To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER CORPORATIONS: REDEMPTIONS AND LIQUIDATIONS SOLUTIONS TO PROBLEM MATERIALS Question/ Learning Problem Objective 10 11 12 13 14 15 16 17 Topic LO Return from investment contrasted with return of investment LO Comparing stock redemption with sale to third party LO 1, 2, Stock redemptions in divorce actions LO Sale or exchange versus dividend treatment on redemption LO Shareholder preference for qualifying or nonqualified stock redemption treatment LO Loss recognition in a qualifying stock redemption LO Basis of property received in stock redemption LO Stock redemptions: effect of state law LO Stock attribution rules: corporations LO Stock attribution rules: when not applicable LO Basis of stock in nonqualified redemption LO Disproportionate redemption: requirements LO 1, Complete termination redemption LO Complete termination redemption: requirements for family attribution waiver LO Partial liquidation: termination of a business test LO 1, Partial liquidation LO Redemption to pay death taxes: shareholders of closely held corporations Status: Present Edition Q/P in Prior Edition New Unchanged Unchanged New New Unchanged New New Unchanged New Unchanged New 11 New Unchanged 14 Unchanged 15 Unchanged Unchanged 16 17 Instructor: For difficulty, timing, and assessment information about each item, see p 6-5 6-1 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-2 2012 Corporations Volume/Solutions Manual Question/ Learning Problem Objective 18 LO 1, 19 20 LO 1, LO 2, 21 LO 22 LO 23 LO 24 LO 25 26 LO LO 27 28 LO 1, 2, LO 29 LO 30 LO 31 LO 32 LO 33 LO 34 LO 35 LO 36 37 *38 LO LO LO 1, 2, *39 LO 40 LO Topic Redemption to pay death taxes: requirements Redemption to pay death taxes Gain/loss recognition to corporation on redemption distribution Tax consequences of redemption to distributing corporation Tax consequences of redemption to distributing corporation: redemptionrelated expenses Preferred stock bailout: definition and impact of § 306 classification Redemption through use of related corporation Corporate liquidation: tax definition Corporate liquidation: recognition of gain or loss by corporation Liquidating and redemption distributions compared: applicability of § 267 Related-party loss limitation: application to post-acquisition loss Built-in loss limitation: effect of basis step-down rule Tax consequences to shareholder in complete liquidation; use of installment method to report gain Section 332 liquidation: consequences to parent Section 332 liquidation: insolvent corporation Section 332 liquidation: tax consequences to subsidiary and minority shareholder Section 332 liquidation: tax consequences to parent and subsidiary Section 332 liquidation: subsidiary tax attributes Section 338: election requirements Section 338: consequences of election Comparison of dividend distribution with qualifying redemption: individual versus corporate shareholder Comparison of tax treatment of dividend distribution and qualifying stock redemption to individual shareholder Comparison of tax treatment of dividend distribution and qualifying stock redemption to corporate shareholder Status: Present Edition Q/P in Prior Edition New Unchanged Unchanged 19 20 Unchanged 21 New Unchanged 23 New Unchanged Unchanged 25 26 New Unchanged 28 New Unchanged 30 New New New Unchanged 35 New Unchanged New Modified 37 38 Unchanged 39 Unchanged 40 Instructor: For difficulty, timing, and assessment information about each item, see p 6-5 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Redemptions and Liquidations Question/ Learning Problem Objective *41 LO 42 LO 43 44 LO LO 45 LO 1, 46 LO *47 LO 1, 48 LO 1, *49 LO 1, 50 *51 LO LO 1, 52 LO *53 54 LO LO *55 LO 1, 2, *56 LO 57 LO 58 LO Topic Comparison of tax treatment of dividend distribution and qualifying stock redemption to individual shareholder with capital loss carryover Comparison of tax treatment of dividend distribution and qualifying stock redemption to corporate shareholder with capital loss carryover Application of stock attribution rules Not essentially equivalent redemption and disproportionate redemption Disproportionate redemption: minimum shares to qualify; tax consequences to shareholder and corporation Complete termination redemption: applicability of family attribution waiver Sale of stock versus complete termination redemption: effect on retiring shareholder, remaining shareholder, and corporation Partial liquidation: tax consequences to individual and corporate shareholders Redemption to pay death taxes and complete termination redemption: consequences to estate and corporation Redemption to pay death taxes: stock of two corporations Disproportionate redemption: consequences to shareholder and effect on E & P Effect of redemption on corporation: E & P adjustment and treatment of redemption expenses Section 306 stock: sale and redemption Redemption through use of related corporations Liquidations and redemptions compared: recognition of loss by corporation and shareholder Complete liquidation: distribution of property subject to liability Related-party loss limitation: pro rata distribution of disqualified property Built-in loss limitation: no tax avoidance purpose 6-3 Status: Present Edition Q/P in Prior Edition Unchanged 41 Unchanged 42 New New Modified 45 Unchanged 46 Modified 47 Unchanged 48 New Modified 50 Unchanged 51 Modified 52 New New New Modified 56 New Modified 58 Instructor: For difficulty, timing, and assessment information about each item, see p 6-5 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-4 2012 Corporations Volume/Solutions Manual Question/ Learning Problem Objective 59 LO *60 LO *61 LO 62 LO *63 LO 64 LO 4, 65 LO 4, 66 LO *67 LO 68 LO Topic Built-in loss limitation: sale and tax avoidance purpose with basis stepdown Complete liquidation: related-party loss limitation Complete liquidation: disqualified property and built-in loss property Complete liquidation: tax consequences to corporation and shareholder when property distributed with liability Complete liquidation: tax consequences to shareholder when installment notes distributed Liquidation of subsidiary: distribution of loss property to minority shareholder Liquidation of subsidiary: gain and loss properties, minority shareholder Liquidation of subsidiary: indebtedness of subsidiary to parent Liquidation of subsidiary: tax consequences to subsidiary and parent Section 338: consequences of election and liquidation of subsidiary Status: Present Edition Q/P in Prior Edition Unchanged 59 Unchanged 60 Unchanged 61 Unchanged 62 Unchanged 63 Modified 64 New Modified 65 Modified 66 Unchanged 68 *The solution to this problem is available on a transparency master Instructor: For difficulty, timing, and assessment information about each item, see p 6-5 Research Problem Topic Structuring a buy-sell agreement Family attribution waiver; independent contractor as prohibited interest Charitable contribution of § 306 stock Gift of stock followed by redemption: assignment of income doctrine Internet activity Internet activity Status: Present Edition Q/P in Prior Edition Unchanged Unchanged Unchanged New New Unchanged © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Redemptions and Liquidations Question/ Problem Difficulty Est’d completion time Easy Easy Medium 5 10 Easy 5 Easy Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Reporting FN-Reporting FN-Reporting 10 11 12 13 Easy Easy Easy Easy Easy Easy Easy Medium 5 5 5 10 FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting 14 15 16 Easy Easy Medium 5 10 FN-Reporting FN-Reporting FN-Reporting 17 18 19 Easy Easy Medium 5 10 FN-Reporting