TAX MEMO C

Tax Memo CInstructions: The memo should not exceed two pages and students should use the tax memo
template provided. However, the answer should be a full 2 pages (double spaced, times new
roman 12pt., 1-inch margins) Do not repeat the question in the answer. Each memo must include
an explanation of the relevant code sections, regs and/or other relevant controlling authority such
as case law. Don’t just cite the rules or cases, explain them and their application to the specific
facts in the questions. Any memo with a similarity score exceeding 25% on Turnitin will be
rejected subject to the professor’s review and sole discretion.
Questions:
1. Part 1: On January 1, 2020, Mark Z., an individual owned all of the stock of Mita
Corporation with an adjusted basis of $2,000. During 2020 Mark Z. received distributions
from Mita Corporation totaling $30,000, consisting of $10,000 in cash and listed
securities having a basis in in Mita Corporation and a fair market value on the date
distributed of $20,000. Mita Corporation’s taxable year is the calendar year. As of
December 31, 2020, Mita Corporation had earnings and profits accumulated after
February 28, 1913, in the amount of $26,000, and it had no earnings and profits and no
deficit for 2020. What result to the shareholder under Section 301?
2. Part 2: The facts are the same as in Example 1 with the exceptions that the shareholder of
Mita Corporation is Banana Corporation and that the securities which were distributed
had an adjusted basis to Mita Corporation M of $15,000. The distribution received by
Banana Corporation totals $25,000 consisting of $10,000 in cash and securities with an
adjusted basis of $15,000. What result to the shareholder under Section 301?
3. An individual, H, his wife, W, his son, S, and his grandson (S’s son), G, own the 100
outstanding shares of stock of a corporation, each owning 25 shares. Apply the stock
attribution rules and determine each individual’s interest in the corporation.
Tax Research Memo
Sample Format
Your Firm
Your Town and State
Date
Relevant Facts
This section should summarize the important facts of the research case. Only
include the relevant facts in a clear and concise manner.
Specific Issues
Identify the issue(s) and state the issue(s) in the form of a question.
Conclusions
Think of your conclusion as the “short” answer to your issue. The conclusion
section is the place to provide tax advice, recommend action(s) for the client to take,
or identify the need for additional information. There may not be a single “best”
alternative to the client’s issue so be sure to consider all applicable alternatives.
Support your conclusion by referencing back to the authority you discussed in the
discussion and analysis section.
Support
This section discusses the issue(s). Begin with the relevant code section(s).
Identify the code section, paraphrase what it says and then discus why it’s
important. Discussion of the relevant Treasury Regulations should follow. Identify the
regulation, paraphrase the important sections, and then address the importance of
the regulation given the facts.
The discussion
should continue by
reviewing relevant Treasury
pronouncements (Revenue Rulings, Revenue Procedures, Letter Rulings, etc.) and
cases. Be sure to include complete cite for each authority. Summarize the important
facts for the pronouncement/case and then compare the facts of the
pronouncement/case to the research facts. Discuss how the facts are similar or
different. Explain how each ruling or case supports or weakens the clients’ position.
Documentation is a very important part communicating tax research and all
statements or opinions should be substantiated with supporting cites. Supporting
cites should be to primary sources only except in rare or unusual situations.
Nonliquidating
Distributions
EARNINGS AND PROFITS
DIVIDENDS
DIVIDENDS RECEIVED DEDUCTION
IN-KIND DISTRIBUTIONS
STOCK DIVIDENDS
Shareholder Rights as the corporate owner
Shareholder rights:
The right to exercise voting control
Entitlement to a share of the corporation’s earnings when
distributions are declared
Entitlement to a share of the corporation’s net assets upon
liquidation
Definitions: Types of Distributions where
shareholders receive earnings and/or assets
Nonliquidating Distributions: also referred to as operating distributions. Example pro rata cash
distribution or dividend. Shareholders continue to hold the same proportional ownership
interest in the corporation as they did before the distribution. (Section 301)
Redemption: the corporation distributes cash or other property to its sharholders in return for
its own stock held by the shareholders. This has the effect of reducing the outstanding shares of
the corporation. Also an example of a nonliquidating distribution. (Sections 301,302)
Liquidating Distributions: the corporation distributes its remaining assets to the shareholders
after payment of its liabilities to its creditors at or about the time of its termination as a going
concern. (Sections 331,332, 336, 337)
Other distributions: in connection with a formal corporate reorganization. (Section 368)
Remember: the rules of double taxation continue to apply to these transactions.
