CHAPTER 3—CORPORATE DISTRIBUTIONS: CASH,
PROPERTY, AND STOCK DIVIDENDS Key
1. T received a distribution with respect to his stock of $50,000. The corporation had neither accumulated nor
current earnings and profits. T is entitled to recover his basis before he reports any gain or income because of
the distribution.
2. A corporation’s balance in its earnings and profits account is equivalent in amount to the balance in its
retained earnings account.
3. During the year, F Corporation sold a parcel of land that it purchased several years ago for $10,000. F
received $20,000 in cash and an $80,000 note payable in eight annual installments beginning next year. With
respect to this sale, F must increase its E&P by $90,000 (i.e., an adjustment to taxable income of $72,000).
4. Unlike other nondeductible expenses, Federal income taxes may not be deducted in computing E&P.
5. R owns 100 percent of F Corporation. In computing earnings and profits, artificial deductions such as the
dividends-received deduction are not allowed. Capital losses, including a loss on the sale of property to R,
however, are considered true economic losses and reduce earnings and profits even though such losses are not
deductible in computing taxable income.
6. During the year, X Corporation distributed $25,000 on March 1 and $75,000 on October 1. As long as X
Corporation has accumulated earnings and profits of at least $100,000 at the beginning of the year, both
distributions will be treated as dividends.
7. J Corporation had current earnings and profits of $10,000 and accumulated earnings and profits at the
beginning of the year of $20,000. Assuming three equal distributions of $60,000 are made during the year, each
distribution will be treated the same.
8. It is possible for a corporation to pay a taxable dividend even though there is a deficit in accumulated
earnings and profits.
9. The General Utilities doctrine stands for the proposition that the corporation does not recognize gain on the
distribution of property.
10. The General Utilities doctrine is consistent with the theory of double taxation.
11. During the year, T Corporation distributed property to its sole shareholder. T must recognize any gain or
loss realized on the distribution.
12. During the year, DEF Corporation distributed land that it had used as a parking lot in its business (value
$40,000, basis $5,000). DEF will recognize gain on the distribution.
13. During the year, C Corporation distributed land worth $30,000 to its sole shareholder, S. The corporation
acquired the property five years ago for $50,000. C recognizes a loss of $20,000 on the distribution of the land.
14. D Corporation distributed to its sole shareholder a truck worth $5,000 (basis $3,000). The net effect of the
distribution on D’s E&P (ignoring taxes) is a reduction of $3,000.
15. F Corporation distributed to its sole shareholder land worth $50,000. The land had a basis of $40,000 and
was subject to a mortgage of $20,000. F must decrease its E&P by $30,000.
16. G Corporation distributed its own bonds to its shareholders as a dividend. The bonds had a face value of
$100,000. However, because the interest rate on the bonds at the date of issue was below the market rate of
interest, the bonds were worth $90,000. G must reduce its E&P by $90,000.
17. During the year, Y Corporation distributed property worth $10,000 (basis $6,000) to its sole shareholder, R.
If R assumes a liability to which the property is subject, both the amount of the distribution and the basis of the
property will be affected.
18. Distributing Corporation purchased land for $50,000 several years ago. The value of the land has since
declined because the adjacent land has been chosen as the site of a toxic waste dump. Good planning would
suggest that instead of selling the land and distributing the proceeds, the corporation should distribute the land
to its shareholders and allow them to sell it. (Ignore any possible assignment of income problems.)
19. Dividends must be formally declared by the corporation’s board of directors before they will be treated as a
dividend for tax purposes.
20. During the year, T borrowed $7,000 from his wholly owned corporation. The loan was interest-free. Under
the operable Code section, T will automatically be deemed to have received a dividend for the interest that he
was not charged.
21. Normally, a stock dividend is nontaxable as long as it does not change the proportionate interests of the
shareholders.
22. A distribution of preferred stock on common stock is taxable because the distribution ultimately changes the
interest of the common shareholder.