FN-Reporting FN-Reporting 20 Medium 10 21 Medium 10 FN-Measurement | FNReporting FN-Reporting 22 23 24 25 26 27 28 29 Easy Easy Easy Easy Easy Medium Easy Medium 5 5 10 10 FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting 30 31 32 33 34 Easy Medium Easy Medium Easy 10 10 35 Easy FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Reporting 6-5 Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic| Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-6 2012 Corporations Volume/Solutions Manual Question/ Problem Est’d completion time Difficulty 36 37 38 Easy Medium Medium 10 10 15 39 Easy 10 40 Easy 10 41 Medium 10 42 Medium 10 43 Medium 10 44 Medium 10 45 Hard 20 46 47 Medium Medium 10 10 48 Medium 10 49 Medium 10 50 Medium 10 51 Medium 10 52 Medium 20 53 Medium 10 54 Easy 55 Medium 56 Easy 57 Medium 10 58 Medium 10 59 Medium 10 10 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Communication | Analytic Analytic Analytic Analytic Analytic Analytic Analytic Communication | Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Redemptions and Liquidations Question/ Problem Difficulty Est’d completion time 60 Hard 10 61 Hard 10 62 Easy 63 Medium 10 64 Medium 10 65 Medium 10 66 Easy 67 Easy 10 68 Medium 10 6-7 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-8 2012 Corporations Volume/Solutions Manual CHECK FIGURES 38.a 38.b 38.c 38.d 38.e 39.a 39.b 40.a 40.b 41.a 41.b 41.c 42.a 42.b 43.a 43.b 44.a 44.b 45 46.a 46.b 46.c 47.a 47.b 48.a 48.b 49 50 51.a 51.b 52 Teal taxable gain of $70,000; Grace dividend income of $250,000 Teal taxable gain of $70,000; Grace $250,000 of dividend, subject to the dividends received deduction Teal taxable gain of $70,000; Grace capital gain of $180,000 Teal taxable gain of $70,000; Grace capital gain of $180,000 Teal no preference; Grace prefers option b., if corporation; option c., if individual $52,500 $75,000 $119,000 $51,000 $110,000 $3,000 Choose qualifying stock redemption $110,000 $0 1,480 shares 1,930 shares $175,000 dividend income $148,500 LTCG 197 minimum shares; Lana $157,600 LTCG; Stork $167,450 reduction in E & P No No Yes Lori dividend income of $400,000; Swan reduces E & P by $400,000; Robert capital gain of $375,000 Robert capital gain of $375,000; Swan reduces E & P by $350,000 Sean capital gain of $175,000; Crane E & P reduced by $180,000 Sean Corporation dividend income of $200,000, subject to dividends received deduction of $160,000 Estate recognizes no gain or loss; Finch reduces E & P by $800,000 No gain Ann long-term capital gain of $84,000; Teal E & P reduced by $90,000 Ann dividend income of $90,000; Teal E & P reduced by $90,000 E & P reduced by $300,000; redemption expenses not deductible 53.a 53.b 53.c 54 55.a 55.b 56.a 56.b 57 58 59 60 61 62 63 64 65.a 65.b 66 67.a No tax consequences other than allocation of stock basis Ordinary income of $100,000, $30,000 basis to common stock Dividend income of $100,000, $30,000 basis to common stock; E & P reduced $100,000 Martin dividend income of $300,000 Dove $140,000 loss not recognized; Julia $20,000 loss not recognized and basis in land of $330,000 Dove $140,000 loss not recognized; Julia $20,000 loss recognized and basis in land of $330,000 $110,000 LTCG $190,000 LTCG $0 $150,000 $90,000 Pink should either distribute the land to Paul or sell it and distribute the cash Pink should either distribute the land to Paul or sell it and distribute the cash Oriole long-term capital gain of $255,000; Samantha long-term capital gain of $240,000 Recognize $180,000 gain in the year of liquidation, and $108,000 gain with each note collection Magenta no loss recognized on distribution to Fuchsia, $15,000 gain recognized on distribution to Marta; Fuchsia no gain or loss recognized and basis of $1,950,000; Marta $145,000 gain recognized and basis of $180,000 Ivory no gain or loss recognized; Gold no gain or loss recognized and $80,000 basis in inventory; Imelda $25,000 gain recognized and $200,000 basis in equipment Ivory $120,000 gain recognized; Gold no gain or loss recognized and $350,000 basis in equipment; Imelda $25,000 recognized gain and $200,000 basis in inventory Green recognizes no loss; Orange recognizes $15,000 gain $0 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Redemptions and Liquidations 67.b 67.c 67.d $0 Marketable securities $250,000, unimproved land $300,000 Both carry over to Wren 68 6-9 Aqua recognized gain of $500,000 and new asset basis of $1.2 million; no gain or loss on liquidation and carryover of $1.2 million basis in assets to Egret © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-10 2012 Corporations Volume/Solutions Manual DISCUSSION QUESTIONS The Code treats distributions that are returns from the shareholder’s investment as dividend distributions, while distributions that are returns of the shareholder’s investment are treated as a sale or exchange of the investment pp 6-2 and 6-3 In a sale of stock to a third party, the shareholder’s ownership interest in the corporation is diminished, and such dispositions result in sale or exchange treatment In a stock redemption, however, a shareholder’s ownership interest in the corporation may be unaffected as a result of the redemption This is particularly true where the stock of the corporation is solely owned or owned entirely or predominately by related parties It is this possibility of little or no diminishment in ownership interest in a stock redemption that gave rise to the qualifying stock redemption rules In those cases where a shareholder’s ownership is sufficiently diminished as a result of a stock redemption, sale or exchange treatment is the result However, if a shareholder’s ownership is relatively unaffected as a result of a stock redemption, the transaction has the same effect as a dividend distribution and is taxed as such p 6-3 • Whether Erica has a preference for personally acquiring the Velvet shares or for a stock redemption of the shares • Whether Erica has the financial resources to acquire the Velvet shares • If Erica does acquire the Velvet shares, her basis in the shares • Whether Velvet has the financial resources, including the ability to issue its own notes, to fund a stock redemption • If property can be distributed in the redemption, whether Velvet has property suitable for a distribution and the tax consequences resulting from such a distribution • If a cash distribution is desired in a redemption, whether Velvet has sufficient cash available for such a distribution or property that can be sold to fund such a distribution • If Velvet must sell property to finance a redemption, the tax consequences resulting from such sale • The effect of any property sale and the redemption distribution on Velvet’s E & P • Whether a sale to Erica or a redemption by Velvet results in sale or exchange treatment to Joseph • If property is distributed pursuant to a redemption, Joseph’s basis and holding period for such property pp 6-3, 6-4, 6-8, 6-12 to 6-14, and 6-28 to 6-30 Brandi’s redemption satisfied the terms of one of the qualifying stock redemptions and was taxed as a sale or exchange That is, $9,000 = 15% (LTCG tax rate) × $60,000 LTCG [$100,000 (amount realized) – $40,000 (basis in stock)] Yuen’s redemption, however, failed to qualify for sale or exchange treatment and, instead, the entire distribution was taxed as a dividend: $15,000 = 15% (dividend tax rate) × $100,000 Example © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-16 2012 Corporations Volume/Solutions Manual not apply in the case of a liquidation, other loss disallowance rules (e.g., related-party loss limitation, built-in loss limitation) may apply to disallow loss recognition by a