FEDERAL TAXATION OF CORPORATIONS AND SHAREHOLDERS
PROFESSOR PIKE
Fall 2011
ASSIGNMENT 1
The casebook for this course is Lind, Schwartz, Lathrope and Rosenberg, Fundamentals of Corporate
Taxation ["LSLR"] (2008). In addition, a current copy of the selected Internal Revenue Code provisions and
regulations is required for the course.
I.
BACKGROUND AND INTRODUCTION
A.
INTRODUCTION: LSLR pp. 2-14.
B.
CORPORATE TAX RATES AND BASE: LSLR pp. 14-20, 23-24, 25-27. Please read pp.
27-34, but don’t sweat the details - this case will be covered primarily by lecture. I.R.C. §11.
If the business entity is treated as a corporation, it is presumptively subject to the tax rates
specified in section 11. Certain corporations may elect to be treated as "S Corporations." We
will discuss the taxation of S corporations and their shareholders in greater detail later in the
semester. However, it should be noted that the corporate tax can be avoided if this election is
made. Read LSLR pp. 686-688; IRC §§1361(a)-(b)(1), 1366(a)-(d)(1) to determine eligibility
to make the S Corporation election and the effect of that election of the corporation's
shareholders.
In addition, businesses may be conducted using the form of a partnership or, increasingly, as a
limited liability company. LLCs, are discussed briefly in the introductory material assigned
above.
Under the so-called “check the box” regulation §301.7701-3, a business entity (that otherwise
would be taxed as a partnership) may elect to be taxed as a corporation. Although you should
be aware that these regulations exist, you are not responsible for their content.
PROBLEMS
1.
Lizzie is an individual who is subject to tax at an effective marginal tax rate of 35%
(see IRC §1(i)). Lizzie operates a proprietorship that will produce taxable income of
$10,000 in 2011. For tax purposes, the income of a proprietorship is included in the
income of the proprietor. How much tax will Lizzie have to pay on the taxable income
earned by the proprietorship?
[NOTE: At the time that this syllabus was prepared, the top marginal tax rate was
scheduled to increase to 39.6%]
2.
Assume the same facts as in Problem 1, except that Lizzie forms a new corporation,
Prague Enterprises, Inc, and that Lizzie owns 100% of its stock. This corporation,
which conducts the business previously conducted by the proprietorship, has taxable
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income of $10,000. Compute Prague Enterprises' tax liability for 2011. (See section
11).
3.
Assume the same facts as in Problem 2, except that Prague Enterprises elects to be
treated as an S corporation. What is the tax liability of Prague Enterprises? How will
Lizzie's tax liability be affected by the operations of Prague Enterprises?
4.
As we shall study later in the semester, a dividend paid by a corporation (other than an
S Corporation) to a shareholder is included in the shareholder's gross income. Under
§1(h)(11), “qualified dividend income” is taxed in the same manner (and at the same
rate as) net capital gains. Read IRC §1(h)(1)(B) and ( C) and §1(h) (11).
What will be the tax consequences to Lizzie if Prague Enterprises distributes all of its
taxable income remaining after the payment of any corporate income tax if: (a) Prague
Enterprises has elected to be treated as an S corporation; and (b) Prague Enterprises is
not an S corporation. In making these determinations, assume that Lizzie is taxed at
the highest tax rates.
5.
II.
Please read United Parcel Services of America v. Commissioner, pp. 27-33. This
complicated case demonstrates an attempt to avoid the corporate income tax utilizing a
series of transaction involving the creation of a “brother-sister” corporate structure,
with an intercorporate transaction. If I am in a good mood, I will cover this
transaction by lecture, but try to make some sense of this on your own.
CORPORATE FORMATION
A.
OVERVIEW: LSLR pp. 60-64. IRC §§351(a)-(b), 358(a)(1), 362(a), 368(c), 1032. Reg.
§1.351-1(a) and (b). Note that the textual material and statutory provisions are rather dense;
do not despair - we will work with these statutory provisions over the course of several
classes.
Problem 5: Review IRC §1031 and consider the gain recognized (if any) and Leah's basis in
the property received in the following exchanges:
B.
a.
