(1) A owns all of the stock of X. The stock’s basis is $100. X has
a total of current and accumulated earnings and profits of $50. X distributes
$200 cash to A “with respect to his stock” (i.e. as a state law “dividend”). How
is the $200 taxed? What is A’s stock basis after the distribution? Alternatively,
X distributes to A A’s note to X for $200 borrowed from X.
Assumptions: The stock of X is owned equally by two shareholders:
Y (a corporation) and A (an individual). X and Y use the accrual method, A uses
the cash method, and all use a calendar taxable years. Assume section 1059 does
not apply. Use a 34 percent corporate tax rate in this problem. During the
current year, X accrued income and expenses as follows:
gross income from business
500
dividends on AT&T stock(consider section 243)
100
interest on municipal bonds(section 103)
100
capital gain
100
total
800
deductible section 162(a)(1) business expenses
430
Noncapital expenses not deductible under section 162€
90
capital losses(see section 1211(a))
146
total
666
net
134
(2) On December 24 of the preceding year, Y and A
incorporated X and capitalized X with cash of $100 each. On December 31 of that
preceding year, Y and A received distributions from X of $5 each; X did not
earn any income for that year. In addition, Y and A received distributions of
$5 each, in the current year. Which distributions should be gross income to
Y and A, in what amounts, and why? What does E&P have to do with this?
Alternative: A just bought the X shares on December 30 of
the current year from another shareholder for FMV of $145, before the
declaration and payment of a $5 distribution to A on December 31 of the current
year. Should the distribution be taxable income to A? Why?
(3) Now assume that Y’s basis in its X stock is $100 and A’s
basis in his X stock is $40. On January 2 of the current taxable year, X
distributes $100 in cash to Y and $100 in cash to A. As of the end of the
preceding taxable year, X’s accumulated E&P was zero. What are the tax
consequences of this distribution to X, Y, and A? [Hint: First compute X’s
current-year taxable income and then compute current-year E&P before
reducing the E&P for the distribution (“interim E&P”); after reducing
for the distribution, compute final accumulated E&P.]
Variation: How much dividend would Y and the holders of
A’s shares receive if A’s shares were owned by a different shareholder every
quarter and $50 was distributed ratably to all shareholders quarterly?
(4) Suppose under the basic facts in (3) above that X had
an accumulated deficit of $100 in its E&P account as of December 31 of the preceding taxable year.
(5) How would your answer to (3) above change if, on
December 1 of the current year (the declaration date), X’s board of directors
voted to pay the $200 distribution by mailing the checks on December 31 of the
current taxable year (the payment date, the identification of which is a
practice generally used only by widely held corporations) to shareholders of
record on December 15 of the current taxable year (the record date), such
checks actually being received by Y and A in the mail on January 2 of the next
year? Assume that Y and A are the public and that they are the only
shareholders (as in the basic facts).
(6) Who recognizes how much income and of what kind in
(5) above if A sells his X stock C for $540 (assume FMV) on December 10 of the
current taxable year?
Alternative: What if Y sells its stock to Z on December
20 for $440?
(7) A owns all of the stock of X, with a basis of $1
million. X owns $1 million cash and a hotel. X has $1 million of E&P. B wants to buy the stock of X for $5M
after X has distributed the cash, but will pay $6 million for the stock without
a prior distribution to A. What should A want, and why?
(8) Change (7)
so that the owner of X is not A but another corporation, Y. What should Y want,
and why?
(9) Suppose that Y is an individual and that X has always
been an S corporation. What is X’s E&P? How is each shareholder’s personal
income tax return affected for the current year by the tax items of X? How will
X’distribution of $100 to each shareholder in the current year affect
shareholders?
Alternative: X has E&P of $100 from years before
it was an S corporation and nothing in its accumulated adjustments account from
prior S years. The $100 capital gain is from the sale of stock held for
investment, and the $500 gross income from business is also gross receipts from
business.
(10) Assumption for problems (1) through (10): A owns half
the common stock of X with an adjusted basis of $40, and Y owns the other half
of the X common stock with an adjusted basis of $100. X’s current E&P from
current-year income and expenses/losses(before consideration of the events
described in (1) though (10) below) is $94, and X has no accumulated E&P. X
uses accrual method, all taxpayers are on the calendar year, and section 1059
does not apply. Assume that the corporate tax rate is 34 percent. [Hint: First
derive an “interim” E&P based on the events described in each problem, but
not including the downward adjustment for the distribution itself.]
(1) X distributes, in
kind, its long-held AT&T stock with an adjusted basis of $40 and FMV of
$100 to Y; X also distributes other long-held AT&T shares with an adjusted
basis of $60 and FMV of $100 to A. What are the results to A, Y, and X? Alternative: The basis of the stock distributed
to A is $120
(2) Suppose that each block of AT&T stock in the basic
facts of (1) above was subject to a $50 non-recourse liability or,
alternatively, a $120 non-recourse liability.
(3) Suppose that the distributed properties were §453 “installment
obligations” of C
(4) Assume for this problem that beginning E&P is $100, rather
than $94. X issues and distributes two negotiable notes payable by X to A and Y
(each note having a face amount and “stated principal amount” and “stated
redemption price at maturity” of $120 and FMV of $100). What would result
now, during the terms of the notes, and upon collection? First, ignore OID,
market discount, and the time-value-of-money rules generally.
(5) X leases some rental property that it owns to T, and
T agrees to pay the annual rent of $60 directly to X’s shareholders, A and Y.
(6) X sells an apartment building that it owns to A and Y
jointly for $100. The property has a basis of $100 and a value of $200.
Alternative: A and Y paid $300 for the property.
(7) X transfers property (a capital asset) with a basis
of $20 and a value of $100 to A as “salary” (Hint: See Fender Sales).
Alternative: X paid A’s “salary” with its preferred stock (worth $100).
(8) A is the sole shareholder of X, which advanced cash to A
from time to time over a period of years upon an open account maintained on the
corporate ledger as “A/R shdr.” The amount now totals $100,000, including
interest at 6 percent, which the bookkeeper has accrued annually. No repayments
have been made. Are there any tax consequences to A or X?
(9) Answer(1) above assuming that X has always been an S
corporation (which means Y is an individual and X has no E&P) and has no other
income or deduction item for the current year. Would you answer change if this
were X’s first year as an S corporation year and X had $100 E&P from prior
years as a C corporation?
(10) Continuing
with the basic facts in (9) above, the next year, X has non-separately computed
loss from operations of $100, no other tax item, and zero net worth when X
borrows $100 from bank upon the strength of A’s personal guaranty.
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