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 both this set of essay questions and your answers, in the original envelope in which this set came.

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, 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 March 1, 1998, Sylvia forms a new corporation, Main Corp. She transfers to Main $40,000 cash, and her minority interest in the stock of another corporation, Other Corp. Sylvia's basis in the Other stock immediately before the incorporation is $15,000, and its fair market value is $65,000. Main issues to Sylvia 80 shares of Main common stock, with a fair market value of $80,000. Main also agrees to assume $25,000 in unsecured debts that Sylvia previously incurred in her business.

On March 22, 1998, Tara becomes a shareholder of Main. She transfers to Main a parcel of land that she has been holding for investment, with a fair market value of $20,000; Tara's basis in the land immediately before the transfer is $5,000. In exchange for the land, Main issues to Tara 20 shares of its preferred stock, with a fair market value of $20,000, so that on March 23, the only shareholders of Main are Sylvia with 80 shares of common and Tara with 20 shares of preferred.

What are the federal income tax consequences -- to Sylvia, Tara and Main -- of the transactions described above? Be sure to discuss the amount, timing and character (capital or ordinary) of each item of income, loss, deduction or credit; and the basis of the stock or assets held by each party.

Discuss.

On May 1, 1998, Oldco, a C corporation, has one class of stock, with 100 shares outstanding. Of these, 20 are owned by George; 70 are owned by George's granddaughter, Diana; and the other 10 are owned by Zeke, an Oldco employee who is unrelated to George and Diana. George's basis in his Oldco stock is $10,000 per share, or $200,000 total. All three shareholders have been active in Oldco's business for many years; lately, however, George and Diana have disagreed about many aspects of the business and are not on speaking terms with each other.

On May 2, 1998, as part of George's retirement, Oldco redeems 10 of George's shares. As consideration for the stock, Oldco transfers to George Blackacre, a parcel of real estate that Oldco was holding for sale to its customers. Blackacre's fair market value is $140,000; Oldco's basis in it immediately before the transfer to George was $115,000.

Immediately after the redemption of George's shares, the shareholders of Oldco are George and Zeke with 10 shares each (11.1 percent each), and Diana with 70 shares (77.8 percent).

Oldco's accumulated earnings and profits at the beginning of 1998 were $20,000. Without regard to the redemption of George's shares, Oldco's earnings and profits for 1998 are $70,000. (You should assume that Oldco made no other distributions to shareholders in 1998.)

What are the federal income tax consequences to George and Oldco of the May 2 redemption? Be sure to discuss the amount, timing and character (capital or ordinary) of each item of income, deduction, loss or credit allocable to each party; George's basis in his Oldco stock and Blackacre immediately after the transaction; and the effects of the redemption on Oldco's earnings and profits.

Explain.

P and T are long-standing C corporations with substantial accumulated earnings and profits. All of the stock of T is owned by Oprah. All of the stock of P is owned by a revocable grantor trust established by Donald. Donald and Oprah and both U.S. citizens.

Oprah's basis in her T stock is $500,000; the T stock has a fair market value of $1,000,000. The assets of T are as follows:
 

	Adjusted basis	Fair market value
Inventory	$ 350,000	$ 800,000
Equipment	450,000	400,000
Goodwill	- 0 -	100,000
Total	$ 800,000	$1,300,000

T's only liabilities are an outstanding debt with a principal balance of $300,000.

On June 1, 1998, P buys all of the stock of T from Oprah for $1,000,000, payable $400,000 down and $100,000 a year for six years, plus interest on the deferred balance at a market rate of interest.

Answer both of the following questions:

A. What are the federal income tax consequences to Oprah, Donald, P and T of the transactions just discussed -- with and without all available elections? Be sure to discuss the amount, timing and character (capital or ordinary) of any income, deduction, loss or credit to each party; the basis of the inventory, equipment and goodwill after the acquisition; P's basis in the T stock; and the impact (if any) of the transaction on T's earnings and profits.

B. After the stock acquisition, can P, T or both elect to be taxed as S corporations?

Discuss.

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