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Exam 14: Corporate Nonliquidating and Liquidating Distributions

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Question 41

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A calendar-year corporation has positive current E&P of $500 and accumulated negative E&P of $1,200. The corporation makes a $400 distribution to its sole shareholder. Which of the following statements is true?

A) The distribution will not be a dividend because total earnings and profits is a negative $700.
B) The distribution may be a dividend, depending on whether total earnings and profits at the date of the distribution is positive.
C) The distribution will be a dividend because current earnings and profits is positive and exceeds the distribution.
D) A distribution from a corporation to a shareholder is always a dividend, regardless of the balance in earnings and profits.

E) B) and C)
F) C) and D)

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Question 42

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A distribution from a corporation to a shareholder will only be treated as a dividend for tax purposes if the distribution is paid out of current and/or accumulated earnings and profits.

A) True
B) False

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Question 43

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The term "earnings and profits" is well-defined in the Internal Revenue Code.

Which statement best describes the concept of the double taxation of corporate income?

Unreasonable compensation issues are more likely to arise in IRS audits of privately-held corporations rather than publicly-traded corporations.

Mike and Michelle decided to liquidate their jointly owned corporation, Pennsylvania Corporation. After liquidating its remaining inventory and paying off its remaining liabilities, Pennsylvania had the following tax accounting balance sheet. $\begin{array} { | l | r | } \hline \text { Taxable income } & \$ 1,000,000 \\\hline \text { Add: } & \\\hline \text { NCL carryover From year 1 } & 40,000 \\\hline \text { Subtract: } & \\\hline \text { Federal income taxes } & ( 340,0000 \\\hline \text { Current E \&P } & \$ 700,000 \\\hline\end{array}$ Under the terms of the agreement, Mike will receive the $200,000 cash in exchange for his 40 percent interest in Pennsylvania. Mike's tax basis in his Pennsylvania stock is $50,000. Michelle will receive the building and land in exchange for her 60 percent interest in Pennsylvania. Her tax basis in the Pennsylvania stock is $100,000. What amount of gain or loss does Pennsylvania recognize in the complete liquidation?

Tar Heel Corporation had current and accumulated E&P of $500,000 at December 31 year 1. On December 31, the company made a distribution of land to its sole shareholder, William Roy. The land's fair market value was $100,000 and its tax and E&P basis to Tar Heel was $25,000. William assumed a mortgage attached to the land of $10,000. The tax consequences of the distribution to William in year 1 would be:

Paladin Corporation had current and accumulated E&P of $500,000 at December 31, year 1. On December 31, the company made a distribution of land to its sole shareholder, Maria Mendez. The land's fair market value was $200,000 and its tax and E&P basis to Paladin was $250,000. Maria assumed a liability of $25,000 attached to the land. The tax consequences of the distribution to Paladin in year 1 would be:

Grand River Corporation reported taxable income of $500,000 in year 1 and paid federal income taxes of $170,000. Not included in the computation was a disallowed meals and entertainment expense of $2,000, tax exempt income of $1,000, and deferred gain on an installment sale of $25,000. The corporation's current earnings and profits for year 1 would be:

Tammy owns 100 shares in Star Struck Corporation. The other 100 shares are owned by her husband Tommy. Which of the following statements is true?

Erie Corporation reported taxable income of $2,200,000 in year 1 before any deduction for any payment to its sole shareholder and employee, LaBron Cleveland. Erie paid a bonus of $200,000 to LaBron at year-end. Erie Corporation is subject to a flat-rate tax of 34%. The bonus meets the requirements to be "reasonable" and is therefore deductible by Erie. LaBron is subject to a marginal tax rate of 35% on the bonus. What is the total federal income tax imposed on the corporate income earned by Erie and paid to LaBron as a bonus?

Jalen transferred his 10 percent interest to Wolverine Company as part of a complete liquidation of the company. In the exchange he received land with a fair market value of $100,000. Jalen's basis in the Wolverine stock was $50,000. The land had a basis to Wolverine Company of $80,000. What amount of gain does Jalen recognize in the exchange and what is his basis in the land he receives?

Madison Corporation reported taxable income of $400,000 in year 2 and accrued federal income taxes of $136,000. Included in the computation was regular depreciation of $200,000 (E&P depreciation is $60,000) , first year expensing under §179 of $100,000, and a net capital loss carryover of $20,000 from year 1. The corporation's current earnings and profits for year 2 would be:

Buckeye Company is owned equally by James and his brother Terrelle, each of whom own 500 shares in the company. Terrelle wants to reduce his ownership in the company, and it was decided that the company will redeem 200 of his shares for $5,000 per share on December 31, year 1. Terrelle's income tax basis in each share is $1,000. Buckeye has current E&P of $10,000,000 and accumulated E&P of $20,000,000. What is the amount and character (capital gain or dividend) recognized by Terrelle as a result of the stock redemption?

The recipient of a nontaxable stock distribution will have a zero tax basis in the stock.

A corporation's "earnings and profits" account is equal to the company's "retained earnings" account on its balance sheet.

Lansing Company is owned equally by Jennifer, her husband Dan, and DeWitt Corporation, which is owned 50 percent by Jennifer and her sister Jane. Each of the three shareholders holds 100 shares in the company. Under the §318 stock attribution rules, how many shares of Lansing stock is Jennifer deemed to own?

Gary and Laura decided to liquidate their jointly owned corporation, Amelia, Inc. After liquidating its remaining inventory and paying off its remaining liabilities, Amelia had the following tax accounting balance sheet. $\begin{array} { | l | r | } \hline \text { Taxable income } & \$ 600,000 \\\hline \text { Add: } & \\\hline \text { Tax-exempt interest } & 30,000 \\\hline \begin{array} { l } \text { Excess of regular tax deprecation over } \\\text { E\&P depreciation }\end{array} & 120,000 \\\hline \text { Subtract: } & \\\hline \text { Federal income taxes } &( 202,000 )\\\hline \text { Nondeductible meals and entertainment } & ( 15,000 ) \\\hline \text { Disallowed expenses related to tax- } \\\text { exempt income } & ( 4,000 ) \\\hline \text { Current E \&P } &\$ 529,000 \\\hline\end{array}$ Under the terms of the agreement, Gary will receive the $100,000 cash in exchange for his interest in Amelia. Gary's tax basis in his Amelia stock is $30,000. Laura will receive the building and land in exchange for her interest in Amelia. Laura's tax basis in her Amelia stock is $60,000. What amount of gain or loss does Gary recognize in the complete liquidation?

Sunapee Corporation reported taxable income of $700,000 from operations for year 1. During the year, the company made a distribution of land to its sole shareholder, Jean McCarthy. The land's fair market value was $125,000 and its tax and E&P basis to Sunapee was $75,000. Jean assumed a mortgage attached to the land of $25,000. Sunapee's tax rate is 34%. Compute Sunapee's total taxable income and federal income tax paid as a result of the distribution. Using your solution, compute Sunapee's current E&P for year 1.

Townsend Corporation declared a 1-for-1 stock split to all common stock shareholders of record on December 31, year 1. Townsend reported current E&P of $400,000 and accumulated E&P of $1,000,000. The total fair market value of the stock distributed was $500,000. Regina Williams owned 1,000 shares of Townsend common stock with a tax basis of $200 per share ($2,000,000 total). The fair market value of the common stock was $300 per share on December 31, year 1. What is Regina's income tax basis in the new and existing common stock she owns in Townsend, assuming the distribution is nontaxable?