Corporate Taxation
Spring 2015
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, unless you have been otherwise expressly authorized by the law school, you must submit your answers using SofTest. 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)

 

            Goodco is a C corporation with accumulated earnings and profits at the beginning of 2015 of $150,000. Goodco has the following assets, none of which was contributed to Goodco by any of its shareholders:

 

Asset

Adjusted basis

Fair market value

Real estate

$1,600,000

$2,000,000

Machinery

500,000

1,000,000

Inventory

600,000

350,000

Accounts receivable

650,000

650,000

Total assets

$3,350,000

$4,000,000

 

 Goodco has liabilities of $3,000,000, and so its net worth is $1,000,000.

 

            Goodco's stock is owned by Maddie and her son, Sean. The stock consists of 50 shares of common stock and 50 shares of preferred stock; Maddie and Sean each own 25 shares of common and 25 shares of preferred. Goodco distributed the preferred stock to Maddie and Sean 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.

 

            Maddie and Sean are approached by executives of Bigco, a publicly traded corporation that wants to acquire Goodco's business. Goodco is completely liquidated, distributing the real estate to Maddie and the machinery, inventory, and receivables to Sean; Maddie and Sean each assume $1,500,000 of Goodco's liabilities. Maddie and Sean then sell all of the former Goodco assets to Bigco for $1,000,000 cash ($500,000 each), and Bigco assumes all of the former Goodco liabilities.

 

            A year after the deal with Bigco has closed, Maddie and Sean are required to pay a $12,000 judgment against Goodco in their capacities as transferees of Goodco. To satisfy the judgment, Maddie and Sean each pay the creditor $6,000.

 

            What are the federal income tax consequences to Maddie, Sean, Goodco and Bigco 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 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 impact of Goodco's earnings and profits.

 

            Discuss.

 

(End of Question 1)

 

QUESTION TWO

(One hour)

 

            Distco is a C corporation with a deficit in its accumulated earnings and profits at the beginning of 2015 of $150,000. Distco’s shareholders are Ruby and Sam. Sam is a nonresident alien. Each shareholder owns half of Distco’s single class of outstanding stock. Ruby’s adjusted basis in her Distco stock is $100,000; Sam’s adjusted basis in her Distco stock is $200,000.

 

            Both Ruby and Sam perform services for Distco. Ruby works full-time for the corporation, about 50 hours per week; Sam works part-time, about 15 hours per week, but she is extremely popular with Distco’s customers and develops all of Distco’s strategic plans. Distco’s startup phase is ending, and it has begun to be profitable.

 

            On July 1, 2015, Distco makes distributions to its shareholders with respect to their stock. In the distributions, Distco pays Ruby $60,000 cash, and Distco transfers to Sam some of Distco’s inventory, with a fair market value of $60,000. Immediately before the distribution, the inventory has an adjusted basis in Distco’s hands of $40,000.

 

            On December 20, 2015, Distco pays year-end cash bonuses to all of its employees, including Ruby and Sam. For employees who are not shareholders, the bonuses are 3 percent of base salary, for a total paid to all nonshareholder employees combined of $30,000. Ruby and Sam each receive a bonus of $35,000.

 

            For 2015, not taking into account the distributions and bonuses just described, Distco has gross income of $1,000,000 and deductions of $800,000.

 

            What are the federal income tax consequences to Ruby, Sam, and Distco 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; and each party's basis in the stock or assets that party holds at each stage of the transactions.

 

            Explain.

 

(End of Question 2)

           


QUESTION THREE

(One hour)

 

            On March 1, 2015, Laila and Malik form a corporation, Corp. In the formation transaction, Laila transfers to Corp Blackacre, a parcel of real estate, and shares of ABC, a publicly traded corporation, in exchange for all of the shares of Corp’s Class A stock. The Corp Class A stock has a fair market value of $180,000. Immediately before the exchange, Blackacre has a fair market value of $200,000, but it is encumbered by a mortgage of $40,000, so that Laila’s “equity” in Blackacre is $160,000. Laila’s adjusted basis in Blackacre immediately before the exchange is $10,000. Corp assumes the mortgage. The ABC stock has a basis in Laila’s hands of $35,000 immediately before the exchange; its fair market value is $20,000.

 

            Also in the formation transaction, Malik transfers to Corp a vacant lot with a fair market value of $30,000 and an adjusted basis to Malik immediately before the transaction of $4,000. In exchange for the lot, Corp transfers to Malik all of Corp’s Class B stock, with a fair market value of $20,000, and Corp’s nonconvertible promissory note for $10,000. The note calls for two annual payments of $5,000 of principal, plus interest at a noncontingent, market rate, payable with each payment of principal. The first payment on the note is due in 2016. Corp incurs no other debt.

 

            On May 10, 2015, Corp files with the Internal Revenue Service a form electing under Section 1362 of the Code to be an S corporation for Corp’s first taxable year. The form includes consents to the election, signed by Laila and Malik.

 

            Answer each of the following questions:

 

A.        (75% of question grade)  What are the federal income tax consequences to Laila, Malik, and Corp 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; and each party's basis in the stock or assets that party holds at each stage of the transactions.

 

B.        (25% of question grade)  Is Corp’s S corporation election valid? If not, why not? Assuming that the election is valid, does it take effect for Corp’s first taxable year?

 

            Discuss.

 

 

(End of examination)

 

 

 

Created by: bojack@lclark.edu
Update:   6 Feb 16
Expires:  31 Aug 17