Leah owns real property which is used in her trade or business. The fair market value
of this property is $30,000, and its adjusted basis is $10,000. Leah exchanges this
property for other real property to be used in her trade or business with a fair market
value of $30,000.
b.
Leah transfers the real property to IBM in exchange for 300 shares of IBM common
stock, which is worth $30,000.
c.
Leah transfers the real property to Leah Enterprises in exchange for 300 shares of Leah
Enterprises common stock, which is a newly formed corporation.
CONTROL OF THE CORPORATION
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LSLR pp. 64-71. IRC §368(c); Reg §1.351-1(a)(1).
Problem 6: Biotech Enterprises, Inc. had outstanding 100 shares of common stock that were
owned by Splice. Although Biotech had developed a promising new drug, it did not
have adequate resources to test the drug and obtain FDA approval to market the drug.
On January 1, 2011, Splice's mother, Ma, transferred Blackacre to Biotech Enterprises
in exchange for 300 shares of Biotech preferred stock. Each share of common and
preferred stock had equal voting rights. Ma's basis in Blackacre was 100 and its fair
market value was 1,500. How much gain, if any, will Ma and Biotech recognize as a
result of the forgoing transactions?
Would the results in this problem differ if either of the following alternatives transactions
occurred in addition to the facts set out above:
C.
1.
On January 10, 2011, Silicon Chip S&L, which was Biotech's bank, purchased 100
shares of Biotech senior preferred stock for $500? Would your answer change if
Biotech purchased this stock from Silicon Chip on February 15, 2011?
2.
On February 1, 2011, Splice transferred $100 in cash to Biotech in exchange for an
additional 10 shares of Biotech common stock?
TRANSFER OF PROPERTY vs. TRANSFER FOR SERVICES
LSLR pp. 71-72. James v. Commissioner (available in the course document section of
MyWCL). IRC §351(d).
Problem 7: X, Y and Z agree to form a new corporation, Lizzie Acres, Inc. Under the
terms of their agreement, X and Y will each contribute real property worth 100. X's
basis in the property to be transferred is 40; Y's basis is 130. Z, who has also served as
an attorney for X and Y, will contribute his services in obtaining more favorable
zoning for the land to be acquired by Lizzie Acres from X and Y. Each of the new
shareholders of the corporation will receive 100 shares of Lizzie Acres common stock.
What questions (if any) would you ask X,Y, and Z? How much gain is recognized as
a result of these exchanges to X, Y, Z and Lizzie Acres? Would you advise the parties
to modify the transaction so that Z also contributed $10 cash to Lizzie Acres? Can
you suggest any other ideas for restructuring this transaction?
D.
RECEIPT OF PROPERTY OTHER THAN STOCK: TREATMENT OF BOOT
LSLR pp. 72-73, 75-83 (Skim Rev. Rul. 68-55); I.R.C. §§ 351(b), 351(g)(1), (2)(A) and (3).
Problem 8: W forms a new corporation, C Corp. W will contribute real property worth 100.
W's basis in the property to be transferred is 45. In exchange for the property, W
receives the following:
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Property Received
Fair Market Value
common stock of C
30
preferred stock of C
20
Cash
10
Automobile
40
The preferred stock is not redeemable, and it pays a non-cumulative 6 percent annual
dividend. How much gain will W realize as a result of this exchange? How much gain will
W recognize when the exchange occurs?
E.
ASSUMPTION OF LIABILITIES
LSLR pp. 83-102, 107-112. IRC §357(a), (b)(1), (c)(1), (2)(A), (3). §1.357-1,2.
Problem 9: Following its incorporation, A transferred Orange-acre Apartments to Lizzie
Acres, Inc. In exchange, A received 100 shares of Lizzie Acres common stock, which are the
only shares of Lizzie Acres outstanding. A had acquired Orange-acre for a cost of $800 and
had claimed depreciation deductions in the aggregate amount of $300. The property's fair
market value was $900. At the time of the transfer, Orangeacre was subject to a first
mortgage indebtedness of $600. How much gain or loss would be recognized by A if:
F.
1.
Lizzie Acres, Inc. assumed A's liability secured by the mortgage on Orangeacre
Apartments? (See Reg §1.357-2(a))
2.
A also transferred Greenacre to Lizzie Acres, Inc. as part of the same overall
transaction. A's basis in Greenacre was 300, and its fair market value was 1000.
