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An S Corporation has four shareholders. The corporation has land with a fair market value of $100,000 and a basis of $20,000. The corporation has accumulated E&P of $ 16,000.The corporation distributes the land in-kind to the four shareholders. Each shareholder’s basis in the corporation is $1,000. Assume the corporation has always been an S Corporation, Assume also that the AAA balance prior to the property distribution is zero. a. Each shareholder has a gain of $20,000. b. Each shareholder has a dividend of $4,000. c. Each shareholder has a gain of $20,000 and a dividend of $4,000. d. Each shareholder has no gain or loss until the property is sold. e. None of the above.

Please explain why you choose this answer. Thank you.

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Keith Leannon
Keith LeannonLv2
29 Sep 2019

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This problem is from Federal income taxation of Corporations and Shareholder 7th edition (James S. Eustice) 5A (9)

The stock of X is owned equally by two shareholders: Y (an individual with a stock basis of $100) and A (an individual with stock basis of $40). X uses the accrual method, A and Y use the cash method, and all use the calendar year. (Assume 1059 does not apply). Use a 34% corporate tax rate in this problem. X has always been an S corporation. During the current year, X accrued income and expenses as follows:

Gross income from Busines $500

Dividends on AT&T stock (consider &243) $100

Interest on municipal bonds (&103) 100

Capital gain 100

Total $800

Deductible &162(a)(1) business expense 430

Noncaptial expenses not deductible under &162(e) 90

Capital losses (see &1211 (a) 146

Total 66

Net $134

Suppose that Y is an individual and that X has always been an S Corporation.

a) What is X's E&P?

For the answer can you please explain how do you get the result.

Lucy has operated a successful Italian import supply business as a sole proprietor for five years. She now plans to dramatically expand her business. To this end, she has lined up some new capital and developed the following plan: 1. She will form a C Corporation that will have four shareholders: Lucy, Jim, Sue and Dave. 2. Lucy will contribute to the corporation accounts receivable that have a value of $100,000 and a basis of zero. She will be issued 100 shares of common stock in return. 3. Jim will contribute $100,000 cash in return for 100 shares. 4. Sue, a recognized expert in Italian goods, will sign a five-year agreement to manage the business. As a signing bonus, she will be issued 100 shares of stock. 5. Dave will contribute a warehouse to corporation I return for 100 shares of stock. The warehouse has a value of $500000 a mortgage balance of $ 400000 and a tax basis of $ 250000. The company will assume the mortgage. 6. Each of the four shareholders also will loan the company $ 450000. The loan, plus the interest at prime, will be paid off in monthly installments over a ten-year period. No payments will be due the first twelve months, then interest-only payments will be due for three years, and then the principal plus interest will be amortized over a six-year period. The projection shows that the company should have no problem with this payment schedule if things go as planned. Advise Lucy on the tax impacts of her plan. What changes would you suggest? Why? How would you advice change if Lucy plans to use an S corporation, not a C corporation?

Your client is a C corporation. Your client has identified two potential acquisition targets that it intends to buy: 


Target 1 – an LLC taxed as a partnership. Assume that all of the value of the LLC is in the form of goodwill for which the LLC has an aggregate “inside” basis of $0. Further assume that the members have an aggregate “outside” basis of $0 in their membership interests. The purchase price for the company is $80M. 


Target 2 – a C corporation. Assume that all of the value of the corporation is in the form of goodwill for which the corporation has an aggregate basis of $0. Further assume that

the corporation has $0 of current or accumulated E&P and that the stockholders have an aggregate basis of $0 in their stock. The purchase price for the company is $65M.

Questions to address in your presentation to the Board of Directors:

Please describe the potential tax consequences to the buyer (e.g., basis step up, consequences on a future sale by the buyer) of the purchase of Target 1’s (a) assets and (b) LLC interests in a transaction where the only consideration paid by the buyer is cash.

Please describe the potential tax consequences to the buyer (e.g., basis step up, consequences on a future sale by the buyer) of the purchase of Target 2’s (a) assets and (b) stock in a transaction where the only consideration paid by the buyer is cash. 


Please describe the potential tax consequences to Target 1 and its members of the sale of Target 1’s (a) assets and (b) membership interests in a transaction where the only consideration paid by buyer is cash. 


Please describe the potential tax consequences to Target 2 and its shareholders of the sale of Target 2’s (a) assets and (b) stock in a transaction where the only consideration paid by buyer is cash. 


Assume that in any asset sale the buyer will be able to amortize any acquired goodwill over 15 years. Assume that the buyer’s applicable tax rate is 42% (federal and state) and that interest rates are 0%. How should the buyer’s Board of Directors think about a step- up in the basis of the assets? How much more would the buyer pay to achieve a basis step up? 


Compare the after-tax consequences (if any difference) to the selling members of Target 1 under the following structures:

Sale of Target 1’s assets for cash followed by the liquidation of Target 1. 


Sale of Target 1’s membership interests for cash. 


Compare the after-tax consequences (if any difference) to the selling stockholders under the following structures:

Sale of Target 2’s assets for cash followed by the liquidation of Target 2. 


Sale of Target 2’s share for cash. 


Assume that the consideration for each transaction will be paid as follows:

70% stock of buyer (a C corporation). 


30% cash. 


Describe (in general terms) how a deal to acquire each of Target 1 and Target 2 might be structured in order to allow the selling members of Target 1 and stockholders of Target 2 to defer recognizing the gain on the receipt of the stock of buyer.

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