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Income Tax 2 > Chapter 7 > Flashcards

Chapter 7 Flashcards

1
Q

What does Earnings & Profits (E&P) measure?

A

A corporation’s economic ability to pay dividends to its shareholders.

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2
Q

How is a corporation’s current-year E&P generally calculated?

A

By making adjustments to its taxable income for items treated differently for E&P purposes.

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3
Q

What are the two E&P balances that must be accounted for separately?

A
  • Current-year E&P
  • Accumulated E&P
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4
Q

What type of income increases a corporation’s E&P?

A
  • Tax-exempt income
  • Amounts subject to special deduction or exclusion
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5
Q

Name two expenditures that decrease a corporation’s E&P.

A
  • Nondeductible entertainment expenses
  • Payment of nondeductible fines and penalties
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6
Q

What impact does a corporation’s Net Operating Loss (NOL) have on E&P?

A

It represents an economic loss and impairs the corporation’s ability to make distributions.

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7
Q

Which depreciation system is used to compute E&P?

A

Alternative Depreciation System (ADS).

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8
Q

What is the definition of a distribution in relation to E&P?

A

A distribution is treated as a dividend to the extent of the distributing corporation’s current-year E&P.

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9
Q

True or False: A distribution creates a current or accumulated E&P deficit.

A

False.

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10
Q

What happens if a corporation’s distribution exceeds its current E&P?

A

The excess is treated as a return of capital.

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11
Q

What is the effect of noncash distributions on E&P?

A

They reduce E&P by the fair market value of the property less liabilities assumed by the shareholder.

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12
Q

Fill in the blank: Stock splits and pro-rata stock dividends are ______ because they do not change the value of the shareholders’ interest.

A

nontaxable

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13
Q

What is the purpose of §302 in stock redemptions?

A

To allow shareholders to treat redemption as an exchange if certain tests are met.

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14
Q

Name one of the brightline tests for determining if a redemption is treated as an exchange.

A
  • Shareholder owns less than 50% of total voting power after the exchange.
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15
Q

What happens to E&P when a corporation pays dividends?

A

E&P is reduced by the amount of the dividends paid.

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16
Q

What is the effect of family attribution rules in stock redemptions?

A

They prohibit shareholders from transferring shares to reduce ownership.

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17
Q

What is the treatment of capital gains when a shareholder redeems stock?

A

Shareholders have a gain or loss by comparing the amount realized to their basis in the stock.

18
Q

How does the IRS define a distribution for tax purposes?

A

A distribution is treated as a dividend to the extent it is paid from E&P.

19
Q

What is the treatment of excess distributions when a corporation has negative current E&P?

A

They are treated as a return of capital.

20
Q

What must be considered when preparing an E&P study?

A

The corporation’s distribution history, including current and prior-year distributions.

21
Q

What is the relationship between accumulated E&P and negative current E&P in distributions?

A

Distributions can still be taken from accumulated E&P even if current E&P is negative.

22
Q

What is the impact of liabilities on noncash distributions?

A

Liabilities assumed by the shareholder are subtracted from the fair market value of the property distributed.

23
Q

What happens to E&P if a corporation distributes property?

A

E&P is reduced by the fair market value of the property on the distribution date.

24
Q

Fill in the blank: If a loss results from a distribution where FMV is less than basis, it ______.

A

cannot be recognized

25
Q

What is the effect of a shareholder receiving a distribution of land with liabilities?

A

The value of the distribution is calculated as FMV minus liabilities assumed.

26
Q

What is included in taxable income adjustments?

A

Certain excluded income such as:
* Tax-exempt bond interest
* Life insurance proceeds
* Federal tax refunds (if cash basis)
* Increase in cash surrender value of corporate-owned life insurance policy

These adjustments ensure that all relevant income is considered for tax calculations.

27
Q

What are some disallowed deductibles when calculating earnings?

A

Disallowed deductibles include:
* DRD
* NOL CF/CB
* NCL CF
* Charitable contributions CF

These deductions are not permitted to adjust taxable income.

28
Q

Which nondeductible expenses are allowed in the calculation of earnings?

A

Nondeductible expenses allowed include:
* Federal income taxes paid or accrued
* CY NCL
* Current-year contributions in excess of 10 percent limit
* Nondeductible premiums

These expenses can affect the taxable income calculation despite being nondeductible.

29
Q

What adjustments are made for timing differences in earnings calculation?

A

Adjustments for timing differences include:
* Installment sales
* Depreciation methods
* Adjustments for gain or loss from sale of property where depreciation is different

Timing differences can significantly impact the reported earnings.

30
Q

How is the amount distributed to shareholders calculated?

A

The amount distributed is calculated as:
* Cash received
* FMV of property received
* Liabilities assumed by shareholder on property received

This calculation determines the total value received by shareholders.

31
Q

What is the basis of property received by shareholders?

A

The basis of property received is:
* FMV of property received
* Liabilities assumed by shareholder who received distribution

Understanding the basis is critical for future tax implications.

32
Q

What is the tax treatment to a corporation regarding loss recognition?

A

Loss is never recognized by the corporation during distributions

This principle helps maintain the corporation’s capital structure.

33
Q

How is gain recognized on distribution by a corporation?

A

Gain recognized on distribution is the greater of:
* FMV of property distributed
* Liability assumed by shareholder (Adjusted basis)

This ensures that the corporation accurately reflects any gain from the transaction.

34
Q

Under what conditions is a stock distribution nontaxable to shareholders?

A

A stock distribution is nontaxable if:
* Made with respect to common stock
* Made pro rata (proportionate interests are maintained)

These conditions help avoid immediate tax liability on stock distributions.

35
Q

What happens if cash is offered as an alternative in a stock distribution?

A

If cash is offered as an alternative, recognize the FMV of the stock distributed as the cash that was offered

This treatment aligns the transaction with cash equivalents.

36
Q

What are the conditions for stock redemptions to be treated as exchanges?

A

Stock redemptions are treated as exchanges if:
* Constructive ownership rules apply
* Shareholder must own less than 50% of voting power after redemption
* Must fall below at least 80% of the shareholder’s original share of voting stock and aggregate value

These conditions ensure that the transaction is treated appropriately for tax purposes.

37
Q

What tax consequences do shareholders face for an exchange?

A

For an exchange, gain is always recognized, and loss is recognized unless the shareholder is related to the corporation

This rule helps delineate the tax implications for shareholders.

38
Q

What tax consequences do distributing corporations face for an exchange?

A

Distributing corporations reduce E&P after cash distributions are accounted for, lesser of:
* Leftover E&P * percent of stock redeemed
* FMV of stock redeemed

This ensures that earnings and profits reflect the impact of stock redemptions.

39
Q

What treatment do noncorporate shareholders receive in partial liquidations?

A

Noncorporate shareholders receive exchange treatment, computing gain or loss based on the tax basis of shares that would have been transferred

This treatment allows for equitable tax implications during partial liquidations.

40
Q

What rules apply to corporate shareholders during stock redemptions?

A

Corporate shareholders are subject to change-in-stock-ownership rules that apply to stock redemptions, which typically results in dividend treatment

This ensures compliance with tax regulations regarding stock ownership changes.

Income Tax 2 (3 decks)

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