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;

-- all shareholders and corporations described in the questions use the calendar year as their taxable year for federal income tax purposes;

-- all shareholders and S corporations report their income on the cash method for such purposes; and

-- all C corporations report their income on the accrual method for such purposes.
 
 

Tagco is a C corporation with accumulated earnings and profits at the beginning of 1992 of $1,000,000. Tagco has the following assets:
 

Asset	Adjusted basis	Fair market value
Real estate (no depreciation recapture)	$ 800,000	$1,000,000
Machinery and equipment (original cost $900,000)	250,000	500,000
Inventory	300,000	200,000
Accounts receivable	325,000	300,000
Total assets	$1,675,000	$2,000,000

Tagco has liabilities of $1,500,000, so its net worth is $500,000.

Tagco's stock is owned by Carla and Jason. Carla is Jason's mother. The stock consists of 100 shares of common stock and 100 shares of preferred stock; Carla and Jason each own 50 shares of common and 50 shares of preferred. Tagco issued the preferred stock to Carla and Jason as a nontaxable stock dividend several years ago, when it had substantial earnings and profits. Each shareholder has an overall basis in his or her stock of $100,000.

Carla and Jason are approached by executives of Raidco, a publicly traded corporation that wants to acquire Tagco's business. The parties propose two alternative structures for the takeover:

A. Tagco is liquidated, distributing the real estate to Carla and the machinery, equipment, inventory and receivables to Jason; Carla and Jason each assume $750,000 of Tagco's liabilities; Carla and Jason then sell all of the former Tagco assets to Raidco for $500,000 cash ($250,000 each), and Raidco assumes all of the former Tagco liabilities.

B. Tagco is merged into Raidco, in a transaction under state merger statutes, in which Carla and Jason receive Raidco stock; each receives Raidco stock representing 2.5 percent of the voting power of the outstanding Raidco stock and having a fair market value of $250,000.

What are the federal income tax consequences to Carla, Jason, Tagco and Raidco of each of the alternative takeover proposals? In each case, be sure to discuss the amount, timing and character (capital or ordinary) of any gain, loss or deduction to each party; each party's basis in the stock or assets that party holds at each stage of the transactions; and the impact of Tagco's earnings and profits.

Discuss.

Excorp is a C corporation with no earnings and profits. As of March 1, 1992, it has 100 shares of common stock outstanding, all of which are held by Daisy. Each share of Excorp stock has a fair market value of $1,000.

On March 2, 1992, Daisy transfers to Excorp a machine that she has been using in her individual business. The machine has a fair market value of $175,000; it is subject to a security interest (i.e., a mortgage) of $100,000. Daisy's adjusted basis in the machine immediately before the transfer is $150,000; her original cost of the machine was $200,000, and she has taken $50,000 of depreciation deductions on it over past years. In exchange for the machine, Excorp issues to Daisy 25 shares of a new class of stock, nonvoting preferred stock, with a fair market value of $1,000 per share; and $50,000 cash. After the transaction, Daisy's 25 shares of preferred stock are the only shares of preferred stock Excorp has outstanding.

On June 15, 1992, Edgar transfers to Excorp a computer with a fair market value of $1,000. Edgar's adjusted basis in the computer, which he has previously used for recreational and hobby purposes, is $2,000. In exchange for the computer, and in consideration for $24,000 worth of past services rendered by Edgar to Excorp, Excorp issues to Edgar 25 additional shares of common stock, with a fair market value of $1,000 per share. The shareholders and Excorp enter into no other exchanges between them during 1992.

Answer each of the following questions:

A. On these facts, which of the shareholders (Daisy, Edgar, both or neither) experiences nonrecognition of gain or loss (either in whole or in part) under Section 351 of the Internal Revenue Code of 1986, as amended (the "Code"), for 1992?

B. Assuming that Daisy's March 2 transaction is described in Section 351(a) of the Code, what are the federal income tax consequences of that transaction to Daisy and Excorp? Be sure to discuss the amount, timing and character (capital or ordinary) of any gain, loss or deduction to each party; Daisy's basis and holding period for the shares of preferred stock issued to her; and Excorp's basis in the machine immediately after the exchange.

Explain.

Klosco is a C corporation engaged in real estate development. Its accumulated earnings and profits at the beginning of 1992 is $100,000. For 1992, not taking into account the transactions discussed below, it has taxable income of $140,000 and earnings and profits of $165,000.

Klosco has two shareholders: Helen, who owns 75 shares of voting common stock and 75 shares of nonvoting common stock; and her grandson, Greg, who owns 25 shares of voting common stock and 25 shares of nonvoting common stock. The corporation has no other shares outstanding. Except for voting rights, the voting and nonvoting shares are identical. Helen's adjusted basis in each share of her stock (voting and nonvoting) at the beginning of 1992 is $1,000, for a total basis of $150,000.

On December 31, 1992, Klosco and Helen consummate an exchange whereby Helen transfers to Klosco 60 shares of her Klosco voting common stock and 60 shares of her Klosco nonvoting common stock; in exchange, Klosco transfers to her Blackacre, one of many parcels of land it is trying to market to the investing public. Blackacre has a fair market value of $360,000; Klosco's adjusted basis in the property immediately before the exchange is $300,000. The fair market value of the shares Helen surrenders to Klosco in the exchange is also $360,000.

Answer each of the following questions:

A. What are the federal income consequences to Helen and Klosco of (1) the corporation's 1992 operating results and (2) the exchange of Helen's shares for Blackacre?

B. How would your answers in A. above be different if Klosco had been an S corporation throughout 1992 and had been an S corporation ever since its formation in 1987 (thus having no history as a C corporation)?

In each part of your answer, be sure to discuss the amount, timing and character (capital or ordinary) of any income, gain, loss or deduction to Helen and Klosco; the impact of Helen's basis in her shares and Klosco's basis in Blackacre; Helen's basis in Blackacre after the exchange; and the transactions' effects (if any) on Klosco's earnings and profits.

Discuss.

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