3.
The facts are the same as in 2, except that the mortgage indebtedness was incurred by
A to pay $600 to settle a lawsuit brought by A's ex-spouse. Would your answer differ
depending on whether the loan was incurred (a) three years before the transfer; or (b)
one week prior to the transfers to Lizzie Acres.
BASIS CONSIDERATIONS IN §351 EXCHANGE
The readings from this chapter of the text have mentioned basis considerations at various
points. Review those discussions. In addition, LSLR pp. 113-121; IRC §§ 358(a), (d) and
(h); 362 (a) and (c); 1032.
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Problem 10: The facts are the same as in Problem 9, and the property transferred to Lizzie
Acres, Inc. are subject to the indebtedness described in question 1 of that problem.
G.
1.
What is A's basis in the stock of Lizzie Acres?
2.
What is Lizzie Acres' basis in the assets received from A?
3.
Would the result differ if the additional facts discussed in question 3 of problem 9 had
been known? Would §358(d)(2) apply in this case?
Collateral Issues
LSLR pp. 121-124. This material is straightforward and class discussion will not be extensive.
III.
NONLIQUIDATING DISTRIBUTIONS
A.
DIVIDEND DISTRIBUTIONS IN GENERAL
1.
Introduction and Statutory Overview: LSLR pp. 159-166. IRC §§ 301(a)-(d), 316(a), 317,
61(a)(7). The operation of these sections is extremely important, and we will use the
following problems to illustrate how they operate. In reading the assigned material and
working through the problems, you may find it less confusing to use the phrase "section 301
distribution" rather than "dividend." (See IRC §301(c)(1)).
Problem 11: Corporation Z has 100 shares of common stock outstanding. 50 shares are
owned by A, an individual; the remaining 50 shares are owned by B, a corporation. Each
shareholder has a basis of 65 in their Z stock. Z makes a distribution of $100 cash to A and a
distribution of a truck worth 100 to B.
Amount Distributed
1.
What is the "amount distributed" to the shareholders in this problem. See IRC
§301(b)(1).
2.
Would the result be different if, in connection with the distribution of the
truck, B had assumed a liability of Z in the amount of 30?
Effect of Distribution on Corporate and Individual Shareholders:
1.
Assuming that Z has earnings and profits in excess of 200, how will A and B
be taxed on this distribution and what will their basis be in the properties
received? (See §§ 301(c) and (d), 316, 243(a)(1)and ( c), 1(h)(11) and 1(h)(1)).
2.
Assuming that Z has no earnings and profits, how will A and B be taxed on
these distributions? (See § 1(h))
B.
EARNINGS AND PROFITS
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LSLR pp. 166-173, 192-193; IRC §§ 312(a)-(c), (f)(1), (k)(1)-(3)(B), (n)(5); 301(e). This
subject is quite difficult and detailed. You just have to wade through the statute
Problem 12: Z, our old friend from Problem 11, has no accumulated earnings and profits,
and its 2011 taxable income was 12,500. Assume that Z Corp. paid federal income taxes of
$3,500. In addition, assume that in computing its taxable income Z Corp claimed (under
§168) depreciation deductions of $3,000. If Z Corp. had computed its depreciation deductions
under the alternative depreciation system, its deduction would have been only $2,000.
Determine Z Corp.'s earnings and profits for the year.
C.
DISTRIBUTIONS OF PROPERTY
LSLR pp. 173-177. IRC §§ 311, 312(b).
Problem 13: The common stock of R corporation is owned by A. A's basis in the R stock
was 20. R's accumulated earnings and profits was 10, and its current earnings and
profits was zero. R owned a classic automobile which had a fair market value of 100.
R's basis in the automobile was 40. R distributed the automobile to A.
a.
Does R recognize any income as a result of the distribution of the automobile to A?
b.
Does the distribution affect R's earnings and profits?
c.
What are the tax consequences to A of the distribution of the automobile to her by R?
d.
D.
How would
your
answers
differ if R's
basis in the
automobile
were 120?
DISGUISED OR CONSTRUCTIVE DIVIDENDS
LSLR pp. 180-187.
