mod 8

Candles, Inc. distributes some defective candles to its shareholders. The market value of the candles was $20,000 (adjusted basis = $60,000). What are the tax consequences of the distribution to Candles?

$0 gain or loss recognized Reason: No loss is recognized on the distribution of noncash property by a corporation. E&P is reduced by the E&P basis in the property.

Which of the following are the characteristics of a distribution defined as a dividend? (Check all that apply.)

*Out of the earnings and profits *distribution of cash or other property *Made to shareholders *Made by a corporation

Aztec Corp. is calculating its current E&P and is considering the following items: Federal income taxes paid $50,000 Political contributions to the state governor's race $5,000 Fines and penalties $1,000 Ordinary and necessary business expenses $50,000 Salaries paid to owner/employees $30,000 Which of the items above should Aztec deduct when adjusting its taxable income to get to E&P? (Check all that apply.)

-Fines and penalties -Political contributions -Federal income taxes

Mitt redeems his entire ownership of stock in Dawn Key Corp. However, Mitt's sons, Rick and Newt, own all of the remaining shares of Dawn Key Corp. after the redemption. What are the requirements that Mitt must meet to waive the family attribution rules for this redemption? (Check all that apply.)

-Mitt may NOT serve as a shareholder, director, officer or consultant for Dawn Key. -Mitt must notify the IRS if he acquires a prohibited interest within 10 years of the redemptions.

When a corporation pays a distribution that is characterized as a dividend, the corporation _______ the dividend from taxable income.

does NOT deduct Reason: Corporations do NOT deduct dividends from taxable income, thus resulting in double-taxation of corporate earnings.

Dividends are taxable at both the corporate and shareholder level, resulting in ______ taxation. (Enter only one word per blank.)

double/multiple

A complete redemption of all the stock of the corporation owned by a shareholder is always treated as a(n):

exchange

The amount of a corporate distribution to a shareholder of property, other than cash, is determined by its ______.

fair market value

When a corporation distributes property to a shareholder in a redemption, it is required to recognize ____, but may NOT recognize ____.

gains losses

Fleck Corporation redeemed stock from a shareholder in exchange for $20,000. The redemption qualified as a dividend. As a result, Fleck will ______.

reduce E&P by $20,000

Vebos, Inc. distributes $10,000 cash and a machine with a fair market value of $5,000 (adjusted basis to Vebos of $200 at the time of distribution) to its shareholder Jody. Vebos had current E&P of $100,000 at the distribution. What is the amount and character of the distribution to Jody?

$15,000 dividend Reason: $10,000 cash + $5,000 FMV of property is all paid from E&P.

Rebellion, Inc. distributes property worth $20,000 (adjusted basis = $5,000) to its shareholder, Jerry. Rebellion's current E&P was $100,000 at the time of distribution. What is Jerry's basis in the property received?

$20,000 Reason: The basis in the property received is the fair market value.

The potential tax consequences of a corporate distribution of cash or other tangible property to a shareholder are ______. (Check all that apply.)

-a gain from the sale of stock -a non-taxable return of the shareholder's capital -a dividend included in gross income Reason: A corporate distribution can be a dividend, return of capital or gain.

Rules designed to treat shares owned by family members or other related parties as shares owned by the shareholder are known as the _____ ______ rules. (Check all that apply.)

-constructive ownership -stock attribution Reason: The constructive ownership or stock attribution rules control how to treat shares owned by family members.

Individuals prefer exchange treatment for redemptions due to the ______. (Check all that apply.)

-increased ability to deduct capital losses -reduction in the amount of income for the adjusted basis

In order to qualify for exchange treatment as a redemption that is NOT essentially equivalent to a dividend, the redemption must ______ (Check all that apply.)

-result in a meaningful reduction of the shareholder's proportionate interest in the corporation Reason: Under a Supreme Court decision, a meaningful reduction is required. -result in the shareholder's voting power being below 50% Reason: The less than 50% ownership test must be met.

A stock redemption could result in

-sale treatment with a gain or loss recognized by the shareholder -dividend treatment, taxable at preferential rates Reason: A stock redemption will be treated as a dividend only if it fails the definition of a redemption under tax law.

Corporate distributions to shareholders are treated in the following order.

