Test bank taxation of individuals and business entities 2015 6e by brian c spilker chap01

AACSB: Reflective Thinking AICPA: BB Critical Thinking Accessibility: Keyboard Navigation Blooms: Remember Learning Objective: 18-02 Compute a corporation's earnings and profits and calc

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Chapter 18 Corporate Taxation: Nonliquidating Distributions

True / False Questions

1 The "double taxation" of corporate income refers to the taxation of corporate income

at both the entity-level and the shareholder-level

True False

5 Green Corporation has current earnings and profits of $100,000 and negative

accumulated earnings and profits of ($200,000) A $50,000 distribution from Green toits sole shareholder will not be treated as a dividend because total earnings and profits is a negative $100,000

True False

6 Green Corporation has negative current earnings and profits of ($100,000) and positive accumulated earnings and profits of $200,000 A $50,000 distribution from Green to its sole shareholder will be treated as a dividend because total earnings andprofits is a positive $100,000

True False

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

True False

8 Only income and deductions included on a corporation's income tax return are

included in the computation of current earnings and profits

True False

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9 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 Cedar will deduct the net capital loss in the computation of current earnings and profits for 20X3

True False

10 Terrapin Corporation incurs federal income taxes of $250,000 in 20X3 Terrapin deducts the federal income taxes in computing its current earnings and profits for 20X3

True False

11 Evergreen Corporation distributes land with a fair market value of $200,000 to its sole shareholder Evergreen's tax basis in the land is $50,000 Assuming sufficient earnings and profits, the amount of dividend reported by the shareholder is

$200,000

True False

12 Evergreen Corporation distributes land with a fair market value of $200,000 to its sole shareholder Evergreen's tax basis in the land is $50,000 Evergreen will report a gain of $150,000 on the distribution regardless of whether its earnings and profits arepositive or negative

True False

13 Evergreen Corporation distributes land with a fair market value of $50,000 to its sole shareholder Evergreen's tax basis in the land is $200,000 Evergreen will report a loss of $150,000 on the distribution regardless of whether its earnings and profits are positive or negative

True False

14 Compensation recharacterized by the IRS as a dividend because it was considered

"unreasonable" will affect only the income tax liability of the corporation paying the compensation

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18 The recipient of a taxable stock dividend will have a tax basis in the stock equal to the fair market value of the stock received

ownership to below 48 percent

24 Battle Corporation redeems 20 percent of its stock for $100,000 in a stock

redemption that is treated as an exchange by the shareholders Battle's E&P at the date of the redemption is $200,000 Battle will reduce its earnings and profits by

$100,000 because of the redemption

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26 Which statement best describes the concept of the "double taxation" of corporation

income?

A Corporate income is subject to two levels of taxation: the regular tax and the alternative minimum tax

B Corporate income is taxed twice at the corporate level: first when earned and then a second time if appreciated property is distributed to a shareholder

C Corporate income is taxed when earned by a C corporation and then a second time at the shareholder level when distributed as a dividend

D Corporate income is subject to two levels of taxation: at the federal level and a second time at the state level

27 Which of the following forms of earnings distributions would not be subject to double

taxation at the corporate and shareholder level?

A

B

C

D Compensation paid to a shareholder/employee of the corporation

28 Which of the following statements best describes the priority of the tax treatment of

a distribution from a corporation to a shareholder?

A The distribution is a dividend to the extent of the corporation's earnings and profits, then a return of capital, and finally gain from sale of stock

B The distribution is a return of capital, then a dividend to the extent of the corporation's earnings and profits, and finally gain from sale of stock

C The distribution is a return of capital, then gain from sale of stock, and finally a dividend to the extent of the corporation's earnings and profits

D The shareholder can elect to treat the distribution as either a dividend to the extent of the corporation's earnings and profits or a return of capital, followed by gain from sale of stock

29 Which of the following statements best describes current earnings and profits?

A Current earnings and profits is another name for a corporation's retained earnings on its balance sheet

B Current earnings and profits is a precisely defined tax term in the Internal Revenue Code and represents a corporation's economic income

C Current earnings and profits is an ill-defined tax concept in the Internal Revenue Code and represents a corporation's economic income

D Current earnings and profits is a conceptual tax concept with no definition in the Internal Revenue Code

30 Which of the following statements best describes the role of current and accumulated

earnings and profits in determining if a distribution is a dividend?

