Test bank for south western federal taxation 2021 corporations partnerships estates and trusts 44th

Test Bank for South-Western Federal Taxation 2021: Corporations, Partnerships, Estates and T

Test Bank for South-Western Federal Taxation 2021: Corporations, Partnerships, Estates and Trusts, 44th Edition, William A. Raabe, James C. Young, Annette Nellen, William H. Hoffman Jr. David M. Maloney To download the complete and accurate content document, go to: https://testbankbell.com/download/test-bank-for-south-western-federal-taxation-2021corporations-partnerships-estates-and-trusts-44th-edition-william-a-raabe-james-c-yo ung-annette-nellen-william-h-hoffman-jr-david-m-malon/

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chapter 7

Indicate whether the statement is true or false.

1. The continuity of business enterprise doctrine requires that at least 40% of the target’s assets are acquired with stock. a. True b. False 2. While a “Type B” reorganization requires that voting stock be used by the acquiring corporation, in a “Type A,” the acquiring corporation can use common or preferred stock and still have the restructuring meet the qualifications of § 368. a. True b. False 3. In a divisive “Type D” reorganization, the distributing corporation obtains control of the new target by exchanging some of its assets for at least 80% of the new target’s outstanding stock. a. True b. False 4. For a corporate restructuring to qualify as a tax-free reorganization, the step transaction doctrine must apply. a. True b. False 5. The Federal income tax treatment of a corporate restructuring is an extension of allowing entities to form without taxation. a. True b. False 6. To qualify as a “Type A” reorganization, mergers must comply with the requirements of pertinent foreign, state, and Federal statutes. a. True b. False 7. The acquiring corporation in a “Type G” reorganization reduces the tax attributes carried over from the bankrupt corporation by the percentage in change in ownership. a. True b. False 8. Without evidence to the contrary, the IRS views transactions occurring within one year of a reorganization as part of the restructuring under the step transaction doctrine. a. True b. False 9. An exchange of common stock for preferred stock or bonds for preferred stock can qualify as a “Type E” reorganization. a. True b. False 10. Individual shareholders would prefer to have a gain on a corporate reorganization treated as a capital gain rather than as a dividend, because they can reduce the amount taxable by their basis in the stock involved.

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chapter 7 a. True b. False 11. When a “Type F” reorganization includes a change from a taxable corporation to a flow-through entity, the original corporation stock loses its § 1244 status and earnings and profits do not carry over. a. True b. False 12. In corporate reorganizations, if an acquiring corporation is using property other than stock as consideration, it may recognize gains but not losses on the transaction. a. True b. False 13. The “Type B” reorganization requires a continuity of business interest. Therefore, the acquiring corporation must obtain at least 40% of the target corporation’s stock through the reorganization. a. True b. False 14. Since debt holders do not own stock, they do not fall under the corporate reorganization rules. a. True b. False 15. In a “Type A” merger, the acquiring corporation may select which liabilities of the target it assumes, but in a “Type A” consolidation, all the liabilities (known and contingent) must be assumed by the new corporation. a. True b. False 16. One advantage of acquiring a corporation with losses is that after a tax-free reorganization, the remaining corporation may combine the negative earnings and profits (E & P) of the target corporation with positive E & P of the acquiring corporation. a. True b. False 17. Liabilities generally are not considered boot in corporate reorganizations except in a “Type C” when cash or other property is received by the target in the transaction. a. True b. False 18. A tax avoidance motive is essential in establishing a sound business purpose for a reorganization. a. True b. False 19. The tax treatment of reorganizations almost parallels the Federal income tax treatment for like-kind exchanges. a. True b. False 20. When a corporation has cancellation-of-debt relief in a “Type G” reorganization, the corporation reduces its benefits Copyright Cengage Learning. Powered by Cognero.

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chapter 7 in tax items such as earnings and profits. a. True b. False 21. Obtaining a favorable letter ruling from the IRS can ensure the desired tax treatment for parties contemplating a corporate reorganization. a. True b. False 22. In a year in which an ownership change occurs for a corporation, the NOL carryforward is limited not only by the § 382 annual limitation but also by the percentage of the year remaining. a. True b. False 23. The gains that shareholders recognize as a part of a corporate reorganization may be treated a dividend to the extent of the corporation’s E & P. a. True b. False 24. For corporate restructurings, meeting the § 368 reorganization “Type” requirements is all that needs to be considered when planning the structure of the transaction. a. True b. False 25. If the acquiring corporation purchased 25% of target stock for cash 10 years ago, the acquiring corporation still can meet the “Type C” reorganization requirement that 80% of the target’s assets be acquired with stock. a. True b. False 26. Target shareholders recognize gain or loss when they receive assets (boot) as well as stock in the acquiring corporation in a transaction meeting the § 368 requirements. a. True b. False 27. The basis for the acquiring corporation in the target’s assets is increased by any gain recognized by the target. a. True b. False 28. When substantially all the assets of the target corporation are received in exchange for voting stock and selected liabilities, the restructuring can qualify as a “Type C” reorganization. a. True b. False 29. When the § 382 limitation is evoked, the acquiring corporation is limited in its use of the tax loss carryover of the loss corporation. The limitation is based on the net present value of the loss corporation using the Federal long-term discount rate. a. True Copyright Cengage Learning. Powered by Cognero.

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chapter 7 b. False 30. For a capital restructuring to qualify as a “Type E,” there must be at least a 50% change in the common stock ownership. a. True b. False 31. The amount of gain recognized by a shareholder in a corporate reorganization is based on the shareholder’s proportionate share of E & P. a. True b. False 32. The continuity of interest doctrine requires that all target shareholders receive some acquiring stock. a. True b. False 33. When applying the § 382 limitation to deductible losses, the § 382 limit first is applied to capital loss carryovers and then to NOLs. a. True b. False 34. In a “Type B” reorganization, the acquiring corporation obtains control by exchanging common and preferred stock in the same percentages as the target’s outstanding common and preferred stock. a. True b. False

Indicate the answer choice that best completes the statement or answers the question.

35. Crested Serpent Eagle (CSE) Corporation is owned by Lin Yuan and Yu Chi. It has been in the manufacturing and lumber businesses for 20 years. For liability protection, the manufacturing assets of CSE are transferred to Serpent Corporation for all its stock. This stock is distributed to Lin Yuan in exchange for her CSE stock. The lumber assets are transferred to Eagle Corporation for all of its stock. Yu Chi receives the Eagle stock in exchange for his CSE shares. CSE then terminates. a. The transaction qualifies as a spin-off “Type D” reorganization. b. The transaction qualifies as a split-off “Type D” reorganization. c. The transaction qualifies as a split-up “Type D” reorganization. d. The transaction is taxable.

36. Spoonbill Corporation has assets with a FMV of $800,000 and adjusted basis of $600,000. It has been manufacturing engineering equipment and laboratory tools for the last eight years. Spoonbill forms a new corporation, Roseate Corporation, by acquiring all of its stock in exchange for the laboratory tool division of Spoonbill. Each of the Spoonbill shareholders receives 1 share of Roseate stock for each 50 shares they own in Spoonbill. How will this transaction be treated for Federal income tax purposes? a. As a split-off “Type D” reorganization. b. As a spin-off “Type D” reorganization. c. As a split-up “Type D” reorganization. d. This transaction is treated as a stock dividend.

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chapter 7 37. WhydahCo is owned by Gilda and her four nieces and nephews. Gilda owns all the WhydahCo voting stock and its $50,000 bond. She wants to relinquish control of the entity; accordingly, WhydahCo redeems all of Gilda’s voting common stock and issues its preferred stock to her. She also exchanges her bond for preferred stock. The nonvoting preferred shares owned by the nieces and nephew are exchanged for voting common stock. Which of the following statements is correct? a. The exchange of a bond for preferred stock is taxable. b. The exchange of common for preferred is not taxable but the exchange of preferred stock for common stock is taxable. c. All of these transactions are taxable. d. The transaction is not currently taxable; this is a “Type E” reorganization.

