Test bank for south western federal taxation 2015 corporations partnerships estates and trusts 38 e

Test Bank for South-Western Federal Taxation 2015: Corporations, Partnerships, Estates and T

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CHAPTER 6: CORPORATIONS: REDEMPTIONS AND LIQUIDATIONS 1. The Code treats corporate distributions that are a return of a shareholder’s investment as sales or exchanges and corporate distributions that are a return from a shareholder’s investment as dividends. a. True b. False ANSWER: True RATIONALE: Distributions that are returns of the shareholder’s investment are treated as a sale or exchange of the investment. Distributions that are returns from the shareholder’s investment are dividend distributions.

2. In general, if a shareholder’s ownership interest is not diminished as a result of a stock redemption, the Code will treat the transaction as a sale or exchange. a. True b. False ANSWER: False RATIONALE: If a shareholder’s ownership interest is not diminished as a result of a stock redemption, the Code generally will treat the transaction as a dividend distribution.

3. Corporate shareholders generally receive less favorable tax treatment from a qualifying stock redemption than from a dividend distribution. a. True b. False ANSWER: True RATIONALE: Because of the dividends received deduction available to corporate shareholders, a corporate shareholder would report only a small portion of a dividend distribution received as taxable income.

4. Yolanda owns 60% of the outstanding stock of Amber Corporation. In a qualifying stock redemption, Amber distributes $20,000 to Yolanda in exchange for one-half of her shares (basis of $35,000). As a result of the redemption, Yolanda has a recognized capital loss of $15,000. a. True b. False ANSWER: False RATIONALE: Since Yolanda owned more than 50% of Amber’s stock at the time of the redemption, § 267 disallows the recognition of the loss.

5. A shareholder’s basis in property acquired in a stock redemption is the property’s fair market value as of the date of redemption. a. True b. False ANSWER:

True

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Chapter 6: Corporations: Redemptions and Liquidations 6. Vireo Corporation redeemed shares from its sole shareholder pursuant to a written agreement between the parties that clearly identified the transaction as a stock redemption (and not a dividend distribution). Since the agreement is binding under state law, the shareholder will receive sale or exchange treatment with respect to the redemption. a. True b. False ANSWER: False RATIONALE: Neither the terminology of the redemption agreement nor state law controls the tax treatment of a stock redemption. Instead, the Code determines the tax treatment of stock redemptions.

7. In applying the § 318 stock attribution rules to a stock redemption, a shareholder is treated as owning the stock of her spouse, children, grandchildren, parents, and siblings. a. True b. False ANSWER: False RATIONALE: Under § 318, stock is attributed from the following family members: spouses, children, grandchildren, and parents. There is no attribution of stock from siblings in a stock redemption.

8. A redemption will qualify as a not essentially equivalent redemption only if the shareholder’s interest in the redeeming corporation has been meaningfully reduced. a. True b. False ANSWER:

True

9. As a result of a redemption, a shareholder’s interest (direct and indirect) in the corporation decreased from 80% to 55%. The redemption qualifies for sale or exchange treatment as a disproportionate redemption. a. True b. False ANSWER: False RATIONALE: The transaction does not qualify under § 302(b)(2) as a disproportionate redemption. The shareholder’s ownership interest after the redemption is less than 80% of the pre-redemption interest [55% < 64% (80% × 80%)] but not less than 50% of the total voting power of the corporation.

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Chapter 6: Corporations: Redemptions and Liquidations 10. Puffin Corporation’s 2,000 shares outstanding are owned as follows: Paul, 800 shares; Sandra (Paul’s sister), 800 shares; and Greta (Paul’s granddaughter), 400 shares. During the current year, Puffin (E & P of $1 million) redeemed 600 shares of Paul’s stock for $100,000. If Paul had acquired the 600 shares five years ago for $30,000, he will have a long-term capital gain of $70,000 from the redemption. a. True b. False ANSWER: True RATIONALE: Under the family attribution rules, Paul is deemed to own the shares owned by his granddaughter, Greta, but not his sister, Sandra. Before the redemption, Paul therefore owns 60% of the Puffin shares outstanding [(800 shares directly plus 400 shares indirectly from Greta) ÷ 2,000 shares]. After the redemption, Paul owns 42.9% of the remaining outstanding shares of Puffin Corporation [(200 shares directly plus 400 shares indirectly from Greta) ÷ 1,400 shares). Since this ownership interest is less than 80% of Paul’s pre­ redemption interest [42.9% < 48% (80% × 60%)] and less than 50% of the total voting power after the redemption, the transaction qualifies as a disproportionate redemption. Thus, Paul has a $70,000 long- term capital gain from the redemption ($100,000 amount realized – $30,000 stock basis).

11. For purposes of the waiver of the family attribution rules in a complete termination redemption, the former shareholder must notify the IRS within 30 days of acquiring a prohibited interest in the corporation during the 10- year period following the redemption. a. True b. False ANSWER:

True

12. Reginald and Roland (Reginald’s son) each own 50% of the stock of Robin Corporation. Reginald’s stock interest is entirely redeemed by Robin Corporation. Two years later, Reginald loans Robin Corporation $250,000. The loan to Robin Corporation does not constitute a prohibited interest for purposes of the family attribution waiver. a. True b. False ANSWER: True RATIONALE: Creditor interests, such as Reginald’s loan to Robin, are not prohibited interests for purposes of the family attribution waiver.

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Chapter 6: Corporations: Redemptions and Liquidations 13. Six years ago, Ronald and his mom each owned 50% of the stock of Bronze Corporation. At such time, Bronze redeemed all of Ronald’s stock. For the redemption year, Ronald filed the agreement required of the family attribution waiver and reported the transaction as a complete termination redemption (i.e., sale or exchange). In the current year, the mom passed away and willed her entire stock interest in Bronze to Ronald.

The inheritance of Bronze stock by Ronald is a prohibited interest for purposes of the family attribution waiver. a. True b. False ANSWER: False RATIONALE: Acquisition of stock by bequest or inheritance does not constitute a prohibited interest for purposes of the family attribution waiver.

14. For purposes of a partial liquidation, a distribution is not essentially equivalent to a dividend if it results in a genuine contraction of the business of the corporation. a. True b. False ANSWER: True RATIONALE: The distribution must result in a genuine contraction of the corporation’s business.

15. For purposes of a partial liquidation, the termination of a business test is a subjective test that should be relied upon only after obtaining a favorable ruling from the IRS. a. True b. False ANSWER: False RATIONALE: The genuine contraction of a corporate business test is a subjective test that should be relied upon only after obtaining a favorable ruling from the IRS. The termination of a business test, however, is a safe-harbor rule that is governed by objective requirements.

16. To qualify a partial liquidation under the termination of a business test, the distribution must consist of the assets of a qualified trade or business. a. True b. False ANSWER:

False

RATIONALE: The distribution must consist of the assets of a qualified trade or business or the proceeds from the sale of such assets.

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Chapter 6: Corporations: Redemptions and Liquidations 17. In determining whether a distribution qualifies as a § 303 redemption to pay death taxes, the stock attribution rules must be applied. a. True b. False ANSWER: False RATIONALE: One of the principal advantages of a redemption to pay death taxes is that the stock attribution rules do not apply.

18. Betty’s adjusted gross estate is $9 million. The death taxes and funeral and administration expenses of her estate total $1.2 million. Included in Betty’s gross estate is stock in Heron Corporation, valued at $3.3 million as of the date of her death. Betty had acquired the stock six years ago at a cost of $810,000. If Heron Corporation redeems $1.2 million of Heron stock from the estate, the transaction will qualify under § 303 as a redemption to pay death taxes and receive sale or exchange treatment. a. True b. False ANSWER:

True

RATIONALE: The value of the Heron Corporation stock in Betty’s gross estate exceeds 35% of the value of the adjusted gross estate ($3.3 million ÷ $9 million = 36.7%); thus, the transaction qualifies under § 303 for sale or exchange treatment.

19. At the time of her death, Janice owned (in terms of the value of the stock outstanding) the following stock: 18% of Dove Corporation and 21% of Hawk Corporation. The value of these stocks is included in Janice’s gross estate. For purposes of applying the 35% of the value of adjusted gross estate requirement under § 303 (i.e., redemption to pay death taxes), the Dove and Hawk stocks are aggregated. a. True b. False ANSWER: False RATIONALE: In a redemption to pay death taxes, stock in corporations in which the decedent held a 20% or more interest is treated as stock in a single corporation for purposes of determining whether the value of stock owned by the decedent exceeds 35% of the value of the decedent’s adjusted gross estate.

20. Grackle Corporation (E & P of $600,000) distributes cash of $200,000 and land (fair market value of $400,000; basis of $250,000) to a shareholder in a qualifying stock redemption. The land distributed is subject to a mortgage of $460,000. Grackle will recognize a gain of $210,000 as a result of the distribution. a. True b. False ANSWER:

True

RATIONALE: Grackle will recognize a gain on the distribution of the land equal to excess of the mortgage over the basis in the land, or $210,000 ($460,000 – $250,000). In a nonliquidating distribution of property, gain is recognized as if the property were sold for its fair market value. When property is distributed subject to a liability, the fair market value in the deemed sale cannot be less than such liability. © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 6: Corporations: Redemptions and Liquidations 21. At a time when Blackbird Corporation had E & P of $700,000 and 1,000 shares of stock outstanding, the corporation distributed $300,000 to redeem 400 shares of its stock. The transaction qualified as a disproportionate redemption for the shareholder. Blackbird’s E & P is reduced by $300,000 as a result of the distribution. a. True b. False ANSWER: False RATIONALE: The reduction in Blackbird’s E & P is the lesser of (1) the amount of the distribution ($300,000), or (2) the same percentage of E & P as the percentage of stock redeemed (40% × $700,000 = $280,000).

22. Tan Corporation paid interest expense on a debt incurred in financing a redemption of its stock. The interest expense is not deductible since it was incurred in connection with a stock redemption. a. True b. False ANSWER: False RATIONALE: Section 162(k) denies the deduction of expenditures incurred in connection with a stock redemption, but that disallowance does not apply to interest expense incurred in financing a redemption.

23. In a redemption of § 306 stock, the redemption proceeds constitute dividend income to the extent of the corporation’s E & P on the date of the redemption. a. True b. False ANSWER:

True

24. Tammy forms White Corporation in a transaction qualifying under § 351. In that transaction, Tammy transferred cash and equipment in exchange for White Corporation common (1,000 shares) and preferred (200 shares) stock. The preferred stock is not § 306 stock for Tammy. a. True b. False ANSWER:

True

RATIONALE: Preferred stock received in a § 351 transaction when forming a new corporation does not satisfy any of the types of transactions (e.g., a nontaxable stock dividend) that would result in “§ 306 stock” status.

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Chapter 6: Corporations: Redemptions and Liquidations 25. Three years ago, Darlene received preferred (§ 306) stock pursuant to a nontaxable stock dividend from Grackle Corporation. In the current year, Darlene gives the Grackle preferred stock to her sister, Nancy. The Grackle preferred stock is § 306 stock with regards to Nancy. a. True b. False ANSWER: True RATIONALE: Stock that has a basis that is determined by reference to the basis of § 306 stock (e.g., a gift of § 306 stock) is § 306 stock.

26. For purposes of the application of § 304 (redemptions through the use of related corporations), a shareholder must own (directly or indirectly) at least 50% of the stock of two more corporations. a. True b. False ANSWER: True RATIONALE: The required ownership for purposes of § 304 is direct or indirect ownership of at least 50% of the stock of two or more corporations.

27. Abel owns all the stock of both Beige Corporation and Brown Corporation. Both corporations have significant amounts of E & P. Abel sells some of his stock in Beige to Brown Corporation. Abel will not have dividend income as a result of the sale of Beige stock. a. True b. False ANSWER: False RATIONALE: If an individual has at least a 50% ownership interest in two corporations and transfers stock in one corporation to the other for money or property, the exchange is treated as a redemption of the stock of the acquiring corporation. The redemption is tested under § 302 for sale or exchange treatment or dividend treatment. After the transaction, Abel owns 100% (directly and indirectly) of the stock of both Beige and Brown. As such, the transaction fails to satisfy any of the qualifying redemption provisions of § 302 and results in a dividend distribution to Abel.

