1. Welcome Back
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2. Welcome Back
Time for Any Question
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3. CHAPTER # 18
REVIEW
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4. Chapter 18
Corporate Taxation:
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5. Corporate Taxation: Non-Liquidating Distributions
Chapter 18
Corporate Taxation: Non-Liquidating Distributions
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6. Framework for Property Distributions
Distributions to shareholders will be taxed in one of the following ways:
Taxed as income (albeit at a lower tax rate)
Return of capital
Capital gains
When distributions from corporations are taxed to shareholders, this creates double taxation of corporate income
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7. Framework for Property Distributions
Some payments to shareholders are deductible by the corporation
Examples are payments for services (salary), interest, and rent
To be deductible, payments to shareholders must be reasonable in amount
Unreasonable payments (e.g., excessive salary) are taxed as “constructive” dividends to shareholders
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8. Constructive Dividends
Examples of constructive dividends
Unreasonable compensation
Shareholder use of corporate assets without an arm’s-length payment
Interest paid to shareholder at excessive interest rates
Payments made by the corporation on behalf of a shareholder
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9. Computing Earnings and Profits
Overview of distributions:
Dividend distributions are included in the shareholder’s gross income
Non-dividend distributions are a return of capital (reduce the shareholder’s tax basis in the corporation’s stock)
Non-dividend distributions in excess of the shareholder’s stock tax basis constitute a gain from sale or exchange of the stock
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10. Determining the Dividend
A “dividend” for tax purposes is:
any distribution of property made by a corporation to its shareholders out of its earnings and profits (E&P)
Two separate E&P accounts to be maintained
Current earnings and profits (CE&P)
Accumulated earnings and profits (AE&P)
Undistributed current E&P is added to the balance of accumulated E&P on the first day of the next tax year
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11. Determining the Dividend
Computing Earnings and Profits begins with taxable income
Taxable income is adjusted as follows:
Income that is excluded from taxable income
Disallowed deductions that do not require an economic outflow
Deduction of expenses that require an economic outflow but are not deducted for computing taxable income
Adjustment of timing for deductions or income because of accounting methods required for E&P computation
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14. Determining the Dividend
Ordering of E&P Distributions
Positive Current E&P and Positive Accumulated E&P
Positive current E&P, negative accumulated E&P
Negative current E&P, positive accumulated E&P
Negative current E&P, negative accumulated E&P
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15. Determining the Dividend
Example 1
Current E&P = $1,000,000
Accumulated E&P = ($500,000)
The corporation distributes $1,000,000 on July 1.
The entire distribution is deemed to come from current E&P and is a dividend to the shareholders.
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16. Determining the Dividend
Example 2
Current E&P = ($1,000,000)
Accumulated E&P = $1,000,000
The corporation distributes $1,000,000 on July 1.
Current E&P is apportioned on a per day basis
AE&P as of July 1 = $1M − ½($1M) = $500,000
$500,000 is a treated as a dividend.
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17. Determining the Dividend
Distributions of Noncash Property to Shareholders
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18. Determining the Dividend
Tax Consequences to a Corporation Paying Noncash Property as a Dividend
The corporation recognizes gains (but not losses) on the distribution of noncash property as a dividend
Gain is recognized to the extent of fair market value in excess of tax basis in the property
Liabilities
If the property’s fair market value is less than liabilities assumed by the shareholder, the fair market value is deemed to be the liability
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19. Determining the Dividend
Example 3
Cher Holder receives a property distribution from Sunny Corporation with a fair value of $200. Cher assumes a $100 mortgage attached to the property. Sunny’s basis in the property distributed is $100.
Sunny Corporation reports a gain of $100 on the distribution ($200 − $100).
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20. Determining the Dividend
Example 4
Cher Holder receives a property distribution from Sunny Corporation with a fair value of $200. Cher assumes a $300 mortgage attached to the property. Sunny’s basis in the property distributed is $100.
Sunny Corporation reports a gain of $200 on the distribution ($300 − $100).
The property’s FMV is deemed to be the amount of the liability assumed because it exceeds the property’s fair market value.
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21. Determining the Dividend
Noncash Property Distributions affect E&P
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22. Stock Dividends
A stock dividend increases the number of shares outstanding
Stock dividends can also take the form of a stock split (e.g., 2-for-1 stock split)
Stock dividends are nontaxable to shareholders if two conditions are met:
Made with respect to common stock and
Pro rata (proportionate interests maintained)
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23. Stock Dividends
Non-pro rata stock dividends usually are taxable as dividends
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24. Stock Redemptions Form of a Stock Redemption
A redemption occurs when a corporation acquires its stock from a shareholder in exchange for property
A redemption results in either a dividend or a sale of the redeemed shares
Individuals prefer exchange treatment because of the preferential tax rates for capital gains
Corporate shareholders prefer dividend treatment because of the dividends received deduction
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25. Stock Redemptions Three types of redemptions are treated as exchanges:
Redemptions that are Substantially Disproportionate are treated as sales
Redemptions in Complete Redemption of all of the Stock of the Corporation Owned by the Shareholder
Redemptions that are not Essentially Equivalent to a Dividend
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26. Stock Redemptions
If the redemption is treated as an exchange the shareholder tax consequences are:
Gain is always recognized
Loss is recognized unless the shareholder is a related person to the corporation
The redeemed shareholder may be related if they owns more than 50% of the stock’s value
Note that ownership is determined using the §267(c) attribution rules
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27. Stock Redemptions Tax Consequences to the Distributing Corporation
Current E&P is reduced by dividend distributions (cash and fair market value of other property adjusted for gain recognized and liabilities distributed)
For an exchange, current and accumulated E&P is reduced by the percentage of stock redeemed (limited to the fair market value of the property distributed)
Current E&P is reduced by dividends before reducing its current E&P for redemptions treated as exchanges
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28. Stock Redemptions
Example 5 Acme Inc. has AE&P at 1/1/16 of $100,000 and CE&P for 2016 is $75,000. Acme redeems all of Bill’s stock on July 1 for $60,000. The stock redeemed represents 25% of Acme stock. On December 31, Acme pays its remaining shareholders dividends of $25,000. Bill treats the redemption as an exchange. What is the effect on Acme’s AE&P and CE&P?
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29. Stock Redemptions
Example 5 What is the effect on Acme’s AE&P and CE&P? 1. CE&P after the dividends is $50,000 ($75,000 − $25,000) 2. AE&P at 7/01/14 is $100,000 + ½($50,000) = $125, Acme reduces AE&P to the lesser of: 25% × $125,000 = $31,250 or $60,000 (fair value of the distribution)
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30. Partial Liquidations Corporations can contract either by:
Distributing stock of a subsidiary to shareholders
Selling a business and distributing the proceeds to shareholders in partial liquidation
Distributions may require the shareholders to exchange some shares of stock or may be pro rata to all the shareholders without an actual exchange of stock
Noncorporate shareholders receive exchange treatment
Corporate shareholders determine their tax consequences using the change-in-stock ownership rules that apply to stock redemptions
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31. Chapter 19
Corporate Formation,
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32. Corporate Formation, Reorganization, and
Chapter 19
Corporate Formation, Reorganization, and
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33. Corporate Formation, Reorganization, and Liquidation
Chapter 19
Corporate Formation, Reorganization, and Liquidation
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34. Break for Minutes
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35. Learning Objectives Review the taxation of property dispositions.
Compute the tax consequences to the parties to a tax-deferred corporate formation.
Identify the different forms of taxable and tax-deferred acquisitions.
Determine the tax consequences to the parties to a corporate acquisition.
Calculate the tax consequences that apply to the parties to a complete liquidation of a corporation.

