Chapter 7

Question 1

Which statement best describes the concept of the “double taxation” of corporation income? A. Corporate income is subject to two levels of taxation: the regular tax and the alternative minimum tax. B. Corporate income is taxed twice at the corporate level: first when earned and then a second time if appreciated property is distributed to a shareholder. C. Corporate income is taxed when earned by a C corporation and then a second time at the shareholder level when distributed as a dividend. D. Corporate income is subject to two levels of taxation: at the federal level and a second time at the state level.

Answer 1

C. Corporate income is taxed when earned by a C corporation and then a second time at the shareholder level when distributed as a dividend. The double taxation of corporate income refers to the taxation of such income at the corporate level and then at the shareholder level when such income is distributed as a dividend.

Question 2

Which of the following forms of earnings distributions would not be subject to double taxation at the corporate and shareholder level? A. Dividend B. Stock redemption C. Partial liquidation D. Compensation paid to a shareholder/employee of the corporation

Answer 2

D. Compensation paid to a shareholder/employee of the corporation Compensation is deductible at the corporate level.

Question 3

Which of the following statements best describes the priority of the tax treatment of a distribution from a corporation to a shareholder? A. The distribution is a dividend to the extent of the corporation’s earnings and profits, then a return of capital, and finally gain from sale of stock. B. The distribution is a return of capital, then a dividend to the extent of the corporation’s earnings and profits, and finally gain from sale of stock. C. The distribution is a return of capital, then gain from sale of stock, and finally a dividend to the extent of the corporation’s earnings and profits. D. The shareholder can elect to treat the distribution as either a dividend to the extent of the corporation’s earnings and profits or a return of capital, followed by gain from sale of stock.

Answer 3

A. The distribution is a dividend to the extent of the corporation’s earnings and profits, then a return of capital, and finally gain from sale of stock. The tax treatment is specified in §301(c).

Question 4

Which of the following statements best describes current earnings and profits? A. Current earnings and profits is another name for a corporation’s retained earnings on its balance sheet. B. Current earnings and profits is a precisely defined tax term in the Internal Revenue Code and represents a corporation’s economic income. C. Current earnings and profits is an ill-defined tax concept in the Internal Revenue Code and represents a corporation’s economic income. D. Current earnings and profits is a conceptual tax concept with no definition in the Internal Revenue Code.

Answer 4

C. Current earnings and profits is an ill-defined tax concept in the Internal Revenue Code and represents a corporation’s economic income. Current earnings and profits more accurately describes economic income (at least compared to taxable income) and is only partially defined in the Internal Revenue Code.

Question 5

Which of the following statements best describes the role of current and accumulated earnings and profits in determining if a distribution is a dividend? A. A distribution will only be a dividend if total earnings and profits (current plus accumulated) is positive at the time of the distribution. B. A distribution can never be a dividend if current earnings and profits are negative. C. A distribution will be a dividend if current earnings and profits for the year are positive, even if accumulated earnings and profits are negative. D. A distribution will never be a dividend if current earnings and profits for the year are negative, even if accumulated earnings and profits is positive.

Answer 5

C. A distribution will be a dividend if current earnings and profits for the year are positive, even if accumulated earnings and profits are negative. Distributions are first treated as paid out of current earnings and profits.

Question 6

A calendar-year corporation has positive current E&P of $500 and accumulated negative E&P of $1,200. The corporation makes a $400 distribution to its sole shareholder. Which of the following statements is true? A. The distribution will not be a dividend because total earnings and profits is a negative $700. B. The distribution may be a dividend, depending on whether total earnings and profits at the date of the distribution is positive. C. The distribution will be a dividend because current earnings and profits are positive and exceed the distribution. D. A distribution from a corporation to a shareholder is always a dividend, regardless of the balance in earnings and profits.

Answer 6

C. The distribution will be a dividend because current earnings and profits are positive and exceed the distribution. Distributions are first treated as paid out of current earnings and profits.

