CHAPTER 5
CORPORATIONS: REDEMPTIONS AND LIQUIDATIONS
SOLUTIONS TO PROBLEM MATERIALS
Problems
30.
a.
Teal Corporation would have a taxable gain of $150,000. The gain would be
ordinary or capital depending on the type of property distributed. The E & P of
Teal Corporation would be increased by $150,000 (the amount of gain to Teal)
and decreased by $250,000 (the FMV of the property distributed). Teal’s E & P
also would be decreased by the amount of tax due on the gain recognized. Grace
would have dividend income of $250,000 and a basis in the asset of $250,000.
b.
The tax consequences to Teal Corporation would be the same as in a. Grace
Corporation would have dividend income of $250,000, but only 20% of the
$250,000, or $50,000, would be taxed to Grace. Because Grace Corporation has a
20% or more ownership interest in Teal Corporation, the 80% dividends received
deduction is applicable. Grace Corporation would have a basis of $250,000 in the
property.
c.
The tax consequences to Teal Corporation would be the same as in a. Grace
would have a capital gain of $170,000 [$250,000 (value of the property) - $80,000
(basis in stock)] and a basis of $250,000 in the property received.
d.
The tax consequences to Teal Corporation would be the same as in a. Grace
Corporation would have a capital gain of $170,000 [$250,000 (value of the
property) - $80,000 (basis in stock)] and a basis of $250,000 in the property
received.
e.
Assuming Grace is an individual, she would choose the qualifying stock
redemption (option c). If the distribution is a qualifying stock redemption, she has
a capital gain of $170,000. If the distribution is a dividend, as in option a., she
would have dividend income of $250,000. Her basis in the property received is
the same whether the transaction is a dividend or a qualifying stock redemption.
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If Grace is a corporation, it would prefer that the distribution be a dividend
because only 20% of the dividend would be taxed (option b). Teal Corporation
itself would have no preference because the tax consequences to it are the same
under each option.
pp. 5-3 to 5-5 and 5-12
31.
a.
Julio's tax liability would be $18,000, computed as follows: $100,000 (amount
realized) - $10,000 (basis in the 200 shares redeemed) = $90,000 (long-term
capital gain) X 20% = $18,000.
b.
Julio's tax liability would be $38,600, computed as follows:
(dividend) X 38.6% = $38,600.
$100,000
Example 2
32.
a.
Tax liability for a corporate shareholder would be $30,600, computed as follows:
$100,000 (amount realized) - $10,000 (basis in the stock) = $90,000 (long-term
capital gain) X 34% = $30,600. Corporations do not receive a preferential tax rate
on long-term capital gains.
b.
Tax liability for a corporate shareholder on a $100,000 dividend from a
corporation in which it has a 15% interest would be $10,200, computed as
follows: $100,000 (dividend) - $70,000 (dividends received deduction of 70% of
$100,000) = $30,000 X 34% = $10,200.
Example 4
33.
a.
Julio may deduct the entire $30,000 capital loss carryover to offset the $90,000
long-term capital gain. Thus, Julio would be taxed on only $60,000 of gain. Tax
liability on the $60,000 long-term capital gain would be $12,000 ($60,000 X
20%).
b.
Julio could only deduct $3,000 of the $30,000 capital loss carryover. Julio's tax
liability on the $100,000 dividend received would be $38,600 ($100,000 X
38.6%).
c.
The preferred outcome in this situation is that which provides sale or exchange
treatment (part a). With a qualifying stock redemption, Julio’s tax liability is
$26,600 less ($38,600 - $12,000) than if the redemption is treated as a dividend.
Example 3
34.
a.
The corporation could offset the entire $30,000 capital loss carryover against the
$90,000 long-term capital gain. Thus, only $60,000 of the gain would be taxed.
The tax liability would be $20,400 ($60,000 X 34%).
b.
The corporation could not deduct any of the $30,000 capital loss carryover.
Corporations may only offset capital losses against capital gains. Thus, the
corporation would have dividend income of $100,000 less a dividends received
deduction of $70,000. The remaining $30,000 would be taxed at 34%, for a tax
liability of $10,200.
Corporations: Redemptions and Liquidations
5-3
Chapter 2 and Example 4
35.
a.
Beatrice owns 655 shares, 300 shares directly and 355 shares indirectly, in Silver.
