Chapter 4

Question 1

What are the 4 types of corporate distributions

Answer 1

1. Complete liquidation of corporation (§§331/336 or §§332/337)
2. Redemption of a shareholder’s stock (corporation remains in existence) (§§302/303/304)
3. Distribution of corporation’s stock to shareholder(s) (§§305/306/307)
4. Dividend distributions (§301)
5. Distribution taxable as a dividend to extent of current and/or accumulated Earnings & Profits
6. Return of capital (basis)
7. Capital gain (once all basis is recovered)

Question 2

What are the percentages of ownership and their applicable dividend received deduction?

Answer 2

• 0-19% gets a 70% deduction
• 20-79% gets 80%
• 80-100% gets 100%

Question 3

What is the pecking order of dividend distributions?

Answer 3

1. Current earnings & profits
2. Accumulated earnings & profits
3. Return of basis
4. Capital gain

Question 4

What are the two methods to calculate E&P, and what are their steps?

Answer 4

Two methods to calculate E&P

1. Income statement approach
   
   1. Start with taxable income for each year from 1913 forward
   2. Adjust each year’s taxable income for the items listed in §312 (see next slide)
   3. Reduce each year’s E&P amount by any taxable dividends paid
   4. Sum up each year’s E&P to calculate total accumulated E&P
2. Balance sheet approach
   
   1. Start with ending balance sheet from prior year
   2. Adjust each balance for cumulative §312 adjustments
   3. Ending equity after reducing for capital stock, paid-in-capital etc. equals accumulated E&P

Question 5

What are the 8 E&P adjustments?

Answer 5

1. Installment sale method not used for E&P
2. Complete contract method not used for E&P – Percentage completion method used
3. Tax exempt income is included in E&P
4. §199 deduction does not reduce E&P
5. Non-deductible expenses are deductible in calculating E&P
6. Non-deductible taxes reduce E&P
7. MACRS depreciation is not used for E&P purposes – the straight-line method over the ADS life is used in calculating the E&P calculation
8. Intangible drilling costs (IDC) are amortized over 60 months for E&P purposes rather than being deducted currently

Question 6

What are the 2 factors involving allocating E&P among multiple distributions in a single year?

Answer 6

1. Current E&P is allocated among ALL distributions on a pro-rata basis (must wait until the corporate year-end to determine the current E&P for the year)
2. Accumulated E&P is allocated to distributions on a chronological order

Note that E&P is a corporate account. No separate E&P accounts exist for each shareholder. As such, it is possible for a new shareholder to receive a distribution of E&P earned by the corporation before the shareholder purchased his/her/its shares

Question 7

What are the considerations of qualified dividends and the 15% solution

Answer 7

Qualified Dividends and the 15% Solution

1. The double tax (tax at corporate and shareholder levels) has been criticized as being overly burdensome
2. In 2003, steps were taken to reduce the burden in the form of a 15% rate for qualified dividends
3. Qualified dividends are subject to the LTCG rate of 15% (at least through the end of this year – 2012)
4. Nearly all dividends out of a domestic C corporation are treated as qualified dividends
5. Generally, dividends out of foreign corporations are not treated as qualified dividends
6. Dividends out of mutual funds are generally not treated as qualified dividends since favorable tax rules allow mutual funds to escape taxation (hence, no double taxation)

Question 8

What are the shareholder and corporate consequences of distributions of property other than cash?

Answer 8

1. Shareholder Consequences:
   
   1. Treated as a distribution to the extent of the property’s FMV (less any liability assumed by the shareholder)
   2. Shareholder’s basis in the property distributed is its FMV (not reduced by the liability assumed by the shareholder)
2. Corporate Consequences:
   
   1. §311(b) taxes the corporation on the spread between the property’s FMV and its basis (only applies to gains – losses not recognized)
   2. Distribution of loss property will permanently eliminate the property’s loss

Question 9

What is the impact on corporate E&P of distributions of property other than cash?

Answer 9

Impact on Corporate E&P

• §311(b) gain will increase Current E&P
• Tax on the §311(b) gain will reduce Current E&P
• Distribution of the appreciated property will reduce Current and potentially Accumulated E&P by its basis adjusted for the §311(b) gain (in other words, the property’s FMV if the asset had a built-in gain prior to distribution)
• Distribution of built-in loss property will reduce the corporation’s E&P by the property’s basis (even though greater than the property’s FMV)

Question 10

What are the effects of a distribution of a corp’s own obligations?