Question 7

A calendar-year corporation has negative current E&P of $500 and accumulated positive E&P of $1,000. The corporation makes a $600 distribution to its sole shareholder. Which of the following statements is true? A. $500 of the distribution will be a dividend because total earnings and profits is $500. B. $0 of the distribution will be a dividend because current earnings and profits are negative. C. $600 of the distribution will be a dividend because accumulated earnings and profits is $1,000. D. Up to $600 of the distribution could be a dividend depending on the balance in accumulated earnings and profits on the date of the distribution.

Answer 7

D. Up to $600 of the distribution could be a dividend depending on the balance in accumulated earnings and profits on the date of the distribution. When current E&P is negative, the status of a distribution is determined based on accumulated E&P at the date of the distribution.

Question 8

Which of these items is not an adjustment to taxable income or net loss to compute current E&P? A. Dividends received deduction B. Tax-exempt income C. Net capital loss carryforward from the prior year tax return D. Refund of prior year taxes for an accrual method taxpayer

Answer 8

D. Refund of prior year taxes for an accrual method taxpayer. Refunds of prior year taxes are included in the computation of current E&P under the cash method of accounting.

Question 9

Grand River Corporation reported taxable income of $500,000 in 20X3 and paid federal income taxes of $170,000. Not included in the computation was a disallowed meals and entertainment expense of $2,000, tax-exempt income of $1,000, and deferred gain on an installment sale of $25,000. The corporation’s current earnings and profits for 20X3 would be: A. $524,000 B. $500,000 C. $354,000 D. $331,000

Answer 9

C. $354,000 $500,000 - $170,000 - $2,000 + $1,000 + $25,000 = $354,000.

Question 10

Au Sable Corporation reported taxable income of $800,000 in 20X3 and paid federal income taxes of $272,000. Not included in the computation was a disallowed penalty of $25,000, life insurance proceeds of $100,000, and an income tax refund from 20X2 of $50,000. Au Sable is an accrual basis taxpayer. The corporation’s current earnings and profits for 20X3 would be: A. $875,000 B. $653,000 C. $603,000 D. $553,000

Answer 10

C. $603,000 $800,000 - $272,000 - $25,000 + $100,000 = $603,000. The refund is not added back because Au Sable is on the accrual method.

Question 11

Oakland Corporation reported a net operating loss of $500,000 in 20X3 and elected to carry the loss forward to 20X4. Not included in the computation was a disallowed meals and entertainment expense of $20,000, tax-exempt income of $10,000, and deferred gain on an installment sale of $250,000. The corporation’s current earnings and profits for 20X3 would be: A. ($500,000) B. ($720,000) C. ($510,000) D. ($260,000)

Answer 11

D. ($260,000) ($500,000) - $20,000 + $10,000 + 250,000 = ($260,000).

Question 12

Packard Corporation reported taxable income of $1,000,000 in 20X3 and paid federal income taxes of $340,000. Included in the taxable income computation was a dividends received deduction of $5,000, a net capital loss carryover from 20X2 of $10,000, and gain of $50,000 from an installment sale that took place in 20X1. The corporation’s current earnings and profits for 20X3 would be: A. $1,015,000 B. $965,000 C. $675,000 D. $625,000

Answer 12

D. $625,000 $1,000,000 - $340,000 + $5,000 + $10,000 - $50,000 = $625,000.

Question 13

Abbot Corporation reported a net operating loss of $400,000 in 20X3, which the corporation elected to carry forward to 20X4. Included in the computation of the loss was regular depreciation of $100,000 (E&P depreciation is $40,000), first year expensing under §179 of $50,000, and a dividends received deduction of $10,000. The corporation’s current earnings and profits for 20X3 would be: A. ($290,000) B. ($330,000) C. ($400,000) D. ($490,000)

Answer 13

A. ($290,000) ($400,000) + $60,000 + $40,000 + $10,000 = ($290,000). The first year expensing under §179 must be capitalized and amortized over 5 years ($10,000 per year).

