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SM Ch06 SWFT2013

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SM Ch06 SWFT2013SM C

    CHAPTER 6

    CORPORATIONS: REDEMPTIONS AND LIQUIDATIONS

    SOLUTIONS TO PROBLEM MATERIALS

     Status: Q/P Question/ Learning Present in Prior Problem Objective Topic Edition Edition

     1 LO 1 Return from investment contrasted with Unchanged 1

    return of investment

     2 LO 1 Why sale or exchange treatment limited New

    to qualifying stock redemptions

     3 LO 1, 2, 6 Stock redemption or sale to third party New

     4 LO 1 Sale or exchange versus dividend Unchanged 4

    treatment on redemption

     5 LO 1 Shareholder preference for qualifying or Unchanged 5

    nonqualified stock redemption

    treatment

     6 LO 1 Loss recognition in a qualifying stock New

    redemption

     7 LO 1 Basis of property received in stock Unchanged 7

    redemption

     8 LO 1 Stock redemptions: effect of state law Unchanged 8

     9 LO 1 Stock attribution rules: partnerships New

     10 LO 1 Stock attribution rules: when not Unchanged 10

    applicable

     11 LO 1 Not essentially equivalent redemption: New

    requirements

     12 LO 1 Disproportionate redemption: Unchanged 12

    requirements

     13 LO 1, 2 Complete termination redemption Unchanged 13

     14 LO 1, 6 Complete termination redemption: New

    requirements for family attribution

    waiver

     15 LO 1 Partial liquidation: termination of a Unchanged 15

    business test

     16 LO 1, 2 Partial liquidation Unchanged 16

     17 LO 1 Redemption to pay death taxes: gain or New

    loss recognition by estate

     18 LO 1, 2 Redemption to pay death taxes: Unchanged 18

    requirements for and consequences of

     19 LO 1, 2 Redemption to pay death taxes Unchanged 19

     20 LO 2, 6 Gain/loss recognition to corporation on Modified 20

    redemption distribution

    6-1

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    6-2 2013 Corporations Volume/Solutions Manual

     Status: Q/P Question/ Learning Present in Prior Problem Objective Topic Edition Edition

     21 LO 2 Tax consequences of redemption to Unchanged 21

    distributing corporation

     22 LO 2 Tax consequences of redemption to Unchanged 22

    distributing corporation: redemption-

    related expenses

     23 LO 3 Preferred stock bailout: consequences of New

    sale

     24 LO 3 Redemption through use of related Unchanged 24

    corporation

     25 LO 4 Corporate liquidation: reasons for New

     26 LO 4 Corporate liquidation: loss limitations New

     27 LO 1, 2, Liquidating and redemption distributions Unchanged 27

    4 compared: applicability of ? 267

     28 LO 4 Related-party loss limitation: disqualified New

    property defined

     29 LO 4 Built-in loss limitation: effect of basis Unchanged 29

    step-down rule

     30 LO 4 Tax consequences to shareholder in Unchanged 30

    complete liquidation; use of

    installment method to report gain

     31 LO 5 Section 332 liquidation: consequences to Unchanged 31

    parent

     32 LO 5 Section 332 liquidation: insolvent Unchanged 32

    corporation

     33 LO 5 Section 332 liquidation: tax consequences Unchanged 33

    to subsidiary and minority shareholder

     34 LO 5 Section 332 liquidation: transfer in New

    satisfaction of indebtedness

     35 LO 5 Section 332 liquidation: subsidiary tax Unchanged 35

    attributes

     36 LO 5 Section 338: consequences of election Unchanged 37

     37 LO 5 Section 338: subsidiary liquidation New

    compared with no election from

    parent’s perspective

     *38 LO 1, 2, Comparison of dividend distribution with Unchanged 38

    6 qualifying redemption: individual

    versus corporate shareholder

     *39 LO 1 Comparison of tax treatment of dividend Modified 39

    distribution and qualifying stock

    redemption to individual shareholder

     40 LO 1 Comparison of tax treatment of dividend Modified 40

    distribution and qualifying stock

    redemption to corporate shareholder

     *41 LO 1 Comparison of tax treatment of dividend Modified 41

    distribution and qualifying stock

    redemption to individual shareholder

    with capital loss carryover

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     Corporations: Redemptions and Liquidations 6-3

     Status: Q/P Question/ Learning Present in Prior Problem Objective Topic Edition Edition