38. Against the will of Rally Corporation’s management, Buoy Corporation offers Rally’s shareholders 2 shares of Buoy common stock for each share of Rally common and 50 shares of Buoy common for each share of Rally preferred. The results of a hostile takeover yield Buoy 85% of Rally common stock and 100% of the preferred. The only stock it did not obtain was that owned by management. This transaction qualifies as a(n): a. “Type A” consolidation. b. “Type B” reorganization. c. “Type D” split-up reorganization. d. Taxable event.

39. Long Corporation has $500,000 of assets with a basis of $350,000 and liabilities of $125,000. ShortCo acquires Long’s assets and $100,000 of liabilities by exchanging $400,000 of its voting stock. Long distributes the ShortCo stock and remaining liabilities to its shareholder in exchange for the shareholder's Long stock with a basis of $275,000 and then it liquidates. Which, if any, of the following statements is correct? a. This restructuring qualifies as a “Type A” reorganization with no recognized gains or losses. b. This restructuring qualifies as a “Type C” reorganization with no recognized gains or losses. c. This qualifies as either a “Type A” or “Type C” and the shareholder has a $25,000 recognized gain. d. The restructuring is taxable because liabilities cannot be distributed to shareholders in a tax-free reorganization.

40. Mars Corporation merges into Jupiter Corporation by exchanging all of its assets for 300,000 shares of Jupiter stock valued at $2 per share and $100,000 cash. Wanda, the sole shareholder of Mars, surrenders her Mars stock (basis $900,000) and receives all of the Jupiter stock transferred to Mars plus the $100,000. How does Wanda treat this transaction on her tax return? a. Wanda recognizes a $100,000 gain. Her Jupiter stock basis is $900,000. b. Wanda recognizes a loss of $100,000. Her Jupiter stock basis is $800,000. c. Wanda recognizes a $100,000 gain. Her Jupiter stock basis is $700,000. d. None of these.

41. A tax-free corporate reorganization can be utilized to: a. Transfer assets in a bankruptcy. b. Resolve management issues by dividing a company into three new companies. c. Combine four corporations into one. d. Create a subsidiary. e. All the above results are possible.

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chapter 7 42. Acquiring Corporation transfers $1 million of its voting common stock and $100,000 cash to Target Corporation in exchange for 90% of Target's assets. The assets retained by Target are used to settle its liabilities. Target then distributes the Acquiring stock and cash received to its shareholders in exchange for all their Target shares. Target then liquidates.

This restructuring qualifies as a: a. “Type A” reorganization. b. “Type B” reorganization. c. “Type C” reorganization. d. Taxable exchange.

43. Weaver Corporation has net assets valued at $800,000 and an NOL of $250,000. On September 30 of the current year, Weaver is acquired by Loom Corporation, a calendar year taxpayer, in a restructuring qualifying as a tax-free reorganization. Weaver shareholders receive 30% of Loom’s shares in exchange for all of their Weaver stock. Assuming that the Federal long-term tax-exempt rate is 3%, what is the maximum amount of Weaver’s NOL available to Loom in the current year? a. $250,000 b. $62,500 c. $24,000 d. Some other amount.

44. Ocelot Corporation is merging into Tiger Corporation under state law requirements. Ocelot transfers assets worth $300,000 to Tiger. Ocelot receives 30,000 shares of Tiger stock and $200,000 cash. Ocelot transfers the Tiger stock, $200,000 cash, and all of its liabilities ($50,000) to its shareholder, Van, in exchange for all his Ocelot stock (basis $100,000). Ocelot then liquidates. How is this transaction treated for tax purposes? a. Since this qualifies as a “Type A” reorganization, Van recognizes no gain. b. Since this qualifies as a “Type C” reorganization, Van recognizes a $200,000 gain. c. Since this qualifies as a “Type A” reorganization, Van recognizes a $150,000 gain. d. Since this does not qualify as a reorganization, Van recognizes a $150,000 gain.

45. Racket Corporation and Laocoon Corporation create Raccoon Corporation. Racket transfers $600,000 in assets for all of Raccoon’s common stock. Racket distributes its remaining assets ($300,000) and the Raccoon common stock to its shareholder, Mia, for all her stock in Racket (basis $950,000) and then liquidates. Laocoon receives all the Raccoon preferred stock for its $400,000 of assets. Laocoon distributes its remaining assets ($300,000) and the Raccoon preferred stock to its shareholder, Carlos, for all his stock in Laocoon (basis $200,000) and then liquidates. How will this transaction be treated for tax purposes? a. This qualifies as a “Type A” reorganization. Mia recognizes no gain or loss, but Carlos recognizes $300,000 gain. b. This qualifies as a “Type C” reorganization. Mia and Carlos recognize $300,000 gain, to the extent of the boot. c. This qualifies as a “Type D” reorganization. Neither Mia nor Carlos recognizes a gain or loss. d. This is a taxable transaction. Mia recognizes $50,000 loss and Carlos recognizes $500,000 gain.

46. Which of the following statements regarding the applicability of the judicial doctrines to a “Type G” reorganization is correct? a. The continuity of interest doctrine is applied to the creditors rather than the shareholders. b. The sound business purpose doctrine does not apply because the restructuring is dictated by state proceedings. c. The continuity of business enterprise doctrine does not apply because the business must change to be profitable. d. The step transaction doctrine presents a problem, because a “Type G” reorganization may take an extended Copyright Cengage Learning. Powered by Cognero.

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chapter 7 period of time to complete.

47. Which of the following statements is correct with regard to liabilities in corporate reorganizations? a. While in a “Type A” merger, all the liabilities of the target must be acquired; in a consolidation, only general liabilities are transferred. b. In a “Type G” reorganization, the target’s liabilities rarely are liquidated. c. Liabilities are problematic for a “Type C” only when the acquiring corporation transfers other property in addition to common stock. d. Long-term liabilities (bonds) can be exchanged tax-free in a “Type E” reorganization as long as the terms of the bonds are greater than 10 years and the interest rates are identical.

48. Ula purchased stock in Purple, Inc., six years ago for $150,000. Purple has assets with a value of $225,000 ($175,000 basis) and liabilities of $60,000. Purple transfers $200,000 of assets and all its liabilities to White Corporation in exchange for White common stock. Purple distributes the White stock and its $25,000 remaining asset (cash) to Ula in exchange for all her Purple stock. Purple then liquidates. How is this transaction treated for tax purposes? a. Ula recognizes a $15,000 gain on the exchange. b. Ula recognizes a $25,000 gain on the exchange. c. Ula recognizes a $25,000 gain and Purple recognizes a $25,000 gain on the exchange. d. Purple recognizes a $50,000 gain on the exchange.

49. Asity Corporation is interested in acquiring the majority of Pitta Corporation’s assets. Pitta’s assets are currently valued at $950,000, and its liabilities are $250,000. However, Asity is not interested in one operating division of Pitta.

Since Pitta desires to be taken over by Asity, Pitta first sells the unwanted division for its net fair market value of $250,000 ($350,000 FMV assets – $100,000 liabilities). Pitta then transfers its remaining assets and liabilities to Asity for $450,000 in common voting stock. Which of the following statements is correct with regard to the proposed restructuring? a. Continuity of interest does not exist for the Pitta shareholders. b. The continuity of business enterprise test is failed. c. There is no sound business purpose for this restructuring. d. The step transaction can be applied to this transaction.

50. Burmese Corporation is interested in acquiring Javanese Corporation by transferring 30% of its stock for all of Javanese’s assets valued at $500,000 (basis of $150,000) and its $200,000 of liabilities. Javanese has $50,000 of capital loss carryforwards that it has been unable to use. Javanese concentrates on pharmaceutical research whereas Burmese manufactures sun glasses. Burmese uses a discount factor of 8%, and the Federal applicable rate is 4%. Javanese will terminate after the restructuring. How will this transaction be treated for tax purposes? a. Since Javanese has liabilities in excess of its basis, this excess will be taxable to Javanese. b. The most of the capital loss carryforward that Burmese can use in any year is $3,000. c. This transaction could qualify as a “Type A” or a “Type C” reorganization. d. All of these. e. None of these.