28. Legal dissolution under state law is required for a liquidation to be complete for tax purposes. a. True b. False ANSWER:

False

RATIONALE: State law does not control in determining whether a liquidation has occurred for tax purposes.

Rather, the test is whether the corporation has ceased to be a going concern.

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Chapter 6: Corporations: Redemptions and Liquidations 29. One similarity between the tax treatment accorded liquidating and nonliquidating distributions is with respect to a shareholder’s basis in property received in such distributions. For each type of distribution, the shareholder’s basis is the property’s fair market value on the date of distribution. a. True b. False ANSWER:

True

30. As a general rule, a liquidating corporation recognizes gains but not losses on the distribution of property in complete liquidation. a. True b. False ANSWER:

False

RATIONALE: Gain and loss recognition is the general rule for the liquidating corporation.

31. Liquidation expenses incurred by a corporation are generally deductible as § 162 trade or business expenses. a. True b. False ANSWER:

True

32. The related-party loss limitation applies to distributions to related parties and either the distribution is pro rata or the property distributed is disqualified property. a. True b. False ANSWER:

False

RATIONALE: The related-party loss limitation applies to liquidating distributions to related parties and either the distribution is not pro rata or the property distributed is disqualified property.

33. The built-in loss limitation in a complete liquidation does not apply to losses attributable to a decline in a property’s fair market value after its transfer to the corporation. a. True b. False ANSWER:

True

34. The related-party loss limitation in a complete liquidation applies only to distributions of property while the built-in loss limitation can apply to a distribution or sale of property. a. True b. False ANSWER:

True

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Chapter 6: Corporations: Redemptions and Liquidations 35. Pursuant to a liquidation, Coral Corporation distributes to Lucinda, a shareholder, land (basis of $90,000, fair market value of $200,000). The land is subject to a $75,000 liability. Lucinda will have a basis of $125,000 in the land. a. True b. False ANSWER: False RATIONALE: The basis of property received in a liquidation is the property’s fair market value on the date of the distribution, or $200,000.

36. A corporation generally will recognize gain or loss on a liquidating distribution of installment notes to its shareholders. a. True b. False ANSWER:

True

37. Section 332 can apply to a parent-subsidiary liquidation even if the subsidiary corporation is insolvent on the date of the liquidation. a. True b. False ANSWER:

False

RATIONALE: The subsidiary must be solvent for § 332 to apply.

38. If a liquidation qualifies under § 332, any minority shareholder will recognize gain or loss equal to the difference between the fair market value of assets received and the basis of the shareholder’s stock. a. True b. False ANSWER: True RATIONALE: The general rule of gain and loss recognition applies to minority shareholders in liquidations subject to § 332. (Note: a subsidiary corporation does not recognize losses on distributions to minority shareholders in liquidations subject to § 332.)

39. A subsidiary corporation is liquidated at a time when it is indebted to its parent corporation. The subsidiary corporation distributes property to the parent corporation in satisfaction of the indebtedness. If the liquidation is governed by § 332, neither the subsidiary nor the parent recognize gain or loss on the transfer of property in satisfaction of indebtedness. a. True b. False ANSWER: False RATIONALE: If pursuant to a liquidation under § 332, a subsidiary corporation does not recognize gain or loss on a transfer of property in satisfaction of indebtedness to its parent. However, the parent corporation does recognize gain or loss equal to the difference between the fair market value of the property received and the parent’s basis in the indebtedness. © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 6: Corporations: Redemptions and Liquidations 40. Brown Corporation purchased 85% of the stock of Green Corporation five years ago for $850,000. In the current year, Brown Corporation liquidates Green Corporation and acquires assets with a basis to Green Corporation of $700,000 (fair market value of $1.1 million). Brown Corporation will have a basis in the assets of $850,000, the same as Brown’s basis in its Green stock. a. True b. False ANSWER:

False

RATIONALE: Brown has a basis of $700,000 in the assets, the same as Green’s basis in the assets.

41. Sparrow Corporation purchased 90% of the stock of Warbler Corporation eight years ago for $1 million. In the current year, Sparrow liquidates Warbler and acquires assets with a basis to Warbler of $850,000 (fair market value of $1.2 million). Sparrow will have a basis in the assets of $850,000 (Warbler’s basis in the assets), and no recognized gain or loss. a. True b. False ANSWER:

True

42. A subsidiary is liquidated pursuant to § 332. The parent has held 100% of the stock in the subsidiary for the past ten years. The subsidiary has a net operating loss carryover of $400,000. The net operating loss does not carry over to the parent. a. True b. False ANSWER: False RATIONALE: The carryover rules of § 381 apply to a liquidation under § 332. The parent corporation takes the subsidiary’s basis in its assets and its tax attributes as well, including net operating loss carryover.

43. If a parent corporation makes a § 338 election, the subsidiary corporation is treated as a new corporation as of the day following the qualified stock purchase date. a. True b. False ANSWER:

True

44. If a parent corporation makes a § 338 election, the subsidiary corporation recognizes gain but not loss on the deemed sale of its assets on the qualified stock purchase date. a. True b. False ANSWER: False RATIONALE: The deemed sale can result in gain and loss recognition to the subsidiary corporation.

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Chapter 6: Corporations: Redemptions and Liquidations 45. If a parent corporation makes a § 338 election, the subsidiary corporation must be liquidated. a. True b. False ANSWER: False RATIONALE: The subsidiary may, but need not, be liquidated.

46. One advantage of acquiring a corporation via an asset purchase instead of a stock purchase is that an asset purchase avoids the transfer of the acquired corporation’s liabilities. a. True b. False ANSWER: True RATIONALE: This is an advantage of an asset purchase over a stock purchase. In a stock purchase, the acquired corporation’s liabilities are transferred along with its assets.

47. Seven years ago, Eleanor transferred property she had used in her sole proprietorship to Blue Corporation for 2,000 shares of Blue Corporation in a transaction that qualified under § 351. The assets had a tax basis to her of $400,000 and a fair market value of $700,000 on the date of the transfer. In the current year, Blue Corporation (E & P of $1 million) redeems 600 shares from Eleanor for $260,000 in a transaction that does not qualify for sale or exchange treatment. With respect to the redemption, Eleanor will have a: a. $140,000 dividend. b. $260,000 dividend. c. $140,000 capital gain. d. $260,000 capital gain. e. None of the above.

ANSWER:

b

RATIONALE: The transaction is treated as a return from her investment, and she has dividend income to the extent of the entire distribution.

48. Seven years ago, Eleanor transferred property she had used in her sole proprietorship to Blue Corporation for 2,000 shares of Blue Corporation in a transaction that qualified under § 351. The assets had a tax basis to her of $400,000 and a fair market value of $700,000 on the date of the transfer. In the current year, Blue Corporation (E & P of $1 million) redeems 600 shares from Eleanor for $260,000 in a transaction that qualifies for sale or exchange treatment. With respect to the redemption, Eleanor will have a: a. $140,000 dividend. b. $260,000 dividend. c. $140,000 capital gain. d. $260,000 capital gain. e. None of the above.

ANSWER: c RATIONALE: The transaction is treated as a return of a portion of her investment. She is treated as having sold 600 of her shares in Blue (basis of $120,000) for $260,000. Therefore, Eleanor’s capital gain from the sale or exchange is $140,000 ($260,000 – $120,000). © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 6: Corporations: Redemptions and Liquidations 49. Finch Corporation distributes property (basis of $225,000, fair market value of $300,000) to a shareholder in a distribution that is a qualifying stock redemption. The property is subject to a liability of $160,000, which the shareholder assumes. The basis of the property to the shareholder is: a. $0. b. $140,000. c. $225,000. d. $300,000. e. None of the above.

ANSWER: d RATIONALE: The shareholder’s basis in property received in a qualifying stock redemption is the fair market value of the property, or $300,000.

50. Coffee Corporation has 2,000 shares of common stock outstanding. John owns 700 of the shares, John’s grandfather owns 100 shares, John’s father owns 100 shares, John’s ex­wife owns 700 shares, and Redbird Partnership owns 400 shares. John is a 50% partner in Redbird Partnership. How many shares is John deemed to own in Coffee Corporation under the § 318 attribution rules? a. 700 b. 1,000 c. 1,100 d. 1,700 e. None of the above ANSWER:

b

RATIONALE: Under the family attribution rules, John is deemed to own the Coffee shares owned by his father, or 100 shares. (The family attribution rules do not extend to ownership of shares by a grandparent or an ex- spouse.) In addition, John is deemed to own 200 shares of Coffee as a result of his 50% interest in Redbird Partnership (50% × 400 shares). Thus, under the § 318 attribution rules, John is deemed to own 1,000 shares (700 shares directly + 300 shares indirectly) in Coffee Corporation.

51. Kite Corporation has 1,000 shares of stock outstanding. Kent owns 300 shares, Kent’s father owns 200 shares, Kent’s daughter owns 100 shares, and Kent’s aunt owns 200 shares. Plover Corporation owns the other 200 shares in Kite Corporation. Kent owns 75% of the stock in Plover Corporation. Applying the § 318 stock attribution rules, how many shares does Kent own in Kite Corporation? a. 500 b. 600 c. 750 d. 950 e. None of the above ANSWER: c RATIONALE: Kent owns 750 shares, 300 shares directly and 450 shares indirectly, in Kite Corporation. Kent owns the shares of his father (200 shares), his daughter (100 shares), and 150 of Plover’s shares [200 (shares owned by Plover) × 75% (Kent’s ownership interest in Plover)].

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Chapter 6: Corporations: Redemptions and Liquidations 52. Keshia owns 200 shares in Parakeet Corporation. Keshia has a 30% beneficiary interest in her deceased grandmother’s estate. The estate owns 400 shares in Parakeet Corporation. None of the other beneficiaries of the estate own stock in Parakeet. In applying the § 318 attribution rules: a. The estate owns 400 shares. b. Keshia owns 320 shares. c. Keshia owns 600 shares. d. The estate owns 460 shares. e. None of the above.

ANSWER: b RATIONALE: Keshia owns 200 shares directly and 120 shares constructively through the estate’s stock ownership [i.e., 30% (beneficiary interest) × 400 shares (estate’s stock ownership)]. An estate is deemed to own all the stock of a beneficiary; thus, the grandmother’s estate owns 600 shares (400 shares directly plus 200 shares indirectly).

53. Which of the following is an incorrect statement regarding the application of the § 318 stock attribution rules? a. An individual is not deemed to own the shares owned by his or her siblings. b. Stock owned by an estate is deemed to be owned in full by a beneficiary. c. Stock owned by any shareholder owning 50% or more of a corporation’s stock is deemed to be owned in full by the corporation. d. Stock owned by a partnership is deemed to be owned proportionately by a partner. e. None of the above.

ANSWER:

b

RATIONALE: Stock owned by an estate is deemed to be owned proportionately by a beneficiary. The other statements are correct regarding the attribution rules.

54. Bristlebird Corporation (E & P of $700,000) has 3,000 shares of common stock outstanding. Juan owns 1,500 shares and his wife, Roberta, owns 1,500 shares. Juan and Roberta each have a basis of $90,000 in their Bristlebird stock. In the current year, Bristlebird Corporation redeems 1,000 shares from Juan for $250,000.

With respect to the distribution in redemption of the Bristlebird stock: a. Juan has dividend income of $250,000. b. Juan has dividend income of $190,000. c. Juan has a capital gain of $250,000. d. Juan has a capital gain of $190,000. e. None of the above.

