Test bank taxation of individuals and business entities 2015 6e by brian c spilker chap01

Chapter 18
Corporate Taxation: Nonliquidating Distributions
True / False Questions
1. The "double taxation" of corporate income refers to the taxation of corporate income
at both the entity-level and the shareholder-level.
True

False

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

False

3. A corporation's "earnings and profits" account is equal to the company's "retained
earnings" account on its balance sheet.
True

False

4. 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.
True

False

5. 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.
True

False

6. Green Corporation has negative current earnings and profits of ($100,000) and
positive accumulated earnings and profits of $200,000. A $50,000 distribution from
Green to its sole shareholder will be treated as a dividend because total earnings and
profits is a positive $100,000.
True

False

7. The term "earnings and profits" is well defined in the Internal Revenue Code.
True

False

8. Only income and deductions included on a corporation's income tax return are
included in the computation of current earnings and profits.
True

False

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9. Cedar Corporation incurs a net capital loss of $20,000 in 20X3 that cannot be

deducted on its income tax return but must be carried forward to 20X4. Cedar will
deduct the net capital loss in the computation of current earnings and profits for
20X3.
True

False

10. 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.
True

False

11. 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.
True

False

12. 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.
True

False

13. 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
loss of $150,000 on the distribution regardless of whether its earnings and profits are
positive or negative.
True

False

14. Compensation recharacterized by the IRS as a dividend because it was considered
"unreasonable" will affect only the income tax liability of the corporation paying the
compensation.
True

False

15. Unreasonable compensation issues are more likely to arise in audits of privately held
corporations rather than publicly traded corporations.
True

False

16. Stock dividends are always tax-free to the recipient.
True

False

17. The recipient of a tax-free stock dividend will have a zero tax basis in the stock.
True

False

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

False

19. A stock redemption is always treated as a sale or exchange for tax purposes.
True

False

20. 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, Tammy must reduce her stock
ownership to below 48 percent.
True

False

21. Brothers and sisters are considered "family" under the stock attribution rules that
apply to stock redemptions.
True

False

22. Diego owns 30 percent of Azul Corporation. Azul Corporation owns 50 percent of
Verde Corporation. Under the attribution rules applying to stock redemptions, Diego
is treated as owning 15 percent of Verde Corporation.
True

False

23. The "family attribution" rules are automatically waived in a complete redemption of a
shareholder's stock.
True

False

24. Battle Corporation redeems 20 percent of its stock for $100,000 in a stock
redemption that is treated as an exchange by the shareholders. Battle's E&P at the
date of the redemption is $200,000. Battle will reduce its earnings and profits by
$100,000 because of the redemption.
True

False

25. A distribution in partial liquidation of a corporation is always treated as a sale or
exchange by an individual shareholder.
True

False

Multiple Choice Questions

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26. Which statement best describes the concept of the "double taxation" of corporation
income?

A.
B.
C.
D.

Corporate income is subject to two levels of taxation: the regular tax and the alter
Corporate income is taxed twice at the corporate level: first when earned and then
Corporate income is taxed when earned by a C corporation and then a second tim
Corporate income is subject to two levels of taxation: at the federal level and a se

27. Which of the following forms of earnings distributions would not be subject to double
taxation at the corporate and shareholder level?

A.
B.
C.
D.

Compensation paid to a shareholder/employee of the corporation

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

A.
B.
C.
D.

The distribution is a dividend to the extent of the corporation's earnings and profit
The distribution is a return of capital, then a dividend to the extent of the corporat
The distribution is a return of capital, then gain from sale of stock, and finally a di
The shareholder can elect to treat the distribution as either a dividend to the exte

29. Which of the following statements best describes current earnings and profits?

A.
B.
C.
D.

Current earnings and profits is another name for a corporation's retained earnings
Current earnings and profits is a precisely defined tax term in the Internal Revenue
Current earnings and profits is an ill-defined tax concept in the Internal Revenue C
Current earnings and profits is a conceptual tax concept with no definition in the I

30. 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.
B.
C.
D.

