Question & Answer

What are inside basis and outside basis, and why are they relevant for taxing partnerships and partners?

Under what circumstances is it possible for partners to recognize gain when contributing property to partnerships?

What is the rationale for requiring partners to defer most gains and all losses when they contribute property to a partnership?

What is a partnership interest, and what specific economic rights or entitlements are included with it?

Compare and contrast the aggregate and entity concepts for taxing partnerships and their partners.

What types of business entities are taxed as flow-through entities?

What is a flow-through entity, and what effect does this designation have on how business entities and their owners are taxed?

Suppose you asked your favorite AI learning tool “What basis does a shareholder take in property received in a liquidating distribution?” and the AI tool provided the following response:

Suppose you asked your favorite AI learning tool “Do stock redemptions have an impact on a corporation's earnings and profits?” and the AI tool provided the following response:

Rex and Felix are the sole shareholders of the Dogs and Cats Corporation (DCC). After several years of operations using the accrual method, they decided to liquidate the corporation and operate the business as a partnership. Rex has a tax basis in his shares of $60,000 and Felix has a tax basis in his shares of $20,000. Rex and Felix hired a lawyer to draw up the legal papers to dissolve the corporation, but they need some tax advice from you, their trusted accountant. DCC’s tax accounting balance sheet at the date of liquidation is as follows: 

AssetsTax BasisFMV

Cash$30,000$30,000

Accounts receivable 10,000 10,000

Inventory 10,000 20,000

Equipment 30,000 20,000

Building 15,000 30,000

Land   5,000   40,000

    Total assets $100,000 $150,000

Liabilities

Accounts payable $5,000

Mortgage payable - Building 10,000

Mortgage payable - Land 10,000

Total liabilities $25,000

Stockholders’ Equity

Common stock - Rex (80%)$100,000

Common stock - Felix (20%) 25,000  

Total shareholders’ equity$125,000

Required:

a) Compute the gain or loss recognized by Rex, Felix, and DCC on a complete liquidation of the corporation assuming each shareholder receives a pro rata distribution of the corporation’s assets and assumes a pro rata amount of the liabilities.

Thriller Corporation has one class of voting common stock, of which 1,000 shares are issued and outstanding. The shares are owned as follows: 

Joe Jackson400

Mike Jackson (Joe’s son)200

Jane Jackson (Joe’s daughter)200

Vinnie Price (unrelated)   200

  Total1,000

Thriller Corporation has current E&P of $300,000 for this year and accumulated E&P at January 1 of this year of $500,000. 

During this year, the corporation made the following distributions to its shareholders: 

03/31: Paid a distribution of $10 per share to each shareholder ($10,000 in total).

06/30: Redeemed 200 shares of Joe’s stock for $200,000.  Joe’s basis in the 200 shares redeemed was $100,000.

09/30: Redeemed 60 shares of Vinnie’s stock for $60,000. His basis in the 60 shares was $36,000.

12/31: Paid a distribution of $10 per share to each shareholder ($7,400 in total).

Petoskey Stone Quarry Inc. (PSQ), a calendar-year, accrual-method C corporation, provides landscaping supplies to local builders in northern Michigan. PSQ has always been a family-owned business and has a single class of voting common stock outstanding.  The 500 outstanding shares are owned as follows: 

Number of shares

Nick Adams 150

Amy Adams (Sandler’s sister) 150

Abigail Adams (Nick’s daughter) 50

Charlie Adams (Nick’s son) 50

Sandler Adams (Nick’s father) 100

   Total shares 500

Nick Adams serves as president of PSQ, and his father Sandler serves as chair of the board. Amy is the company’s CFO, and Abigail and Charlie work as employees of the company.  Sandler would like to retire and sell his shares back to the company. The fair market value of the shares is $500,000. Sandler’s tax basis in his PSQ shares is $10,000. 

The redemption is tentatively scheduled to take place on December 31 of this year.  At the beginning of the year, PSQ had accumulated earnings and profits of $2,500,000.  The company projects current E&P of $200,000.  The company intends to pay a pro rata cash distribution of $300 per share to its shareholders on December 1 of this year. 

Lanco Corporation, an accrual-method corporation, reported taxable income of $1,460,000 this year. Included in the computation of taxable income were the following items:

• MACRS depreciation of $200,000. Depreciation for earnings and profits purposes is $120,000.

• A net capital loss carryover of $10,000 from last year.

• A net operating loss carryover of $25,000 from last year.

• $65,000 capital gain from the distribution of land to the company’s sole shareholder (see below).

Not included in the computation of taxable income were the following items:

• Tax-exempt income of $5,000.

• Life insurance proceeds of $250,000.

• Excess current-year charitable contribution of $2,500 (to be carried over to next year).

• Tax-deferred gain of $20,000 on a like-kind exchange.

• Nondeductible life insurance premium of $3,500.

• Nondeductible interest expense of $1,000 on a loan used to buy tax-exempt bonds.

Lanco accrued and paid federal income taxes this year of $306,600. Lanco’s accumulated E&P at the beginning of the year was $2,400,000. 