liquidating corporation pp 6-4, 6-13, 6-17, and 6-22 28 Yes, the related-party loss limitation can apply to a loss attributable to a post-acquisition decline in fair market value of property Unlike the built-in loss limitation which applies only to assets acquired by the corporation with a pre-existing loss (fair market value less than basis), the related-party loss limitation is more expansive The related-party loss limitation applies to any loss attributable to the distribution of property to a related party and such distribution either (1) is not pro rata or (2) is disqualified property This definition could encompass property that has declined in value after its acquisition by the liquidating corporation p 6-20 29 The 2004 enactment of the basis step-down rule applicable to net built-in losses in § 351 transactions significantly limits the scope of the built-in loss limitation However, the built-in loss limitation remains relevant for several reasons First, if a shareholder’s § 351 transfer includes appreciated property, the “net built-in loss” is reduced by such appreciation In such cases, the resulting reduction (step-down) in the basis of depreciated properties does not eliminate all of the built-in loss for such properties (See Chapter 4, Example 22.) To the extent not eliminated by the basis step-down rule, the built-in loss limitation remains applicable Second, the built-in loss limitation is applicable when the election is made to apply the basis step-down to the shareholder’s basis in the stock received in the transaction, instead of the corporation’s basis in the transferred property Third, the built-in loss limitation remains relevant for properties transferred to a corporation prior to the effective date of the basis step-down rule (i.e., properties transferred prior to October 23, 2004) pp 6-18 to 6-22 30 The general rule under § 331 provides for sale or exchange treatment to the shareholder The shareholder is treated as having sold his or her stock to the corporation being liquidated Thus, the difference between the fair market value of the assets received from the corporation and the adjusted basis of the stock surrendered is the gain or loss recognized Typically, the stock is a capital asset in the hands of the shareholder and capital gain or loss results The basis of property received in a liquidation is the property’s fair market value on the date of the distribution A shareholder’s gain on the receipt of installment notes obtained by a liquidating corporation on the sale of its assets may be deferred to the point of collection under § 453(h) The shareholder must allocate his or her stock basis among the notes and any other assets received from the corporation With respect to the notes received, the shareholder may defer gain until the notes are collected pp 6-23 and 6-24 31 A parent corporation recognizes no gain or loss in a § 332 liquidation of a subsidiary The parent takes a basis in the property received equal to the subsidiary’s basis in such property In addition, the parent’s holding period in the property includes that of the subsidiary Other tax attributes of the subsidiary (e.g., net operating loss carryover, E & P) also carry over to the parent corporation The parent’s basis in its subsidiary stock is eliminated (If the parent receives property from the subsidiary in satisfaction of indebtedness, the parent recognizes gain or loss.) pp 6-24 to 6-26 32 Section 332 does not apply to an insolvent subsidiary Instead, the parent corporation has an ordinary loss deduction under § 165(g) (worthless security of an affiliated corporation) equal to its basis in the subsidiary stock p 6-25 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Redemptions and Liquidations 6-17 33 A subsidiary corporation recognizes gain (but not loss) on the distribution of property to a minority shareholder pursuant to a liquidation otherwise governed by § 332 The minority shareholder recognizes gain or loss equal to the excess of the fair market value of the property received over the shareholder’s basis in the subsidiary stock The basis of the property received by the minority shareholder is the property’s fair market value on the date of the distribution p 6-25 34 Condor will recognize no gain or loss and will have a carryover basis of $800,000 in Dove’s assets Condor acquires the $220,000 of E & P and any other tax attributes of Dove (e.g., net operating loss carryover) Condor’s basis in the Dove stock disappears Dove recognizes no gain or loss on the liquidation pp 6-24 to 6-27 35 A parent corporation acquires the tax attributes of a subsidiary corporation liquidated pursuant to § 332 Under § 381, the subsidiary’s E & P, net operating loss carryover, and other tax attributes carry over to the parent corporation p 6-27 36 For § 338 to apply, a corporation (the “parent”) must acquire stock representing at least 80% of the voting power and at least 80% of the value of another corporation (the “subsidiary”) within a 12-month period (“qualified stock purchase”) The stock must be acquired in a taxable transaction, and a stock acquisition by a member of an affiliated group that includes the parent is considered to be an acquisition by the parent The parent corporation must then make the § 338 election by the 15th day of the ninth month beginning after the month in which the qualified stock purchase occurs p 6-27 37 Upon making a § 338 election, the subsidiary is treated as having sold its assets on the qualified stock purchase date for a value that is determined with reference to the parent’s basis in the subsidiary stock plus any liabilities of the subsidiary The deemed sale of assets results in gain or loss recognition to the subsidiary corporation The subsidiary is then treated as a new corporation that purchased those assets on the day following the qualified stock purchase date for a similarly computed value The deemed purchase results in a new stepped-up (or -down) basis for the subsidiary’s assets The new basis in the subsidiary’s assets carries over to the parent corporation if the subsidiary corporation is subsequently liquidated pp 6-27 and 6-28 PROBLEMS 38 a Teal Corporation would have a taxable gain of $70,000 on the property distribution [$250,000 (fair market value) – $180,000 (basis in property)] The gain would be ordinary or capital depending on the type of property distributed The E & P of Teal Corporation would be increased by $70,000 (the amount of gain to Teal) and decreased by $250,000 (the FMV of the property distributed) Teal’s E & P also would be decreased by the amount of tax due on the gain recognized Grace would have dividend income of $250,000 and a basis in the property of $250,000 b The tax consequences to Teal Corporation would be the same as in option a Grace Corporation would have dividend income of $250,000, but only 20% of the $250,000, or $50,000, would be taxed to Grace Because Grace Corporation has a 20% or more ownership interest in Teal Corporation, the 80% dividends received deduction is applicable Grace Corporation would have a basis of $250,000 in the property c The tax consequences to Teal Corporation would be the same as in option a Grace would have a capital gain of $180,000 [$250,000 (value of the property) – $70,000 (basis in stock)] and a basis of $250,000 in the property received © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-18 2012 Corporations Volume/Solutions Manual d The tax consequences to Teal Corporation would be the same as in option a Grace Corporation would have a capital gain of $180,000 [$250,000 (value of the property) – $70,000 (basis in stock)] and a basis of $250,000 in the property received