Beatrice constructively owns the stock of her husband (120 shares), daughter (80
shares), grandson (50 shares), and 70% of the 150 shares, or 105 shares, owned by
Maroon Corporation.
b.
The stock attribution rules do not apply to stock held by a corporation if the
shareholder owns less than 50% of the stock in that corporation. Thus, Beatrice
would only own 550 shares, 300 shares directly and 250 shares owned by her
husband (120 shares), daughter (80 shares), and grandson (50 shares).
c.
Beatrice would now own 675 shares in Silver, the 655 shares as computed in part
a. above plus 20 shares as a result of her 20% Yellow Partnership interest [100
(shares owned by Yellow Partnership) X 20% (Beatrice’s interest in the
partnership)].
Exhibit 5-1
36.
a.
All of the Hawk Corporation stock owned by Vulcan Corporation is deemed to be
owned by Shonda. Therefore, Shonda must report the $60,000 as dividend
income. The redemption does not qualify as a not essentially equivalent
redemption. After the redemption, Shonda owns 53% of the stock of Hawk [95
(Vulcan shares deemed owned by Shonda) ÷ 180 (remaining outstanding shares in
Hawk)]. Shonda still has the dominant control of Hawk; thus, there has not
been a “meaningful reduction” in her interest in Hawk. Further, her
remaining ownership interest fails the requirements for a disproportionate
redemption or complete termination redemption. pp. 5-5 to 5-9 and
Example 7
b.
The basis in the 20 shares redeemed attaches to Vulcan’s basis in the Hawk
Corporation stock it owns. p. 5-7 and Footnote 7
c.
Since the redemption is treated as an ordinary dividend distribution, Hawk’s
E & P is reduced to $140,000 ($200,000 - $60,000). Chapter 4
37.
Hoffman, Raabe, Smith, and Maloney, CPAs
5191 Natorp Boulevard
Mason, OH 45040
May 10, 2002
Lana Pierce
1000 Main Street
Oldtown, MN 55166
Dear Lana:
This letter is in response to your question concerning the tax consequences of the
redemption of 100 shares of stock you own in Stork Corporation. You were paid $45,000
for the shares and you have a tax basis of $10,000 in the stock. Your mother, Lori, owns
100 shares in Stork, and the remaining shares are owned by an unrelated individual. Our
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conclusion is based upon the facts as outlined in your May 5 letter. Any change in facts
may cause our conclusion to be inaccurate.
You will have a capital gain of $35,000 on the redemption. Stork Corporation redeemed
100 of the 200 shares you owned in the corporation. For purposes of this transaction, you
are deemed to own all of Lori’s 100 shares. Prior to the redemption, you had a 30%
ownership [20% (direct ownership) + 10% (Lori’s constructively owned)] in the
corporation as Stork Corporation had 1,000 shares outstanding. After the redemption you
have only a 22.22% ownership [200 (your remaining 100 shares in Stork + Lori’s 100
shares) ÷ 900 (remaining outstanding shares in Stork)]. Because, after the redemption,
you owned less than 50% of the stock in Stork Corporation and less than 80% of your
original ownership [22.22% is less than 24% (80% X 300 shares/1,000 shares)], the
redemption qualifies for capital gain treatment.
Should you need additional information or need to clarify our conclusion, do not hesitate
to call on me.
Sincerely,
Marilyn C. Jones, CPA
Partner
TAX FILE MEMORANDUM
DATE:
May 8, 2002
FROM:
Marilyn C. Jones
SUBJECT:
Lana Pierce
Today I talked to Lana Pierce with respect to her May 5 letter. She received a cash
payment of $45,000 from Stork Corporation in exchange for 100 of the 200 shares she
owned in the corporation. Lana’s mother, Lori, owns 100 shares of Stork, and the
remaining shares are owned by an unrelated individual. She wants to know the tax
consequences of the redemption.
At issue: Will the stock redemption qualify for capital gain treatment or will the $45,000
be treated as a taxable dividend?
Conclusion: Lana Pierce has a capital gain of $35,000. Lana is deemed to own Lori’s
100 shares before and after the redemption. Lana's percentage ownership in Stork
Corporation was 30% (300 shares/1,000 shares) before the redemption and 22.22% (200
shares/900 shares) after the redemption. Because the 80% and 50% tests set out in
§ 302(b)(2) are met, the stock redemption qualifies for capital gain treatment.
pp. 5-8, 5-9, and Exhibit 5-1
38.
a.