A distribution will only be a dividend if total earnings and profits (current plus accu
A distribution can never be a dividend if current earnings and profits are negati
A distribution will be a dividend if current earnings and profits for the year are pos
A distribution will never be a dividend if current earnings and profits for the year a

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31. 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.
B.
C.
D.

The distribution will not be a dividend because total earnings and profits is a nega
The distribution may be a dividend, depending on whether total earnings and profi
The distribution will be a dividend because current earnings and profits are positiv
A distribution from a corporation to a shareholder is always a dividend, regardless

32. 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.

B.
C.
D.

$500 of the distribution will be a dividend because total earnings and profits is $
$0 of the distribution will be a dividend because current earnings and profits are
$600 of the distribution will be a dividend because accumulated earnings and pro
Up to $600 of the distribution could be a dividend depending on the balance in ac

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

A.
B.
C.
D.

Dividends received deduction
Tax-exempt income
Net capital loss carryforward from the prior year tax return
Refund of prior year taxes for an accrual method taxpayer

34. 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.
B.

C.
D.
35. 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.
B.
C.
D.

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36. 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.
B.
C.
D.
37. 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.
B.
C.
D.
38. 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.
B.
C.
D.
39. 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.
B.
C.
D.

18-6

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40. 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.
B.
C.
D.
41. 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.
B.
C.
D.
42. 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.
B.
C.

D.
43. 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.
B.
C.
D.

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44. 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.
B.
C.
D.
45. 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.
B.
C.
D.

$400,000 divide
$100,000 dividend, $200,000 tax-free return of basis, and $100,000 capital ga
$200,000 dividend and $200,000 tax-free return of basis
$300,000 dividend and $100,000 tax-free return of basis

46. 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.
B.
C.
D.

$300,000 divide
$100,000 dividend, $100,000 tax-free return of basis, and $100,000 capital ga
$100,000 dividend and $200,000 tax-free return of basis
$0 dividend, $100,000 tax-free return of basis, and $200,000 capital gain

47. 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.
B.
C.
D.

$200,000 divide
$100,000 dividend, $50,000 tax-free return of basis, and $50,000 capital gain
$100,000 dividend and $100,000 tax-free return of basis
$0 dividend, $50,000 tax-free return of basis, and $150,000 capital gain

18-8
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48. 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.
B.
C.
D.

$100,000 dividend and a tax basis in the land of $100,000
$100,000 dividend and a tax basis in the land of $90,000
Dividend of $90,000 and a tax basis in the land of $100,000

Dividend of $90,000 and a tax basis in the land of $90,000

49. 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.
B.
C.
D.

No gain recognized and a reduction in E&P of $200,000
$150,000 gain recognized and a reduction in E&P of $200,000
$150,000 gain recognized and a reduction in E&P of $50,000
No gain recognized and a reduction in E&P of $50,000

50. 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.
B.
C.
D.

No gain recognized and a reduction in E&P of $200,000

$150,000 gain recognized and a reduction in E&P of $200,000
$150,000 gain recognized and a reduction in E&P of $175,000
No gain recognized and a reduction in E&P of $175,000

51. 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.
B.
C.
D.

No loss recognized and a reduction in E&P of $250,000
$50,000 loss recognized and a reduction in E&P of $250,000
$50,000 loss recognized and a reduction in E&P of $150,000
No loss recognized and a reduction in E&P of $200,000

18-9
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52. 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.
B.
C.
D.

No loss recognized and a reduction in E&P of $200,000
$50,000 loss recognized and a reduction in E&P of $200,000
$50,000 loss recognized and a reduction in E&P of $225,000
No loss recognized and a reduction in E&P of $225,000

53. Which of the following payments could be treated as a constructive dividend by the
IRS?

A.
B.
C.
D.

End-of-year bonus payment to a shareholder/employee
Rent paid to a shareholder/lessor
Interest paid to a shareholder/creditor
All of these payments could be treated as a constructive dividend by the IRS

54. Which of the following factors would not be considered in determining if
compensation paid to a shareholder/employee is reasonable?

A.
B.

C.
D.

The individual's duties and responsibilities
What individuals performing in comparable capacities at other companies are p
Whether the corporation has a formal compensation policy
The individual's marginal income tax rate

55. Which of the following statements is not considered a potential answer to the
dividend puzzle (why do corporations pay dividends)?