A A distribution will only be a dividend if total earnings and profits (current plus accumulated) is positive at the time of the distribution

B A distribution can never be a dividend if current earnings and profits are negative

C A distribution will be a dividend if current earnings and profits for the year are positive, even if accumulated earnings and profits are negative

D A distribution will never be a dividend if current earnings and profits for the year are negative, even if accumulated earnings and profits is positive

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31 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

32 A calendar-year corporation has negative current E&P of $500 and accumulated

positive E&P of $1,000 The corporation makes a $600 distribution to its sole

shareholder Which of the following statements is true?

A $500 of the distribution will be a dividend because total earnings and profits is $500

B $0 of the distribution will be a dividend because current earnings and profits are negative

C $600 of the distribution will be a dividend because accumulated earnings and profits is $1,000

D Up to $600 of the distribution could be a dividend depending on the balance in accumulated earnings and profits on the date of the distribution

33 Which of these items is not an adjustment to taxable income or net loss to compute

current E&P?

C Net capital loss carryforward from the prior year tax return

D Refund of prior year taxes for an accrual method taxpayer

34 Grand River Corporation reported taxable income of $500,000 in 20X3 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 20X3 would be:

A

B

C

D

35 Au Sable Corporation reported taxable income of $800,000 in 20X3 and paid federal

income taxes of $272,000 Not included in the computation was a disallowed penalty

of $25,000, life insurance proceeds of $100,000, and an income tax refund from 20X2

of $50,000 Au Sable is an accrual basis taxpayer The corporation's current earnings

and profits for 20X3 would be:

A

B

C

D

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36 Oakland Corporation reported a net operating loss of $500,000 in 20X3 and elected

to carry the loss forward to 20X4 Not included in the computation was a disallowed meals and entertainment expense of $20,000, tax-exempt income of $10,000, and deferred gain on an installment sale of $250,000 The corporation's current earnings and profits for 20X3 would be:

dividends received deduction of $5,000, a net capital loss carryover from 20X2 of

$10,000, and gain of $50,000 from an installment sale that took place in 20X1 The corporation's current earnings and profits for 20X3 would be:

expensing under §179 of $50,000, and a dividends received deduction of $10,000 The corporation's current earnings and profits for 20X3 would be:

A

B

C

D

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40 Greenwich Corporation reported a net operating loss of $800,000 in 20X3, which the corporation elected to carry forward 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:

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44 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

B

C

D

45 Beaver Company reports current E&P of $100,000 in 20X3 and accumulated E&P at

the beginning of the year of $200,000 Beaver distributed $400,000 to its sole

shareholder on January 1, 20X3 The shareholder's tax basis in her stock in Beaver is

$200,000 How is the distribution treated by the shareholder in 20X3?

B $100,000 dividend, $200,000 tax-free return of basis, and $100,000 capital gain

C $200,000 dividend and $200,000 tax-free return of basis

D $300,000 dividend and $100,000 tax-free return of basis

46 Longhorn Company reports current E&P of $100,000 in 20X3 and accumulated E&P at

the beginning of the year of negative $200,000 Longhorn distributed $300,000 to its

sole shareholder on January 1, 20X3 The shareholder's tax basis in his stock in

Longhorn is $100,000 How is the distribution treated by the shareholder in 20X3?

D $0 dividend, $100,000 tax-free return of basis, and $200,000 capital gain

47 Husker Corporation reports current E&P of negative $200,000 in 20X3 and

accumulated E&P at the beginning of the year of $300,000 Husker distributed

$200,000 to its sole shareholder on December 31, 20X3 The shareholder's tax basis

in her stock in Husker is $50,000 How is the distribution treated by the shareholder

in 20X3?