ANSWER: a RATIONALE: Under the § 318 attribution rules, Juan is deemed to own the shares owned by Roberta, his wife. Thus, Juan is deemed to own 100% of the stock in Bristlebird Corporation before and after the redemption. The distribution does not satisfy any of the qualifying stock redemption rules; instead, the entire distribution of $250,000 is taxed as dividend income. The $60,000 basis in the stock redeemed attaches to the basis of Juan’s remaining 500 shares in Bristlebird Corporation.

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Chapter 6: Corporations: Redemptions and Liquidations 55. Hazel, Emily, and Frank, unrelated individuals, own all of the stock in Wren Corporation (E & P of $1.2 million) as follows: Hazel, 1,500 shares; Emily, 300 shares; and Frank, 200 shares. Wren redeems 900 of Hazel’s shares (basis of $210,000) for $625,000. With respect to the distribution in redemption of the stock: a. Hazel has a capital gain of $415,000. b. Hazel has a capital gain of $625,000. c. Hazel has dividend income of $415,000. d. Hazel has dividend income of $625,000. e. None of the above.

ANSWER: d RATIONALE: The distribution does not satisfy any of the qualifying stock redemption provisions and, as such, is taxed as dividend income. Hazel’s ownership interest in Wren Corporation after the redemption is 54.6% (600 shares owned after redemption ÷ 1,100 shares outstanding after redemption). Since she continues to control Wren Corporation after the redemption, the transaction fails both the not essentially equivalent redemption provision and the disproportionate redemption provision. The $210,000 basis in the stock redeemed attaches to that of Hazel’s remaining stock in Wren.

56. Lucinda owns 1,100 shares of Blackbird Corporation stock at a time when Blackbird has 2,000 shares of stock outstanding. The remaining shareholders are unrelated to Lucinda. What is the minimum number of shares Blackbird must redeem from Lucinda so that the transaction will qualify as a disproportionate redemption? a. 220 b. 393 c. 484 d. 880 e. None of the above ANSWER:

b

RATIONALE: Before the redemption, Lucinda owns 55% of the outstanding shares of Blackbird stock. To qualify as a disproportionate redemption, Lucinda must own, after the redemption, less than 44% (80% × 55%) of the remaining outstanding shares of Blackbird stock. Using a simple algebraic formula, the minimum number of shares (rounded up to the next whole number) that must be redeemed is 393 shares.

(1,100 shares − X shares )  44% ( 2,000 shares − X shares )

1,100 – X = .44(2,000 – X) 1,100 – X = 880 – .44X 1,100 = 880 + .56X 220 = .56X 392.86 = X

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Chapter 6: Corporations: Redemptions and Liquidations 57. Hannah, Greta, and Winston own the stock in Redpoll Corporation (E & P of $900,000) as follows: Hannah, 600 shares; Greta, 400 shares; and Winston, 1,000 shares. Greta is Hannah’s daughter, and Winston is Hannah’s brother. Redpoll Corporation redeems 400 of Hannah’s shares (basis of $55,000) for $240,000.

Hannah purchased the stock three years ago as an investment. With respect to the stock redemption, Hannah has: a. Long-term capital gain of $185,000. b. Long-term capital gain of $240,000. c. Dividend income of $185,000. d. Dividend income of $240,000. e. None of the above.

ANSWER:

a

RATIONALE: The redemption meets both tests of § 302(b)(2) and qualifies for sale or exchange treatment.

Before and after the redemption, Hannah is deemed to own the shares owned by Greta, her daughter, but none of the shares owned by Winston. (The family attribution rules do not include siblings.) Thus, before the redemption, Hannah has a 50% interest in Redpoll [(600 shares directly plus 400 shares indirectly from Greta) ÷ 2,000 shares outstanding]. After the redemption, Hannah owns 37.5% of the stock in Redpoll Corporation [600 shares (200 directly plus 400 indirectly from Greta) ÷ 1,600 postredemption shares outstanding]. The 37.5% ownership interest is less than 50% of the total voting power and less than 80% of Hannah’s original ownership [37.5% < 40% (80% × 50%)]. Thus, the distribution is a disproportionate redemption and Hannah has a long-term capital gain of $185,000 [$240,000 (amount realized) – $55,000 (stock basis)].

58. Ethel, Hannah, and Samuel, unrelated individuals, own the stock in Broadbill Corporation (E & P of $700,000) as follows: Ethel, 300 shares; Hannah, 300 shares; and Samuel, 400 shares. Broadbill redeems 200 of Samuel’s shares (basis of $175,000) for $250,000. If Samuel’s stock is a capital asset and has been held for over three years, Samuel has: a. A long-term capital gain of $75,000. b. A short-term capital gain of $75,000. c. Ordinary income of $250,000. d. Ordinary income of $75,000. e. None of the above.

ANSWER: a RATIONALE: The redemption meets both tests of § 302(b)(2). After the redemption, Samuel owns 25% (200 ÷ 800) of the shares outstanding, and this is less than 80% of his original ownership [80% × 40% (400 ÷ 1,000) = 32%]. The 25% ownership also is less than 50% of the total voting power. Thus, the distribution qualifies as a disproportionate redemption and $75,000 of longterm capital gain is recognized [$75,000 = $250,000 (amount realized) – $175,000 (basis of shares redeemed)].

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Chapter 6: Corporations: Redemptions and Liquidations 59. Julian, Berta, and Maria own 400 shares, 400 shares, and 200 shares, respectively, in Caramel Corporation (E & P of $750,000). Berta is Julian’s sister, and Maria is Julian’s aunt. Caramel Corporation redeems all of Julian’s stock for $420,000. Julian paid $200 a share for the stock five years ago. Julian continued to serve on Caramel’s board of directors after the redemption. With respect to the redemption: a. Dividend income of $340,000. b. Dividend income of $420,000. c. Long-term capital gain of $340,000. d. Long-term capital gain of $420,000. e. None of the above.

ANSWER: c RATIONALE: The redemption is a complete termination redemption of § 302(b)(3) and qualifies for sale or exchange treatment. Julian is not deemed to own any of the stock owned by his sister, Berta, or his aunt, Maria. Family attribution under § 318 is limited to one’s spouse, children, grandchildren, and parents. Julian therefore has completely terminated his interest in Caramel Corporation. (Since Julian is not deemed to own the stock of his sister or aunt, his continued employment with Caramel is not relevant.) Thus, Julian has a long- term capital gain of $340,000 [$420,000 (amount realized) – $80,000 (stock basis)].

60. Lupe and Rodrigo, father and son, each own 50% of the stock outstanding of Heron Corporation (E & P of $400,000). During the current year, Heron redeems all of Lupe’s shares for $250,000. The transaction cannot qualify as a complete termination redemption if: a. Lupe received a $250,000 note receivable from Heron in the stock redemption. b. Lupe loaned Heron Corporation $50,000 two years following the redemption. c. Rodrigo continued to serve on Heron Corporation’s board of directors for two years following the redemption. d. Three years after the redemption, Lupe inherited Rodrigo’s shares in Heron as a result of his son’s death. e. None of the above.

ANSWER:

e

RATIONALE: None of the answers would preclude use of the family attribution waiver. A creditor interest by the former shareholder (options a. and b.) is not a prohibitive interest for purposes of the waiver. Rodrigo’s continued role on Heron’s board does not constitute a prohibited interest for Lupe (option c.). Acquisition of stock in Heron Corporation by inheritance does not constitute a prohibited interest for Lupe for purposes of the family attribution waiver (option d.).

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Chapter 6: Corporations: Redemptions and Liquidations 61. Leon owns 750 shares of the 2,000 outstanding shares of Crane Corporation (E & P of $900,000). None of the other shareholders of Crane are related to Leon. Leon acquired his Crane shares ten years ago for $80,000.

Crane has operated several trades or businesses for more than five years. In the current year, Crane sells the assets of one of those trades or businesses and distributes the proceeds from the asset sale to the shareholders in a pro rata stock redemption. In this transaction, Leon receives $250,000 in redemption of 300 shares of Crane. As a result of this transaction, Leon will recognize: a. $218,000 dividend income. b. $250,000 dividend income. c. $218,000 long-term capital gain. d. $250,000 long-term capital gain. e. None of the above.

ANSWER:

c

RATIONALE: The transaction qualifies as a partial liquidation under the termination of a business test. Crane Corporation operates two or more qualified trades or businesses, the distribution relates to the proceeds from the sale of one of the qualified trades or businesses, and Crane is actively engaged in the conduct of a qualified trade or businesses after the distribution. As such, sale or exchange treatment applies and Leon has a long-term capital gain of $218,000 [$250,000 (amount realized) – $32,000 (stock basis)]. It is not relevant that the distribution is pursuant to a pro rata stock redemption.

62. Which of the following statements is correct with respect to a partial liquidation? a. The genuine contraction of a corporate business requirement is an objective test that taxpayers can rely upon with certainty. b. The distribution of proceeds from the sale of excess inventory to shareholders in exchange for part of their stock will not satisfy the not essentially equivalent to a dividend test. c. A stock redemption pursuant to a partial liquidation cannot be pro rata with respect to the shareholders. d. The termination of a business test requires that the distributing corporation actively conducted at least three trades or businesses for at least five years. e. None of the above.

ANSWER: b RATIONALE: The distribution of proceeds from the sale of excess inventory will not satisfy the not essentially equivalent to a dividend test. The not essentially equivalent to a dividend test is applied at the corporate level and requires a genuine contraction of the business of the corporation. That requirement is subjective and taxpayers contemplating a partial liquidation should first request a ruling on the transaction from the IRS. A redemption pursuant to a partial liquidation may be pro rata. The termination of a business test requires that the distributing corporation actively conduct at least two trades or businesses for at least five years.

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Chapter 6: Corporations: Redemptions and Liquidations 63. The gross estate of John, decedent, includes stock in Crimson Corporation and Jade Corporation valued at $1.3 million and $2 million, respectively. John’s adjusted gross estate is $9 million. He owned 23% of the Crimson stock and 31% of the Jade stock. Immediate members of John’s family own the remaining shares of both Crimson and Jade. Those individuals are also the sole beneficiaries of John’s estate. Death taxes and funeral and administration expenses for John’s estate are $1.3 million. John had a basis of $475,000 in the Crimson stock and $510,000 in the Jade stock. Crimson Corporation (E & P of $3 million) distributed land worth $1.3 million (basis of $800,000) to John’s estate in redemption of all of the Crimson stock. Which of the following is a correct statement regarding the tax consequences of this redemption? a. The estate recognizes dividend income of $1.3 million on the redemption. b. Crimson Corporation recognizes no gain on the distribution of the land. c. The estate recognizes no gain or loss on the redemption. d. The estate has a basis of $800,000 in the land. e. None of the above.

ANSWER:

c

RATIONALE: Because there is included in John’s gross estate a 20% or more interest in two or more stocks, the 35% test is applied by combining the values of the Crimson and Jade stocks. Section 303, therefore, applies to the redemption [($1.3 million + $2 million)/$9 million = 36.7%], and sale or exchange treatment results. The amount received in redemption of the Crimson stock equals the estate’s basis in the stock (date of death value); thus, no gain or loss is recognized by the estate on the redemption. With respect to Crimson Corporation, a gain of $500,000 [$1.3 million (fair market value) – $800,000 (land basis)] is recognized on the distribution of the land. The estate’s basis in the land is equal to the fair market value on the date of the distribution, or $1.3 million.

64. The adjusted gross estate of Keith, decedent, is $12 million. Included in the gross estate is stock in Gold Corporation (E & P of $1.3 million), a closely held corporation, valued at $4.6 million as of the date of Keith’s death. Keith had acquired the stock twelve years ago at a cost of $900,000. Death taxes and funeral and administration expenses for Keith’s estate are $2.3 million. Gold Corporation redeems one-half of the stock from Keith’s estate in a § 303 redemption to pay death taxes using property with a fair market value of $2.3 million (adjusted basis of $1.9 million). Which of the following is a correct statement regarding the tax consequences of this redemption? a. The estate will have a basis of $2.3 million in the property received from Gold Corporation in redemption of the estate’s stock. b. Gold Corporation will not reduce its E & P as a result of the distribution of the property to Keith’s estate. c. The estate will recognize a $1.4 million long-term capital gain on the redemption. d. Gold Corporation recognizes no gain (or loss) on the distribution of the property to Keith’s estate. e. None of the above.

