not deemed to be owned in full by the estate. d. The estate's basis in the Iris stock is stepped up to the fair market value at date of death. e. The distribution qualifies as a § 303 redemption to pay death taxes to the extent of $2,000,000.

a. Yes. An estate's basis in property acquired from a decedent is generally the property's fair market value on the date of death. Typically, there is little change in the fair market value of stock from the date of a decedent's death to the date of a redemption to pay death taxes. When the redemption price in a redemption to pay death taxes is the same as the estate's basis in the stock, the estate will recognize no gain (or loss) on the transaction. The estate's basis in the Iris stock is stepped up to the $6,000,000 fair market value at date of death. As to the Iris stock redeemed under § 303 for $2,000,000, the estate recognizes no gain or loss [$2,000,000 (proceeds qualifying for § 303 treatment) - $2,000,000 (estate's stepped-up basis in shares)] b. Yes. A distribution qualifies as a § 303 redemption to pay death taxes is limited to the extent of the death taxes and funeral and administration expenses, or $2,000,000. The remainder of the distribution, $4,000,000, does not qualify for sale or exchange treatment under § 303; instead, that portion of the distribution must be tested under the § 302 qualifying stock redemption provisions. Under the § 318 stock attribution rules, shares owned by an heir are deemed to be owned in full by the estate. Therefore, Raul's estate is deemed to own the Iris shares owned by its sole heir, Monica, or 100% of the Iris stock outstanding after the redemption. Thus, $4,000,000 of the distribution satisfies none of the § 302 qualifying stock redemption provisions and, instead, is treated as a dividend distribution to the estate. c. No. Under the § 318 stock attribution rules, stock owned by a beneficiary or an heir is deemed to be owned in full by an estate or a trust. Therefore, Raul's estate is deemed to own the Iris shares owned by its sole heir, Monica, or 100% of the Iris stock outstanding after the redemption. d. Yes. An estate's basis in property acquired from a decedent is generally the property's fair market value on the date of death. Therefore, the estate's basis in the Iris stock is stepped up to the $6,000,000 fair market value at date of death. e. Yes. Section 303 applies only to a distribution made with respect to stock of a corporation that is included in the gross estate of a decedent and whose value exceeds 35 percent of the value of the adjusted gross estate. The fair market value of the Iris Corporation stock included in Raul's estate exceeds 35% of the value of the adjusted gross estate ($6,000,000 ÷ $16,000,000 = 37.5%). Thus, the distribution qualifies as a§ 303 redemption to pay death taxes to the extent of the death taxes and funeral and administration expenses, or $2,000,000. CH19

Classify each of the following as "Yes" (a tax consequence) or "No" (not a tax consequence) regarding a § 338 election. a. The subsidiary is treated as having sold its assets on the qualified stock purchase date for a value that is determined with reference to the parent's basis in the subsidiary stock. b. The deemed sale of assets results in gain or loss recognition to the subsidiary corporation. c. The deemed purchase results in a new stepped-up basis for the subsidiary's assets. d. The new basis in the subsidiary's assets carries over to the parent corporation if the subsidiary corporation is not liquidated.

a. Yes. Upon making a § 338 election, the subsidiary is treated as having sold its assets on the qualified stock purchase date for a value that is determined with reference to the parent's basis in the subsidiary stock plus any liabilities of the subsidiary. The deemed sale of assets results in gain or loss recognition to the subsidiary corporation. b. Yes. Upon making a § 338 election, the subsidiary is treated as having sold its assets on the qualified stock purchase date for a value that is determined with reference to the parent's basis in the subsidiary stock plus any liabilities of the subsidiary. The deemed sale of assets results in gain or loss recognition to the subsidiary corporation. c. Yes. The deemed sale results in gain (or loss) recognition to the subsidiary, and the deemed purchase results in a stepped-up (or -down) basis for the subsidiary's assets. d. No. The subsidiary may, but need not, be liquidated. If the subsidiary is liquidated, the parent will obtain a carryover of the stepped-up (or -down) basis of the subsidiary's assets. ch20

On January 1, Year 1, Kee Corp., a C corporation, had a $50,000 deficit in E&P. For Year 1, Kee had current E&P of $10,000 and made a $30,000 cash distribution to its shareholders. What amount of the distribution is taxable as dividend income to Kee's shareholders?

