Topic 3

Question 1

A distribution from a corporation to a shareholder will always be treated as a dividend for tax purposes.

Answer 1

False

It could also be a return of capital or gain from sale of the stock.

Question 2

This year the shareholders in Lucky Corporation can choose between receiving an additional 100 shares of stock or cash of $100. Lucky’s shareholders will be taxed on the distribution if Lucky has sufficient E&P.

Answer 2

True

Question 3

Stock distributions are always tax-free to the recipient shareholder.

Answer 3

False
Stock distributions can be taxed as dividend income to shareholders when the distribution has the potential of changing ownership proportions. For example, a distribution where the shareholder has a choice between receiving stock or cash will be taxable (assuming sufficient E&P) even for those shareholders who choose to receive stock.

Question 4

The recipient of a tax-free stock distribution will have a zero tax basis in the stock.

Answer 4

False

The recipient must allocate a portion of the basis from existing stock.

Question 5

The recipient of a taxable stock distribution will have a tax basis in the stock equal to the fair market value of the stock received.

Answer 5

True

Question 6

Tammy owns 60 percent of the stock of Huron Corporation. Unrelated individuals own the remaining 40 percent. For a stock redemption to be treated as an exchange under the “substantially disproportionate” rule, the redemption must reduce Tammy’s stock ownership in Huron Corporation below 48 percent.

Answer 6

True
Tammy’s stock ownership must be reduced below 50 percent and be less than 80 percent of her existing ownership (80% × 60% = 48%).

Question 7

Which statement best describes the concept of the “double taxation” of corporation income?

1. Corporate income is subject to two levels of taxation: the regular tax and excess profits tax.
2. 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.
3. Corporate income is taxed when earned by a C corporation and then a second time at the shareholder level when distributed as a dividend.

Answer 7

Corporate income is taxed when earned by a C corporation and then a second time at the shareholder level when distributed as a dividend.

Question 8

Which of the following stock distributions would be tax-free to the shareholder?

1. A 2-for-1 stock split to all holders of common stock.
2. A stock distribution where the shareholder could choose between cash and stock.
3. A stock distribution to all holders of preferred stock.

Answer 8

A 2-for-1 stock split to all holders of common stock.

To be tax-free, the stock distribution must be on common stock and made pro rata to all shareholders.

Question 9

Which of the following statements is true?

1. All stock redemptions are treated as exchanges for tax purposes.
2. A stock redemption not treated as an exchange will automatically be treated as a taxable dividend.
3. All stock redemptions are treated as dividends if received by an individual.
4. 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 9

A stock redemption is treated as an exchange only if it meets one of three stock ownership tests described in the Internal Revenue Code.

Question 10

A distribution from a corporation to a shareholder will only be treated as a dividend for tax purposes if the distribution is paid out of current or accumulated earnings and profits.

Answer 10

True

Question 11

Green Corporation has current earnings and profits of $100,000 and negative accumulated earnings and profits of ($200,000). A $50,000 distribution from Green to its sole shareholder will not be treated as a dividend because total earnings and profits is a negative $100,000.

Answer 11

False

The distribution will be a dividend because Green has positive current E&P.

Question 12

Only taxable income and deductible expenses are included in the computation of current earnings and profits.

Answer 12

False

The computation also includes tax-exempt income and nondeductible expenses.

Question 13

Terrapin Corporation incurs federal income taxes of $250,000 in 20X3. Terrapin deducts the federal income taxes in computing its current earnings and profits for 20X3.

Answer 13

True

E&P is an after-tax computation.

Question 14

Evergreen Corporation distributes land with a fair market value of $200,000 to its sole shareholder. Evergreen’s tax basis in the land is $50,000. Assuming sufficient earnings and profits, the amount of dividend reported by the shareholder is $200,000.

Answer 14

True

Question 15

Evergreen Corporation distributes land with a fair market value of $200,000 to its sole shareholder. Evergreen’s tax basis in the land is $50,000. Evergreen will report a gain of $150,000 on the distribution regardless of whether its earnings and profits are positive or negative.

Answer 15

True

Question 16

Evergreen Corporation distributes land with a fair market value of $50,000 to its sole shareholder. Evergreen’s tax basis in the land is $200,000. Evergreen will report a tax loss of $150,000 on the distribution regardless of whether its earnings and profits are positive or negative.

Answer 16

False

Losses are not recognized on distributions of property.

Question 17

Which of the following statements best describes the priority of the tax treatment of a distribution from a corporation to a shareholder?

1. 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.
2. 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.