ANSWER:

a

RATIONALE: The basis rules for stock acquired from a decedent apply to give the estate a stepped-up basis.

Thus, the basis of the stock redeemed will be $2.3 million and the estate will not have a gain on the redemption. Gold Corporation will recognize a gain of $400,000 ($2.3 million fair market value – $1.9 million basis) on the distribution of appreciated property to redeem the estate’s stock. The basis of property received in a stock redemption is its fair market value.

The property distribution will result in a reduction in Gold’s E & P in an amount not in excess of the ratable share of the E & P attributable to the stock redeemed. © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 6: Corporations: Redemptions and Liquidations 65. The adjusted gross estate of Debra, decedent, is $8 million. Debra’s estate will incur death taxes and funeral and administration expenses of $1 million. Debra’s gross estate includes stock in Silver Corporation that she had purchased twelve years ago for $600,000 (date of death fair market value of $3 million). At the time of her death, Debra owned 80% of the stock in Silver Corporation. Silver Corporation (E & P of $4 million) redeems all of the estate’s stock in the corporation for $3 million. Debra’s will names her daughter, Dena, who owns the remaining 20% interest in Silver Corporation, as her sole heir. With respect to this redemption, Debra’s estate has the following income: a. $0. b. $2.4 million long-term capital gain. c. $2 million dividend. d. $3 million dividend. e. None of the above.

ANSWER:

c

RATIONALE: The value of the Silver Corporation stock included in Debra’s gross estate exceeds 35% of the adjusted gross estate ($3 million ÷ $8 million = 37.5%); thus, § 303 treatment is available to the extent of the death taxes and funeral and administration expenses ($1 million). Because there is a step-up in basis in the stock under § 1014, there is no gain recognized on this portion of the redemption. The remaining $2 million of the redemption that is in excess of the § 303 limit does not qualify for sale or exchange treatment. Dena, the sole beneficiary of Debra’s estate, owns 100% of the Silver stock outstanding after the redemption, and that ownership interest is attributed to the estate under § 318. As a result of this attribution, none of the § 302 qualifying stock redemption provisions are satisfied with respect to the excess redemption.

Therefore, the estate has $2 million of dividend income. The estate’s basis in the shares associated with the nonqualifying stock redemption ($2 million, with the § 1014 step-up) attaches to the basis of Dena’s shares.

66. Which of the following is a correct statement regarding a redemption to pay death taxes under § 303? a. An estate recognizes gain on the redemption equal to the excess of the distribution proceeds over the decedent’s basis in the stock. b. The § 318 stock attribution rules do not apply to the redemption. c. The value of the stock in the decedent’s gross estate must exceed 40% of the value of the adjusted gross estate. d. A corporation recognizes gains and losses on the distribution of property in the redemption. e. None of the above.

ANSWER:

b

RATIONALE: The attribution rules do not apply to a redemption to pay death taxes under § 303. An estate recognizes gain (or loss) on a redemption equal to the excess of the distribution proceeds over the estate’s basis in the stock. Because the stock basis is stepped up to the fair market value on the date of death, no gain (or loss) generally occurs. The value of the stock must exceed 35% of the adjusted gross estate. A corporation recognizes gains but not losses on the distribution of property in a redemption.

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Chapter 6: Corporations: Redemptions and Liquidations 67. Copper Corporation (E & P of $1.2 million) distributes land (basis of $410,000, fair market value of $650,000) to Lauren, a shareholder, to carry out a qualifying stock redemption. Lauren had a basis of $90,000 in the shares redeemed. Which of the following is an incorrect statement regarding the redemption? a. If the land is distributed subject to a $500,000 liability, Copper Corporation will recognize a gain of $240,000. b. If the land is distributed subject to a $500,000 liability, Lauren will have a basis in the land of $650,000. c. If the land is distributed subject to a $500,000 liability, Lauren will recognize a gain of $60,000. d. If the land is distributed subject to a $700,000 liability, Copper Corporation will recognize a gain of $290,000. e. None of the above.

ANSWER:

e

RATIONALE: If the land is distributed subject to a $500,000 liability, the following tax consequences occur.

Copper Corporation will recognize a gain of $240,000 ($650,000 fair market value – $410,000 basis) (option a.). Lauren will have a basis in the land equal to $650,000, its fair market value (option b.), and she will recognize a gain of $60,000 [$150,000 net fair market value ($650,000 – $500,000 liability) – $90,000 stock basis] (option c.). If the land is distributed subject to a $700,000 liability, Copper Corporation will recognize a gain of $290,000 ($700,000 liability – $410,000 basis) (option d.).

68. To carry out a qualifying stock redemption, Turaco Corporation (E & P of $800,000) transfers land held for investment purposes to Aida, a shareholder. The land had a basis of $250,000, a fair market value of $400,000, and is subject to a $300,000 liability. Aida has a basis of $70,000 in the shares redeemed. Which of the following is a correct statement regarding the tax consequences of this redemption? a. Aida will have $400,000 of dividend income. b. Aida will have a $100,000 basis in the land. c. Turaco Corporation will recognize a gain of $50,000. d. Aida will recognize a gain of $30,000. e. None of the above.

ANSWER: d RATIONALE: A qualifying stock redemption is treated as a sale or exchange of the stock; thus, Aida will recognize a gain of $30,000 [$100,000 (fair market value net of liability) – $70,000 (stock basis)]. The basis of property received in a stock redemption, qualifying or not, is the property’s fair market value on the date of the distribution ($400,000). Turaco will recognize a gain of $150,000 [$400,000 (fair market value) – $250,000 (land basis)] on the distribution of the land.

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Chapter 6: Corporations: Redemptions and Liquidations 69. Canary Corporation has 5,000 shares of stock outstanding. It redeems in a qualifying stock redemption 1,200 shares for $475,000 at a time when it has paid-in capital of $300,000 and E & P of $1.5 million. What would be the charge to Canary’s E & P as a result of the redemption? a. $72,000 b. $300,000 c. $432,000 d. $475,000 e. None of the above ANSWER:

e

RATIONALE: In a qualifying stock redemption, E & P is reduced by no more than the ratable share of the E & P of Canary Corporation attributable to the stock redeemed ($360,000 = $1.5 million × 24%).

70. In the current year, Quail Corporation distributed installment notes payable in redemption of some of its shares. Quail incurred the following expenditures in connection with the redemption: accounting fees of $7,000 and legal fees of $8,000. In addition, Quail paid $10,000 of interest expense on the installment notes payable. The distribution was a qualifying stock redemption. How much of the $25,000 is deductible in the current year? a. $0 b. $7,000 c. $10,000 d. $25,000 e. None of the above ANSWER:

c

RATIONALE: Section 162(k) disallows a deduction for expenditures incurred by a corporation in connection with the redemption of its shares. However, interest expense that is otherwise deductible under § 163 is not subject to this disallowance. Thus, Quail Corporation can deduct the $10,000 of interest expense on the debt incurred to finance the redemption.

71. Which of the following is an incorrect statement regarding the tax consequences of a § 306 stock disposition? a. In a sale of § 306 stock, the shareholder generally recognizes ordinary income equal to the fair market value of the preferred stock on the date it was acquired in the stock dividend. b. No loss is recognized on a sale of § 306 stock. c. The issuing corporation’s E & P is not reduced by a sale of § 306 stock. d. In a redemption of § 306 stock, the shareholder generally recognizes dividend income equal to the amount of the redemption proceeds. e. None of the above.

ANSWER:

e

RATIONALE: In a sale of § 306 stock, the shareholder generally recognizes ordinary income equal to the fair market value of the preferred stock on the date it was acquired in the stock dividend. No loss is recognized in a sale of § 306 stock, nor is the issuing corporation’s E & P affected by such a sale. In a redemption of § 306 stock, the redemption proceeds equal dividend income to the extent of the corporation’s E & P at the date of redemption.

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Chapter 6: Corporations: Redemptions and Liquidations 72. Connie sold 400 shares of § 306 stock (basis of $20,000) in Blackbird Corporation to Larry (an unrelated individual) for $50,000. When the § 306 stock was issued to Connie, the stock had a value of $50,000, and Blackbird had E & P of $500,000. At the time the § 306 stock is sold, Blackbird’s E & P is $550,000. At the time of the sale, Connie owned 900 shares of common stock (basis of $210,000) in Blackbird. With respect to the sale of the § 306 stock by Connie: a. Connie has $50,000 of ordinary income. b. Blackbird Corporation reduces its E & P by $50,000. c. Connie has a $30,000 capital gain. d. After the sale, Connie has a $210,000 basis in the common stock. e. None of the above.

ANSWER:

a

RATIONALE: She has ordinary income of $50,000, the entire proceeds from the sale of the § 306 stock.

Connie’s basis in the § 306 stock increases the basis of her common stock to $230,000 ($210,000 + $20,000). Blackbird’s E & P is unaffected by the sale of the § 306 stock.

73. Rodolfo makes a gift of § 306 stock (basis of $75,000, fair market value of $100,000) in Kiwi Corporation to his daughter, Josie. When the stock was issued to Rodolfo, his share of Kiwi Corporation’s E & P was $80,000. When its E & P is $200,000, Kiwi Corporation redeems all of Josie’s stock for $100,000. With respect to the stock redemption: a. Josie will recognize a capital gain of $25,000. b. The redemption does not reduce Kiwi Corporation’s E & P. c. Josie will recognize dividend income of $80,000. d. Josie will recognize dividend income of $100,000. e. None of the above.

ANSWER: d RATIONALE: A gift of § 306 stock is not a taxable disposition for Rodolfo, but the § 306 taint carries over to Josie. When Kiwi Corporation redeems Josie’s § 306 stock, the amount received is treated as dividend income to the extent of Kiwi’s E & P at the time of redemption. Kiwi Corporation reduces it E & P by the $100,000 distribution.

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Chapter 6: Corporations: Redemptions and Liquidations 74. Joe owns 100% of Green Corporation (E & P of $500,000) and 100% of Navy Corporation (E & P of $400,000). Joe sells 100 shares in Green (basis of $40,000) to Navy for $70,000, its fair market value. Joe purchased the stock in Green six years ago. Joe has: a. Dividend income of $70,000. b. A long-term capital gain of $70,000. c. Dividend income of $30,000. d. A long-term capital gain of $30,000. e. None of the above.

ANSWER: a RATIONALE: Sections 302 and 304 would cause the entire $70,000 to be dividend income. If a taxpayer has at least a 50% ownership in two corporations and transfers stock in one corporation to the other for money or property, the exchange is treated as a redemption of the stock of the acquiring corporation. The redemption is tested under § 302 for sale or exchange treatment or dividend treatment. Before the sale, Joe owned 100% of Green Corporation. He owns 100% after the sale because of his constructive ownership of all the shares transferred to Navy Corporation. The not essentially equivalent redemption provisions of § 302(b)(1) and the disproportionate redemption provisions of § 302(b)(2) are not met; thus, the $70,000 is dividend income.

75. In comparing a qualifying stock redemption with a complete liquidation, which of the following statements is incorrect? a. Liquidations and qualifying stock redemptions parallel each other in terms of the effect that E & P has on the nature of the gain or loss recognized by the shareholder. b. The basis of property acquired is its fair market value on the date of distribution for both a qualifying stock redemption and a liquidation. c. Both a qualifying stock redemption and a complete liquidation produce sale or exchange treatment to the shareholder. d. A corporation will recognize gain upon the distribution of appreciated property for both a qualifying stock redemption and a complete liquidation, but a corporation will recognize loss upon a distribution of depreciated property only for a liquidating distribution. e. Section 267 disallows recognition of losses between related parties in a complete liquidation but not in a qualifying stock redemption.

ANSWER: e RATIONALE: The opposite is true. Section 267 disallows recognition of losses between related parties in a qualifying stock redemption but not in a complete liquidation.