A.
B.
C.
D.

Paying dividends avoids the double taxation of corporate income
Demanding that managers pay out dividends restricts their investment activities a
Paying dividends is a source of investor goodwill
Dividends are a signal to the capital markets about the health of a corporation's

56. Which of the following stock dividends would be tax-free to the shareholder?

A.
B.
C.
D.

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

A stock dividend to all holders of preferred stock
Both a 2-for-1 stock split to all holders of common stock and a stock dividend to a

18-10
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57. 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.
B.
C.
D.

$0 dividend income and a tax basis in the new stock of $100 per share
$0 dividend income and a tax basis in the new stock of $60 per share
$0 dividend income and a tax basis in the new stock of $40 per share
$15,000 dividend and a tax basis in the new stock of $100 per share

58. 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.
B.
C.
D.

$0 dividend income and a tax basis in the new stock of $180 per share
$0 dividend income and a tax basis in the new stock of $67.50 per share
$0 dividend income and a tax basis in the new stock of $56.25 per share
$10,800 dividend and a tax basis in the new stock of $180 per share

59. Which of the following individuals is not considered "family" for purposes of applying
the stock attribution rules to a stock redemption?

A.
B.
C.
D.
60. Which of the following statements is true?

A.
B.
C.
D.

All stock redemptions are treated as exchanges for tax purposes.
A stock redemption not treated as an exchange will automatically be treated as a
All stock redemptions are treated as dividends if received by an individual.
A stock redemption is treated as an exchange only if it meets one of three stock o

61. 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.
B.
C.
D.

Any percentage less than 70 percent
Any percentage less than 56 percent
Any percentage less than 50 percent
All stock redemptions involving individuals are treated as exchanges

18-11
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62. 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.
B.
C.
D.

Any percentage less than 60 percent
Any percentage less than 50 percent
Any percentage less than 48 percent
All stock redemptions involving individuals are treated as exchanges

63. 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.
B.
C.
D.

$25,000 capital gain and a tax basis in each of her remaining shares of $500.
$25,000 capital gain and a tax basis in each of her remaining shares of $100.
$50,000 dividend and a tax basis in each of her remaining shares of $100.
$50,000 dividend and a tax basis in each of her remaining shares of $50.

64. 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.
B.

C.
D.

No reduction in E&P because of the exchange.
A reduction of $50,000 in E&P because of the exchange.
A reduction of $62,500 in E&P because of the exchange.
A reduction of $125,000 in E&P because of the exchange.

65. 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.
B.
C.
D.

No reduction in E&P because of the exchange.
A reduction of $50,000 in E&P because of the exchange.
A reduction of $40,000 in E&P because of the exchange.
A reduction of $80,000 in E&P because of the exchange.

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66. 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.
B.
C.
D.

$75,000 capital gain and a tax basis in each of his remaining shares of $1,000.
$75,000 capital gain and a tax basis in each of his remaining shares of $2,000.
$150,000 dividend and a tax basis in each of his remaining shares of $1,000.
$150,000 dividend and a tax basis in each of his remaining shares of $4,000.

67. 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.
B.
C.
D.

No reduction in E&P because of the exchange.
A reduction of $150,000 in E&P because of the exchange.
A reduction of $187,500 in E&P because of the exchange.
A reduction of $375,000 in E&P because of the exchange.

68. 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.
B.
C.
D.
69. 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.
B.
C.
D.

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70. 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.
B.

C.
D.
71. 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.
B.
C.
D.
72. 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.
B.
C.
D.
73. 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.
B.
C.
D.

A stock redemption that completely terminates Tammy's direct interest in a corpor
A stock redemption that completely terminates Tammy's direct interest in a corpor

A stock redemption that completely terminates Tammy's direct interest in a corpo
A stock redemption that completely terminates Tammy's direct interest in a corpo

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74. 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.
B.
C.
D.

