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Date: 11th April 2006   Time: 12:00         User ID: 40520




                                                                     CHAPTER 6

                                                     CORPORATIONS: REDEMPTIONS
                                                         AND LIQUIDATIONS

                                                 SOLUTIONS TO PROBLEM MATERIALS




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

                        1          Tax treatment of return from investment versus         Unchanged     1**
                                     return of investment
                        2          Reason for limitations on sale or exchange treatment   Unchanged     2**
                                     on stock redemptions
                        3          Corporate shareholder preference for dividend          Modified      3**
                                     versus qualifying stock redemption
                        4          Stock redemptions in property settlements              Unchanged     4**
                        5          Sale or exchange versus dividend treatment on          Unchanged     5**
                                     redemption
                       6           Loss recognition in a qualifying stock redemption      Unchanged     6**
                       7           Basis of property received in stock redemption         New
                       8           Stock attribution rules: family members                New
                       9           Stock attribution rules: when not applicable           Unchanged     9**
                      10           Not essentially equivalent redemption: meaningful      Unchanged    10**
                                     reduction test
                      11           Basis of stock in a nonqualified stock redemption      Unchanged    11**
                      12           Disproportionate redemption: application of 80%        New
                                     and 50% tests
                      13           Complete termination redemption                        Unchanged    13**
                      14           Complete termination redemption: family attribution    Unchanged    14**
                                     waiver
                      15           Partial liquidation: requirements                      Unchanged    15**
                      16           Partial liquidation                                    Unchanged    16**
                      17           Redemption to pay death taxes: advantages              Unchanged    17**
                      18           Redemption to pay death taxes: 35% test                Modified     18**
                      19           Redemption to pay death taxes                          Unchanged    19**
                      20           Gain/loss recognition to corporation on redemption     Unchanged    20**
                                     distribution
                      21           Tax consequences of redemption to distributing         Unchanged    21**
                                     corporation
                      22           Preferred stock bailout: general tax consequences      Unchanged    22**

                                                                          6-1
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                 6-2                           2007 Corporations Volume/Solutions Manual


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

                       23          Redemption through use of related corporation              New
                       24          Corporate liquidation for tax purposes                     Unchanged    24**
                       25          Liquidations and redemptions compared: recognition         Unchanged    25**
                                      of gain or loss by distributing corporation
                       26          Related-party loss limitation: when applicable             New
                       27          Built-in loss limitation: tax avoidance purpose            Unchanged    27**
                                      explained
                       28          Tax consequences to shareholder in complete                Unchanged    28**
                                      liquidation: use of installment method to report gain
                       29          Liquidation of subsidiary: general requirements            Unchanged    29**
                       30          Liquidation of subsidiary: nonrecognition of loss on       Modified     30**
                                      distribution to minority shareholder
                       31          Liquidation of subsidiary: indebtedness to parent          Unchanged    31**
                       32          Liquidation of subsidiary: tax consequences to             Modified     32**
                                      parent and subsidiary
                      33           Requirements for application of § 338                      Unchanged    33**
                      34           Tax consequences of a § 338 election                       Unchanged    34**
                     *35           Comparison of dividend distribution with qualifying        Unchanged    35**
                                      redemption: individual versus corporate
                                      shareholder
                     *36           Comparison of tax treatment of dividend distribution       Modified     36**
                                      and qualifying stock redemption to individual
                                      shareholder
                       37          Comparison of tax treatment of dividend distribution       Modified     37**
                                      and qualifying stock redemption to corporate
                                      shareholder
                     *38           Comparison of tax treatment of dividend distribution       Modified     38**
                                      and qualifying stock redemption to individual
                                      shareholder with capital loss carryover
                       39          Comparison of tax treatment of dividend distribution       Modified     39**
                                      and qualifying stock redemption to corporate
                                      shareholder with capital loss carryover
                     *40           Application of stock attribution rules                     Unchanged    40**
                      41           Not essentially equivalent redemption: no                  Unchanged    41**
                                      meaningful reduction
                       42          Disproportionate redemption                                Unchanged    42**
                       43          Complete termination redemption: family attribution        Modified     43**
                                      waiver
                     *44           Sale of stock versus complete termination                  Unchanged    44**
                                      redemption: effect on retiring shareholder,
                                      remaining shareholder, and corporation
                       45          Partial liquidation: tax consequences to individual        Unchanged    45**
                                      and corporate shareholders
                     *46           Redemption to pay death taxes: consequences to             New
                                      estate and corporation; appreciated property
                                      distributed to and sold by estate
                       47          Redemption of stock to pay death taxes: stock of two       Unchanged    47**
                                      corporations
                     *48           Disproportionate redemption: consequences to               Unchanged    48**
                                      shareholder and effect on E & P
                       49          Effect of redemption on corporation: E & P adjustment      Unchanged    49**
                                      and treatment of redemption expenses
                     *50           Section 306 stock: tax consequences of sale                Modified     50**
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                                              Corporations: Redemptions and Liquidations                              6-3


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

                      51           Redemption through use of related corporations             Unchanged            51**
                     *52           Liquidations and redemptions compared: recognition         Modified             52**
                                      of loss by corporation and shareholder
                     *53           Complete liquidation: distribution of property subject     Unchanged            53**
                                      to liability
                      54           Related-party loss limitation: pro rata distribution of    New
                                      disqualified property
                      55           Built-in loss limitation: no tax avoidance purpose         Modified             55**
                      56           Built-in loss limitation: sale and tax avoidance           Modified             56**
                                      purpose
                     *57           Complete liquidation: related-party loss limitation        Unchanged            57**
                     *58           Complete liquidation: disqualified property and            Unchanged            58**
                                      built-in loss property
                     *59           Complete liquidation: tax consequences to                  Unchanged            59**
                                      shareholder when installment notes distributed
                      60           Liquidation of subsidiary: distribution of loss property   Unchanged            60**
                                      to minority shareholder
                      61           Liquidation of subsidiary: indebtedness of subsidiary      Modified             61**
                                      to parent
                     *62           Liquidation of subsidiary: tax consequences to             Modified             62**
                                      subsidiary and parent
                      63           Liquidation of subsidiary: insolvent subsidiary            Unchanged            63**
                      64           When not to make the § 338 election                        Unchanged            64**

                 Research
                 Problem

                        1          Complete termination of an interest under                  Unchanged             1**
                                      § 302(b)(3): director as a prohibited interest;
                                      attribution and family discord
                        2          Redemption to pay death taxes: stock of two                New
                                      corporations; intervening liquidating distribution
                                      for one stock
                        3          Deductible payments to settle litigation and               Unchanged             2**
                                      employment claims versus nondeductible
                                      redemption expenses
                        4          Shareholder receipt of post-liquidation proceeds           Unchanged             4**
                        5          Internet activity                                          New
                        6          Internet activity                                          Unchanged             6**

                                   *The solution to this problem is available on a transparency master.
                                   **Refers to the Solution Manual materials for Chapter 5 in the 2006 Edition.
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                 6-4                           2007 Corporations Volume/Solutions Manual