The redemption cannot qualify as a complete termination redemption. Jacque is
deemed to own Monique’s 800 shares or 67% (800/1,200) of the remaining shares
outstanding. The family attribution waiver does not apply because Jacque holds a
Corporations: Redemptions and Liquidations
5-5
prohibited interest in Thrush Corporation (i.e., directorship) immediately after the
redemption.
b.
The redemption can qualify as a complete termination redemption. Monique’s
position as a director does not constitute a prohibited interest for Jacque. Thus, if
the other requirements for the family attribution waiver are satisfied (e.g., Jacque
files the required agreement with the IRS), the redemption completely terminates
Jacque’s ownership interest in Thrush.
c.
The redemption cannot qualify as a complete termination redemption. To qualify
for the family attribution waiver, the former shareholder cannot acquire a stock
ownership interest in the corporation (other than by bequest or inheritance) during
the 10 years following the redemption.
p. 5-9 and Examples 12 and 13
39.
a.
With respect to the distribution, Lori would have ordinary dividend income of
$400,000 and Swan Corporation would reduce its E & P by $400,000. As a result
of the stock transaction, Lori would have a basis of $400,000 in the newly
acquired 100 shares and become the sole shareholder of Swan. Roberta would
have a capital gain of $375,000 [$400,000 (amount realized) - $25,000 (basis in
stock)] on the sale. The stock transaction would not affect Swan.
b.
The transaction would constitute a complete termination redemption and result in
a capital gain of $375,000 [$400,000 (amount realized) - $25,000 (basis in stock)]
to Roberta. Lori would become the sole shareholder as a result of the redemption.
Swan would reduce its E & P by $350,000 [$700,000 (E & P at time of
redemption) X 50% (interest redeemed)].
pp. 5-9, 5-13, and Chapter 4
40.
a.
To qualify as a partial liquidation, the distribution must be either not essentially
equivalent to a dividend or pursuant to the termination of an active business.
Further, the distribution must be pursuant to a plan and made within the plan (or
succeeding) year. Assuming the plan and timing requirements are satisfied, the
redemption will qualify as a partial liquidation as to Walt but not as to Yellow
Corporation. The distribution qualifies as a partial liquidation as to Walt because
it represents the termination of an active business that has been in existence for at
least five years. White Corporation continues to operate the furniture division, a
business that also has been in existence for at least five years. A partial
liquidation can be pro rata with respect to the shareholders. The distribution does
not qualify as a partial liquidation as to Yellow Corporation because such
treatment is limited to noncorporate shareholders.
Walt will receive sale or exchange treatment on the redemption resulting in a
capital gain of $1,020,000 [$1,500,000 (amount realized) - $480,000 (basis in
stock redeemed)].
Yellow Corporation will have dividend income equal to the entire distribution
received, or $1,500,000. Because Yellow will have a dividends received
deduction of $1,200,000 ($1,500,000 X 80%) with respect to the redemption, only
$300,000 of the distribution from White will be taxed. The $600,000 basis in the
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White Corporation stock redeemed attaches to Yellow’s basis in its remaining
shares of White stock.
b.
The redemption may qualify as a partial liquidation as to Walt but not as to
Yellow Corporation. Since White has not operated the furniture division for at
least five years prior to the redemption, the distribution will not qualify as the
termination of an active business. Therefore, to qualify as a partial liquidation,
the distribution must not be essentially equivalent to a dividend. This requires a
genuine contraction of White Corporation’s business, a determination that is
based on a facts and circumstances basis. White Corporation would be advised to
seek a favorable ruling from the IRS as to tax treatment of the distribution to
Walt. As discussed in part a. above, partial liquidation treatment is not available
to corporate shareholders such as Yellow Corporation.
If the distribution does represent a genuine contraction of White Corporation’s
business, Walt will receive sale or exchange treatment on the redemption resulting
in a capital gain of $1,020,000 [$1,500,000 (amount realized) - $480,000 (basis in
stock redeemed)]. If the distribution does not qualify as a partial liquidation,
Walt will have dividend income equal to the entire distribution received, or
$1,500,000. In that case, the $480,000 basis in the White Corporation stock
redeemed attaches to Walt’s basis in his remaining shares of White stock.