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Chapter 6: Corporations: Redemptions and Liquidations 76. Pursuant to a complete liquidation, Lilac Corporation distributes the following assets to its unrelated shareholders: land held for three years as an investment (basis of $300,000, fair market value of $600,000), inventory (basis of $100,000, fair market value of $80,000), and marketable securities held for four years as an investment (basis of $200,000, fair market value of $240,000). What are the tax consequences to Lilac Corporation as a result of the liquidation? a. Lilac Corporation would recognize no gain or loss on the liquidation. b. Lilac Corporation would recognize a net capital gain of $320,000. c. Lilac Corporation would recognize a net capital gain of $340,000 and an ordinary loss of $20,000. d. Lilac Corporation would recognize a net capital gain of $340,000. e. None of the above.

ANSWER:

c

RATIONALE: A corporation generally recognizes both gains and losses on liquidating distributions, as if the property were sold for its fair market value. This deemed sale results in ordinary loss of $20,000 in the case of the inventory, and a net capital gain of $340,000 in the case of the investment properties.

77. Pursuant to a complete liquidation, Oriole Corporation distributes to its shareholders land with a basis of $350,000 and a fair market value of $800,000. The land is subject to a liability of $920,000. What is Oriole’s recognized gain or loss on the distribution? a. $0 b. $120,000 loss c. $450,000 gain d. $570,000 gain e. None of the above ANSWER:

d

RATIONALE: Section 336 provides that a liquidating corporation recognizes gain or loss on the distribution of property in complete liquidation. When property distributed in a complete liquidation is subject to a liability of the liquidating corporation, the fair market value of the property cannot be less than the amount of the liability. Thus, Oriole recognizes a gain of $570,000 [$920,000 (liability) – $350,000 (land basis)].

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Chapter 6: Corporations: Redemptions and Liquidations 78. The stock in Rhea Corporation is owned by Jennifer (80%) and Lucy (20%), mother and daughter. In a liquidation of the corporation in the current year, Rhea distributes land that it purchased two years ago for $675,000 to Lucy. The property has a fair market value on the date of distribution of $450,000. One year later, Lucy sells the land for $400,000. What loss, if any, will Rhea Corporation recognize with respect to the distribution of land? a. $0 b. $45,000 c. $225,000 d. $275,000 e. None of the above ANSWER:

a

RATIONALE: The related-party loss limitation applies to disallow the entire $225,000 loss realized on the distribution [$450,000 (fair market value) – $675,000 (land basis)]. There is a distribution of loss property to a related party (Lucy is deemed to own her mother’s shares and, thus, 100% of Rhea Corporation directly and indirectly) and the distribution is not pro rata.

79. The stock in Toucan Corporation is held equally by two brothers. Four years ago, the shareholders transfer property (basis of $200,000, fair market value of $220,000) to Toucan Corporation as a contribution to capital. In the current year and pursuant to a complete liquidation of Toucan, the property is distributed proportionately to the brothers. At the time of the distribution, the property had a fair market value of $40,000. What amount of loss will Toucan Corporation recognize on the distribution of the property? a. $0 b. $20,000 c. $160,000 d. $180,000 e. None of the above ANSWER: a RATIONALE: The related-party loss limitation applies to disallow the entire $160,000 loss realized on the distribution [$40,000 (fair market value) – $200,000 (property basis)]. There is a distribution of loss property to a related party (both brothers own, directly and indirectly, 100% of Toucan) and the distribution consists of disqualified property (acquired by Toucan in a contribution to capital transaction within 5 years of the distribution). Since the property consists of disqualified property, it is irrelevant that the distribution is pro rata with respect to the shareholders.

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Chapter 6: Corporations: Redemptions and Liquidations 80. Magenta Corporation acquired land in a § 351 exchange one year ago. The land had a basis of $320,000 and a fair market value of $350,000 on the date of the transfer. Magenta Corporation has two shareholders, Mark (70%) and Megan (30%), who are brother and sister. Magenta Corporation adopts a plan of liquidation in the current year. On this date, the land has decreased in value to $250,000. Magenta Corporation sells the land for $250,000 and distributes the proceeds pro rata to Mark and Megan. What amount of loss may Magenta Corporation recognize on the sale of the land? a. $0 b. $21,000 c. $30,000 d. $70,000 e. None of the above ANSWER:

d

RATIONALE: The related-party loss limitation does not apply to sales. The property does not have a built-in loss on the date of the transfer to the corporation; thus, the built-in loss limitation does not apply. The basis of the property to Magenta Corporation is $320,000 and, upon a sale of the property for $250,000, Magenta Corporation would recognize the $70,000 loss.

81. Purple Corporation has two equal shareholders, Joshua and Ellie, who are father and daughter. One year ago, the two shareholders transferred properties to Purple in a § 351 exchange. Joshua transferred land (basis of $600,000, fair market value of $450,000) and securities (basis of $70,000, fair market value of $250,000), while Ellie transferred equipment (basis of $420,000, fair market value of $700,000). In the current year, Purple Corporation adopts a plan of liquidation, sells all of its assets, and distributes the proceeds pro rata to Joshua and Ellie. The only loss realized upon disposition of the properties was with respect to the land that had decreased in value to $310,000 and was sold for this amount. Purple never used the land for any business purpose during the time it was owned by the corporation. What amount of loss can Purple Corporation recognize on the sale of the land? a. $0 b. $140,000 c. $150,000 d. $290,000 e. None of the above ANSWER: b RATIONALE: The sale of the land results in a realized loss of $290,000 [$310,000 (amount realized) – $600,000 (basis in land)]. The land had a built-in loss of $150,000 [$450,000 (fair market value) – $600,000 (basis)] on the date it was acquired in the § 351 exchange. Since the land was acquired within two years of the plan of liquidation, a tax avoidance purpose is assumed. There was no business purpose for transferring the property to Purple; thus, the built-in loss limitation disallows $150,000 of the loss. The related-party loss limitation does not apply to sales; therefore, the remaining $140,000 loss realized during the period Purple held the property is recognized. [Note that the § 362(e)(2) basis step-down rules for loss properties acquired in carryover basis transactions does not apply to the land, as there was no net built-in loss on the two properties transferred by Joshua. Section § 362(e)(2) is discussed in Chapter 4.]

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Chapter 6: Corporations: Redemptions and Liquidations 82. Last year, Crow Corporation acquired land in a transaction that qualified under § 351. The land had a basis of $400,000 to the contributing shareholder and a fair market value of $310,000. Assume that the shareholder also transferred equipment (basis of $100,000, fair market value of $200,000) in the same § 351 exchange. In the current year, Crow Corporation adopted a plan of liquidation and distributes the land to Ali, a shareholder who owns 20% of the stock in Crow Corporation. The land’s fair market value was $230,000 on the date of the distribution to Ali. Crow Corporation acquired the land to use as security for a loan it had hoped to obtain from a local bank. In negotiating with the bank for a loan, the bank required the additional capital investment as a condition of its making a loan to Crow Corporation. How much loss can Crow Corporation recognize on the distribution of the land? a. $0 b. $80,000 c. $90,000 d. $170,000 e. None of the above ANSWER:

d

RATIONALE: Crow Corporation had a business reason for acquiring the land. Further, the land was not distributed to a related party. Thus, the loss limitation provisions do not apply and the entire loss of $170,000 [$230,000 (fair market value) – $400,000 (land basis)] is allowed. [Note that the § 362(e)(2) basis step-down rules for loss properties acquired in carryover basis transactions does not apply to the land, as there was no net built-in loss on the two properties transferred by shareholder. Section § 362(e)(2) is discussed in Chapter 4.]

83. During the current year, Ecru Corporation is liquidated and distributes its only asset, land, to Kena, the sole shareholder. On the date of distribution, the land has a basis of $250,000, a fair market value of $650,000, and is subject to a liability of $500,000. Kena, who takes the land subject to the liability, has a basis of $120,000 in the Ecru stock. With respect to the distribution of the land, which of the following statements is correct? a. Kena recognizes a gain of $530,000. b. Ecru Corporation recognizes a gain of $250,000. c. Kena recognizes a gain of $30,000. d. Kena has a basis of $250,000 in the land. e. None of the above.

ANSWER: c RATIONALE: In a complete liquidation, a shareholder recognizes gain equal to the difference between the fair market value of property received from the corporation and the basis of the stock surrendered. When property is received subject to a liability, such liability reduces the amount realized by the shareholder. Thus, Kena recognizes a gain of $30,000 [$150,000 (net fair market value of land) – $120,000 (basis in Ecru stock)]. Ecru recognizes a gain of $400,000 [$650,000 (fair market value) – $250,000 (basis)] on the distribution of land. Kena’s basis in the land is its fair market value on the date of the distribution, or $650,000.

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Chapter 6: Corporations: Redemptions and Liquidations 84. In the current year, Dove Corporation (E & P of $1 million) distributes all of its property in a complete liquidation. Alexandra, a shareholder, receives land having a fair market value of $200,000. Dove Corporation had purchased the land as an investment three years ago for $125,000, and the land was distributed subject to a $100,000 liability. Alexandra took the land subject to the $100,000 liability. What is Alexandra’s basis in the land? a. $0 b. $100,000 c. $125,000 d. $200,000 e. None of the above ANSWER: d RATIONALE: The basis of property received in a complete liquidation is the property’s fair market value on the date of distribution, or $200,000.

85. After a plan of complete liquidation has been adopted, Condor Corporation sells its only asset, land (basis of $220,000), to Eduardo (an unrelated party) for $300,000. Under the terms of the sale, Condor Corporation receives cash of $50,000 and Eduardo’s notes for the balance of $250,000. The notes are payable over the next five years ($50,000 per year) and carry an appropriate interest rate. Immediately after the sale, Condor Corporation distributes the cash and notes to Maria, the sole shareholder of Condor Corporation. Maria has a basis of $30,000 in the Condor stock. The installment notes have a value equal to their face amount. If Maria wishes to defer as much gain as possible on the transaction, which of the following is correct? a. Condor Corporation recognizes no gain or loss on the distribution of the installment notes. b. Maria recognizes a gain of $20,000 in the year of liquidation. c. Maria recognizes a gain of $45,000 in the year of liquidation. d. Maria recognizes a gain of $270,000 in the year of liquidation. e. None of the above.

ANSWER:

c

RATIONALE: Maria may defer gain on the receipt of the notes to the point of collection. Maria will allocate her basis in the Condor stock between the cash and the installment notes. Using the relative fair market value approach, the stock basis is allocated $5,000 to the cash [$50,000 (amount of cash) ÷ $300,000 (total distribution) × $30,000 (stock basis)], and $25,000 to the notes [$250,000 (FMV of notes) ÷ $300,000 (total distribution) × $30,000 (stock basis)]. Maria must recognize a gain of $45,000 [$50,000 (cash received) – $5,000 (basis allocated to the cash)] in the year of liquidation. Maria will report 90% of each note collected as capital gain [$225,000 (gross profit) ÷ $250,000 (contract price)]. The interest element will be accounted for separately. Condor Corporation will recognize a gain on the distribution equal to the excess of the installment notes’ fair market value and the basis Condor had in the notes.

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Chapter 6: Corporations: Redemptions and Liquidations 86. Indigo has a basis of $1 million in the stock of Owl Corporation, a subsidiary in which it owns 100% of all classes of stock. Indigo purchased the stock in Owl 10 years ago. In the current year, Indigo liquidates Owl and acquires assets worth $1.2 million. At the time of its liquidation, Owl Corporation had a basis of $800,000 in the assets and E & P of $500,000. Which of the following statements is correct with respect to the liquidation? a. Owl recognizes a gain of $400,000. b. Indigo has an $800,000 basis in the assets. c. Owl’s E & P of $500,000 is eliminated. d. Indigo recognizes a gain of $200,000. e. None of the above.

