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Chapter 19 Corporations: Distributions Not In Complete Liquidation
Discussion Questions
1. LO.2 In determining Blue Corporation’s current E & P for 2016, how should taxable income be adjusted as a result of the following transactions?
a. A capital loss carryover from 2015, fully used in 2016.
b. Nondeductible meal expenses in 2016.
c. Interest on municipal bonds received in 2016.
d. Nondeductible lobbying expenses in 2016.
e. Loss on a sale between related parties in 2016.
f. Federal income tax refund received in 2016.
2. LO.3 Describe the effect of a distribution in a year when the distributing corporation has any of the following:
a. A deficit in accumulated E & P and a positive amount in current E & P.
b. A positive amount in accumulated E & P and a deficit in current E & P.
c. A deficit in both current and accumulated E & P.
d. A positive amount in both current and accumulated E & P.
3. LO.3 A calendar year corporation has substantial accumulated E & P, but it expects to incur a deficit in current E & P for the year due to significant losses in the last half of the year. A cash distribution to its shareholders on January 1 should result in a return of capital. Comment on the validity of this statement.
4. LO.4 Discuss the rationale for the reduced tax rates on dividends paid to individuals.
5. LO.1, 2, 3, 4, 5 Orange Corporation distributes $200,000 in cash to each of its three shareholders: Sandy, Byron, and Fuchsia Corporation. What factors must be considered when determining how the distribution is treated for tax purposes by the shareholders?
6. LO.5 Assume the same facts as in Question 5, except that noncash property is distributed. What factors must be considered when determining how the distribution is treated for tax purposes by Orange Corporation?
7. LO.5 Ochre Corporation’s board of directors decides to distribute property to its shareholders rather than pay a cash dividend. Why might Ochre’s board make this decision?
8. LO.5 Raven Corporation owns three machines that it uses in its business. It no longer needs two of these machines and is considering distributing them to its two shareholders as a property dividend. All three machines have a fair market value of $20,000 each. The basis of each machine is as follows: Machine A, $27,000; Machine B, $20,000; and Machine C, $12,000. The corporation has asked you for advice. What do you recommend?
9. LO.5 Tangerine Corporation is considering a property distribution to its shareholders.
If appreciated property is to be used, does it matter to Tangerine whether the property distributed is a long-term capital asset or property subject to depreciation recapture? Would your answer differ if the property distributed has a fair market value less than the adjusted basis? Explain.
10. LO.6 Samantha is the president and sole shareholder of Toucan Corporation. She is paid an annual salary of $500,000, while her son, Aaron, the company’s chief financial officer, is paid a salary of $290,000. Aaron works for Toucan on a part-time basis and spends most of his time training for triathlons. Toucan advances $85,000 to Samantha as an interest-free loan. What are the tax issues?
11. LO.6 Whether compensation paid to a corporate employee is reasonable is a question of fact to be determined from the surrounding circumstances. How would the resolution of this problem be affected by each of the following factors?
a. The employee owns no stock but is the mother-in-law of the sole shareholder.
b. The shareholder-employee does not have a college degree.
c. The shareholder-employee works 40 hours per week for another unrelated employer.
d. The shareholder-employee was underpaid for services during the formative period of the corporation.
e. The corporation has never paid a dividend.
f. Year-end bonuses are paid to all employees, but officer-shareholders receive disproportionately larger bonuses.
12. LO.6, 10 Pink Corporation has several employees. Their names and salaries are listed below.
Judy $470,000
Holly (Judy’s daughter) 100,000
Terry (Judy’s son) 100,000
John (an unrelated third party) 320,000
Holly and Terry are the only shareholders of Pink Corporation. Judy and John share equally in the management of the company’s operations. Holly and Terry are both full-time college students at a university 200 miles away. Pink has substantial
E & P and has never distributed a dividend. Discuss any problems related to Pink’s salary arrangement.
13. LO.8, 9, 10 Chao, Louis, and Mari, unrelated individuals, own all of the shares of Cerise
Corporation. All three shareholders have been active in the management of Cerise since its inception. In the current year, Chao wants to retire and sell all of her shares in the corporation. What issues should be considered in determining whether Chao should sell her stock to one of the other shareholders, to Cerise Corporation, or to a third party?
14. LO.8 Corporate shareholders typically prefer dividend treatment on a stock redemption.
Why?
15. LO.8 Do the stock attribution rules apply to all stock redemptions? Explain.
16. LO.8 Briefly discuss the requirements for a redemption to qualify as a not essentially equivalent redemption.
17. LO.8 If a redemption is treated as a dividend (“nonqualified stock redemption”), what happens to the basis of the stock redeemed?
18. LO.8, 9 Tammy and Barry formed Pheasant Corporation several years ago in a transaction that qualified under § 351. Both shareholders serve as officers and on the board of directors of Pheasant. In the current year, Pheasant Corporation redeemed all of Barry’s shares in the corporation with a property distribution. What are the tax issues for Barry and Pheasant?
19. LO.8 Explain the requirements for a redemption to pay death taxes. What are the tax consequences of a redemption to pay death taxes for the shareholder and the corporation?
20. LO.8, 9 Angie and her daughter, Ann, who are the only shareholders of Bluebird
Corporation, each paid $100,000 four years ago for their shares in Bluebird.
Angie also owns 20% of the stock in Redbird Corporation. The Redbird stock is worth $500,000, and Angie’s basis in the stock is $50,000. Angie dies in the current year leaving all of her property to her husband, Gary, but Ann wants to be the sole shareholder of Bluebird Corporation. Bluebird has assets worth $4 million (basis of $700,000) and E & P of $1 million. Angie’s estate is worth approximately $6 million.
Angie had made gifts during her lifetime to Ann. What are the tax issues for Angie’s estate, Ann, and Bluebird?