Question 14

Madison Corporation reported taxable income of $400,000 in 20X3 and accrued federal income taxes of $136,000. Included in the computation of taxable income was regular depreciation of $200,000 (E&P depreciation is $60,000) and a net capital loss carryover of $20,000 from 20X2. The corporation’s current earnings and profits for 20X3 would be: A. $424,000 B. $404,000 C. $380,000 D. $344,000

Answer 14

A. $424,000 $400,000 - $136,000 + $140,000 + $20,000 = $424,000. The capital loss carryover reduced E&P in 20X2.

Question 15

Greenwich Corporation reported a net operating loss of $800,000 in 20X3, which the corporation elected to carry forward to 20X4. The computation of the loss did not include a disallowed fine of $50,000, life insurance proceeds of $500,000, and a current year charitable contribution of $10,000 that will be carried forward to 20X4. The corporation’s current earnings and profits for 20X3 would be: A. ($250,000) B. ($260,000) C. ($300,000) D. ($360,000)

Answer 15

D. ($360,000) ($800,000) - $50,000 + $500,000 - $10,000 = ($360,000).

Question 16

Bruin Company reports current E&P of $200,000 in 20X3 and accumulated E&P at the beginning of the year of $100,000. Bruin distributed $400,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $400,000 B. $300,000 C. $200,000 D. $100,000

Answer 16

B. $300,000 The distribution is a dividend to the extent of current and accumulated E&P. The tax status of the dividend is determined based on current E&P for the full year.

Question 17

Aztec Company reports current E&P of $200,000 in 20X3 and accumulated E&P at the beginning of the year of negative $100,000. Aztec distributed $300,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $300,000 B. $200,000 C. $100,000 D. $0

Answer 17

B. $200,000 The distribution is a dividend to the extent of current E&P. The tax status of the dividend is determined based on current E&P for the full year.

Question 18

Inca Company reports current E&P of negative $100,000 in 20X3 and accumulated E&P at the beginning of the year of $200,000. Inca distributed $300,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $0 B. $100,000 C. $200,000 D. $300,000

Answer 18

C. $200,000 When current E&P is negative, the tax status of the dividend is determined by calculating accumulated E&P on the date of the distribution.

Question 19

Wildcat Corporation reports current E&P of negative $200,000 in 20X3 and accumulated E&P at the beginning of the year of $100,000. Wildcat distributed $300,000 to its sole shareholder on December 31, 20X3. How much of the distribution is treated as a dividend in 20X3? A. $0 B. $100,000 C. $200,000 D. $300,000

Answer 19

A. $0 If accumulated E&P is positive, but current E&P is negative, then a distribution is a dividend to the extent of net E&P (accumulated E&P less an allocated portion of the deficit in current E&P) on the date of the distribution.

Question 20

Beaver Company reports current E&P of $100,000 in 20X3 and accumulated E&P at the beginning of the year of $200,000. Beaver distributed $400,000 to its sole shareholder on January 1, 20X3. The shareholder’s tax basis in her stock in Beaver is $200,000. How is the distribution treated by the shareholder in 20X3? A. $400,000 dividend B. $100,000 dividend, $200,000 tax-free return of basis, and $100,000 capital gain C. $200,000 dividend and $200,000 tax-free return of basis D. $300,000 dividend and $100,000 tax-free return of basis

Answer 20

D. $300,000 dividend and $100,000 tax-free return of basis. The distribution is a dividend to the extent of current and accumulated E&P at January 1, 20X3. The excess distribution is a tax-free return of basis because the shareholder’s tax basis in her stock exceeds the distribution.

Question 21

Longhorn Company reports current E&P of $100,000 in 20X3 and accumulated E&P at the beginning of the year of negative $200,000. Longhorn distributed $300,000 to its sole shareholder on January 1, 20X3. The shareholder’s tax basis in his stock in Longhorn is $100,000. How is the distribution treated by the shareholder in 20X3? A. $300,000 dividend B. $100,000 dividend, $100,000 tax-free return of basis, and $100,000 capital gain C. $100,000 dividend and $200,000 tax-free return of basis D. $0 dividend, $100,000 tax-free return of basis, and $200,000 capital gain

Answer 21

B. $100,000 dividend, $100,000 tax-free return of basis, and $100,000 capital gain. The distribution is a dividend to the extent of current E&P at December 31, 20X3. The excess $200,000 distribution is first a tax-free return of basis to the extent of the shareholder’s tax basis and then capital gain.