Tax Consequences to the Shareholders
Section 301 Trilogy
Section 301 is the starting point in the road map!
Distributions of a corporation of property (money, securities, or any other property except the
corporation’s own stock or stock options in its own stock) to the shareholder “with respect to the
corporation’s stock.”
Section 301 breaks Nonliquidating Distributions into 3 parts:
◦ 1. the portion of the distribution that is a dividend is includible in the shareholder’s gross income under
301(c)(1). After 2003, dividends are eligible for capital gains rates.
◦ 2. the portion of the distribution that is not a dividend (if any) reduces the shareholder’s basis in the
corporate stock under 301(c)(2).
◦ 3. Any remaining portion of the distribution, also not a dividend, (if any) is treated as a gain from the
deemed sale or exchange of property under 301(c)(3). Basis cannot be reduced below zero in step 2. This
receives special capital gains treatment since stock is held as a capital asset. This is known as the qualified
dividend rule under Section 1(h)(11).
This means that an operating distribution can be a entirely a dividend, partially a dividend, or not a dividend
at all.
When a corporation is a shareholder, it is subject to the same rules under Section 301.
So, what is a Dividend?
The Section 316 E&P Test
Section 61(a)(7) includes dividends in gross income.
Section 316 defines a dividend as any distribution of property made by a corporation to its
shareholders out of its earnings and profits either accumulated after 1913 (accumulated
earnings and profits) or out of earnings and profits of the current taxable year (current earnings
and profits).
Remember this does not include distributions of the corporation’s own stock, known as a stock
dividend. Section 305 cover stock dividends.
Parts 2 and 3 of the 301 trilogy deal with the excess portion that is not a dividend under the
section 316 test.
Key Questions Involving Earnings and Profits of a Corporation
What is the role that earnings and profits play in determining the tax
treatment of distributions.
How to compute a corporation’s earnings and profits (E & P).
How to determine taxable dividends paid during the year by
correctly allocating current and accumulated E & P to corporate
distribution
What is the tax treatment of dividends for individual shareholders.
E&P: No definition in the code!!!!!
Calculation begins with taxable income, plus or minus certain adjustments.
Cont’d
Allocating E&P: Accumulated vs. Current
If positive balance in both current and accumulated E & P
◦ Distributions are deemed made first from current E & P, then accumulated E & P
If distributions exceed current E & P, must allocate current and accumulated E & P to each distribution
◦ Allocate current E & P pro rata (using dollar amounts) to each distribution
◦ Apply accumulated E & P in chronological order
If current E & P is positive and accumulated E & P has a deficit
◦ Accumulated E & P is not netted against current E & P
◦ Distribution is deemed to be taxable dividend to extent of positive current E & P balance
If accumulated E & P is positive and current E & P is a deficit, net both at the date of distribution
◦ If balance is zero or a deficit, distribution is a return of capital to the extent of basis; any excess results in a
taxable gain
◦ If balance is positive, distribution is a dividend to the extent of the balance
◦ A deficit in current E & P is allocated ratably during the year unless the parties can show otherwise
Cash Dividend Example
Examples: Current E&P and Accumulated E&P
Section 301 Trilogy example
On January 1, 2021, A, an individual, owned all of the stock of Corporation M, consisting of a
single share with an adjusted basis of $2,000. During 2021, A received distributions from
Corporation M totaling $30,000, consisting of $10,000 in cash and listed securities having a basis
in the hands of Corporation M and a fair market value on the date distributed of $20,000.
