Chapter 18 Homework

Solutions
34.
a.
All $400,000 is treated as a dividend because the distribution is less than the
companys total earnings and profits of $500,000.
b.
Rays tax basis in his Hawkeye stock remains $75,000.
c.
Accumulated E&P as of January 1 is $100,000, computed as $500,000 $400,000.
35.
a.
Christine has dividend income of $300,000, all of which is from the
companys current E&P.
b.
Christine reduces her tax basis in the Jayhawk stock by $75,000 to $0, which
is the lesser of the distribution in excess of current E&P ($100,000) or her
basis in the Jayhawk stock ($75,000). The remaining $25,000 is treated as
gain from sale of the Jayhawk stock (capital gain).
c.
Jayhawk has a deficit in accumulated E&P of negative $200,000. Current
E&P was reduced to $0, leaving a carryover of the beginning of the year
accumulated E&P.
36.
a.
Boomer reports a dividend of $50,000. He first computes balance in E&P as
of June 30 by allocating the deficit in current E&P pro rata over the year.
The deficit in current E&P on June 30 is negative $150,000, computed as
[($300,000) x 6/12]. Hence, accumulated E&P as of June 30 is $50,000,
computed as $200,000 - $150,000.
b.

Boomers tax basis in his Sooner stock is $0, which is his beginning tax basis
of $75,000 less the lesser of the distribution in excess of accumulated E&P
($350,000) or his basis in the Sooner stock ($75,000). The remaining
$250,000 is treated as gain from sale of the Sooner stock (capital gain).
c.
Sooners balance in accumulated E&P is $(150,000), computed as
follows:
Accumulated E&P, beginning of this year
Current E&P
Dividend paid
Accumulated E&P, end of the year

$200,000
(300,000)
( 50,000)
$(150,000)

The deficit equals the deficit in current E&P that arose after the
dividend payment [($300,000) x 6/12].
37.
a.
$0. No part of the distribution is treated as a dividend because both current
and accumulated E&P are negative.
b.
Melanies tax basis in her Blackhawk stock is $0, which is her beginning tax
basis less the lesser of the distribution in excess of accumulated E&P
($400,000) or her basis in the Blackhawk stock ($75,000). The remaining
$325,000 is treated as gain from sale of the Blackhawk stock (capital gain).
c.
Negative $500,000, the combined deficit in the beginning balance in
accumulated E&P and the deficit in current E&P.
39.

[LO2] Boilermaker, Inc. reported taxable income of $500,000 this year and
paid federal income taxes of $170,000. Not included in the companys
computation of taxable income is tax-exempt income of $20,000, disallowed
meals and entertainment expenses of $30,000, and disallowed expenses
related to the tax-exempt income of $1,000. Boilermaker deducted
depreciation of $100,000 on its tax return. Under the alternative (E&P)
depreciation method, the deduction would have been $60,000. Compute the
companys current E&P.
Taxable income
Add:
Tax-exempt interest
Excess of regular tax deprecation over E&P depreciation

$500,000
20,000
40,000

Subtract:
Federal income taxes
Disallowed portion of meals and entertainment
Disallowed expenses related to tax-exempt income
Current E&P
45.

[LO2] Beaver Corporation reported taxable income of $500,000 from

operations this year. The company paid federal income taxes of $170,000 on
this taxable income. During the year, the company made a distribution of land
to its sole shareholder, Eugenia VanDam. The lands fair market value was
$20,000 and its tax and E&P basis to Beaver was $50,000. Eugenia assumed a
mortgage on the land of $25,000. Any gain from the distribution will be taxed
at 34 percent. Beaver had accumulated E&P of $1,500,000.
c.

Compute Beavers accumulated E&P at the beginning of next year.

Current E&P
Subtract: E&P basis of land distributed
Add: Mortgage assumed by Eugenia
CE&P after distribution
Accumulated E&P, beginning of this year
Accumulated E&P, beginning of next year

48.

(170,000)
(30,000)
( 1,000)
$359,000

$330,000
(50,000)
25,000
$305,000
1,500,000
$1,805,000

[LO4] Hoosier Corporation declared a 2-for-1 stock split to all shareholders of

record on March 25 of this year. Hoosier reported current E&P of $600,000
and accumulated E&P of $3,000,000. The total fair market value of the stock
distributed was $1,500,000. Barbara Bloomington owned 1,000 shares of
Hoosier stock with a tax basis of $100 per share.
a.

What amount of taxable dividend income, if any, does Barbara recognize this
year? Assume the fair market value of the stock was $150 per share on March
25 of this year.
The stock dividend is not taxable because it is pro rata to all the
shareholders.

b.

What is Barbaras income tax basis in the new and existing stock she owns in
Hoosier Corporation, assuming the distribution is tax-free?
The new stock is allocated part of the tax basis of the old stock based on
relative fair market value. In a 2 for 1 stock split, Barbara would allocate
half of the basis of the old stock ($100) to the new stock, making her tax basis
in the old and new stock $50 per share.

c.

How does the stock dividend affect Hoosiers accumulated E&P at the
beginning of next year?

Hoosier does not adjust its E&P for the stock dividend because it is not
taxable to the shareholders.
51.

[LO5] Flintstone Company is owned equally by Fred Stone and his sister
Wilma, each of whom hold 1,000 shares in the company. Wilma wants to
reduce her ownership in the company, and it was decided that the company
will redeem 250 of her shares for $25,000 per share on December 31 of this
year. Wilmas income tax basis in each share is $5,000. Flintstone has current
E&P of $10,000,000 and accumulated E&P of $50,000,000.
a.

What is the amount and character (capital gain or dividend) recognized by

Wilma as a result of the stock redemption, assuming only the substantially
disproportionate with respect to the shareholder test is applied?
Wilma reduces her ownership in Flintstone Company from 50% to 42.9%
(750/1,750). Wilma fails the substantially disproportionate test to treat
the redemption as an exchange. Although she reduces her ownership below
50%, her ownership percentage after the redemption is not less than 80% of
her ownership before the redemption (80% x 50% = 40%). As a result,
Wilma recognizes a dividend of $6,250,000 ($25,000 x 250 shares).

53.

[LO5] Bedrock, Inc. is owned equally by Barney Rubble and his wife Betty,
each of whom held 1,000 shares in the company. Betty wants to reduce her
ownership in the company, and it was decided that the company will redeem
500 of her shares for $25,000 per share on December 31 of this year. Bettys
income tax basis in each share is $5,000. Bedrock has current E&P of
$10,000,000 and accumulated E&P of $50,000,000.
a.

What is the amount and character (capital gain or dividend) recognized by

Betty as a result of the stock redemption, assuming only the substantially
disproportionate with respect to the shareholder test is applied?
Betty reduces her direct ownership in Bedrock, Inc. from 50% to 33.3%
(500/1,500). However, under the family attribution rules, she is deemed to
own the 1,000 shares owned by her husband, Barney. Her stock ownership
before the exchange is 100%, and her ownership after the exchange is still
100% (1,500/1,500). Betty fails the substantially disproportionate test to
treat the redemption as an exchange. As a result, Betty recognizes a dividend
of $12,500,000 ($25,000 x 500 shares).