Question 1

Sydney Corporation has accumulated E & P of $80,000 on January 1, 2009.In 2009, Sydney Corporation has current E & P of $50,000 (before any distribution).On December 31, 2009, Sydney Corporation distributes $150,000 to its sole shareholder, Courtney (an individual).Sydney Corporation's E & P as of January 1, 2010, is:

A)$80,000.
B)$50,000.
C)$0.
D)$20,000 deficit.
E)None of the above.

C

Accepted Answer

The current E&P of $50,000 is not enough to cover the $150,000 distribution. Therefore, the distribution will be treated as a dividend to the extent of current E&P ($50,000) and the remaining $100,000 will be treated as a return of capital. As a result, there will be no E&P left as of January 1, 2010, and it will be zero.

Question 2

As of January 1, 2009, Tokyo Corporation has a deficit in accumulated E & P of $75,000.For tax year 2009, current E & P (all of which accrued ratably) is $40,000 (prior to any distribution).On July 1, 2009, Tokyo Corporation distributes $60,000 to its sole, noncorporate shareholder.The amount of the distribution that is a dividend is:

A)$0.
B)$40,000.
C)$60,000.
D)$75,000.
E)None of the above.

B

Accepted Answer

A distribution is considered a dividend to the extent of the corporation's current and accumulated earnings and profits (E&P). Since Tokyo Corporation has a current E&P of $40,000 for 2009, the distribution is a dividend to the extent of this amount. The deficit in accumulated E&P does not affect the current year's E&P.

Question 3

Five years ago, Angie purchased 1,000 shares of common stock in Brussels Corporation for $60,000.In the current year, Angie receives a nontaxable stock dividend of 50 shares of Brussels preferred.Total values at the time of the dividend are: $40,000 for the preferred and $80,000 for the common.Based on this information, Angie's basis is

A)$80,000 in the common and $40,000 in the preferred.
B)$20,000 in the common and $40,000 in the preferred.
C)$40,000 in the common and $20,000 in the preferred.
D)$51,000 in the common and $9,000 in the preferred.
E)None of the above.

C

Accepted Answer

Angie's initial investment in the common stock was $60,000 for 1,000 shares, which gives a per-share basis of $60.

When she received a stock dividend of 50 shares of preferred stock, she did not pay any taxes on it. However, the IRS considers stock dividends to be a taxable event that creates a new basis for the shares received. To calculate the new basis for Angie's shares of preferred stock, we need to multiply the number of shares received by the fair market value of the preferred stock at the time of the dividend.

The total value of the preferred stock is $40,000, so the fair market value of each share of preferred stock is $40,000 / 50 shares = $800 per share. Thus, Angie's basis in the 50 shares of preferred stock is $800 per share x 50 shares = $40,000.

Since Angie did not pay anything for the preferred stock she received, her basis in the common stock must be decreased by the full fair market value of the preferred stock she received. This means her new basis in the common stock is $60 per share x 1,000 shares - $40,000 (the fair market value of the preferred stock she received) = $20,000.

Therefore, Angie's basis is $40,000 in the preferred and $20,000 in the common, which is answer choice C.

Question 4

Athens Corporation distributes land with a fair market value of $60,000 and an adjusted basis of $25,000.The land is subject to a liability of $20,000.What is the total effect of the distribution on the E & P of Athens?

A)Athens's E & P is neither increased nor decreased.
B)Athens's E & P is reduced by $5,000.
C)Athens's E & P is increased by $35,000.
D)Athens's E & P is reduced by $40,000.
E)None of the above.

Accepted Answer

The distribution of land with a fair market value of $60,000 and an adjusted basis of $25,000 results in a realized gain of $35,000 ($60,000 - $25,000). However, since the land is subject to a liability of $20,000, the amount of gain recognized for tax purposes is reduced to $15,000 ($35,000 - $20,000). This $15,000 gain reduces the E & P of Athens by the same amount, resulting in a reduction of $5,000 ($15,000 x 0.33).

Question 5

A corporation sells property (basis of $90,000) to its sole shareholder for $80,000, the fair market value of the property.With respect to the sale,&#10;A)The corporation has a tax loss of $10,000.&#10;B)The shareholder has a constructive dividend of $10,000.&#10;C)The shareholder has a basis of $80,000 in the property.&#10;D)The corporation does not recognize a tax loss but reduces its E & P account $90,000.&#10;E)None of the above.

Accepted Answer

The shareholder has a basis of $80,000 in the property.

Question 6

On January 1, London Corporation (a calendar year taxpayer) has accumulated E & P of $140,000.During the year, London incurs a net loss of $200,000 from operations that accrues ratably.On June 30, London distributes $50,000 to Melissa, its sole shareholder.How much of the $50,000 represents ordinary dividend income to Melissa?