Corporation M’s taxable year is the calendar year. As of December 31, 2020, Corporation M had
accumulated earnings and profits in the amount of $26,000, and it had no earnings and profits
and no deficit for 2021.
Of the $30,000 received by A, $26,000 is treated as an ordinary dividend; of the remaining
$4,000, $2,000 is applied against and reduces the adjusted basis of A’s stock under section
301(c)(2), and the $2,000 in excess of the adjusted basis of A’s stock is treated as gain from the
sale or exchange of property under section 301(c)(3)(A). If A immediately sells the stock in
Corporation M, the basis for determining gain or loss on the sale will be zero.
Tax Consequences to Corporate Shareholders:
Dividends Received Deduction Section 243
Unlike an individual shareholder, if the dividend is received from a domestic corporation, the
corporate shareholder receives a special dividend received deduction under Section 243.
Corporations treat dividends as ordinary income and are permitted a dividends received
deduction. If a corporation receives dividends from related entities, the corporation can then
deduct from 50% up to 100% of the dividend received from its income tax. The relevant
percentage of deduction depends on how much ownership the receiving corporation has in
the company paying the dividend. Special code rules for computation.
There are a few limitations to the DRD: The DRD is only available to C corporations; not LLCs, S
corporations, or individuals. There is a 45-day minimum holding period for common stock.
The DRD does not apply to preferred stock.
Tax Consequences to the Distributing Corporation
Section 311 In-Kind Distributions
No gain or loss on the distribution of cash distribution to shareholders. Section 311(b)
Following the cash distribution, the adjustments to corporate E&P is simple: reduce by the
amount of cash distributed and a corporation cannot create a deficit in E&P by making a
distribution. Section 312.
But the rules change under Section 311(b) dealing with in-kind distributions of property
(property other than cash). Here, corporations must recognize a gain on the distribution o
appreciated property but cannot recognize loss upon the distribution of loss property.
Adjustments to E&P are also more complicated.
Dividends are not deductible.
In-Kind: Tax Consequences to the Corporation
Corporate Distribution of Appreciated Property
If the property being distributed is appreciated, the corporation recognizes a
gain. For federal tax purposes, the gain is treated as if the corporation had sold
the property at fair market value to the shareholder.
The taxation of the gain depends on the nature of the assets distributed.
Ordinary income, inventory, and unrealized receivables are among assets taxed
at the less preferable income tax rate. A gain from capital assets and certain
property used in a business is subject to the more desirable capital gains tax. It is
therefore to the corporation’s benefit to distribute capital assets rather than
ordinary income or inventory.
In-Kind: Tax Consequences to the Corporation
Corporate Distribution of Property Subject to Liabilities
When the liabilities of the distributed property are less the FMV, corporate level gain under
Section 311 will be measured by the FMV over adjusted basis.
Corp X distributes property with a basis of $80 and FMV of $150 to sh. A, subject to a $100
mortgage on the property. Corp will report a taxable gain of $70 under Section 311 (b)
When the liabilities of the distributed property exceed the FMV, corporate level gain under
Section 311 will be measured by the excess of liabilities over adjusted basis.
Corp X distributes property with a basis of $80 and FMV of $150 to sh. A, subject to a $200
mortgage on the property. Corp will report a taxable gain of $120 under Section 311 (b)
Tax Consequences to shareholders of inkind distributions
When property (rather than cash) is distributed, the amount of the dividend
equals the fair market value (FMV) of the property on the date of the
distribution, reduced by any liabilities assumed by the shareholder or to which
the property is subject (Sec. 301(b)). The fair market value of any property
distributed is determined as of the date of the distribution.
In addition, as is the case with cash dividends, the distribution must be from
current or accumulated E&P to be classified as a dividend. The shareholder’s
basis in appreciated property received in a distribution equals the property’s
FMV (Sec. 301(d)). The shareholder’s holding period begins on the date of
distribution.