$10,000 Treatment of a distribution is determined by reference to accumulated E&P only after any current E&P have been accounted for. To the extent current E&P are sufficient to cover a distribution, the distribution is treated as a taxable dividend, even if there is a deficit in the accumulated E&P. Thus, the current E&P of $10,000 results in ordinary dividend income to Kee's shareholders of $10,000. ch18 ch19

John Budd is the sole shareholder of Ral Corp., an accrual-basis taxpayer engaged in wholesaling operations. Ral's retained earnings at January 1, 2020, amounted to $1 million. For the year ended December 31, 2020, Ral's book income, before federal income tax, was $300,000. Included in the computation of this $300,000 were the following: Dividends received on 500 shares of stock of a taxable domestic corporation that had 1,000,000 shares of stock outstanding (Ral had no portfolio indebtedness) $1,000 Loss on sale of investment in stock of unaffiliated corporation (this stock had been held for 2 years; Ral had no other capital gains or losses) (5,000) In computing taxable income for 2020, Ral should deduct a capital loss of

$0 A corporation may deduct capital losses in the tax year incurred but only to the extent of capital gains (without regard to whether they are short or long term). ch17

Lark Corporation and its wholly owned subsidiary, Day Corporation, both operated on a calendar year. In January Year 1, Day adopted a plan of complete liquidation. Two months later, Day paid all of its liabilities and distributed its remaining assets to Lark. These assets consisted of the following: Cash $50,000 Land (at cost) 10,000 Fair market value of the land was $30,000. Upon distribution of Day's assets to Lark, all of Day's capital stock was canceled. Lark's basis for the Day stock was $7,000. Lark's recognized gain on receipt of Day's assets in liquidation was

$0 A parent corporation recognizes no gain or loss upon the receipt of a liquidating distribution from a controlled corporation. Control means ownership of at least 80% of the subsidiary's voting power and 80% of the total value of the stock. The parent corporation takes a carryover basis and holding period in the property received in the liquidation, and its basis in the subsidiary's stock disappears. ch20

For the year ended December 31, 2020, Kell Corp.'s book income, before income taxes, was $70,000. Included in the computation of this $70,000 was $10,000 of proceeds of a life insurance policy, representing a lump-sum payment in full as a result of the death of Kell's controller. Kell was the owner and beneficiary of this policy since 2005. In its income tax return for 2020, Kell should report taxable life insurance proceeds of

$0 For employer-owned policies issued prior to August 17, 2006, proceeds of a life insurance policy paid by reason of death of the insured are excluded by the beneficiary. Since no part of the $10,000 represents interest on proceeds retained by the insurance company, no part of it is reported as gross income. ch17

Forrest Corp. owned 100% of both the voting stock and total value of Diamond Corp. Both corporations were C corporations. Forrest's basis in the Diamond stock was $200,000 when it received a lump sum liquidating distribution of property as a result of the redemption of all of Diamond stock. The property had an adjusted basis of $270,000 and a fair market value of $500,000. What amount of gain did Forrest recognize on the distribution?

$0 Neither the parent corporation nor a controlled subsidiary recognizes gain or loss on a liquidating distribution to the parent. Control means the parent owns 80% or more of both the voting power and total value of the stock of the liquidating corporation. Forrest Corp. controls Diamond Corp. because it owns 100% of both the voting stock and total value of Diamond Corp. Therefore, Forrest does not recognize any gain on the liquidating distribution. ch20

During 2020, Jake transferred land having an adjusted basis of $35,000 and a fair market value of $47,000 to Otter Corporation. In exchange for the land, he received $5,000 cash, equipment having an adjusted basis of $3,000 and a fair market value of $5,000, and 80% of Otter Corporation's only class of stock outstanding. The stock received by Jake had a fair market value of $37,000. What is the amount of gain that Jake will recognize?

$10,000 The realized gain equals the fair market value of property received ($37,000 stock + $5,000 equipment + $5,000 cash) less the adjusted basis of the property transferred ($35,000), or $12,000. If other property or money is received in addition to the stock, any gain realized by the recipient is recognized but not in excess of the sum of the money plus the fair market value of other property received. The sum of boot property received is $10,000 ($5,000 equipment + $5,000 cash). Thus, $10,000 is the recognized gain. ch18 ch19

In 2020, Pine Corporation had losses of $20,000 from operations. It received $180,000 in dividends from a 25%-owned domestic corporation. Pine's taxable income is $160,000 before the dividends-received deduction. What is the amount of Pine's dividends-received deduction?