     42 LO 1 Comparison of tax treatment of dividend Modified 42

    distribution and qualifying stock

    redemption to corporate shareholder

    with capital loss carryover

     43 LO 1 Application of stock attribution rules Unchanged 43

     44 LO 1 Not essentially equivalent redemption and Unchanged 44

    disproportionate redemption

     45 LO 1, 2 Disproportionate redemption: minimum Unchanged 45

    shares to qualify; tax consequences to

    shareholder and corporation

     46 LO 1 Complete termination redemption: New

    applicability of family attribution

    waiver

     *47 LO 1, 2 Sale of stock versus complete termination Unchanged 47

    redemption: effect on retiring

    shareholder, remaining shareholder,

    and corporation

     48 LO 1, 2 Partial liquidation: tax consequences to New

    individual and corporate shareholders

     *49 LO 1, 2 Redemption to pay death taxes and Unchanged 49

    complete termination redemption:

    consequences to estate and corporation

     50 LO 1 Redemption to pay death taxes: stock of Unchanged 50

    two corporations

     *51 LO 1, 2 Disproportionate redemption: New

    consequences to shareholder and effect

    on E & P

     52 LO 2 Effect of redemption on corporation: Modified 52

    E & P adjustment and treatment of

    redemption expenses

     *53 LO 3 Section 306 stock: sale and redemption Unchanged 53

     54 LO 3 Redemption through use of related Unchanged 54

    corporations

     *55 LO 1, 2, Liquidations and redemptions compared: Unchanged 55

    4 recognition of loss by corporation and

    shareholder

     *56 LO 4 Complete liquidation: distribution of Modified 56

    property subject to liability

     57 LO 4 Related-party loss limitation: pro rata Unchanged 57

    distribution of disqualified property

     58 LO 4 Built-in loss limitation: no tax avoidance Unchanged 58

    purpose

     59 LO 4 Built-in loss limitation: distribution and New 59

    tax avoidance purpose with basis step-

    down

     *60 LO 4 Complete liquidation: related-party loss Modified 60

    limitation

     *61 LO 4 Complete liquidation: disqualified Modified 61

    property and built-in loss property

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    6-4 2013 Corporations Volume/Solutions Manual

     Status: Q/P Question/ Learning Present in Prior Problem Objective Topic Edition Edition

     62 LO 4 Complete liquidation: tax consequences New

    to corporation and shareholder when

    property distributed with liability

     *63 LO 4 Complete liquidation: tax consequences Modified 63

    to shareholder when installment notes

    distributed

     64 LO 4, 5 Liquidation of subsidiary: distribution of Unchanged 64

    loss property to minority shareholder

     65 LO 4, 5 Liquidation of subsidiary: gain and loss Unchanged 65

    properties, minority shareholder

     66 LO 5 Liquidation of subsidiary: indebtedness Unchanged 66

    of subsidiary to parent

     *67 LO 5 Liquidation of subsidiary: tax Unchanged 67

    consequences to subsidiary and parent

     68 LO 5 Section 338: election requirements New

     *The solution to this problem is available on a transparency master.

     Status: Q/P Research Present in Prior Problem Topic Edition Edition

     1 Family attribution waiver; independent Unchanged 2

    contractor as prohibited interest

     2 Charitable contribution of ? 306 stock Unchanged 3

     3 Gift of stock followed by redemption: Unchanged 4

    assignment of income doctrine

     4 Constructive liquidation New

     5 Internet activity Unchanged 5

     6 Internet activity New

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     Corporations: Redemptions and Liquidations 6-5

    CHECK FIGURES

    38.a. Teal taxable gain of $70,000; Grace redemption expenses not deductible;

     dividend income of $250,000. $18,500 interest deductible.

    38.b. Teal taxable gain of $70,000; Grace 53.a. No tax consequences other than

     $250,000 of dividend, subject to the allocation of stock basis.

     dividends received deduction. 53.b. Ordinary income of $100,000,

    38.c. Teal taxable gain of $70,000; Grace $30,000 basis to common stock.

     capital gain of $180,000. 53.c. Dividend income of $100,000,

    38.d. Teal taxable gain of $70,000; Grace $30,000 basis to common stock;

     capital gain of $180,000. E & P reduced $100,000.

    38.e. Teal no preference; Grace prefers 54. Martin dividend income of $300,000.

     option b., if corporation; option c., if 55.a. Dove $140,000 loss not recognized;

     individual. Julia $20,000 loss not recognized and 39.a. $37,500. basis in land of $330,000.

    39.b. $67,500. 55.b. Dove $140,000 loss not recognized; 40.a. $85,000. Julia $20,000 loss recognized and 40.b. $30,600. basis in land of $330,000.

    41.a. $50,000. 56.a. $270,000 LTCG.

    41.b. $3,000. 56.b. $240,000 LTCG.

    41.c. Choose qualifying stock redemption. 57. $0.