51. Grebe Corporation is a car dealership that has been in existence for 10 years. It has also been in the car leasing business for 6 years. Both businesses produce substantial amounts of cash, and Grebe has been investing this cash in mutual funds for the past 10 years. Grebe is interested in separating its businesses. It will create (a) new corporation(s) to receive assets in exchange for stock. Which of the following is correct regarding this transaction? a. Grebe must distribute at least 80% of the new corporation(s) stock to its shareholders in exchange for a proportionate amount of Grebe’s stock. If the shareholders do not exchange stock, the transaction receives Copyright Cengage Learning. Powered by Cognero.

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chapter 7 dividend treatment. b. Grebe may create up to three new corporations because it has three lines of business. If three new corporations are created, Grebe ceases to exist because it will have no assets. c. The new corporations created will carry over no tax attributes or earnings and profits from Grebe. d. Using a split-off “Type D” reorganization, Grebe can transfer the car leasing business to the new corporation and exchange the new corporation stock for some of the Grebe stock held by its shareholders.

52. Which of the following statements is true regarding “Type A” reorganizations? a. At least 80% of the acquiring corporation’s consideration must be voting stock, but the other 20% can be cash or preferred stock. b. The target shareholders must receive a proprietary interest in the acquiring corporation. This means that target shareholders must receive at least 40% of all the acquiring corporation’s stock. c. Substantially all the target’s assets must be transferred to the acquiring corporation. This means at least 90% of the net asset value. d. Assumption of all liabilities for a “Type A” reorganization includes unknown and contingent liabilities.

53. Which of the following statements regarding “Type B” reorganizations is true? a. Since a parent-subsidiary relationship is created, the tax attribute carryover limitations are problematic. b. The acquisition of liabilities can cause problems when the liabilities of the target are greater than 20% of the total consideration and the acquiring owned target stock prior to the “Type B” reorganization. c. The acquisition of common and preferred target stock by the acquiring entity can be directly from the shareholders or from the target corporation. d. The acquiring corporation must distribute the target stock it obtains to its shareholders. The acquiring shareholders do not always have to turn in acquiring stock in exchange for the target stock.

54. Xian Corporation and Win Corporation would like to combine into one entity. Win redeems 90% of its common stock and all of its nonvoting preferred stock in exchange for 40% of Xian’s common and 20% of its nonvoting preferred stock.

Win then distributes the Xian stock to its shareholders. Win then becomes a subsidiary of Xian. a. This is a taxable transaction. b. This restructuring qualifies as a divisive “Type D” reorganization. c. This restructuring qualifies as a “Type B” reorganization. d. This restructuring qualifies as a “Type E” reorganization. e. This restructuring qualifies as a “Type C” reorganization.

55. Manx Corporation transfers 40% of its stock and $50,000 in cash to Somali Corporation for $500,000 of assets and all $200,000 of its liabilities. Somali exchanges the Manx stock, cash, and its remaining $100,000 of assets with its shareholders for all their Somali stock. After the exchange, Somali liquidates. The exchange qualifies as what type of transaction? a. “Type A” reorganization. b. “Type B” reorganization. c. “Type C” reorganization. d. A taxable exchange.

56. Saucer Corporation has a value of $800,000, basis in its assets of $670,000, and liabilities of $200,000. Cup Corporation acquires 90% of Saucer’s assets by exchanging $550,000 of its voting stock, $20,000 cash, and assuming $150,000 of Saucer’s liabilities. The remaining 10% of Saucer’s assets not acquired is $80,000 cash. Saucer distributes the Copyright Cengage Learning. Powered by Cognero.

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chapter 7 Cup stock, $100,000 in cash and associated $50,000 in liabilities to its shareholder, Sam, in exchange for his Saucer stock (basis $560,000). Saucer then liquidates. How will this transaction be treated for tax purposes? a. As a “Type A” reorganization. Sam recognizes $50,000 gain and Saucer recognizes $20,000 gain. b. As a “Type A” reorganization. Sam recognizes $100,000 gain and Saucer recognizes $120,000 gain. c. As a “Type C” reorganization. Sam recognizes $50,000 gain and Saucer recognizes $20,000 gain. d. As a “Type C” reorganization. Sam recognizes $40,000 gain and Saucer recognizes no gain. e. As a taxable transaction.

57. Which of the following statements is true concerning all types of tax-free corporate reorganizations? a. Assets are transferred from one corporation to another. b. Stock is exchanged with shareholders. c. Liabilities that are assumed when cash is also used as consideration will be treated as boot. d. None is true.

58. Which of the following statements is false? a. A “Type B” reorganization is most likely to run afoul of the continuity of interest doctrine because the target remains a separate corporation. b. Liabilities are problematic for “Type A” and “Type C” reorganizations. c. The step transaction doctrine can be problematic in “Type B” and “Type C” reorganizations. d. “Type E” and “Type F” are not likely to be subject to the § 382 limitation.

59. Peony owns all of the Garden Corporation common stock with a basis of $400,000 and a value of $900,000. Her grandchildren own nonvoting preferred stock with a basis and value of $540,000 that pays a 6% annual dividend. Peony would like to transfer her ownership of Garden to her grandchildren but retain a guaranteed income from Garden. What would be the most tax effective method of making this transfer? a. Peony sells her common stock to her grandchildren. They pay for the stock on the installment method over 20 years with a 6% interest on the unpaid balance. b. Garden redeems all of Peony’s common stock and issues her a 20-year bond for $900,000 that pays 6% interest. c. Garden redeems Peony’s common stock and issues her preferred stock with a 6% yearly dividend rate. Garden exchanges the grandchildren’s preferred stock for common stock. d. Peony exchanges 60% of her common stock with her grandchildren for all of their preferred stock. The grandchildren then have control and Peony retains 40% of the common stock.

60. All the following statements are true about corporate reorganization except: a. Taxable amounts for shareholders are classified as a dividend or capital gain. b. Reorganizations receive treatment similar to corporate formations under § 351. c. The transfers of stock to and from shareholders qualify for like-kind exchange treatment. d. The value of the stock received by the shareholder less the gain not recognized (postponed) will equal the shareholder’s basis in the stock received.

61. Which of the following conclusions regarding bonds in tax-favored corporate reorganizations is false? a. Bonds exchanged must have the same face value to ensure that the holder will receive equal value when the bonds are repaid. b. The interest rates on the bonds should be the same percentage because if the bond holder receives a security with a higher interest rate, the bondholder is receiving an asset with a greater value.

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chapter 7 c. Debt instruments with lives longer than 10 years are treated as securities because they have more risk associated with the likelihood that they will be repaid; this is similar to the risk with owning stock long-term. d. Bonds exchanged for stock do not receive tax-favored treatment because this exchange is essentially the purchase of stock by changing a debt holder into a shareholder.

62. Heart Corporation has net assets valued at $1 million and an NOL of $250,000. On December 31 of last year, Heart is acquired by Brain Corporation, a calendar year taxpayer, in a restructuring qualifying as a tax-free reorganization. Heart shareholders receive 45% of Brain’s shares in exchange for all of the Heart stock. Assuming that the Federal long-term tax-exempt rate is 3% and Brain’s discount factor is 7%, what is the maximum amount that Brain can use of Heart’s NOL this year? a. $12,500 b. $30,000 c. $100,000 d. $250,000 63. Besides the statutory requirements for tax-free treatment for corporate reorganizations, there are several judicial requirements. Which of the following is not a judicial requirement for corporate reorganizations? a. The ownership change doctrine should be met. b. The continuity of business enterprise test must be met. c. There must be a sound business purpose for the restructuring. d. The step transaction doctrine should not apply.

64. Humming Inc. is interested in acquiring BirdCo, a supplier of materials for Humming’s products, and feels that it could improve the management of BirdCo. Current management has been lax in monitoring product quality, which could lead to recalls or lawsuits. Management of BirdCo is not supportive of a merger because they could lose their positions, whereas most of the shareholders support the acquisition as a method of obtaining new management. There is a very small minority of shareholders who do not want to be shareholders of Humming. BirdCo has assets of $5 million with a basis of $6 million. Its liabilities are $2 million. Which of the following would be the best solution for Humming in its acquisition of BirdCo? a. “Type A” reorganization. b. “Type B” reorganization. c. “Type C” reorganization. d. Humming buys BirdCo’s assets for cash and BirdCo distributes the cash to its shareholders and liquidates. e. Humming buys BirdCo’s stock for cash directly from the shareholders.

