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.
 
 

On January 1, 1994, Parenco, an Oregon corporation, owns all of the outstanding stock of another Oregon corporation, Subcorp. (Parenco and Subcorp do not file a consolidated tax return.) In addition, Parenco owns investment real estate with an adjusted basis of $3,200,000 and a fair market value of $2,800,000. Parenco has no debts.

Parenco's adjusted basis in its Subcorp stock is $2,400,000. Subcorp's assets are as follows:
 

	Adjusted basis	Fair market value
Inventory	$1,680,000	$1,600,000
Equipment	320,000	400,000
Goodwill	- 0 -	1,000,000
Total	$2,000,000	$3,000,000

Subcorp's only liabilities are an outstanding debt with a principal balance of $1,000,000. The fair market value of Subcorp's outstanding stock is $2,000,000.

All of Parenco's stock is held by an individual, Helen. Helen's adjusted basis in her Parenco stock is $4,000,000; its fair market value is $4,800,000.

In a restructuring designed to implement some of Helen's business strategies, Subcorp is liquidated into Parenco. Parenco takes over all of the assets, and assumes all $1,000,000 of the liabilities, of Subcorp. The liquidating distributions are made during January and February of 1994.

Later the same year, in an unrelated transaction not foreseeable at the time of the Subcorp liquidation, Parenco is liquidated. In the Parenco liquidation, Helen receives from Parenco the inventory, equipment and goodwill once owned by Subcorp (with the same fair market values listed above) and Parenco's investment real estate (still with a fair market value of $2,800,000). As part of the liquidation of Parenco, Helen assumes all $1,000,000 of the liabilities, formerly incurred by Subcorp, which Parenco previously assumed in the Subcorp liquidation.

What are the federal income tax consequences to Subcorp, Parenco and Helen of each of the transactions just described? Be sure to discuss the amount, timing and character (capital or ordinary) of any income, gain, loss or deduction recognized by each party, and the basis of the stock and assets held by each party at each stage of the transactions.

Explain.

X-co is a profitable C corporation with accumulated earnings and profits of $400,000. On December 30, 1994, its shares (a single class of voting common stock) are owned as follows: 50 shares by Alan; 35 shares by Belinda; and 15 shares by the estate of Mona, Belinda's mother, who recently died. The beneficiaries of Mona's estate are Belinda and Belinda's brother, Sid; each is a one-half beneficiary. (Alan is not related to either Belinda or Sid.)

Each share of X-co's stock has a fair market value of $5,000. Alan and Belinda each have a stock basis of $3,000 per share; Mona's estate has a basis of $4,800 per share. Thus, share ownership on December 30 can be charted as follows:
 

Shareholder	No. shares	Total basis	Total value
Alan	50	$150,000	$250,000
Belinda	35	$105,000	$175,000
Mona's Est.	15	$ 72,000	$ 75,000

On December 31, 1994, X-co redeems 30 shares of its stock -- 20 shares from Alan, and five shares from each of Belinda and Mona's estate. In the redemption, Alan receives $100,000 cash; Belinda receives $25,000 cash; and the estate receives Blackacre, a parcel of unimproved real estate that X-co has been holding for investment, with a fair market value of $25,000. Blackacre's adjusted basis in X-co's hands immediately before the redemption is $15,000.

Immediately after the redemptions, Alan actually owns 30 shares (about 42.85 percent of the outstanding shares) of X-co stock; Belinda actually owns 30 shares (also approximately 42.85 percent of the outstanding shares); and the estate actually owns 10 shares (roughly 14.30 percent).

Aside from the transactions described in this question, X-co "breaks even" for the taxable year 1994 -- that is, its gross income and its deductions for the year happen to match exactly.

Answer each of the following questions:

A. What are the federal income tax consequences -- to X-co, Alan, Belinda and the estate of Mona -- of the transactions just discussed?

B. How (if at all) would your answer to this question be different if X-co were an S corporation throughout 1994, and had been an S corporation (with no earnings and profits) ever since its formation?

In each part, be sure to discuss the amount, timing and character (capital or ordinary) of any income, gain, loss or deduction to each party; the estate's basis in Blackacre immediately after the redemptions; and in Part A, the effect (if any) of the redemptions on X-co's earnings and profits.

Discuss.

On June 1, 1994, Paula and Quigley form a corporation, Corp. Paula, an active real estate professional, transfers to Corp. Brownacre, a parcel of improved real estate with an adjusted basis to Paula of $25,000 and a fair market value of $100,000. Brownacre is encumbered by a mortgage securing a loan that Paula took out in 1992 for business reasons; the balance of the loan as of June 1, 1994 is $40,000, so that Paula's "equity" in Brownacre is $60,000.

In addition to Brownacre, Paula contributes to Corp. Paula's personal promissory note for $15,000, payable in five years, with annual payments of interest only due in the interim at the prime rate. In exchange for Brownacre and her note, Paula receives 75 shares of Corp.'s voting common stock (the only class it issues). Quigley transfers $25,000 cash to Corp. and receives 25 Corp. shares, for a total of 100 shares outstanding as of the close of business on June 1, 1994.

On September 1, 1994, Roscoe becomes a shareholder. Roscoe transfers to Corp. equipment with an adjusted basis to Roscoe of zero and a fair market value of $20,000; the equipment's original cost was $45,000. In exchange for the equipment, Roscoe receives 20 shares of Corp. voting common stock. Also on September 1, 1994, Paula transfers $5,000 cash and receives five additional shares of Corp. voting common stock. As of the close of business on September 1, 1994, Corp.'s shares are held as follows: 80 shares (64 percent) by Paula; 25 shares (20 percent) by Quigley; and 20 shares (16 percent) by Roscoe.

What are the federal income tax consequences to Corp., Paula, Quigley and Roscoe of the transaction(s) just described? Be sure to discuss the amount, timing and character (capital or ordinary) of any income, gain, loss or deduction recognized by each party, and the basis of the stock or assets held by each party after each event discussed.

Explain.

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