e Assuming Grace is an individual, she would choose the qualifying stock redemption (option c.) If the distribution is a qualifying stock redemption, she has a capital gain of $180,000 If the distribution is a dividend, as in option a., she would have dividend income of $250,000 Her basis in the property received is the same whether the transaction is a dividend or a qualifying stock redemption If Grace is a corporation, it would prefer that the distribution be a dividend because only 20% of the dividend would be taxed (option b.) Teal Corporation itself would have no preference because the tax consequences from the transaction are the same under each option pp 6-3, 6-4, 6-12, 6-13, and 6-28 39 a Julio’s tax liability would be $52,500, computed as follows: $500,000 (amount realized) – $150,000 (basis in the 600 shares redeemed) = $350,000 (long-term capital gain) × 15% = $52,500 b Julio’s tax liability would be $75,000, computed as follows: $500,000 (dividend) × 15% = $75,000 Example 40 a Tax liability for a corporate shareholder would be $119,000, computed as follows: $500,000 (amount realized) – $150,000 (basis in the stock) = $350,000 (long-term capital gain) × 34% = $119,000 Corporations not receive a preferential tax rate on long-term capital gains b Tax liability for a corporate shareholder on a $500,000 dividend from a corporation in which it has a 15% interest would be $51,000, computed as follows: $500,000 (dividend) – $350,000 [70% (dividends received deduction) × $500,000] = $150,000 × 34% = $51,000 Corporations not receive a preferential tax rate on dividend income Example 41 a Julio may deduct the entire $110,000 capital loss carryover to offset $110,000 of the $350,000 long-term capital gain Thus, Julio would be taxed on only $240,000 of gain Tax liability on the $240,000 long-term capital gain would be $36,000 ($240,000 × 15%) b Julio could only deduct $3,000 of the $110,000 capital loss carryover Julio’s tax liability on the $500,000 dividend received would be $75,000 ($500,000 × 15%) c The preferred outcome in this situation is that which provides sale or exchange treatment (option a.) With a qualifying stock redemption, Julio’s tax liability is $39,000 less ($75,000 – $36,000) than if the redemption is treated as a dividend Example © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Redemptions and Liquidations 42 6-19 a The corporation could offset the entire $110,000 capital loss carryover against the $350,000 long-term capital gain Thus, only $240,000 of the gain would be taxed The tax liability would be $81,600 ($240,000 × 34%) b The corporation could not deduct any of the $110,000 capital loss carryover Corporations may only offset capital losses against capital gains Thus, the corporation would have dividend income of $500,000 less a dividends received deduction of $350,000 (70% × $500,000) The remaining $150,000 would be taxed at 34%, for a tax liability of $51,000 Example and Chapter 43 a Josephina owns 1,480 shares, 800 shares directly and 680 shares indirectly, in Magpie Corporation Josephina is treated as owning the stock of her daughter (500 shares) and 60% of the 300 shares, or 180 shares, owned by Petrel Partnership Siblings are not related parties under the § 318 stock attribution rules, and the attribution rules not apply to the stock held by a corporation if the shareholder owns less than 50% of the stock in the corporation b Josephina would now own 1,930 shares in Magpie Corporation, the 1,480 shares as computed in part a., above, plus 75% of the 600 shares, or 450 shares, owned by Tern Corporation Exhibit 6.1 44 a The distribution does not satisfy any of the qualifying stock redemption provisions; thus, Pedro has $175,000 of dividend income After the redemption, Pedro owns 53.8% of the Indigo shares outstanding after the redemption [350 (postredemption shares owned) ÷ 650 (postredemption shares outstanding)] This postredemption ownership interest fails the requirements for a disproportionate redemption or a complete termination redemption Also, since Pedro still has dominant control of Indigo, there has not been a “meaningful reduction” of his ownership interest in Indigo Thus, the transaction fails to qualify as a not essentially equivalent redemption Pedro’s basis in the 350 shares redeemed attaches to the basis in his remaining Indigo shares Thus, Pedro has a $119,000 basis in his remaining 350 shares pp 6-5 to 6-8 and Example b The distribution qualifies as a disproportionate redemption; thus, Pedro has a recognized long-term capital gain of $148,500 [$225,000 (amount realized) – $76,500 (basis in shares redeemed)] After the redemption, Pedro has an ownership interest in Indigo of 45.5% [250 (postredemption shares owned) ÷ 550 (postredemption shares outstanding)] This ownership interest is less than 80% of his original ownership [45.5% < 56% (80% × 70%)] and less than 50% of the total combined voting power Example 45 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 May 6, 2011 Lana Johnson 1000 Main Street Oldtown, MN 55166 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-20 2012 Corporations Volume/Solutions Manual Dear Lana: This letter is in response to your questions concerning a possible redemption of shares of stock you own in Stork Corporation Currently, you own 450 shares of Stork common stock, and the remaining outstanding shares are owned by Lori Johnson (your sister), 450 shares, and Leo Johnson (your son), 100 shares You paid $200 per share for your stock eight years ago You are interested in reducing your stock ownership in Stork via a stock redemption that would pay you $1,000 per share, the fair market value of the stock Stork Corporation (E & P of $850,000) would distribute cash for the entire redemption transaction You have asked us to determine the minimum number of shares that you would have to redeem in order to obtain favorable long-term capital gain treatment, and the overall tax consequences of such a redemption to both you and Stork Corporation Our conclusion is based upon the facts as outlined in your April 27 letter Any change in facts may cause our conclusions to be inaccurate In the redemption transaction, you will be deemed to own the shares owned by your son, Leo As such, your current ownership interest is 55% {[450 shares (owned directly) + 100 shares (owned by your son)] ÷ 1,000 shares outstanding} To obtain long-term capital gain treatment on a redemption, your postredemption ownership must be less than 50% of the total remaining shares outstanding, and less than 80% of your preredemption ownership of 55% (i.e., less than 44%) The minimum number of shares that you must redeem to obtain the desired results is 197 shares A redemption of 197 shares would satisfy the postredemption ownership tests After the redemption, your ownership interest of 43.96% [353 shares (253 shares owned directly plus your son’s 100 shares) ÷ 803 shares (Stork shares outstanding after redemption)] satisfies both the 50% and 80% tests The redemption of 197 shares would result in a long-term capital gain to you in the amount of $157,600 [$197,000 (redemption proceeds) – $39,400 (cost of shares redeemed)] Your tax on the gain of $157,600 would be limited to $23,640 ($157,600 × 15%) The redemption would result in a reduction of Stork Corporation’s E & P in the amount of $167,450 [$850,000 (E & P preredemption) × 19.7% (percentage of shares outstanding represented by your shares redeemed)] Should you need additional information or need to clarify our conclusion, not hesitate to call on me Sincerely, Marilyn C Jones, CPA Partner TAX FILE MEMORANDUM DATE: May 5, 2011 FROM: Marilyn C Jones SUBJECT: Lana Johnson