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Chapter 19 Corporations: Distributions Not In Complete Liquidation
Research Problems
Research Problem 1. Kenny Merinoff and his son, John, own all of the outstanding stock of Flamingo Corporation. Both John and Kenny are officers in the corporation and, together with John’s uncle, Ira, comprise the entire board of directors. Flamingo uses the cash method of accounting and has a calendar year-end. In late 2009, the board of directors adopted the following legally enforceable resolution (agreed to in writing by each of the officers):
Salary payments made to an officer of the corporation that shall be disallowed in whole or in part as a deductible expense for Federal income tax purposes shall be reimbursed by such officer to the corporation to the full extent of the disallowance. It shall be the duty of the board of directors to enforce payment of each such amount.
In 2014, Flamingo paid Kenny $800,000 in compensation. John received $650,000. On an audit in late 2015, the IRS found the compensation of both officers to be excessive.
It disallowed deductions for $400,000 of the payment to Kenny and $350,000 of the payment to John. The IRS recharacterized the disallowed payments as constructive dividends.
Complying with the resolution by the board of directors, both Kenny and John repaid the disallowed compensation to Flamingo Corporation in 2016. John and Kenny have asked you to determine how their repayments should be treated for tax purposes.
John is still working as a highly compensated executive for Flamingo, while Kenny is retired and living off his savings. Prepare a memo for your firm’s client files describing the results of your research.
Research Problem 2. Emerald Corporation is required to change its method of accounting for Federal income tax purposes. The change will require an adjustment to income to be made over three tax periods. Jonas, the sole shareholder of Emerald
Corporation, wants to better understand the implications of this adjustment for E & P purposes, as he anticipates a distribution from Emerald in the current year. Prepare a memo for your firm’s client files describing the results of your research.
Research Problem 3. Your firm has a new individual client, Carla Navarro, who has been assigned to you for preparation of the current year’s tax return. Upon review of Carla’s tax returns from prior years, you notice that she reported a large capital gain from a stock redemption in 2014. Upon further investigation, you determine that stock in the corporation was owned by some of Carla’s family members at the time of the redemption and that the only way the redemption would have qualified for sale or exchange treatment would have been if Carla had availed herself of the family attribution waiver for a complete termination redemption. You establish that the redemption terminated Carla’s direct stock ownership in the corporation, that she had no interest in the corporation since the redemption, and that she retained all records pertaining to the redemption. However, you cannot find any evidence that the notification agreement required of a family attribution waiver was properly filed.When asked about the missing agreement, Carla indicated that she knew nothing about any required agreement and that if such an agreement was required, her previous CPA should have taken care of it. Your partner has asked you to research whether it is still possible to file an effective family attribution waiver agreement for Carla. In amemo for the tax file, summarize the results of your research.
Research Problem 4. In July 2013, Windstream Corp. (Nasdaq: WIN), a Fortune 500 and S&P 500 company, made an announcement regarding the taxation of a recent distribution. It also made a projection regarding the anticipated tax consequences of future distributions. Locate articles or press releases regarding Windstream’s announcement and related distribution. What might have led Windstream to make the announcement? What implications might the information contained in the announcement have for investors’ expectations regarding the company’s future earnings? On what might the predictions regarding the taxation of future distributions be based?
Research Problem 5. Stock buy-back (redemption) programs are a frequent occurrence among publicly traded corporations. Using the Internet as your sole research source, find at least six publicly traded corporations that announced stock buy-back programs in 2015. What are some of the reasons noted by these corporations for the buy-back programs?
Roger CPA Review Questions
1. Candy Corp. is a C Corporation that began operations in year 1. Candy Corp.’s year 1 through year 3 taxable earnings and profits (E & P) are as follows:
Year E & P
1 ($25,000)
2 5,000
3 10,000
On the last day of year 3, Candy Corp. makes a $12,500 cash shareholder distribution, distributed equally among its two shareholders, Goode and Plenteau. How much of Goode’s distribution is a nontaxable return of capital? Assume sufficient basis in Goode’s stock investment.
a. $5,000
b. $0
c. $1,250
d. $6,250
2. As of December 31, 2016, Eliot Corp. has net income per books of $100,000, which includes municipal bond interest of $4,000, a deduction for business meals of $5,000, a deduction for a net capital loss of $5,000, and a deduction for Federal income taxes of $22,000. What is Eliot Corp.’s current earnings and profits (E & P) for 2016?
a. $98,500
b. $107,500
c. $125,500
d. $100,000
Internet
Activity
Use the tax resources of the Internet to address the following questions. Do not restrict your search to the Web, but include a review of newsgroups and general reference materials, practitioner sites and resources, primary sources of the tax law, chat rooms and discussion groups, and other opportunities.
