Problem 172 (c) & (d) Clarification

1. Problem 172 (c) & (d) Clarification Issue: What is A’s basis in stock on sale of ½ to B on 7/1? Two Possibilities: Determine at end of year or at time of sale. If end of year determination: (c) Basis would be: (10k – 3k return of capital on 10/1) / 2 = 3.5k. Gain on sale would be 15k less 3.5k = 11.5k. Basis in A’s remaining shares 3.5k. (d) Basis would be: (10k – 2.5 return on 4/1 – 5k return 10/1) / 2 = 1.25k. Gain on sale would be 13.75k. Basis in A’s remaining shares would be 1.25k. If time of sale determination: (c) Basis would be: 10k / 2 = 5k. Gain on sale 10k. Basis in remaining share would be 5k less 3k = 2k. (d) Basis would be: (10k – 2.5k return on 4/1) / 2 = 3.75k. Gain on sale would be 11.25k (15k less 3.75k). Basis in A’s remaining shares would be 3.75 before 10/1 5k distribution, which would take basis to zero and trigger 1.25 gain to A. Which approach correct? ??, but most think end of year. LLM - Corporate Tax Instructor: Dwight Drake

2. Problem 177 Basic Facts: Z owns all common stock of C Corp, basis of 8k; 25k accumlated E&P, no current E&P. C distributes to Z inventory – FMV 20k, basis 11k. - C Corp has gain of 9k (20k-11k) per 311(b)(1) and current E&P goes to 9k. - Z has 20k dividend: 9k from current E&P; 11k from accumulated E&P - Z basis in inventory 20k. - C Corp accumulated E&P to next year 14k (25k-11k) (b) Same as (a) but no accumulated E&P. - C Corp has gain of 9k (20k-11k) per 311(b)(1) and current E&P goes to 9k. - Z has 9k dividend: 9k from current E&P; 8k return of capital; 3k LTCG - Z basis in inventory 20k. - S Corp accumulated E&P to next year is 0. Property distribution reduces E&P to extent thereof per 312(a). LLM - Corporate Tax Instructor: Dwight Drake

3. Problem 177 Basic Facts: Z owns all common stock of C Corp, basis of 8k; 25k accumulated E&P, no current E&P. (c) C distributes to Z land – FMV 20k, basis 11k, debt 16k. - S Corp has gain of 9k 1231 gain (20k-11k) per 311(b)(1) and current E&P goes to 9k. - Z has 4k dividend (20k less 16k): Plenty of accumulated E&P - Z basis in land 20k. - C Corp accumulated E&P to next year is 30k (25k plus 9k gain, less 4k distribution) LLM - Corporate Tax Instructor: Dwight Drake

4. Problem 177 Basic Facts: Z owns all common stock of C Corp, basis of 8k; 25k accumulated E&P, no current E&P. (d) C has 15k current E&P, distributes to Z land – FMV 20k, basis 30k. - S Corp has 10k loss (30k-20k), but can’t recognize per 311(a) - Z has 20k dividend : Plenty of accumulated E&P - Z basis in land 20k. - C Corp accumulated E&P to next year is 10k (25k + 15k gain, less 30k basis in land). Note: If sold and then distributed cash, C Corp recognizes 10k loss. Z still has 20k dividend. C Corp’s E&P carryover still 10k (40k less 10k loss, less 20k distribution). Only difference is 10k recognized loss. LLM - Corporate Tax Instructor: Dwight Drake

5. Problem 177 Basic Facts: Z owns all common stock of C Corp, basis of 8k; 25k accumulated E&P, no current E&P. (e) C distributes to Z equipment – FMV 10k, basis 0 for tax; 2k for E&P - C Corp has gain of 10k ordinary gain (10k-0k). - Z has 10k dividend : Plenty of accumulated E&P - Z basis in equipment 10k. - S Corp accumulated E&P to next year is 23k (25k + 8k E & P produced by distribution, less 10k distribution). 312(b). LLM - Corporate Tax Instructor: Dwight Drake

6. Problem 179 Basic Facts: A owns all common stock of D Corp, basis of 100k; 1005k accumulated E&P, no current E&P. On 1/1, D Corp distributes 100k note, payable in 30 yrs to A, no interest. Issue price for OID purposes 5k. - A has 5k income under 301 – FMV of note. - D Corp has no gain - parenthetical of 311(b)(1)(A). - D Corp E&P reduced only by 5k – 312(a)(2). - OID interest income reported ratably over time by A, with corresponding interest deduction to D Corp. LLM - Corporate Tax Instructor: Dwight Drake