ANSWER:

b

RATIONALE: Indigo has a basis in the assets equal to Owl’s basis [§ 334(b)], or $800,000. The liquidation is governed by § 332 and, as a result, neither Indigo Corporation [§ 332(a)] nor Owl Corporation [§ 337(a)] recognize gain (or loss). Under § 381, Owl’s E & P ($500,000) carries over to Indigo.

87. The stock of Lavender Corporation is held as follows: 80% by Jade Corporation (basis of $400,000) and 20%

by Tiffany (basis of $100,000). Lavender Corporation is liquidated in December of the current year, pursuant to a plan adopted earlier in the year. Pursuant to the liquidation, Lavender Corporation distributed Asset A (basis of $600,000, fair market value of $900,000) to Jade, and Asset B (basis of $250,000, fair market value of $225,000) to Tiffany. No election is made under § 338. With respect to the liquidation of Lavender: a. Lavender recognizes a loss of $25,000 on the distribution of Asset B. b. Jade has a basis in Asset A of $900,000. c. Tiffany has a basis in Asset B of $225,000. d. Jade recognizes a gain of $500,000. e. Lavender recognizes a gain of $300,000 on the distribution of Asset A. ANSWER: c RATIONALE: Tiffany has a basis in Asset B equal to its fair market value, or $225,000. In distributions from a subsidiary corporation to a minority shareholder, pursuant to a § 332 parent-subsidiary liquidation, gains but not losses are recognized. Thus, Lavender does not recognize the $25,000 loss realized on the distribution of Asset B to Tiffany [$225,000 (fair market value) – $250,000 (basis in Asset B)] (option a.). In a § 332 parent- subsidiary liquidation, the parent corporation recognizes no gain or loss and takes a carryover basis in assets received. Thus, Jade recognizes no gain (option d.) and has a basis in Asset A equal to Lavender’s basis, or $600,000 (option b.). A subsidiary recognizes no gain or loss on liquidating distributions to a parent corporation under § 332; thus, Lavender recognizes no gain on the distribution of Asset A to Jade (option e.).

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Chapter 6: Corporations: Redemptions and Liquidations 88. Penguin Corporation purchased bonds (basis of $190,000) of its 100% owned subsidiary, Finch Corporation, at a discount. Pursuant to a § 332 liquidation and in satisfaction of the indebtedness, Finch distributes land worth $200,000 (basis of $160,000) to Penguin. Which of the following statements is correct with respect to the distribution of land? a. Neither Finch nor Penguin recognize gain (or loss). b. Finch recognizes no gain and Penguin recognizes a gain of $10,000. c. Finch recognizes a gain of $40,000 and Penguin recognizes no gain. d. Finch recognizes a gain of $40,000 and Penguin recognizes a gain of $10,000. e. None of the above.

ANSWER: b RATIONALE: Penguin recognizes a gain of $10,000 [$200,000 (value of land) – $190,000 (basis in bonds)].

Finch recognizes no gain or loss on distributions pursuant to a § 332 liquidation, even if property is transferred in satisfaction of indebtedness to Penguin.

89. The stock of Loon Corporation is held as follows: 85% by Duck Corporation and 15% by Gerald, an individual. Loon Corporation is liquidated in December of the current year, pursuant to a plan adopted earlier in the year. Loon Corporation distributes land with a basis of $350,000 and fair market value of $390,000 to Gerald in liquidation of his stock interest. Gerald had a basis of $200,000 in his Loon stock. How much gain will Loon Corporation recognize in this liquidating distribution? a. $0 b. $40,000 c. $190,000 d. $390,000 e. None of the above ANSWER:

b

RATIONALE: In a § 332 liquidation, a distribution of property to a minority shareholder is treated in the same manner as a nonliquidating distribution; that is, gain but not loss is recognized by the corporation on the distribution. Thus, the distribution of the land to Gerald results in a recognized gain of $40,000 ($390,000 – $350,000).

90. Scarlet Corporation, the parent corporation, has a basis of $600,000 in the stock of Brown Corporation, a subsidiary in which it owns 90% of all classes of stock. Scarlet purchased the stock in Brown Corporation 10 years ago. In the current year, Scarlet Corporation liquidates Brown Corporation and acquires assets worth $800,000 and with a tax basis to Brown Corporation of $950,000. What basis will Scarlet Corporation have in the assets acquired from Brown Corporation? a. $0 b. $600,000 c. $800,000 d. $950,000 e. None of the above ANSWER:

d

RATIONALE: Property received by a parent corporation in a complete liquidation of its subsidiary under § 332 has the same basis the property had in the hands of the subsidiary, or $950,000. The parent’s basis in the stock of the liquidated subsidiary disappears. © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 6: Corporations: Redemptions and Liquidations 91. During the current year, Goldfinch Corporation purchased 100% of the stock of Dove Corporation and made a qualified election under § 338. Which of the following statements is incorrect with respect to the § 338 election? a. Dove is treated as a new corporation as of the day following the qualified stock purchase date. b. Dove must be liquidated pursuant to the § 338 election. c. Dove Corporation is treated as having sold its assets on the qualified stock purchase date. d. Dove can recognize gain or loss as a result of the § 338 election. e. None of the above.

ANSWER:

b

RATIONALE: Dove Corporation may, but need not, be liquidated. Dove is treated as a new corporation as of the day following the qualified stock purchase date. Dove Corporation is treated as having sold its assets on the qualified stock purchase date. The deemed sale that results from a § 338 election can result in recognized gain or loss for the subsidiary (Dove).

92. Which of the following statements is correct with respect to the § 338 election? a. The subsidiary corporation makes the § 338 election. b. A qualified stock purchase occurs when a corporation acquires, in a taxable transaction, at least 80% of the stock (voting power and value) of another corporation within an18-month period. c. The parent recognizes no gain (loss) as a result of the election. d. Gain, but not loss, is recognized by the subsidiary as a result of a deemed sale of its assets. e. None of the above.

ANSWER:

c

RATIONALE: The parent recognizes no gain (loss) as a result of the election. The parent corporation makes the § 338 election (option a.). To count towards the 80% qualified stock purchase requirement, the stock must be acquired in a taxable transaction and within a 12-month period (option b.).

Gains and losses are recognized by the subsidiary in the deemed sale of its assets (option d.).

93. Tanya is in the 33% tax bracket. She acquired 1,000 shares of stock in Swan Corporation seven years ago for $100 a share. In the current year, Swan Corporation (E & P of $1.2 million) redeems all of her shares for $160,000. What are the income tax consequences to Tanya if: a. The redemption qualifies for sale or exchange treatment, and Tanya has no other transactions in the current year involving capital assets? b. The redemption does not qualify for sale or exchange treatment?

ANSWER: a. If the redemption qualifies for sale or exchange treatment, Tanya will have a long-term capital gain of $60,000 [$160,000 (amount realized) – $100,000 (stock basis)]. Her income tax liability on the $60,000 gain will be $9,000 ($60,000 × 15%). b. If the redemption distribution of $160,000 does not qualify as a sale or exchange, it will be treated as dividend income and her tax liability will be $24,000 ($160,000 × 15%). (The entire $160,000 will be subject to tax at the 15% rate; Tanya will have no basis offset.)

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Chapter 6: Corporations: Redemptions and Liquidations 94. Steve has a capital loss carryover in the current year of $30,000. He owns 3,000 shares of stock in Carmine Corporation, which he purchased six years ago for $20 per share. In the current year, Carmine Corporation (E & P of $750,000) redeems all of his shares for $140,000. Steve is in the 33% tax bracket. What is his income tax liability with respect to the corporate distribution if: a. The redemption qualifies for sale or exchange treatment, and Steve has no other transactions in the current year involving capital assets? b. The redemption does not qualify for sale or exchange treatment?

ANSWER: a. Steve will have a capital gain of $80,000 on the redemption [$140,000 (amount realized) – $60,000 (stock basis)]. Steve can offset the $30,000 capital loss carryover against the $80,000 of capital gain. His income tax liability on the remaining $50,000 gain will be $7,500 ($50,000 × 15%). b. If the redemption distribution does not qualify for sale or exchange treatment, the entire $140,000 will be taxed as a dividend at 15%, producing a tax of $21,000. With no other capital gain transactions in the current year, Steve can deduct only $3,000 of the $30,000 capital loss carryover to offset his other (ordinary) income.

95. Hawk Corporation has 2,000 shares of stock outstanding: Marina owns 800 shares, Russell owns 500 shares, Velvet Partnership owns 400 shares, and Yellow Corporation owns 300 shares. Marina and Russell, unrelated individuals, are equal partners of Velvet Partnership. Marina owns 35% of the stock in Yellow Corporation. a. Applying the § 318 stock attribution rules, determine how many shares in Hawk Corporation each shareholder owns, directly and indirectly: Marina: Russell: Velvet Partnership: Yellow Corporation: b. Assume, instead, that Marina owns 60% of Yellow Corporation. How many shares does Marina own, directly and indirectly, in Hawk Corporation?

ANSWER: a. Marina owns 1,000 shares [800 shares directly and 200 shares indirectly from Velvet Partnership (400 shares × 50% partnership interest)]. The stock attribution rules do not apply to stock held by a corporation if the shareholder owns less than 50% of the stock in that corporation. Russell owns 700 shares [500 shares directly and 200 shares indirectly from Velvet Partnership (400 shares × 50% partnership interest)]. Velvet Partnership owns 1,700 shares (400 shares directly plus 800 shares indirectly from Marina plus 500 shares indirectly from Russell). Stock owned by a partner is deemed to be owned in full by a partnership.

Yellow Corporation owns 300 shares in Hawk Corporation. There is no attribution to Yellow Corporation from Marina, a less than 50% shareholder. b. Marina owns 1,180 shares [800 shares directly plus 200 shares indirectly from Velvet Partnership (400 shares × 50% partnership interest) plus 180 shares indirectly from Yellow Corporation (300 shares × 60% shareholder interest)]. Stock owned by a corporation is deemed to be owned proportionately by any shareholder owning 50% or more of the corporation’s stock.

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Chapter 6: Corporations: Redemptions and Liquidations 96. Starling Corporation was organized fifteen years ago to construct office furniture. Eight years ago, Starling began a fast food business. In the current year, Starling discontinues its fast food business and sells all of the assets used in that business for $2 million. Further, Starling distributes the entire sales proceeds in a pro rata redemption of 250 shares of stock from each of its two equal shareholders—Morgan, an individual, and Magpie Corporation (i.e., 500 shares in total redeemed). Morgan has a basis of $100,000 in her redeemed stock, Magpie Corporation has a basis of $125,000 in its redeemed stock, and both shareholders have held their stock interest in Starling for several years. Starling Corporation has E & P of $4 million and 2,000 shares outstanding at the time of the distribution. What are the tax consequences of the stock redemption to Morgan, to Magpie Corporation, and to Starling Corporation?

ANSWER: The redemption satisfies the termination of a business test under the partial liquidation rules. As a result, the redemption is a partial liquidation as to Morgan but not as to Magpie Corporation.

Section 302(b)(4) permits sale or exchange treatment only to noncorporate shareholders. Morgan has a long-term capital gain of $900,000 [$1 million (one-half of the sales proceeds) – $100,000 (basis in shares redeemed)]. Magpie Corporation has dividend income of $1 million (one-half of the sales proceeds), reduced by a dividends received deduction under § 243 of $800,000 (80% × $1 million), or a net increase in taxable income of $200,000. Magpie’s $125,000 basis in the redeemed shares is added to the basis in its remaining shares of Starling stock. Starling Corporation’s E & P will be decreased $1.5 million {$500,000 [12.5% (percentage of shares outstanding redeemed from Morgan) × $4 million (E & P as of the redemption date)], plus $1 million [dividend distribution to Magpie Corporation]}.