23. T was granted one right for each share of stock that she owned. She elected to allocate basis to the stock
rights. T was unwilling to exercise the rights to buy new stock because of the outlook for the company, and
consequently they lapsed. Despite her views on the company’s future, she continued to hold her original stock.
She is not allowed to deduct a loss equal to the basis assigned to the rights.
24. RST Corporation declared a dividend this year. The dividend was payable in RST stock worth $40 per
share, or the shareholders could elect to receive cash of $40. B received stock and C elected to receive cash. B’s
dividend is nontaxable, whereas C’s dividend is taxable.
25. The basic rules governing distributions contained in $ 301 cover the distributions of all property to a
shareholder, including all of those items below except
26. R received a distribution with respect to his stock during the past year. He should treat the amount received
27. Which of the following statements best describes accumulated earnings and profits?
28. Assuming current earnings and profits are computed by making certain modifications to current taxable
income, which of the following is false?
29. For which of the following items would an adjustment to taxable income not be required in computing
earnings and profits?
30. JKL Corporation had a balance of $25,000 in accumulated earnings and profits at the beginning of the
year.Its current earnings and profits for the year were $10,000. During the year, JKL made two
distributions:$30,000 on June 1 and $20,000 on October 1. The distribution on October 1 represents a dividend
of
31. HIJ Corporation had a balance of $100,000 in accumulated earnings and profits at the beginning of the
year.During the current year it had a deficit in current earnings and profits of $73,000, which was attributable to
poor performance throughout the year. The corporation made two distributions during the year: $60,000 on
February 1 and $40,000 on December 1. The distributions will be treated as follows:
32. XYZ Corporation reported taxable income of $91,500 for the current year. It has provided the following
information for use in computing earnings and profits:
Dividends received (from 45% corporation) $10,000
Interest from tax-exempt municipal bonds 2,000
Depreciation, using accelerated cost recovery percentages under
MACRS (straight line, using ADS would have been $12,000) 15,000
Long-term capital gain 8,000
The corporation’s current earnings and profits before considering taxes is
33. ABC Corporation’s beginning balance of accumulated earnings and profits is a deficit of $100,000 and had
current earnings and profits of $20,000. On March 1, the corporation distributed $45,000 to its sole shareholder,
R, who had a basis in his stock of $30,000. R will report
34. During the year, P&B Construction Corp. distributed a crane used in its business to S, who owns 100
percent of the stock. The crane was worth $10,000 and had a basis of $19,000. The corporation also distributed
land worth $70,000 (basis $40,000). Assuming P&B has substantial earnings and profits, the corporation will
report
35. During the year, T Corporation distributed land used in its business to its sole shareholder. The land was
worth $50,000 (basis, $10,000). Assuming the corporation has substantial earnings and profits, and ignoring the
effect of any taxes on the distribution, the net effect of the transaction on E&P will be
36. The net effect on E&P in all of the following cases is a net decrease equal to the adjusted basis of the
distributed property except for a distribution of
37. This year A&S Disposal Corp. distributed land that it had used as a garbage site to its sole shareholder,
J.The land was worth $30,000 (basis $10,000) and was subject to a $16,000 mortgage, which J assumed. The
corporation had $200,000 of earnings and profits. Ignoring any taxes that may or may not arise on the
distribution, the net effect of the distribution on earnings and profits of A&S will cause it to
38. This year, Corporation Z distributed land held for investment to its sole individual shareholder. The land
was worth $100,000 (basis $70,000) and was subject to a liability of $40,000. Assuming the corporation has
substantial earnings and profits, and ignoring the effect of any taxes on the distribution, the net effect of the
transaction on E&P will be a decrease of
39. S Corporation distributed land used in its business worth $30,000 (basis $5,000) to its sole shareholder,
G.Assuming S has substantial earnings and profits, G’s dividend and basis for the property will be
40. T Inc. distributed land used in its business worth $21,000 (basis $18,000) to its sole shareholder,Z
Corporation. The land was subject to a mortgage of $5,000. Assuming T has substantial earnings and profits,
Z’s dividend and basis for the property will be
41. L is the sole shareholder of the X Corporation. L has received advances from the corporation
totalling$20,000. X did not charge any interest on the advances when the going rate was 9 percent. Which of the
following statements is false!