$104,000 A corporate deduction for dividends received from domestic taxable corporations is allowed. Pine Corporation may deduct 65% of dividends received from a domestic corporation in which Pine owned between 20% and 80% of the stock. This dividends-received deduction is limited to 65% of taxable income. Without regard to the limitation, Pine could deduct $117,000 ($180,000 × 65%). Pine, however, is limited to a $104,000 deduction ($160,000 taxable income × 65%). Thus, Pine's dividends-received deduction is $104,000. ch17

In 2020, Garland Corp. contributed $100,000 to a qualified charitable organization. Garland's 2020 taxable income before the deduction for charitable contributions was $410,000. Included in that amount was a $20,000 dividends-received deduction. Garland also had carryover contributions of $10,000 from the prior year. In 2020, what amount can Garland deduct as charitable contributions?

$107,500 The charitable contribution deduction for corporations is limited to 25% of the taxable income computed before the charitable contribution deduction, dividends-received deduction, and capital loss carryback. Garland's charitable contribution deduction should be $107,500 [($410,000 + $20,000) × 25%]. ch17

You transfer property with an adjusted basis of $20,000 and a fair market value of $31,000 in exchange for 100% of the stock in a new corporation. You receive 100 shares of stock having a fair market value of $16,000 and $10,000 in cash. The corporation also assumes a $5,000 mortgage on the property. Which of the following is correct?

$11,000 gain realized; $10,000 recognized. The gain realized on this transaction is $11,000 [($16,000 FMV of stock + $10,000 cash + $5,000 assumption of liability) - $20,000 adjusted basis of transferred property]. However, the transaction qualifies under Sec. 351 for nonrecognition. Transfer of mortgaged property to a controlled corporation does not require the recognition of gain unless the liabilities transferred or assumed are greater than the basis of all the property transferred. Accordingly, the only gain that must be recognized is the gain attributable to the amount of boot property received. The $10,000 cash received is boot property. ch18 ch19

Porter Corporation, a calendar-year taxpayer reporting on the accrual basis, had accumulated earnings and profits of $110,000 as of January 1, 2020. The following occurred during the year: Taxable income $46,000 Unused charitable contributions 1,800 Depreciation claimed on return --MACRS (straight-line would have been $4,500) 5,600 Federal income tax accrual 5,400 Net capital losses (3,200) What is the amount of Porter Corporation's accumulated earnings and profits (E&P) as of December 31, 2020?

$146,700 Calculation of E&P begins with taxable income according to the tax return. Nondeductible expenditures are subtracted from taxable income, e.g., federal income taxes, charitable contributions in excess of the percentage of taxable income limitation, and net capital losses. Also, E&P are calculated based upon straight-line depreciation using the alternative depreciation system, so excess MACRS depreciation must be added back. E&P at January 1, 2020 $110,000 Taxable income for 2020 46,000 Add: Excess depreciation 1,100 Deduct: Excess contributions (1,800) Net capital loss (3,200) Federal income taxes (5,400) E&P at December 31, 2020 $146,700 ch18 ch19

T, a calendar-year corporation that began doing business 10 years ago, had $35,000 in accumulated earnings and profits on January 1 of this year. T had an operating loss of $60,000 for the first 6 months of this year but had $10,000 in earnings and profits for the entire year. T made a distribution of $25,000 cash to its shareholders on April 1 this year. What is the amount of T's accumulated earnings and profits at the close of business on December 31?

$20,000 Determination must first be made as to whether or not the cash distribution is a dividend. Section 316 defines a dividend as a distribution of earnings and profits. Regulation 1.316-1(a)(1)(ii) states that current E&P is to be computed at the end of the tax year without regard to distributions during the year. At December 31 of this year, T has a current E&P of $10,000 and accumulated E&P of $35,000. The cash distribution comes first from current E&P ($10,000 - $10,000 = $0), with the balance from accumulated E&P, thereby leaving a $20,000 balance ($35,000 - $15,000). ch18 ch19