97. Sam’s gross estate includes stock in Tern Corporation and Wren Corporation, valued at $1.4 million and $980,000, respectively. At the time of Sam’s death, the stock represented 22% of Tern’s outstanding stock and 27% of Wren’s outstanding stock. Sam’s adjusted gross estate equals $6,500,000. Death taxes and funeral and administration expenses for Sam’s estate total $980,000. Sam had a basis of $350,000 in the Tern stock and $190,000 in the Wren stock at the time of his death. None of the beneficiaries of Sam’s estate own (directly or indirectly) any stock in Tern Corporation, but some of the beneficiaries own stock of Wren Corporation. Consider the following independent questions. a. What are the tax consequences to the estate if all of its Wren stock is redeemed by Wren Corporation for $980,000? b. What are the tax consequences to the estate if all of its Tern stock is redeemed by Tern Corporation for $1.4 million?

ANSWER: a. The redemption qualifies under § 303 as a sale or exchange. The combined value of the stock in Tern Corporation and Wren Corporation exceeds 35% of the value of the adjusted gross estate [($1.4 million + $980,000) ÷ $6,500,000 = 36.6%]. Tern and Wren stock are combined for purposes of the 35% test since Sam owned at least 20% of the stock of each corporation. There would be no gain recognized by Sam’s estate because § 1014 would apply to give the stock a stepped-up basis to the date of death value [$980,000 (redemption distribution) – $980,000 (stepped-up basis) = $0]. b. The estate will receive sale or exchange treatment under § 303 to the extent of the death taxes and funeral and administration expenses of $980,000. The remaining portion of the distribution would qualify as a complete termination redemption, as none of the beneficiaries own Tern stock that could be attributed to the estate. There would be no gain recognized by the estate because § 1014 would apply to give the stock a stepped-up basis to the date of death value [$1.4 million (redemption distribution) – $1.4 million (stepped-up basis) = $0].

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Chapter 6: Corporations: Redemptions and Liquidations 98. Raul’s gross estate includes 1,500 shares of stock of Orange Corporation (basis to Raul of $600,000, fair market value on date of death of $4.1 million). The estate will incur $2.2 million of death taxes and funeral and administration expenses, and the adjusted gross estate is $9 million. Denise, Raul’s daughter and sole heir of his estate, owns the remaining 500 shares of Orange Corporation’s (2,000) shares outstanding. In the current year, Orange (E & P of $5 million) redeems all of the estate’s 1,500 shares for $4.1 million. What are the tax consequences of the redemption to Raul’s estate?

ANSWER: A portion of the redemption qualifies under § 303 as a sale or exchange. The value of the stock in Orange Corporation exceeds 35% of the value of the adjusted gross estate [($4.1 million ÷ $9 million) = 45.6%]. A redemption to pay death taxes applies to the extent of the sum of the death taxes and funeral and administration expenses, or $2.2 million. The estate’s basis in the shares redeemed under § 303 is $2.2 million (stepped-up basis); thus, this portion of the redemption results in no gain or loss to the estate. The remainder of the distribution ($1.9 million) must be tested under the qualifying stock redemption provisions of § 302 for sale or exchange treatment.

For purposes of § 302, the stock attribution rules of § 318 apply and the shares owned by Denise, the estate’s sole beneficiary, are deemed to be owned by the estate. As such, the estate owns (directly and indirectly) 100% of the Orange shares outstanding after the redemption and none of the § 302 provisions are satisfied. The $1.9 million therefore is treated as a dividend distribution to the estate. The estate’s basis in the shares not qualifying for sale or exchange treatment ($1.9 million stepped-up basis) attaches to the basis of Denise’s shares in Orange Corporation.

99. Ivory Corporation (E & P of $1 million) has 2,000 shares of common stock outstanding owned by unrelated parties as follows: Veronica, 1,000 shares, and Tommie, 1,000 shares. Veronica and Tommie each paid $150 per share for the Ivory stock 12 years ago. In May of the current year, Ivory distributes land held as an investment (basis of $180,000, fair market value of $390,000) to Veronica in redemption of 350 of her shares. a. What are the tax results to Veronica on the redemption of her Ivory stock? b. What are the tax results to Ivory Corporation on the distribution of the land?

ANSWER: a. Veronica has a long-term capital gain of $337,500 [$390,000 (amount realized) – $52,500 (stock basis)]. The distribution qualifies as a disproportionate redemption under § 302(b)(2).

Veronica has a 50% (1,000 shares ÷ 2,000 shares) ownership interest in Ivory Corporation before the redemption and a 39.4% (650 shares ÷ 1,650 postredemption shares) ownership interest after the redemption. Both the 50% and the 80% [i.e., 39.4% < 40% (80% × 50%)] tests are met. Veronica will have a basis of $390,000 in the land. b. Ivory Corporation has a recognized capital gain of $210,000 [$390,000 (fair market value) – $180,000 (adjusted basis)] on the distribution of the land. Gains (but not losses) are recognized in nonliquidating distributions. In a qualifying stock redemption, E & P is reduced by no more than the ratable share of the E & P attributable to the stock redeemed; thus, Ivory reduces its E & P by $175,000 [$1 million E & P × 17.5% (percentage of stock redeemed)].

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Chapter 6: Corporations: Redemptions and Liquidations 100. As of January 1 of the current year, Grouse Corporation has E & P of $600,000. Fumiko owns 320 shares of Grouse’s common stock (basis of $45,000). On that date, Grouse Corporation declares and distributes a nontaxable preferred stock dividend, of which Fumiko receives 100 shares. Immediately after the stock dividend, the fair market value of one share of Grouse common stock is $500, and the fair market value of one share of Grouse preferred stock is $200. Two months later, Fumiko sells the 100 shares of preferred stock to an unrelated individual for $20,000. a. Assuming Fumiko is in the 33% tax bracket, what are his income tax consequences resulting from the sale of the preferred stock? b. What is the effect on Grouse Corporation’s E & P as a result of the sale of the preferred stock?

ANSWER: a. The preferred stock is § 306 stock and that provision governs the treatment of the sale. After the distribution and before the sale, the preferred stock has a basis to Fumiko of $5,000 [($20,000 value of preferred ÷ $180,000 value of preferred and common) × $45,000 (the original basis of the common stock)]. The sale of the § 306 stock results in $20,000 of ordinary income to Fumiko. This is the amount of dividend income Fumiko would have recognized if cash had been distributed instead of the preferred stock (the § 306 taint). The $20,000 is treated as dividend income for purposes of the 15% preferential tax rate on such income; thus, the preferred stock sale results in a tax of $3,000 ($20,000 × 15%) for Fumiko. The $5,000 basis in the preferred stock is added back to the basis of the common stock, giving such stock a $45,000 basis again. b. The ordinary income that results from a sale of § 306 stock is not dividend income; thus, the stock sale does not affect Grouse Corporation’s E & P.

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Chapter 6: Corporations: Redemptions and Liquidations 101. The stock in Crimson Corporation is owned by Angel and Melawi, who are unrelated. Angel owns 60% and Melawi owns 40% of the stock. All of Crimson Corporation’s assets were acquired by purchase. The following assets are to be distributed in complete liquidation of Crimson Corporation:

Cash Inventory Equipment Land

Adjusted Basis $300,000 110,000 180,000 460,000

Fair Market Value $300,000 100,000 200,000 400,000

a. What gain or loss, if any, would Crimson Corporation recognize if it distributes the cash, inventory, and equipment to Angel and the land to Melawi? b. What gain or loss, if any, would Crimson Corporation recognize if it distributes the equipment and land to Angel and the cash and inventory to Melawi?

ANSWER: a. With respect to the distributions to Angel, Crimson Corporation will recognize a gain of $20,000 on the distribution of the equipment but not the loss of $10,000 on the distribution of the inventory. This is a distribution of loss property to a related party and the distribution is not pro rata; thus, the related-party loss limitation applies. With respect to the distribution of the land to Melawi, Crimson Corporation will recognize a loss of $60,000. Melawi is not a related party and the built-in loss limitation does not apply. b. With respect to the distributions to Angel, Crimson Corporation will recognize a gain of $20,000 on the distribution of the equipment but not the loss of $60,000 on the distribution of the land. Again, this is a distribution of loss property to a related party and the distribution is not pro rata. With respect to the distribution of the inventory to Melawi, Crimson Corporation will recognize a loss of $10,000. Melawi is not a related party and the built-in loss limitation does not apply.

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Chapter 6: Corporations: Redemptions and Liquidations 102. Mary and Jane, unrelated taxpayers, own Gray Corporation’s stock equally. One year before the complete liquidation of Gray, Mary transfers land (basis of $200,000, fair market value of $130,000) to Gray Corporation as a contribution to capital. Assume that Mary also contributed other property in the same transaction having a basis of $20,000 and fair market value of $100,000. In liquidation, Gray distributes the land to Jane. At the time of the liquidation, the land is worth $110,000. a. How much loss, if any, may Gray Corporation recognize on the distribution of the land to Jane? b. Assume that the transfer of land to Gray Corporation was made so that the corporation could subdivide the land and build residential housing. However, a subsequent deterioration of the housing market forced Gray Corporation to abandon its plans. What amount of loss may Gray Corporation recognize on the distribution of the land to Jane?

ANSWER: a. Since the land was acquired by Gray Corporation as a contribution to capital within two years of liquidation, a tax avoidance purpose is assumed and the built-in loss limitation applies. As a result, Gray will recognize only $20,000 of the loss. This represents the amount of decline in value occurring after Gray acquired the property. The built-in loss of $70,000 [$130,000 (fair market value) – $200,000 (land basis)] existing at the time of transfer to Gray is disallowed.

Since Jane does not own more than 50% of the Gray stock, the related-party loss limitation does not apply. b. Because there was a business purpose for the transfer of the property to Gray, all of the $90,000 loss realized [$110,000 (fair market value) – $200,000 (land basis)] on the distribution is recognized. Since Jane does not own more than 50% of the Gray stock, the related-party loss limitation does not apply.

Note that the § 362(e)(2) basis step-down rules for loss properties acquired in carryover basis transactions does not apply to the undeveloped land, as there was no net built-in loss on the two properties transferred by Mary. Section § 362(e)(2) is discussed in Chapter 4.

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Chapter 6: Corporations: Redemptions and Liquidations 103. After a complete liquidation has been adopted, Wren Corporation sells its only asset, unimproved land (basis of $200,000) held as an investment. The land is sold to Seth (an unrelated party) for $500,000. Under the terms of the sale, Wren Corporation receives cash of $50,000 and Seth’s notes for the balance of $450,000.

The notes are payable over the succeeding 5 years ($90,000 per year) and carry an appropriate rate of interest.

Immediately after the sale, Wren Corporation distributes the cash and notes to Adam, the sole shareholder of Wren. Adam has an adjusted basis of $80,000 in the Wren stock. The installment notes have a value equal to their face amount of $450,000. a.

How will Wren Corporation be taxed on the distribution?

b.

How will Adam be taxed on his receipt of the cash and notes?

ANSWER: a. Wren Corporation may use the installment method on the sale of the land. However, Wren recognizes gain of $270,000 ($450,000 fair market value – $180,000 adjusted basis) on the distribution of the installment notes. The basis to Wren in the notes is $180,000, computed as follows.

· Gain realized on sale of land: $500,000 – $200,000 = $300,000 · Gain recognized on sale of land: $50,000 (cash) × 60% [gross profit percentage = ($300,000 gross profit ÷ $500,000 contract price)] = $30,000

· Basis in notes: $450,000 (fair market value of notes) – $270,000 (remaining gain to be recognized) = $180,000 b. Adam must allocate the adjusted basis in his Wren stock ($80,000) between the cash and the installment notes as follows:

Adam must recognize a gain of $42,000 [$50,000 (cash received) – $8,000 (basis allocated to the cash)] in the year of liquidation.

Adam must recognize a gain equal to 84% of each dollar collected on the notes, computed as follows: $450,000 (contract price) – $72,000 (allocated basis) = $378,000 (gross profit) The gross profit percentage is 84%:

Thus, Adam must report a gain of $75,600 [$90,000 (amount of note) × 84% (gross profit percentage)] on the collection of each note over the next 5 years. The interest element is accounted for separately as ordinary income.