Answer 17

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.

Question 18

Which of the following statements best describes the role of current and accumulated earnings and profits in determining if a distribution is a dividend?

1. A distribution can never be a dividend if current earnings and profits are negative.
2. At a minimum, some portion of the distribution will be a dividend if current earnings and profits for the year are positive, even if accumulated earnings and profits are negative.

Answer 18

At a minimum, some portion of the distribution will be a dividend if current earnings and profits for the year are positive, even if accumulated earnings and profits are negative.

Question 19

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?

1. The distribution will be a dividend because current earnings and profits are positive and exceed the distribution.
2. The distribution will not be a dividend because total earnings and profits is a negative $700.

Answer 19

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 20

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?

1. $500 of the distribution will be a dividend because total earnings and profits is $500.
2. 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 20

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.

Question 21

Which of these items is not an adjustment to taxable income or net loss to compute current E&P?

1. Dividends received deduction.
2. Tax-exempt income.
3. Net capital loss carryforward utilized in the current year from the prior year tax return.
4. Refund of prior year taxes for an accrual method taxpayer.

Answer 21

Refund of prior year taxes for an accrual method taxpayer.

Question 22

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 a current year transaction treated as an installment sale of $25,000. The corporation’s current earnings and profits for 20X3 would be:

1. $524,000.
2. $500,000.
3. $354,000
4. $331,000.

Answer 22

$354,000

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

Question 23

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?

1. $300,000.
2. $200,000.
3. $100,000.
4. $0.

Answer 23

$200,000.

Question 24

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?

1. $0
2. $100,000.
3. $200,000.
4. $300,000.

Answer 24

$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 25

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:

1. $100,000 dividend and a tax basis in the land of $100,000.
2. $100,000 dividend and a tax basis in the land of $90,000.
3. Dividend of $90,000 and a tax basis in the land of $100,000.
4. Dividend of $90,000 and a tax basis in the land of $90,000.

Answer 25

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 26

Which of the following are subtractions from taxable income in computing current E&P?

1. Federal income taxes paid.
2. Current charitable contributions in excess of 10 percent limitation.
3. Current year net capital loss.
4. All of the choices are subtractions from taxable income in computing current E&P.

Answer 26

All of the choices are subtractions from taxable income in computing current E&P.

Question 27

A liquidation of a corporation always is a taxable event for the shareholder(s) of the liquidated corporation.

Answer 27

False
Tax deferral applies to a corporate shareholder owning 80 percent or more of the corporation’s stock before it is liquidated.

Question 28

The tax basis of property received by a noncorporate shareholder in a complete liquidation will be the property’s fair market value.

Answer 28

True

Question 29

Which of the following statements does not describe a tax consequence to shareholders in a complete liquidation?

1. All complete liquidations are taxable to the shareholders.
2. Complete liquidations are taxable to all individual shareholders.
3. Complete liquidations are taxable to all corporate shareholders owning stock of the liquidated corporation representing less than 80 percent or more of voting power and value.
4. Complete liquidations are tax deferred to corporate shareholders owning stock of the liquidated corporation representing 80 percent or more of voting power and value.

Answer 29

All complete liquidations are taxable to the shareholders.

Question 30

Red Blossom Corporation transferred its 40 percent interest to Tea Company as part of a complete liquidation of the company. In the exchange, Red Blossom received land with a fair market value of $500,000. The corporation’s basis in the Tea Company stock was $300,000. The land had a basis to Tea Company of $600,000. What amount of gain does Red Blossom recognize in the exchange and what is its basis in the land it receives?

1. $200,000 gain recognized and a basis in the land of $600,000.
2. $200,000 gain recognized and a basis in the land of $500,000.

Answer 30

$200,000 gain recognized and a basis in the land of $500,000.

Question 31

Which of the following statements best describes the recognition of loss on property transferred to shareholders in complete liquidation of a corporation?

1. The liquidated corporation always recognizes loss on the distribution of property in complete liquidation of the corporation.
2. The liquidated corporation never recognizes loss on the distribution of property in complete liquidation of the corporation.
3. The liquidated corporation recognizes loss on the distribution of property in complete liquidation of the corporation if the property is distributed to individuals who are not related parties to the corporation.
4. The liquidated corporation recognizes loss on the distribution of property in complete liquidation of the corporation only if the property is distributed to individuals who are related parties to the corporation.

Answer 31

The liquidated corporation recognizes loss on the distribution of property in complete liquidation of the corporation if the property is distributed to individuals who are not related parties to the corporation.