                                                                  CHECK FIGURES

                 35.a.       Teal taxable gain of $150,000;              48.b.    Tan E & P reduced by $180,000.
                             Grace dividend income of $250,000.          49.      E & P reduced by $240,000;
                 35.b.       Teal taxable gain of $150,000;                       redemption expenses not deductible.
                             Grace $250,000 of dividend, subject         50.a.    No tax consequences other than
                             to the dividends received deduction.                 allocation of stock basis.
                 35.c.       Teal taxable gain of $150,000;              50.b.    Ordinary income of $15,000, return
                             Grace capital gain of $170,000.                      of capital of $5,000, $1,667 basis to
                 35.d.       Teal taxable gain of $150,000;                       common stock.
                             Grace capital gain of $170,000.             50.c.    Dividend income of $20,000, $6,667
                 35.e.       Teal no preference; Grace prefers                    basis to common stock; E & P
                             option b., if corporation; option c., if             reduced $20,000.
                             individual.                                 51.      Bob dividend income of $30,000.
                 36.a.       $12,750.                                    52.a.    Hawk $20,000 loss not recognized;
                 36.b.       $15,000.                                             Michele $30,000 loss not recognized
                 37.a.       $28,900.                                             and basis of $280,000.
                 37.b.       $6,800.                                     52.b.    Hawk $20,000 loss not recognized;
                 38.a.       $40,000.                                             Michele $30,000 loss recognized
                 38.b.       $3,000.                                              and basis of $280,000.
                 38.c.       Choose qualifying stock redemption.         53.a.    $200,000 LTCG.
                 39.a.       $40,000.                                    53.b.    $300,000 LTCG.
                 39.b.       $0.                                         54.      $0.
                 40.a.       285 shares.                                 55.      $250,000.
                 40.b.       250 shares.                                 56.      $140,000.
                 40.c.       315 shares.                                 57.      Pink should either distribute the land
                 41.         Bubba dividend income of $90,000;                    to Paul or sell it and distribute the
                             Meadowlark E & P reduced by                          cash.
                             $90,000.                                    58.      Pink should either distribute the land
                 42.         Long-term capital gain of $70,000.                   to Paul or sell it and distribute the
                 43.a.       No.                                                  cash.
                 43.b.       Yes.                                        59.      Recognize $75,000 gain in the year
                 43.c.       Yes.                                                 of liquidation, and $45,000 gain with
                 44.a.       Lori dividend income of $800,000;                    each note collection.
                             Swan reduces E & P by $800,000;             60.      Magenta no gain or loss recognized
                             Roberta capital gain of $750,000.                    on distribution to Fuchsia, $20,000
                 44.b.       Roberta capital gain of $750,000;                    loss not recognized on distribution
                             Swan reduces E & P by $700,000.                      to Marta; Fuchsia no gain or loss
                 45.         Walt capital gain of $1,890,000;                     recognized and basis of $950,000;
                             Redbird dividend income of $2                        Marta $75,000 gain recognized and
                             million, subject to dividends received               basis of $105,000.
                             deduction; Blue Jay E & P reduced           61.      Green recognizes no gain; Orange
                             by $3,750,000.                                       recognizes $25,000 gain.
                 46.         Red recognizes $160,000 gain and            62.a.    $0.
                             reduces E & P by $500,000; estate           62.b.    $0.
                             recognizes no gain on redemption,           62.c.    $1,300,000.
                             basis in land of $500,000, and              62.d.    Both carry over to Cardinal.
                             $20,000 gain on sale.                       63.      Section 332 does not apply;
                 47.         No gain.                                             ordinary loss allowed.
                 48.a.       Jacob long-term capital gain of             64.a.    Yes.
                             $240,000.                                   64.b.    No.
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                                              Corporations: Redemptions and Liquidations                              6-5


                 DISCUSSION QUESTIONS

                  1.      A nonliquidating distribution treated as a return from an investment is taxed as dividend
                          income. Alternatively, a nonliquidating distribution treated as a return of an investment is
                          taxed as a sale or exchange of the investment. Qualifying stock redemptions are nonliqui-
                          dating distributions that result in sale or exchange treatment. pp. 6-2 and 6-3

                  2.      Unlike a stock sale to an unrelated third party, where the shareholder’s interest in the cor-
                          poration is reduced, a stock redemption may leave the shareholder’s interest unaltered.
                          This is particularly true when the shareholder is the sole shareholder of the corporation and
                          when parties related to the shareholder (e.g., family members) own stock of the corpora-
                          tion. If the shareholder’s interest has not been substantively reduced as a result of the
                          stock redemption, the distribution may have the same effect as a dividend. p. 6-3

                  3.      The statement is correct. Because of the dividends received deduction available to
                          corporate shareholders, only a small portion of the dividend income is subject to tax. p. 6-4

                  4.      l     Does Brown Corporation have sufficient financial resources to redeem the stock?

                          l     If a cash redemption is preferred, does Brown have sufficient liquidity for such a distri-
                                bution?

                                l    If Brown Corporation would be required to sell an asset to fund a cash redemption,
                                     what would be the tax consequences of the sale?

                          l     If property can be distributed in the redemption, what would be the tax consequences
                                of the distribution?

                                l    Can Brown redeem the stock in exchange for installment notes?

                          l     What is Brown’s E&P at the time of the redemption?

                          l     What are the tax consequences to Salvador in a stock redemption by Brown for cash?
                                Redemption for property? Redemption for installment notes?

                          l     Does Petra have a strong desire to acquire Salvador’s stock?

                                l    If yes, does Petra have the financial resources to acquire the stock?

                          pp. 6-3, 6-9, 6-13, and 6-27 to 6-29

                  5.      Kanisha’s redemption failed to qualify for sale or exchange treatment. Instead, the entire
                          distribution is taxed as a dividend at the 15% preferential tax rate for such income (i.e.,
                          $15,000 = 15% Â $100,000). Susan’s redemption, however, satisfied the terms of one of
                          the qualifying redemption provisions and was taxed as a sale or exchange. That is,
                          $10,500 = 15% Â [$100,000 (amount realized) À $30,000 (basis in shares)]. Example 1

                  6.      In general, losses realized in a qualifying stock redemption will be recognized. However, if
                          the shareholder owned (directly or indirectly) more than 50% of the corporation’s stock at
                          the time of the redemption, the loss would not be recognized by reason of § 267. The stock
                          attribution rules under that provision would apply in determining the shareholder’s owner-
                          ship interest. p. 6-4
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                 6-6                           2007 Corporations Volume/Solutions Manual


                  7.      A shareholder’s basis in property received in a stock redemption is the property’s fair mar-
                          ket value as of the date of the redemption. This is the case for both qualifying and nonquali-
                          fying stock redemptions. p. 6-4

                  8.      For purposes of the family attribution rules, ‘‘related parties’’ include the spouse, children,
                          grandchildren, and parents of the individual. Exhibit 6-1

                  9.      The family attribution rules do not apply to a complete termination redemption when the for-
                          mer shareholder does not hold a prohibited interest for ten years after the redemption and
                          files the required notification agreement with the IRS. All of the other attribution rules still
                          apply to a complete termination redemption, however. pp. 6-6 and 6-9

                          The stock attribution rules are not relevant in determining whether a distribution qualifies
                          as a partial liquidation. Instead, the distribution must not be essentially equivalent to a
                          dividend with reference to the effect of the distribution on the corporation. pp. 6-6 and 6-10

                          The stock attribution rules also do not apply in satisfying the requirements of a redemption
                          to pay death taxes. pp. 6-6 and 6-11

                 10.      To qualify as a not essentially equivalent redemption, the distribution must result in a
                          ‘‘meaningful reduction’’ in the shareholder’s interest in the corporation. A decrease in the
                          shareholder’s voting control appears to be the most important factor in determining
                          whether the ‘‘meaningful reduction test’’ has been satisfied. Also considered are decreases
                          in the shareholder’s right to share in corporate earnings or to receive corporate assets
                          upon liquidation. The meaningful reduction test cannot be satisfied if the shareholder con-
                          tinues to have a controlling interest (i.e., more than 50%) in the corporation after the
                          redemption. The stock attribution rules apply in determining a shareholder’s ownership
                          interest in the corporation before and after the redemption. The meaningful reduction test
                          applies regardless of whether common stock or preferred stock is redeemed. p. 6-6

                 11.      The basis attaches to the shareholder’s remaining stock basis or, if that shareholder has
                          no remaining direct stock ownership, to stock the shareholder owns constructively. p. 6-7
                          and Example 8

                 12.      The redemption qualifies for sale or exchange treatment under the disproportionate
                          redemption rules. After the redemption, Bernie’s ownership interest of 38.46% (500
                          shares/1,300 shares) satisfies both the 80% test [38.46% is less than 40% (80% Â 800
                          shares/1,600 shares)] and the 50% test. Example 9

                 13.      l     Whether the transfer of Polly’s property to Flycatcher Corporation qualifies as a non-
                                taxable exchange under § 351.

                          l     Polly’s basis in her stock.

                          l     Whether the redemption qualifies for sale or exchange treatment.

                          l     Whether Polly is related to any shareholder of Flycatcher Corporation.

                          l     If Polly is related to a shareholder of Flycatcher, will she continue as a director of Fly-
                                catcher or as a consultant to the corporation?

                          l     What is Flycatcher’s E & P at the time of the distribution?