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Chapter 6: Corporations: Redemptions and Liquidations 104. The stock of Tan Corporation (E & P of $1.5 million) is owned as follows: 90% by Egret Corporation (basis of $900,000), and 10% by Zoe (basis of $70,000). Both shareholders acquired their shares in Tan more than six years ago. In the current year, Tan Corporation liquidates and distributes land (fair market value of $1.1 million, basis of $1.3 million) and equipment (fair market value of $700,000, basis of $410,000) to Egret Corporation, and securities (fair market value of $200,000, basis of $260,000) to Zoe. What are the tax consequences of these distributions to Egret, to Tan, and to Zoe? ANSWER: The liquidating distribution to Egret is governed by § 332, resulting in no recognized gain or loss to either Egret or Tan. Egret has a carryover basis in both the land ($1.3 million) and the equipment ($410,000), and the basis in its Tan stock disappears. Tan’s E & P and other tax attributes carry over to Egret as provided under § 381. In distributions from a subsidiary corporation to a minority shareholder pursuant to a § 332 parent-subsidiary liquidation, gains but not losses are recognized. [§ 336(d)(3).] Thus, in the case of Tan, the $60,000 loss realized [$200,000 (fair market value) – $260,000 (basis)] on the distribution of the securities is not recognized. Zoe recognizes a long-term capital gain of $130,000 [$200,000 (fair market value of securities) – $70,000 (basis in Tan stock)], and she has a basis in the securities equal to their fair market value, or $200,000.

105. On March 15, 2013, Blue Corporation purchased 10% of the Gold Corporation stock outstanding. Blue Corporation purchased an additional 40% of the stock in Gold on October 24, 2013, and an additional 25% on April 4, 2014. On July 23, 2014, Blue Corporation purchased the remaining 25% of Gold Corporation stock outstanding. a. For purposes of the § 338 election, on what date does a qualified stock purchase occur? b. What is the due date for making the § 338 election?

ANSWER: a. A qualified stock purchase occurs when one corporation acquires, in a taxable transaction, stock representing at least 80% of the total voting power and at least 80% of the value of another corporation within a 12-month period. For purposes of Blue Corporation, a qualified stock purchase occurs with the July 23, 2014, purchase [90% = 40% (October 24, 2013) + 25% (April 4, 2014) + 25% (July 23, 2014)]. b. The § 338 election must be made by the fifteenth day of the ninth month beginning after the month in which a qualified stock purchase occurs. Since Blue’s qualified stock purchase date is July 23, 2014, the election must be filed by April 15, 2015.

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Chapter 6: Corporations: Redemptions and Liquidations 106. Do noncorporate and corporate shareholders typically have the same preference for the tax treatment of a stock redemption? Explain.

ANSWER: No, noncorporate and corporate shareholders typically do not have the same preference for the tax treatment of a stock redemption. Noncorporate taxpayers generally prefer sale or exchange treatment (a qualifying stock redemption) over that of a dividend distribution. In a qualifying stock redemption, the shareholder is allowed to recover his or her redeemed stock basis tax-free.

Also, the excess of the redemption distribution over the stock basis is (typically) a capital gain. If the shareholder has capital losses from other transactions, the capital gain resulting from a qualifying stock redemption can increase the shareholder’s deductibility of such capital losses. In a nonqualified stock redemption, the entire distribution is taxable as a dividend (assuming adequate E & P) that cannot be used to increase the utilization of capital losses.

Corporate taxpayers, however, generally prefer dividend treatment (a nonqualified stock redemption) for a stock redemption. This preference stems from the availability of the dividends received deduction for such taxpayers. As a result of the dividends received deduction, only a nominal amount of any dividend resulting from a nonqualified stock redemption would be subject to tax.

107. Explain the stock attribution rules that apply in the case of stock redemptions.

ANSWER: In general, the § 318 stock attribution rules apply in determining a taxpayer’s ownership interest (direct and indirect) in a corporation before and after a stock redemption. The stock attribution rules do not apply in the case of partial liquidations or redemptions to pay death taxes. Further, the family attribution rules can be waived in the case of some complete termination redemptions (e.g., taxpayer has no prohibited interest for 10 years after redemption).

Family attribution: An individual is deemed to own the stock owned by his or her spouse, children, grandchildren, and parents (not siblings or grandparents).

Partnership attribution: A partner is deemed to own the stock owned by a partnership to the extent of the partner’s proportionate interest in the partnership. Stock owned by a partner is deemed to be owned in full by a partnership.

Estate or trust attribution: A beneficiary or heir is deemed to own the stock owned by an estate or trust to the extent of the beneficiary or heir’s proportionate interest in the estate or trust. Stock owned by a beneficiary or heir is deemed to be owned in full by an estate or trust.

Corporation attribution: Stock owned by a corporation is deemed to be owned proportionately by any shareholder owning 50% or more of the corporation’s stock. Stock owned by a shareholder who owns 50% or more of a corporation is deemed to be owned in full by the corporation.

108. When does a redemption qualify as a not essentially equivalent redemption under § 302(b)(1)?

ANSWER: To qualify as a not essentially equivalent redemption, the distribution must result in a meaningful reduction in the shareholder’s interest in the redeeming corporation. In determining whether a shareholder’s interest has been meaningfully reduced, the courts place greatest emphasis on the decrease in the shareholder’s voting control that results from the redemption. Other factors considered in the application of the meaningful reduction test include reductions in the shareholder’s rights to current and liquidating distributions. The stock attribution rules of § 318 apply for purposes of the meaningful reduction test.

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Chapter 6: Corporations: Redemptions and Liquidations 109. What are the requirements that must be satisfied for a distribution to qualify under § 302(b)(2) as a disproportionate redemption?

ANSWER: To qualify as a disproportionate redemption, the stock redemption must satisfy the following requirements: (1) The shareholder’s ownership interest in the corporation after the redemption must be less than 80% of his or her ownership interest in the corporation before the redemption.

(2) After the redemption, the shareholder must own less than 50% of the total combined voting power of all classes of stock entitled to vote.

The stock attribution rules apply in determining a shareholder’s ownership interest before and after the redemption.

110. Explain the requirements for the termination of a business test for purposes of a partial liquidation. Why is this test generally preferable over the genuine contraction of a corporate business test for qualifying a distribution as a partial liquidation?

ANSWER: To qualify for the termination of a business test, a corporation must satisfy the following requirements:

· The corporation has two or more qualified trades or businesses (i.e., businesses that have been conducted for the 5-year period ending on the date of the distribution and the businesses were not acquired in a taxable transaction during such 5-year period).

· The distribution consists of the assets of a qualified trade or business or the proceeds from the sale of such assets.

· The corporation is actively engaged in the conduct of a qualified trade or business immediately after the distribution.

The termination of a business test provides an objective safe harbor rule for meeting the not essentially equivalent to a dividend requirement. The genuine contraction of a corporate business test also can be applied to satisfy the not essentially equivalent to a dividend requirement.

However, the genuine contraction of a corporate business test is subjective and should be relied upon only after receiving a favorable IRS ruling. Because of the greater certainty provided by the termination of a business test, it is the preferred avenue for qualifying a distribution as a partial liquidation.

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Chapter 6: Corporations: Redemptions and Liquidations 111. When is a redemption to pay death taxes under § 303 most advantageous?

ANSWER: The principal advantage of a § 303 redemption to pay death taxes is that the stock attribution rules do not apply to such redemptions. Thus, a redemption to pay death taxes is most fortuitous when a redemption would not satisfy any of the other qualifying stock redemption provisions due to the attribution rules. Such would be the case when a corporation’s stock is owned entirely by the decedent’s estate and the beneficiaries of the estate. In such cases, a redemption of stock from the estate would not satisfy any of the § 302 qualifying stock redemptions because under that provision the estate is deemed to own the stock owned by the beneficiaries. However, since the stock attribution rules do not apply to a redemption to pay death taxes, sale or exchange treatment is available under § 303.

While sale or exchange treatment under § 303 is limited to the sum of the death taxes and funeral and administration expenses, there is no requirement that the redemption proceeds be used for such expenditures or that the estate even require additional funds to pay such expenditures. An estate might have sufficient liquidity to meet the death-related expenses and still use a § 303 redemption to cash out some of its stock holdings at little or no tax consequence.

112. Under what circumstances will preferred stock received in a nontaxable stock dividend not generate ordinary income, under § 306, upon its disposition?

ANSWER: Section 306 does not result in ordinary income on the disposition of preferred stock received in a nontaxable dividend in a number of instances. For example, preferred stock is not “§ 306 stock” if, at the time of the stock dividend distribution, the corporation had no E & P. Thus, the disposition of such preferred stock will not generate ordinary income. Also, § 306 does not apply to a sale or redemption of preferred stock that results in the complete termination of the shareholder’s entire stock interest (§ 318 attribution rules apply). Further, a disposition in a partial liquidation or complete liquidation of the corporation will not result in ordinary income under § 306. Finally, § 306 ordinary income treatment upon disposition is limited to the corporation’s E & P at the time of the stock dividend distribution, in the case of a sale of the preferred stock, or at the time of the redemption of the preferred stock. A disposition for more than this ordinary income taint will result in return of capital or capital gain treatment.

113. Explain why the antistuffing rules were enacted to limit the deductibility of losses realized by a corporation upon liquidation.

ANSWER: The loss limitation (“antistuffing”) rules were enacted primarily to address the artificial losses that could otherwise result with respect to properties that were acquired by a corporation in carryover basis transactions (i.e., § 351 and contribution to capital transactions). When loss property (i.e., fair market value less than adjusted basis) is transferred to a corporation and a carryover basis applies, there exists the possibility loss could be recognized twice: once upon disposition of the property by the corporation, and again upon disposition of the transferring shareholder’s stock. The antistuffing rules are not limited to carryover basis scenarios (e.g., the related-party loss limitation can apply with respect to property that is acquired in a non-carryover basis transaction), but the overriding reason for the enactment of the rules was to limit the opportunities for taxpayers to use carryover basis transactions to create artificial losses. The enactment of the basis step-down rules for loss properties acquired in carryover basis scenarios reduces the impact of the antistuffing rules upon liquidation, particularly with respect to the builtin loss limitation.

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Test Bank for South-Western Federal Taxation 2015: Corporations, Partnerships, Estates and T

Chapter 6: Corporations: Redemptions and Liquidations 114. What are the tax consequences of a § 332 liquidation to the parent corporation, subsidiary corporation, and minority shareholder?

ANSWER: A parent corporation recognizes no gain or loss pursuant to a § 332 liquidation, and the parent’s basis in property received is equal the subsidiary’s basis in such property. In addition, a carryover holding period applies for the property. The parent also acquires the subsidiary’s other tax attributes (e.g., E & P, net operating loss carryover, business tax credit carryover, capital loss carryover). The parent’s basis in the subsidiary stock disappears. (If property is received from the subsidiary in satisfaction of indebtedness, the parent recognizes gain or loss equal to the difference between the fair market value of the property received and the parent’s basis in the indebtedness.)

A subsidiary corporation recognizes no gain or loss on distributions of property to a parent corporation in a § 332 liquidation, including property distributed in satisfaction of indebtedness.

However, a subsidiary recognizes gain (but not loss) on the distribution of property to any minority shareholder.

A minority shareholder recognizes gain or loss equal to the difference between the fair market value of the property received and the shareholder’s basis in the subsidiary stock. The minority shareholder’s basis in property received equals the property’s fair market value on the date of distribution.

115. Compare the sale of a corporation’s assets with a sale of its stock from the perspective of the seller.

ANSWER: A sale of a corporation’s assets presents more problems than a sale of its stock. When a corporation’s assets are sold, the sale proceeds are distributed to the shareholders in liquidation of the corporation. Both the corporation and the shareholders must treat the transaction as a sale for tax purposes. The transfer of assets requires that title be changed and that creditors be notified.

Further, if valuable nontransferable trademarks, contracts, or licenses are involved, an asset sale may not be feasible. The sale of stock avoids these nontax problems, and only the shareholders report the transaction for tax purposes.

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