36. Tax-Deferred Transfers of Property to a Corporation
Section 351 Tax Deferral Requirements
Transfer of property to the corporation (not services alone)
In exchange for stock of the corporation
Receipt of boot triggers gain, but not loss
Boot is nonqualifying property received by the shareholder
Transferor(s) of property must be in control of the corporation immediately after the transfer
Control is defined as ownership of 80 percent or more of the corporation’s voting stock and each class of nonvoting stock

37. Tax-Deferred Transfers of Property to a Corporation
Receipt of boot triggers gain up to the FMV of the boot
Boot is allocated based on the FMV of the properties transferred
The character of gain recognized depends on the nature of the asset transferred on which gain is recognized

38. Tax-Deferred Transfers of Property to a Corporation

39. Tax-Deferred Transfers of Property to a Corporation
Assumption of a liability is generally not treated as boot
Basis is computed as follows:

40. Tax-Deferred Transfers of Property to a Corporation
Contributions to Capital
Transfer of property but no stock or other property is received in return
Corporation takes a carryover tax basis in property contributed by a shareholder,
Corporation takes a zero tax basis in property contributed by a nonshareholder,
Shareholder making a capital contribution increases the tax basis in existing stock by the tax basis of the property contributed

41. Tax-Deferred Transfers of Property to a Corporation
Section 1244 Stock
Small corporation (<$1 million capitalization) and
Original shareholder
Corporation must meet an active trade or business requirement for 5 years before the stock meets the §1244 requirements
Shareholder can recognize up to $50,000 per year of ordinary loss ($100,000 if married joint) on sale of the stock (excess is capital loss)

42. Taxable and Tax-deferred Corporate Acquisitions
When negotiating an acquisition, management of the acquiring corporation must decide whether to acquire assets or stock and what to use as consideration
Motivations for an acquisition:
Desire to diversify
Acquire a source of raw materials (vertical integration)
Expand into new product or geographic markets
Acquire specific assets or technologies
Providing improved distribution channels

43. Taxable and Tax-deferred Corporate Acquisitions
Buyer can purchase either stock or assets in a transaction that is either taxable or tax-deferred to the seller
Allows the acquiring corporation to step-up the tax basis of the assets acquired to fair value
Stock acquisitions and tax-deferred asset acquisitions
Tax basis of the target corporation’s assets remain at their carryover basis (generally, cost less any depreciation)

44. Computing the Tax Consequences to the Parties from a Corporate Acquisition
1) Taxable Acquisitions
Cash purchases of stock are common for public firms
Cash has nontax advantages
A stock acquisition for cash results in the acquired company retaining its tax and legal identity albeit as a subsidiary of the acquiring company
The acquiring company can liquidate acquired company into itself or merge it into an existing subsidiary to remove the subsidiary

45. Computing the Tax Consequences to the Parties from a Corporate Acquisition
2) Tax-Deferred Acquisitions
Taxpayers to organize a corporation in a tax-deferred manner under §351
Taxpayers to reorganize their corporate structure in a tax deferred manner
For tax purposes, reorganizations include:
Acquisitions and dispositions of corporate assets (including subsidiaries stock)
Corporation’s restructuring of its capital structure

46. Judicial Principles
Continuity of Interest (COI) - Shareholders of the acquired corporation retain a continuing ownership interest in the target
Continuity of Business Enterprise (COBE)
The acquiring corporation must continue the target corporation’s historic business or continue to use a significant portion of the target corporation’s historic business assets
Business Purpose Test
Acquiring corporation must be able to show a significant nontax avoidance purpose for engaging in the transaction for meeting business purpose test

47. Computing the Tax Consequences to the Parties from a Corporate Acquisition
Type A Asset Acquisitions
One corporation acquires the assets and liabilities of another corporation in return for stock or a combination of stock and cash
Acquisition is tax-deferred if the transaction satisfies the continuity of interest, continuity of business, and business purpose requirements
Must meet state law requirements to be a merger or consolidation

48. Computing the Tax Consequences to the Parties from a Corporate Acquisition
Forward Triangular Type A Merger
Acquiring corporation uses stock of its parent corporation to acquire the target corporation’s stock, after which the target corporation merges into the acquiring corporation
For tax-deferred purpose, the transaction must meet the requirements to be a Type A merger
Acquiring corporation must use solely the stock of its parent corporation and acquire “substantially all” of the target corporation’s property in the transaction
Target corporation merges into an 80 percent or more owned acquisition subsidiary of the acquiring corporation
Acquisition subsidiary must acquire “substantially all” of the target corporation’s properties in the exchange

49. Computing the Tax Consequences to the Parties from a Corporate Acquisition
Tax deferred forward triangular asset (“A”) acquisition T
Shareholders
Acquiring
A stock & cash
A stock + $
T stock
Acquisition
Subsidiary
Target
Assets & Liabilities

50. Computing the Tax Consequences to the Parties from a Corporate Acquisition
Reverse Triangular Type A Merger
Acquiring corporation uses stock of its parent corporation to acquire the target corporation’s stock, after which the acquiring corporation merges into the target corporation
For tax-deferred purpose, the transaction must satisfy three requirements
Surviving corporation must hold “substantially all” of the properties of both the surviving and the merged corporations
Target shareholders must transfer in exchange an amount of stock in the target that constitutes control of the target (80 percent or more of the target’s stock)
Target shareholders must receive parent corporation voting stock in return

51. Computing the Tax Consequences to the Parties from a Corporate Acquisition
Tax deferred reverse triangular asset (“A”) acquisition T
Shareholders
Acquiring
A stock & cash
A stock + $
T stock
Acquisition
Subsidiary
Target
Assets & Liabilities

52. Computing the Tax Consequences to the Parties from a Corporate Acquisition
Type B Stock-for-Stock Reorganizations
Acquiring corporation must exchange solely voting stock for stock of the target corporation
Acquiring corporation must control the target corporation after the transaction
Acquiring corporation takes a carryover tax basis in the target corporation stock received in the exchange
For tax-deferred purpose, the target shareholders must receive solely voting stock of the acquiring corporation

53. Computing the Tax Consequences to the Parties from a Corporate Acquisition
Tax deferred stock acquisition (“B” reorganization)
“solely” A
voting stock S A A
T stock
“controls” T T

54. Computing the Tax Consequences to the Parties from a Corporate Acquisition
Type C
Acquiring corporation uses its voting stock to acquire “substantially all” of the target corporation’s assets
End result of a Type C reorganization resembles a Type A reorganization
Major difference between Type C and Type A is that state law governs the form of the Type A merger, while the IRC governs the form of the Type C reorganization
Type D
Corporation transfers all or part of its assets to another corporation, and immediately after the transfer the shareholders of the transferor corporation own at least 50 percent of the voting power or value of the transferee corporation and own at least 80 percent of the transferee corporation

55. Computing the Tax Consequences to the Parties from a Corporate Acquisition
Cash mergers generally are carried out through an acquisition (merger) subsidiary
An acquisition subsidiary isolates the liabilities of T in a separate corporation apart from the parent company
The transfer of cash to the Target shareholders is taxable to the shareholders

56. Computing the Tax Consequences to the Parties from a Corporate Acquisition
Structure of the transaction
Acquiring
Corporation T
Shareholders 2
cash 1
cash
AS stock
T stock
Acquisition
Subsidiary
Target
Corporation
Reverse merger 3

57. Computing the Tax Consequences to the Parties from a Corporate Acquisition
End result
Acquiring
Corporation
Isolates liabilities
Target
Corporation

58. Computing the Tax Consequences to the Parties from a Corporate Acquisition
Tax fiction – purchase of shares for cash
Taxable event to T shareholders
Acquiring
Corporation T
Shareholders 2
T stock
Cash 1
Acquisition
Subsidiary
Assets + Liabilities
Target
Corporation

59. Complete Liquidation of a Corporation
Occurs when a corporation acquires all of its stock from all of its shareholders in exchange for “all” of its net assets, after which time the corporation ceases to do business
For tax purposes, Form 966 needs to be filed by corporation in order to inform IRS of its intention to liquidate its tax existence
Form should be filed within 30 days after the owners resolve to liquidate the corporation

60. Complete Liquidation of a Corporation
Tax Consequences to the Shareholders in a Complete Liquidation
Depends on
Shareholder’s identity
Ownership percentage in the corporation
All noncorporate shareholders receiving liquidating distributions have a fully taxable transaction
Shareholders treat the property received as in “full payment in exchange for the stock” transferred

61. Complete Liquidation of a Corporation
A noncorporate shareholder computes capital gain or loss by subtracting the stock’s tax basis from the money and FMV of property received in return
Shareholder’s tax basis in the property received equals the property’s fair market value
Debt assumed by the shareholder reduces the (net) FMV of property received
FMV of the property cannot be less than the debt assumed by the shareholder (IRC § 336(b))

62. Complete Liquidation of a Corporation
Corporate shareholders owning 80 percent or more of the stock of the liquidating corporation do not recognize gain or loss on the receipt of liquidating distributions
The tax basis in the property transferred carries over to the recipient which allows a group of corporations under common control to reorganize their organizational structure without tax consequences

63. Complete Liquidation of a Corporation
Taxable Liquidating Distributions
Liquidating corporation recognizes all gains and certain losses on taxable distributions of property to shareholders
Liquidating corporation does not recognize loss if the property is
Distributed to a related party
Distribution is non-pro rata
Asset distributed is disqualified property

64. Complete Liquidation of a Corporation
Disqualified property is property acquired within five years of the date of distribution in a tax deferred §351 transaction or as a nontaxable contribution to capital
Loss on the complete liquidation of such property is not recognized if the property distributed was acquired in a §351 transaction or as a contribution to capital, and a principal purpose of the contribution was to recognize a loss by the liquidating corporation

65. Complete Liquidation of a Corporation
This rule prevents a built-in loss existing at the time of the distribution from being recognized by treating the basis of the property distributed as being its FMV at the time it was contributed to the corporation
This provision is designed as an anti-stuffing provision to prevent shareholders from contributing property with built-in losses to a corporation shortly before a liquidation to offset gain property distributed in the liquidation

66. Complete Liquidation of a Corporation
Nontaxable Liquidating Distributions
The liquidating corporation does not recognize gain or loss on tax-free distributions of property to an 80 percent corporate shareholder
Liquidation-related expenses, including the cost of preparing and effectuating a plan of complete liquidation, are deductible by the liquidating corporation on its final Form 1120
Deferred or capitalized expenditures such as organizational expenditures also are deductible on the final tax return

67. Happiness is having all homework up to date
Homework assignment
Using Connect – 6 Questions for 60 Points for Chapter 19.
Tax Return; Course Project: Corporation Tax Return Problem # 2 “Blue Catering Service Inc.'s (BCS) 2016 Form 1120” on Pages C-16 till C-18.
Complete the “Connect Orientation” at Connect web site for 5 points, before 03/26/2017.
Quiz # 1 is Available from today till 2/27/2017 at 11:59 PM.
Prepare chapter 20 “Forming and Operating Partnerships
Happiness is having all homework up to date
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68. Thank you and See You Next Week at the Same Time, Take Care
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