Henry has dividend income of $50,000 and a tax basis in his remaining shares of $
Henry has capital gain of $25,000 and a tax basis in his remaining shares of $100
Henry has dividend income of $50,000 and a tax basis in his remaining shares of
Henry has capital gain of $25,000 and a tax basis in his remaining shares of $200

75. 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.
B.
C.
D.

Tiara does not recognize any dividend income or capital gain.
Tiara recognizes capital gain of $50,000.
Tiara recognizes dividend income of $50,000.
Tiara recognizes capital gain of $25,000.

Essay Questions
76. Superior Corporation reported taxable income of $1,000,000 in 20X3. Superior paid a
dividend of $100,000 to its sole shareholder, Mary Yooper. Superior Corporation is
subject to a flat rate tax of 34%. The dividend meets the requirements to be a
"qualified dividend" and Mary is subject to a tax rate of 15% on the dividend. What is
the total federal income tax imposed on the corporate income earned by Superior
and distributed to Mary as a dividend?

18-15
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77. Erie Corporation reported taxable income of $2,200,000 in 20X3 before any
deduction for any payment to its sole shareholder and employee, LaBron Cleveland.
Erie paid a bonus of $200,000 to LaBron at year-end. Erie Corporation is subject to a
flat-rate tax of 34%. The bonus meets the requirements to be "reasonable" and is
therefore deductible by Erie. LaBron is subject to a marginal tax rate of 35% on the
bonus. What is the total federal income tax imposed on the corporate income earned
by Erie and paid to LaBron as a bonus?

78. St. Clair Company reports positive current E&P of $500,000 in 20X3 and positive
accumulated E&P at the beginning of the year of $400,000. St. Clair Company
distributed $600,000 to its sole shareholder, Danielle Brush on December 31, 20X3.
Danielle's tax basis in her St. Clair stock is $120,000. How much of the $600,000
distribution is treated as a dividend to Danielle and what is her basis in St. Clair stock
after the distribution?

79. Austin Company reports positive current E&P of $200,000 and negative accumulated
E&P of $300,000. Austin distributed $250,000 to its sole shareholder, Betsy Bevo, on
December 31, 20X3. Betsy' tax basis in her stock is $125,000. How much of the
$250,000 distribution is treated as a dividend to Betsy and what is her tax basis in
Austin stock after the distribution?

18-16
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80. Elk Company reports negative current E&P of $200,000 and positive accumulated
E&P of $300,000. Elk distributed $200,000 to its sole shareholder, Barney Rubble, on
December 31, 20X3. Barney's tax basis in his Elk stock is $75,000. What is the tax
treatment of the distribution to Barney and what is his tax basis in Elk stock after the

distribution?

81. Houghton Company reports negative current E&P of ($500,000) and negative
accumulated E&P of ($800,000). Houghton distributed $100,000 to its sole
shareholder, Blossom Applegate, on December 31, 20X3. Blossom's tax basis in her
Houghton stock is $50,000. What is the tax treatment of the distribution to Blossom
and what is her tax basis in Houghton stock after the distribution?

82. Loon, Inc. reported taxable income of $600,000 in 20X3 and paid federal income
taxes of $202,000. Not included in the company's computation of taxable income is
tax-exempt interest of $30,000, disallowed meals and entertainment expenses of
$15,000, and disallowed expenses related to the tax-exempt income of $4,000. Loon
deducted depreciation of $200,000 on its tax return. Under the alternative (E&P)
depreciation method, the deduction would have been $80,000. Compute the
company's current E&P for 20X3.

18-17
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83. Orchard, Inc. reported taxable income of $800,000 in 20X3 and paid federal income
taxes of $272,000. Included in the company's computation of taxable income is gain
from sale of a depreciable asset of $200,000. The income tax basis of the asset was
$50,000. The E&P basis of the asset using the alternative depreciation system was
$75,000. Compute the company's current E&P for 20X3.

84. Walloon, Inc. reported taxable income of $1,000,000 in 20X3 and paid federal income
taxes of $340,000. The company reported a capital gain from sale of investments of
$150,000, which was partially offset by a $40,000 net capital loss carryover from

20X2, resulting in a net capital gain of $110,000 included in taxable income.
Compute the company's current E&P for 20X3.

