Chapter 7

Question 1

What does Earnings & Profits (E&P) measure?

Answer 1

A corporation’s economic ability to pay dividends to its shareholders.

Question 2

How is a corporation’s current-year E&P generally calculated?

Answer 2

By making adjustments to its taxable income for items treated differently for E&P purposes.

Question 3

What are the two E&P balances that must be accounted for separately?

Answer 3

• Current-year E&P
• Accumulated E&P

Question 4

What type of income increases a corporation’s E&P?

Answer 4

• Tax-exempt income
• Amounts subject to special deduction or exclusion

Question 5

Name two expenditures that decrease a corporation’s E&P.

Answer 5

• Nondeductible entertainment expenses
• Payment of nondeductible fines and penalties

Question 6

What impact does a corporation’s Net Operating Loss (NOL) have on E&P?

Answer 6

It represents an economic loss and impairs the corporation’s ability to make distributions.

Question 7

Which depreciation system is used to compute E&P?

Answer 7

Alternative Depreciation System (ADS).

Question 8

What is the definition of a distribution in relation to E&P?

Answer 8

A distribution is treated as a dividend to the extent of the distributing corporation’s current-year E&P.

Question 9

True or False: A distribution creates a current or accumulated E&P deficit.

Answer 9

False.

Question 10

What happens if a corporation’s distribution exceeds its current E&P?

Answer 10

The excess is treated as a return of capital.

Question 11

What is the effect of noncash distributions on E&P?

Answer 11

They reduce E&P by the fair market value of the property less liabilities assumed by the shareholder.

Question 12

Fill in the blank: Stock splits and pro-rata stock dividends are ______ because they do not change the value of the shareholders’ interest.

Answer 12

nontaxable

Question 13

What is the purpose of §302 in stock redemptions?

Answer 13

To allow shareholders to treat redemption as an exchange if certain tests are met.

Question 14

Name one of the brightline tests for determining if a redemption is treated as an exchange.

Answer 14

• Shareholder owns less than 50% of total voting power after the exchange.

Question 15

What happens to E&P when a corporation pays dividends?

Answer 15

E&P is reduced by the amount of the dividends paid.

Question 16

What is the effect of family attribution rules in stock redemptions?

Answer 16

They prohibit shareholders from transferring shares to reduce ownership.

Question 17

What is the treatment of capital gains when a shareholder redeems stock?

Answer 17

Shareholders have a gain or loss by comparing the amount realized to their basis in the stock.

Question 18

How does the IRS define a distribution for tax purposes?

Answer 18

A distribution is treated as a dividend to the extent it is paid from E&P.

Question 19

What is the treatment of excess distributions when a corporation has negative current E&P?

Answer 19

They are treated as a return of capital.

Question 20

What must be considered when preparing an E&P study?

Answer 20

The corporation’s distribution history, including current and prior-year distributions.

Question 21

What is the relationship between accumulated E&P and negative current E&P in distributions?

Answer 21

Distributions can still be taken from accumulated E&P even if current E&P is negative.

Question 22

What is the impact of liabilities on noncash distributions?

Answer 22

Liabilities assumed by the shareholder are subtracted from the fair market value of the property distributed.

Question 23

What happens to E&P if a corporation distributes property?

Answer 23

E&P is reduced by the fair market value of the property on the distribution date.

Question 24

Fill in the blank: If a loss results from a distribution where FMV is less than basis, it ______.

Answer 24

cannot be recognized

Question 25

What is the effect of a shareholder receiving a distribution of land with liabilities?

Answer 25

The value of the distribution is calculated as FMV minus liabilities assumed.

Question 26

What is included in taxable income adjustments?

Answer 26

Certain excluded income such as: * Tax-exempt bond interest * Life insurance proceeds * Federal tax refunds (if cash basis) * Increase in cash surrender value of corporate-owned life insurance policy ## Footnote These adjustments ensure that all relevant income is considered for tax calculations.

Question 27

What are some disallowed deductibles when calculating earnings?

Answer 27

Disallowed deductibles include: * DRD * NOL CF/CB * NCL CF * Charitable contributions CF ## Footnote These deductions are not permitted to adjust taxable income.

Question 28

Which nondeductible expenses are allowed in the calculation of earnings?

Answer 28

Nondeductible expenses allowed include: * Federal income taxes paid or accrued * CY NCL * Current-year contributions in excess of 10 percent limit * Nondeductible premiums ## Footnote These expenses can affect the taxable income calculation despite being nondeductible.

Question 29

What adjustments are made for timing differences in earnings calculation?

Answer 29

Adjustments for timing differences include: * Installment sales * Depreciation methods * Adjustments for gain or loss from sale of property where depreciation is different ## Footnote Timing differences can significantly impact the reported earnings.

Question 30

How is the amount distributed to shareholders calculated?

Answer 30

The amount distributed is calculated as: * Cash received * FMV of property received * Liabilities assumed by shareholder on property received ## Footnote This calculation determines the total value received by shareholders.

Question 31

What is the basis of property received by shareholders?

Answer 31

The basis of property received is: * FMV of property received * Liabilities assumed by shareholder who received distribution ## Footnote Understanding the basis is critical for future tax implications.

Question 32

What is the tax treatment to a corporation regarding loss recognition?

Answer 32

Loss is never recognized by the corporation during distributions ## Footnote This principle helps maintain the corporation's capital structure.

Question 33

How is gain recognized on distribution by a corporation?

Answer 33

Gain recognized on distribution is the greater of: * FMV of property distributed * Liability assumed by shareholder (Adjusted basis) ## Footnote This ensures that the corporation accurately reflects any gain from the transaction.

Question 34

Under what conditions is a stock distribution nontaxable to shareholders?

Answer 34

A stock distribution is nontaxable if: * Made with respect to common stock * Made pro rata (proportionate interests are maintained) ## Footnote These conditions help avoid immediate tax liability on stock distributions.

Question 35

What happens if cash is offered as an alternative in a stock distribution?

Answer 35

If cash is offered as an alternative, recognize the FMV of the stock distributed as the cash that was offered ## Footnote This treatment aligns the transaction with cash equivalents.

Question 36

What are the conditions for stock redemptions to be treated as exchanges?

Answer 36

Stock redemptions are treated as exchanges if: * Constructive ownership rules apply * Shareholder must own less than 50% of voting power after redemption * Must fall below at least 80% of the shareholder’s original share of voting stock and aggregate value ## Footnote These conditions ensure that the transaction is treated appropriately for tax purposes.

Question 37

What tax consequences do shareholders face for an exchange?

Answer 37

For an exchange, gain is always recognized, and loss is recognized unless the shareholder is related to the corporation ## Footnote This rule helps delineate the tax implications for shareholders.

Question 38

What tax consequences do distributing corporations face for an exchange?

Answer 38

Distributing corporations reduce E&P after cash distributions are accounted for, lesser of: * Leftover E&P * percent of stock redeemed * FMV of stock redeemed ## Footnote This ensures that earnings and profits reflect the impact of stock redemptions.

Question 39

What treatment do noncorporate shareholders receive in partial liquidations?

Answer 39

Noncorporate shareholders receive exchange treatment, computing gain or loss based on the tax basis of shares that would have been transferred ## Footnote This treatment allows for equitable tax implications during partial liquidations.

Question 40

What rules apply to corporate shareholders during stock redemptions?

Answer 40

Corporate shareholders are subject to change-in-stock-ownership rules that apply to stock redemptions, which typically results in dividend treatment ## Footnote This ensures compliance with tax regulations regarding stock ownership changes.