Yellow Corporation will have dividend income equal to the entire distribution
received, or $1,500,000. Because Yellow will have a dividends received
deduction of $1,200,000 with respect to the redemption, only $300,000 of the
distribution from White will be taxed. The $600,000 basis in the White
Corporation stock redeemed attaches to Yellow’s basis in its remaining shares of
White stock.
pp. 5-10 and 5-11
41.
The redemption qualifies under § 303 to the extent of $100,000, the amount of death
taxes and funeral and administration expenses. Since Debra owned a 20% or more
interest in both Lark and Owl, the values of the two stocks can be combined to satisfy the
35% of adjusted gross estate test [i.e., ($150,000 + $250,000)/$900,000 = 44%]. The
estate’s basis in the Lark shares is stepped-up to fair market value; thus, the estate has no
gain or loss on this portion of the transaction [i.e., $100,000 (proceeds qualifying for
§ 303 treatment) - $100,000 (estate’s basis in shares)]. To receive sale or exchange
treatment on the $50,000 distribution for the remaining Lark shares, the transaction must
qualify under the § 302 redemption rules. If the estate is not deemed to own any
additional Lark stock under the § 318 attribution rules, this portion of the transaction
would qualify as a complete termination redemption. Assuming sale or exchange
treatment is available, the estate would have no gain or loss [i.e., $50,000 (proceeds
qualifying for § 302 treatment) - $50,000 (estate’s basis in shares)]. If sale or exchange
treatment is not available, the estate would have a $50,000 dividend. (In such case, the
estate’s basis in the redeemed shares would presumably attach to the shares attributed to
the estate under § 318.) pp. 5-9, 5-11, 5-12, and Examples 17 and 18
42.
Red Corporation will recognize a $300,000 gain [$1,000,000 (fair market value) $700,000 (basis)] on the distribution of the land to the estate. Red Corporation’s E & P is
reduced by $1,000,000 as a result of the distribution. The estate will recognize no gain
[$1,000,000 (amount realized) - $1,000,000 (estate’s basis in stock)] on the redemption
Corporations: Redemptions and Liquidations
5-7
and it will have a basis in the land equal to its fair market value, or $1,000,000. When it
sells the land for $900,000, the estate recognizes a loss of $100,000. pp. 5-11 to 5-13
43.
a.
Ann would have a capital gain of $55,000 [$80,000 (amount realized) - $25,000
(basis in the 25 shares)]. The redemption qualifies as a disproportionate
redemption. Ann had a 50% (50 shares/100 shares) ownership in Teal
Corporation prior to the redemption and a 33.33% (25 shares/75 shares)
ownership after the redemption. Both the 50% and the 80% [33.33% is less than
40% (80% X 50%)] tests are met. p. 5-8 and Example 10
b.
E & P of Teal Corporation will be $90,000 after the redemption: $100,000
(accumulated E & P) + $20,000 (current E & P) - $30,000 [25% (the percentage
stock redemption) X $120,000 (the balance in E & P)]. Example 20
44.
Hoffman, Raabe, Smith, and Maloney, CPAs
5191 Natorp Boulevard
Mason, OH 45040
December 5, 2002
Crane Corporation
506 Wall Street
Winona, MN 55987
Dear President of Crane Corporation:
This letter is in response to your questions concerning Crane Corporation’s tax
consequences arising out of a redemption of its stock. Crane Corporation had 1,000
shares of stock outstanding when it redeemed 150 shares for $200,000. The shareholder
received sale or exchange treatment on the redemption. Crane had paid-in capital of
$500,000 and E & P of $900,000 at the time of the redemption. As a result of the
redemption transaction, Crane Corporation incurred $30,000 of accounting and legal fees.
Our conclusions are based upon the facts as outlined in your November 27 letter. Any
change in facts may cause our conclusions to be inaccurate.
Crane Corporation would reduce its E & P in the amount of $135,000 as a result of the
redemption. This represents a 15% decrease in the amount of the E & P corresponding to
the 15% stock redemption. When a stock redemption results in sale or exchange
treatment for the shareholder, the E & P account of a corporation is reduced in an amount
not in excess of the ratable share of the E & P of the distributing corporation attributable
to the stock redeemed. The $65,000 balance of the redemption distribution would reduce
the paid-in capital of the corporation.
