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Exam 5: Corporations: Earnings and Profits and Dividend Distributions

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Question 41

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Coral Corporation declares a nontaxable dividend payable in rights to subscribe to common stock.Each right entitles the holder to purchase one share of stock for $25.One right is issued for every two shares of stock owned.John owns 100 shares of stock in Coral,which he purchased three years ago for $3,000.At the time of the distribution,the value of the stock is $45 per share and the value of the rights is $2 per share.John receives 50 rights.He exercises 25 rights and sells the remaining 25 rights three months later for $2.50 per right.

A) John must allocate a part of the basis of his original stock in Coral to the rights.
B) If John does not allocate a part of the basis of his original stock to the rights, his basis in the new stock is zero.
C) Sale of the rights produces ordinary income to John of $62.50.
D) If John does not allocate a part of the basis of his original stock to the rights, his basis in the new stock is $625.
E) None of the above.

F) C) and D)
G) All of the above

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Question 42

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During the current year,Blue Corporation sold equipment for $220,000.The equipment had an adjusted basis of $150,000 at the sale date and was purchased a few years ago for $250,000.MACRS deductions claimed on the equipment was $100,000 while ADS depreciation was $60,000.As a result of the sale,what adjustment to taxable income is needed to determine E & P?

A) No adjustment is required.
B) Add $40,000 to taxable income.
C) Subtract $40,000 from taxable income.
D) Add $30,000 to taxable income.
E) None of the above.

F) A) and B)
G) All of the above

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Question 43

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Honeysuckle Corporation is wholly owned by Tabatha.Corporate employees and annual salaries include Tabatha ($300,000); Ryan,Tabatha's son ($80,000); Regina,Tabatha's daughter ($100,000); and Quincy ($120,000).The operation of Honeysuckle Corporation is shared about equally between Tabatha and Quincy (an unrelated party).Ryan and Regina are full-time college students at a university about 100 miles away.Honeysuckle Corporation has substantial E & P but has not distributed a dividend for the past three years.Discuss problems related to the salary arrangement for Honeysuckle Corporation.

The rules used to determine the taxability of stock dividends also apply to distributions of stock rights.

In August,Sunglow Corporation declares a $4 dividend out of E & P on each share of common stock to shareholders of record on October 1.Elaine and Tom each purchase 100 shares of Sunglow stock on September 1.On September 15,Elaine also purchases a short position in Sunglow.Tom sells 50 of his shares on October 15 and continues to hold the remaining 50 shares through the end of the year.Elaine closes her short position in Sunglow on December 15.With respect to the dividends,which of the following is correct?

A corporate shareholder that receives a constructive dividend cannot apply a dividends received deduction to the distribution.

Using the legend provided, classify each statement accordingly. In all cases, assume that taxable income is being adjusted to arrive at current E & P for 2008. a.Increase b.Decrease c.No effect -Nondeductible fines and penalties incurred in 2008.

During the year,Aqua Corporation distributes land to its sole shareholder.If the fair market value of the land is more than its adjusted basis,Aqua will recognize gain on the distribution.

Tern Corporation,a cash basis taxpayer,has taxable income of $500,000 for the current year.Tern elected $100,000 of § 179 expense.It also had a related party loss of $20,000 and a realized (not recognized) gain from an involuntary conversion of $75,000.It paid Federal income tax of $150,000 and paid a nondeductible fine of $10,000.Tern's current E & P is:

Under no circumstances can a distribution generate (or add to)a deficit in E & P.

Using the legend provided, classify each statement accordingly. In all cases, assume that taxable income is being adjusted to arrive at current E & P for 2008. a.Increase b.Decrease c.No effect -Domestic production activities deduction claimed in 2008.

Using the legend provided, classify each statement accordingly. In all cases, assume that taxable income is being adjusted to arrive at current E & P for 2008. a.Increase b.Decrease c.No effect -Loss on sale between related parties in 2008.

Tern Corporation distributes equipment (basis of $70,000 and fair market value of $90,000) as a property dividend to its shareholders.The equipment is subject to a liability of $100,000.Tern Corporation recognizes gain of:

Constructive dividends have no effect on a distributing corporation's E & P.

Jen,the sole shareholder of Mahogany Corporation,sold her stock to Jason on July 1 for $90,000.Jen's stock basis at the beginning of the year was $60,000.Mahogany made a $30,000 cash distribution to Jen immediately before the sale,while Jason received a $60,000 cash distribution from Mahogany on November 1.As of the beginning of the current year,Mahogany had $16,000 in accumulated E & P,while current E & P (before distributions) was $30,000.Which of the following statements is correct?

As of January 1,Cassowary Corporation has a deficit in accumulated E & P of $100,000.For the tax year,current E & P (accrued ratably) is $240,000 (prior to any distributions) .On July 1,Cassowary Corporation distributes $275,000 to its sole shareholder.The amount of the distribution that is a dividend is:

Scarlet Corporation has a deficit in accumulated E & P of $500,000.It has current E & P of $350,000.On July 1,Scarlet distributes $400,000 to its sole shareholder,Lupita.Lupita has a basis of $95,000 in her stock in Scarlet Corporation.As a result of the distribution,Lupita has:

Emu Corporation (a calendar year taxpayer) has taxable income of $250,000,and its financial records reflect the following for the year. Emu Corporation's current E & P is:

Using the legend provided, classify each statement accordingly. In all cases, assume that taxable income is being adjusted to determine current E & P for 2008. a.Increase b.Decrease c.No effect -Excess capital loss in year incurred.

On January 1,Cotton Candy Corporation (a calendar year taxpayer)has accumulated E & P of $400,000.Its current E & P for the year is $120,000 (before considering dividend distributions).During the year,Cotton Candy distributes $800,000 ($400,000 each)to its equal shareholders,Mary and Larry.Mary has a basis in her stock of $95,000,while Larry's basis is $160,000.What is the effect of the distribution by Cotton Candy Corporation on Mary and Larry?