D $0 dividend, $50,000 tax-free return of basis, and $150,000 capital gain

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48 Tar Heel Corporation had current and accumulated E&P of $500,000 at December 31 20X3 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 20X3 would be:

A $100,000 dividend and a tax basis in the land of $100,000

B $100,000 dividend and a tax basis in the land of $90,000

C Dividend of $90,000 and a tax basis in the land of $100,000

D Dividend of $90,000 and a tax basis in the land of $90,000

49 Cavalier Corporation had current and accumulated E&P of $500,000 at December 31 20X3 On December 31, the company made a distribution of land to its sole

shareholder, Tom Jefferson The land's fair market value was $200,000 and its tax andE&P basis to Cavalier was $50,000 The tax consequences of the distribution to

Cavalier in 20X3 would be:

A No gain recognized and a reduction in E&P of $200,000

B $150,000 gain recognized and a reduction in E&P of $200,000

C $150,000 gain recognized and a reduction in E&P of $50,000

D No gain recognized and a reduction in E&P of $50,000

50 Montclair Corporation had current and accumulated E&P of $500,000 at December

31, 20X3 On December 31, the company made a distribution of land to its sole

shareholder, Molly Pitcher The land's fair market value was $200,000 and its tax and E&P basis to Montclair was $50,000 Molly assumed a liability of $25,000 attached to the land The tax consequences of the distribution to Montclair in 20X3 would be:

A No gain recognized and a reduction in E&P of $200,000

B $150,000 gain recognized and a reduction in E&P of $200,000

C $150,000 gain recognized and a reduction in E&P of $175,000

D No gain recognized and a reduction in E&P of $175,000

51 Catamount Company had current and accumulated E&P of $500,000 at December 31,20X3 On December 31, the company made a distribution of land to its sole

shareholder, Caroline West The land's fair market value was $200,000 and its tax

and E&P basis to Catamount was $250,000 The tax consequences of the distribution

to Catamount in 20X3 would be:

A No loss recognized and a reduction in E&P of $250,000

B $50,000 loss recognized and a reduction in E&P of $250,000

C $50,000 loss recognized and a reduction in E&P of $150,000

D No loss recognized and a reduction in E&P of $200,000

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52 Paladin Corporation had current and accumulated E&P of $500,000 at December 31,

20X3 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 20X3

would be:

A No loss recognized and a reduction in E&P of $200,000

B $50,000 loss recognized and a reduction in E&P of $200,000

C $50,000 loss recognized and a reduction in E&P of $225,000

D No loss recognized and a reduction in E&P of $225,000

53 Which of the following payments could be treated as a constructive dividend by the

IRS?

A End-of-year bonus payment to a shareholder/employee

D All of these payments could be treated as a constructive dividend by the IRS

54 Which of the following factors would not be considered in determining if

compensation paid to a shareholder/employee is reasonable?

A The individual's duties and responsibilities

B What individuals performing in comparable capacities at other companies are paid

C Whether the corporation has a formal compensation policy

D The individual's marginal income tax rate

55 Which of the following statements is not considered a potential answer to the

dividend puzzle (why do corporations pay dividends)?

A Paying dividends avoids the double taxation of corporate income

B Demanding that managers pay out dividends restricts their investment activities and forces them to adopt more efficient investment policies

C Paying dividends is a source of investor goodwill

D Dividends are a signal to the capital markets about the health of a corporation's activities

56 Which of the following stock dividends would be tax-free to the shareholder?

A A 2-for-1 stock split to all holders of common stock

B A stock dividend where the shareholder could choose between cash and stock

C A stock dividend to all holders of preferred stock

D Both a 2-for-1 stock split to all holders of common stock and a stock dividend to all holders of preferred stock are tax-free to the shareholder

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57 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?

A $0 dividend income and a tax basis in the new stock of $100 per share

B $0 dividend income and a tax basis in the new stock of $60 per share

C $0 dividend income and a tax basis in the new stock of $40 per share

D $15,000 dividend and a tax basis in the new stock of $100 per share

58 Wonder Corporation declared a common stock dividend to all shareholders of record

on September 30, 20X3 Shareholders will receive three shares of Wonder stock for

each five shares of stock they already own Diana owns 300 shares of Wonder stock

with a tax basis of $90 per share (a total basis of $27,000) The fair market value of

the Wonder stock was $180 per share on September 30, 20X3 What are the tax

consequences of the stock dividend to Diana?

