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At  the  beginning  of  Year  1,  ABC,  Inc.  (ABC)  has  one  class  of  stock (i.e., common stock), and  there  are  only  100  shares  of  that  common  stock  outstanding.  Jen  owns  40%  of  the  ABC common  stock  and  has  a  basis  of  $400  in  that  stock.  The  other  60%  of  the  ABC  stock  is  held equally  by  Jen’s  friend  Marina  (who  has  a  basis  of  $200  in  her  stock),  Marina’s  daughter  Elena (who  has  a  basis  of  $200  in  her  stock),  and  Jen’s  mother  Jacky  (who  has  a  basis  of  $200  in  her stock).  In  Year  1,  ABC  has  $50,000  of  earnings  and  profits  from  its  operations  (that  are  not attributable  to  any  specific  period  during  that  year)  and  no  accumulated  earnings  and  profits.  On June  1  of  Year  1,  ABC  distributes  $20,000  to  its  shareholders.  On  November  12  of  Year  1,  ABC distributes  a  parcel  of  land  with  a  fair  market  value  of  $10,000  and  a  basis  of  $5,000  to  its shareholders.  In  Year  2,  ABC  has  a  current  deficit  in  earnings  and  profits  of  $40,000  (that  is  not attributable  to  any  specific  period  during  that  year).  On  April  1  of  Year  2,  ABC  distributes  $20,000 to its  shareholders.  In Years  3 and 4,  ABC  has  ample  earnings  and profits. At  the  beginning  of  Year  1,  DEF,  Inc.  (DEF)  has  one  class  of  stock  (i.e.,  common  stock), and  there  are  only  200  shares  of  that  common  stock  outstanding.  Jen  owns  40%  of  the  DEF common  stock  and  has  a  basis  of  $400  in  that  stock.  The  other  60%  of  the  DEF  stock  is  held equally  by  Jen’s  friend  Marina  (who  has  a  basis  of  $200  in  her  stock),  Marina’s  daughter  Elena (who  has  a  basis  of  $200  in  her  stock),  and  Jen’s  mother  Jacky  (who  has  a  basis  of  $200  in  her stock).  DEF  is  profitable  and  has  ample  earnings  and  profits.  In  Year  4,  Jen,  Marina,  and  Jacky each  transfer  10  shares  of  ABC  common  stock  (with  a  fair  market  value  of  $10,000)  to  DEF  in exchange  for  one  additional  share  of  DEF  stock  (with  a  fair  market  value  of  $1,000)  plus  $9,000  in cash. In  Year  5,  ABC  adopted  a  periodic  redemption  plan  under  which  each  shareholder  of  ABC is  eligible  to  have  no  more  than  2  shares  of  ABC  stock  redeemed  each  year.  No  more  than  a  total  of 4  shares  can  be  redeemed  in  any  one  year  under  the  plan.  In  Year  5,  no  shareholder  made  an election  to  have  shares  redeemed. In  Year  6,  however,  DEF  elected  to  have  2  of  its  shares  of  ABC stock  redeemed;  no  other  shareholder  elected  to  have  stock  redeemed  that  year.  Based  on subsequent  participation  in  the  plan,  this  redemption  by  DEF  in  Year  6  was  not  an  isolated redemption. Discuss  the  U.S.  federal  income  tax  consequences  of  this  series  of  events  to  all parties  involved. In your  answer,  please  be  sure  to  discuss  all  relevant  tax  consequences  (with  and without  available  elections)—including,  but  not  limited  to,  the  amount,  timing,  and  character  of any  income;  basis;  holding  period;  and  tax  attributes  (e.g.,  earnings  and  profits  and  net  operating losses).   

CORPORATE TAX EXAM SAMPLE

At the beginning of Year 1, ABC, Inc. (ABC) has one class of stock (i.e., common stock),
and there are only 100 shares of that common stock outstanding. Jen owns 40% of the ABC
common stock and has a basis of $400 in that stock. The other 60% of the ABC stock is held
equally by Jen’s friend Marina (who has a basis of $200 in her stock), Marina’s daughter Elena
(who has a basis of $200 in her stock), and Jen’s mother Jacky (who has a basis of $200 in her
stock). In Year 1, ABC has $50,000 of earnings and profits from its operations (that are not
attributable to any specific period during that year) and no accumulated earnings and profits. On
June 1 of Year 1, ABC distributes $20,000 to its shareholders. On November 12 of Year 1, ABC
distributes a parcel of land with a fair market value of $10,000 and a basis of $5,000 to its
shareholders. In Year 2, ABC has a current deficit in earnings and profits of $40,000 (that is not
attributable to any specific period during that year). On April 1 of Year 2, ABC distributes $20,000
to its shareholders. In Years 3 and 4, ABC has ample earnings and profits.

At the beginning of Year 1, DEF, Inc. (DEF) has one class of stock (i.e., common stock),
and there are only 200 shares of that common stock outstanding. Jen owns 40% of the DEF
common stock and has a basis of $400 in that stock. The other 60% of the DEF stock is held
equally by Jen’s friend Marina (who has a basis of $200 in her stock), Marina’s daughter Elena
(who has a basis of $200 in her stock), and Jen’s mother Jacky (who has a basis of $200 in her
stock). DEF is profitable and has ample earnings and profits. In Year 4, Jen, Marina, and Jacky
each transfer 10 shares of ABC common stock (with a fair market value of $10,000) to DEF in
exchange for one additional share of DEF stock (with a fair market value of $1,000) plus $9,000 in
cash.

In Year 5, ABC adopted a periodic redemption plan under which each shareholder of ABC
is eligible to have no more than 2 shares of ABC stock redeemed each year. No more than a total of
4 shares can be redeemed in any one year under the plan. In Year 5, no shareholder made an
election to have shares redeemed. In Year 6, however, DEF elected to have 2 of its shares of ABC
stock redeemed; no other shareholder elected to have stock redeemed that year. Based on
subsequent participation in the plan, this redemption by DEF in Year 6 was not an isolated
redemption.

Discuss the U.S. federal income tax consequences of this series of events to all
parties involved. In your answer, please be sure to discuss all relevant tax consequences (with and

without available elections)—including, but not limited to, the amount, timing, and character of

any income; basis; holding period; and tax attributes (e.g., earnings and profits and net operating
losses).

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