Corporate Taxation
Spring 2017
Bogdanski
FINAL EXAMINATION
(Three hours)
This examination consists of three essay questions, each of which will be given equal weight in determining grades. Three hours will be permitted for this examination.
At the end of the three hours, you must turn in this set of essay questions in the original envelope in which this set came. If you are using a computer, unless you have been otherwise expressly authorized by the law school, you must submit your answers using SofTest. If you are writing answers by hand, you must write them all in the bluebook(s) you have been provided, and return the bluebook(s) along with this set of questions in the envelope.
No credit will be given for anything written on this set of questions. Only your electronic answer file or bluebook(s) will be graded.
Pay close attention to the final portion, or “call,” of each question. Failure to respond to the matters called for will result in a low score for the question. On the other hand, discussion of matters outside the scope of the call of the question will not receive credit.
Be sure to explain as thoroughly as possible your answers to the questions posed. Your reasoning, discussion, and analysis are often as important as any particular conclusion you reach.
The suggested time limit for each question is one hour. Experience has shown that failure to budget one’s time according to this limit can result in a drastic lowering of one’s overall grade on this examination.
Unless otherwise instructed, assume that:
• all shareholders described in the questions are individuals;
• all shareholders and corporations described in the questions use the calendar year as their taxable year for federal income tax purposes;
• all shareholders report their income on the cash method for such purposes; and
• all corporations report their income on the accrual method for such purposes.
Any references to “the Code” are to the Internal Revenue Code of 1986, as amended.
QUESTION ONE
(One hour)
Maria and Gwen own all of the stock of Corp, a C corporation with substantial (but reasonable) accumulated earnings and profits. Gwen is Maria’s grandmother. Maria owns 80 percent of the stock of Corp; Gwen owns the other 20 percent. Neither shareholder performs services for Corp. Prior to the transactions described next, Corp has only one class of stock, voting common stock, outstanding. Maria’s Corp stock has a fair market value of $400,000 and an aggregate adjusted basis to Maria of $80,000.
In 2017, Corp’s board of directors (which includes Maria and Gwen) decides to make distributions to Corp’s shareholders. The distribution transaction has two elements:
1. Corp creates a new class of stock – nonvoting preferred stock – and issues 100 shares of the preferred stock to Gwen. The preferred stock issued to Gwen has a fair market value of $20,000. The preferred stock does not share in any future growth in the assets or earnings of Corp.
2. Corp issues to Maria a five-year promissory note, bearing interest at a market rate, with a face value and a fair market value of $80,000.
Neither shareholder surrenders any Corp shares or any other consideration to Corp in the distribution transaction.
Maria also owns stock in another C corporation, Broco, which also has substantial (but reasonable) accumulated earnings and profits. Maria owns 60 percent of the stock of Broco; the other 40 percent is owned by Maria’s cousin, Cecil. Broco has only one class of stock, voting common stock, outstanding.
In 2018, in a transaction unrelated to the Corp distributions in 2017, Maria sells all of her Corp stock to Broco for $350,000 cash, which is the fair market value of the Corp stock at the time of the sale. Maria retains the Corp promissory note.
Neither corporation elects to be an S corporation at any time.
What are the federal income tax consequences to Maria, Gwen, Corp, and Broco of each of the transactions just described, with and without any other available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of any income, gain, loss, or deduction realized or recognized by each party; each party’s basis in the stock or assets that party holds, at each stage of the transactions; and the effects of each of the transactions on each corporation’s earnings and profits.
Discuss.
(End of Question 1)
QUESTION TWO
(One hour)
Risco is a C corporation whose sole class of outstanding stock is owned equally by two shareholders, Jim and Keisha. Jim is a nonresident alien. Jim and Keisha purchased their stock several years ago from Risco’s founder, an unrelated party. Each shareholder currently has an adjusted basis in his or her respective shares of $100,000. Prior to the transactions discussed next, Risco has a small deficit in its accumulated earnings and profits.