Question 22

Husker Corporation reports current E&P of negative $200,000 in 20X3 and accumulated E&P at the beginning of the year of $300,000. Husker distributed $200,000 to its sole shareholder on December 31, 20X3. The shareholder’s tax basis in her stock in Husker is $50,000. How is the distribution treated by the shareholder in 20X3? A. $200,000 dividend B. $100,000 dividend, $50,000 tax-free return of basis, and $50,000 capital gain C. $100,000 dividend and $100,000 tax-free return of basis D. $0 dividend, $50,000 tax-free return of basis, and $150,000 capital gain

Answer 22

B. $100,000 dividend, $50,000 tax-free return of basis, and $50,000 capital gain. When current E&P is negative, the tax status of the dividend is determined by calculating accumulated E&P on the date of the distribution. Accumulated E&P at 12/31/X3 is $100,000. The remaining distribution is a tax-free return of basis, with the excess treated as capital gain.

Question 23

Tar Heel Corporation had current and accumulated E&P of $500,000 at December 31 20X3. On December 31, the company made a distribution of land to its sole shareholder, William Roy. The land’s fair market value was $100,000 and its tax and E&P basis to Tar Heel was $25,000. William assumed a mortgage attached to the land of $10,000. The tax consequences of the distribution to William in 20X3 would be: A. $100,000 dividend and a tax basis in the land of $100,000 B. $100,000 dividend and a tax basis in the land of $90,000 C. Dividend of $90,000 and a tax basis in the land of $100,000 D. Dividend of $90,000 and a tax basis in the land of $90,000

Answer 23

C. Dividend of $90,000 and a tax basis in the land of $100,000. The dividend amount is the fair market value less the liability assumed. The tax basis of the land is the fair market value.

Question 24

Cavalier Corporation had current and accumulated E&P of $500,000 at December 31 20X3. On December 31, the company made a distribution of land to its sole shareholder, Tom Jefferson. The land’s fair market value was $200,000 and its tax and E&P basis to Cavalier was $50,000. The tax consequences of the distribution to Cavalier in 20X3 would be: A. No gain recognized and a reduction in E&P of $200,000 B. $150,000 gain recognized and a reduction in E&P of $200,000 C. $150,000 gain recognized and a reduction in E&P of $50,000 D. No gain recognized and a reduction in E&P of $50,000

Answer 24

B. $150,000 gain recognized and a reduction in E&P of $200,000. The distributing corporation recognizes gain on the distribution, which is included in E&P, net of tax, and reduces E&P by the land’s fair market value.

Question 25

Montclair Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Molly Pitcher. The land’s fair market value was $200,000 and its tax and E&P basis to Montclair was $50,000. Molly assumed a liability of $25,000 attached to the land. The tax consequences of the distribution to Montclair in 20X3 would be: A. No gain recognized and a reduction in E&P of $200,000 B. $150,000 gain recognized and a reduction in E&P of $200,000 C. $150,000 gain recognized and a reduction in E&P of $175,000 D. No gain recognized and a reduction in E&P of $175,000

Answer 25

C. $150,000 gain recognized and a reduction in E&P of $175,000. The distributing corporation recognizes gain on the distribution, which is included in E&P, net of tax, and reduces E&P by the land’s fair market value less the liability assumed by the shareholder.

Question 26

Catamount Company had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Caroline West. The land’s fair market value was $200,000 and its tax and E&P basis to Catamount was $250,000. The tax consequences of the distribution to Catamount in 20X3 would be: A. No loss recognized and a reduction in E&P of $250,000 B. $50,000 loss recognized and a reduction in E&P of $250,000 C. $50,000 loss recognized and a reduction in E&P of $150,000 D. No loss recognized and a reduction in E&P of $200,000

Answer 26

A. No loss recognized and a reduction in E&P of $250,000. The distributing corporation does not recognize loss on the distribution and reduces E&P by the land’s E&P basis.