No deduction is allowed for expenditures incurred by a corporation in connection with the
redemption of its stock. As such, none of the $30,000 of accounting and legal fees is
deductible.
Should you need additional information or need to clarify our conclusions, do not hesitate
to call on me.
Sincerely,
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2003 Annual Edition/Solutions Manual
Astia Jackson, CPA
Partner
TAX FILE MEMORANDUM
DATE:
December 2, 2002
FROM:
Astia Jackson
SUBJECT:
Crane Corporation
Today I talked to the President of Crane Corporation with respect to its November 27
letter. Crane Corporation had 1,000 shares of stock outstanding. It redeemed 150 shares
for $200,000, when it had paid-in capital of $500,000 and E & P of $900,000. The
redemption qualified for sale or exchange treatment for the shareholder. Crane incurred
$30,000 of accounting and legal fees with respect to the redemption transaction.
At issue: What is the reduction in Crane Corporation's E & P as a result of the
redemption? Also, are the redemption expenditures deductible by Crane?
Conclusion: Under § 312(n)(7), the E & P account of a corporation is reduced by a
qualifying stock redemption in an amount not in excess of the ratable share of the E & P
of the distributing corporation attributable to the stock redeemed. Since Crane
Corporation redeemed 15% of its stock, the reduction in E & P is 15% of the E & P
account, or $135,000. Section 162(k) specifically disallows the deductibility of
redemption expenditures. As such, none of the $30,000 of accounting and legal fees is
deductible by Crane.
p. 5-13
45.
a.
There are no tax consequences upon receipt of the preferred stock. It is a
nontaxable stock dividend. However, the stock is classified as § 306 stock. The
basis of $60,000 in their original common shares is reallocated between the
preferred stock and the common stock based on the fair market value of each.
The basis is reallocated as follows:
Fair market value of common:
Fair market value of preferred:
200 X $400
100 X $200
=
=
$ 80,000
20,000
$100,000
Basis of common: 80/100 X $60,000 = $48,000
Basis of preferred: 20/100 X $60,000 = $12,000
b.
A sale of the preferred stock to Adam will produce $20,000 of ordinary income,
which is the fair market value of the preferred stock on the date of distribution.
However, the $20,000 will not be dividend income. Thus, the E & P of Blue
Corporation will not be reduced. With respect to the remaining $15,000 of the
sales price, $12,000 will reduce the basis of the preferred stock to zero (i.e., a
return of capital), and the remaining $3,000 will be capital gain.
Corporations: Redemptions and Liquidations
c.
5-9
The redemption is treated as a dividend distribution to the extent of Blue
Corporation’s E & P on the date of the redemption; thus, Ahmad will have a
dividend of $35,000. The $12,000 basis of the preferred stock is added back to
the basis of Ahmad’s common stock. Blue Corporation’s E & P is reduced by
$35,000 as a result of the distribution.
Examples 21 and 22
46.
Bob has a taxable dividend of $30,000. Pursuant to § 304, the sale is treated as a
redemption subject to § 302. After the redemption, Bob continues to own all 1,000
shares of Goose stock [800 (shares directly owned) + 200 (shares owned constructively
through his sole ownership of Heron)]. As a result, the redemption satisfies none of the
qualifying stock redemption provisions. The amount of the dividend income is
determined by the E & P of the acquiring corporation (Heron Corporation) and then by
the E & P of the acquired corporation (Goose Corporation).
The basis of the Goose Corporation stock to Heron Corporation is $5,000, the adjusted
basis of stock in the hands of Bob. Bob’s $5,000 basis in the “sold” Goose stock is added
to his basis in the Heron Corporation stock.
pp. 5-16, 5-17, and Figure 5-1
47.
a.
No loss is recognized by either Hawk Corporation or Michele. In the case of
Hawk, the $20,000 loss realized [$180,000 (fair market value) - $200,000 (basis)]
on the nonliquidating distribution of the land is disallowed under § 311(a). (Note:
Hawk Corporation’s loss also would be disallowed under § 267.) As to Michele,
her $40,000 loss realized [$180,000 (fair market value of land) - $220,000 (stock
basis)] in the qualifying stock redemption is disallowed under § 267 because
Michele and Hawk Corporation are related parties. Under that provision, Michele
is deemed to own the stock of her sisters, or 100% of the Hawk stock in total. Her
basis in the land is its fair market value, or $180,000.
b.