During the year, Lanco made the following distributions to its sole shareholder, Luigi Nutt: 

• June 30:  $50,000

• September 30:  Parcel of land with a fair market value of $75,000. Lanco’s tax basis in the land was $10,000.  Luigi assumed an existing mortgage on the property of $15,000.

Cartman Corporation owns 90 shares of SP Corporation. The remaining 10 shares are owned by Kenny (an individual). After several years of operations, Cartman decided to liquidate SP Corporation by distributing the assets to Cartman and Kenny. The tax basis of Cartman’s shares is $10,000, and the tax basis of Kenny’s shares is $7,000.  SP reported the following balance sheet at the date of liquidation:

Jones Mills Inc. (JMI) decided to liquidate its wholly owned subsidiary, Most Help Inc. (MH). MH had the following tax accounting balance sheet:

    FMV         Tax BasisAppreciation

Cash$  200,000$     200,000

Building      50,000         10,000        40,000

Land    150,000       200,000      (50,000)

Total$  400,000$     410,000$    (10,000)

Jefferson Millinery Inc. (JMI) decided to liquidate its wholly owned subsidiary, 8 Miles High Inc. (8MH). 8MH had the following tax accounting balance sheet.

    FMV         Tax basisAppreciation

Cash$  200,000$     200,000

Building      50,000         10,000        40,000

Land    150,000         90,000        60,000

Total$  400,000$     300,000$    100,000

Tiffany and Carlos decided to liquidate their jointly owned corporation, Royal Oak Furniture (ROF).  After liquidating its remaining inventory and paying off its remaining liabilities, ROF had the following tax accounting balance sheet.

    FMV         Tax BasisAppreciation (Depreciation)

Cash$  200,000$     200,000

Building      50,000         10,000       40,000

Land    150,000       200,000      (50,000)

Total$  400,000$     410,000$    (10,000)

Shauna and Danielle decided to liquidate their jointly owned corporation, Woodward Fashions Inc. (WFI).  After liquidating its remaining inventory and paying off its remaining liabilities, WFI had the following tax accounting balance sheet.

    FMV        Tax basisAppreciation

Cash$  200,000$     200,000

Building      50,000         10,000        40,000

Land    150,000         90,000        60,000

Total$  400,000$     300,000$    100,000

Wolverine Corporation made a distribution of $500,000 to Jin Inc. in partial liquidation of the company on December 31 of this year. Jin Inc. owns 100 percent of Wolverine Corporation. The distribution was in exchange for 50 percent of Jin Inc.’s stock in the company. At the time of the distribution, the shares had a fair market value of $200 per share. Jin Inc.’s tax basis in the shares was $50 per share. Wolverine had E&P of $8,000,000 at the time of the distribution. 

Aggie Corporation made a distribution of $500,000 to Rusty Cedar in partial liquidation of the company on December 31 of this year.  Rusty, an individual, owns 100 percent of Aggie Corporation. The distribution was in exchange for 50 percent of Rusty’s stock in the company. At the time of the distribution, the shares had a fair market value of $200 per share. Rusty’s tax basis in the shares was $50 per share. Aggie had E&P of $8,000,000 at the time of the distribution. 

Bonnie and Clyde are the only two shareholders in Getaway Corporation. Bonnie owns 60 shares with a basis of $3,000, and Clyde owns the remaining 40 shares with a basis of $12,000. At year-end, Getaway is considering different alternatives for redeeming some shares of stock. Evaluate whether each of the following stock redemption transactions will qualify for sale or exchange treatment.

Spartan Corporation redeemed 25 percent of its shares for $2,000 on July 1 of this year, in a transaction that qualified as an exchange under §302(a).  Spartan’s accumulated E&P at the beginning of the year was $2,000. Its current E&P is $12,000.  Spartan made dividend distributions of $1,000 on June 1 and $4,000 on August 31.  Determine the balance in Spartan’s accumulated E&P at the beginning of next year.  See Rev. Rul. 74-338 and Rev. Rul. 74-339 for help in making this calculation. 

EG Corporation redeemed 200 shares of stock from one of its shareholders in exchange for $200,000. The redemption represented 20 percent of the corporation’s outstanding stock. The redemption was treated as an exchange by the shareholder. By what amount does EG reduce its E&P as a result of the redemption under the following E&P assumptions? 

Using the facts from the previous problem, Oriole Corporation proposes to pay Larry $100,000 and give him an installment note that will pay him $30,000 per year for the next 10 years plus a market rate of interest. Will this arrangement allow Larry to treat the redemption as an exchange?

Oriole Corporation, a privately held company, has one class of voting common stock, of which 1,000 shares are issued and outstanding. The shares are owned as follows: 

Larry Byrd400

Paul Byrd (Larry’s son)200

Lady Byrd (Larry’s daughter)200

Cal Rifkin (unrelated)   200

  Total1,000

Larry is considering retirement and would like to have the corporation redeem all of his shares for $400,000.