Problem 14: Development Corp is a highly successful builder of new homes and it has tons
of earnings and profits. Several years ago, it lent its sole shareholder, H, $1,000,000
which she used to purchase a second home in Florida. It did not charge H any interest.
What are the tax consequences of this arrangement to H. In analyzing this problem,
consider §7872 and: (1) assume that the applicable federal rate is ten percent; and (2)
consider what additional facts would influence your analysis.
E
ANTI-AVOIDANCE LIMITATIONS ON THE DIVIDENDS RECEIVED
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DEDUCTION: LSL&R pp. 187-192. IRC §§243(a), ( c)(1), 1059 (a)-( c)(2). We will not
discuss this material relatively briefly – and these provisions will not (knowingly) be
included on the final exam – I just thought that you should be exposed to these types of
provision that illustrate the principle that if things look too good to be true, they probably are.
IV. REDEMPTIONS AND SIMILAR TRANSACTIONS
A.
INTRODUCTION: LSL&R pp. 208-213; IRC §§ 302(a), (c)(1), (d), 317, 318. Study the
attribution rules in §318 with some care because we will work with them extensively. In
addition, familiarize yourself with §1202(a)-(b)(2), (c)(1)-(2)(A), (d)(1).
Problem 15: p. 213 Problem 1.
B.
REDEMPTIONS TESTED AT THE SHAREHOLDER LEVEL
1.
Complete Terminations under §302(b)(3): LSL&R pp. 218-235. IRC §§302(b)(3),
(c)(1)-(2)(C); 318.
Problem 16: p. 235, Problem 1 (factual variation (a) - ( c)); Problem 3 (factual
variation (a)).
In working through Problem 1, variation (a), assume that the waiver described
in section 302(c)(2) has been made.
2.
Substantially Disproportionate Redemptions under §302(b)(2): LSL&R pp. 214217. IRC §302(b)(2).
Problem 17: p. 217. Problem 1.
C.
D.
3.
Redemptions Not Essentially Equivalent to a Dividend: LSL&R pp. 236-249; IRC
§302(b)(1).
4.
Partial Liquidations under § 302(b)(4): LSL&R pp. 249-252; IRC §302(b)(4), (e).
This material will not be discussed in class.
TREATMENT OF THE CORPORATION:
1.
Effect of Redemption on Corporation's Income and Earnings and Profits:
LSL&R pp. 254-260. IRC §312(n)(7).
2.
Stock Reacquisition Expenses: LSL&R pp. 260-262. IRC §162(k).
DISTRIBUTIONS RELATED TO OTHER TRANSACTIONS
1.
Distributions as Part of Bootstrap Acquisitions: LSL&R pp. 194-207, 263-268;
IRC §§ 246A and 1059(a)-( c)(2).
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Problem 18: A owns all of the stock of X corporation. A’s basis in the stock is
$40,000 and the fair market value of these shares is $100,000. M wants to acquire the
business operations of X corporation, which have a fair market value of $60,000. X
corporation also has liquid assets of $40,000 that are not needed in its business
operations. X corporation has tons of earnings and profits. Consider the tax
consequences of the following acquisition techniques:
(A)
X corporation distributes $40,000 to A, who then sells the X
corporation stock to M for $60,000.
(B)
A sells the X corporation stock to M for $100,000. X corporation then
distributes $40,000 to M..
A sells 60 % of the X corporation stock to M. Then, X corporation
redeems the remainder of A’s stock for $40,000.
( C)
2.
E.
Constructive Dividend Issues: LSL&R pp. 268-271.
REDEMPTIONS THROUGH THE USE OF RELATED CORPORATIONS
LSL&R pp. 287-299; IRC §304(a)-(b)(2), ( c).
NOTE: This stuff is difficult.
Reeeeeeeal difficult.
Problem 19: A owns 100 shares of Wowwy Corporation common stock and 200
shares of Zowwy Inc. common stock. A's basis in the Zowwy stock is $12,000
and his basis in the Wowwy stock is $5,000. The earnings and profits of these
corporations are as follows:
Corporation
Accumulated
E&P
Zowwy
Wowwy
Current
E&P
9,000
0
4,000
(20,000)
QUESTION: On January 1, A sold 100 shares of Zowwy Corporation common stock
to Wowwy Corporation for $15,000. What are the tax consequences of this
sale to A?