                          l     Whether Flycatcher has a recognized gain (or unrecognized loss) as a result of the
                                property distribution.
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                                              Corporations: Redemptions and Liquidations                               6-7


                          l     What is the effect of the distribution on Flycatcher’s E & P?

                          l     Whether Flycatcher incurred any (nondeductible) redemption expenditures as a result
                                of the distribution.
                          pp. 6-9, 6-12, 6-13, and Chapter 4

                 14.      The requirements for the family attribution waiver in a complete termination redemption
                          are: (1) the former shareholder must have no interest (other than that of a creditor) in the
                          corporation during the 10-year period following the redemption, and (2) the former
                          shareholder must file an agreement to notify the IRS of any prohibited interest acquired
                          within the 10-year period and to retain all necessary records related to the redemption
                          during this time period. A stock interest acquired by bequest or inheritance will not
                          constitute a prohibited interest. The required agreement should be in the form of a
                          separate statement signed by the former shareholder and attached to the return for the
                          year in which the redemption occurs. p. 6-9

                 15.      In determining whether a distribution is not essentially equivalent to a dividend for the
                          partial liquidation rules, the test is applied at the corporate level (rather than the
                          shareholder level, as is the case of a not essentially equivalent redemption). The test
                          requires a genuine contraction of the corporation’s business and is based on the facts and
                          circumstances of each case. A safe-harbor rule provides that a distribution pursuant to the
                          termination of an active trade or business will satisfy the not essentially equivalent to a divi-
                          dend test. To qualify for the termination of an active business test, the distribution must
                          consist of the assets (or the proceeds from the sale of the assets) from a trade or business
                          that was actively conducted throughout the five-year period ending on the date of the distri-
                          bution. In addition, the corporation must continue to actively conduct another five-year-old
                          trade or business immediately after the distribution. Finally, neither of the active busi-
                          nesses must have been acquired in a taxable transaction within that same five-year period.
                          pp. 6-10, 6-11, and Concept Summary 6-1

                 16.      l     Was the discontinued business operated by Beige for the five-year period preceding
                                the redemption distribution and, if so, was the business acquired by Beige in a taxable
                                transaction?
                          l     Were any of the assets distributed in the redemption appreciated assets (fair market
                                value greater than basis)?

                          l     What was Beige Corporation’s E & P at the time of the redemption distribution?

                          l     What was the percentage of stock outstanding that was redeemed?

                          l     Did Beige incur any expenses with respect to the redemption distribution?

                          l     Were any of the shareholders corporate taxpayers?

                          l     What were the shareholders’ bases in the stock redeemed?
                          pp. 6-10 to 6-12

                 17.      Section 303 provides two principal advantages to shareholders redeeming stock. First, the
                          provision allows for sale or exchange treatment without regard to the stock attribution
                          rules. This exception is particularly advantageous when the stock is that of a family-owned
                          corporation and the beneficiaries of the decedent’s estate are family members. Under
                          § 303, the stock of these beneficiaries is not attributed to the estate; thus, sale or exchange
                          treatment is available for redemptions that might not qualify under § 302.
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                 6-8                           2007 Corporations Volume/Solutions Manual


                          The second advantage of § 303, relative to redemptions qualifying under § 302, is that
                          there is generally no gain or loss recognized by the estate in a redemption to pay death
                          taxes. This is because the stock’s basis is stepped up to the fair market value at death (or
                          alternate valuation date, if elected).

                          pp. 6-11 and 6-12

                 18.      The estate qualifies for a redemption to pay death taxes under § 303 because the value of
                          the Violet Corporation stock in Yolanda’s gross estate exceeds 35% of the value of the
                          adjusted gross estate ($800,000 ‚ $2,100,000 = 38.1%). Section 303 treatment is limited
                          to the sum of death taxes and funeral and administration expenses ($400,000), however.
                          pp. 6-11, 6-12, and Example 16

                 19.      l     Valuation of Angie’s estate. Chapter 17

                          l     Whether the executor should elect the alternate valuation date. Chapter 17

                          l     Whether Angie’s lifetime gifts to Ann included stock in Bluebird Corporation and, if so,
                                the facts surrounding that transfer (e.g., dates, motivation).

                          l     Whether a redemption of the estate’s shares in Redbird Corporation will qualify under
                                § 303.

                          l     Whether a redemption of the estate’s shares in Bluebird will qualify under § 303
                                (redemption to pay death taxes) or § 302 (complete termination redemption).

                          l     If a redemption of Bluebird stock is advantageous, whether noncash property should
                                be distributed in the redemption and, if so, which property.

                          l     Whether Ann should purchase the estate’s shares in Bluebird.

                          l     Effect of Angie’s lifetime gifts for her estate as to the unified tax credit. Chapter 17

                          l     Marital and other estate deductions. Chapter 17

                          l     Due date of estate tax return. Chapter 17

                          l     Income tax return for estate. Chapter 19

                 20.      Corporate distributions in redemption of stock are governed under § 311. That provision
                          provides that gains, but not losses, are recognized on the distribution of noncash property
                          when the property’s fair market value differs from its basis. As such, the distribution of
                          Property A would result in an $18,000 recognized gain [$30,000 (fair market value) À
                          $12,000 (basis)] to Indigo. The $6,000 loss inherent in Property B [$30,000 (fair market
                          value) À $36,000 (basis)] would not be recognized on the distribution of that property.
                          Indigo could distribute the cash, as neither gain nor loss is recognized by Indigo on a cash
                          distribution. However, a sale of Property B to recognize the $6,000 loss and a distribution
                          of the sales proceeds to Linda produces more favorable results. (To avoid the related party
                          loss disallowance rules of § 267, the sale must not be to Linda.) pp. 6-12 and 6-13

                 21.      l     Whether Kackie should distribute cash and/or property in the redemption(s).

                          l     Whether Kackie would have a recognized gain (or unrecognized loss) on a distribution
                                of property in the redemption(s).
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                                              Corporations: Redemptions and Liquidations                                 6-9


                          l     Whether the distribution(s) would result in a qualifying stock redemption to the share-
                                holder(s).

                          l     What would be the effect of the redemption distribution(s) on Kackie’s E & P?

                          l     Whether Kackie would incur any (nondeductible) redemption related expenditures
                                (e.g., fees related to transfer of title in a property distribution).

                          pp. 6-12 and 6-13

                 22.      In a sale of § 306 stock to an unrelated party, the shareholder generally recognizes ordi-
                          nary income to the extent of the stock’s fair market value on the date of the stock dividend.
                          The 15% preferential tax rate for dividends applies to this ordinary income. If the amount
                          realized in the sale exceeds the ordinary income taint, the excess is applied against the
                          basis of the preferred stock. No loss is recognized on a sale of § 306 stock; instead, any
                          unrecovered basis in the preferred stock attaches to the basis of the shareholder’s com-
                          mon stock. p. 6-15 and Example 20

                 23.      Under § 304, when a shareholder sells stock he or she owns in one corporation to a related
                          corporation, the sale is treated as a redemption subject to §§ 302 and 303. Assuming
                          adequate E & P, the amount realized by the shareholder is typically given dividend income
                          treatment. Two corporations are related if the shareholder has at least a 50% ownership in
                          both corporations. If the related corporation threshold (50%) is not met, however, sale or
                          exchange treatment is the result. pp. 6-15 and 6-16

                 24.      For tax purposes, a corporate liquidation exists when a corporation ceases to be a going
                          concern. The corporation continues solely to wind up affairs, pay debts, and distribute any
                          remaining assets to its shareholders. Retention of a nominal amount of assets to pay
                          remaining debts and preserve legal status will not defeat liquidation status. Legal
                          dissolution under state law is not required for a liquidation to be complete for tax purposes.
                          p. 6-16

                 25.      In liquidating distributions, gains and losses are generally recognized by the distributing
                          corporation. (The antistuffing rules disallow recognition of some losses, and special rules
                          exist if the distribution is pursuant to the liquidation of a subsidiary corporation.) In nonliqui-
                          dating distributions, the corporation recognizes gains but not losses. For both types of dis-
                          tributions, when the property distributed is subject to a liability, the fair market value used
                          to determine gain (or loss) may not be less than the amount of the liability. pp. 6-12, 6-17,
                          and 6-18