Today I talked to Lana Johnson with respect to her April 27 letter She is interested in reducing her ownership interest in Stork Corporation (E & P of $850,000) in a stock redemption that would provide her long-term capital gain treatment Stork would pay Lana $1,000 for each share of the corporation’s stock, the estimated fair market value of the stock Currently, Stork Corporation has 1,000 shares of stock outstanding owned by the following © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Redemptions and Liquidations 6-21 individuals: Lana Johnson, 450 shares; Lori Johnson (Lana’s sister), 450 shares; and Leo Johnson (Lana’s son), 100 shares Lana paid $200 per share for the stock eight years ago She has asked us to determine the minimum number of shares that she would have to redeem in order to obtain favorable long-term capital gain treatment, and the overall tax consequences of such a redemption to both her and Stork Corporation At issue: What is the minimum number of shares that must be redeemed to qualify for sale or exchange treatment for Lana? What are the tax consequences to Lana and Stork Corporation upon such a redemption? Conclusion: For purposes of a stock redemption, the shares owned by Lana’s son, Leo, are deemed owned by Lana (The shares owned by Lana’s sister, Lori, are not considered owned by her under the § 318 attribution rules.) Thus, Lana is deemed to own 55% of the Stork shares prior to any redemption {[450 shares (owned directly) + 100 shares (owned indirectly from Leo)] ÷ 1,000 shares outstanding} Using an algebraic formula, it is determined that Lana must redeem a minimum of 197 shares in order to satisfy the 50% and 80% postredemption ownership tests of a disproportionate redemption under § 302(b)(2) (550 – X) ÷ (1,000 – X) < 55% × 80% To solve X: (550 – X) ÷ (1,000 – X) = 44% Multiply both sides of equation by (1,000 – X) to get: (550 – X) = 44(1,000 – X) (550 – X) = 440 – 44X 110 = 56X 197 (rounded up) = X A redemption of 197 shares would satisfy both of the postredemption ownership tests After the redemption, Lana’s ownership interest of 43.96% [353 shares (253 shares owned directly plus Leo’s 100 shares) ÷ 803 shares (Stork shares outstanding after redemption)] satisfies both the 50% and 80% tests A redemption of 197 shares in Stork would result in a long-term capital gain to Lana in the amount of $157,600 [$197,000 (amount realized) – $39,400 (basis of shares redeemed)] Her tax on the gain of $157,600 would be limited to $23,640 ($157,600 × 15%) The redemption would result in a reduction of Stork Corporation’s E & P in the amount of $167,450 [$850,000 (E & P preredemption) × 19.7% (percentage of shares outstanding represented by your shares redeemed)] Examples and 19 46 a The redemption cannot qualify as a complete termination redemption John is deemed to own Edward’s 1,000 shares, or 59% (1,000 ÷ 1,700) of the remaining shares outstanding The family attribution waiver does not apply because John failed to file the required notification agreement with his tax return for the year of the redemption b While an acquisition by John of stock in Thrush by bequest or inheritance is not a prohibited interest, an acquisition by purchase is a prohibited interest Even if the other requirements for the family attribution waiver are satisfied (e.g., John files the required agreement with the IRS), John has acquired a prohibited interest within the 10-year postredemption period Thus, the redemption cannot qualify as a complete termination redemption © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-22 2012 Corporations Volume/Solutions Manual c The redemption can qualify as a complete termination redemption Retaining a creditor interest is not a prohibited interest Thus, if the other requirements for the family attribution waiver are satisfied, the redemption completely terminates John’s ownership interest in Thrush pp 6-8 and 6-9 47 a With respect to the distribution, Lori would have dividend income of $400,000 and Swan Corporation would reduce its E & P by $400,000 As a result of the stock transaction, Lori would have a basis of $400,000 in the newly acquired 500 shares and become the sole shareholder of Swan Robert would have a capital gain of $375,000 [$400,000 (amount realized) – $25,000 (basis in stock)] on the sale The stock transaction would not affect Swan b The transaction would constitute a complete termination redemption and result in a capital gain of $375,000 [$400,000 (amount realized) – $25,000 (basis in stock)] to Robert (Siblings are not related parties under § 318; thus, Robert’s continued employment with Swan is irrelevant and a complete termination redemption results.) Lori would become the sole shareholder as a result of the redemption Swan would reduce its E & P by $350,000 [$700,000 (E & P at time of redemption) × 50% (interest redeemed)] p 6-8, Examples and 19, Exhibit 6.1, and Chapter 48 a The transaction qualifies as a partial liquidation as to Sean, an individual shareholder Under § 302(b)(4), a distribution qualifies as a partial liquidation if it (1) is not essentially equivalent to a dividend (e.g., satisfies the termination of a business safe harbor test) and (2) is both pursuant to a plan and made within the plan (or succeeding) year The distribution of proceeds from a sale of a trade or business that Crane Corporation owned and operated for the last five years (i.e., a qualified trade or business), coupled with the continued operation of another qualified trade or business after the distribution, satisfies the termination of a business test Sean will receive sale or exchange treatment on the redemption resulting in a capital gain of $175,000 [$200,000 (amount realized) – $25,000 (basis in stock redeemed)] Crane Corporation reduces its E & P by $180,000 [20% (percentage of shares outstanding redeemed from Sean) × $900,000 (E & P as of the date of distribution)] for the distribution to Sean b The distribution does not qualify as a partial liquidation as to Sean Corporation, because § 302(b)(4) is limited to noncorporate shareholders Instead, Sean Corporation will have dividend income equal to the entire distribution received, or $200,000 Because Sean Corporation will have a dividends received deduction of $160,000 ($200,000 × 80%) with respect to the redemption, only $40,000 of the distribution from Crane will be taxed The $25,000 basis in the Crane Corporation stock redeemed attaches to Sean Corporation’s basis in its remaining shares of Crane stock Crane Corporation reduces its E & P by $200,000, the amount of the dividend distribution pp 6-9, 6-10, and Examples 3, 14, 15, and 19 49 The distribution does not qualify as a redemption to pay death taxes as the fair market value of the Finch Corporation stock included in Tanya’s estate does not exceed 35% of the value of the adjusted gross estate ($1.4 million ÷ $7 million = 20%) However, the distribution does qualify as a complete termination redemption, as all of the estate’s direct ownership interest in Finch is eliminated and there is no indirect (constructive) ownership in Finch attributed to the © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Redemptions and Liquidations 6-23 estate (Taylor, the sole heir, has no ownership interest in Finch.) Sale or exchange treatment results and the estate recognizes no gain (or loss) [$1.4 million (amount realized) – $1.4 million (stepped-up basis in stock)] Finch Corporation reduces its E & P by $800,000 ($2 million preredemption E & P × 40% stock redemption = $800,000) pp 6-8 and 6-11 to 6-13 50 Since Bridgett owned a 20% or more interest in both Crane Corporation and Eagle Corporation, the fair market values