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, this set of essay questions and your answers to them will be collected. All answers must be entered in the bluebooks you have been provided (or, for those typing or operating computers, on separate sheets of plain white paper). No credit will be given for anything written on this set of questions.

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, you should assume that all shareholders described in the questions are individuals; that all shareholders and corporations described in the questions report their income on the calendar year for federal income tax purposes; that all shareholders report their income on the cash method for such purposes; and that all corporations report their income on the accrual method for such purposes.
 
 

Crenco is a C corporation that has been in existence and operation since June of 1989; it makes widgets. Crenco's two shareholders on June 30, 1991 are Lester, a men's clothier, who owns 60 shares of Crenco's voting common stock, and Mary, a newspaper columnist, who owns the other 40 shares of voting common. Each share of the voting common stock has a fair market value of $1,000. As of June 30, 1991, there are no other shares of Crenco outstanding.

On July 1, 1991, Lester transfers to Crenco a tract of real estate, Blackacre, with a fair market value of $405,000, subject to a mortgage of $250,000. Lester purchased Blackacre many years earlier as an investment; his adjusted basis in Blackacre immediately prior to the transfer is $100,000. Lester also contributes to Crenco his personal promissory note with a principal amount of $150,000. In addition to taking Blackacre subject to the mortgage, Crenco assumes a liability of $5,000 that Lester incurred in his clothing business. Crenco also issues to Lester 300 shares of its voting common stock, with a fair market value of $1,000 per share.

On December 15, 1991, Mary transfers to Crenco another tract of long-held investment real estate, Whiteacre, with a fair market value of $190,000. Mary's adjusted basis in Whiteacre immediately prior to the transfer is $10,000; there are no mortgages or other liabilities connected with the property. Crenco issues to Mary 100 shares of a new class of stock, nonvoting common stock, with a fair market value of $90,000; plus its promissory note, which is truly debt for tax purposes, with a face amount and fair market value of $100,000. The note calls for payment of $50,000 of principal, plus accrued interest at a market rate, in each of the years 1992 and 1993. Except for its lack of voting rights, the nonvoting common stock is identical in all respects to Crenco's voting common stock.

Answer each of the following questions:

(i) What are the federal income tax consequences to Lester, Mary and Crenco of the July 1 and December 15 transactions? Be sure to discuss the amount, timing and character (capital or ordinary) of any gain, loss or deduction to each party; Lester's basis and holding period for the 300 shares of stock issued to him; Mary's basis and holding period for the nonvoting common stock; and Crenco's bases in Blackacre and Whiteacre.

(ii) As of December 16, 1991, is Crenco eligible to elect to be an S corporation? Why or why not?

Discuss.

Catacorp is a C corporation in existence since 1985. Catacorp has one class of stock, voting common stock, with 100 shares outstanding. Twenty shares are owned by Frank, an individual; another 25 are owned by Frank's daughter, Dee. Another 40 shares are owned by a general partnership, in which Frank is a one-fifth partner and Frank's brother, Bob, is the four-fifths partner. The remaining 15 shares are scattered among 10 different unrelated individual shareholders; Frank has options to purchase seven of these shares at their fair market value, determined if and when the options are exercised. Frank's basis in his 20 shares is $200,000.

Catacorp proposes to redeem Frank's 20 shares of stock on July 1, 1991. It is planned that in the redemption, Catacorp will transfer to Frank rental real estate with a fair market value of $250,000, and an adjusted basis to Catacorp immediately before the redemption of $25,000; Frank will accept the property in exchange for his 20 shares. Frank, who has not been active in Catacorp's business for some time, is moving to a faraway locale and does not plan to participate as an officer, director, employee or independent contractor in Catacorp's business. He intends, however, to remain a minority partner in the partnership.

At the beginning of 1991, Catacorp's accumulated earnings and profits are a deficit of $200,000. For the year 1991, not taking into account the transactions described in this question, Catacorp estimates that it will have current earnings and profits of about $150,000.

Frank asks you, a tax lawyer, for advice on the tax impacts of the proposed redemption on him and on Catacorp. Write a memorandum describing the potential federal income tax consequences of the proposal. Be sure to discuss the amount, timing and character (capital or ordinary) of any gain, loss or deduction to each party; the impact of Frank's basis in his shares and Catacorp's basis in the rental property; Frank's basis in the rental property after the redemption; and the effect of the transaction on Catacorp's earnings and profits.

Explain.

Pascorp is a C corporation engaged in buying and selling real estate for profit. All of its stock is owned by an individual, Sally. Sally's basis in her Pascorp shares is $100,000.

Pascorp has for many years owned 90 percent of the outstanding common stock (the only class outstanding) of Surco, another corporation, which operates a commercial real estate dealership in a declining metropolitan area. The other 10 percent of the stock of Surco is owned by Michelle, an individual. Pascorp's basis in its Surco stock is $400,000; Michelle's basis in her Surco stock is $20,000. Pascorp and Surco do not file a consolidated tax return.

In 1990, Surco has $75,000 cash and two other assets, Greenacre and Redacre. Both are tracts of real estate that Surco has been holding for sale to customers. Greenacre has a fair market value of $90,000 and a basis to Surco of $120,000. Redacre has a fair market value of $10,000 and a basis to Surco of $5,000.

Surco liquidates in 1990. It uses its cash to pay all of its outstanding debts; it distributes Redacre to Michelle; and it distributes Greenacre to Pascorp. The entire liquidation, including all the distributions, takes place within 1990.

Two years later, in an unrelated transaction, Sally sells all of the shares of Pascorp to Byerco, another C corporation, for $250,000 cash. Immediately before the stock purchase, Pascorp has assets with an aggregate fair market value of $300,000 and an aggregate adjusted basis of $175,000, and liabilities of $50,000.

Answer each of the following questions:

(i) What are the federal income tax consequences to Pascorp, Surco and Michelle of the liquidation of Surco in 1990? Be sure to discuss the amount, timing and character (capital or ordinary) of any gain, loss or deduction to each party; Pascorp's basis in Greenacre; and Michelle's basis in Redacre.

(ii) What are the federal income tax consequences to Sally, Pascorp and Byerco of the transaction involving the Pascorp stock in 1992 (with and without any possible elections)? Be sure to discuss the amount, timing and character (capital or ordinary) of any gain, loss or deduction to each party; Byerco's basis in the Pascorp stock; and Pascorp's basis in its assets after the stock sale.

Discuss.

Created by:  bojack@lclark.edu
Update: 07 Mar 02
Expires: 31 Aug 02