                 26.      The related-party loss limitation disallows losses on the distribution of property to a related
                          party if either 1) the distribution is not pro rata or 2) the property is disqualified property. A
                          shareholder owning, directly or indirectly (under the § 267 attribution rules), more than 50%
                          in value of the corporation’s outstanding stock is a related party. A distribution is pro rata
                          when it is distributed to the shareholders according to their proportionate ownership
                          interests. Disqualified property is property that is acquired by the corporation in a § 351 or
                          contribution to capital transaction during the 5-year period ending on the date of the distri-
                          bution. p. 6-19

                 27.      A tax avoidance purpose is presumed if the property was acquired by the corporation
                          within two years of the adoption of a plan of liquidation. This presumptive rule can be
                          rebutted if there was a clear and substantial relationship between the property and the
                          corporation’s business(es). The built-in loss rule will apply only in very limited cases where
                          the corporation acquired the property in question more than two years prior to the adoption
                          of the plan of liquidation. pp. 6-20 and 6-21
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                 6-10                          2007 Corporations Volume/Solutions Manual


                 28.      The general rule under § 331 provides for sale or exchange treatment to the shareholder.
                          The shareholder is treated as having sold his or her stock to the corporation being liqui-
                          dated. Thus, the difference between the fair market value of the assets received from the
                          corporation and the adjusted basis of the stock surrendered is the gain or loss recognized.
                          Typically, the stock is a capital asset in the hands of the shareholder and capital gain or
                          loss results. The basis of property received in a liquidation is the property’s fair market
                          value on the date of the distribution.

                          A shareholder’s gain on the receipt of installment notes obtained by a liquidating corpora-
                          tion on the sale of its assets may be deferred to the point of collection under § 453(h). The
                          shareholder must allocate his or her stock basis among the various assets received from
                          the corporation. With respect to the notes received, the shareholder may defer gain until
                          the notes are collected.

                          pp. 6-22, 6-23, and Example 33

                 29.      a.       The date of the adoption of a plan of complete liquidation is crucial in determining
                                   whether § 332 applies. The parent corporation must own 80% or more of the sub-
                                   sidiary’s voting stock and 80% or more in value of all its other stock (other than non-
                                   voting preferred) at the time the plan of liquidation is adopted (and until all property
                                   is distributed), or the liquidation will not qualify under § 332.

                          b.       The period of time in which the corporation must liquidate also is crucial in deter-
                                   mining whether § 332 applies. The subsidiary must distribute all its property in com-
                                   plete cancellation of all its stock within the taxable year in which the first distribution
                                   is made or within three years from the close of the tax year in which the first distribu-
                                   tion occurred pursuant to the adoption of a plan by the corporation. Otherwise, the
                                   liquidation will not qualify under § 332.

                          c.       The subsidiary must be solvent for § 332 to apply. If the subsidiary is insolvent, the
                                   parent corporation will have a deductible ordinary loss for its worthless stock in the
                                   subsidiary.

                          pp. 6-23, 6-24, and Footnote 40

                 30.      The statement is incorrect. When a subsidiary corporation liquidates under § 332, gains
                          and losses are not recognized on distributions to the parent corporation. However, distribu-
                          tions to minority shareholders are subject to the same rules applicable to nonliquidating
                          distributions. That is, the subsidiary recognizes gains but not losses on distributions to
                          minority shareholders. p. 6-24

                 31.      When § 332 applies, the subsidiary does not recognize gain or loss upon the transfer of
                          property to the parent. This is the case even if the transfer satisfies a debt. The parent cor-
                          poration may recognize a gain or loss on the receipt of property in satisfaction of indebted-
                          ness, however. Examples 35 and 36

                 32.      Condor will recognize no gain or loss and will have a carryover basis of $900,000 in Dove’s
                          assets. Condor acquires any of Dove’s tax attributes (e.g., E & P, net operating loss carry-
                          over). Condor’s basis in the Dove stock disappears. Dove recognizes no gain or loss on
                          the liquidation. pp. 6-23 to 6-25

                 33.      For § 338 to apply, the parent must ‘‘purchase’’ within a 12-month period at least 80% of
                          the voting power and at least 80% of the value of the acquired corporation. ‘‘Purchase’’ is
                          defined by § 338(h)(3) to include all acquisitions of stock except the following: (1) a transac-
                          tion where basis of the stock is the same as in the hands of the transferor, (2) an acquisition
                          of stock by inheritance, (3) a transaction where § 351 applies, and (4) an acquisition of
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                          stock from a related party where ownership of the stock would have been attributed to the
                          transferee under § 318. The acquiring corporation must then make the § 338 election by
                          the 15th day of the ninth month following the month of the ‘‘qualified stock purchase.’’ p. 6-26

                 34.      Upon a § 338 election, the subsidiary is treated as having sold its assets on the date of the
                          qualified stock purchase. The deemed selling price is determined with reference to the
                          parent’s basis in the subsidiary stock plus liabilities of the subsidiary. The subsidiary recog-
                          nizes gain (or loss) as a result of the deemed sale. Then, as of the day following the quali-
                          fied stock purchase date, the subsidiary is treated as a new corporation that purchased
                          those same assets for a similarly computed amount. The deemed purchase of the assets
                          thus results in a stepped-up (or -down) basis in the assets. Since the subsidiary is treated
                          as a new corporation, its tax attributes (e.g., E & P) start anew as of such date. If the sub-
                          sidiary is liquidated, it recognizes no gain (or loss) as a result of the liquidation (except for
                          gain on distributions to minority shareholders).

                          The parent corporation incurs no gain (or loss) as a result of the § 338 election, and it
                          retains its basis in the subsidiary stock. If the subsidiary is liquidated, the subsidiary stock
                          basis disappears and the parent takes the stepped-up (or -down) basis in the assets
                          acquired. The parent recognizes no gain (or loss) on the liquidation.

                          pp. 6-26 and 6-27

                 PROBLEMS

                 35.      a.       Teal Corporation would have a taxable gain of $150,000. The gain would be ordi-
                                   nary or capital depending on the type of property distributed. The E & P of Teal Cor-
                                   poration would be increased by $150,000 (the amount of gain to Teal) and
                                   decreased by $250,000 (the FMV of the property distributed). Teal’s E & P also
                                   would be decreased by the amount of tax due on the gain recognized. Grace would
                                   have dividend income of $250,000 and a basis in the property of $250,000.

                          b.       The tax consequences to Teal Corporation would be the same as in a. Grace Cor-
                                   poration would have dividend income of $250,000, but only 20% of the $250,000,
                                   or $50,000, would be taxed to Grace. Because Grace Corporation has a 20% or
                                   more ownership interest in Teal Corporation, the 80% dividends received deduction
                                   is applicable. Grace Corporation would have a basis of $250,000 in the property.

                          c.       The tax consequences to Teal Corporation would be the same as in a. Grace would
                                   have a capital gain of $170,000 [$250,000 (value of the property) À $80,000 (basis
                                   in stock)] and a basis of $250,000 in the property received.

                          d.       The tax consequences to Teal Corporation would be the same as in a. Grace Cor-
                                   poration would have a capital gain of $170,000 [$250,000 (value of the property) À
                                   $80,000 (basis in stock)] and a basis of $250,000 in the property received.

                          e.       Assuming Grace is an individual, she would choose the qualifying stock redemption
                                   (option c.). If the distribution is a qualifying stock redemption, she has a capital gain
                                   of $170,000. If the distribution is a dividend, as in option a., she would have dividend
                                   income of $250,000. Her basis in the property received is the same whether the
                                   transaction is a dividend or a qualifying stock redemption. If Grace is a corporation, it
                                   would prefer that the distribution be a dividend because only 20% of the dividend
                                   would be taxed (option b.). Teal Corporation itself would have no preference because
                                   the tax consequences from the transaction are the same under each option.

                          pp. 6-3, 6-4, and 6-12
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                 36.      a.       Julio’s tax liability would be $12,750, computed as follows: $100,000 (amount real-
                                   ized) À $15,000 (basis in the 200 shares redeemed) = $85,000 (long-term capital
                                   gain) Â 15% = $12,750.

                          b.       Julio’s tax liability would be $15,000, computed as follows: $100,000 (dividend) Â
                                   15% = $15,000.

