ACC 570

CH 19 HOMEWORK SOLUTIONS PART A – CORPORATE DISTRIBUTIONS

33. Jade Corporation’s current EP is computed as follows:

Taxable income $330,000

Federal income tax liability (112,000)

Interest income from tax-exempts 5,000

Disallowed portion of meals and entertainment expenses (1,500)

Life insurance premiums paid, net of increase in

cash surrender value ($3,500 – $700) (2,800)

Proceeds from life insurance policy, net of cash

surrender value ($130,000 – $20,000) 110,000

Excess capital losses (13,000)

Excess of MACRS depreciation over EP

depreciation ($26,000 – $16,000) 10,000

Allowable portion of 2007 § 179

expenses (20% ´ $100,000) (20,000)

Organizational expense amortization 600*

Dividends received deduction (70% ´ $25,000) 17,500

LIFO recapture adjustment 10,000

Installment sale gain (3,000)**

Current EP $331,133

*[($9,000 organizational expenses balance after deducting $5,000 in 2009 / 180 months amortization period) ´ 12 months in 2010]

**{[($40,000 sales price – $32,000 adjusted basis)/$40,000 sales price] ´ $15,000}


34. Taxable Income E & P Increase

Increase (Decrease) (Decrease)

a. $20,000 No effect

b. ($36,000) $33,900*

c. No effect $140,000

d. $9,000 $21,000**

e. ($60,000) $60,000

f. ($60,000) $48,000***

g. No effect ($12,000)†

h. ($90,000) ($10,000)††

i. No effect ($50,000)

*Although mining exploration costs are deductible in full under the income tax, they are amortized over 120 months when computing EP. Since $300 per month is amortizable ($36,000/120 months), $2,100 is currently deductible for EP purposes ($300 × 7 months). Thus, of the $36,000 income tax deduction, $33,900 is added back to EP ($36,000 – $2,100 deduction allowed).

**The receipt of a $30,000 dividend generates a dividends received deduction of $21,000 with a net effect on taxable income of a $9,000 increase. For EP purposes, the dividends received deduction is added back.

***Only 20% of current-year §179 expense is allowed for EP purposes. Thus, 80% of the amount deducted for income tax purposes is added back.

†In each of the four succeeding years, 20% of the §179 expense is allowed as a deduction for EP purposes.

††ADS straight-line depreciation is allowed for EP purposes; thus, EP is decreased by $10,000 (the excess of ADS depreciation over the amount allowed under MACRS).


36. Amount Return of

Taxable Capital

a. $ 70,000 $60,000 Taxed to the extent of current EP.

b. $140,000 $70,000 Accumulated EP and current EP netted on the date of distribution.

c. $150,000 $ -0- Taxed to the extent of current and accumulated E & P.

d. $ 80,000 $50,000 Accumulated EP and current EP are netted on the date of distribution. There is a dividend to the extent of any positive balance.

e. $100,000 $30,000 When the result in current EP is a deficit for the year, the deficit is allocated on a pro rata basis to distributions made during the year. On June 30, EP is $100,000 [current EP is a deficit of $20,000 (i.e., 1/2 of $40,000) netted with accumulated EP of $120,000].

43. Sandpiper owns 25% of Owl. Owl distributes land (FMV=50; basis=80), subject to 40k debt.

a. Sandpiper Corporation has dividend income of $10,000 [$50,000 (fair market value of the land) – $40,000 (liability on the land)]. The $10,000 dividend creates an $8,000 dividends received deduction under §243. Consequently, only $2,000 of the dividend is subject to tax. Sandpiper Corporation has a basis of $50,000 in the land.

b. Owl Corporation may not deduct the loss on the land. Its EP is reduced by $40,000 [the $80,000 basis of the land (which is greater than the fair market value) – the $40,000 liability on the land]. Balance is now $120,000.


47. Of 1,000 shares in Cardinal, Hubert owns 300; father owns 100; uncle owns 100. Redbird Corp. owns 400 & Hubert owns 80% of Redbird.

H (300) HF (100) HU (100)

80%

Redbird (400)

Yellow Pship Cardinal (1,000 total shares)

a. Hubert owns 720 shares, 300 shares directly and 420 shares indirectly, in Cardinal Corporation. Hubert constructively owns the stock of his father (100 shares) and 80% of the 400 shares, or 320 shares, owned by Redbird Corporation. Ancestors other than parents are not related parties under § 318; thus, Hubert is not deemed to own the shares of the uncle.

b. The stock attribution rules do not apply to the stock held by a corporation if the shareholder owns less than 50% of the stock in the corporation. Thus, Hubert would only own 400 shares, 300 shares directly and 100 shares owned by his father.

c. Hubert would now own 750 shares in Cardinal, the 720 shares as computed in part a., above, plus 30 shares as a result of his 30% interest in Yellow Partnership [100 (shares owned by Yellow Partnership) × 30% (Hubert’s interest in Yellow)].

48. Shawn owns 200 of 1,000 sh. in Hawk & 70% of Vulture; Vulture owns 600 shares of Hawk. Hawk Corp. redeems 100 shares for $125,000 (basis in his shares is $150 each). Hawk’s E&P is $700,000.

·  $125,000 dividend income.

Before the redemption: 620 (200 + 70%[600]) of 1,000 shares (62%);

After the redemption, 520 of 900 shares (57.8%)

50% test failed.

80% test failed (57.8% > 80%[62%]).

·  The basis in the 100 shares redeemed ($15,000) attaches to Sheldon’s basis in the Hawk Corporation stock he still owns. Result is $30,000 basis in his 100 remaining shares.

·  Since the redemption is treated as an ordinary dividend distribution, Hawk’s EP is reduced to $575,000 ($700,000 – $125,000).

49. Lana owns 400 of 1,000 shares of Stork ($200 per share basis). Mother owns 200 shares; Grandfather owns 400 shares. Wants to redeem @ $1,000 per share. Minimum number to qualify as a redemption (sale)?

·  Ownership before redemption: 60% (400 direct + 200 mom / 1,000 total)

·  Maximum ownership after redemption:

o  < 50% total &

o  < 80% of her preredemption % (i.e., < 48%)

· 

·  Minimum redemption is 231 shares

o  (600 – x ) / (1,000 – x) = .48

o  X = 231

· 

·  After the redemption, your ownership interest of 47.98% [369 shares (169 shares direct + mom’s 200 shares) ÷ 769 shares

·  Results

o  LTCG of $184,800 [$231,000 (redemption proceeds) – $46,200 (basis)].

o  Reduction of Stork Corporation’s E & P of $207,900 [$900,000 (E & P preredemption) × 23.1% (percentage of shares outstanding represented by shares redeemed)].

50. Thrush has 3,000 shares. Ownership is: John = 1,300; father = 1,000; sister = 700.

Thrush redeems all of John’s 1,300 shares.

Tests:

Before: John has constructive ownership of 77% (2,300 of 3,000 shares)

After: John has constructive ownership of 59% (1,000 of 1,700 shares)

Numerical tests for disproportionate distribution failed (50% & 80%).

a. The redemption cannot qualify as a complete termination redemption. The family attribution waiver does not apply because John did not file the required notification agreement with his tax return in the redemption year.

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.

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.