A $0 dividend income and a tax basis in the new stock of $180 per share

B $0 dividend income and a tax basis in the new stock of $67.50 per share

C $0 dividend income and a tax basis in the new stock of $56.25 per share

D $10,800 dividend and a tax basis in the new stock of $180 per share

59 Which of the following individuals is not considered "family" for purposes of applying

the stock attribution rules to a stock redemption?

A

B

C

D

60 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

61 Sam owns 70 percent of the stock of Club Corporation Unrelated individuals own the

remaining 30 percent For a stock redemption of Sam's stock to be treated as an

exchange under the "substantially disproportionate" test, what percentage of Club

stock must Sam own after the redemption?

D All stock redemptions involving individuals are treated as exchanges

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62 Sara owns 60 percent of the stock of Lea Corporation Unrelated individuals own the

remaining 40 percent For a stock redemption of Sara's stock to be treated as an

exchange under the "substantially disproportionate" test, what percentage of Lea

stock must Sara own after the redemption?

D All stock redemptions involving individuals are treated as exchanges

63 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?

A $25,000 capital gain and a tax basis in each of her remaining shares of $500

B $25,000 capital gain and a tax basis in each of her remaining shares of $100

C $50,000 dividend and a tax basis in each of her remaining shares of $100

D $50,000 dividend and a tax basis in each of her remaining shares of $50

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?

A No reduction in E&P because of the exchange

B A reduction of $50,000 in E&P because of the exchange

C A reduction of $62,500 in E&P because of the exchange

D A reduction of $125,000 in E&P because of the exchange

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?

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66 Viking Corporation is owned equally by Sven and his wife Olga, each of whom hold

100 shares in the company Viking redeemed 75 shares of Sven's stock in the

company on December 31, 20X3 Viking paid Sven $2,000 per share His income tax

basis in each share is $1,000 Viking has total E&P of $500,000 What are the tax

consequences to Sven because of the stock redemption?

A $75,000 capital gain and a tax basis in each of his remaining shares of $1,000

B $75,000 capital gain and a tax basis in each of his remaining shares of $2,000

C $150,000 dividend and a tax basis in each of his remaining shares of $1,000

D $150,000 dividend and a tax basis in each of his remaining shares of $4,000

67 Viking Corporation is owned equally by Sven and his wife Olga, each of whom hold

100 shares in the company Viking redeemed 75 shares of Sven's stock for $2,000 per

share on December 31, 20X3 Viking has total E&P of $500,000 What are the tax

consequences to Viking because of the stock redemption?

68 Corona Company is owned equally by Maria, her sister Carlita, her mother Gabriella,

and her grandmother Olivia, each of whom hold 100 shares in the company Under

the family attribution rules, how many shares of Corona stock is Maria deemed to

69 Panda Company is owned equally by Min, her husband Bin, her sister Xiao, and her

grandson, Han, each of whom hold 100 shares in the company Under the family

attribution rules, how many shares of Panda stock is Min deemed to own?

A

B

C

D

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70 Beltway Company is owned equally by George, his brother Thomas, and a partnership

owned 50 percent by George and his father Abe Each of the three shareholders holds

100 shares in the company Under the §318 stock attribution rules, how many shares

of Beltway stock is George deemed to own?

A

B

C

D

71 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?

A

B

C

D

72 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 DeWitt Corporation deemed to own?

A

B

C

D

73 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?

A A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as an exchange for tax purposes

B A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as a dividend for tax purposes

C A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as an exchange if Tammy waives the family attribution rules and files a "triple i" agreement with the IRS

D A stock redemption that completely terminates Tammy's direct interest in a corporation will be treated as a dividend to the extent that the redemption exceeds Tammy's tax basis in the redeemed shares

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74 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?