    42.a. $50,000. 58. $150,000.

    42.b. $0. 59. $175,000.

    43.a. 1,480 shares. 60. Pink should either distribute the land 43.b. 1,930 shares. to Paul or sell it and distribute the 44.a. $175,000 dividend income. cash.

    44.b. $148,500 LTCG. 61. Pink should either distribute the land 45. 197 minimum shares; Lana $157,600 to Paul or sell it and distribute the

     LTCG; Stork $167,450 reduction in cash.

     E & P. 62. Scarlet LTCL of $35,000; Jake LTCG

    46.a. No. of $80,000.

    46.b. Yes. 63. Recognize $90,000 gain in the year of 46.c. Yes. liquidation, and $72,000 gain with

    46.d. No. each note collection.

    47.a. Lori dividend income of $400,000; 64. Magenta no loss recognized on

     Swan reduces E & P by $400,000; distribution to Fuchsia, $15,000 gain

     Robert capital gain of $375,000. recognized on distribution to Marta; 47.b. Robert capital gain of $375,000; Fuchsia no gain or loss recognized

     Swan reduces E & P by $350,000. and basis of $1,950,000; Marta

    48.a. Sultan recognized gain of $300,000; $145,000 gain recognized and basis

     Turquoise dividend income of of $180,000.

     $350,000; Lime recognizes gain of 65.a. Ivory no gain or loss recognized;

     $200,000. Gold no gain or loss recognized and 48.b. Dividend income of $350,000 to $80,000 basis in inventory; Imelda

     Sultan and Turquoise; Lime $25,000 gain recognized and

     recognizes gain of $275,000. $200,000 basis in equipment.

    49. Estate recognizes no gain or loss; 65.b. Ivory $120,000 gain recognized; Gold

     Finch reduces E & P by $800,000. no gain or loss recognized and 50. No gain. $350,000 basis in equipment; Imelda 51.a. Tammy dividend of $75,000; $25,000 recognized gain and

     Broadbill E & P reduced by $75,000. $200,000 basis in inventory.

    51.b. Tammy LTCG of $67,500; Broadbill 66. Green recognizes no loss; Orange

     E & P reduced by $75,000. recognizes $15,000 gain.

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    6-6 2013 Corporations Volume/Solutions Manual 52. E & P reduced by $300,000; $13,000 67.a. $0.

    67.b. $0. 67.d. Both carry over to Wren.

    67.c. Marketable securities $250,000, 68. Qualified stock purchase May 2,

     unimproved land $300,000. 2012; file election by February 15,

     2013.

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     Corporations: Redemptions and Liquidations 6-7

    DISCUSSION QUESTIONS

     1. The Code treats distributions that are returns from the shareholder’s investment as dividend

    distributions, while distributions that are returns of the shareholder’s investment are treated as

    a sale or exchange of the investment. p. 6-2 and Examples 1 and 2

     2. In a sale of stock to a third party, the shareholder’s ownership interest in the corporation is diminished, and such dispositions result in sale or exchange treatment. In a stock redemption, however, a shareholder’s ownership interest in the corporation may be unaffected as a result of the redemption. This is particularly true where the stock of the corporation is solely owned or owned entirely or predominately by related parties. It is this possibility of little or no diminishment in ownership interest in a stock redemption that gave rise to the qualifying stock redemption rules. In those cases where a shareholder’s ownership is sufficiently diminished as a result of a stock redemption, sale or exchange treatment is the result. However, if a shareholder’s ownership is relatively unaffected as a result of a stock redemption, the transaction has the same effect as a dividend distribution and is taxed as such. pp. 6-2 and 6-3

     3. ; Whether Louis or Mari have a preference for personally acquiring the Cerise stock or for a

    stock redemption or for a sale to a third party.

    ; Whether Louis or Mari have the financial resources to acquire the Cerise stock. ; If Louis or Mari do acquire the Cerise stock, their basis in the shares.

    ; Whether Cerise Corporation has the financial resources, including the ability to issue its

    own notes, to fund a stock redemption.

    ; If Chao has a preference for a cash transaction, whether Cerise has sufficient cash

    available for such a distribution or property that can be sold to fund a distribution.

    ; If Cerise must sell property to finance a redemption, what property should be sold and

    the tax consequences resulting from such a sale?

    ; If property can be distributed in the redemption, whether Cerise has property suitable for a

    distribution and the tax consequences from such a distribution.

    ; If property is distributed pursuant to a redemption, Chao’s basis and holding period for

    such property.

    ; The effect of any property sale and redemption distribution on Cerise’s E & P.

