ACC610 Week 2 Assignment Exercises

Chapter 5 – Problem 24

At the start of the current year, Blue Corporation (a calendar year taxpayer) has accumulated E & P of $100,000. Blue’s current E & P is $60,000, and at the end of the year, it distributes $200,000 ($100,000 each) to its equal shareholders, Pam and Jon. Pam’s stock basis is $11,000; Jon’s stock basis is $26,000. How is the distribution treated for tax purposes?

Each shareholder has dividend income of $ 80,000. In addition, Pam has in stock basis to $ 0 and a capital of $ 9,000. Jon has in stock basis to $ 6,000.

The many tax regimes that may apply to company distributions give rise to their significance. Distributions received by shareholders may be categorized as ordinary income, selectively taxed dividend payments, capital gain, or a non ­ taxable return of capital from the firm. Distributing profits to shareholders is often not tax deductible for the company.

Chapter 5 – Problem 27

Sparrow Corporation (a calendar year, accrual basis taxpayer) had the following transactions in 2015, its second year of operation.

Taxable income =$330,000, Federal income tax liability paid=112,000,Tax­exempt interest income=5,000,Meals and entertainment expenses (total)=3,000,Premiums paid on key employee life insurance=3,500,Increase in cash surrender value attributable to life insurance premiums=700,Proceeds from key employee life insurance policy=130,000,Cash surrender value of life insurance policy at distribution=20,000,Excess of capital losses over capital gains=13,000,MACRS deduction=26,000,Straight­line depreciation using ADS lives=16,000,Section 179 expense elected during 2014=25,000,Dividends received from domestic corporations (less than 20% owned) =25,000.

Sparrow uses the LIFO inventory method, and its LIFO recapture amount increased by $10,000 during 2015. In addition, Sparrow sold property on installment during 2014. The property was sold for $40,000 and had an adjusted basis at sale of $32,000. During 2015, Sparrow received a $15,000 payment on the installment sale. Finally, assume that no additional first­year depreciation was claimed. Compute Sparrow’s current E & P.

Taxable income $330,000

Federal income tax liability paid (69,300)

Tax­exempt interest income 5,000

Disallowed portion of meals and entertainment expenses (1,500)

Life insurance premiums paid, net of increase

In cash surrender value (3,500 ­ 700) (2,800) Proceeds from life insurance policy, net cash

Surrender value (130,000 ­ 20,000) 110,000

Excess capital losses (13,000)

Expenses (26,000 ­ 16,000) 10,000

Allowable portion of 2013 SS 179

Expenses (20% x 25,000) (5,000)

Dividends received deduction (70% x $35,000) 24,500

LIFO recapture adjustment 10,000

Installment sale gain (40,000­32,000)/40,000*15,000) (3,000) = $394,900 Answer:

$394,900.

Chapter 5 – Problem 50

Kristen, the president and sole shareholder of Egret Corporation, has earned a salary bonus of $30,000 for the current year. Because of the lower tax rates on qualifying dividends, Kristen is considering substituting a dividend for the bonus. Assume that the tax rates are 28% for Kristen and 34% for Egret Corporation.

a. How much better off would Kristen be if she were paid a dividend rather than salary?

Amount = Net Amount of Dividend ­ Net Bonus

Net Amount of Dividend = Dividend Amount ­ Tax on Dividend = $30,000 ­ (15% * $30,000)

= $30,000 ­ (0.15 * $30,000)

= $30,000 ­ $4,500

= $25,500

Net Bonus = Amount of Salary Bonus ­ Tax on Salary Bonus = $30,000 ­ (28% * $30,000)

= $30,000 ­ (0.28 * $30,000)

= $30,000 ­ $7,200

= $21,600

Amount = $25,500 ­ $21600

= $3400

Answer

a)

Therefore, Kristen would be better off by $3 400 more if she were paid a dividend.

b. How much better off would Egret Corporation be if it paid Kristen a salary rather than a dividend

Answer

Salaries are expense and are deducted while calculating the taxable income. Therefore, 34% of $30,000 would be saved as it would never be taxed. Dividends are distributed after the taxes have been paid. Thus, the cost of salary would become 66% of $30,000 or $ 19800 The company saves $10200 by giving her a bonus versus a dividend.

Hence, Egret will be $6,300 [$30,000 (cost of a dividend) ­ $19800 (cost of a bonus)] better off in case bonus is paid

c. If Egret Corporation pays Kristen a salary bonus of $40,000 instead of a $30,000 dividend, how would your answers to (a) and (b) change?