A Henry has dividend income of $50,000 and a tax basis in his remaining shares of $100 per share

B Henry has capital gain of $25,000 and a tax basis in his remaining shares of $100 per share

C Henry has dividend income of $50,000 and a tax basis in his remaining shares of $200 per share

D Henry has capital gain of $25,000 and a tax basis in his remaining shares of $200 per share

75 General Inertia Corporation made a pro rata distribution of $50,000 to Tiara, Inc in

partial liquidation of the company on December 31, 20X3 Tiara, Inc owns 500 shares

(50%) of General Inertia The distribution was in exchange for 250 shares of Tiara's

stock in the company After the partial liquidation, Tiara 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 Tiara'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 amount of dividend or capital gain does Tiara recognize because of the

transaction?

A Tiara does not recognize any dividend income or capital gain

B Tiara recognizes capital gain of $50,000

C Tiara recognizes dividend income of $50,000

D Tiara recognizes capital gain of $25,000

Essay Questions

76 Superior Corporation reported taxable income of $1,000,000 in 20X3 Superior paid a

dividend of $100,000 to its sole shareholder, Mary Yooper Superior Corporation is

subject to a flat rate tax of 34% The dividend meets the requirements to be a

"qualified dividend" and Mary is subject to a tax rate of 15% on the dividend What is

the total federal income tax imposed on the corporate income earned by Superior

and distributed to Mary as a dividend?

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77 Erie Corporation reported taxable income of $2,200,000 in 20X3 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?

78 St Clair Company reports positive current E&P of $500,000 in 20X3 and positive accumulated E&P at the beginning of the year of $400,000 St Clair Company

distributed $600,000 to its sole shareholder, Danielle Brush on December 31, 20X3 Danielle's tax basis in her St Clair stock is $120,000 How much of the $600,000 distribution is treated as a dividend to Danielle and what is her basis in St Clair stockafter the distribution?

79 Austin Company reports positive current E&P of $200,000 and negative accumulated E&P of $300,000 Austin distributed $250,000 to its sole shareholder, Betsy Bevo, on December 31, 20X3 Betsy' tax basis in her stock is $125,000 How much of the

$250,000 distribution is treated as a dividend to Betsy and what is her tax basis in Austin stock after the distribution?

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80 Elk Company reports negative current E&P of $200,000 and positive accumulated E&P of $300,000 Elk distributed $200,000 to its sole shareholder, Barney Rubble, on December 31, 20X3 Barney's tax basis in his Elk stock is $75,000 What is the tax treatment of the distribution to Barney and what is his tax basis in Elk stock after the distribution?

81 Houghton Company reports negative current E&P of ($500,000) and negative

accumulated E&P of ($800,000) Houghton distributed $100,000 to its sole

shareholder, Blossom Applegate, on December 31, 20X3 Blossom's tax basis in her Houghton stock is $50,000 What is the tax treatment of the distribution to Blossom and what is her tax basis in Houghton stock after the distribution?

82 Loon, Inc reported taxable income of $600,000 in 20X3 and paid federal income taxes of $202,000 Not included in the company's computation of taxable income is tax-exempt interest of $30,000, disallowed meals and entertainment expenses of

$15,000, and disallowed expenses related to the tax-exempt income of $4,000 Loon deducted depreciation of $200,000 on its tax return Under the alternative (E&P) depreciation method, the deduction would have been $80,000 Compute the

company's current E&P for 20X3

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83 Orchard, Inc reported taxable income of $800,000 in 20X3 and paid federal income taxes of $272,000 Included in the company's computation of taxable income is gain from sale of a depreciable asset of $200,000 The income tax basis of the asset was

$50,000 The E&P basis of the asset using the alternative depreciation system was

$75,000 Compute the company's current E&P for 20X3

84 Walloon, Inc reported taxable income of $1,000,000 in 20X3 and paid federal incometaxes of $340,000 The company reported a capital gain from sale of investments of

$150,000, which was partially offset by a $40,000 net capital loss carryover from 20X2, resulting in a net capital gain of $110,000 included in taxable income

Compute the company's current E&P for 20X3

85 Otter Corporation reported taxable income of $400,000 from operations for 20X3 The company paid federal income taxes of $136,000 on this taxable income During the year, the company made a distribution of land to its sole shareholder, Emmet Jugg The land's fair market value was $50,000 and its tax and E&P basis to Otter was