65. Monal Corporation merged with Bobwhite Corporation two years ago. At the time of the merger, Monal held an earnings and profits (E & P) deficit of $250,000, and Bobwhite had a positive E & P of $200,000. Last year’s current E & P was $ 100,000 for the successor company. Despite having only $10,000 E & P for the current year, Monal makes a distribution to its shareholders of $270,000. How much of the distribution is taxed to the shareholders? a. $270,000 b. $210,000 c. $110,000 d. $60,000 66. All the following should apply to a tax favored corporate restructuring except: a. The reorganization is planned to be accomplished over five months.

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chapter 7 b. Transactions to remove any barriers occur within three months of the restructuring. c. The purpose of the restructuring is to ensure a supply of raw materials. d. All of these statements are true.

67. A shareholder bought 10,000 shares of Coral Corporation for $50,000 several years ago. When the stock is valued at $90,000, Coral redeems the shares in exchange for 5,000 shares of Blush Corporation stock and a $10,000 Blush bond.

This transaction meets the requirements of § 368. Which of the following statements is false regarding this transaction? a. The shareholder has a realized gain of $40,000. b. The shareholder has a postponed gain of $30,000. c. The shareholder has a basis in the Blush stock of $60,000. d. The shareholder has a recognized gain of $10,000.

68. Pallid Swift, Inc. is an S corporation located in Colorado. In the past year, PallidSwift has become profitable; but due to its rapid growth, it has no excess cash for distributions. Therefore, Pallid Swift decides that it should become a C corporation. a. This transaction qualifies as a “Type F” reorganization. b. This transaction qualifies as a “Type E” reorganization. c. This transaction qualifies as a "Type D" shift reorganization. d. This change is a taxable event.

69. Cuckoo Corporation has just lost a $500,000 product liability suit. Before the lawsuit, its assets were valued at $600,000 (basis of $400,000), and it had general liabilities of $300,000 and $100,000 of bonds outstanding. It also has a $50,000 capital loss carryover, and a $150,000 NOL carryforward. Cuckoo is solely owed by Emmy Lou. A state restructuring creates Turaco as the successor company to Cuckoo. Which of the following statements is false? a. This transaction qualifies as a “Type G” reorganization. b. Emmy Lou may not receive any stock in Turaco in the restructuring. c. When Turaco reduces Cuckoo’s tax attributes for the cancellation of debt income relief, it first reduces the capital loss, then the NOL, and last the basis in the assets. d. The bondholders of Cuckoo become shareholders of Turaco.

70. Angus Corporation purchased 15% of Hereford Corporation four years ago for $150,000. Angus acquires 75% more of Hereford’s stock directly from Hereford shareholders in an exchange for 25% of Angus common stock currently outstanding. There is still 10% of the Hereford stock held by its original shareholders because they are not interested in being common shareholders of Angus. This transaction qualifies as what type of reorganization? a. “Type A” reorganization. b. “Type B” reorganization. c. “Type C” reorganization. d. A taxable exchange.

71. Why is the shareholder’s basis in the new stock received in a corporate reorganization the value of the stock received less the postponed gain? a. This ensures that the basis is the value of the stock given up in the reorganization. b. The realized gain is the amount that would be recognized if the stock was sold outright. This gain may not be recognized, however, unless there is boot involved. c. The basis is the vehicle to ensure that the gain postponed will be recognized in the future when the stock is sold.

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chapter 7 d. A carryover basis or a substituted basis will not include the postponed gain that is necessary in a tax-deferred transaction such as a reorganization.

72. In which type of corporate reorganization do shareholders receive stock in at least two other corporations in exchange for all the stock in the original corporation? a. “Type A” consolidation reorganization. b. “Type D” spin-off reorganization. c. “Type D” split-off reorganization. d. Some other type of reorganization.

73. Target sells assets not desired by Acquirer before entering into a reorganization transaction with Acquirer. In which reorganization will the step transaction doctrine not apply to the sale by Target? a. “Type A” reorganization. b. “Type B” reorganization. c. “Type C” reorganization. d. Only “Type A” and “Type C”.

74. Dahlia owns $100,000 in Crimson Topaz preferred stock. The annual dividend rate on the preferred is 4%. She exchanges this preferred stock for $60,000 in Crimson Topaz bonds paying 4% annual interest and $40,000 in common stock. How is this transaction treated for tax purposes? a. All of this transaction is taxable. b. The transaction is not currently taxable because it qualifies as a “Type E” reorganization. c. Only the exchange of the preferred stock for the common stock is taxable, because of the reduction in preferential treatment upon liquidation. d. Only the exchange of the preferred stock for the bond is taxable.

75. Which of the following statements is true? a. The dollar amounts involved in reorganizations are generally substantial; thus, it is important that the financial and tax treatment of the reorganization be consistent. b. A letter ruling indicates the income tax treatment the IRS will apply to the proposed corporate restructuring transaction. c. Careful planning can ensure that all gains recognized by individual shareholders receive beneficial dividend treatment. d. None is true.

76. Bobcat Corporation redeems all of Zed’s 4,000 shares and distributes to him 2,000 shares of Van Corporation stock plus $50,000 cash. Zed’s basis in his 20% interest in Bobcat is $100,000 and the stock’s value is $250,000. At the time Bobcat is acquired by Van, the accumulated earnings and profits of Bobcat are $200,000 and of Van are $75,000. How does Zed treat this transaction for tax purposes? a. Zed recognizes no gain in this reorganization. b. Zed reports a $50,000 recognized dividend. c. Zed reports a $50,000 recognized capital gain. d. Zed reports a $40,000 recognized dividend and a $10,000 capital gain.

77. Flower Corporation has two divisions that it has operated for the last 10 years: Gerbera with a value of $806,000 (basis $400,000) and Daisy with a value of $744,000 (basis 800,000). While Gerbera is profitable, Daisy continues to Copyright Cengage Learning. Powered by Cognero.

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chapter 7 incur losses and created a $350,000 NOL for Flower two years ago. Flower has decided this year it would like to become two corporations: Gerbera and Daisy. Which of the following is the best method for Flower to become two corporations? a. Under a § 351 creation of a corporation, Flower transfers all of the Daisy division assets and the NOL to the new corporation (Daisy) for all of its stock. Flower retains the stock and Daisy becomes a subsidiary without limitations on its NOL use. b. Using a split-off, Flower transfers the Gerbera division assets to the new corporation (Gerbera) for all of its stock. Flower distributes all of the Gerbera stock to its shareholders in exchange for 52% of their Flower stock.

Flower retains the Daisy division and NOL without limitations on its use. c. Using a spin-off, Flower transfers the Daisy division assets to the new corporation (Daisy) for all of its stock.

Flower distributes all of the Daisy stock to its shareholders. Flower retains the Gerbera division and NOL without limitations on its use. d. Using a split-up, Flower transfers the Daisy division assets to the new corporation (Daisy) for all of its stock and transfers the Gerbera division assets to the new corporation (Gerbera) for all of its stock. Flower distributes all of the Daisy and Gerbera stock to its shareholders in exchange for 100% of their Flower stock, and Flower then terminates. The Daisy division retains the NOL without limitations on its use.

Enter the appropriate word(s) to complete the statement.

78. For a “Type C” reorganization, substantially all of the assets means that at least ____________________ percent of the net asset value and ____________________ percent of the gross asset value.

79. Federal bankruptcy legislation created the Type ____________________ reorganization. To qualify for this type of reorganization, the corporation must be ____________________ before the reorganization.

80. In a ____________________ reorganization, shareholders may exchange preferred stock for common or common for preferred stock.

81. Changing from an S corporation to a C corporation is a Type ____________________ reorganization.

82. The tax treatment of the parties involved in a tax-free reorganization almost exactly parallels the treatment under the like-kind exchange provisions. When ____________________ is received, gain may be ____________________, and losses are ____________________.