7. Hot Constructive Dividend Scenarios 1. Excessive compensation to shareholder-employees 2. Corporation payment of personal shareholder expenses 3. Equity disguised as debt – the interest deduction and return of capital issue 4. Excessive shareholder rental 5. Phony family employment 6. Personal use of corporate assets 7. Bargain sales or rentals of corporate property 8. Brother – Sister Corp 482 Trap LLM - Corporate Tax Instructor: Dwight Drake

8. Trap Four: Section 482 – Rev. Rule 69-630 Bargain sale C Corp A C Corp B Imputed Income Imputed Dividend Imputed Contribution Common owners LLM - Corporate Tax Instructor: Dwight Drake

9. 243 Deduction Protectors 1. 246 – Stock not held long enough 2. 249A - Debt financed stock ownership 3. 1059 - Extraordinary dividends – 2 yr rule and consolidated return rule 4. The Waterman Bootstrap Acquisition LLM - Corporate Tax Instructor: Dwight Drake

10. Problem 192 June 1: P Corp stock trades at 15 – declares dividend $1 per share. Record date – June 8. Payment date – June 12. June 3: I Corp buys 1000 shares for 15k, collects $1000 dividend on June 12. June 15: I Corp sells stock for 14k Tax consequences to I Corp? Desire would be 243 shelter of 70% of 1k dividend and 1k STCL. But flunk excess 45 holding period of 246(c). So, no 243 deduction. All 1k dividend taxable. Sale date Dec 1. 246(c) not apply – more than 45 days satisfied. 243 deduction of 70% allowed. LLM - Corporate Tax Instructor: Dwight Drake

11. Problem 192 June 1: P Corp stock trades at 15 – declares dividend $1 per share. Record date – June 8. Payment date – June 12. June 3: I Corp buys 1000 shares for 15k, collects $1000 dividend on June 10 June 15: I Corp sells stock for 14k Sale still on Dec 1, but second dividend of $1 paid on August 15? Per 1059(c)(3)(A), dividends with ex-dates within 85 days treated as one dividend for 10% excessive dividend to basis rule. Here, 2k dividend over 10% of 15k basis. Effect under 1059(a) is that basis reduced by non-taxable portion - $1400. Hence, stock basis reduced to 13,600 (15k less 1400). Note, 243 deduction still allowed, but creates basis reduction. When stock sold for 14k, have 400 gain, not 1000 STCL. LLM - Corporate Tax Instructor: Dwight Drake

12. Problem 192 June 1: P Corp stock trades at 15 – declares dividend $1 per share. Record date – June 8. Payment date – June 12 June 3: I Corp buys 1000 shares for 15k, collects $1000 dividend on June 10 June 15: I Corp sells stock for 14k I Corp receives total 3k dividends, but holds 25 months before sale. 1059(a) still applies. Stock must have been held 2 years before dividend announcement date. Holding period after not relevant. Hence, 243 deduction (70% - 2100) would reduce basis to 12.9k. LLM - Corporate Tax Instructor: Dwight Drake

13. Problem 192 I Corp borrowed 15k to buy stock, paid 1500 interest and received 1000 dividend? What result? No 243 dividend deduction per 246(a). “Average Indebtedness Percentage” is 100%, so entire deduction lost. What if debt 7.5k? Then “Average Indebtedness Percentage” 50% under 246A. Half of 243 deduction disallowed. Deduction reduced to 35% or net $350. LLM - Corporate Tax Instructor: Dwight Drake

14. Problem 206 Basic Facts: C Corp hold X Corp stock more than 2 yrs, not part of consolidated group. Basis in stock 150k. - X Corp pays 100k dividend to C Corp. Plenty of E&P. - B buys X Corp stock from S for 400k. - Goal: 100k dividend sheltered 70% by 243; capital gain on sale reduced 100k. Will it work? It’s the Waterman, TSN, Litton Industries issue. Note, if held stock for less than 2 yrs or consolidated return, than basis in stock reduced by tax-free dividend per 1059 and plan fails. Here, 1059 no apply. Risky if can’t show business purpose (TSN) or unrelated acts (Litton). Was dividend cash unwanted by buyer? Step Transaction/Sham doctrines may kill under Waterman rationale. LLM - Corporate Tax Instructor: Dwight Drake