of the two stocks are combined for purposes of the 35% of adjusted gross estate test The redemption qualifies under § 303 [$2,750,000 (combined stock value) exceeds $2,625,000 (35% × $7.5 million adjusted gross estate)] to the extent of $750,000, the amount of death taxes and funeral and administration expenses Since the estate’s basis in the Crane shares is stepped up to fair market value at date of death, the estate has no gain or loss on the stock redemption [$750,000 (proceeds qualifying for § 303 treatment) – $750,000 (estate’s basis in shares)] pp 6-11, 6-12, and Example 17 51 a The transaction qualifies for sale or exchange treatment as a disproportionate redemption Ann’s postredemption ownership interest of 29.4% [500 (postredemption shares owned by Ann) ÷ 1,700 (postredemption shares outstanding)] satisfies both the 80% test [29.4% is less than 32% (80% × 800/2,000) and the 50% test As a result, Ann will recognize a long-term capital gain of $84,000 [$90,000 (amount realized) – $6,000 (basis in 300 shares redeemed) Teal Corporation’s E & P is reduced by $90,000, the amount of the distribution {$90,000 is less than the limitation of $135,000 [15% (percentage of shares outstanding redeemed from Ann) × $900,000 (E & P as of the date of distribution)]} Examples and 19 b The transaction does not qualify for sale or exchange treatment As a result of the stock attribution rules, Ann is deemed to own the shares owned by Bonnie, her daughter Ann’s postredemption ownership interest of 64.7% [1,100 (500 postredemption shares owned directly + Bonnie’s 600 shares) ÷ 1,700 (postredemption shares outstanding)] fails to satisfy any of the qualifying stock redemption provisions Ann therefore will recognize dividend income equal to the amount of the distribution, or $90,000 The $6,000 basis in the Teal Corporation stock redeemed attaches to Ann’s basis in her remaining shares of Teal stock Teal Corporation’s E & P is reduced by $90,000, the amount of the dividend distribution Example 10 and Chapter 52 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 December 6, 2011 Crane Corporation 506 Wall Street Winona, MN 55987 Dear President of Crane Corporation: This letter is in response to your questions concerning Crane Corporation’s tax consequences arising out of a redemption of its stock Crane Corporation had 2,000 shares of stock outstanding when it redeemed 500 shares for $370,000 The shareholder received sale or exchange treatment on the redemption Crane had paid-in capital of $300,000 and E & P of $1.2 million at the time of the redemption As a result of the redemption transaction, Crane Corporation incurred $13,000 of accounting and legal fees Our conclusions are based upon © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-24 2012 Corporations Volume/Solutions Manual the facts as outlined in your November 28 letter Any change in facts may cause our conclusions to be inaccurate Crane Corporation would reduce its E & P in the amount of $300,000 as a result of the redemption This represents a 25% decrease in the amount of the E & P corresponding to the 25% stock redemption When a stock redemption results in sale or exchange treatment for the shareholder, the E & P account of a corporation is reduced in an amount not in excess of the ratable share of the E & P of the distributing corporation attributable to the stock redeemed The $70,000 balance of the redemption distribution would reduce the paid-in capital of the corporation No deduction is allowed for expenditures incurred by a corporation in connection with the redemption of its stock As such, none of the $13,000 of accounting and legal fees is deductible Should you need additional information or need to clarify our conclusions, not hesitate to call on me Sincerely, Astia Jackson, CPA Partner TAX FILE MEMORANDUM DATE: December 2, 2011 FROM: Astia Jackson SUBJECT: Crane Corporation Today I talked to the president of Crane Corporation with respect to its November 28 letter Crane Corporation had 2,000 shares of stock outstanding It redeemed 500 shares for $370,000, when it had paid-in capital of $300,000 and E & P of $1.2 million The redemption qualified for sale or exchange treatment for the shareholder Crane incurred $13,000 of accounting and legal fees with respect to the redemption transaction At issue: What is the reduction in Crane Corporation’s E & P as a result of the redemption? Also, are the redemption expenditures deductible by Crane? Conclusion: Under § 312(n)(7), the E & P account of a corporation is reduced by a qualifying stock redemption in an amount not in excess of the ratable share of the E & P of the distributing corporation attributable to the stock redeemed Since Crane Corporation redeemed 25% of its stock, the reduction in E & P is 25% of the E & P account, or $300,000 Section 162(k) specifically disallows the deductibility of redemption expenditures As such, none of the $13,000 of accounting and legal fees is deductible by Crane pp 6-13, 6-14, and Example 19 53 a Neither Ramon nor Sophie recognizes income upon receipt of the preferred stock It is a nontaxable stock dividend under § 305 However, the stock is classified as § 306 stock The $75,000 basis in their original common shares is reallocated between the preferred stock and the common stock based on the relative fair market value of each The basis is reallocated as follows: © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Redemptions and Liquidations 6-25 Fair market value of common: Fair market value of preferred: 500 × $300 = $150,000 500 × $200 = 100,000 $250,000 Basis of common: 150/250 × $75,000 = $45,000 Basis of preferred: 100/250 × $75,000 = $30,000 b A sale of the preferred stock to Anthony will produce $100,000 of ordinary income, which is the fair market value of the preferred stock on the date of distribution The $100,000 will not be dividend income; thus, the E & P of Gull Corporation will not be reduced as a result of the distribution However, the $100,000 is treated as dividend income for purposes of the 15% preferential tax rate on such income The $30,000 basis of the preferred stock is added back to the basis of the common stock, giving a basis in such stock of $75,000 ($45,000 + $30,000) c In a redemption of § 306 stock, the shareholder recognizes dividend income to the extent of the corporation’s E & P on the date of the redemption Since Gull Corporation has ample E & P, the entire $100,000 of redemption proceeds will be dividend income to Ramon The $30,000 basis in the preferred stock is added back to the basis of Ramon’s common stock, giving a basis in such stock of $75,000 ($45,000 + $30,000) Gull’s E & P is reduced by the $100,000 dividend distribution pp 6-14, 6-15, and Example 20 54 Martin owns 50% or more in both Black Corporation and in Blue Corporation; thus, § 304 applies to the transaction The sale is treated as a redemption of the stock of Black Corporation To determine ownership before and after the redemption, reference is made to Martin’s ownership in Blue Corporation After the sale, Martin continues to own, directly and indirectly, 50% or 500 shares of Blue Corporation: 300 shares directly + 200 shares indirectly from Black [100% × 200 (shares owned by Black)] Martin’s ownership interest was unchanged as a result of the stock sale; thus, none of the qualifying stock redemption provisions are satisfied The $300,000 will be treated as a dividend to the extent of E & P of Black Corporation and then to the extent of E & P of Blue Corporation Thus, there is adequate E & P to cause the entire $300,000 to be taxed as a dividend The $120,000 basis Martin had in the Blue stock sold to Black Corporation