Constructive Dividends
Corporations sometimes enter into transactions that are not typically dividends but may be considered so
by the IRS. The following are examples of potential constructive dividends:
• Payments made to others for the personal benefit of the shareholder;
• Payments to family members of shareholders;
• Excessive compensation/purported loans to shareholders;
• Loans to shareholders at “below-market” interest rates;
• Improvements to shareholders’ property; and
• Bargain purchases of corporate property/free use of corporate property by a shareholder.
Constructive dividends do not have to be declared formally or designated as a dividend. They need not be
paid pro rata to all shareholders. Legally, they do not even have to be a dividend under state law; all that
is required is a finding by the IRS that a shareholder received some benefit from the corporation. From a
tax point of view, there is no difference between a formal dividend and a constructive dividend.
Example: Property Distributed for Less
Than FMV Deemed a Dividend
If property is transferred by a corporation to a shareholder for an amount less
than its fair market value in a sale or exchange, such shareholder is treated as
having received a distribution to which section 301 applies. For example, on
January 3, 2021, A, a shareholder of Corporation X, purchased property from X
for $20 when the fair market value of such property was $100. The amount of
the distribution to A determined under section 301(b) is $80.
As for the corporation, the corporate level gain realized by the corporation
under Section 311(b) is the excess of the fair market value of the property over
the adjusted basis of the property at the time of transfer.
Stock Dividends
Tax Treatment to Shareholders
•A stock dividend is a dividend paid to shareholders in the form of additional shares in the company.
In the stock dividend, additional shares are given to shareholders whereas in stock split already
issued shares are split in an agreed ratio.
•General Rule: Stock dividends are not taxed until the shares are sold by their owner.
Basis rules: Section 307 If a shareholder receives stock (new stock) as a distribution on stock
previously held (old stock) and such distribution is a nontaxable stock dividend, the basis of the old
stock is allocated between the old stock and new stock in proportion to their fair market values on
the date of distribution. The basis of each share of stock in a particular class of stock is determined
by dividing the basis of that class of stock by the number of shares in that class.
•Like stock splits, stock dividends dilute the share price because additional shares have been issued.
•Stock dividends do not affect the value of the company.
•A company may prefer to pay dividends in stock rather than cash in order to preserve its cash
reserves.
Eisner v Macomber
Understanding Section 305 Stock Dividends
What was the Supreme Court’s ruling?
Tax Consequences of Section 305 Rules
to Shareholders in a Stock Dividend
The Supreme Court held in favor of Mrs. Macomber:
There is no gain from the distribution of a pro rara stock dividend that does not
alter the shareholder’s proportionate interest in the corporation. This ruling
was later codified in the code in Section 305. Section 305(a) Nonrecognition
Rule. The basis of the stock will be allocated under Section 307.
The exceptions to the nonrecognition provision cover situations where the stock
distribution alters or may alter the proportionate interest of the shareholders.
Section 305(b): Six exceptions to nonrecognition. If one of the exceptions apply,
the stock dividend will be treated as a dividend under Section 301 to the extent
of E&P. Shares will receive a fair market value basis under 301(d)
Section 305 Exceptions to General
Nonrecognition Rule
Distributions of Stock and Stock Rights
The General Rule under subsection 305(a) shall not apply to a distribution by a
corporation of its stock, and the distribution shall be treated as a distribution
of property to which Section 301 applies because in these situations there
results in (or can result in) an increase in the proportionate interests of other
shareholders in the assets or earnings and profits of the corporation.
These exceptions include: (1) distributions in lieu of money, (2)
disproportionate distributions, (3) convertible preferred stock and debentures,
(4) distributions of common and preferred stock, (5) certain transactions
increasing a shareholder’s proportionate interest, and (6) dividends on
preferred stock.
Read: Examples and Explanations problems 1-3.
Examples of 305(b)
Tax Consequences to the Corporation
Section 312
No tax consequences
No reduction in E&P so long as the distribution is not taxable to the shareholders
under 305(a)
If taxable to the shareholders under 305(b), then E&P is reduced by the FMV of
the taxable portion of the stock distribution.