                          Example 1

                 37.      a.       Tax liability for a corporate shareholder would be $28,900, computed as follows:
                                   $100,000 (amount realized) À $15,000 (basis in the stock) = $85,000 (long-term
                                   capital gain) Â 34% = $28,900. Corporations do not receive a preferential tax rate
                                   on long-term capital gains.

                          b.       Tax liability for a corporate shareholder on a $100,000 dividend from a corporation
                                   in which it has a 25% interest would be $6,800, computed as follows: $100,000 (div-
                                   idend) À $80,000 [80% (dividends received deduction) Â $100,000] = $20,000 Â
                                   34% = $6,800. Corporations do not receive a preferential tax rate on dividend
                                   income.

                          Example 3

                 38.      a.       Julio may deduct the entire $40,000 capital loss carryover to offset the $85,000
                                   long-term capital gain. Thus, Julio would be taxed on only $45,000 of gain. Tax
                                   liability on the $45,000 long-term capital gain would be $6,750 ($45,000 Â 15%).

                          b.       Julio could only deduct $3,000 of the $40,000 capital loss carryover. Julio’s tax
                                   liability on the $100,000 dividend received would be $15,000 ($100,000 Â 15%).

                          c.       The preferred outcome in this situation is that which provides sale or exchange
                                   treatment (part a.). With a qualifying stock redemption, Julio’s tax liability is $8,250
                                   less ($15,000 À $6,750) than if the redemption is treated as a dividend.

                          Example 2

                 39.      a.       The corporation could offset the entire $40,000 capital loss carryover against the
                                   $85,000 long-term capital gain. Thus, only $45,000 of the gain would be taxed. The
                                   tax liability would be $15,300 ($45,000 Â 34%).

                          b.       The corporation could not deduct any of the $40,000 capital loss carryover. Corpo-
                                   rations may only offset capital losses against capital gains. Thus, the corporation
                                   would have dividend income of $100,000 less a dividends received deduction of
                                   $80,000 (80% Â $100,000). The remaining $20,000 would be taxed at 34%, for a
                                   tax liability of $6,800.

                          Example 3 and Chapter 2

                 40.      a.       Hubert owns 285 shares, 200 shares directly and 85 shares indirectly, in Cardinal
                                   Corporation. Hubert constructively owns the stock of his daughter (50 shares) and
                                   70% of the 50 shares, or 35 shares, owned by Redbird Corporation. Grandparents
                                   are not related parties under § 318; thus, Hubert is not deemed to own the shares
                                   of the grandmother.

                          b.       The stock attribution rules do not apply to the stock held by a corporation if the
                                   shareholder owns less than 50% of the stock in the corporation. Thus, Hubert
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                                   would only own 250 shares, 200 shares directly and 50 shares owned by his
                                   daughter.

                          c.       Hubert would now own 315 shares in Cardinal, the 285 shares as computed in part
                                   a., above, plus 30 shares as a result of his 30% interest in Yellow Partnership [100
                                   (shares owned by Yellow Partnership) Â 30% (Hubert’s interest in Yellow)].

                          Exhibit 6-1

                 41.      The redemption is not treated as a qualifying stock redemption. More specifically, it does
                          not qualify as a not essentially equivalent redemption. Prior to the redemption, Bubba
                          owned 60% (300 shares ‚ 500 shares) of the Meadowlark stock. After the redemption,
                          Bubba owns 51.2% (210 shares ‚ 410 shares) of the Meadowlark shares then outstanding.
                          Because Bubba continues to own a majority interest in Meadowlark after the redemption,
                          the ‘‘meaningful reduction’’ test is not satisfied. The entire $90,000 distribution is treated as
                          a dividend to Bubba, and the $27,000 basis in the 90 shares redeemed attaches to the
                          basis of Bubba’s remaining 210 shares. Since the transaction is treated as a dividend
                          distribution to Bubba, Meadowlark’s E & P is reduced to $910,000 ($1 million À $90,000).
                          pp. 6-6, 6-7, Examples 6 and 8, and Chapter 5

                 42.                                 Hoffman, Raabe, Smith, and Maloney, CPAs
                                                              5191 Natorp Boulevard
                                                                Mason, OH 45040

                          May 12, 2006

                          Lana Pierce
                          1000 Main Street
                          Oldtown, MN 55166

                          Dear Lana:

                          This letter is in response to your question concerning the tax consequences of the redemp-
                          tion of 200 shares of stock you own in Stork Corporation. You were paid $80,000 for the
                          shares and you have a tax basis of $10,000 in the stock. The remaining shares are owned
                          by two unrelated individuals. Our conclusion is based upon the facts as outlined in your
                          May 5 letter. Any change in facts may cause our conclusion to be inaccurate.

                          You will have a long-term capital gain of $70,000 on the redemption. Stork Corporation
                          redeemed 200 of the 300 shares you owned in the corporation. Prior to the redemption,
                          you had a 30% ownership in Stork Corporation (300 shares ‚ 1,000 shares outstanding).
                          After the redemption, you have only a 12.5% ownership [100 (your remaining shares in
                          Stork) ‚ 800 (remaining outstanding shares in Stork)]. After the redemption, you owned
                          less than 50% of the stock in Stork Corporation and less than 80% of your original owner-
                          ship [12.5% is less than 24% (80% Â 300 shares/1,000 shares)]; thus, the redemption
                          qualifies for capital gain treatment.

                          Should you need additional information or need to clarify our conclusion, do not hesitate to
                          call on me.

                          Sincerely,

                          Marilyn C. Jones, CPA
                          Partner
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                 6-14                          2007 Corporations Volume/Solutions Manual


                          TAX FILE MEMORANDUM

                          DATE:            May 9, 2006

                          FROM:            Marilyn C. Jones

                          SUBJECT:         Lana Pierce

                          Today I talked to Lana Pierce with respect to her May 5 letter. She received a cash pay-
                          ment of $80,000 from Stork Corporation (E & P of $350,000) in exchange for 200 of the
                          300 shares she owned in the corporation. The remaining shares are owned by two unre-
                          lated individuals. She wants to know the tax consequences of the redemption.

                          At issue: Will the stock redemption qualify for capital gain treatment or will the $80,000 be
                          treated as a taxable dividend?

                          Conclusion: Lana Pierce has a long-term capital gain of $70,000. Lana’s percentage own-
                          ership in Stork Corporation was 30% (300 shares ‚ 1,000 shares) before the redemption
                          and 12.5% (100 shares ‚ 800 shares) after the redemption. Because the 80% and 50%
                          tests set out in § 302(b)(2) are met, the stock redemption qualifies for capital gain treat-
                          ment.

                          p. 6-8 and Example 9

                 43.      a.       The redemption cannot qualify as a complete termination redemption. Jacque is
                                   deemed to own Monique’s 800 shares or 67% (800 ‚ 1,200) of the remaining
                                   shares outstanding. The family attribution waiver does not apply because Jacque
                                   failed to file the required notification agreement with the tax return for the year of
                                   the redemption.

                          b.       The redemption can qualify as a complete termination redemption. Acquisition of
                                   stock in Thrush by bequest or inheritance is not a prohibited interest. Thus, if the
                                   other requirements for the family attribution waiver are satisfied (e.g., Jacque files
                                   the required agreement with the IRS), the redemption completely terminates Jac-
                                   que’s ownership interest in Thrush.

                          c.       The redemption can qualify as a complete termination redemption. Retaining a
                                   creditor interest is not a prohibited interest. Thus, if the other requirements for the
                                   family attribution waiver are satisfied, the redemption completely terminates Jac-
                                   que’s ownership interest in Thrush.

                          p. 6-9 and Example 11

                 44.      a.       With respect to the distribution, Lori would have dividend income of $800,000 and
                                   Swan Corporation would reduce its E & P by $800,000. As a result of the stock
                                   transaction, Lori would have a basis of $800,000 in the newly acquired 200 shares
                                   and become the sole shareholder of Swan. Roberta would have a capital gain of
                                   $750,000 [$800,000 (amount realized) À $50,000 (basis in stock)] on the sale. The
                                   stock transaction would not affect Swan.

