WILLIAM MITCHELL COLLEGE OF LAW
FINAL EXAMINATION--TAKE-HOME
CORPORATE TAX (LL.M.)
FALL 1997
Professor DENISE ROY
Handout Date: Wednesday, December 3, 1997, 12:00 p.m.
Due Date: Wednesday, December 17, 1997, 9:00 p.m.
ADDITIONAL INSTRUCTIONS:
1. ONCE YOU HAVE PICKED UP THIS EXAM, YOU MAY DISCUSS THE EXAM WITH OTHER MEMBERS OF THE CLASS. DO NOT DISCUSS THE EXAM, THE ISSUES RAISED IN THE COURSE OR ANY OTHER ASPECT OF THE COURSE WITH ANY PERSON OTHER THAN MEMBERS OF THE CLASS AND ME. YOU MUST WRITE YOUR OWN EXAM ANSWERS, INCLUDING DIAGRAMS.
2. You may use the textbook and Internal Revenue Code volume assigned for the course, your own notes and outlines and any course handouts. You may not consult any outside materials.
3. This examination must be typewritten or printed (not handwritten) and is subject to a 15-page length limitation. In addition, each section of the exam is subject to the page limitation specified on the exam. Any required diagrams must be provided on separate sheets of paper that will not be counted for purposes of the applying the page limitation(s). IF YOU EXCEED THE PAGE LIMITATION(S), YOU WILL BE GRADED ONLY ON THE PAGES THAT FALL WITHIN THE LIMITATION (E.G., ON THE FIRST 15 PAGES). Answers must be doubled spaced on 8-1/2 x 11 inch paper with non-proportional-type font (1) having no more than 12 characters per inch (CPI) (2) and normal top and bottom 1 inch margins and left and right 1 inch margins. Do not justify the right-hand margin of your text. Type only on one side of each sheet of paper. Do not use footnotes. PLACE YOUR TEST NUMBER ON EACH PAGE OF YOUR ANSWER AND NUMBER YOUR PAGES. FAILURE TO COMPLY WITH THESE INSTRUCTIONS MAY BE TAKEN INTO ACCOUNT IN YOUR GRADE.
4. You will be graded on the quality of your analysis rather than on the conclusions you reach. Do not discuss extraneous issues. Limit your analysis to federal income tax issues. Do not discuss other tax (e.g., payroll, estate and gift, state) issues that may be presented unless we discussed them in class.
5. You may assume that (1) corporations are Subchapter C corporations, (2) gains from the disposition of property are capital gains, and (3) taxpayers use the cash method of accounting, unless the question specifically states otherwise.
6. You need not provide numerical answers but may do so if you choose. In some cases you may not have sufficient information to provide numerical answers. If you do provide numerical answers, be sure to explain how you reached your conclusions.
Good luck on your exam. It has been a pleasure working with you this semester. Denise Roy
I (40%)
Write no more than 6 pages total on the questions in this section.
In 1992, good friends Yolanda and Bea formed Proper Topper, Inc., as a C corporation to operate a chain of hat shops. They each own 50 percent of the corporation's voting common stock (the only class outstanding), and each has a basis of $50,000. The business has been successful and has accumulated earnings and profits over its five years of operations. Bea would like to retire from the business, but Yolanda cannot afford to buy out her interest. They are considering having the corporation acquire all of Bea's stock for $100,000 worth of consideration in 1998.
(a) Suppose that Proper Topper distributes to Bea in exchange for all her stock (1) $60,000 in cash and (2) property worth $40,000 in which the corporation has a basis of $10,000. What will be the tax consequences to Bea and the corporation from this transaction?
(b) Suppose that Proper Topper instead agrees to pay $10,000 in cash and provide a promissory note for the remaining $90,000.
(1) Suppose that the promissory note calls for nine additional annual installments of $10,000 each plus interest at the prime rate. How does your analysis in (a), above, change, if at all, as a result of this change in the consideration paid by the corporation for Bea's stock?
