Corporate Taxation
Spring 2018
Bogdanski
  

FINAL EXAMINATION

(Three hours)

INSTRUCTIONS

            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, then unless you have been otherwise expressly authorized by the law school, you must submit your answers using Examplify. 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)

            On January 20, 2018, Amy transfers Blackacre, a parcel of rental real estate, to a newly formed corporation, Corp. In exchange for Blackacre, Amy receives 800 shares of Corp’s common stock. The stock has a fair market value of $800,000. Immediately before the exchange, Blackacre’s fair market value is $1,000,000, and Amy, who owns Blackacre free and clear of any liens or encumbrances, has an adjusted basis in Blackacre of $500,000.

            In addition to the Corp common stock, Amy also receives from Corp in the exchange Corp’s contingent, subordinated income debenture, with a fair market value of $200,000. The debenture calls for annual payments by Corp to Amy in 2019 and 2020. Shortly after the exchange with Amy, Corp commences business operations.

            On March 20, 2018, Corp issues 400 shares of its common stock to Bibi in exchange for Bibi’s agreement to perform future services on Corp’s behalf. The stock issued to Bibi, which has an aggregate fair market value of $250,000, is immediately vested, and its issuance to Bibi in exchange for future services is valid under applicable state law. Corp issues no additional stock.

            On March 25, 2018, Corp files an election with the Internal Revenue Service under Section 1362(a) of the Code. Amy and Bibi both sign consents to the election, and Corp includes the consents with its election.

            In 2019 and 2020, Corp is highly profitable and makes the payments to Amy that are called for in the debenture. 

            Answer all of the following questions:

                   A. (80 percent of question grade) What are the federal income tax consequences to Corp, Amy, and Bibi 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 Corp’s earnings and profits. 

                   B. (20 percent of question grade) Is Corp’s March 25 election valid? Assuming that it is, what is its effect, and when does it take effect?

            Discuss. 

(End of Question 1)

QUESTION TWO

(One hour)

            RST is a corporation with two classes of stock outstanding, common and preferred. The preferred stock is held by an insurance company that is unrelated to the common stockholders. At the start of the current year, RST has accumulated earnings and profits of $400,000, which is a reasonable accumulation considering the nature of RST’s business.

            The outstanding common stock of RST is owned as follows:

            Lco is a limited liability company, the only member of which is an individual, Tito. Lco has not made any tax elections. Wilma is Tito’s spouse. Doli is the daughter of Tito and Wilma. Doli received her shares five years ago as a gift from Tito. Trust No. 1 was established by the will of Tito’s late mother, Maya. The sole beneficiary of Trust No. 1 is Doli.

            Tito is RST’s landlord. Tito owns the real estate housing RST’s corporate headquarters and primary operations center.

            On July 1 of the current year, RST redeems all 400 of its shares held by Lco, in exchange for $50,000 cash and RST’s promissory note with a face value and fair market value of $350,000. The promissory note is payable over five years; it bears interest at a market rate. Immediately before the redemption, Lco’s stock in RST has an adjusted basis of $500 per share, or an aggregate adjusted basis of $200,000. RST makes no other distributions with respect to its stock, nor does it redeem any of its other stock, for many years.

            For the current year, RST has a net operating loss, and a deficit in earnings and profits, of $100,000. 

            What are the federal income tax consequences to Lco, Tito, Doli, and RST 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 RST’s earnings and profits. 

            Explain.

(End of Question 2)

QUESTION THREE

(One hour)

            Zzz is a highly successful C corporation with accumulated earnings and profits that exceed the demands of its operations. Zzz’s stock is owned by its founder and chief executive, an individual named Jung. Jung owns 90 percent of Zzz’s outstanding common stock, and all of Zzz’s outstanding preferred stock. The preferred stock was issued by Zzz to Jung in a tax-free stock dividend six months ago. The other 10 percent of Zzz’s common stock is owned by Rachel, an individual unrelated to Jung.

            Jung’s adjusted basis in all of his Zzz stock is $200,000. Rachel’s adjusted basis in all of her Zzz stock is $20,000.

            Zzz has the following assets:

            Jung is approached by a publicly traded company, Pubcorp, which offers Zzz a total of $1,500,000 in cash and notes for all of Zzz’s assets, including goodwill and going concern value, but excluding the equipment. On behalf of Zzz, Jung makes a verbal commitment to Pubcorp to accept its offer. The next week, the board of directors of Zzz and both of Zzz’s shareholders vote to adopt a plan of liquidation and accept the Pubcorp offer for Zzz.

            The following month, the acquisition closes. Zzz transfers all of its assets, other than the equipment, to Pubcorp in exchange for $1,000,000 cash and a promissory note of Pubcorp with a face value and a fair market value of $500,000. The note provides for deferred annual payments of $100,000 of principal for five years, along with interest at a market rate. Pubcorp does not assume any liabilities of Zzz, nor does it take the Zzz assets subject to any liabilities.

            A few months later, after paying all its debts, Zzz distributes all of its remaining cash, $500,000, and the $500,000 Pubcorp note to Jung in redemption of all of Jung’s Zzz common and preferred stock. At the same time, Zzz distributes the equipment, with a fair market value of $80,000, to Rachel in redemption of all of Rachel’s Zzz common stock. By virtue of these transactions, Zzz is completely liquidated and dissolved.

            What are the federal income tax consequences to Zzz, Jung, and Rachel 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 Zzz’s earnings and profits. 

            Discuss.

(End of examination)

Created by: bojack@lclark.edu
Update:  6 Apr 19
Expires:  31 Aug 20