Question 1: X has 10 shareholders, each of whom owns 100 of its 1,000 outstanding shares of common stock (worth $100 per share). No other stock is outstanding. Find out whether the securities explained in the situations below are best characterized as debt or equity of X (support your answer with citations as essential).
a) X issues to the public for cash $1 million worth of “pure preferred” stock (nonvoting, nonparticipating, nonconvertible), callable in five years at par, paying a 12% cumulative dividend.
b) In return for a transfer of $1,250,000 cash, X issues an unsecured promissory note for $1,250,000 to Mr. Pang, a well-known local venture capitalist, payable in 6 years with interest keyed to X’s profitability. The note is subordinated to all other debt. X could not have borrowed this amount on these terms from a bank.
c) X issues to the public 1,000 notes for $1,000 each, maturing in 20 years, at which time the holder will be entitled to elect to receive either $600 cash or 50 shares of X common stock. Interest will be paid quarterly in an amount based on X’s common dividend, but not less than $60 per annum. The interest rate for nonconvertible unsubordinated debt in the market is 12%. The notes will be subordinated to all other debt.
Question 2: L has business assets worth $6,000,000, NOL carryovers of $1,000,000 expiring in 14 years, and NOL carryovers of $1,400,000 expiring in 15 years. 100% of L’s stock is worth $8,000,000. The long-term tax exempt rate is 5%. The current third party market interest rate is 6%. Commercial bank mortgage rates are 3%.
a) What will the § 382 limitation be if an ownership change occurs with respect to L’s stock? Assuming sufficient taxable income, how long will it take to fully utilize the NOLs?
b) Same questions and facts as (a) above, except L has minimal assets and 100% of its stock is worth $2,000,000.
Question 3: A owns all of the stock of X with a basis of $200. A’s three sons own all of the stock of Y equally. X and Y each have 100 shares of common stock outstanding (worth $4 each) and E&P of $100, respectively. A sells one half of the X stock to Y for $200.
a) What is the amount and character of income or loss to A on this transaction?
No because it only applies to redemptions. 318 test IRC 302(a) does not qualify under family attribution.
b) Would your answer change if X, rather than A’s three sons, owned all of the stock of Y? Why or why not?
Question 4: All of the outstanding stock of X corporation is owned by Abby (30 shares, $30,000 basis), Bennett (30 shares, $30,000 basis), and Candice (40 shares, $40,000 basis), who are unrelated. X has an earnings and profits deficit for the current year of $10,000 and accumulated earnings and profits (excluding the current year deficit) of $220,000. X plans to completely liquidate in the current year.
a) What are the tax consequences to Abby if X distributes a piece of equipment used in X’s business with a fair market value of $25,000 to Abby in exchange for her stock as part of the complete liquidation of X. (Assume X will also make similar distributions to Bennett and Candice).
b) What are the tax consequences to X of the distribution to Abby? X’s basis in the equipment was $36,000. X bought the equipment new six years ago.