Question 27

Paladin Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Maria Mendez. The land’s fair market value was $200,000 and its tax and E&P basis to Paladin was $250,000. Maria assumed a liability of $25,000 attached to the land. The tax consequences of the distribution to Paladin in 20X3 would be: A. No loss recognized and a reduction in E&P of $200,000 B. $50,000 loss recognized and a reduction in E&P of $200,000 C. $50,000 loss recognized and a reduction in E&P of $225,000 D. No loss recognized and a reduction in E&P of $225,000

Answer 27

D. No loss recognized and a reduction in E&P of $225,000. The distributing corporation does not recognize loss on the distribution and reduces E&P by the land’s E&P basis less the liability assumed by the shareholder.

Question 28

Which of the following payments could be treated as a constructive dividend by the IRS? A. End-of-year bonus payment to a shareholder/employee B. Rent paid to a shareholder/lessor C. Interest paid to a shareholder/creditor D. All of these payments could be treated as a constructive dividend by the IRS

Answer 28

D. All of these payments could be treated as a constructive dividend by the IRS. All of the payments are deductible by the corporation and could be treated as a nondeductible dividend by the IRS.

Question 29

Which of the following factors would not be considered in determining if compensation paid to a shareholder/employee is reasonable? A. The individual’s duties and responsibilities B. What individuals performing in comparable capacities at other companies are paid C. Whether the corporation has a formal compensation policy D. The individual’s marginal income tax rate

Answer 29

D. The individual’s marginal income tax rate The IRS and courts do not list the individual’s marginal tax rate as a factor in determining if compensation is reasonable.

Question 30

Which of the following statements is not considered a potential answer to the dividend puzzle (why do corporations pay dividends)? A. Paying dividends avoids the double taxation of corporate income B. Demanding that managers pay out dividends restricts their investment activities and forces them to adopt more efficient investment policies C. Paying dividends is a source of investor goodwill D. Dividends are a signal to the capital markets about the health of a corporation’s activities

Answer 30

A. Paying dividends avoids the double taxation of corporate income. Dividends result in the double taxation of corporate income.

Question 31

Which of the following stock dividends would be tax-free to the shareholder? A. A 2-for-1 stock split to all holders of common stock B. A stock dividend where the shareholder could choose between cash and stock C. A stock dividend to all holders of preferred stock D. Both a 2-for-1 stock split to all holders of common stock and a stock dividend to all holders of preferred stock are tax-free to the shareholder

Answer 31

A. A 2-for-1 stock split to all holders of common stock. To be tax-free, the stock dividend must be on common stock and made pro rata to all shareholders.

Question 32

El Toro Corporation declared a common stock dividend to all shareholders of record on June 30, 20X3. Shareholders will receive 1 share of El Toro stock for each 2 shares of stock they already own. Raoul owns 300 shares of El Toro stock with a tax basis of $60 per share. The fair market value of the El Toro stock was $100 per share on June 30, 20X3. What are the tax consequences of the stock dividend to Raoul? A. $0 dividend income and a tax basis in the new stock of $100 per share B. $0 dividend income and a tax basis in the new stock of $60 per share C. $0 dividend income and a tax basis in the new stock of $40 per share D. $15,000 dividend and a tax basis in the new stock of $100 per share

Answer 32

C. $0 dividend income and a tax basis in the new stock of $40 per share. The stock dividend is nontaxable because it is pro rata. The tax basis of the new stock is pro rated from the tax basis of the stock on which it was paid. The tax basis of the 300 shares is $18,000 ($60 per share). The total basis is now allocated across 450 shares so the per share basis is $40 ($18,000/450 = $40 per share).

Question 33

Wonder Corporation declared a common stock dividend to all shareholders of record on September 30, 20X3. Shareholders will receive three shares of Wonder stock for each five shares of stock they already own. Diana owns 300 shares of Wonder stock with a tax basis of $90 per share (a total basis of $27,000). The fair market value of the Wonder stock was $180 per share on September 30, 20X3. What are the tax consequences of the stock dividend to Diana? A. $0 dividend income and a tax basis in the new stock of $180 per share B. $0 dividend income and a tax basis in the new stock of $67.50 per share C. $0 dividend income and a tax basis in the new stock of $56.25 per share D. $10,800 dividend and a tax basis in the new stock of $180 per share

Answer 33

C. $0 dividend income and a tax basis in the new stock of $56.25 per share. The stock dividend is nontaxable because it is pro rata. The tax basis of the new stock is pro rated from the tax basis of the stock on which it was paid. The tax basis = $27,000/480 shares = $56.25 per share.