QUESTION: Would the result differ if, in addition to the stock ownership described
above, G, an individual unrelated to A, owned 100 shares of Wowwy
common and H, another individual unrelated to A, owned 200 shares of
Zowwy common?
V.
DISTRIBUTIONS OF STOCK
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A.
DISTRIBUTIONS OF STOCK AND STOCK RIGHTS UNDER § 305.
1.
Introduction: LSL&R pp. 303-305; IRC §§ 305 (a)-(d)(2), 307(a); §1.307-1(a).
2.
Exceptions to the General Rule -- §305(b) and (c): LSL&R pp. 305-313
Problem 20: Lizzie and Leah each own 100 shares of Pike Enterprises, Inc. common
stock. Each of these shareholders has a basis of $1,000 in this stock. Prior to
the events discussed below, each share of Pike Enterprises common stock had a
fair market value of $50.
Pike Enterprises owns all 100 shares of WCL Development Company. At the
relevant dates, Pike Enterprises has earnings and profits of $500. What are the
tax and basis consequences to Lizzie and Leah of the following distributions?
(Each of the distributions are alternatives)
a.
Pike Enterprises distributes 25 shares of Pike Enterprises common
stock to Lizzie and 25 shares to Leah. The fair market value of this
stock was $40 per share.
b.
Pike Enterprises distributes 25 shares of WCL Development common
stock to Lizzie and 25 shares to Leah. The fair market value of this
stock was $10 per share.
c.
Pike Enterprises distributes bonds of Pike Enterprises to Lizzie and to
Leah. These bonds provide that interest will be paid at the market rate,
and that the principal amount of the bonds will be paid to the holder of
the bonds in 15 years. The fair market value of the bonds received by
each shareholder was $250.
d.
Pike Enterprises distributes 50 shares of Pike Enterprises common
stock to Barbara, who is the corporation's Chief Executive Officer.
Prior to this distribution, Barbara did not own any stock of Pike
Enterprises. The fair market value of this common stock was $40 per
share. See IRC §83(a), (h).
e.
Pike Enterprises distributes 50 shares of Pike Enterprises preferred
stock to Lizzie and 50 shares of Pike Enterprises preferred stock to
Leah. The fair market value of this stock was $10 per share.
f.
Assume that Andy owns 100 shares of Pike Enterprises nonvoting
preferred stock. Pike Enterprises distributes $1,000 cash to Andy and
25 shares of common stock to Lizzie and 25 shares of common stock to
Leah.
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B.
PREFERRED STOCK BAILOUTS AND §306 STOCK. LSL&R pp. 314-323; IRC §§
306(a)-(c), 307. We will concentrate on the Chamberlin case (to understand the abuse in
response to which §306 was enacted) and problem 21 to see how §306 operates. We will not
examine the remaining material from the casebook in class.
Problem 21: L and M are individuals who each own 100 shares of common stock of
Electronics, Inc. Each of them had a basis of $2,000 in this stock. On January
1, Electronics issued one share of preferred stock as a dividend for each share
of common stock outstanding. At the time of this distribution, Electronics had
earnings and profits of $800, and each share of the preferred stock had a fair
market value of $10. After the distribution, the preferred stock had a basis of
$5 per share. (Trust me on this one.)
a.
Did L recognize any income as a result of receiving the preferred
stock?
b.
On March 1 on the following year, L sold his 100 shares of preferred
stock to Z, an unrelated individual, for $1,000. What are the tax
consequences to L of this sale?
c.
Would the result differ if the stock received as a dividend had been
common stock rather than preferred stock?
d.
Would the result differ if the preferred stock had been issued to the
shareholders when the corporation was first organized? (NOTE:
§306(c)(3) does not apply to this transaction - it can be ignored for
purposes of this course).
e.
What would the tax consequences have been if:
(1) L had not sold the stock to Z, and
(2) Electronics had redeemed L's preferred stock on March 1,
assuming that Electronics' earnings and profits had
remained at $800? Would the result be different if
Electronics' earnings and profits had increased to
$2,000?
VI.
CAPITAL STRUCTURE OF THE CORPORATION
LSL&R pp. 132-150 §1244(a)-(b).
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