                          b.       The transaction would constitute a complete termination redemption and result in a
                                   capital gain of $750,000 [$800,000 (amount realized) À $50,000 (basis in stock)] to
                                   Roberta. (Siblings are not related parties under § 318; thus, Roberta remaining as
                                   a director is irrelevant and a complete termination redemption results.) Lori would
                                   become the sole shareholder as a result of the redemption. Swan would reduce its
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                                   E & P by $700,000 [$1,400,000 (E & P at time of redemption) Â 50% (interest
                                   redeemed)].

                          pp. 6-3, 6-9, 6-13, Example 19, Exhibit 6-1, and Chapter 5

                 45.      The transaction qualifies as a partial liquidation with respect to Walt. The distribution
                          consisted of the proceeds from the sale of a trade or business operated by Blue Jay for the
                          five-year period preceding the date of the distribution (i.e., a qualified trade or business),
                          and Blue Jay continued to operate another qualified trade or business after the distribution.
                          This satisfies the termination of an active business test, and the distribution is treated as
                          not essentially equivalent to a dividend. It does not matter that the redemption was pro rata
                          with respect to the shareholders. Walt has a capital gain of $1,890,000 [$2 million (amount
                          realized) À $110,000 (basis in stock)] as a result of the stock redemption.

                          Corporate shareholders, such as Redbird Corporation, do not qualify for partial liquidation
                          treatment. Since the stock redemption was a pro rata redemption, the transaction does not
                          satisfy any of the other qualifying stock redemption provisions. Thus, Redbird has $2
                          million of dividend income from the distribution. However, Redbird receives a dividends
                          received deduction of $1,600,000 [80% (applicable percentage for 50% shareholder) Â $2
                          million] with respect to the dividend. As a result, Redbird incurs a tax on $400,000 of
                          income. The $200,000 basis in the stock redeemed attaches to Redbird’s basis in its
                          remaining shares in Blue Jay.

                          Blue Jay will reduce its E & P by $1,750,000 with respect to Walt’s qualifying stock redemp-
                          tion [$7 million (E & P pre-redemption) Â 25% (percentage of shares outstanding repre-
                          sented by Walt’s shares redeemed)]. Blue Jay will reduce its E & P by the entire $2 million
                          dividend distribution to Redbird Corporation.

                          pp. 6-7, 6-10, 6-11, 6-13, and Examples 3 and 19

                 46.      Red Corporation will recognize a $160,000 gain [$500,000 (fair market value) À $340,000
                          (basis)] on the distribution of the land to the estate. Red Corporation’s E & P is reduced by
                          $500,000 (fair market value of the land) as a result of the distribution [$500,000 is less than
                          10% (percentage of stock outstanding redeemed) of E & P at the time of redemption]. The
                          estate may utilize § 303 to characterize the stock redemption because the stock’s value
                          exceeds 35% of the value of the adjusted gross estate ($1,000,000 ‚ $2,500,000 = 40%)
                          and the amount of the redemption proceeds ($500,000) does not exceed the sum of the
                          death taxes and funeral and administration expenses ($500,000). Therefore, the estate will
                          recognize no gain [$500,000 (amount realized) À $500,000 (stepped-up basis in stock)] on
                          the redemption, and it will have a basis in the land equal to its fair market value, or
                          $500,000. When it sells the land for $520,000, the estate recognizes a gain of $20,000.
                          pp. 6-11 to 6-13

                 47.      Since Bridgett owned a 20% or more interest in both Crane Corporation and Eagle
                          Corporation, the fair market values of the two stocks can be combined for purposes of the
                          35% of adjusted gross estate test. The redemption qualifies under § 303 [$670,000 (com-
                          bined stock value) exceeds $630,000 (35% Â $1.8 million adjusted gross estate)] to the
                          extent of $220,000, the amount of death taxes and funeral and administration expenses.
                          Since the estate’s basis in the Eagle shares is stepped up to fair market value at date
                          of death, the estate has no gain or loss on the stock redemption [$220,000 (proceeds
                          qualifying for § 303 treatment) À $220,000 (estate’s basis in shares)]. pp. 6-11, 6-12, and
                          Example 17

                 48.      a.       Jacob would have a long-term capital gain of $240,000 [$260,000 (amount real-
                                   ized) À $20,000 (basis in shares redeemed)]. The redemption qualifies as a dispro-
                                   portionate redemption. Jacob had a 50% ownership in Tan Corporation before the
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                                   redemption and a 37.5% ownership after the redemption [300 (post-redemption
                                   shares owned) ‚ 800 (post-redemption shares outstanding)]. Both the 80% test
                                   [37.5% is less than 40% (80% Â 50%)] and the 50% test are met. p. 6-8 and Exam-
                                   ple 9

                          b.       Tan Corporation’s E & P is reduced by $180,000 as a result of the qualifying stock
                                   redemption [lesser of $260,000 (distribution) or $180,000 ($900,000 pre-redemption
                                   E & P Â 20% stock redemption)]. Example 19

                 49.                                 Hoffman, Raabe, Smith, and Maloney, CPAs
                                                              5191 Natorp Boulevard
                                                                Mason, OH 45040

                          December 6, 2006

                          Crane Corporation
                          506 Wall Street
                          Winona, MN 55987

                          Dear President of Crane Corporation:

                          This letter is in response to your questions concerning Crane Corporation’s tax consequen-
                          ces arising out of a redemption of its stock. Crane Corporation had 2,000 shares of stock
                          outstanding when it redeemed 400 shares for $300,000. The shareholder received sale or
                          exchange treatment on the redemption. Crane had paid-in capital of $500,000 and E & P of
                          $1.2 million at the time of the redemption. As a result of the redemption transaction, Crane
                          Corporation incurred $10,000 of accounting and legal fees. Our conclusions are based
                          upon the facts as outlined in your November 22 letter. Any change in facts may cause our
                          conclusions to be inaccurate.

                          Crane Corporation would reduce its E & P in the amount of $240,000 as a result of the
                          redemption. This represents a 20% decrease in the amount of the E & P corresponding to
                          the 20% stock redemption. When a stock redemption results in sale or exchange treatment
                          for the shareholder, the E & P account of a corporation is reduced in an amount not in
                          excess of the ratable share of the E & P of the distributing corporation attributable to the
                          stock redeemed. The $60,000 balance of the redemption distribution would reduce the
                          paid-in capital of the corporation.

                          No deduction is allowed for expenditures incurred by a corporation in connection with the
                          redemption of its stock. As such, none of the $10,000 of accounting and legal fees is
                          deductible.

                          Should you need additional information or need to clarify our conclusions, do not hesitate
                          to call on me.

                          Sincerely,

                          Astia Jackson, CPA
                          Partner
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                                              Corporations: Redemptions and Liquidations                            6-17


                          TAX FILE MEMORANDUM

                          DATE:            December 5, 2006

                          FROM:            Astia Jackson

                          SUBJECT:         Crane Corporation

                          Today I talked to the President of Crane Corporation with respect to its November 22 letter.
                          Crane Corporation had 2,000 shares of stock outstanding. It redeemed 400 shares for
                          $300,000, when it had paid-in capital of $500,000 and E & P of $1.2 million. The redemp-
                          tion qualified for sale or exchange treatment for the shareholder. Crane incurred $10,000
                          of accounting and legal fees with respect to the redemption transaction.

                          At issue: What is the reduction in Crane Corporation’s E & P as a result of the redemption?
                          Also, are the redemption expenditures deductible by Crane?

                          Conclusion: Under § 312(n)(7), the E & P account of a corporation is reduced by a qualify-
                          ing stock redemption in an amount not in excess of the ratable share of the E & P of the dis-
                          tributing corporation attributable to the stock redeemed. Since Crane Corporation
                          redeemed 20% of its stock, the reduction in E & P is 20% of the E & P account, or
                          $240,000. Section 162(k) specifically disallows the deductibility of redemption expendi-
                          tures. As such, none of the $10,000 of accounting and legal fees is deductible by Crane.