Hawk Corporation recognizes no loss and Michele recognizes a $40,000 loss. In
the case of Hawk, the $20,000 loss realized on the liquidating distribution of the
land is not recognized under the related-party loss limitation of § 336(d)(1). The
distribution of the land to Michele, a related party (under § 267), is not pro rata
with respect to the shareholders. As to Michele, her $40,000 loss is recognized.
Section 267 does not apply in the case of liquidating distributions. Her basis in
the land is its fair market value, or $180,000.
pp. 5-12, 5-13, 5-19, 5-21, 5-24, and Example 24
48.
a.
Oriole Corporation would have recognized gain of $500,000 [$600,000 (fair
market value) - $100,000 (basis)]. Under the general rule of § 336(a), the land is
treated as if it were sold for its fair market value. Since the land was a capital
asset held for more than one year, Oriole has a $500,000 long-term capital gain.
b.
Oriole Corporation has a recognized long-term capital gain of $600,000 on the
distribution. Under § 336(b), when property distributed in a complete liquidation
is subject to a liability of the liquidating corporation, the fair market value of that
property is treated as not being less than the amount of the liability. Thus, the
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2003 Annual Edition/Solutions Manual
$100,000 adjusted basis in the land is subtracted from the $700,000 liability for a
gain of $600,000.
Example 25 and Chapter 2
49.
A loss of $20,000 is recognized. Because the fair market value of the land exceeded its
basis at the time of the § 351 exchange, the built-in loss limitation does not apply.
Further, the related-party loss limitation does not apply to a sale of property. The realized
loss of $20,000 [$280,000 (selling price) - $300,000 (carryover basis)] is, therefore, fully
recognized. pp. 5-20 to 5-23 and Figure 5-2
50.
A loss of $15,000 is recognized. The land was built-in loss property when it was
acquired in the § 351 exchange. Further, the sale of the land occurred within 2 years of
the exchange; thus, a tax avoidance purpose is presumed to exist. The realized loss of
$20,000 [$280,000 (selling price) - $300,000 (carryover basis)] is disallowed to the extent
of the $5,000 built-in loss [$295,000 (fair market value) - $300,000 (basis)]. Therefore,
the recognized loss is $15,000 ($20,000 - $5,000). The 2-year presumption rule can be
overcome and all of the loss recognized if there is a clear and substantial business
relationship between the contributed land and Gray’s business. The related-party loss
limitation does not apply to a sale of property. Example 30 and Figure 5-2
51.
No loss is recognized. The land is disqualified property that is distributed to a related
party (both Arnold and Beatrice are considered 100% shareholders under the § 267
attribution rules). Thus, the related-party loss limitation applies and none of the realized
loss of $20,000 [$280,000 (fair market value) - $300,000 (carryover basis)] is recognized.
Example 29 and Figure 5-2
52.
a.
If Pink Corporation distributes all the land to Maria, none of the $1,200,000 loss
realized [$600,000 (fair market value) - $1,800,000 (basis)] on the distribution
will be recognized since Maria is a related party and the land is disqualified
property.
b.
If all the land is distributed to Paul, Pink Corporation will have a recognized loss
of $1,200,000. The land was valued at more than its basis on the date of the
transfer to Pink; thus, the built-in loss limitation does not apply. Because Paul is
an unrelated party, the related-party loss limitation does not apply.
c.
Even though the distribution is pro rata, the property is disqualified property; thus,
the loss on the distribution to Maria, a related party, would be disallowed. Of the
$1,200,000 loss, 20% (Paul’s interest), or $240,000, would be allowed. For the
reasons noted in option b. above, the loss limitations do not apply to the
distribution to Paul.
d.
In this case, 50% of the $1,200,000 realized loss, or $600,000, would be
disallowed. The property is disqualified property; thus, the loss on the
distribution to Maria, a related party, would be disallowed. The remaining
$600,000 loss will be recognized. For the reasons noted in option b. above, the
loss limitations do not apply to the distribution to Paul.
e.