3. As of December 31, 2016, Hardy Corp. has net income per books of $120,000, which includes straight-line depreciation expense of $5,000. Hardy Corp. claimed accelerated depreciation of $15,000 for tax purposes. Also included in book income were lobbying expenses of $4,000 and a Federal income tax refund of $5,000. What is Hardy Corp.’s current earnings and profits (E & P) for 2016?
a. $119,000
b. $109,000
c. $120,000
d. $114,000
4. As of December 31, 2016, Caledonia Corp. has taxable income of $150,000, which includes a $20,000 accelerated depreciation deduction; had straight-line depreciation been used, the deduction would have been $6,000. Also included in taxable income is an operating loss carryforward from a prior year of $3,000. Additionally,
Caledonia earned $4,000 in municipal bond interest during the year. What is Caledonia
Corp.’s current earnings and profits (E & P) for 2016?
a. $164,000
b. $171,000
c. $157,000
d. $168,000
5. At the beginning of the year, Crispin, a C corporation, had a deficit of $35,000 in accumulated earnings and profits (E & P). For the current year, Crispin reported E & P of $12,000. Crispin distributed $10,000 during the year. What was the amount of
Crispin’s accumulated E & P deficit at year-end?
a. $23,000
b. $33,000
c. $27,000
d. $37,000
6. On January 1 of the current year, Quail Corp., an accrual-basis, calendar-year C corporation, had accumulated earnings and profits (E & P) of $20,000. On December 31 of the current year, Quail Corp. has current E & P of $24,000, earned evenly throughout the year. Ray and Devi were sole equal shareholders of Quail throughout the year.
Quail made two distributions to shareholders during the year: $30,000 on July 1 and $30,000 on December 31. How much of the December 31 distribution is taxable dividend income for Devi?
a. $7,000
b. $11,000
c. $6,000
d. $1,000
7. Compendium Corp. distributed cash and personal property to its sole shareholder.
Considering the following facts, what is the amount of gain that would be recognized by Compendium as the result of making this distribution to its shareholder?
Item Amount
Cash $25,000
Personal property
Fair market value 10,000
Adjusted basis 4,000
Liability on property assumed by shareholder 12,000
a. $4,000
b. $6,000
c. $8,000
d. $29,000
8. How does a shareholder treat the gain on a redemption of stock that qualifies as a redemption to pay death taxes under § 303?
a. As a tax-free transaction
b. Partly as capital gain and partly as a dividend
c. Entirely as capital gain
d. Entirely as a dividend
9. Calvin owns 40% of the outstanding shares of Copernicus Corp., which has accumulated earnings and profits of $100,000 as of December 31, year 1. The outstanding shares not owned by Calvin are owned by parties unrelated to Calvin. On January 1 of year 2, Calvin, wishing to pursue another business opportunity, sells his stock back to Copernicus Corp. Copernicus distributes cash of $250,000 in redemption of all of Calvin’s stock. If Calvin’s adjusted basis for the stock on the date of redemption is $125,000, what will be the tax effect of the redemption to Calvin?
a. $125,000 capital gain
b. $25,000 dividend
c. $125,000 dividend
d. $150,000 dividend
10. Calliope Corp. has outstanding 400 shares of common stock of which Yak, So, Day, and Ren each own 100 shares, or 25%. No stock is considered constructively owned by any of the shareholders under § 318. Calliope redeems 34 shares from Yak, 24 shares from So, and 42 shares from Day. Which shareholder(s) qualify for exchange treatment on this redemption?
I. Yak
II. So
III. Day
a. None
b. II only
c. III only
d. I and II only
11. Close Corp. distributed cash and a parcel of land in a nonliquidating distribution to its sole shareholder. The following facts apply to this distribution:
Item Amount
Cash $50,000
Land
Fair market value 30,000
Adjusted basis 40,000
Based on these facts, what amount of gain or loss should be recognized by Close
Corp. as a result of this distribution?
a. $60,000 loss
b. No gain or loss should be recognized
c. $10,000 loss
d. $40,000 gain
12. Callow Corp. has 400 shares of stock outstanding. Callow exchanges $150,000 cash for 100 of the shares in a qualifying stock redemption. Just prior to the redemption,
Callow had earnings and profits (E & P) of $300,000. By what amount will Callow
Corp.’s E & P be reduced as a result of this redemption? Assume a sufficiently large additional paid-in capital account balance.
a. $150,000
b. E & P will not be reduced
c. $75,000
d. Depends on balance in additional paid-in capital