Corporation W, which uses the accrual method of accounting, had earnings and profits of $95,000 on December 31, Year 1. Based on the following information, compute earnings and profits as of December 31, Year 2: Taxable income per return $185,000 Contributions in excess of 10% limitation 1,500 Interest paid for tax-exempt bonds 1,000 Tax-exempt interest received 3,000 Federal income taxes 55,400 MACRS depreciation in excess of straight-line alternative depreciation system 1,500

$226,600 Calculation of earnings and profits begins with taxable income according to the tax return. Tax-exempt income is added to the taxable income, and nondeductible expenditures are subtracted, e.g., federal income taxes, charitable contributions in excess of the 10% limitation, and interest paid for tax-exempt bonds. Also, earnings and profits are calculated based upon straight-line depreciation using the alternative depreciation system, so excess MACRS depreciation must be added back.E&P at December 31, Year 1$ 95,000Taxable income for Year 2185,000Add: Tax-exempt interest3,000Excess depreciation1,500Deduct: Excess contributions(1,500)Interest paid on tax-exempt bonds(1,000)Federal income taxes(55,400)E&P at December 31, Year 2$226,600 ch18 ch19

Quigley, Roberk, and Storm form a corporation. Quigley exchanges $25,000 of legal fees for 30 shares of stock. Roberk exchanges land with a basis of $10,000 and a fair market value of $100,000 for 60 shares of stock. Storm exchanges $10,000 cash for 10 shares of stock. What amount of income should each shareholder recognize? Quigley Roberk Storm

$25,000 $90,000 $0 Section 351 requires that no gain or loss be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in the corporation and immediately after the exchange, such person or persons control the corporation. Control is ownership of at least 80% of the voting stock and at least 80% of the nonvoting stock; however, stock exchanged for services is not counted toward the 80%. Since Quigley received his stock for services, only Roberk and Storm are counted toward control, and they only own 70% of the stock. Therefore, Sec. 351 does not apply. The $25,000 of legal fees contributed by Quigley is recognized as compensation for services, Roberk must recognize a gain of $90,000 ($100,000 FMV land - $10,000 AB land), and Storm recognizes no gain because his shares were paid for with cash. CH18 ch19

Two unrelated individuals, Dave and Tom, own all the stock of Arnold Corporation, which has earnings and profits of $400,000. Because of his inactivity in the business for the last several years, Dave has decided to retire from the business completely and move to Oregon. Accordingly, Arnold Corporation will redeem all the stock owned by Dave and, in return, Dave will receive a distribution of $500,000. Dave's adjusted basis in the stock is $250,000. What will be the tax effect to Dave?

$250,000 capital gain. Under Sec. 302(b)(3), if a corporation redeems all of its stock owned by a shareholder, the redemption is treated as a distribution in part or full payment in exchange for the stock. Since Arnold Corporation redeemed all of Dave's stock, the $500,000 distribution is treated as payment for the stock, and any gain is treated as capital gain. The amount of the gain is computed under Sec. 1001 and is the amount by which the distribution exceeds the shareholder's basis in the stock. In this case, the gain is $250,000 ($500,000 distribution - $250,000 basis). Since the stock is a capital asset, the recognized gain is a capital gain. Because the distribution is treated as being in exchange for the stock and not as a dividend, the amount of the corporation's earnings and profits is irrelevant. Earnings and profits affect distributions only when those distributions have the character of dividends. ch20

Francis Corporation had taxable income of $260,000 for its initial taxable year. A review of company records revealed the following information: 1. The current-year tax depreciation expense on furniture and fixtures, the only asset owned by Francis Corporation, was $10,000. If Francis had used the alternative depreciation system (straight-line method), depreciation expense deducted would have been $5,000. 2. Francis had tax-exempt interest income of $22,000 that has not been included in taxable income. 3. Francis paid dividends of $16,000 that were not deducted. 4. Francis had $20,000 of returns and allowances that were deducted on the return. 5. Francis reported a $20,000 gain on an installment sale of a noninventory item. The total gain on the sale was $100,000. Earnings and profits for Francis Corporation at the close of the current year were