attaches to his basis in the Black stock Black Corporation has a basis of $120,000 in its Blue stock pp 6-15 and 6-16 55 a In the case of Dove Corporation, the $140,000 realized loss [$330,000 (fair market value) – $470,000 (land basis)] is not recognized on the nonliquidating distribution of the land under § 311(a) As to Julia, her $20,000 loss realized [$330,000 (fair market value of land) – $350,000 (stock basis)] in the qualifying stock redemption is disallowed under § 267 because Julia and Dove Corporation are related parties Under that provision, Julia is deemed to own the stock of her daughter (Maxine) and her granddaughter (Janine), or 100% of the Dove stock in total Her basis in the land is its fair market value, or $330,000 b The $140,000 loss realized by Dove Corporation on the distribution of the land is again disallowed In this case, the loss is disallowed under the related-party loss limitation Since Julia is deemed to own 100% of the stock of Dove, this is a distribution of loss property to a related party and such distribution is not pro rata As to Julia, her $20,000 loss is recognized Section 267 does not apply in the case of liquidating distributions Her basis in the land is its fair market value, or $330,000 pp 6-4, 6-13, 6-17 to 6-20, 6-23, and Examples 18, 22, and 25 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-26 56 2012 Corporations Volume/Solutions Manual a Oriole Corporation would recognize gain of $110,000 [$420,000 (fair market value) – $310,000 (basis)] Under the general rule of § 336(a), the land is treated as if it were sold for its fair market value Since the land was a capital asset held for more than one year, Oriole has a $110,000 long-term capital gain b Oriole Corporation has a recognized long-term capital gain of $190,000 on the distribution Under § 336(b), when property distributed in a complete liquidation is subject to a liability of the liquidating corporation, the fair market value of that property is treated as not being less than the amount of the liability Thus, the $310,000 adjusted basis in the land is subtracted from the $500,000 liability for a gain of $190,000 Example 23 and Chapter 57 Bronze Corporation may not recognize any of the realized loss of $45,000 [$215,000 (fair market value) – $260,000 (basis in land)] Under § 267, each of the brothers own, directly and indirectly, 100% of the stock of Bronze Further, the land was transferred to the corporation in a § 351 transaction within the five-year period preceding the liquidation Thus, the related-party loss limitation applies to the distribution of the land Since disqualified property was distributed to related parties, is does not matter that the distribution was pro rata Also, the related-party loss limitation can apply to property that is appreciated (fair market value greater than basis) at the time of its transfer to the corporation Example 27 58 Crow Corporation may recognize the entire loss realized on the distribution of the land to Ali, or $150,000 [$150,000 (value on date of distribution) – $300,000 (basis)] (The basis stepdown rule does not apply, as there is no net built-in loss on the § 351 transfer to Crow; thus, Crow will have a basis of $300,000 in the land.) The built-in loss limitation does not apply to the distribution to Ali, as there was a clear business reason for transferring the land to Crow Corporation Further, the related-party loss limitation does not apply, as Ali is not a related party pp 6-18 to 6-22 and Example 32 59 The loss that occurred after the equipment’s acquisition by Grackle Corporation, or $90,000 [$200,000 (selling price) – $290,000 (value on date of acquisition)], is recognized The basis step-down rules of § 362(e)(2) would apply to give Grackle a $290,000 basis in the equipment [$360,000 (transferor shareholder’s basis) – $70,000 (net built-in loss of property transferred)] The equipment was acquired by Grackle in a contribution to capital transaction within years of the adoption of the plan of liquidation and there was no clear business purpose for the acquisition The built-in loss limitation applies to sales of such property pursuant to liquidation However, there is no built-in loss after application of basis step-down rules The related-party loss limitation does not apply to sales pp 6-18 to 6-22 and Example 31 60 a If Pink Corporation distributes all the land to Maria, none of the $160,000 loss realized [$640,000 (fair market value) – $800,000 (basis)] on the distribution will be recognized since Maria is a related party and the land is disqualified property b If all the land is distributed to Paul, Pink Corporation will have a recognized loss of $160,000 The land was valued at more than its basis on the date of the § 351 transfer to Pink; thus, the built-in loss limitation does not apply Because Paul is an unrelated party, the related-party loss limitation does not apply c Even though the distribution is pro rata, the property is disqualified property; thus, the $112,000 loss on the distribution to Maria (i.e., 70% × $160,000), a related party, would be disallowed Of the $160,000 loss, 30% (Paul’s interest), or $48,000, would © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Redemptions and Liquidations 6-27 be allowed For the reasons noted in option b above, the loss limitations not apply to the distribution to Paul d In this case, 50% of the $160,000 realized loss, or $80,000, would be disallowed The property is disqualified property; thus, the loss on the distribution to Maria, a related party, would be disallowed The remaining $80,000 loss will be recognized For the reasons noted in option b above, the loss limitations not apply to the distribution to Paul e Because the property does not have a built-in loss on the date of the transfer to the corporation, the built-in loss limitation does not apply Further, the related-party loss limitation does not apply to a sale of property Upon the sale, Pink Corporation would recognize the entire $160,000 loss Pink Corporation should either distribute the land to Paul (option b.) or sell it and distribute the cash (option e.) pp 6-18 to 6-22 and Figure 6.1 61 a The answer would not change The land is disqualified property that is distributed to a related party; thus, the entire $160,000 loss realized is disallowed under the relatedparty loss limitation b The property had a built-in loss of $100,000 [$700,000 (fair market value) – $800,000 (basis)] when it was transferred to Pink Corporation Further, the transfer occurred within years of the date the plan of liquidation was adopted Unless Pink can rebut the presumption of a tax avoidance purpose for the transfer, the built-in loss of $100,000 is disallowed The remaining $60,000 loss will be recognized Because Paul is an unrelated party, the related-party loss limitation does not apply to a distribution to him If Pink Corporation can establish a business reason for the transfer of the property to the corporation and rebut the 2-year presumption rule, the entire $160,000 loss would be recognized c The loss on the property distributed to Maria, or $112,000, will be disallowed entirely because it is a distribution of disqualified property to a related party Unless Pink Corporation can rebut the presumption of a tax avoidance purpose for the transfer, an additional $30,000 of the loss [$100,000 (built-in loss) × 30% (Paul’s interest)] will be disallowed As a result, $18,000 of the loss will be recognized [$60,000 (post-transfer loss) × 30% (Paul’s interest)] If Pink Corporation can rebut the 2-year presumption rule, $48,000 of loss would be recognized [$160,000 (total loss) × 30% (Paul’s interest)] d The loss