83. Since the “Type B” reorganization precludes the use of ____________________, gain or loss is not recognized. In this type of reorganization, a ____________________ relationship between the acquiring and target corporations is created.

84. In a ____________________ reorganization, the original corporation must receive at least 80% percent of new corporations’ stock. The assets transferred to the new corporations must have been owned and conducted as a trade or business for at least ____________________ years.

85. The ____________________ doctrine ensures that the acquiring corporation cannot immediately sell the target corporation's assets it receives in the reorganization. The ____________________ doctrine also prevents transactions that appear to be sales from qualifying as nontaxable reorganizations.

86. The ____________________ provides a restriction on the amount of tax attributes that can be carried over from the target to the acquiring corporation after an ownership change occurs.

87. The acquiring corporation in a “Type G” reorganization must reduce the tax attributes carried over to it to the extent of the ____________________ relief.

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chapter 7 88. The term “reorganization” refers to any restructuring that will be tax-free under Code section _________________________.

89. Liabilities are problematic only in the ____________________ reorganization when the ____________________ corporation transfers other property (boot) as well as stock to the target.

90. In a ____________________ reorganization, each corporation must obtain the approval of the majority of its shareholders. The acquiring corporation must assume at least ____________________ percent of the target’s liabilities.

91. ____________________ is other property received along with stock in a restructuring falling under § 368. If the shareholders receive the other property, it can be taxed as ____________________ and/or ____________________.

92. The ____________________ doctrine treats several transactions as if they were one transaction when they are all integrated. The ____________________ doctrine ensures that the restructuring has a purpose beyond tax avoidance or evasion.

93. The yearly § 382 limitation is computed by multiplying the ____________________ of the loss corporation’s stock on the change date by the ____________________. For the ____________________, the § 382 limitation is multiplied by the fraction equal to the number of days remaining in the year divided by the number of days in the year.

94. Loss Corporation carries over an NOL, built-in ordinary losses, and capital losses. The § 382 limitation is applied to these carryover attributes in the following order: ____________________, ____________________, ____________________.

Match the following items with the statements that follow. Terms may be used more than once. a. Boot b. Business credits c. Capital gain d. Continuity of business enterprise e. Continuity of interest f. Dividend g. Discount rate h. Earnings and profits i. Federal long-term tax-exempt rate j. Liability assumption k. Ordinary gain l. Ownership change m. Section 382 limitation n. Sound business purpose o. Step transaction 95. Carries over to new corporations in a split-up reorganization.

96. A 50 percentage-point change in ownership that occurs because of tax-free reorganization.

97. Tax avoidance is not enough; transaction must have a corporate economic consequence.

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chapter 7 98. Requires the computation of a deduction equivalent when determining its limitation.

99. Rate used to determine the § 382 limitation.

100. When the transactions are so interdependent that the accomplishment of one would be fruitless without the completion of the series.

101. Shareholders recognize gain to the extent the restructuring qualifies as a redemption.

102. Any asset other than stock or securities received by the target shareholders.

103. Requires at least a 40% carryover ownership by target shareholders.

104. Can be treated as boot if cash as well as voting stock is the consideration used by the acquiring corporation in a “Type C” reorganization.

What type of reorganization is effected in each of the following independent transactions? a. “A” reorganization, merger b. “A” reorganization, consolidation c. “B” reorganization d. “C” reorganization e. “D” reorganization, spin-off f. “D” reorganization, split-off g. “D” reorganization, split-up h. “E” reorganization i. “F” reorganization j. “G” reorganization k. Taxable transaction 105. Flower Corporation is owned by Carry and Kim. All of Carry’s stock (value of $200,000) is exchanged for $200,000 in bonds. Kim exchanges no stock in the transaction.

106. Green Corporation transfers 20% of its voting stock to Brown Corporation’s shareholders in exchange for 60% of Brown’s common stock and 90% of its preferred stock. Green acquired 30% of Brown’s common stock three years ago in a taxable transaction. Brown becomes a subsidiary of Green.

107. Solar currently operates nine lines of business that have been in existence for 10 years. To protect its assets from possible lawsuits, Solar transfers each division to newly formed corporations in exchange for all of the stock of the new corporations. Solar distributes the stock in the nine new corporations to its shareholders in exchange for 45% of their stock in Solar.

108. BarkCo and WoodCo contribute all of their assets to Tree Corporation in exchange for all of Tree’s stock. BarkCo and WoodCo distribute the Tree stock to their shareholders in exchange for their stock in BarkCo and WoodCo. The exchange completes the liquidation of BarkCo and WoodCo and each ceases to exist.

109. Pear Corporation wishes to merge with Plum Corporation. Plum has more name recognition with consumers, so Pear would like Plum to be the surviving corporation. Pear transfers all of its assets and only liabilities associated with real estate to Plum for 45% of Plum’s shares. Pear distributes the Plum stock to its shareholders in exchange for their Pear stock. Pear then liquidates.

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chapter 7 110. Jones Corporation is insolvent and under state law protection from its creditors. Its assets are transferred to Smith Corporation in exchange for all of its stock. The stock is distributed to the creditors of Jones, and the shareholders receive only stock valued at 10% of their stock.

111. Acquiring Corporation receives all the assets of Target Corporation in exchange for 1,000 preferred shares and 6,000 common shares of Acquiring, $25,000 cash, and assumption of all the liabilities of Target. After distributing the Acquiring stock and cash to its shareholders, Target liquidates.

112. Snow Corporation, located in Washington state, establishes Rain Corporation, located in Arizona. Snow then transfers all of its assets to Rain in exchange for all of Snow’s stock. After distributing the Rain stock to its shareholders, Snow liquidates.

113. Black Corporation has been engaged in manufacturing toys and investing in high technology corporate stock for eight years. Black creates Blue and White Corporations. It transfers the toy division to Blue and the investments to White in exchange for all of each corporation’s common voting stock. The stock of Blue and White is distributed to Black shareholders in return for all of their Black stock. Black then liquidates.

114. Apple Corporation transfers voting stock to Orange Corporation in exchange for substantially all of its assets and its liabilities associated with the plant and equipment. Its general liabilities are not acquired by Apple. Orange distributes the Apple stock to its shareholders in exchange for their Orange stock. Orange then liquidates.

115. Dipper Corporation is acquiring Bulbul Corporation by exchanging 220,000 shares of Dipper stock and $80,000 cash for all of Bulbul’s assets (valued at $500,000), liabilities ($200,000), and accumulated earnings and profits ($120,000).

Betty purchased 40% of Bulbul five years ago for $60,000, and Keith purchased the remaining 60% for $90,000. What is the amount of the gain or loss (if any) that Betty and Keith recognize, assuming that the exchange qualifies as a § 368 reorganization? What is the basis in their new Dipper stock?

116. On March 1, Cream Corporation transfers all of its assets to Coffee Corporation in exchange for 10% of its common voting stock. At the time of the reorganization, Cream has assets valued at $4 million (basis of $3 million), and its earnings and profits account shows a deficit of $650,000. Coffee’s earnings and profits as of March 1 were $420,000. Due to the reorganization, Coffee has an NOL for the current year of $150,000. Coffee still declares its usual dividends of $100,000 paid on April 30, August 31, and December 31 ($300,000 of total dividends).

How are the Coffee shareholders taxed on the distribution?

117. Present Value Tables needed for this question. Tony is the sole shareholder of Create Corporation. He is a chemical engineer and has been working hard to create a unique product but has been unsuccessful. Thus, Create has accumulated an NOL of $420,000. This year he finally finds the right combination for a new cleaning product.

Predicting that Create will be very profitable next year, the corporation borrows $250,000 to pay Tony the salary he rightly deserves. Next year, Create does become profitable, earning $100,000 before application of carryovers. Mega Corporation, a huge ($50 million value, 25% combined state and Federal tax bracket) competitor, offers to purchase the patent from Create for $1,050,000.