$351,000 In computing earnings and profits of a corporation, all income that is nontaxable or exempt from tax is added to taxable income. The earnings and profits are reduced by any expenditures or expenses of the corporation that are not deductible for tax purposes. Depreciation is usually determined under the alternative depreciation system (straight-line method). If depreciation reported for tax purposes exceeds straight-line depreciation, the difference is added back to taxable income. A corporation that sells property on the installment basis is treated for earnings and profits purposes as if it had not used the installment method. No adjustment is required for returns and allowances since deducting returns and allowances is an acceptable tax accounting procedure for computing taxable income and earnings and profits. The computation of earnings and profits for Francis Corporation in the current year is as follows: Taxable income $260,000 Depreciation ($10,000 - $5,000) 5,000 Tax-exempt interest income 22,000 Installment sale gain not reported fortax purposes ($100,000 - $20,000) 80,000 Current earnings and profits $367,000 Less: Dividends paid out of current earnings and profits (16,000) Earnings and profits balance $351,000 ch18 ch19

John Budd is the sole shareholder of Ral Corp., an accrual-basis taxpayer engaged in wholesaling operations. Ral's retained earnings at January 1, 2020, amounted to $1 million. For the year ended December 31, 2020, Ral's book income, before federal income tax, was $300,000. Included in the computation of this $300,000 were the following:Key employee insurance premiums paid on Budd's life (Ral is the beneficiary of this policy.)$3,000Group term insurance premiums paid on $10,000 life insurance policies for each of Ral's four employees (The employees' spouses are the beneficiaries.)4,000What amount should Ral deduct for key employee and group life insurance premiums in computing taxable income for 2020?

$4,000 Ral Corp. may deduct the premiums paid for group term life insurance. However, no deduction is allowed for premiums paid for life insurance for which the corporation is the beneficiary. ch17

As an investment, Rambo Corporation owns 10% of the stock of Duntulum Corporation with a basis of $8,000 and a market value of $50,000. Rambo uses the Duntulum stock to redeem approximately 1%, or $10,000 par value, of its own outstanding stock from unrelated, noncorporate shareholders. As a result of this transaction, Rambo must report

$42,000 gain. The general rule is that a corporation does not recognize gain or loss on the distribution of property with respect to its stock. But a corporation that distributes appreciated property must recognize gain equal to the excess of the FMV of the property over its adjusted basis, as if the stock were sold to the distributee immediately before the exchange. The recognized gain is $42,000 ($50,000 - $8,000). ch20

Danny owns 35% of Batch Corporation's only class of stock outstanding. His daughter Ann and son-in-law Tony each own 20%. Ann is legally separated from Tony. Danny's father owns 25% of Batch's outstanding stock. What is Ann's percentage of stock ownership under the attribution rules for stock redemption?

55% Under Sec. 318, a shareholder is considered to constructively own stock that is in fact owned by another shareholder. Section 318(a)(1)(A) states that a shareholder is considered to own the stock owned by the shareholder's spouse, children, grandchildren, and parents. However, Sec. 318(a)(1)(A) excludes a spouse who is legally separated from the shareholder. Therefore, Ann constructively owns 55% of the stock (Ann's 20% and her father's 35%). ch20

Omar, an individual in the 37% tax bracket, wants to shift some of his income to a new corporation in order to take advantage of the 21% corporate tax rate. Omar plans to avoid any tax on dividends by retaining all earnings within the corporation. Will Omar's plan work? Omar's ability to achieve tax savings by shifting income to a corporation may be limited by either AET or PHC . Omar could be subject to a ________% penalty tax on undistributed income retained by the corporation.

Answer: either AET or PHC; 20%; undistributed income retained by. The accumulated earnings tax imposes a 20 percent tax on the current year's corporate earnings that have been accumulated without a reasonable business need. The personal holding company (PHC) tax was enacted to discourage the sheltering of certain kinds of passive income in corporations owned by individuals with high marginal tax rates. Like the accumulated earnings tax, the PHC tax employs a 20 percent rate and is designed to force a corporation to distribute earnings to shareholders. However, in any single year, the IRS cannot impose both the PHC tax and the accumulated earnings tax. Generally, a company is considered a PHC and may be subject to the tax if: More than 50 percent of the value of the outstanding stock is owned by five or fewer individuals at any time during the last half of the year, and A substantial portion (60 percent or more) of the corporation's income is comprised of passive types of income including dividends, interest, rents, royalties, or certain personal service income. Omar's ability to achieve tax savings by shifting income to a corporation may be limited by either the accumulated earnings tax (AET) or the personal holding company (PHC) tax. The AET and PHC tax are designed to prevent corporations and their shareholders from avoiding the double tax on dividend distributions. Both provisions impose a 20% penalty tax on undistributed income retained by a corporation. Thus, Omar's tax savings will be dependent on whether either of these taxes apply. CH17

A group of corporations (A, B, C, D, and E) all having only one class of stock have the following ownership and classification: Corp. A -- Domestic corporation that owns 85% of B, 20% of C, and 100% of E's outstanding stock Corp. B -- Domestic corporation that owns 70% of C and 100% of D's outstanding stock Corp. C -- Domestic corporation that owns 10% of A's stock Corp. D -- B's Foreign Sales Corporation (FSC) Corp. E -- Foreign corporation that owns 10% of C and 5% of B's stock Which are members of an affiliated group?