on the distribution of disqualified property to Maria, or $80,000, will be disallowed Of the remaining $80,000 loss, 50% of the built-in loss of $100,000, or $50,000, will be disallowed unless Pink Corporation can demonstrate a business purpose for the transfer If Pink can rebut the 2-year presumption rule, $80,000 of the loss, or the portion pertaining to the distribution to Paul, would be recognized e If Pink Corporation cannot show a business purpose for the transfer, the built-in loss of $100,000 would be disallowed The remaining $60,000 loss would be recognized If Pink can rebut the 2-year presumption rule, the entire $160,000 loss would be recognized The related-party loss limitation does not apply to a sale of property Pink Corporation should either distribute the land to Paul (option b.) or sell it and distribute the proceeds (option e.) © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-28 2012 Corporations Volume/Solutions Manual Note: The basis step-down rule does not apply, as there is no net built-in loss on the § 351 transfer; thus, Pink will have a basis of $800,000 in the land pp 6-18 to 6-22 and Figure 6.1 62 Oriole Corporation will recognize a long-term capital gain of $255,000 [$480,000 (fair market value) – $225,000 (basis)] on the liquidating distribution of land Samantha will recognize a long-term capital gain of $240,000 [$330,000 (fair market value of land less liability) – $90,000 (basis of stock)] pp 6-18 and 6-23 63 The tax results of these transactions to Helen are as follows: • Helen may defer gain on the receipt of the notes to the point of collection under the installment method • Helen must allocate her $80,000 basis in the Purple Corporation stock between the cash and the installment notes Using the relative fair market value approach, 25% [$200,000 (amount of cash) ÷ $800,000 (total distribution)] of $80,000 (basis in the stock), or $20,000, is allocated to the cash, and 75% [$600,000 (FMV of the notes) ÷ $800,000 (total distribution)] of $80,000 (basis in the stock), or $60,000, is allocated to the notes • Helen must recognize $180,000 [$200,000 (cash received) – $20,000 (basis allocated to the cash)] in the year of the liquidation • Since Helen’s gross profit on the notes is $540,000 [$600,000 (FMV of notes) – $60,000 (basis allocated to the notes)], the gross profit percentage is 90% [$540,000 (gross profit) ÷ $600,000 (FMV of notes)] Thus, Helen must report a gain of $108,000 [$120,000 (amount of annual payment) × 90% (gross profit percentage)] on the collection of each note over the next five years • The interest element is accounted for separately Example 34 64 Magenta does not recognize the loss on the distribution of assets to Fuchsia, its parent corporation However, the $15,000 gain realized [$180,000 (fair market value) – $165,000 (basis)] on the land distribution to Marta, a minority shareholder, is recognized Fuchsia recognizes no gain or loss in the liquidation, and it has a carryover basis of $1,950,000 in the assets received Magenta’s tax attributes (e.g., E & P) also carry over to Fuchsia Fuchsia’s basis in the Magenta stock disappears Marta recognizes a $145,000 gain [$180,000 (amount realized) – $35,000 (basis of stock)] in the liquidation, and she has a basis in the land of $180,000 pp 6-24 to 6-27 and Concept Summary 6.2 65 a Section 332 applies to the liquidation and Ivory Corporation (subsidiary) recognizes no gain (or loss) on the distribution of the cash and inventory to Gold Corporation (parent) In liquidations otherwise governed by § 332, a subsidiary corporation recognizes gain but not loss on distributions to a minority shareholder; thus, Ivory does not recognize the $150,000 loss realized on the distribution of the equipment to Imelda (minority shareholder) Gold Corporation recognizes no gain or loss on the liquidation and takes a basis of $80,000 in the inventory Gold’s basis in its Ivory Corporation stock is eliminated Imelda recognizes a gain of $25,000 ($200,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Redemptions and Liquidations 6-29 amount realized – $175,000 basis in stock), and she has a basis of $200,000 in the equipment b Again, Section 332 applies and Ivory recognizes no gain or loss on the distribution of the cash and equipment to Gold Corporation However, Ivory Corporation does recognize the gain of $120,000 ($200,000 fair market value – $80,000 basis) on the distribution of the inventory to Imelda Gold Corporation recognizes no gain or loss on the liquidation and takes a basis of $350,000 in the equipment Gold’s basis in its Ivory Corporation stock is eliminated Imelda recognizes a gain of $25,000 ($200,000 amount realized – $175,000 basis in stock), and she has a basis of $200,000 in the inventory Examples 35 and 38 66 Green Corporation recognizes no loss on the transfer of the land to satisfy its indebtedness to Orange Corporation Transfers by a subsidiary corporation pursuant to a § 332 liquidation are subject to the nonrecognition rules of § 337 Orange Corporation, however, will recognize a gain of $15,000 [$200,000 (fair market value of the land) – $185,000 (basis in the bonds)] pp 6-24 to 6-26 and Examples 36 and 37 67 a Cardinal Corporation recognizes no gain (or loss) on its liquidation under § 337 b Wren Corporation recognizes no gain (or loss) on the liquidation under § 332 c Wren Corporation takes a carryover basis in the assets, or $250,000 for the marketable securities and $300,000 for the unimproved land Wren’s basis in the Cardinal stock disappears d Wren Corporation acquires Cardinal Corporation’s E & P of $560,000 and net operating loss carryover of $45,000 under § 381 pp 6-24 to 6-27 and Chapter 68 As a result of the § 338 election, Aqua Corporation is treated as having sold all of its assets on August 9, 2011, the qualified stock purchase date, for an amount equal to the aggregate deemed sale price of $1.2 million This deemed sale results in a recognized gain to Aqua equal to $500,000 [$1.2 million (aggregate deemed sale price) – $700,000 (basis in assets)] Aqua is then treated as a new corporation that purchased those assets for an amount equal to the adjusted grossed-up basis of $1.2 million The § 338 election has no tax consequences for Egret Corporation The liquidation of Aqua Corporation qualifies under § 332; thus, neither Aqua [§ 337(a)] nor Egret [§ 332(a)] will recognize gain or loss Egret Corporation will take a basis in Aqua’s assets equal to Aqua’s (stepped-up) basis of $1.2 million, and the basis in its Aqua stock disappears Egret’s holding period in the assets acquired begins on August 9, 2011 The liquidation also results in a carryover of Aqua’s tax attributes (e.g., E & P) to Egret, but the amount of such attributes should be zero given the deemed reincorporation and subsequent liquidation of Aqua pp 6-27 and 6-28 The answers to the Research Problems are incorporated into the Instructor’s Guide with Lecture Notes to accompany the 2012 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION: CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-30 2012 Corporations Volume/Solutions Manual NOTES © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ... http://downloadslide.blogspot.com 6-18 2012 Corporations Volume/Solutions Manual d The tax consequences to Teal Corporation would be the same as in option a Grace Corporation would have a capital gain... part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-30 2012 Corporations Volume/Solutions Manual NOTES © 2012 Cengage Learning All Rights Reserved...To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 6-2 2012 Corporations Volume/Solutions Manual Question/ Learning Problem Objective