Because the property does not have a built-in loss on the date of the transfer to the
corporation, the built-in loss limitation does not apply. Further, the related-party
Corporations: Redemptions and Liquidations
5-11
loss limitation does not apply to a sale of property.
Corporation would recognize the entire $1,200,000 loss.
Upon the sale, Pink
Pink Corporation should either distribute the land to Paul (option b.) or sell it and
distribute the cash (option e.).
pp. 5-20 to 5-23 and Figure 5-2
53.
a.
The answer would not change. The land is disqualified property that is distributed
to a related party; thus, the entire $1,200,000 loss realized is disallowed under the
related-party loss limitation.
b.
The property had a built-in loss of $300,000 [$1,500,000 (fair market value) $1,800,000 (basis)] when it was transferred to Pink Corporation. Further, the
transfer occurred within 2 years of the date the plan of liquidation was adopted.
Unless Pink can rebut the presumption of a tax avoidance purpose for the transfer,
the built-in loss of $300,000 is disallowed. The remaining $900,000 loss will be
recognized. Because Paul is an unrelated party, the related-party loss limitation
does not apply to a distribution to him. If Pink Corporation can establish a
business reason for the transfer of the property to the corporation and rebut the
2-year presumption rule, the entire $1,200,000 loss would be recognized.
c.
The loss on the property distributed to Maria, or $960,000, will be disallowed
entirely because it is a distribution of disqualified property to a related party.
Unless Pink Corporation can rebut the presumption of a tax avoidance purpose for
the transfer, an additional $60,000 of the loss [$300,000 (built-in loss) X 20%
(Paul’s distribution)] will be disallowed. As a result, $180,000 of the loss will be
recognized [$900,000 (post-transfer loss) X 20% (Paul’s distribution)]. If Pink
Corporation can rebut the 2-year presumption rule, $240,000 of loss would be
recognized [$1,200,000 (total loss) X 20% (Paul’s distribution)].
d.
The loss on the distribution of disqualified property to Maria, or $600,000, will be
disallowed. Of the remaining $600,000 loss, 50% of the built-in loss of $300,000,
or $150,000, will be disallowed unless Pink Corporation can demonstrate a
business purpose for the transfer. If Pink can rebut the 2-year presumption rule,
$600,000 of the loss, or the portion pertaining to the distribution to Paul, would be
recognized.
e.
If Pink Corporation cannot show a business purpose for the transfer, the built-in
loss of $300,000 would be disallowed. The remaining $900,000 loss would be
recognized. If Pink can rebut the 2-year presumption rule, the entire $1,200,000
loss would be recognized. The related-party loss limitation does not apply to a
sale of property.
Pink Corporation should either distribute the land to Paul (option b.) or sell it and
distribute the proceeds (option e.).
pp. 5-20 to 5-23 and Figure 5-2
54.
The tax results of these transactions to Helen are as follows:
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2003 Annual Edition/Solutions Manual

Helen may defer gain on the receipt of the notes to the point of collection under the
installment method.

Helen must allocate her $50,000 basis in the Purple Corporation stock between the
cash and the installment notes. Using the relative fair market value approach, 20%
[$100,000 (amount of cash)/$500,000 (total distribution)] of $50,000 (basis in the
stock), or $10,000, is allocated to the cash, and 80% [$400,000 (FMV of the
notes)/$500,000 (total distribution)] of $50,000 (basis in the stock), or $40,000, is
allocated to the notes.

Helen must recognize $90,000 [$100,000 (cash received) - $10,000 (basis allocated to
the cash)] in the year of the liquidation.

Since Helen's gross profit on the notes is $360,000 [$400,000 (FMV of notes) $40,000 (basis allocated to the notes)], the gross profit percentage is 90% [$360,000
(gross profit)/$400,000 (FMV of notes)]. Thus, Helen must report a gain of $72,000
[$80,000 (amount of annual payment) X 90% (gross profit percentage)] on the
collection of each note over the next five years.

The interest element is accounted for separately.
Example 35
55.
Magenta recognizes no gain on the distribution of assets to Fuchsia, its parent
corporation. The land distribution to Marta results in a $25,000 nonrecognized loss
[$50,000 (fair market value) - $75,000 (basis)] to Magenta.