$30,000 Emmet assumed a mortgage attached to the land of $10,000 Any gain from the distribution will be taxed at 34% The company had accumulated E&P of

$900,000 at the beginning of the year Compute Otter's total taxable income and federal income tax paid because of the distribution (assume a tax rate of 34%) Usingyour solution, compute Otter's current E&P for 20X3

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86 Ozark Corporation reported taxable income of $500,000 from operations for 20X3 During the year, the company made a distribution of land to its sole shareholder, Marcus Twain The land's fair market value was $100,000 and its tax and E&P basis toOzark was $125,000 Marcus assumed a mortgage attached to the land of $25,000 Ozark's tax rate is 34% The company had accumulated E&P of $850,000 at the beginning of the year Compute Ozark's total taxable income and federal income tax paid because of the distribution Using your solution, compute Otter's accumulated E&P at January 1, 20X4

87 Sherburne Corporation reported current earnings and profits for 20X3 of $500,000 During the year, the company made a distribution of land to its sole shareholder, Ted Bozeman The land's fair market value was $150,000 and its tax and E&P basis to Sherburne was $100,000 Ted assumed a mortgage attached to the land of $25,000 What amount of dividend income does Ted report because of the distribution and what is Ted's income tax basis in the land received from Sherburne?

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88 Sunapee Corporation reported taxable income of $700,000 from operations for 20X3 During the year, the company made a distribution of land to its sole shareholder, JeanMcCarthy 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 because of the distribution Using your solution, compute Sunapee's current E&P for 20X3

89 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 taxliability does Tappan Company face? (Ignore payroll taxes)

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90 Townsend Corporation declared a 1-for-1 stock split to all common stock shareholders

of record on December 31, 20X3 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, 20X3 What is Regina's income tax basis in the new and existing common stock she owns in Townsend, assuming thedistribution is tax-free?

91 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 in his new and existing common stock in Sweetwater, assuming the distribution is non-taxable?

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92 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?

93 Pine Creek Company is owned equally by Bob and his sister Samantha, each of whomown 1,000 shares in the company On December 31, 20X3, Pine Creek redeemed 200

of Samantha's shares for $5,000,000 in a transaction treated as an exchange by Samantha Pine Creek has current E&P of $10,000,000 and accumulated E&P of

$30,000,000 (computed without regard to the stock redemption) Assuming Pine Creek did not make any dividend distributions during 20X3, by what amount does thecompany reduce its E&P because of the redemption?

94 Goose Company is owned equally by Val and her sister Eugenia, each of whom own

500 shares in the company Val wants to reduce her ownership in the company and have the transaction treated as an exchange for tax purposes Determine the

minimum amount of stock that Goose must redeem from Val for her to treat the redemption as being "substantially disproportionate with respect to the shareholder" and receive exchange treatment

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95 Crystal, Inc is owned equally by John and his wife Arlene, each of whom own 500 shares in the company Arlene wants to reduce her ownership in the company, and it was decided that the company will redeem 200 of her shares for $5,000 per share on December 31, 20X3 Arlene's income tax basis in each share is $1,000 Crystal has current E&P of $1,000,000 and accumulated E&P of $3,000,000 What is the amount and character (capital gain or dividend) recognized by Arlene as a result of the stock redemption, assuming only the "substantially disproportionate with respect to the shareholder" test is applied?

96 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?

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97 Tiger Corporation, a privately-held company, has one class of voting common stock,

of which 1,000 shares are issued and outstanding The shares are owned as follows:

How many shares of stock is Mark deemed to own under the family attribution rules

in a stock redemption?

98 Geneva Corporation, a privately-held company, has one class of voting common stock, of which 1,000 shares are issued and outstanding The shares are owned as follows:

Madison has a 20 percent interest in the partnership The remaining 80 percent is owned by unrelated individuals Madison owns 40% of Packer Corporation The other

60 percent is owned by her father

How many shares of stock is Madison deemed to own under the family attribution rules in a stock redemption?