Answer

If Egret paid Kristen a $40,000 bonus, she would receive $26,600 after tax [$35,000bonus ­

($35,000 × 24% tax rate)]. This is better than receiving a $30,000 dividend, which provides $22,800 after 24% tax. A $35,000 bonus costs Egret Corporation $27,650 after­tax [$35,000 bonus ­ (21% tax rate × $35000)] and is clearly a less expensive option than a kind of nondeductible dividend which is $30,000.

d. What should Kristen do?Answer

By giving Kristen a $30,000 bonus, Egret Corporation may decrease its taxable income and, in consequence, its tax liabilities by taking advantage of a tax deduction. In contrast, dividend payments do not qualify for a tax break. Therefore, Egret Corporation will not benefit from any tax savings from paying the dividend.

Kristen should be given a bonus from the company since doing so would reduce their tax liability. Kristen would be eligible for a larger bonus payment if the company decided to award her a salary bonus of more than $40,000.

Both the company and Kristen would benefit more from a salary bonus than a dividend distribution due to the tax advantages the former offers.

Chapter 6 – Problem 38

Teal Corporation, with E & P of $2 million, distributes property with a basis of $150,000 and a fair market value of $400,000 to Grace. She owns 15% of the outstanding Teal shares.

a. What are the tax consequences to Teal Corporation and to Grace if the distribution is a

property dividend?

Teal Corporation would have a $250,000 taxable gain if the divided property was worth $400,000 and its basis was $150,000. The gain may be ordinary or capital depending on the transferred property. Teal’s E&P would climb by $250,000 (its gain) and decline by $400,000 (its loss) (the FMV of the property distributed). Gain tax would lower Teal’s earnings and profits. Grace’s dividend income and property base are both $400,000.

b. What are the tax consequences in (a) if Grace is a corporation?

Option a has the same tax repercussions for Teal Corporation. Grace Corporation’s $400,000 dividend income would be taxed at 30%, or $120,000. Grace Corporation’s less­than­20% stake in Teal Corporation qualifies for the 70% dividends deduction. Grace Corporation’s $400,000 property base

c. What are the tax consequences to Teal Corporation and to Grace if the distribution is a qualifying stock redemption? Assume that Grace’s basis in the redeemed shares is $90,000.

Teal’s E&P is lowered by the ratable portion of its E&P attributable to the redeemed shares

(percentage not reported – PLEASE REMEMBER IN CLASS ASSUMED 1/2 OF STOCK

REDEEMED). $2,250,000 x 15% x 1/2 = $168,750 E&P REDUCTION. Grace would have a $310,000 capital gain ($400,000 property value ­ $90,000 stock basis) and a $400,000 property basis.

d. What are the tax consequences in (c) if Grace is a corporation?

If Teal Corporation went with option c, it would face the same tax repercussions as before. With a valuation of $400,000 and a cost basis of $90,000 in shares, Grace Corporation would have a capital gain of $310,000. in addition to $400,000 in basis in the acquired property.

e. If the parties involved could choose from among the preceding options, which would they choose? Why?

Grace would pick eligible stock redemption if she’s an individual (option c.). If it’s a qualified stock redemption, she’ll make $310,000. Option a. would provide her $400,000 in dividend income. Her basis in the property obtained is the same for dividends and stock redemptions. Grace like dividends since just 30% of dividends are taxed (option b.). Teal Corporation has no choice since each alternative has the same tax repercussions.

Chapter 6 – Problem 43

Silver Corporation has 2,000 shares of common stock outstanding. Howard owns 600 shares, Howard’s grandfather owns 300 shares, Howard’s mother owns 300 shares, and Howard’s son owns 100 shares. In addition, Maroon Corporation owns 500 shares. Howard owns 70% of the stock in Maroon Corporation.

a. Applying the § 318 stock attribution rules, how many shares does Howard own in Silver Corporation?

Given,

Howard’s own shares = 600 shares

Howard’s mother owns = 300 shares

Howard’s son owns = 100 shares

Maroon Corporation owns = 500 shares

Howard owns 70% of the stock in Maroon Corporation.

Number of shares Howard own in Silver Corporation = 600 + 300 + 100 + (500 *70%)

Number of shares Howard own in Silver Corporation = 1,000 + 350

Number of shares Howard own in Silver Corporation = 1,350 shares

b. Assume that Howard owns only 40% of the stock in Maroon Corporation. How many shares does Howard own, directly and indirectly, in Silver Corporation?

If Howard owned 40% of the stock of Maroon Corporation, then she would constructively own _____ shares in Silver Corporation?

Howard constructively owns = 600 + 300 + 100 Howard constructively owns = 1000 Share

c. Assume the same facts as in (a) above, but in addition, Howard owns a 25% interest in Yellow Partnership. Yellow owns 200 shares in Silver Corporation. How many shares does Howard own, directly and indirectly, in Silver Corporation?

Howard owns, directly and indirectly, in Silver Corporation = 600 + 300 + 100 + 500*70% + 200*25%

Howard owns, directly and indirectly, in Silver Corporation = 1400 shares.