Knowing that Create’s NOL should be useful to Mega, Tony suggests a restructuring where he receives $800,000 in Mega stock, Mega assumes all of Create’s liabilities ($250,000) plus $75,000 cash for the NOL. Mega counter offers with cash for the NOL (to be determined), and $1,050,000 of stock. It will not assume any liabilities. How much would be the maximum cash offered by Mega for the NOL, assuming that Mega uses a 12% discount factor and the Federal long-term tax-exempt rate is 4%? If Tony accepts Mega’s offer, what type of reorganization, if any, is this restructuring?

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chapter 7 118. Pipe Corporation is interested in acquiring all of Ore Corporation. It currently owns 30% of the outstanding Ore stock, which it purchased six years ago for $250,000. Pipe is a manufacturer of plumbing pipes with assets valued at $3 million and liabilities of $1 million. Ore supplies Pipe with copper from its mines that are valued at $4 million with $3 million in mortgages. Pipe negotiates the restructuring with Ore’s management. Pipe is concerned about potential environmental issues from the strip mining used by Ore and feels it needs liability protection. a.

Given these facts, what type of reorganization would you suggest for Pipe and Ore?

b.

Provide a diagram of the reorganization you suggest.

119. Acquiring Corporation transfers $500,000 stock and land with a value of $400,000 (basis of $250,000) to Target for most of its assets. The assets not acquired in the “Type A” reorganization are distributed to Target’s shareholder, Tia. They are valued at $100,000 (basis of $120,000). Acquiring stock and the land also are distributed to Tia in exchange for her stock in Target. Tia’s basis in her stock is $650,000. What is the gain or loss recognized by Acquiring, Target, and Tia on this restructuring? What is Tia’s basis in the Acquiring stock?

120. Present Value Tables needed for this question. Sugar Corporation would like to acquire Salt Corporation on January 1 of the current year in a tax-free reorganization. Salt is particularly appealing to Sugar because Salt has a $350,000 capital loss that can carry over for five years. Sugar expects large capital gains for the next several years in addition to its expected $2.5 million net income. At the time of the restructuring, Salt has assets valued at $2 million (basis of $1.4 million). Sugar is proposing exchanging 45% of its stock for all of Salt’s assets. The Federal long-term taxexempt rate is 2.5% and Sugar’s discount rate for investment decisions is currently 7%. What is the maximum present value of the capital loss to Sugar assuming it has a combined state and Federal tax rate of 25%?

121. Sauce Corporation is very interested in acquiring a controlling interest in Pear Corporation to obtain operating efficiencies.

Sauce currently owns 30% of Pear, which it bought six years ago for $600,000. Sauce is a fruit processor with assets valued at $3 million and liabilities of $1 million. Pear supplies Sauce with fruit from its orchards that are valued at $4 million with $3 million in mortgages. Sauce has negotiated a restructuring with most of Pear’s shareholders. It will exchange one share of its stock for two shares of Pear. Pear’s founder, who own 10% of the outstanding common stock, is not willing to relinquish her stock and thus, Sauce cannot own 100% of Pear. What type of reorganization is being used here?

122. Cotinga Corporation is acquiring Petrel Corporation through a “Type C” reorganization by exchanging 20% of its voting stock and $50,000 for all of Petrel’s assets (value of $800,000 and basis of $600,000) and liabilities ($100,000).

Jerrika owns 48% of Petrel (basis $270,000), and Allen owns the remaining 52% (basis $380,000). They exchange their stock in Petrel for their proportionate shares of the Cotinga stock and cash. What is the value of the Cotinga stock received by Jerrika and Allen? What are the amounts of gains/losses each recognizes due to the reorganization? What is Jerrika’s and Allen’s basis in the Cotinga stock?

123. Gera owns 25,000 shares of Flow Corporation’s common stock, for which she paid $250,000. The other 5,000 shares belong to Gera’s brother, Earl, which he purchased for $50,000. Wanting to expand a few years ago, Flow sold $200,000 in bonds to Earl. The expansion has paid off, and Flow now can afford to redeem 50% of Earl’s bonds.

Rather than have the bond redeemed, Earl would prefer to receive 100 shares of preferred stock for the $100,000 in bonds.

At the same time, Gera also would like to own preferred stock, so she turns in 5,000 shares of her common stock in exchange for 100 shares of preferred stock and 5,000 shares of her common for a $100,000 bond. Gera and Earl then each will hold 100 shares of preferred and $100,000 in bonds. Gera still owns 15,000 shares of common, and Earl owns 5,000 Copyright Cengage Learning. Powered by Cognero.

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chapter 7 shares of common.

The common stock is valued at $20 per share the day before the preferred is issued. The preferred shares are valued at $1,000 each. State the type of reorganization, if any, for which these transactions qualify. What is the amount of gain or loss that Gera and Earl recognize on these transactions?

124. Tin Corporation was created 10 years ago. It currently is valued at $1.5 million as follows: Tacks division ($420,000), Safety Pins division ($580,000), Paper Clips division ($450,000), and investment assets ($50,000). Tin currently has three shareholders: Antonio, who was the initial shareholder and now owns 40% of the stock (basis in stock $350,000), and Beth and Chang, each of whom purchased 30% of Tin two years ago for $435,000.

Tin is having management problems because the shareholders cannot agree on the future of the company. They have determined that it would be best to divide up the company and go their separate ways. Each shareholder feels that the others do not deserve to continue using the Tin Corporation name. a.

Determine what would be the best method to divide the corporation among the shareholders with the least amount of taxes.

b.

Draw a diagram of the solution you suggested in part a.

c.

Any investments that should be received by the new entities will be distributed to the shareholders in exchange for their Tin stock. Beth is the only shareholder who has indicated that she prefers to receive some investments. Determine the gain or loss each entity and shareholder will have upon the division.

125. Briefly describe the Federal judicial doctrines that may apply to tax-free corporate reorganizations.

126. In each of the following reorganizations, there is an exchange of stock for assets or stock for stock. Indicate for each reorganization the type of stock used for the exchanges and the minimum percentage of stock that may be used for the restructurings to meet the § 368 requirements.

Types: A; B; C; divisive D. 127. Provide the formula for the § 382 limitation and demonstrate how the formula is used in the year of the takeover.

What is the purpose of the § 382 limitation?

128. Discuss the treatment of accumulated earnings and profits (E & P) in a corporate reorganization when both corporations have positive E & P and when the target corporation has a negative E & P. 129. Compare the consideration that can be used in “Type A,” “Type B,” and “Type C” reorganizations.

130. What will cause the corporations involved in a § 368 reorganization to recognize gain or loss? What will cause shareholders of the companies involved in the corporate reorganization to recognize gain or loss? If gain is recognized by shareholders, what are the different tax character possibilities?

131. Explain whether shareholders are exempted from gain/loss recognition in nontaxable corporate reorganization or the gain/loss recognition is merely postponed. If postponed, what is the vehicle for ensuring the postponed gain/loss will be recognized in the future?

132. Both § 382 and “Type G” reorganizations allow beneficial tax attributes to carry over from the loss corporations to Copyright Cengage Learning. Powered by Cognero.

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chapter 7 the successor. Compare the list of attributes are carried over for “Type G” reorganizations and for § 382, and the order of reduction/use of these attributes.

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chapter 7 Answer Key 1. False 2. True 3. True 4. False 5. True 6. True 7. False 8. True 9. True 10. True 11. False 12. True 13. False 14. False 15. False 16. False 17. True 18. False 19. True 20. False 21. True 22. True 23. True 24. False 25. True Copyright Cengage Learning. Powered by Cognero.

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chapter 7 26. False 27. True 28. True 29. False 30. False 31. False 32. False 33. True 34. False 35. c 36. b 37. d 38. b 39. b 40. d 41. e 42. c 43. d 44. d 45. a 46. a 47. c 48. a 49. d 50. e 51. d Copyright Cengage Learning. Powered by Cognero.

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chapter 7 52. d 53. c 54. a 55. a 56. e 57. d 58. a 59. c 60. c 61. b 62. b 63. a 64. b 65. b 66. b 67. c 68. a 69. c 70. b 71. c 72. d 73. a 74. d 75. b 76. d Copyright Cengage Learning. Powered by Cognero.

