Exam 19: Corporations: Distributions Not in Complete Liquidation

Puce Corporation, an accrual basis taxpayer, has struggled to survive since its formation, six years ago.As a result, it has a deficit in accumulated E & P at the beginning of the year of $340,000.This year, however, Puce earned a significant profit; taxable income was $240,000.Consequently, Puce made two cash distributions to Martha, its sole shareholder: $150,000 on July 1 and $200,000 December 31.The following information might be relevant to determining the tax treatment of the distributions.

The tax treatment of corporate distributions at the shareholder level does not depend on:

A shareholder's holding period of property acquired in a stock redemption begins on the date of the distribution.

Corporate distributions are presumed to be paid out of E & P and are treated as dividends unless the parties to the transaction can show otherwise.

In a not essentially equivalent redemption [§ 302(b)(1)], the meaningful reduction test is an objective safe harbor rule that taxpayers can rely upon for sale or exchange treatment.

Currently, Brown Corporation (E & P of $800,000) has 1,000 shares of common stock outstanding.Pat owns 200 shares.His wife owns 400 shares, his daughter owns 100 shares, and his father owns 300 shares.Two years ago, Pat transferred $30,000 to Brown Corporation in exchange for 100 newly issued shares of nonvoting preferred stock.In the current year, Brown Corporation redeems Pat's preferred stock for $50,000, its fair market value.With respect to the distribution in redemption of the preferred stock:

During the current year, Goose Corporation sold equipment for $500,000 (adjusted basis of $260,000).The equipment was purchased a few years ago for $560,000 and $300,000 in MACRS deductions have been claimed.ADS depreciation would have been $200,000.As a result of the sale, the adjustment to taxable income needed to determine current E & P is:

Stephanie is the sole shareholder and president of Hawk Corporation.She feels that she can justify at least a $220,000 bonus this year because of her performance.However, rather than a bonus in the form of a salary, she plans to have Hawk pay her a $220,000 dividend.Because Stephanie's marginal tax rate is 35%, she prefers to receive a dividend taxed at 15%.Her accountant, however, suggests a $310,000 bonus in lieu of the $220,000 dividend since Hawk Corporation is in the 34% tax bracket.Should Stephanie take the $220,000 dividend or the $310,000 bonus? Support your answer by computing the after-tax cost of the two alternatives to Hawk and to Stephanie.

Gold Corporation has accumulated E & P of $2 million as of January 1 of the current year.During the year, it expects to have earnings from operations of $1,680,000 and to distribute $900,000 in cash to shareholders.Gold Corporation also expects to sell an asset for a loss of $2 million.Thus, it anticipates incurring a deficit of $320,000 for the year.What can Gold do to minimize the amount of dividend income to its shareholders?

Scarlet Corporation (a calendar year taxpayer) has taxable income of $150,000, and its financial records reflect the following for the year. Scarlet Corporation's current E & P is:

Yolanda owns 60% of the outstanding stock of Amber Corporation. In a qualifying stock redemption, Amber distributes $20,000 to Yolanda in exchange for one-half of her shares (basis of $35,000). As a result of the redemption, Yolanda has a recognized capital loss of $15,000.

Puffin Corporation makes a property distribution to its sole shareholder, Bonnie. The property distributed is a car (basis of $30,000; fair market value of $20,000) that is subject to a $6,000 liability which Bonnie assumes.Puffin has no accumulated E & P and $30,000 of current E & P from other sources during the year.What is Puffin's E & P after taking into account the distribution of the car?

Vulture Corporation distributes land (basis of $250,000, fair market value of $475,000) to Bonita, a shareholder, to carry out a qualifying stock redemption. The land is distributed subject to a $300,000 liability. Bonita had a basis of $25,000 in the shares redeemed. With respect to the redemption:

Sally and her mother are the sole shareholders of Owl Corporation. During the current year, Owl distributes cash in redemption of all of Sally's stock. Sally continues to be employed as controller for Owl after the redemption. The distribution is a complete termination redemption resulting in sale or exchange treatment for Sally.

In the current year, Warbler Corporation (E & P of $250,000) made the following property distributions to its shareholders (all corporations): Warbler Corporation is not a member of a controlled group.As a result of the distribution:

When current E & P is positive and accumulated E & P has a deficit balance, the two accounts are netted for dividend determination purposes.

Grackle Corporation (E & P of $600,000) distributes cash of $200,000 and land (fair market value of $400,000; basis of $250,000) to a shareholder in a qualifying stock redemption. The land distributed is subject to a mortgage of $460,000. Grackle will recognize a gain of $150,000 as a result of the distribution.

Tracy and Lance, equal shareholders in Macaw Corporation, receive $600,000 each in distributions on December 31 of the current year. Macaw's current year taxable income is $1 million and it has no accumulated E & P. Last year, Macaw sold an appreciated asset for $1,200,000 (basis of $400,000). Payment for one-half of the sale of the asset was made this year. How much of Tracy's distribution will be taxed as a dividend?

Under certain circumstances, a distribution can generate (or add to) a deficit in E & P.

To determine E & P, some (but not all) previously excluded income items are added back to taxable income.