                          p. 6-13 and Example 19

                 50.      a.       There are no tax consequences upon receipt of the preferred stock. It is a nontax-
                                   able stock dividend under § 305. However, the stock is classified as § 306 stock.
                                   The $40,000 basis in their original common shares is reallocated between the pre-
                                   ferred stock and the common stock based on the fair market value of each. The
                                   basis is reallocated as follows:

                                      Fair market value of common:               500 Â $150 =        $75,000
                                      Fair market value of preferred:            200 Â $75 =          15,000
                                                                                                     $90,000
                                      Basis of common: 75/90 Â $40,000 = $33,333
                                      Basis of preferred:15/90 Â $40,000 = $6,667

                          b.       A sale of the preferred stock to Adam will produce $15,000 of ordinary income,
                                   which is the fair market value of the preferred stock on the date of distribution. The
                                   $15,000 will not be dividend income; thus, the E & P of Blue Corporation will not be
                                   reduced as a result of the distribution. However, the $15,000 is treated as dividend
                                   income for purposes of the 15% preferential tax rate on such income. The remain-
                                   ing $5,000 of the sales price will reduce the basis of the preferred stock to $1,667
                                   (i.e., a return of capital). That amount is added back to the basis of the common
                                   stock, giving a new basis in such stock of $35,000 ($33,333 + $1,667).

                          c.       In a redemption of § 306 stock, the shareholder recognizes dividend income to the
                                   extent of the corporation’s E & P on the date of the redemption. Since Blue Corpo-
                                   ration has ample E & P, the entire $20,000 of redemption proceeds will be dividend
                                   income to Ahmad. The $6,667 of basis in the preferred stock is added back to the
                                   basis of Ahmad’s common stock, giving a new basis in such stock of $40,000
                                   ($33,333+$6,667). Blue’s E & P is reduced by the $20,000 dividend distribution.

                          p. 6-15 and Example 20
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                 6-18                          2007 Corporations Volume/Solutions Manual


                 51.      Bob has dividend income of $30,000. Pursuant to § 304, the sale is treated as a redemption
                          subject to § 302. After the redemption, Bob continues to own all 1,000 shares of Goose
                          stock [800 (shares directly owned)+200 (shares owned constructively through his sole
                          ownership of Heron)]. As a result, the redemption satisfies none of the qualifying stock
                          redemption provisions. The amount of the dividend income is determined by the E & P of
                          the acquiring corporation (Heron Corporation) and then by the E & P of the acquired corpo-
                          ration (Goose Corporation).

                          Heron Corporation’s basis in the Goose Corporation stock is $5,000, the adjusted basis of
                          stock in the hands of Bob. Bob’s $5,000 basis in the ‘‘sold’’ Goose stock is added to his
                          basis in the Heron Corporation stock.

                          p. 6-16

                 52.      a.        In the case of Hawk, the $20,000 loss [$280,000 (fair market value) À $300,000
                                    (basis)] is not recognized on the nonliquidating distribution of the land under
                                    § 311(a). As to Michele, her $30,000 loss realized [$280,000 (fair market value of
                                    land) À $310,000 (stock basis)] in the qualifying stock redemption is disallowed
                                    under § 267 because Michele and Hawk Corporation are related parties. Under that
                                    provision, Michele is deemed to own the stock of her sisters, or 100% of the Hawk
                                    stock in total. Her basis in the land is its fair market value, or $280,000.

                          b.        The $20,000 loss realized by Hawk Corporation on the distribution of the land is
                                    again disallowed. In this case, the loss is disallowed under the related-party loss
                                    limitation. Since Michele is deemed to own 100% of the stock of Hawk, there is a dis-
                                    tribution of loss property to a related party and such distribution is not pro rata. As to
                                    Michele, her $30,000 loss is recognized. Section 267 does not apply in the case of
                                    liquidating distributions. Her basis in the land is its fair market value, or $280,000.

                          pp. 6-4, 6-12, 6-17 to 6-19, 6-22, and Examples 18, 22, and 25

                 53.      a.        Oriole Corporation would recognize gain of $200,000 [$800,000 (fair market value) À
                                    $600,000 (basis)]. Under the general rule of § 336(a), the land is treated as if it were
                                    sold for its fair market value. Since the land was a capital asset held for more than
                                    one year, Oriole has a $200,000 long-term capital gain.

                          b.        Oriole Corporation has a recognized long-term capital gain of $300,000 on the dis-
                                    tribution. Under § 336(b), when property distributed in a complete liquidation is sub-
                                    ject to a liability of the liquidating corporation, the fair market value of that property
                                    is treated as not being less than the amount of the liability. Thus, the $600,000
                                    adjusted basis in the land is subtracted from the $900,000 liability for a gain of
                                    $300,000.

                          Example 23 and Chapter 2

                 54.      No loss is recognized. The land is disqualified property that is distributed to a related party
                          (both Arnold and Beatrice are considered 100% shareholders under the § 267 attribution
                          rules). Thus, the related-party loss limitation applies and none of the realized loss of
                          $50,000 [$250,000 (fair market value) À $300,000 (carryover basis)] is recognized. Exam-
                          ple 27 and Figure 6-1

                 55.      Crow Corporation may recognize the entire loss realized on the distribution of the land to
                          Ali, or $250,000 [$150,000 (value on date of distribution) À $400,000 (basis)]. The built-in
                          loss limitation does not apply, as there was a clear business reason for transferring the land
                          to Crow Corporation. Further, the related-party loss limitation does not apply, as Ali is not a
                          related party. pp. 6-18 to 6-21 and Example 31
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                                              Corporations: Redemptions and Liquidations                               6-19


                 56.      Only the loss that occurred after the equipment’s acquisition by Grackle Corporation, or
                          $140,000 [($90,000 (selling price) À $230,000 (value on date of acquisition)], is recog-
                          nized. The equipment was acquired by Grackle in a contribution to capital transaction
                          within 2 years of the adoption of the plan of liquidation and there was no clear business pur-
                          pose for the acquisition. Therefore, the built-in loss of $80,000 [$230,000 (value on date of
                          acquisition) À $310,000 (basis on date of acquisition)] is not recognized. The built-in loss
                          limitation applies to sales of property pursuant to liquidation. The related-party loss limita-
                          tion does not apply to such sales. pp. 6-18 to 6-21 and Example 30

                 57.      a.       If Pink Corporation distributes all the land to Maria, none of the $1 million loss real-
                                   ized [$700,000 (fair market value) À $1,700,000 (basis)] on the distribution will be
                                   recognized since Maria is a related party and the land is disqualified property.

                          b.       If all the land is distributed to Paul, Pink Corporation will have a recognized loss of
                                   $1 million. The land was valued at more than its basis on the date of the transfer to
                                   Pink; thus, the built-in loss limitation does not apply. Because Paul is an unrelated
                                   party, the related-party loss limitation does not apply.

                          c.       Even though the distribution is pro rata, the property is disqualified property; thus,
                                   the loss on the distribution to Maria (i.e., $700,000), a related party, would be disal-
                                   lowed. Of the $1 million loss, 30% (Paul’s interest), or $300,000, would be allowed.
                                   For the reasons noted in option b. above, the loss limitations do not apply to the dis-
                                   tribution to Paul.

                          d.       In this case, 50% of the $1 million realized loss, or $500,000, would be disallowed.
                                   The property is disqualified property; thus, the loss on the distribution to Maria, a
                                   related party, would be disallowed. The remaining $500,000 loss will be recog-
                                   nized. For the reasons noted in option b. above, the loss limitations do not apply to
                                   the distribution to Paul.

                          e.       Because the property does not have a built-in loss on the date of the transfer to the
                                   corporation, the built-in loss limitation does not apply. Further, the related-party loss
                                   limitation does not apply to a sale of property. Upon the sale, Pink Corporation
                                   would recognize the entire $1 million loss.

                          Pink Corporation should either distribute the land to Paul (option b.) or sell it and distribute
                          the cash (option e.).

                          pp. 6-18 to 6-21 and Figure 6-1

                 58.      a.       The answer would not change. The land is disqualified property that is distributed
                                   to a related party; thus, the entire $1 million loss realized is disallowed under the
                                   related-party loss limitation.

                          b.       The property had a built-in loss of $200,000 [$1,500,000 (fair market value) À
                                   $1,700,000 (basis)] when it was transferred to Pink Corporation. Further, the trans-
                                   fer occurred within 2 years of the date the plan of liquidation was adopted. Unless
                                   Pink can rebut the presumption of a tax avoidance purpose for the transfer, the
                                   built-in loss of $200,000 is disallowed. The remaining $800,000 loss will be recog-
                                   nized. Because Paul is an unrelated party, the related-party loss limitation does not
                                   apply to a distribution to him. If Pink Corporation can establish a business reason
                                   for the transfer of the property to the corporation and rebut the 2-year presumption
                                   rule, the entire $1 million loss would be recognized.