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99 Half Moon Corporation made a distribution of $300,000 to Arnold Swartz in partial liquidation of the company on December 31, 20X3 Arnold owns 100% of Half Moon Corporation (1,200 shares) The distribution was in exchange for 50% of Arnold's stock in the company (600 shares) At the time of the distribution, the shares had a fair market value of $500 per share Arnold's income tax basis in the shares was $250per share Half Moon had total E&P of $2,000,000 at the time of the distribution What is the amount and character (capital gain or dividend) of any income or gain recognized by Arnold as a result of the partial liquidation?

100

Yellowstone Corporation made a distribution of $300,000 to Cheney, Inc in partial liquidation of the company on December 31, 20X3 Cheney, Inc owns 50 percent of Yellowstone Corporation (1,000 shares) The other 50 percent is owned by an

unrelated corporation The distribution was in exchange for 50% of Cheney's stock in the company (500 shares) At the time of the distribution, the shares had a fair market value of $800 per share Cheney's income tax basis in the shares was $500 per share Yellowstone had total E&P of $5,000,000 at the time of the distribution What is the amount and character (capital gain or dividend) of any income or gain recognized by Cheney as a result of the partial liquidation?

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Chapter 18 Corporate Taxation: Nonliquidating Distributions

Answer Key

True / False Questions

1 The "double taxation" of corporate income refers to the taxation of corporate income at both the entity-level and the shareholder-level

TRUE

AACSB: Reflective Thinking AICPA: BB Critical Thinking Accessibility: Keyboard Navigation

Blooms: Remember Learning Objective: 18-01 Explain the basic tax law framework that applies to property distributions from a

corporation to a shareholder Level of Difficulty: 1 Easy Topic: Tax framework for property distributions

2 A distribution from a corporation to a shareholder will always be treated as a dividend for tax purposes

FALSE

It could also be a return of capital or gain from sale of the stock

Blooms: Remember Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount

received by a shareholder Level of Difficulty: 1 Easy Topic: Earnings, profits, and shareholder dividends

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

FALSE

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

TRUE

5 Green Corporation has current earnings and profits of $100,000 and negative accumulated earnings and profits of ($200,000) A $50,000 distribution from Green

to its sole shareholder will not be treated as a dividend because total earnings andprofits is a negative $100,000

FALSE

The distribution will be a dividend because Green has positive current E&P

Blooms: Understand Learning Objective: 18-02 Compute a corporation's earnings and profits and calculate the dividend amount

received by a shareholder Level of Difficulty: 2 Medium Topic: Earnings, profits, and shareholder dividends

6 Green Corporation has negative current earnings and profits of ($100,000) and positive accumulated earnings and profits of $200,000 A $50,000 distribution from Green to its sole shareholder will be treated as a dividend because total earnings and profits is a positive $100,000

TRUE

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

FALSE

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8 Only income and deductions included on a corporation's income tax return are included in the computation of current earnings and profits

FALSE

The computation also includes tax-exempt income and nondeductible expenses

9 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 Cedar will deduct the net capital loss in the computation of current earnings and profits for 20X3

TRUE

10 Terrapin Corporation incurs federal income taxes of $250,000 in 20X3 Terrapin deducts the federal income taxes in computing its current earnings and profits for 20X3

TRUE

E&P is an after-tax computation

11 Evergreen Corporation distributes land with a fair market value of $200,000 to its sole shareholder Evergreen's tax basis in the land is $50,000 Assuming sufficient earnings and profits, the amount of dividend reported by the shareholder is

$200,000

TRUE

AACSB: Reflective Thinking AICPA: BB Critical Thinking

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Accessibility: Keyboard Navigation

12 Evergreen Corporation distributes land with a fair market value of $200,000 to its sole shareholder Evergreen's tax basis in the land is $50,000 Evergreen will report a gain of $150,000 on the distribution regardless of whether its earnings and profits are positive or negative

TRUE

13 Evergreen Corporation distributes land with a fair market value of $50,000 to its sole shareholder Evergreen's tax basis in the land is $200,000 Evergreen will report a loss of $150,000 on the distribution regardless of whether its earnings andprofits are positive or negative

FALSE

Losses are not recognized on distributions of property

14 Compensation recharacterized by the IRS as a dividend because it was considered

"unreasonable" will affect only the income tax liability of the corporation paying the compensation

FALSE

The recipient will be eligible for a lower tax rate on the dividend and not be subject

to payroll tax on the recharacterized amount

Blooms: Apply Learning Objective: 18-03 Identify situations in which a corporation may be deemed to have paid a

"constructive dividend" to a shareholder.