A)$0.
B)$10,000.
C)$40,000.
D)$50,000.
E)None of the above.

Accepted Answer

First, we need to calculate London's E&P at the time of distribution. 
Accumulated E&P on January 1: $140,000 
Net loss for the year (accrued ratably): ($200,000)/2 = ($100,000) 
Adjusted E&P on June 30: $40,000

Next, we need to determine the impact of the distribution on Melissa's tax liability. 
Since Melissa is the sole shareholder, the distribution is assumed to be made out of London's E&P. 
Distribution on June 30: $50,000

Since the distribution of $50,000 is less than the adjusted E&P of $40,000, we can assume that the entire distribution is treated as a dividend. 
Therefore, the amount of the distribution that represents ordinary dividend income to Melissa is $50,000. Answer: C.

Question 7

Lisbon Corporation has E & P of $75,000.It distributes land with a fair market value of $60,000 (adjusted basis of $25,000) to its sole shareholder, Josiah.The land is subject to a liability of $20,000 that Josiah assumes.

A)Josiah has a taxable dividend of $60,000.
B)Josiah has a taxable dividend of $40,000.
C)Josiah has a taxable dividend of $35,000.
D)Josiah has a taxable dividend of $20,000.
E)Josiah's basis in the land is $25,000.

Accepted Answer

When a corporation distributes property to a shareholder, the distribution is generally treated as a dividend to the extent of the corporation's earnings and profits (E&P), and then as a return of capital to the extent of the shareholder’s basis in the stock. In this case, since the E&P of the corporation is $75,000 and the fair market value of the land distributed is $60,000, the distribution would be treated as a dividend of $60,000. However, since Josiah assumes a liability of $20,000, his taxable dividend would be reduced by that amount, resulting in a taxable dividend of $40,000 ($60,000 - $20,000). Additionally, Josiah's basis in the land would be stepped up to its fair market value of $60,000.

Question 8

Madrid Corporation has accumulated E & P of $100,000 on January 1, 2009.In 2009, Madrid Corporation had an operating loss of $170,000.It distributed cash of $90,000 to Jamie, its sole shareholder, on December 31, 2009.Madrid Corporation's balance in its E & P account as of January 1, 2010, is:

A)$160,000 deficit.
B)$70,000 deficit.
C)$0.
D)$10,000.
E)None of the above.

Accepted Answer

The first step in determining the balance in Madrid Corporation's E & P account as of January 1, 2010, is to determine its E & P balance as of December 31, 2009.

Starting E&P balance on January 1, 2009 = $100,000 
Operating loss for 2009 = ($170,000) 
Cash distribution to shareholder = ($90,000)

Net E&P balance as of December 31, 2009 = ($160,000)

Therefore, Madrid Corporation's balance in its E & P account as of January 1, 2010, is a $70,000 deficit ($160,000 ending balance for 2009 minus $90,000 cash distribution to shareholder).

Question 9

Paris Corporation has a deficit in accumulated E & P of $60,000.For 2009, it has current E & P of $40,000.On March 31, 2009, Paris distributes $65,000 to its sole shareholder, Jennifer.Jennifer has a basis of $10,000 in her stock in Paris Corporation.

A)Jennifer has dividend income of $65,000.
B)Jennifer has dividend income of $40,000, reduces her stock basis to zero, and has a capital gain of $15,000.
C)Jennifer has dividend income of $40,000 and reduces her stock basis to $5,000.
D)Jennifer has no dividend income, reduces her stock basis to zero, and has a capital gain of $10,000.
E)None of the above.

Accepted Answer

Jennifer has dividend income equal to the current E&P of $40,000. The remaining $25,000 distribution reduces her stock basis to zero, and the excess $15,000 is treated as a capital gain.

Question 10

Assume taxable income is the starting point for computing E & P.During 2008, Moscow Corporation made a charitable contribu?tion of $100,000.Of this amount $10,000 could not be deducted in arriving at Moscow's taxable income for 2008 because of the 10% limitation.The $10,000 was carried over to 2009 and fully deducted in that year.

A)The excess charitable contribution deduction reduces Moscow Corporation's E & P for 2009.
B)The excess charitable contribution deduction of $10,000 would reduce Moscow Corporation's E & P in 2008.
C)The excess charitable contribution increases Moscow Corporation's E & P for 2008.
D)The excess charitable contribution deduction has no effect on Moscow Corporation's E & P in 2009.
E)None of the above.

Accepted Answer

The excess charitable contribution deduction of $10,000 would reduce Moscow Corporation's E & P in 2008. This is because E & P is calculated starting with taxable income, and the $10,000 excess deduction reduces taxable income in 2008. The fact that it was carried over and fully deducted in 2009 has no effect on E & P for that year.

Deck 5: Corporations: Earnings and Profits and Dividend Distributions