28 Feb At the beginning of Year 1, ABC, Inc. (ABC) has one class of stock (i.e., common stock), and there are only 100 shares of that co
At the beginning of Year 1, ABC, Inc. (ABC) has one class of stock (i.e., common stock), and there are only 100 shares of that common stock outstanding. Jen owns 40% of the ABC common stock and has a basis of $400 in that stock. The other 60% of the ABC stock is held equally by Jen’s friend Marina (who has a basis of $200 in her stock), Marina’s daughter Elena (who has a basis of $200 in her stock), and Jen’s mother Jacky (who has a basis of $200 in her stock). In Year 1, ABC has $50,000 of earnings and profits from its operations (that are not attributable to any specific period during that year) and no accumulated earnings and profits. On June 1 of Year 1, ABC distributes $20,000 to its shareholders. On November 12 of Year 1, ABC distributes a parcel of land with a fair market value of $10,000 and a basis of $5,000 to its shareholders. In Year 2, ABC has a current deficit in earnings and profits of $40,000 (that is not attributable to any specific period during that year). On April 1 of Year 2, ABC distributes $20,000 to its shareholders. In Years 3 and 4, ABC has ample earnings and profits. At the beginning of Year 1, DEF, Inc. (DEF) has one class of stock (i.e., common stock), and there are only 200 shares of that common stock outstanding. Jen owns 40% of the DEF common stock and has a basis of $400 in that stock. The other 60% of the DEF stock is held equally by Jen’s friend Marina (who has a basis of $200 in her stock), Marina’s daughter Elena (who has a basis of $200 in her stock), and Jen’s mother Jacky (who has a basis of $200 in her stock). DEF is profitable and has ample earnings and profits. In Year 4, Jen, Marina, and Jacky each transfer 10 shares of ABC common stock (with a fair market value of $10,000) to DEF in exchange for one additional share of DEF stock (with a fair market value of $1,000) plus $9,000 in cash. In Year 5, ABC adopted a periodic redemption plan under which each shareholder of ABC is eligible to have no more than 2 shares of ABC stock redeemed each year. No more than a total of 4 shares can be redeemed in any one year under the plan. In Year 5, no shareholder made an election to have shares redeemed. In Year 6, however, DEF elected to have 2 of its shares of ABC stock redeemed; no other shareholder elected to have stock redeemed that year. Based on subsequent participation in the plan, this redemption by DEF in Year 6 was not an isolated redemption. Discuss the U.S. federal income tax consequences of this series of events to all parties involved. In your answer, please be sure to discuss all relevant tax consequences (with and without available elections)—including, but not limited to, the amount, timing, and character of any income; basis; holding period; and tax attributes (e.g., earnings and profits and net operating losses).
CORPORATE TAX EXAM SAMPLE
At the beginning of Year 1, ABC, Inc. (ABC) has one class of stock (i.e., common stock), and there are only 100 shares of that common stock outstanding. Jen owns 40% of the ABC common stock and has a basis of $400 in that stock. The other 60% of the ABC stock is held equally by Jen’s friend Marina (who has a basis of $200 in her stock), Marina’s daughter Elena (who has a basis of $200 in her stock), and Jen’s mother Jacky (who has a basis of $200 in her stock). In Year 1, ABC has $50,000 of earnings and profits from its operations (that are not attributable to any specific period during that year) and no accumulated earnings and profits. On June 1 of Year 1, ABC distributes $20,000 to its shareholders. On November 12 of Year 1, ABC distributes a parcel of land with a fair market value of $10,000 and a basis of $5,000 to its shareholders. In Year 2, ABC has a current deficit in earnings and profits of $40,000 (that is not attributable to any specific period during that year). On April 1 of Year 2, ABC distributes $20,000 to its shareholders. In Years 3 and 4, ABC has ample earnings and profits.
At the beginning of Year 1, DEF, Inc. (DEF) has one class of stock (i.e., common stock), and there are only 200 shares of that common stock outstanding. Jen owns 40% of the DEF common stock and has a basis of $400 in that stock. The other 60% of the DEF stock is held equally by Jen’s friend Marina (who has a basis of $200 in her stock), Marina’s daughter Elena (who has a basis of $200 in her stock), and Jen’s mother Jacky (who has a basis of $200 in her stock). DEF is profitable and has ample earnings and profits. In Year 4, Jen, Marina, and Jacky each transfer 10 shares of ABC common stock (with a fair market value of $10,000) to DEF in exchange for one additional share of DEF stock (with a fair market value of $1,000) plus $9,000 in cash.
In Year 5, ABC adopted a periodic redemption plan under which each shareholder of ABC is eligible to have no more than 2 shares of ABC stock redeemed each year. No more than a total of 4 shares can be redeemed in any one year under the plan. In Year 5, no shareholder made an election to have shares redeemed. In Year 6, however, DEF elected to have 2 of its shares of ABC stock redeemed; no other shareholder elected to have stock redeemed that year. Based on subsequent participation in the plan, this redemption by DEF in Year 6 was not an isolated redemption.
Discuss the U.S. federal income tax consequences of this series of events to all parties involved. In your answer, please be sure to discuss all relevant tax consequences (with and
without available elections)—including, but not limited to, the amount, timing, and character of
any income; basis; holding period; and tax attributes (e.g., earnings and profits and net operating losses).
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