A, B, and C. Under Sec. 1504(a), an affiliated group means one or more chains of includible corporations connected through stock ownership with a common parent corporation if at least 80% of the total voting power and value is owned directly by one or more of the other corporations, and if the common parent corporation owns directly at least 80% of the total voting power and value of at least one of the other corporations. Although Corporations D and E are wholly owned, they are not members of the affiliated group because foreign corporations (which include FSCs) are excluded from the definition of includible corporations by Sec. 1504(b). Corporation A is the common parent because it owns 85% of Corporation B directly, and Corporation A combined with Corporation B owns 90% of Corporation C. Thus, Corporations A, B, and C are members of an affiliated group. ch17

What is the usual result to the shareholders of a distribution in complete liquidation of a corporation?

Capital gain or loss. Capital gain or loss treatment is the usual result of a distribution received by a shareholder in complete liquidation of a corporation. The gain or loss is long-term or short-term, depending on the length of time the stock has been held. The shareholder's gain or loss is the difference between the amount realized and the basis in the stock. ch20

Donna exchanges property having an $18,000 adjusted basis and a $35,000 fair market value for 70 shares of the newly created Table Corporation stock. Evelyn exchanges legal services worth $15,000 for the remaining 30 shares of Table Corporation stock. Which of the following is true?

Evelyn must recognize $15,000 of income, and Donna must recognize $17,000 gain on the exchange. Section 351(a) provides that no gain or loss is recognized if one person or more transfers property to a corporation solely in exchange for stock in such corporation and if, immediately after the exchange, such person or persons are in control of the corporation. "Control" is defined in Sec. 368(c) as the ownership of stock possessing at least 80% of the total combined voting power of all classes of voting stock and at least 80% of the total number of shares of all other classes of stock. However, a tax-free transfer to a controlled corporation applies only to a transfer of property. A transfer of services in exchange for stock is fully taxable. Accordingly, Evelyn must recognize $15,000 of income for the legal services provided. Donna must recognize $17,000 ($35,000 - $18,000) of gain because she is not in control of the corporation for purposes of nonrecognition under Sec. 351. Since Evelyn provided only services, her shares are not counted when determining control. ch18 ch19

Lincoln Corp., a calendar-year C corporation, made a nonliquidating cash distribution of $1.5 million to its shareholders with respect to its stock. At that time, Lincoln's current and accumulated earnings and profits totaled $825,000, and its total paid-in capital for tax purposes was $10 million. Lincoln had no corporate shareholders. Which of the following statements, if any, are true regarding Lincoln's cash distribution? I. The distribution was taxable as $1.5 million in dividends to its shareholders. II. The distribution reduced its shareholders' adjusted bases in Lincoln stock by $675,000.

II only. In general, any distribution of money or property made by a corporation to its shareholders with respect to their stock out of the corporation's earnings and profits is treated as a taxable dividend. The current and accumulated earnings and profits therefore determine the level of taxability. The dividend will equal $825,000. The remaining distribution of $675,000 will reduce the adjusted bases of shareholders' stock, as it is treated as a return of capital. Therefore, only Statement II is correct. ch18 ch19

Which of the following costs are amortizable organizational expenditures?