Question 34

Which of the following individuals is not considered “family” for purposes of applying the stock attribution rules to a stock redemption? A. Parents B. Grandchildren C. Grandparents D. Spouse

Answer 34

C. Grandparents Children also are considered “family” under the 318 attribution rules.

Question 35

Which of the following statements is true? A. All stock redemptions are treated as exchanges for tax purposes. B. A stock redemption not treated as an exchange will automatically be treated as a taxable dividend. C. All stock redemptions are treated as dividends if received by an individual. D. A stock redemption is treated as an exchange only if it meets one of three stock ownership tests described in the Internal Revenue Code.

Answer 35

D. A stock redemption is treated as an exchange only if it meets one of three stock ownership tests described in the Internal Revenue Code. To be an exchange, one of the stock ownership tests described in §302(b) must be satisfied. Stock redemptions not treated as exchanges are tested under §301 and could be a tax-free return of capital or gain from sale of stock.

Question 36

Sam owns 70 percent of the stock of Club Corporation. Unrelated individuals own the remaining 30 percent. For a stock redemption of Sam’s stock to be treated as an exchange under the “substantially disproportionate” test, what percentage of Club stock must Sam own after the redemption? A. Any percentage less than 70 percent B. Any percentage less than 56 percent C. Any percentage less than 50 percent D. All stock redemptions involving individuals are treated as exchanges

Answer 36

C. Any percentage less than 50 percent Under §302(b)(2), Sam must own less than the lesser of 1) 80% × 70% = 56% or 2) 50%.

Question 37

Sara owns 60 percent of the stock of Lea Corporation. Unrelated individuals own the remaining 40 percent. For a stock redemption of Sara’s stock to be treated as an exchange under the “substantially disproportionate” test, what percentage of Lea stock must Sara own after the redemption? A. Any percentage less than 60 percent B. Any percentage less than 50 percent C. Any percentage less than 48 percent D. All stock redemptions involving individuals are treated as exchanges

Answer 37

C. Any percentage less than 48 percent. Under §302(b)(2), Sara must own less than the lesser of 1) 80% × 60% = 48% or 2) 50%.

Question 38

Comet Company is owned equally by Pat and his sister Pam, each of whom hold 100 shares in the company. Pam wants to reduce her ownership in the company, and it was decided that the company will redeem 50 of her shares for $1,000 per share on December 31, 20X3. Pam’s income tax basis in each share is $500. Comet has total E&P of $250,000. What are the tax consequences to Pam because of the stock redemption? A. $25,000 capital gain and a tax basis in each of her remaining shares of $500. B. $25,000 capital gain and a tax basis in each of her remaining shares of $100. C. $50,000 dividend and a tax basis in each of her remaining shares of $100. D. $50,000 dividend and a tax basis in each of her remaining shares of $50.

Answer 38

A. $25,000 capital gain and a tax basis in each of her remaining shares of $500. The redemption will be treated as an exchange because Pam meets the substantially disproportionate test (her 33% ownership after the redemption is less than 50% and less than 40%). Her remaining shares retain a basis of $500 per share.

Question 39

Comet Company is owned equally by Pat and his sister Pam, each of whom hold 100 shares in the company. Comet redeems 50 of Pam’s shares on December 31, 20X3, for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes. Comet has total E&P of $250,000 on December 31, 20X3. What are the tax consequences to Comet because of the stock redemption? A. No reduction in E&P because of the exchange. B. A reduction of $50,000 in E&P because of the exchange. C. A reduction of $62,500 in E&P because of the exchange. D. A reduction of $125,000 in E&P because of the exchange.

Answer 39

B. A reduction of $50,000 in E&P because of the exchange. In a stock redemption treated as an exchange, the distributing corporation reduces E&P by the lesser of the amount paid in the redemption or the % of stock redeemed times E&P at the date of the redemption.