In the fall of 2017, the shareholders determine that Risco needs additional assets to function optimally. The shareholders agree to supply the additional assets within a few months.
In December of 2017, Jim contributes a large piece of equipment to Risco in exchange for 100 additional shares of Risco’s single class of stock. Immediately before the exchange, the equipment, which was fully depreciated for tax purposes, has an adjusted basis in Jim’s hands of zero, and a fair market value of $215,000. The stock transferred to Jim in the exchange has a fair market value of $200,000. In addition to the stock, Risco transfers to Jim some unwanted inventory with a fair market value of $15,000. Immediately before the transfer, Risco has an adjusted basis in this inventory of $12,000.
In April of 2018, Keisha contributes to Risco Blackacre, improved rental real estate, with a fair market value of $380,000 and an adjusted basis to Keisha of $150,000. Blackacre is encumbered by a long-term mortgage of $180,000, so that Keisha’s “equity” in the property is $200,000. In exchange for Blackacre, Risco assumes the mortgage and transfers to Keisha 100 additional shares of Risco’s single class of stock. The stock transferred to Keisha has a fair market value of $200,000.
Risco makes no distributions to its shareholders with respect to their Risco stock in 2017 or 2018.
What are the federal income tax consequences to Jim, Keisha, and Risco of each of the transactions just described, with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of any income, gain, loss, or deduction realized or recognized by each party; each party’s basis in the stock or assets that party holds at each stage of the transactions; and the effects of the transactions on Risco’s earnings and profits.
Explain.
(End of Question 2)
QUESTION THREE
(One hour)
Tarco is a C corporation. Tarco’s shares are owned equally by three individual shareholders: Derek, Elvin, and Felicia, all of whom are U.S. citizens. Each shareholder has an aggregate adjusted basis in his or her shares of Tarco stock of $200,000.
The balance sheet of Tarco shows the following assets, and the adjusted basis of each. Tarco, which has always been managed conservatively, has outstanding debts of only $50,000.
|
Asset |
Adjusted basis |
|
Cash |
$ 200,000 |
|
Workshop building |
300,000 |
|
Vehicles and equipment |
150,000 |
|
Inventory |
300,000 |
|
Total |
$ 950,000 |
Tarco also has built up considerable goodwill with its customers and suppliers. This intangible asset, in which Tarco has a basis of zero, has a sizeable fair market value, as does the corporation’s other assets.
Tarco and its shareholders are approached by Predco, a publicly traded C corporation that is interested in acquiring Tarco’s business. Predco offers to purchase all of Tarco’s assets from Tarco for $1,500,000 cash – payable half immediately, and the other half three years from now, with interest on the unpaid balance, computed at a market rate, payable quarterly in the interim. Predco would also assume the $50,000 of Tarco debt. Tarco could liquidate a year or two after the closing and distribute its assets (consideration received from Predco, plus post-closing interest earned on a bank account) to the shareholders.
As an alternative, Predco would be willing to purchase all the stock of Tarco from the shareholders. Like the possible asset sale, the proposed stock purchase would feature payment of half the purchase price immediately, and the other half three years from now, with interest on the unpaid balance, computed at a market rate, payable quarterly in the interim. As part of a stock purchase, Predco would require the Tarco shareholders to indemnify Predco against any unknown liabilities of Tarco that might be discovered after the transaction closes. The exact purchase price for the stock would depend in part on the tax consequences of the acquisition to Predco, both at the closing and in the future.
A. (80% of question grade) What would the federal income tax consequences be to Derek, Elvin, Felicia, Tarco, and Predco of each of the proposed alternative transactions just described, with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of any income, gain, loss, or deduction realized or recognized by each party; each party’s basis in the stock or assets that party holds at each stage of the transactions; and the effects of the transactions on Tarco’s earnings and profits.
B. (20% of question grade) Would the analysis in Part A be different if Tarco elected to be an S corporation between now and the sale?
Discuss.
(End of examination)
Created by: bojack@lclark.edu
Update: 17 May 17
Expires: 31 Aug 18