Question: 1. List the four basic adjustments that a corporation makes to taxable income or net loss to compute current E&P. What is the rationale for making these adjustments?
2. Amy is the sole shareholder of a corporation. Rather than have the corporation pay her a dividend, Amy decides to have the corporation declare a "bonus" at year-end and pay her tax-deductible compensation. How does this effect Amy's taxes and the corporation's taxes?
3. Why would a corporation issue a stock dividend to its shareholders instead of a cash dividend?
4. What effect does a nontaxable stock dividend create for a shareholder?
5. What would cause a stock dividend to be taxable to the recipient?
6. What stock ownership tests must be met before a shareholder receives exchange treatment under the substantially disproportionate change-in-stock-ownership test in a stock redemption? Why is a change in stock ownership test used to determine the tax status of a stock redemption?
7. What are the criteria to meet the "not essentially equivalent to a dividend" change-in-stock-ownership test in a stock redemption?
8. Which members of a family are included in the family attribution rules? Is there any rationale for the family members included in the test?
9. Is there anything a shareholder can do to waive the family attribution rules in a complete redemption of stock?
10. Does a corporation's computation of earnings and profits resulting from a distribution differ based on the tax treatment of a stock redemption to the shareholder (that is, as either a dividend or exchange)?
11. Nittany Company pays its sole shareholder, Tammy Lion, a salary of $100,000. At the end of each year, the company pays Tammy a "bonus" equal to the difference between the corporation's taxable income for the year (before the bonus) and $75,000. In this way, the company hopes to keep its taxable income at amounts that are taxed at either 15 percent or 25 percent. This year Nittany reported pre-bonus taxable income of $675,000 and paid Tammy a bonus of $600,000. On audit, the IRS determined that individuals working in Tammy's position earned on average $300,000 per year. The company had no formal compensation policy and never paid a dividend.
a. How much of Tammy's bonus might the IRS recharacterize as a dividend?
b. What arguments might Tammy make to counter this assertion?
c. Assuming the IRS recharacterizes $200,000 of Tammy's bonus as a dividend, what additional income tax liability does Nittany Company face?
12. Hoosier Corporation declared a 2-for-1 stock split to all shareholders of record on March 25 of this year. Hoosier reported current E&P of $600,000 and accumulated E&P of $3,000,000. The total fair market value of the stock distributed was $1,500,000. Barbara Bloomington owned 1,000 shares of Hoosier stock with a tax basis of $100 per share.
a.What amount of taxable dividend income, if any, does Barbara recognize this year? Assume the fair market value of the stock was $150 per share on March 25 of this year.
b.What is Barbara's income tax basis in the new and existing stock she owns in Hoosier Corporation, assuming the distribution is tax-free?
c.How does the stock dividend affect Hoosier's accumulated E&P at the beginning of next year?
13. Badger Corporation declared a stock dividend to all shareholders of record on March 25 of this year. Shareholders will receive one share of Badger stock for each ten shares of stock they already own. Madison Cheeseman owns 1,000 shares of Badger stock with a tax basis of $100 per share. The fair market value of the Badger stock was $110 per share on March 25 of this year.
a. What amount of taxable dividend income, if any, does Madison recognize this year?
b. What is Madison's income tax basis in her new and existing stock in Badger Corporation, assuming the distribution is non-taxable?
c. How would you answer parts (a) and (b) if Madison was offered the choice between 1 share of stock in Badger for each 10 shares she owned or $100 cash for each 10 shares she owned in Badger?
14. Wildcat Company is owned equally by Evan Stone and his sister Sara, each of whom held 1,000 shares in the company. Sara wants to reduce her ownership in the company, and it was decided that the company will redeem 500 of her shares for $25,000 per share on December 31 of this year. Sara's income tax basis in each share is $5,000. Wildcat has current E&P of $10,000,000 and accumulated E&P of $50,000,000.
a. What is the amount and character (capital gain or dividend) recognized by Sara as a result of the stock redemption?
b. What is Sara's income tax basis in the remaining 500 shares she owns in the company?
c. Assuming the company did not make any dividend distributions during this year, by what amount does Wildcat reduce its E&P as a result of the redemption? .
15. Flintstone Company is owned equally by Fred Stone and his sister Wilma, each of whom hold 1,000 shares in the company. Wilma wants to reduce her ownership in the company, and it was decided that the company will redeem 250 of her shares for $25,000 per share on December 31 of this year. Wilma's income tax basis in each share is $5,000. Flintstone has current E&P of $10,000,000 and accumulated E&P of $50,000,000.
a. What is the amount and character (capital gain or dividend) recognized by Wilma as a result of the stock redemption, assuming only the "substantially disproportionate with respect to the shareholder" test is applied?
b. Given your answer to question a, what is Wilma's income tax basis in the remaining 750 shares she owns in the company?
c. Assuming the company did not make any dividend distributions this year, by what amount does Flintstone reduce its E&P as a result of the redemption?
d. What other argument might Wilma make to treat the redemption as an exchange?
16. Acme Corporation has 1,000 shares outstanding. Joan and Bill are married, and they each own 20 shares of Acme. Joan's daughter, Shirley also owns 20 shares of Acme. Joan is an equal partner with Jeri in the J&J partnership, and this partnership owns 60 shares of Acme. Jeri is not related to Joan or Bill. How many shares of Acme is Shirley deemed to own under the stock attribution rules?
17. Bedrock, Inc. is owned equally by Barney Rubble and his wife Betty, each of whom held 1,000 shares in the company. Betty wants to reduce her ownership in the company, and it was decided that the company will redeem 500 of her shares for $25,000 per share on December 31 of this year. Betty's income tax basis in each share is $5,000. Bedrock has current E&P of $10,000,000 and accumulated E&P of $50,000,000.
a. What is the amount and character (capital gain or dividend) recognized by Betty as a result of the stock redemption, assuming only the "substantially disproportionate with respect to the shareholder" test is applied?
b. Given your answer to part a, what is Betty's income tax basis in the remaining 500 shares she owns in the company?
c. Assuming the company did not make any dividend distributions this year, by what amount does Bedrock reduce its E&P as a result of the redemption?
d. Can Betty argue that the redemption is "not essentially equivalent to a dividend" and should be treated as an exchange?
18. Assume in the previous problem that Betty and Barney are not getting along and have separated due to marital discord (although they are not legally separated). In fact, they cannot even stand to talk to each other anymore and communicate only through their accountant. Betty wants to argue that she should not be treated as owning any of Barney's stock in Bedrock because of their hostility towards each other. Can family hostility be used as an argument to void the family attribution rules?
Consult Rev. Rul. 80-26, 1980-1 C.B. 66, Robin Haft Trust v. Comm., 510 F.2d 43 (CA-1 1975), Metzger Trust v. Comm., 693 F.2d 459 (CA-5 1982, and Cerone v. Comm., 87 TC 1 (1986).