85. Otter Corporation reported taxable income of $400,000 from operations for 20X3.
The company paid federal income taxes of $136,000 on this taxable income. During
the year, the company made a distribution of land to its sole shareholder, Emmet
Jugg. The land's fair market value was $50,000 and its tax and E&P basis to Otter was
$30,000. Emmet assumed a mortgage attached to the land of $10,000. Any gain
from the distribution will be taxed at 34%. The company had accumulated E&P of
$900,000 at the beginning of the year. Compute Otter's total taxable income and
federal income tax paid because of the distribution (assume a tax rate of 34%). Using
your solution, compute Otter's current E&P for 20X3.

18-18
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86. Ozark Corporation reported taxable income of $500,000 from operations for 20X3.
During the year, the company made a distribution of land to its sole shareholder,
Marcus Twain. The land's fair market value was $100,000 and its tax and E&P basis to
Ozark was $125,000. Marcus assumed a mortgage attached to the land of $25,000.
Ozark's tax rate is 34%. The company had accumulated E&P of $850,000 at the
beginning of the year. Compute Ozark's total taxable income and federal income tax
paid because of the distribution. Using your solution, compute Otter's accumulated
E&P at January 1, 20X4.

87. Sherburne Corporation reported current earnings and profits for 20X3 of $500,000.
During the year, the company made a distribution of land to its sole shareholder, Ted
Bozeman. The land's fair market value was $150,000 and its tax and E&P basis to

Sherburne was $100,000. Ted assumed a mortgage attached to the land of $25,000.
What amount of dividend income does Ted report because of the distribution and
what is Ted's income tax basis in the land received from Sherburne?

18-19
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88. Sunapee Corporation reported taxable income of $700,000 from operations for 20X3.
During the year, the company made a distribution of land to its sole shareholder, Jean
McCarthy. The land's fair market value was $125,000 and its tax and E&P basis to
Sunapee was $75,000. Jean assumed a mortgage attached to the land of $25,000.
Sunapee's tax rate is 34%. Compute Sunapee's total taxable income and federal
income tax paid because of the distribution. Using your solution, compute Sunapee's
current E&P for 20X3.

89. Tappan Company pays its sole shareholder, Carlita Hill, a salary of $200,000. At the
end of each year, the company pays Carlita a "bonus" equal to the difference
between the corporation's taxable income for the year (before the bonus) and
$75,000. For 20X3, Tappan reported pre-bonus taxable income of $800,000 and paid
Carlita a bonus of $725,000. On audit, the IRS determined that individuals working in
Carlita's position earned on average $300,000 per year. The company had no formal
compensation policy and never paid a dividend. How much of Carlita's compensation
(salary plus bonus) might the IRS recharacterize as a dividend? Assuming the IRS
recharacterizes $500,000 of Carlita's bonus as a dividend, what additional income tax
liability does Tappan Company face? (Ignore payroll taxes)

18-20
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90. Townsend Corporation declared a 1-for-1 stock split to all common stock shareholders
of record on December 31, 20X3. Townsend reported current E&P of $400,000 and
accumulated E&P of $1,000,000. The total fair market value of the stock distributed
was $500,000. Regina Williams owned 1,000 shares of Townsend common stock with
a tax basis of $200 per share ($2,000,000 total). The fair market value of the
common stock was $300 per share on December 31, 20X3. What is Regina's income
tax basis in the new and existing common stock she owns in Townsend, assuming the
distribution is tax-free?

91. Sweetwater Corporation declared a stock dividend to all common stock shareholders
of record on December 31, 20X3. Shareholders will receive 1 share of Sweetwater
common stock for each 5 shares of common stock they already own. Pierre Dorgan
owns 500 shares of Sweetwater common stock with a tax basis of $150 per share.
The fair market value of the Sweetwater common stock was $90 per share on
December 31. What is Pierre's income tax basis in his new and existing common
stock in Sweetwater, assuming the distribution is non-taxable?

