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Exam 5: Corporations: Earnings Profits and Dividend Distributions

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Question 1

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Using the legend provided, classify each statement accordingly. In All cases, assume that taxable income is being adjusted to arrive at current E & P for 2014. a. Increase b. Decrease c. No effect -Meal and entertainment expenses not deducted in 2014 because of the 50% limitation.

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Question 2

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A distribution in excess of E & P is treated as capital gain by shareholders.

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In the current year, Carnation Corporation has a § 179 expense of $60,000. As a result, in the current year, taxable income must be increased by $48,000 to determine current E & P.

Brown Corporation, an accrual basis corporation, has taxable income of $150,000 in the current year. Included in its determination of taxable income are the following transactions. -Brown incurred a $65,000 capital loss from the sale of stock. Because Brown had no capital gains this year, none of the loss is deductible. -The corporation's Federal income tax liability is $41,750. -Brown incurred $18,000 in nondeductible meal and entertainment expenses. -Brown uses the LIFO method when accounting for inventory. This year, the company's LIFO recapture amount increased by $3,000. -Brown claimed a domestic production activities deduction under § 199 of $1,500. What is Brown's current E & P for the year?

An increase in the LIFO recapture amount must be added to taxable income to determine E & P.

Glenda is the sole shareholder of Condor Corporation. She sold her stock to Melissa on October 31 for $150,000. Glenda's basis in Condor stock was $50,000 at the start of the year. Condor distributed land to Glenda immediately before the sale. Condor's basis in the land was $20,000 (fair market value of $25,000) . On December 31, Melissa received a $75,000 cash distribution from Condor. During the year, Condor has $20,000 of current E & P and its accumulated E & P balance on January 1 is $10,000. Which of the following statements is true?

The terms "earnings and profits" and "retained earnings" are identical in meaning.

Purple Corporation has accumulated E & P of $100,000 on January 1, 2014. In 2014, Purple has current E & P of $130,000 (before any distribution) . On December 31, 2014, the corporation distributes $250,000 to its sole shareholder, Cindy (an individual) . Purple Corporation's E & P as of January 1, 2015 is:

Using the legend provided, classify each statement accordingly. In All cases, assume that taxable income is being adjusted to arrive at current E & P for 2014. a. Increase b. Decrease c. No effect -Intangible drilling costs deducted currently.

Constructive dividends have no effect on a distributing corporation's E & P.

Thistle Corporation declares a nontaxable dividend payable in rights to subscribe to common stock. One right and $25 entitle the holder to subscribe to one share of stock. One right is issued for each share of stock held. Annette, a shareholder, owns 200 shares of stock that she purchased five years ago for $3,000. At the date of distribution of the rights, the market values were $50 per share for the stock and $25 for a right. Annette received 200 rights. She exercises 160 rights and purchases 160 additional shares of stock. She sells the remaining 40 rights for $1,080. What are the tax consequences to Annette?

If a distribution of stock rights is taxable and their fair market value is less than 15 percent of the value of the old stock, then either a zero basis or a portion of the old stock basis may be assigned to the rights, at the shareholder's option.

Renee, the sole shareholder of Indigo Corporation, sold her stock to Chad on July 1 for $180,000. Renee's stock basis at the beginning of the year was $120,000. Indigo made a $60,000 cash distribution to Renee immediately before the sale, while Chad received a $120,000 cash distribution from Indigo on November 1. As of the beginning of the current year, Indigo had $26,000 in accumulated E & P, while current E & P (before distributions) was $90,000. Which of the following statements is correct?

When computing E & P, taxable income is not adjusted for § 179 expense.

To determine E & P, some (but not all) previously excluded income items are added back to taxable income.

Pink Corporation declares a nontaxable dividend payable in rights to subscribe to common stock. Each right entitles the holder to purchase one share of stock for $25. One right is issued for every two shares of stock owned. Jack owns 100 shares of stock in Pink, which he purchased three years ago for $3,000. At the time of the distribution, the value of the stock is $45 per share and the value of the rights is $2 per share. Jack receives 50 rights. He exercises 25 rights and sells the remaining 25 rights three months later for $2.50 per right.

Sylvia owns 25% of Cormorant Corporation. Cormorant sells diamonds to retail jewelry businesses. While Cormorant has a deficit in accumulated E & P of $56,000 at the beginning of the year, its current E & P is $500,000. Since the company had a successful year, Cormorant pays a $36,000 distribution to each of the company's four shareholders on December 15. Three shareholders receive cash, but Cormorant distributes a diamond (adjusted basis of $40,000 and a fair market value of $36,000) to Sylvia in lieu of cash. Determine the effect of distributing the diamond on Cormorant's and on Sylvia's taxable income. What is Sylvia's basis in the diamond? Was the distribution good tax planning on the part of Cormorant? Why or why not?

Finch Corporation (E & P of $400,000) distributed machinery ($10,000 adjusted basis, $150,000 fair market value) to its sole shareholder, Kathleen. The property is subject to a $50,000 mortgage, which Kathleen assumed. How much dividend income does Kathleen recognize as a result of the distribution and what is her basis in the machinery?

Distributions that are not dividends are a return of capital and decrease the shareholder's basis.

Using the legend provided, classify each statement accordingly. In All cases, assume that taxable income is being adjusted to arrive at current E & P for 2014. a. Increase b. Decrease c. No effect -Interest received from municipal bonds in 2014.