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chapter 7 77. c 78. 90, 70 79. G, insolvent 80. Type E 81. F 82. boot, recognized, not recognized 83. boot, parent-subsidiary 84. divisive "D", five 85. continuity of business enterprise, continuity of interest 86. Section 382 limitation § 382 limitation 87. cancellation-of-debt-income COD income 88. 368 89. Type C, acquiring 90. Type A, 100 91. Boot, dividends, capital gain 92. step transaction, sound business purpose 93. fair market value, Federal long-term tax-exempt rate, initial (first) year 94. capital loss, built-in ordinary loss, NOL 95. h 96. l 97. n 98. b 99. i 100. o Copyright Cengage Learning. Powered by Cognero.

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chapter 7 101. c 102. a 103. e 104. j 105. k 106. c 107. f 108. b 109. d 110. j 111. a 112. i 113. k 114. d 115. Bulbul is worth $300,000 ($500,000 – $200,000). Betty receives $120,000 (40%) of this amount; Keith receives $180,000.

Betty’s and Keith’s gains and stock basis are computed as follows.

Betty

Keith

Adjusted Basis Realized Gain Recognized Gain Postponed Gain in Dipper Stock $120,000 $32,000 $60,000 $ 88,000 (60,000) (32,000) (28,000) $ 60,000 $28,000 $ 60,000 $180,000 (90,000) $ 90,000

$48,000

$90,000 (48,000) $42,000

$132,000 (42,000) $ 90,000

116.

The $300,000 distributions are taxed to the shareholders as dividends to the extent of $270,000 and $30,000 is a return of capital. As of the date of the merger, Coffee Corporation maintains two separate earnings and profits accounts: its own original with a positive balance of $420,000 and Cream’s with a deficit of $650,000. The NOL for the year reduces Coffee’s original earnings and profits account to $270,000 ($420,000 – Copyright Cengage Learning. Powered by Cognero.

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chapter 7 $150,000). Since Coffee has an earnings and profits account with a positive balance, the distribution is treated as a dividend to the Coffee shareholders until the earnings and profits are exhausted; then $30,000 of the distribution in December is a return of capital.

117. Mega should not pay more than $59,327 for the NOL. Use a “Type C” reorganization.

Since Create would experience a more than 50 percentage-point change in ownership, the § 382 limitation would apply.

Mega would acquire assets from Create with a value of $1,050,000. With a 4% Federal long-term tax-exempt rate, the § 382 limitation is $42,000 ($1,050,000 × 4%) and the tax benefit of this deduction would be $10,500 ($42,000 × 25%). It would take Mega 10 years to fully utilize the NOL ($420,000 ÷ $42,000). Using an 12% discount rate for 10 years (5.6502), the $10,500 tax savings for 10 years is valued at $59,327 ($10,500 × 5.6502).

The merger proposed by Mega would meet the requirement of a “Type C” reorganization. With a “Type C,” Mega can acquire none of Create’s liabilities. Since the only cash is the $59,327, 95% of the assets are acquired with Mega stock.

With a “Type A” merger, all liabilities would need to be assumed by Mega. If the acquisition proceeded as Tony suggested, the transaction would not meet the “Type C” requirements of having 80% of the consideration consist of Mega stock. The $75,000 cash will cause the $250,000 liabilities to be treated as boot. Therefore, $325,000 ($75,000 cash + $250,000 liabilities) of the $1,125,000 total consideration ($800,000 stock + $75,000 cash + $250,000 liabilities) is not stock. This is 29% of the total amount. Thus, stock used would be less than 80% and therefore not meet the “Type C” requirements. Tony should accept Mega’s offer of $1,050,000 in stock and $59,327 as this would meet the requirements of a "Type C" reorganization. The cash only amounts to 5% of the assets.

118. a. The acquisition could be set up as a “Type B” reorganization. Pipe can acquire the 70% of the outstanding common stock by exchanging Pipe voting stock for Ore stock. Since Ore will remain a separate corporation, Pipe can protect its assets from potential environmental lawsuits. With the previously acquired 30% of Ore stock, Pipe will now own 100% of the stock and therefore meets the control requirement for a “Type B” reorganization. The fact that the previously owned 30% was acquired with cash does not violate the solely voting stock consideration requirement. b. Diagram of “Type B” Reorganization

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chapter 7

119. Acquiring recognizes $150,000 gain on land; Target cannot recognize its loss on the assets; and Tia recognizes a $350,000 gain. Tia’s basis in her stock $500,000.

Acquiring’s gain on the land is $400,000 value – $250,000 basis. While Target realizes a $20,000 loss on the assets ($100,000 value – $120,000 basis), loss recognition is disallowed.

Tia receives $1 million for her Target stock ($500,000 Acquiring stock + $400,000 land + $100,000 assets), and her basis in the stock is $650,000. The gain recognized

by Tia is caused by the boot received ($400,000 land + $100,000 assets). Since Tia’s recognized gain cannot be greater than her realized gain, her gain is limited to $350,000.

Thus, Tia’s stock basis is $500,000. Gain and basis amounts are computed as follows.

Tia

Adjusted Basis in Realized Gain Recognized Gain Postponed Gain Acquiring Stock $1,000,000 $350,000 $350,000 $500,000 (650,000) (350,000) (–0–) $ 350,000 $ –0– $500,000

120. Since there is more than a 50 percentage-point ownership change in Salt, the capital loss carryforward will be subject to the § 382 limitation. The maximum period for a capital loss carryforward is five years. The amount of capital loss that Sugar can use to offset its future income is $50,000 per year ($2 million × 2.5%), and the tax benefit of this is $12,500 ($50,000 × 25%). . Therefore, Sugar can use only $250,000 of the capital losses in the next five years ($50,000 × 5).

Using a 7% discount factor for five years, the present value of the usable capital loss carryforward is $51,253 (12,500 × 4.1002).

121.

The acquisition could be set up as a “Type B” reorganization. Sauce can acquire the 60% of the outstanding Pear common stock it does not own either directly from the Pear shareholders or through Pear by exchanging Sauce voting stock for Pear stock. With the 30% previously acquired, Sauce will now own 90% of the Pear stock and therefore meet the 80% control requirement for a “Type B” Copyright Cengage Learning. Powered by Cognero.

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chapter 7 reorganization. The fact that the previously owned 30% was acquired with cash does not violate the solely voting stock consideration requirement.

122. Value of Cotinga stock received: Jerrika $312,000; Allen $338,000. Jerrika has $24,000 recognized gain; Allen cannot recognize his loss. Basis in Cotinga stock: Jerrika $270,000; Allen $354,000.

Total Cotinga stock exchanged $650,000 ($800,000 assets – $100,000 liabilities – $50,000). Jerrika receives $312,000 in Cotinga stock ($650,000 × 48%) and $24,000 cash for a total of $336,000. Allen receives $338,000 in Cotinga stock ($650,000 × 52%) and $26,000 cash for a total of $364,000.

The gain recognized for Jerrika and Allen on the exchange and their basis in the Cotinga stock is computed as follows.

Jerrika

Allen

Realized Gain/ Loss $ 336,000 (270,000) $ 66,000

Recognized Gain/ Loss $24,000

Postponed Gain/ Loss $ 66,000 (24,000) $ 42,000

Adjusted Basis in Cotinga Stock $312,000 (42,000) $270,000

–0–

($16,000) (–0–) ($16,000)

$338,000 + 16,000 $354,000

$ 364,000 (380,000) ($ 16,000)

$

123. The exchange of Earl’s bond for preferred stock qualifies as a “Type E” reorganization. The exchange of Gera’s common stock for preferred stock is also a “Type E” reorganization, but her exchange of common stock for a bond is a taxable transaction. A “Type E” reorganization does not include an exchange of stock for bonds in its nontaxable treatment.

Since the preferred stock received by Earl is valued at $100,000 and the bond he is exchanging is $100,000, he has no realized or recognized gain. His basis in his preferred stock is $100,000.