18-21
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92. Buckeye Company is owned equally by James and his brother Terrelle, each of whom
own 500 shares in the company. Terrelle wants to reduce his ownership in the
company, and it was decided that the company will redeem 200 of his shares for
$5,000 per share on December 31, 20X3. Terrelle's income tax basis in each share is
$1,000. Buckeye has current E&P of $10,000,000 and accumulated E&P of

$20,000,000. What is the amount and character (capital gain or dividend) recognized
by Terrelle because of the stock redemption?

93. Pine Creek Company is owned equally by Bob and his sister Samantha, each of whom
own 1,000 shares in the company. On December 31, 20X3, Pine Creek redeemed 200
of Samantha's shares for $5,000,000 in a transaction treated as an exchange by
Samantha. Pine Creek has current E&P of $10,000,000 and accumulated E&P of
$30,000,000 (computed without regard to the stock redemption). Assuming Pine
Creek did not make any dividend distributions during 20X3, by what amount does the
company reduce its E&P because of the redemption?

94. Goose Company is owned equally by Val and her sister Eugenia, each of whom own
500 shares in the company. Val wants to reduce her ownership in the company and
have the transaction treated as an exchange for tax purposes. Determine the
minimum amount of stock that Goose must redeem from Val for her to treat the
redemption as being "substantially disproportionate with respect to the shareholder"
and receive exchange treatment.

18-22
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95. Crystal, Inc. is owned equally by John and his wife Arlene, each of whom own 500
shares in the company. Arlene wants to reduce her ownership in the company, and it
was decided that the company will redeem 200 of her shares for $5,000 per share on
December 31, 20X3. Arlene's income tax basis in each share is $1,000. Crystal has
current E&P of $1,000,000 and accumulated E&P of $3,000,000. What is the amount
and character (capital gain or dividend) recognized by Arlene as a result of the stock
redemption, assuming only the "substantially disproportionate with respect to the

shareholder" test is applied?

96. Crescent Corporation is owned equally by George and his daughter Olympia, each of
whom own 100 shares in the company. George wants to retire from the company, and
it was decided that the company will redeem all 100 of his shares for $10,000 per
share on December 31, 20X3. George's income tax basis in each share is $2,000.
Crescent has current E&P of $1,000,000 and accumulated E&P of $5,000,000. What
must George do to ensure that the redemption will be treated as an exchange?

18-23
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97. Tiger Corporation, a privately-held company, has one class of voting common stock,
of which 1,000 shares are issued and outstanding. The shares are owned as follows:

How many shares of stock is Mark deemed to own under the family attribution rules
in a stock redemption?

98. Geneva Corporation, a privately-held company, has one class of voting common
stock, of which 1,000 shares are issued and outstanding. The shares are owned as
follows:

Madison has a 20 percent interest in the partnership. The remaining 80 percent is
owned by unrelated individuals. Madison owns 40% of Packer Corporation. The other
60 percent is owned by her father.
How many shares of stock is Madison deemed to own under the family attribution
rules in a stock redemption?

18-24
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99. Half Moon Corporation made a distribution of $300,000 to Arnold Swartz in partial
liquidation of the company on December 31, 20X3. Arnold owns 100% of Half Moon
Corporation (1,200 shares). The distribution was in exchange for 50% of Arnold's
stock in the company (600 shares). At the time of the distribution, the shares had a
fair market value of $500 per share. Arnold's income tax basis in the shares was $250
per share. Half Moon had total E&P of $2,000,000 at the time of the distribution.
What is the amount and character (capital gain or dividend) of any income or gain
recognized by Arnold as a result of the partial liquidation?

100 Yellowstone Corporation made a distribution of $300,000 to Cheney, Inc. in partial
.
liquidation of the company on December 31, 20X3. Cheney, Inc. owns 50 percent of
Yellowstone Corporation (1,000 shares). The other 50 percent is owned by an
unrelated corporation. The distribution was in exchange for 50% of Cheney's stock in
the company (500 shares). At the time of the distribution, the shares had a fair
market value of $800 per share. Cheney's income tax basis in the shares was $500
per share. Yellowstone had total E&P of $5,000,000 at the time of the distribution.
What is the amount and character (capital gain or dividend) of any income or gain
recognized by Cheney as a result of the partial liquidation?

18-25
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