    ; The tax treatment of any expenditures incurred in a redemption of Chao’s shares,

    including interest expense related to a debt-financed redemption.

    ; Whether there is a market for a sale of the stock to a third party.

    pp. 6-3, 6-4, 6-8, 6-12, 6-13, and 6-29

     4. Brandi’s redemption satisfied the terms of one of the qualifying stock redemptions and was taxed as a sale or exchange. That is, $9,000 = 15% (LTCG tax rate) × $60,000 LTCG [$100,000 (amount realized) $40,000 (basis in stock)]. Yuen’s redemption, however, failed

    to qualify for sale or exchange treatment and, instead, the entire distribution was taxed as a dividend: $15,000 = 15% (dividend tax rate) × $100,000. Example 3

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6-8 2013 Corporations Volume/Solutions Manual

     5. A noncorporate shareholder generally would prefer a qualifying stock redemption as that

    would result in sale or exchange treatment rather than the dividend distribution treatment

    associated with a nonqualified stock redemption. With a sale or exchange, there is a tax-free

    recovery of the redeemed stock’s basis and capital gain (loss) treatment on any excess

    (deficiency). Capital gains can be offset by capital losses and if long term in nature, are

    subject to the 15% maximum tax rate. In contrast, nonqualified stock redemption treatment

    would result in the entire distribution being taxed as a dividend (assuming adequate E & P).

    While dividend income generally attracts the same preferential tax rate as long-term capital

    gains, such income cannot be offset by capital losses. Examples 3 and 4

     Corporate shareholders, alternatively, generally prefer nonqualified stock redemption

    treatment, as a corporate taxpayer typically would report only a small portion of the resulting

    dividend income as taxable income due to the availability of the dividends received deduction.

    Further, corporate taxpayers do not receive any preferential tax rate on long-term capital gains

    (or dividend income). Example 5

    6. The statement is correct. A qualifying stock redemption is treated as a sale or exchange; thus,

    the redemption results in a realized and recognized loss of $20,000 [$80,000 (amount realized)

     $100,000 (stock basis)]. Section 267 disallows loss recognition in a qualifying stock

    redemption if the shareholder owned (directly or indirectly) more than 50% of the

    corporation’s stock at the time of the redemption. p. 6-4

     7. The statement is incorrect. A shareholder’s basis in property received in a nonliquidating

    distribution, including both qualifying and nonqualified stock redemptions, is equal to the

    property’s fair market value on the date of the redemption. p. 6-4

     8. The tax treatment accorded a stock redemption is determined by the Code, not by state law. A

    corporate distribution treated as a sale or exchange under state law may not satisfy any of the

    qualifying stock redemption provisions of the Code. p. 6-4

     9. Stock owned by a partnership is deemed to be owned proportionately by a partner. Stock

    owned by a partner is deemed to be owned in full by the partnership. Exhibit 6.1 10. The statement is incorrect. In general, for purposes of the qualifying stock redemption

    provisions, the stock attribution rules apply in determining a shareholder’s ownership interest

    before and after a redemption. However, the attribution rules do not apply in the case of

    partial liquidations or redemptions to pay death taxes. Further, the family attribution rules can

    be waived in the case of certain complete terminations. pp. 6-5 to 6-12

    11. A corporate distribution in exchange for stock qualifies as a not essentially equivalent

    redemption if there is a “meaningful reduction” in the shareholder’s ownership after the

    redemption. The “meaningful reduction test” is applied whether the stock redeemed is

    common stock or preferred stock. A decrease in the redeeming shareholder’s voting control

    appears to be the most significant indicator of a meaningful reduction, but reductions in the

    rights of redeeming shareholders to share in corporate earnings or to receive corporate assets

    upon liquidation are also considered. If a shareholder continues to have dominant voting

    control after a redemption, there probably will not be a “meaningful reduction” in the

    shareholder’s ownership in the corporation. The ? 318 attribution rules apply in determining

    whether there has been a meaningful reduction. pp. 6-6 and 6-7

    12. To qualify as a disproportionate redemption, the shareholder’s ownership interest in the

    corporation after the redemption must be:

    ; less than 80% of the ownership interest before the redemption, and

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     Corporations: Redemptions and Liquidations 6-9

    ; less than 50% of the total combined voting power of all classes of stock entitled to vote. The stock attribution rules apply in determining the shareholder’s ownership interest before and after the redemption. pp. 6-7 and 6-8

    13. ; Barry’s basis in the property transferred in the ? 351 transaction and the basis in his stock.

    ; If Barry transferred property in the ? 351 transaction with a built-in loss and if so,

    whether the election was made to reduce the shareholder’s stock basis in lieu of the

    basis step-down applicable to Pheasant.