Answer 10

1. “Dividend” distributions of the corporation’s debt obligations are taxed as follows:
2. The shareholder picks up dividend income equal to the FMV of the debt obligation assuming sufficient current and/or accumulated E&P
3. The shareholder has a basis equal to the FMV of the debt obligation
4. For the corporation, one could argue that the corporation will recognize a §311(b) gain equal to the value of the debt obligation since the corporation does NOT have a basis in its own debt obligation. Fortunately, there is an exception to §311(b) which excludes this transaction from the §311(b) gain!!
5. The corporation’s E&P is reduced by the principal amount of the debt obligation (even though it has no basis)
6. Ultimately, the corporation’s payment(s) retiring the debt obligation will NOT reduce E&P a second time

Question 11

What are the facts, issues, and holding of the Tanner case?

Answer 11

Disguised and Constructive Dividends
Tanner v. Commissioner
Facts:

1. Petitioners (Tanner) were minority shareholders in Tanner Motors – a Volvo dealership in Phoenix, Arizona
2. The corporation’s policy was each year to provide corporate officer with the use of a new Volvo – title and ownership of the vehicles remaining in the corporation’s name
3. Tanner did not reimburse the corporation for the personal use of the Volvos
4. The cost to the corporation of providing the use of these vehicles amounted to approximately $500/year/vehicle
5. Under audit, the IRS asserted that Tanner must pick up the FMV for the usage of the Volvos as a constructive dividend from the corporation (as though the corporation paid a cash dividend in this amount and the shareholder paid the corporation an equal amount for the use of the Volvo during the year)

Issue:
Was there a constructive dividend to the Tanner for personal use of the car?

Holding:
Yes, there was a constructive dividend

Question 12

What are the facts and issues of the Honigman case?

Answer 12

Honigman v. Commissioner
Facts:

1. The National Building Corporation (National) was incorporated in 1946
2. Honigman and his family owned a 35% interest in National
3. In early 1963, steps were taken to completely liquidate National
4. Among the assets of National, the only “loser” was the Pantlind Hotel.
5. National was aware that it should sell the Pantlind Hotel prior to adopting a plan of liquidation in order to recognize the loss on the hotel
6. During this period, the hotel was offered for sale in the market for amounts ranging from $200,000 to $250,000 over the mortgage balance of $590,000. At this price, the hotel did not sell
7. Honigman offered to buy the hotel for $50,000 in excess of the mortgage balance (note that the hotel was never offered in the market for this value)
8. On 05/27/63, the hotel was sold to Honigman for $661,000. At this time, National’s basis in the hotel amounted to $1,486,000
9. The Honigmans did not report any income on their tax return related to the bargain purchase
10. National claimed a loss on its return equal to the difference between the $661,000 sales price and the $1,486,000 of basis or a total loss of $825,000
11. The IRS argued that the hotel when sold to Honigmans was worth $1,300,000 and asserted that a constructive dividend had been received by the Honigmans
12. The IRS also disallowed the loss recognized by National
13. The tax court (the underlying court) determined that the value of the hotel was $830,000 and created a constructive dividend to Honigmans. National’s loss was not adjusted
14. The court of appeals accepted the tax court’s valuation of $830,000

Issues:

1. Given that Honigman purchased the hotel for a value less than its FMV (a bargain purchase), was their a constructive or disguised dividend to Honigman
2. Does National get a loss equal to the difference between the amount paid by Honigman and the gross adjusted basis?

Holding:
Sale Dividend Total
FMV $ 661,000 $169,000 $ 830,000
Basis 1,183,429 302,571 1,486,000
Loss $ 522,429 $133,571 $ 656,000
Deductible Not
Loss Deductible

Question 13

What are the facts and issues of the Litton case?

Answer 13

Chapter 04-08
Distinguishing Dividends from Sales
Litton Industries, Inc. v. Commissioner
Facts:

1. On 10/04/67, Litton acquired all the outstanding stock of Stouffer Corp.
2. In 1972, Litton explored the possibility of selling Stouffer
3. In 1972, Stouffer’s accumulated E&P amounted to $30 million
4. On 08/23/72, Stouffer declared a $30 million dividend payable to Litton with a note (from Stouffer to Litton)
5. Two weeks later, Litton announced publicly its interest in disposing of Stouffer for $105 million
6. Discussions were held with several potential buyers. In addition, Litton explored the possibility of taking Stouffer public
7. On 03/01/73, Nestle offered to buy the Stouffer stock from Litton for cash of $75 million AND payment for the $30 million note (a result of the dividend)

Issue:
Should the dividend paid by a note from Stouffer to Litton be respected or should the $30 million paid by Nestle to satisfy the note be treated as sales proceeds for the sale of the Stouffer stock?

Holding:

The dividend was respected thus reducing the overall sales price of the Stouffer stock by $30 million!!