Question 40

Comet Company is owned equally by Pat and his sister Pam, each of whom hold 100 shares in the company. Comet redeems 50 of Pam’s shares on December 31, 20X3, for $1,000 per share in a transaction that Pam treats as an exchange for tax purposes. Comet has total E&P of $160,000 on December 31, 20X3. What are the tax consequences to Comet because of the stock redemption? A. No reduction in E&P because of the exchange. B. A reduction of $50,000 in E&P because of the exchange. C. A reduction of $40,000 in E&P because of the exchange. D. A reduction of $80,000 in E&P because of the exchange.

Answer 40

C. A reduction of $40,000 in E&P because of the exchange. In a stock redemption treated as an exchange, the distributing corporation reduces E&P by the lesser of the amount paid in the redemption or the % of stock redeemed times E&P at the date of the redemption. (25% of $160,000 = $40,000).

Question 41

Viking Corporation is owned equally by Sven and his wife Olga, each of whom hold 100 shares in the company. Viking redeemed 75 shares of Sven’s stock in the company on December 31, 20X3. Viking paid Sven $2,000 per share. His income tax basis in each share is $1,000. Viking has total E&P of $500,000. What are the tax consequences to Sven because of the stock redemption? A. $75,000 capital gain and a tax basis in each of his remaining shares of $1,000. B. $75,000 capital gain and a tax basis in each of his remaining shares of $2,000. C. $150,000 dividend and a tax basis in each of his remaining shares of $1,000. D. $150,000 dividend and a tax basis in each of his remaining shares of $4,000.

Answer 41

D. $150,000 dividend and a tax basis in each of his remaining shares of $4,000. The redemption will be treated as a dividend because Sven is treated as owning 100% of the corporation’s stock after the redemption through his wife Olga. The exchange will be treated as a dividend of $150,000. Sven’s stock basis in his redeemed shares is transferred to his remaining 25 shares ($100,000/25 = $4,000).

Question 42

Viking Corporation is owned equally by Sven and his wife Olga, each of whom hold 100 shares in the company. Viking redeemed 75 shares of Sven’s stock for $2,000 per share on December 31, 20X3. Viking has total E&P of $500,000. What are the tax consequences to Viking because of the stock redemption? A. No reduction in E&P because of the exchange. B. A reduction of $150,000 in E&P because of the exchange. C. A reduction of $187,500 in E&P because of the exchange. D. A reduction of $375,000 in E&P because of the exchange.

Answer 42

B. A reduction of $150,000 in E&P because of the exchange. The redemption will be treated as a dividend because Sven is treated as owning 100% of the corporation’s stock after the redemption through his wife Olga. As a result, Viking reduces its E&P by the amount distributed.

Question 43

Corona Company is owned equally by Maria, her sister Carlita, her mother Gabriella, and her grandmother Olivia, each of whom hold 100 shares in the company. Under the family attribution rules, how many shares of Corona stock is Maria deemed to own? A. 100 B. 200 C. 300 D. 400

Answer 43

B. 200 Maria is treated as owning the shares of her mother, but not those of her sister or grandmother.

Question 44

Panda Company is owned equally by Min, her husband Bin, her sister Xiao, and her grandson, Han, each of whom hold 100 shares in the company. Under the family attribution rules, how many shares of Panda stock is Min deemed to own? A. 100 B. 200 C. 300 D. 400

Answer 44

C. 300 Min is treated as owning the shares of her husband and her grandson, but not her sister.

Question 45

Beltway Company is owned equally by George, his brother Thomas, and a partnership owned 50 percent by George and his father Abe. Each of the three shareholders holds 100 shares in the company. Under the §318 stock attribution rules, how many shares of Beltway stock is George deemed to own? A. 100 B. 150 C. 200 D. 300

Answer 45

C. 200 George is treated as owning his pro rata shares in Beltway owned by the partnership. Under the family attribution rules, George is treated as owning 100% of the partnership. He owns his own shares plus 100% of the stock owned by the partnership.

Question 46

Lansing Company is owned equally by Jennifer, her husband Dan, and DeWitt Corporation, which is owned 50 percent by Jennifer and her sister Jane. Each of the three shareholders holds 100 shares in the company. Under the §318 stock attribution rules, how many shares of Lansing stock is Jennifer deemed to own? A. 100 B. 200 C. 250 D. 300

Answer 46

C. 250 Jennifer is treated as owning her husband’s shares and 50% of the shares owned by the corporation. Under the family attribution rules, Jennifer is not treated as owning any of her sister’s stock in the corporation. Because she owns 50% of DeWitt’s stock, she is treated as owning 50 shares of Lansing through DeWitt.