                          c.       The loss on the property distributed to Maria, or $700,000, will be disallowed
                                   entirely because it is a distribution of disqualified property to a related party. Unless
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                 6-20                          2007 Corporations Volume/Solutions Manual


                                   Pink Corporation can rebut the presumption of a tax avoidance purpose for the
                                   transfer, an additional $60,000 of the loss [$200,000 (built-in loss) Â 30% (Paul’s
                                   interest)] will be disallowed. As a result, $240,000 of the loss will be recognized
                                   [$800,000 (post-transfer loss) Â 30% (Paul’s interest)]. If Pink Corporation can
                                   rebut the 2-year presumption rule, $300,000 of loss would be recognized [$1 million
                                   (total loss) Â 30% (Paul’s interest)].

                          d.       The loss on the distribution of disqualified property to Maria, or $500,000, will be
                                   disallowed. Of the remaining $500,000 loss, 50% of the built-in loss of $200,000, or
                                   $100,000, will be disallowed unless Pink Corporation can demonstrate a business
                                   purpose for the transfer. If Pink can rebut the 2-year presumption rule, $500,000 of
                                   the loss, or the portion pertaining to the distribution to Paul, would be recognized.

                          e.       If Pink Corporation cannot show a business purpose for the transfer, the built-in loss
                                   of $200,000 would be disallowed. The remaining $800,000 loss would be recog-
                                   nized. If Pink can rebut the 2-year presumption rule, the entire $1 million loss would
                                   be recognized. The related-party loss limitation does not apply to a sale of property.

                          Pink Corporation should either distribute the land to Paul (option b.) or sell it and distribute
                          the proceeds (option e.).

                          pp. 6-18 to 6-21 and Figure 6-1

                 59.      The tax results of these transactions to Helen are as follows:

                          l     Helen may defer gain on the receipt of the notes to the point of collection under the
                                installment method.

                          l     Helen must allocate her $100,000 basis in the Purple Corporation stock between the
                                cash and the installment notes. Using the relative fair market value approach, 25%
                                [$100,000 (amount of cash) ‚ $400,000 (total distribution)] of $100,000 (basis in the
                                stock), or $25,000, is allocated to the cash, and 75% [$300,000 (FMV of the notes) ‚
                                $400,000 (total distribution)] of $100,000 (basis in the stock), or $75,000, is allocated
                                to the notes.

                          l     Helen must recognize $75,000 [$100,000 (cash received) À $25,000 (basis allocated
                                to the cash)] in the year of the liquidation.

                          l     Since Helen’s gross profit on the notes is $225,000 [$300,000 (FMV of notes) À
                                $75,000 (basis allocated to the notes)], the gross profit percentage is 75% [$225,000
                                (gross profit) ‚ $300,000 (FMV of notes)]. Thus, Helen must report a gain of $45,000
                                [$60,000 (amount of annual payment) Â 75% (gross profit percentage)] on the collec-
                                tion of each note over the next five years.

                          l     The interest element is accounted for separately.

                          Example 33

                 60.      Magenta recognizes no gain on the distribution of assets to Fuchsia, its parent corporation.
                          The $20,000 loss realized [$105,000 (fair market value) À $125,000 (basis)] on the land
                          distribution to Marta is not recognized.

                          Fuchsia recognizes no gain or loss in the liquidation, and it has a carryover basis of
                          $950,000 in the assets received. Magenta’s tax attributes (e.g., E & P) also carry over to
                          Fuchsia. Fuchsia’s basis in the Magenta stock disappears.
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                                              Corporations: Redemptions and Liquidations                          6-21


                          Marta recognizes a $75,000 gain [$105,000 (amount realized) À $30,000 (basis of stock)]
                          in the liquidation, and she has a basis in the land of $105,000.

                          Concept Summary 6-2

                 61.      Green Corporation recognizes no gain on the transfer of the land to satisfy its
                          indebtedness to Orange Corporation. Transfers by a subsidiary corporation pursuant to a
                          § 332 liquidation are subject to the nonrecognition rules of § 337. Orange Corporation,
                          however, must recognize a gain of $25,000 [$100,000 (fair market value of the land) À
                          $75,000 (basis in the bonds)]. Examples 35 and 36

                 62.      a.       Wren Corporation recognizes no gain (or loss) on its liquidation under § 337. The
                                   liquidation meets the requirements of § 332.

                          b.       Cardinal Corporation recognizes no gain (or loss) on the liquidation under § 332.

                          c.       Cardinal Corporation takes a carryover basis in the assets, or $1,300,000. Cardi-
                                   nal’s basis in the Wren stock disappears.

                          d.       Cardinal Corporation acquires Wren Corporation’s E & P of $600,000 and net oper-
                                   ating loss carryover of $150,000 under § 381.

                          pp. 6-23 to 6-25 and Chapter 7

                 63.                                 Hoffman, Raabe, Smith, and Maloney, CPAs
                                                              5191 Natorp Boulevard
                                                                Mason, OH 45040

                          October 12, 2006

                          Quail Corporation
                          1010 Cypress Lane
                          Community, MN 55166

                          Dear President of Quail Corporation:

                          This letter is in response to your question as to the tax consequences to Quail Corporation
                          if it liquidates its wholly owned subsidiary, Sparrow Corporation. Our conclusion is based
                          on the facts as outlined in your October 5 letter. Any change in facts may cause our conclu-
                          sion to be inaccurate.

                          Because Sparrow Corporation is insolvent (its liabilities exceed the value of its assets),
                          Quail Corporation would have an ordinary loss deduction for its worthless stock in Sparrow
                          Corporation. The loss to Quail would be measured by the fair market value of Sparrow’s
                          net assets less Quail’s basis in the Sparrow stock.

                          Should you need additional information or need to clarify our conclusion, do not hesitate to
                          call on me.

                          Sincerely,

                          Larry C. Williams, CPA
                          Partner
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                 6-22                          2007 Corporations Volume/Solutions Manual


                          TAX FILE MEMORANDUM

                          DATE:            October 10, 2006

                          FROM:            Larry C. Williams

                          SUBJECT:         Quail Corporation

                          Today I talked to the President of Quail Corporation with respect to his October 5 letter.
                          Quail Corporation is considering liquidating its wholly owned subsidiary Sparrow Corpora-
                          tion and wants to know the tax consequences upon a liquidation of Sparrow Corporation.

                          At issue: What are the tax consequences of a liquidation of a wholly owned subsidiary
                          when the subsidiary is insolvent?

                          Conclusion: Because Sparrow Corporation is insolvent, § 332 would not apply to the liqui-
                          dation. Quail Corporation would have an ordinary loss deduction for its worthless stock in
                          Sparrow Corporation under § 165(g)(3).

                          p. 6-24 and Chapter 4

                 64.      a.       Because Canary purchased 80% or more of Falcon’s stock within a 12-month pe-
                                   riod, it could make a § 338 election. Since the qualified stock purchase date was
                                   January 3, 2006, the § 338 election must be made by October 16, 2006. If made,
                                   the election is irrevocable.

                          b.       Canary Corporation should not elect § 338. If § 338 is elected, Falcon’s assets
                                   (regardless of whether Falcon Corporation is liquidated) would receive a stepped-
                                   down basis. Falcon Corporation would recognize a loss on the deemed sale of its
                                   assets; however, the loss probably could not be utilized since Falcon undoubtedly
                                   has had tax losses, rather than taxable income, in the past. Further, since Falcon
                                   would be treated as a new corporation as a result of the § 338 election, any loss car-
                                   ryovers (e.g., NOL) would disappear.

                          pp. 6-25 to 6-27




                 The answers to the Research Problems are incorporated into the 2007 Corporations Volume of
                 the Instructor’s Guide with Lecture Notes to Accompany WEST FEDERAL TAXATION: CORPO-
                 RATIONS, PARTNERSHIPS, ESTATES & TRUSTS.

				
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