42. Which of the following statements is true?
43. B owns 100 shares of T Corporation common stock, which he acquired on June 1, 2004 for $800. On
October 15 of this year he received a stock dividend of 25 shares of preferred worth $4 per share when the
common was worth $1 per share. What is B’s basis in his preferred stock and when does his holding period
begin?
44. During the year, R and his wife S both received a distribution of stock from XYZ Corporation. R will report
no dividend income
45. M Corporation makes a distribution of $15,000 to its sole shareholder, Mr. Higgins. At the close of the year
the corporation had $8,000 of accumulated and current earnings and profits. Mr. Higgins’ basis in his stock is
$5,000. He must report
46. R Corporation files its tax return on a cash basis and has a taxable income of $50,000. It received a Federal
income tax refund of $3,000. Interest income of $6,000 includes $2,000 that is tax-exempt. Payroll tax penalties
of $250 were assessed and paid. R Corporation’s current earnings and profits, as calculated using these items
only, would be
47. Q Corporation files its tax return on the accrual basis and has a taxable income of $80,000. It files its tax
return showing an income tax of $15,450. It sold securities yielding a net short-term capital loss of $30,000
during the tax year. Q Corporation’s current earnings and profits, as calculated using these items only, would
be
48. In year one W Corporation paid an annual premium of $6,000 on an insurance policy covering its
president.The cash surrender value of the policy increased by $2,500. The policy has a $650,000 face value and
lists W Corporation as the beneficiary. In year 10, when the cash surrender value of the policy has grown
to$50,000, the president dies, before the corporation is required to pay the annual premium. Which statement(s)
of the following is(are) true?
49. Which of the following statements is false?
50. At the end of the taxable year B Corporation has current E&P of $50,000 without reduction for any
distributions made during the year. The corporation also has accumulated E&P of $45,000. A distribution
of$40,000 is made on May 1 and another distribution of $60,000 is made on December 1. B Corporation files
on the accrual basis using a calendar year. The distributions are made to its sole shareholder. The amount of
current E&P allocated to the May 1 distribution of $40,000 is
51. At the end of the taxable year B Corporation has current E&P of $50,000 without reduction for any
distributions made during the year. The corporation also has accumulated E&P of $45,000. A distribution
of$40,000 is made on May 1 and another distribution of $60,000 is made on December 1. B Corporation files
on the accrual basis using a calendar year. The distributions are made to its sole shareholder. The amount of
accumulated E&P allocated to the December 1 distribution of $60,000 is
52. H Corporation distributed land with a fair market value of $100,000 (basis $20,000) to Y Corporation, a70
percent shareholder. As a result, the amounts of the distribution to Y Corporation and basis of land to Y
Corporation are
53. In 1986 the General Utilities doctrine was repealed, resulting in a complete revision of the treatment of the
distributing corporation. As a result, corporations must
54. To avoid recharacterization as a dividend, an advance to a shareholder must represent a bona fide loan.
Abona fide debtor-creditor relationship is generally suggested by
55. Constructive distributions arising from a payment for the shareholder’s benefit have been found where the
corporation paid for the following:
56. Shareholders who receive stock rights have the following alternatives with respect to their use:
57. In allocating current earnings and profits, the IRS has ruled that they are
58. B Corporation has a deficit in accumulated and current earnings and profits. Despite its history of recent
losses, B Corporation expects operations to become profitable next year. Assuming that the corporation plans to
make a distribution, timing is critical because
59. Categories of corporate payments that avoid dividend treatment may include the following: