Question

TAX 502 - LessonAssignment #6: Penalty Taxes onUndistributed Corporate Income, Dividendsand Other NonliquidatingDistributions

Reading

Text: StudyChapters 7 and 8 of the Bittker & Eustice text.

Assignments

The following Assignmentsshould be completed and submitted to the course faculty via thelearning platform for evaluation and grading. Submit your responsesto these questions in one WORD document. List the question first,and then your response.

Copy the question, andthen provide your answer on all of the following:

LESSON 6, PROBLEM#1

In not less than 1,000 words discuss"earnings and profits". Your discussion should include majordifferences between computing current earnings and profits andcurrent taxable income as well as why earnings and profits shouldbe calculated before a corporation decides to make a distributionto its shareholders.

LESSON 6, PROBLEM#2

Allan owns all of the stock of CadyCo.The stock’s basis is $100,000. CadyCo has a total of current andaccumulated earnings and profits of $50,000. CadyCo distributes$200,000 cash to Allan “with respect to his stock” (i.e., as astate law “dividend”). How is the $200,000 taxed? What is Allan’sstock basis after the distribution? Alternatively, CadyCodistributes to Allan his note to CadyCo for $200,000 borrowed fromCadyCo.

LESSON 6, PROBLEM#3

Assumptions: The stock ofChadCo is owned equally by two shareholders: SecondCo (acorporation) and Arnold (an individual). ChadCo and SecondCo usethe accrual method, Arnold uses the cash method. All use a calendartaxable year. Assume § 1059 does not apply. Use a 34 percentcorporate tax rate in this problem. During the current year, ChadCoaccrued income and expenses as follows:

Gross income from business	$500,000
Dividends on AT&T stock (consider§ 243)	100,000
Interest on municipal bonds (§103)	100,000
Capital gain	100,000
Total	$800,000
Deductible § 162(a)(l) businessexpenses	$430,000
Noncapital expenses not deductibleunder § 162(e)	90,000
Capital losses (see § 1211(a))	146,000
Total	$666,000
Net	$134,000

On December 24 of the preceding year, SecondCo and Arnoldincorporated ChadCo and capitalized ChadCo with cash of $100,000each. On December 31 of that preceding year, SecondCo and Arnoldreceived distributions from ChadCo of $5,000 each; ChadCo did notearn any income for that year. In addition, SecondCo and Arnoldreceived distributions of $5,000 each, in the current year.

Which distributions should begross income to SecondCo and Arnold, in what amounts, and why? Whatdoes E&P have to do with this?

Alternative: Arnold just bought the ChadCo shares on December 30of the current year from another shareholder for FMV of $145,000,before the declaration and payment of a

$5,000 distribution to Arnold onDecember 31 of the current year.

Should the distribution be taxableincome to Arnold? Why?

Now assume that SecondCo’s basis in its ChadCo stock is $100,000and Arnold’s basis in his ChadCo stock is $40,000. On January 2 ofthe current taxable year, ChadCo distributes $100,000 in cash toSecondCo and $100,000 in cash to Arnold. As of the end of thepreceding taxable year, ChadCo’s accumulated E&P was zero.

What are the tax consequences ofthis distribution to ChadCo, SecondCo, and Arnold? [Hint: Firstcompute ChadCo’s current-year taxable income and then computecurrent- year E&P before reducing the E&P for thedistribution (“interim E&P”); after reducing for thedistribution, compute final accumulated E&P.]

Variation: Assume Arnold’s shares were owned by a differentshareholder every quarter and $50,000 was distributed ratably toall shareholders quarterly?

How much dividend would SecondCoand the holders of Arnold’s shares receive?

Suppose under the basic facts in (3) above that ChadCo had anaccumulated deficit of

$100,000 in its E&P account as ofDecember 31 of the preceding taxable year.

If, on December 1 of the current year (the declaration date),ChadCo’s board of directors voted to pay the $200,000 distributionby mailing the checks on December 31 of the current taxable year(the payment date, the identification of which is a practicegenerally used only by widely held corporations) to shareholders ofrecord on December l5 of the current taxable year (the recorddate), such checks actually being received by SecondCo and Arnoldin the mail on January 2 of the next year? Assume that SecondCo andArnold are the public and that they are the only shareholders (asin the basic facts).

How would your answer to (3) abovechange?

Suppose that SecondCo is an individual and that ChadCo hasalways been an S corporation.

What is ChadCo’s E&P‘? How iseach shareholder’s personal income tax return affected for thecurrent year by the tax items of ChadCo? How willChadCo distribution of

$100,000 to each shareholder inthe current year affect shareholders?