1. Dividend to the extent of E&P included in gross income 2. Non-taxable return of capital that reduces the shareholders basis 3. Gain from sale or exchange of stock

GW Corp. has two shareholders; Devana owns 40 shares and Alpine Corp. owns the other 60 shares. Devana is a 40% shareholder in Alpine Corp. Under the attribution rules for the change in stock ownership tests in a redemption, how many shares of GW Corp. are attributed to Devana?

40 Reason: Devana owns 40 shares directly. Because her ownership in Alpine is less than 50%, none of those shares are attributed to her.

Kevin directly owns 50 shares of Sharon Company stock. He is a 50% partner in AMI Partnership which also owns 50 shares of Sharon. Prior to any stock redemption, how many shares of stock are attributed to Kevin?

75 Reason: The 50 shares Kevin holds directly + 25 shares (50% x 50) of the shares held by AMI.

True or false: The family attribution rules can be waived in a complete redemption of stock by a shareholder.

True Reason: The family attribution rules can we waived in a complete redemption subject to restrictions.

Walnut Corporation has one class of stock with 500 shares outstanding. Chuck owns 200 of the shares and wants to redeem some of them for other property. In order for redemption to be treated as an exchange, Chuck ______.

must redeem at least 59 shares Reason: Chuck owns 40% of the shares (200 ÷ 500). In order to meet the 80% test, Chuck needs his ownership percentage to drop below 32% (40% × 80%). Walnut must redeem 59 shares [(200-x)/(500-x) < 32%] in order to meet the 80% test.

A corporation that distributes additional shares of its own stock with respect to existing shares already held by shareholders has made a ________ ________.

stock dividend/split/distribution

Distributions come out of E&P in the following order.

Current, then accumulated Reason: Dividends first come from current E&P, then from accumulated E&P.

Cougar, Inc. has correctly computed the following information for tax purposes: Taxable income $200,000 Federal income taxes $60,000 Cougar's income includes: Dividends received deduction $5,000 Meals $4,000 (8,000 x 50% limit) $3,000 business fine Cougar did not include $10,000 of municipal bond interest and deferred gain from an installment sale of $20,000. What is Cougar's current E&P for the year?

Reason: $200,000 - $60,000 (taxes) + $5,000 (DRD) - $4,000 (other 50% of meals) + $10,000 (tax-exempt income) + $20,000 (def gain on installment sale) - $3,000 (non-deductible fine) = $168,000.

Match the result of a corporate noncash property distribution with its result.

Taxable gain to the corporation-Fair market value of distributed property exceeds its adjusted basis Loss not recognized-Fair market value of distributed property is less than its adjusted basis

Which of the following does NOT reduce accumulated E&P?

The amount of liabilities assumed by the shareholder on property received

A stock redemption is

an acquisition by a corporation of its own stock from a shareholder in exchange for property

Marcie and her husband, Franklin, each own 50 shares of Chestnut, Inc. Sally, Marcie's old high school friend, owns the remaining 50 shares (150 total shares outstanding). Chestnut redeems 40 of Marcie's shares for $38,000 (her adjusted basis was $5,000). What is the tax treatment of the redemption to Marcie?

$38,000 dividend Reason: As her spouse, Franklin's shares are attributed to Marcie. Thus Marcie owns 60 (her remaining 10 + Franklin's 50) shares of Chestnut's total 110 (150 - 40) outstanding. Because 60 ÷ 110 > 50%, Marcie fails the 50% test and the redemption is treated as a dividend.

Collins, Inc. issued a nontaxable stock dividend of one share for each share owned. Melissa, a shareholder of Collins, had a total basis in her 500 shares of stock of $5,000. The total basis of Melissa's 1,000 shares of stock after the dividend is ______.

$5,000 Reason: Melissa's total basis does not change.

Gopher, Inc. has $40,000 of current E&P and $10,000 of accumulated E&P at the start of the year. The sole shareholder, Carl has a basis in his stock of $20,000. If Gopher distributes $100,000 to Carl, it will be treated as a ______.

$50,000 dividend, $20,000 return of capital, and $30,000 capital gain Reason: Distributions treated as a dividend to the extent of E&P ($50,000), return of capital to extent of basis ($20,000) and excess is capital gain ($30,000).

Macadamia Corp. redeems 60 shares of common stock from Patty in exchange for $50,000. Patty held 100 shares of the 150 total outstanding shares in Macadamia for the past 5 years. Patty's basis in the 60 redeemed shares was $10,000. Assuming Patty has a 15% tax rate on both dividends and long-term capital gains, what is Patty's tax liability from this redemption?

