Corp. & Part. Tax - Problem 5

Problem Set 5

In each case, assume that X is a business entity owned by three owners, R, S and T. Each owner has a one-third ownership share -- stock, partnership interests or LLC interests, as the case may be. Each owner has been active in the management of X. Like stock, the partnership and LLC interests entitle each owner to a share of the capital of X as well as a share of its profits.

X's books reveal the following assets:

	*Basis*	*Fair Market Value*
Cash	$ 6,000	$ 6,000
Land (investment)	9,000	15,000
Inventory	21,000	30,000
Total	$ 36,000	$ 51,000

In addition, X has a strong customer following, which it has cultivated over the years through advertising and other activities that have generated immediate business expense deductions.

X has outstanding a bank debt of $21,000. It is the only liability of X.

P is a corporation that wishes to purchase X.

What are the tax consequences to X, R, S, T and P of each of the following fact patterns? Consider the basis of each taxpayer's assets as well as the amount, character and timing of any income each taxpayer has. In each case, address each of the following scenarios:

Scenario A. X is a C corporation (or an "association") with substantial earnings and profits ("E&P"). Each shareholder's stock basis is $5,000.

Scenario B. X is an S corporation that has been an S corporation all its life; therefore, it has no E&P. Each shareholder's stock basis is $5,000.

Scenario C. X is a partnership, or an LLC taxed as a partnership. Under the partnership agreement or LLC operating agreement, all items of income, deduction, loss and credit are allocated equally among R, S and T. The agreement's allocations have substantial economic effect. The $21,000 bank debt is properly allocated one-third to each partner under the regulations under I.R.C. § 752. Each partner's basis in his or her partnership interest or LLC interest is $12,000.

In this problem set, we will first discuss all of the problems together as applied to C corporations. We will then discuss all of the problems together in the context of S corporations; finally, we will discuss all of the problems together in the context of partnerships.

Problem 5.1. P buys R's, S's and T's ownership interests for $15,000 each.

Problem 5.2. P buys all of X's assets from X for $45,000, plus the assumption of X's $21,000 liability to the bank. X liquidates and dissolves, distributing $15,000 in cash to each of R, S and T.

Problem 5.3. X liquidates and dissolves, distributing its assets to R, S and T as one-third tenants in common. R, S and T assume the liability of X. R, S and T immediately sell the former X assets to P for $45,000 cash, plus P's assumption of the X liability.

Suggested Study for Problem Set 5

Scenario A (C corporations): I.R.C. §§ 331, 334(a), 336, 1001, 1060, 197.

Scenario B (S corporations): Same Code sections as Scenario A, plus I.R.C. §§ 1366, 1367.

Scenario C (partnerships): I.R.C. §§ 708, 731, 732, 741, 751(a), 1001, 1060, 197.

Study Guide Reading

For those using the Black Letter study guide (optional), this material is covered in Chapter IX (pages 237-266), Chapter XVIII (pages 511-530), and Chapter XX (pages 555-574).

Created by: bojack@lclark.edu
Update: 10 Jan 08
Expires: 31 Aug 08