Fuchsia recognizes no gain or loss in the liquidation, and it has a carryover basis of
$620,000 in the assets received. Magenta’s tax attributes (e.g., E & P) carry over to
Fuchsia. Fuchsia’s basis in the Magenta stock disappears.
Marta recognizes a $20,000 gain [$50,000 (amount realized) - $30,000 (basis of stock)] in
the liquidation, and she has a basis in the land of $50,000.
Concept Summary 5-2
56.
Green Corporation recognizes no gain on the transfer of the land to satisfy its
indebtedness to Orange Corporation. Transfers by a subsidiary corporation pursuant to a
§ 332 liquidation are subject to the nonrecognition rules of § 337. Orange Corporation,
however, must recognize a gain of $50,000 [$500,000 (fair market value of the land) $450,000 (basis in the bonds)]. Examples 37 and 38
57.
a.
Wren Corporation recognizes no gain (or loss) on its liquidation under § 337. The
liquidation meets the requirements of § 332. Since the Wren stock was acquired
three years ago, a § 338 election is not available to Cardinal.
b.
Cardinal Corporation recognizes no gain (or loss) on the liquidation under § 332.
c.
Cardinal Corporation takes a carryover basis in the assets, or $900,000.
Cardinal’s basis in the Wren stock disappears. As noted in part a. above, a § 338
election is not available to Cardinal.
Corporations: Redemptions and Liquidations
d.
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Cardinal Corporation acquires Wren Corporation’s E & P of $500,000 and net
operating loss carryover of $120,000 under § 381.
pp. 5-26, 5-28, and Chapter 7
58.
Hoffman, Raabe, Smith, and Maloney, CPAs
5191 Natorp Boulevard
Mason, OH 45040
October 11, 2002
Quail Corporation
1010 Cypress Lane
Community, MN 55166
Dear President of Quail Corporation:
This letter is in response to your question as to the tax consequences to Quail Corporation
if it liquidates its wholly owned subsidiary, Sparrow Corporation. Our conclusion is
based on the facts as outlined in your October 5 letter. Any change in facts may cause our
conclusion to be inaccurate.
Because Sparrow Corporation is insolvent (its liabilities exceed the value of its assets),
Quail Corporation would have an ordinary loss deduction for its worthless stock in
Sparrow Corporation. The loss to Quail would be measured by the fair market value of
Sparrow's net assets less Quail's basis in the Sparrow stock.
Should you need additional information or need to clarify our conclusion, do not hesitate
to call on me.
Sincerely,
Larry C. Williams, CPA
Partner
TAX FILE MEMORANDUM
DATE:
October 8, 2002
FROM:
Larry C. Williams
SUBJECT:
Quail Corporation
Today I talked to the President of Quail Corporation with respect to his October 5 letter.
Quail Corporation is considering liquidating its wholly owned subsidiary Sparrow
Corporation and wants to know the tax consequences upon a liquidation of Sparrow
Corporation.
At issue: What are the tax consequences of a liquidation of a wholly owned subsidiary
when the subsidiary is insolvent?
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2003 Annual Edition/Solutions Manual
Conclusion: Because Sparrow Corporation is insolvent, § 332 would not apply to the
liquidation. Quail Corporation would have an ordinary loss deduction for its worthless
stock in Sparrow Corporation under § 165(g)(3).
p. 5-26 and Chapter 3
59.
a.
Because Canary purchased 80% or more of Falcon's stock within a 12-month
period, it could make a § 338 election. p. 5-29
b.
Canary Corporation should not elect § 338. If § 338 is elected, Falcon's assets
(regardless of whether Falcon Corporation is liquidated) would receive a steppeddown basis. Falcon Corporation would recognize a loss on the deemed sale of its
assets; however, the loss probably could not be utilized since Falcon undoubtedly
has had tax losses, rather than taxable income, in the past. Further, since Falcon
would be treated as a new corporation as a result of the § 338 election, any loss
carryovers (e.g., NOL) would disappear. pp. 5-29 and 5-30
The answers to the Research Problems are incorporated into the 2003 Annual Edition of the
Instructor's Guide with Lecture Notes to Accompany WEST FEDERAL TAXATION:
CORPORATIONS, PARTNERSHIPS, ESTATES, AND TRUSTS.
Corporations: Redemptions and Liquidations
NOTES
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