Gera receives a $100,000 bond for 5,000 shares having a basis of $50,000 [($250,000 basis/25,000 shares) × 5,000] and recognizes a gain of $50,000 ($100,000 – $50,000). Gera recognizes no gain on the exchange of her 5,000 common shares (value of $100,000) for 100 shares preferred (value of $100,000).

124. a. A divisive “Type D” split-up reorganization will meet the needs of the shareholders with the least amount of taxes. The split-up will ensure that none of the shareholders are able to use the Tin Corporation name in the future, because Tin is required to cease to exist after the reorganization. b.

Diagram of the split-up “Type D” reorganization.

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c.

Since Antonio owns 40% of the Tin stock, he should receive 40% of the value of Tin, or $600,000 ($1.5 million × 40%). The Safety Pins division assets ($580,000) should be transferred to the Safety Pin Corporation in exchange for its stock. This Safety Pin stock plus $20,000 of investments will be exchanged for Antonio’s Tin stock. The $20,000 of investments will cause Antonio to recognize a $20,000 gain and his basis in the Safety Pin stock is $350,000 ($600,000 – $350,000 = $250,000 realized gain; recognized $20,000; postponed $230,000; and $580,000 – $230,000 = $350,000 basis in Safety Pin stock).

Beth owns 30% of the Tin stock and should receive 30% of the value of Tin, or $450,000 ($1.5 million × 30%). The Tacks division assets ($420,000) should be transferred to the Tacks Corporation in exchange for its stock. The Tacks stock plus $30,000 of investments should be exchanged for Beth’s Tin stock. The $30,000 of investments will cause Beth to recognize a $15,000 gain, and her basis in the Tacks stock is $420,000 ($450,000 – $435,000 = $15,000 realized gain; recognized $15,000; postponed $0; and $420,000 basis in Tacks stock) Chang also owns 30% of the Tin stock and thus also should receive 30% of the value of Tin, or $450,000 ($1.5 million × 30%). The Paper Clips division assets ($450,000) should be transferred to the Paper Clips Corporation in exchange for its stock. The Paper Clips stock will be exchanged for Chang’s Tin stock. Since Chang received no boot, he recognizes no gain and therefore has a carryover basis of $435,000 in the Paper Clip stock.

125.

Even if the statutory reorganization requirements are literally followed, restructurings will not be treated as tax-free unless they also meet the following judicial doctrines.

Step transaction. This doctrine prevents taxpayers from engaging in a series of transactions for the purpose of obtaining tax benefits that would not be allowed if the transaction was accomplished in a single step. When the steps are so interdependent that the accomplishment of one step would be fruitless without the completion of the series of steps, the transactions may be collapsed into a single step.

Sound Business Purpose. Tax-free treatment of a restructuring is only available to those transactions that are motivated by some valid business needs of the corporations. The economic benefits of the reorganization must go beyond mere tax avoidance. Thus, a reorganization to acquire tax attributes of another corporation, such as an NOL or business credits, does not have a sound business purpose and will not receive tax-free treatment.

Continuity of Business Enterprise. To ensure that the tax-free treatment is limited to transactions that are mere changes Copyright Cengage Learning. Powered by Cognero.

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chapter 7 in the form and not the substance of the business, this test requires that there be a continuation of the target’s business.

Specifically, this test requires the acquiring corporation to either (1) continue the target corporation’s historic business (historic business test) or (2) use a significant portion of the target corporation’s assets in its business (asset use test).

Continuity of Interest. To distinguish between a sale of assets and a reorganization, the continuity of interest doctrine requires that the shareholders of the target corporation have a continuing investment in the succeeding entity after the restructuring. To qualify for tax-free treatment, the target corporation shareholders must receive acquiring corporation stock equal to at least 40% of their prior stock ownership in the target.

126. The stock requirements for § 368 reorganizations are as follows. ∙ ∙

∙

Type A: Acquiring may use common or preferred, voting or nonvoting in the exchange for target’s assets. However, the continuity of interest doctrine requires at least 40% be common stock.

Type B: Acquiring must exchange voting stock for common or preferred, voting or nonvoting stock of the target.

After the reorganization, the acquiring must own at least 80% of the target’s stock. The acquiring corporation’s target stock owned before the reorganization can be counted toward the 80% control requirement.

Type C: Acquiring must use voting stock in the exchange for target’s assets. At least 80% of the assets must be acquired with voting stock.

∙ ∙

Type D Divisive: The original corporation must receive at least 80% of the target’s stock (80% of the total combined voting power and 80% of all other classes of stock).

127.

The formula for determining the § 382 limitation is as follows.

Loss Corporation’s FMV on the change dated × Federal long-term tax-exempt rate = Yearly § 382 limitation × Number of days remaining in change year/number of days in year (365 or 366) = Change year § 382 limitation The purpose of the § 382 limitation is to discourage the acquisition of a corporation merely for its loss carryovers or unused tax credits. The § 382 limitation restricts the use of loss tax attributes to a hypothetical future income stream that would have been received if the stock were sold and the proceeds invested in long-term tax-exempt securities.

128. The accumulated earnings and profits (E & P) of corporations that are parties to a reorganization are added together when both corporations have positive E & P. Thus, the acquiring corporation’s E & P is increased by the target’s E & P. If the target corporation, however, has a negative E & P, the accounts are not commingled. The negative E & P is treated as received by the acquiring corporation as of the reorganization date. The negative E & P may offset only the future earnings of the successor corporation. Thus, the successor corporation must maintain two separate E & P accounts; one for prior E & P and another for the deficit E & P transferred to the corporation and subsequent earnings.

129. With a “Type A” reorganization, the consideration can be stock and other property. There is no requirement that the stock be voting. However, to meet the continuity of interest doctrine, at least 40% of the consideration should be stock. A “Type B” reorganization requires that all of the consideration used by the acquiring corporation be voting stock. If other than voting stock is used, the “Type B” will not be tax-free. Voting stock must be 80% of the consideration given by the acquiring corporation in a “Type C” reorganization. If cash or other property is also given, the liabilities will be considered boot. This can cause the “Type C” to lose its tax-free status. If only stock is used, the liabilities are not considered boot.

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chapter 7 130. Corporations involved in § 368 reorganizations are not permitted to recognize losses. The acquiring corporation can recognize gain if it transfers appreciated property (boot) along with its stock to the target. The target will recognize gain if it fails to distribute the boot to its shareholders. The target also can recognize gain if it distributes its own appreciated property to its shareholders.

Shareholders will recognize gains when they receive boot (nonstock property) in exchange for their stock in their corporation. Shareholders can recognize losses if they only receive boot and no stock.

Shareholder recognized gain in a corporate reorganization may have the following tax characters. ∙ Dividend to the extent of the shareholder’s proportionate share of corporate earnings and profits (E & P). The remaining gain is capital gain. ∙ If the requirements of § 302(b) can be met, the transaction will qualify for stock redemption treatment, usually as a capital gain.

131. In reorganizations, neither gain nor loss is recognized by the shareholders as long as the corporations meet the legislative and judicial requirements for nontaxable treatment. However, this does not mean that the shareholders are exempted from taxation. Rather, the recognition of the gain/loss is merely postponed until there is a taxable transaction.

The vehicle for postponing gain/loss that is not recognized is the basis in the new stock received. If no gain or loss is recognized, the basis in the new stock is carried over from the basis in the old stock. If gain is recognized because the shareholder received “boot,” the basis in the new stock is adjusted to account for the remaining gain realized but not recognized (postponed gain). The four-column template of Concept Summary 7.1 is useful for determining the consequences of a corporate reorganization.

132.

The order of reduction in tax attributes in a “Type G” reorganization is as follows.

1. NOLs 2. Capital losses 3. Basis in property The order for application of the § 382 limitation is as follows.

1. Built-in capital losses 2. Capital losses 3. Built-in ordinary losses 4. NOLs Thus, not only is the order different, but also the tax attributes themselves are different. For the “Type G,” NOLs are reduced before capital losses, whereas with § 382, capital losses are before NOLs. The “Type G” includes a reduction in basis that, at the election of the acquiring corporation, can be reduced before the other attributes. Having a basis reduction does not make sense for the § 382 limitation.

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