(2) Suppose that the promissory note calls for annual payments over a 20-year term plus interest at 18 percent, that the note is secured by an interest in the corporation's assets, and that the corporation will restrict dividend payments, limit new indebtedness and refrain from taking certain extraordinary corporate actions (like a merger or liquidation) during the term of the note. How does your analysis in (a), above, change, if at all, as a result of this change in the consideration paid by the corporation for Bea's stock?
(c) Suppose that Yolanda and Bea are sisters. How does your analysis in (a), above, change, if at all?
(d) Suppose that Bea is Yolanda's mother.
(1) How does your analysis in (a), above, change, if at all?
(2) How does your analysis in (b)(1) and (2), above, change, if at all?
(e) Suppose that Bea retains an interest in 20 shares of nonvoting, preferred stock (the only preferred shares outstanding) that she received in exchange for making an additional capital contribution to the corporation in 1994. How does your analysis in (a), above, change, if at all?
(f) Suppose that Proper Topper properly elected taxation as a Subchapter S corporation effective in 1994. How does your analysis in (a) change, if at all?
II (60%)
Write no more than 9 pages total (not including diagrams) on the questions in this section.
Jim and Carol each own 50 percent of the voting common stock (the only class outstanding) of Red Rover Auto Supplies (a retail automobile parts store), which is worth $500,000, has an asset basis of $100,000 and has $400,000 in accumulated earnings and profits. They borrowed $50,000 each from Neighborhood Bank to buy their stock 8 years ago (so their stock basis is $50,000 each), and each now owes $40,000 to Neighborhood. Jim and Carol have been approached by Big Bad Auto, which is interested in adding the Red Rover store to its national chain of retail auto parts stores. Big Bad Auto has assets worth $10 million at a basis of $6 million and has accumulated earnings and profits of $2 million. Darryl and Rosa each own 50% of the voting common stock (the only class outstanding) of Big Bad Auto, and each has a stock basis of $100,000. Big Bad Auto has offered the following consideration for the Red Rover stock owned by Jim and Carol: $120,000 cash, $300,000 in nonvoting preferred stock in the combined business (not convertible to common) and assumption of the $80,000 Neighborhood debt. Jim and Carol are interested in the offer (they would love to retire), but they do not want to pay any tax on receipt of the preferred stock. They (and their corporation) are your clients, and they have come to you for tax advice. For purposes of the following questions, assume that the acquisition would not qualify as a tax-free reorganization under Section 368.
(a) Advise your clients whether, and the extent to which, formation of a new corporation to combine ownership of the two businesses would permit them to achieve their goals. It is up to you to determine the details of how a new corporation might be used to combine the businesses in a way that best accomplishes your clients' goals. Such combination could involve having the new corporation own the assets of both corporations or the stock of both corporations, or it could involve some combination of stock and asset ownership. To help your clients understand how the transaction would work, use a separate sheet of paper to diagram (1) the transaction you would propose and (2) where the parties will end up after the transaction. Be sure to spell out to your clients all the tax consequences of the transaction, even those that do not appear directly related to their specified goals.
(b) Suppose that, within six months after the acquisition, the new corporation will offer for sale to the public newly issued voting common stock representing one-half the value of the combined business. How does your analysis in (a), above, change, if at all?
(c) Suppose that, instead of combining the two businesses in a new corporation, Red Rover sells its assets to Big Bad Auto in exchange for $200,000 in cash and $300,000 in nonconvertible, nonvoting preferred stock in Big Bad Auto and that Red Rover then distributes that consideration to Jim and Carol in exchange for their stock. Describe the tax consequences of this transaction for the parties. Compare the advantages and disadvantages of this transaction relative to the new corporation transaction you have devised in (a), above.
(d) Suppose that Red Rover is, and always has been, taxed as a Subchapter S corporation.
(1) How does your analysis in (a), above, change, if at all?
(2) How does your analysis in (c), above, change, if at all?
THE END
0 Nonproportional fonts, such as Courier, have letters that are all the same size. Therefore, the number of characters per inch does not vary depending on the letters used. 0 CPI is not the same as "point" size (e.g., 10-point font). The exam questions appear in Courier font size 10, which meets the 12 CPI requirement. Use a ruler or compare with the exam questions to make sure you get the font size correct.