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Exam 7: Corporate Taxation: Nonliquidating Distributions

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Question 21

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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 are positive and exceed the distribution.
D) A distribution from a corporation to a shareholder is always a dividend, regardless of the balance in earnings and profits.

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

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Question 22

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Which of the following statements is true?

A) All stock redemptions are treated as exchanges for tax purposes.
B) A stock redemption not treated as an exchange will automatically be treated as a taxable dividend.
C) All stock redemptions are treated as dividends if received by an individual.
D) A stock redemption is treated as an exchange only if it meets one of three stock ownership tests described in the Internal Revenue Code.

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

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Question 23

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Wildcat Corporation reports current E&P of negative $200,000 in 20X3 and accumulated E&P at the beginning of the year of $100,000.Wildcat distributed $300,000 to its sole shareholder on December 31,20X3.How much of the distribution is treated as a dividend in 20X3?

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

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

General Inertia Corporation made a distribution of $50,000 to Henry Tiara in partial liquidation of the company on December 31,20X3.Henry owns 500 shares (50%) of General Inertia.The distribution was in exchange for 250 shares of Henry's stock in the company.After the partial liquidation,Henry continued to own 50% of the remaining stock in General Inertia.At the time of the distribution,the shares had a fair market value of $200 per share.Henry's income tax basis in the shares was $100 per share.General Inertia had total E&P of $800,000 at the time of the distribution.What are the tax consequences to Henry because of the transaction?

Green Corporation has negative current earnings and profits of ($100,000)and positive accumulated earnings and profits of $250,000.A $50,000 distribution from Green to its sole shareholder will be treated as a dividend because total earnings and profits is a positive $150,000.

Greenwich Corporation reported a net operating loss of $800,000 in 20X3,which the corporation elected to carryforward to 20X4.The computation of the loss did not include a disallowed fine of $50,000,life insurance proceeds of $500,000,and a current year charitable contribution of $10,000 that will be carried forward to 20X4.The corporation's current earnings and profits for 20X3 would be:

Comet Company is owned equally by Pat and his sister Pam,each of whom hold 100 shares in the company.Comet redeems 50 of Pam's shares on December 31,20X3,for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes.Comet has total E&P of $250,000 on December 31,20X3.What are the tax consequences to Comet because of the stock redemption?

Cedar Corporation incurs a net capital loss of $20,000 in 20X3 that cannot be deducted on its income tax return but must be carried forward to 20X4.However,Cedar will deduct the net capital loss in the computation of current earnings and profits for 20X3.

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 31,20X3.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 because of the stock redemption?

Sweetwater Corporation declared a stock dividend to all common stock shareholders of record on December 31,20X3.Shareholders will receive 1 share of Sweetwater common stock for each 5 shares of common stock they already own.Pierre Dorgan owns 500 shares of Sweetwater common stock with a tax basis of $150 per share.The fair market value of the Sweetwater common stock was $90 per share on December 31.What is Pierre's income tax basis per share in his new and existing common stock in Sweetwater,assuming the distribution is non-taxable?

Crescent Corporation is owned equally by George and his daughter Olympia,each of whom own 100 shares in the company.George wants to retire from the company,and it was decided that the company will redeem all 100 of his shares for $10,000 per share on December 31,20X3.George's income tax basis in each share is $2,000.Crescent has current E&P of $1,000,000 and accumulated E&P of $5,000,000.What must George do to ensure that the redemption will be treated as an exchange?

El Toro Corporation declared a common stock dividend to all shareholders of record on June 30,20X3.Shareholders will receive 1 share of El Toro stock for each 2 shares of stock they already own.Raoul owns 300 shares of El Toro stock with a tax basis of $60 per share.The fair market value of the El Toro stock was $100 per share on June 30,20X3.What are the tax consequences of the stock dividend to Raoul?

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

Which of the following statements is not considered a potential answer to the question of why corporations pay dividends?

Comet Company is owned equally by Pat and his sister Pam,each of whom hold 100 shares in the company.Pam wants to reduce her ownership in the company,and it was decided that the company will redeem 50 of her shares for $1,000 per share on December 31,20X3.Pam's income tax basis in each share is $500.Comet has total E&P of $250,000.What are the tax consequences to Pam because of the stock redemption?

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?

Tappan Company pays its sole shareholder,Carlita Hill,a salary of $200,000.At the end of each year,the company pays Carlita a "bonus" equal to the difference between the corporation's taxable income for the year (before the bonus)and $75,000.For 20X3,Tappan reported pre-bonus taxable income of $800,000 and paid Carlita a bonus of $725,000.On audit,the IRS determined that individuals working in Carlita's position earned on average $300,000 per year.The company had no formal compensation policy and never paid a dividend.How much of Carlita's compensation (salary plus bonus)might the IRS recharacterize as a dividend? Assuming the IRS recharacterizes $500,000 of Carlita's bonus as a dividend,what additional income tax liability does Tappan Company face? (Ignore payroll taxes)

Comet Company is owned equally by Pat and his sister Pam,each of whom hold 100 shares in the company.Comet redeems 50 of Pam's shares on December 31,20X3,for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes.Comet has total E&P of $160,000 on December 31,20X3.What are the tax consequences to Comet because of the stock redemption?