$6,000 Reason: After the exchange Patty owns 40/90 shares (44%) which is less than 50% and also less than 80% of her ownership percentage before the redemption. As a result, her redemption qualifies as an exchange. $50,000 less $10,000 basis = $40,000 x 15% = $6,000.

Gopher, Inc. has $40,000 of current E&P and $50,000 of accumulated E&P at the start of the year. The sole shareholder, Carl has a basis in his stock of $10,000. If Gopher distributes $60,000 cash to Carl, it will be treated as a ______.

$60,000 dividend Reason: Distributions are dividends to the extent of E&P. The first $40,000 comes from current E&P and the next $20,000 ($60,000 less $40,000) comes from accumulated E&P.

Gopher, Inc. has negative $40,000 current E&P and $100,000 of accumulated E&P. Gopher made a $70,000 distribution at the end of the year. What is the character of the distribution?

$60,000 dividend and $10,000 return of capital to the extent of basis. Reason: Total E&P at time of distribution is $60,000 ($100,000 - $40,000). Distribution in excess of total E&P is return of capital.

Gopher, Inc. has negative $40,000 current E&P for 2019. Accumulated E&P at the beginning of the year was $100,000. Gopher made a $70,000 distribution on January 1, 2019. What is the character of the distribution?

$70,000 dividend Reason: Total E&P at time of distribution is $100,000 (no current E&P at start of year) and thus entire distribution is dividend from accumulated E&P.

Storrs-It Corporation distributes land to its shareholder, Jim, that has a fair market value of $36,000 and an attached mortgage of $10,000 (which Jim assumes). Storrs-It has tax and E&P basis of $6,000 in the land. Storrs-It has $100,000 of current E&P (excluding the net of tax gain on the property distribution). What is the total net effect on Storrs-It's E&P from the distribution, assuming a 21% tax rate on the gain?

($2,300) Reason: The FMV of the property exceeds its basis; thus the FMV of the land is a $36,000 reduction of E&P. The liabilities assumed ($10,000) by Jim increase E&P. The gain is $36,000 - $6,000 = $30,000 increase in E& P less taxes of $6,300 ($30,000 x 21%). Net change = ($36,000) + $10,000 + $30,000 - $6,300 = ($2,300)

Marcie and her husband, Franklin, each own 50 shares of Chestnut, Inc. Sally, Marcie's old high school friend, owns the remaining 50 shares (150 total shares outstanding). Chestnut redeems 40 of Marcie's shares for $38,000 (her adjusted basis was $5,000). What is the tax treatment of the basis of the shares redeemed?

Add the $5,000 basis to Marcie's remaining 10 shares. Reason: As her spouse, Franklin's shares are attributed to Marcie. Thus Marcie owns 60 (her remaining 10 + Franklin's 50) shares of Chestnut's total 110 (150 - 40) outstanding. Because 60 ÷ 110 > 50%, Marcie fails the 50% test and the redemption is treated as a dividend. As a result, the unused basis is added to the basis of Marcie's remaining shares.

A measure of a corporation's economic profits is known as

Earnings & Profits

True or false: Under no circumstances will a shareholder who has shares redeemed be able to treat the stock redemption as an exchange unless the shareholder meets the bright line change-in-stock-ownership tests.

False Reason: The not essentially equivalent to a dividend test is still available.

Which of the following is one of the bright line tests of a substantially disproportionate redemption?

The shareholder owns less than 50% of the voting power of the corporation after the redemption.

Almonds, Inc. redeems 25 shares of Lucy's common stock in exchange for $10,000, dropping her ownership from 40 shares to 15. There is only one class of stock and 100 shares were outstanding prior to the redemption. Is Lucy's redemption substantially disproportionate?

Yes Reason: Lucy owns less than 50% (15 ÷ 75). Lucy's percentage ownership went from 40% (40 ÷ 100) to 20% (15 ÷ 75), which is more than the 80% decrease required (32% is 80% of 40%). The market value test is met by virtue of there being only one class of common stock.

When current E&P is negative, the tax status of a distribution is determined by the ______.

accumulated E&P on the date of distribution Reason: total E&P = current E&P + accumulated E&P