    ; Whether the redemption qualifies for sale or exchange treatment.

    ; Whether Barry is related to any shareholder of Pheasant Corporation.

    ; If Barry is related to a shareholder of Pheasant, will he continue employment with the

    corporation?

    ; Barry’s basis and holding period in the property received in the redemption.

    ; Pheasant’s E & P at the time of the distribution.

    ; Whether Pheasant has a recognized gain or an unrecognized loss as a result of the property

    distribution.

    ; The effect of the distribution on Pheasant’s E & P.

    ; Whether Pheasant incurred any (nondeductible) redemption expenditures as a result of the

    distribution.

    pp. 6-8, 6-9, 6-12, 6-13, 6-19 to 6-21, and Chapter 4

    14. Unless Lauren satisfies the requirements for the family attribution waiver, she is deemed to own the shares owned by Brett, or 100% of the Viridian shares outstanding after the redemption. Such a level of ownership would not satisfy any of the qualifying stock redemption provisions for sale or exchange treatment. If Lauren satisfies the requirements of the family attribution waiver (e.g., no prohibited interest held during the 10-year post-redemption period), the redemption would qualify for sale or exchange treatment as a complete termination redemption. Lauren’s current employment with Viridian Corporation,

    as President and Chair of the board of directors, would constitute prohibited interests for purposes of the family attribution waiver. As such, Lauren would have to resign from those positions as a condition for qualifying the redemption for sale or exchange treatment. pp. 6-8, 6-30, and Exhibit 6.1

    15. A distribution will qualify under the termination of a business test if the following requirements are satisfied.

     ; The corporation must have two or more qualified trades or businesses. A qualified trade

    or business is any trade or business that (1) has been actively conducted for the 5-year

    period ending on the date of the distribution and (2) was not acquired in a taxable

    transaction during that 5-year period.

     ; The distribution consists of the assets of a qualified trade or business or the proceeds from

    the sale of such assets.

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6-10 2013 Corporations Volume/Solutions Manual

     ; The corporation is actively engaged in the conduct of a qualified trade or business

    immediately after the distribution.

     p. 6-10

    16. ; Whether Brown operated the discontinued business and one other business for the entire

    five-year period preceding the distribution.

    ; Whether Brown would recognize gain or loss on the distribution or sale of the assets. If

    the assets are sold, whether any would be sold to related parties.

    ; Whether Brown would incur any expenses with respect to any sale of assets or distribution

    to shareholders.

    ; Brown’s E & P before and after any distribution.

    ; Whether there will be a redemption of stock from the shareholders and, if so, whether the

    redemption would be pro rata with respect to the shareholders.

    ; The shareholders’ basis in their Brown stock before and after any distribution.

    ; Whether any of the shareholders are corporate taxpayers.

    ; The shareholders’ basis in any assets received in a distribution.

    pp. 6-3, 6-4, 6-9, 6-10, 6-12, and 6-13

    17. A redemption to pay death taxes (? 303) results in sale or exchange treatment for the estate.

    The estate’s basis in the stock redeemed is generally the stock’s fair market value on the date

    of the decedent’s death. Usually there is little change in the stock’s fair market value from the

    decedent’s date of death to the date of a redemption to pay death taxes; thus, an estate would

    recognize little or no gain or loss on the sale or exchange that results from such a redemption.

    pp. 6-10 and 6-11

    18. A redemption to pay death taxes is applicable to stock of a corporation that is included in the

    gross estate of a decedent and whose value exceeds 35% of the value of the adjusted gross estate.

    In determining the 35% requirement, stock of two or more corporations is treated as the stock of

    a single corporation if 20% or more in value of the outstanding stock of each corporation is

    included in the decedent’s gross estate. Sale or exchange treatment is available under ? 303 to

    the extent of the sum of the estate’s death taxes and funeral and administration expenses.

    A redemption to pay death taxes is treated as a sale or exchange of the stock for the estate

    (shareholder). Because the estate’s basis in the redeemed stock is stepped up (or down) to fair

    market value at death (or alternate valuation date, if elected), there is generally no gain (or

    loss) recognized by the estate in a ? 303 redemption. If property is received in the redemption,

    the estate’s basis in the property is its fair market value on the date of the redemption. The

    property’s holding period begins on the date of the redemption.

     The distributing corporation recognizes gain (but not loss) on any distribution of property

    pursuant to a redemption to pay death taxes. The corporation’s E & P is reduced by an

    amount not in excess of the ratable share of the E & P attributable to the stock redeemed. No

    deduction is allowed for any expenditures incurred in connection with the redemption.

     pp. 6-10 to 6-13

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