Question 47

Lansing Company is owned equally by Jennifer, her husband Dan, and DeWitt Corporation, which is owned 50 percent by Jennifer and her sister Jane. Each of the three shareholders holds 100 shares in the company. Under the §318 stock attribution rules, how many shares of Lansing stock is DeWitt Corporation deemed to own? A. 100 B. 200 C. 250 D. 300

Answer 47

D. 300 DeWitt is treated as owning the stock of its 50%-or-more shareholders. DeWitt owns its own stock, Jennifer’s stock, and Dan’s stock attributed to Jennifer under the family attribution rules

Question 48

Tammy owns 100 shares in Star Struck Corporation. The other 100 shares are owned by her husband Tommy. Which of the following statements is true? A. A stock redemption that completely terminates Tammy’s direct interest in a corporation will be treated as an exchange for tax purposes. B. A stock redemption that completely terminates Tammy’s direct interest in a corporation will be treated as a dividend for tax purposes. C. A stock redemption that completely terminates Tammy’s direct interest in a corporation will be treated as an exchange if Tammy waives the family attribution rules and files a “triple i” agreement with the IRS. D. A stock redemption that completely terminates Tammy’s direct interest in a corporation will be treated as a dividend to the extent that the redemption exceeds Tammy’s tax basis in the redeemed shares.

Answer 48

C. A stock redemption that completely terminates Tammy’s direct interest in a corporation will be treated as an exchange if Tammy waives the family attribution rules and files a “triple i” agreement with the IRS. To be treated as an exchange, Tammy must waive the family attribution rules and file a triple i agreement with the IRS.

Question 49

General Inertia Corporation made a distribution of $50,000 to Henry Tiara in partial liquidation of the company on December 31, 20X3. Henry owns 500 shares (50%) of General Inertia. The distribution was in exchange for 250 shares of Henry’s stock in the company. After the partial liquidation, Henry continued to own 50% of the remaining stock in General Inertia. At the time of the distribution, the shares had a fair market value of $200 per share. Henry’s income tax basis in the shares was $100 per share. General Inertia had total E&P of $800,000 at the time of the distribution. What are the tax consequences to Henry because of the transaction? A. Henry has dividend income of $50,000 and a tax basis in his remaining shares of $100 per share. B. Henry has capital gain of $25,000 and a tax basis in his remaining shares of $100 per share. C. Henry has dividend income of $50,000 and a tax basis in his remaining shares of $200 per share. D. Henry has capital gain of $25,000 and a tax basis in his remaining shares of $200 per share.

Answer 49

B. Henry has capital gain of $25,000 and a tax basis in his remaining shares of $100 per share. Under the partial liquidation rules, an individual receives exchange treatment in the transaction.

Question 50

General Inertia Corporation made a pro rata distribution of $50,000 to Tiara, Inc. in partial liquidation of the company on December 31, 20X3. Tiara, Inc. owns 500 shares (50%) of General Inertia. The distribution was in exchange for 250 shares of Tiara’s stock in the company. After the partial liquidation, Tiara continued to own 50% of the remaining stock in General Inertia. At the time of the distribution, the shares had a fair market value of $200 per share. Tiara’s income tax basis in the shares was $100 per share. General Inertia had total E&P of $800,000 at the time of the distribution. What amount of dividend or capital gain does Tiara recognize because of the transaction? A. Tiara does not recognize any dividend income or capital gain. B. Tiara recognizes capital gain of $50,000. C. Tiara recognizes dividend income of $50,000. D. Tiara recognizes capital gain of $25,000.

Answer 50

C. Tiara recognizes dividend income of $50,000. Under the partial liquidation rules, a corporate shareholder tests the tax status of the distribution under the section 302(b) rules. In a pro rata distribution, Tiara’s ownership in General Inertia does not change. As a result, the distribution will be treated as a dividend and eligible for the dividend received deduction.