Legal fees for drafting the corporate charter. A corporation is deemed to elect to deduct up to $5,000 (subject to a phase-out) of qualified organizational expenses. Any remaining amount is amortized over a period of 180 months. Expenditures associated with the formation of the corporation, including legal fees for drafting the corporate charter, are amortizable. ch17

In 2011, Mr. P purchased stock for $1,000. In 2019, he received a return of capital of $800 and reduced the basis of his stock by that amount. In 2020, he received return of capital of $300, which reduced the basis of his stock to zero. At no time did the corporation have earnings and profits (E&P). He would report the $100 that was in excess of his basis as

Long-term capital gain. A corporate distribution is a "dividend" that must be included in the recipient's gross income under Sec. 301(c)(1) to the extent it comes from current or accumulated earnings and profits of a corporation. To the extent the distribution exceeds current and accumulated earnings and profits, it is treated as a return of capital to the shareholder. Once the basis of the stock has been reduced to zero, any distributions received are treated as a gain from the sale of the stock. Mr. P's capital gain is long-term because he held the stock for more than 1 year. ch18 ch19

Which of the following groups may elect to file a consolidated corporate return?

Members of an affiliated group. A single federal income tax return may be filed by two or more includible corporations that are members of an affiliated group. Includible corporations are all corporations except (1) tax-exempt corporations, (2) S corporations, (3) foreign sales corporations, (4) insurance corporations, (5) REITs, (6) regulated investment companies, and (7) domestic international sales corporations. An affiliated group includes each corporation in a chain of corporations under the following conditions:The other group members must directly own stock in the corporation that represents 80% or more of both total voting power and total value outstanding.A parent corporation must directly own stock under the 80% rules of at least one includible corporation. CH17

Which one of the following is a corporate reorganization as defined in the Internal Revenue Code?

Mere change in place of organization of one corporation. A mere change in place of organization of one corporation qualifies as a corporate reorganization. Unless a transaction fits one of the reorganization types as defined in the IRC, the tax-free treatment of exchanges in reorganization does not apply. ch20

Ms. Glantz owns all 100 shares of Remsen Company. These shares were all acquired on February 18, 2011. Ms. Glantz's basis in the stock is $20,000. Remsen Company adopted a plan of complete liquidation and distributed $56,000 to Ms. Glantz. Ms. Glantz received $16,000 in 2019 and $40,000 in 2020. How much gain or loss is recognized by Ms. Glantz in 2019 and 2020?

No gain or loss in 2019 and $36,000 gain in 2020. When a series of liquidating distributions is made, the shareholder must use the cost recovery method for recognition of gain or loss. Each payment received is first applied against the basis of the stock. When basis is exceeded, a gain must be recognized. Ms. Glantz received $16,000 in 2019. This $16,000 distribution reduced Ms. Glantz's basis in the stock, but no gain was recognized in 2019 because she still had basis in the stock of $4,000. In 2020, Ms. Glantz received $40,000 that completely exhausted her basis. The remaining excess of $36,000 is recognized as a gain in 2020. ch20

During 2020, Marlene, Nancy, and Olive formed a new corporation. Solely in exchange for stock, Marlene and Nancy contributed appreciated property, while Olive contributed services. The exchanges of Marlene and Nancy will be nontaxable if

Olive receives 10% of the stock. Section 351 states that no gain or loss is recognized when property is transferred to a corporation in exchange for the corporation's stock if the person(s) transferring the property is(are) in control of the corporation immediately after the transfer. "Control" is defined by the Code as at least 80% ownership of the corporation's voting and nonvoting stock. If Olive receives 10% of the stock, then Marlene and Nancy together will receive the remaining 90%. Thus, 90% ownership interest qualifies Marlene and Nancy for tax-free treatment. Olive is not able to receive the tax-free treatment because she gave only services and not property. The FMV of the stock Olive receives will be included in her gross income. ch18 ch19

With regard to consolidated tax returns, which of the following statements is true?

Operating losses of one group member may be used to offset operating profits of the other members included in the consolidated return. Operating losses of one group member must be used to offset current-year operating profits of other group members before a net operating loss carryforward can occur. ch17

Orson Corp. had an E&P deficit of $160,000 at December 31, 2019. Its net income per books was $80,000 for 2020. Cash dividends on common stock totaling $40,000 were paid in December 2020. Orson should report the distribution to its shareholders as

Ordinary dividends 100%. A corporate distribution is a dividend and is included in the recipient's income to the extent it comes from accumulated or current E&P. A distribution is considered made from the most recently accumulated E&P. Orson's distribution comes entirely from the $80,000 in current E&P even though there is a deficit in accumulated E&P. Note that E&P are not the same as net income; however, if there is $80,000 of net income, there will likely be sufficient E&P for the dividend. The distribution is, therefore, entirely ordinary dividend income to the shareholders. ch18 ch19