Level of Difficulty: 3 Hard Topic: Constructive dividends

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

TRUE

Blooms: Understand Learning Objective: 18-03 Identify situations in which a corporation may be deemed to have paid a

"constructive dividend" to a shareholder.

Level of Difficulty: 2 Medium Topic: Constructive dividends

16 Stock dividends are always tax-free to the recipient

FALSE

Blooms: Remember Learning Objective: 18-04 Explain the basic tax rules that apply to stock dividends.

Level of Difficulty: 1 Easy Topic: Stock dividends

17 The recipient of a tax-free stock dividend will have a zero tax basis in the stock

FALSE

The recipient must allocate a portion of the basis from existing stock

18 The recipient of a taxable stock dividend will have a tax basis in the stock equal to the fair market value of the stock received

TRUE

19 A stock redemption is always treated as a sale or exchange for tax purposes

FALSE

Blooms: Remember

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Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions.

Level of Difficulty: 1 Easy Topic: Stock redemptions

20 Tammy owns 60 percent of the stock of Huron Corporation Unrelated individuals own the remaining 40 percent For a stock redemption to be treated as an

exchange under the "substantially disproportionate" rule, Tammy must reduce her stock ownership to below 48 percent

TRUE

Tammy's stock ownership must be reduced below 50 percent and be less than 80 percent of her existing ownership (80% × 60% = 48%)

AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Accessibility: Keyboard Navigation

Blooms: Analyze Blooms: Apply Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions.

Level of Difficulty: 2 Medium Topic: Stock redemptions

21 Brothers and sisters are considered "family" under the stock attribution rules that apply to stock redemptions

FALSE

Only a spouse, children, grandchildren, and parents

Blooms: Remember Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions.

Level of Difficulty: 1 Easy Topic: Stock redemptions

22 Diego owns 30 percent of Azul Corporation Azul Corporation owns 50 percent of Verde Corporation Under the attribution rules applying to stock redemptions, Diego is treated as owning 15 percent of Verde Corporation

FALSE

The corporation to shareholder attribution rule only applies if Diego owns 50 percent or more of Azul Corporation

Blooms: Apply Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions.

Level of Difficulty: 3 Hard Topic: Stock redemptions

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23 The "family attribution" rules are automatically waived in a complete redemption

Blooms: Understand Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions.

Level of Difficulty: 2 Medium Topic: Stock redemptions

24 Battle Corporation redeems 20 percent of its stock for $100,000 in a stock

redemption that is treated as an exchange by the shareholders Battle's E&P at thedate of the redemption is $200,000 Battle will reduce its earnings and profits by

$100,000 because of the redemption

FALSE

Battle reduces its E&P by the lesser of $100,000 or 20% of E&P at the date of the redemption ($40,000)

Blooms: Apply Learning Objective: 18-05 Comprehend the different tax consequences that can arise from stock redemptions.

Level of Difficulty: 3 Hard Topic: Stock redemptions

25 A distribution in partial liquidation of a corporation is always treated as a sale or exchange by an individual shareholder

TRUE

Blooms: Understand Learning Objective: 18-06 Describe a partial liquidation from a stock redemption and the difference in tax

consequences to the shareholders Level of Difficulty: 2 Medium Topic: Partial liquidations

Multiple Choice Questions

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26 Which statement best describes the concept of the "double taxation" of

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Blooms: Remember Learning Objective: 18-01 Explain the basic tax law framework that applies to property distributions from a

corporation to a shareholder Level of Difficulty: 1 Easy Topic: Tax framework for property distributions

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