WILLIAM MITCHELL COLLEGE OF LAW
FINAL EXAMINATION--TAKE-HOME
CORPORATE TAX (LL.M.)
FALL 1998
Professor DENISE ROY
Handout Date: Friday, December 4, 1998, 8:30 a.m.
Due Date: Wednesday, December 16, 1998, 8:00 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 10-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 10 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 3 pages (not including diagrams) on the questions in this section.
Your client, Healthionics, Inc., is a Subchapter S corporation in the business of manufacturing electronic medical equipment. It operates a division (not a separate corporation) that researches, develops and tests new equipment prototypes. Because the division engages in tests involving human subjects, its activities pose significant liability risks for the corporation. To shield its manufacturing operations from this liability, Healthionics' executives would like to move this research and development ("R&D") division into a subsidiary corporation. They have heard that Subchapter S corporations may own "wholly owned" subsidiaries and would like to explore the tax implications of forming such a subsidiary to hold its R&D division.
(a) Describe and diagram the likely transaction structure Healthionics would use to "drop" (transfer) its R&D division into a new subsidiary. (Even if you know something about it, do not discuss state incorporation law.)
(b) Explain the likely tax consequences of the transaction described in (a) and list any further information you would need to analyze those tax consequences fully. Explain why the additional information is significant.
(c) Advise Healthionics whether it should elect to treat its new R&D subsidiary as a qualified subchapter S subsidiary (QSSS) and explain your analysis.
(d) You are aware that the IRS would treat a QSSS election as a deemed liquidation of the subsidiary. Applying the liquidation rules we studied in class (in other words, without referring to any special QSSS rules), explain the likely tax consequences of such a deemed liquidation.
II. (60%)
Write no more than 7 pages (not including diagrams) on the questions in this section.
Ice Cream Inc. is a calendar-year corporation. It properly elected taxation as a small business corporation under Subchapter S of the Internal Revenue Code effective as of the first day of its first taxable year and at all times thereafter.
Ice Cream has 100 shares of common stock outstanding, of which only 90 shares have voting rights. Ben and Jerry, soul mates who are otherwise unrelated to each other, each own 45 shares of the voting common stock with basis of $400,000 apiece. Thus, each owns 50 percent of the voting common stock and 45 percent of the total common stock of Ice Cream Inc. Ben's mother, Cass, owns the 10 shares of Ice Cream nonvoting common stock, or 10 percent of the total common stock, with a basis of $100,000. Altogether, the corporation's 100 issued and outstanding shares of common stock are worth $5,000,000; therefore, Ben and Jerry's stock interests are worth at least $2,250,000 each, and Cass' stock is worth up to $500,000 (probably something less since it does not carry voting rights, but you can use $500,000 for purposes of analysis).
Ice Cream mostly owns and operates ice cream manufacturing and packaging plants and a chain of retail ice cream shops. In 1993, consistent with its bleeding heart image and simultaneously with introduction of its new "Spotted Owl" flavor of ice cream, Ice Cream purchased some old growth forest in the Pacific Northwest for $440,000, hoping to prevent logging that would threaten the endangered spotted owls living on the property. Now that the federal government has pledged to protect the endangered owls at all costs, Ice Cream is free to get rid of the old growth forest property. Ben and Jerry are considering proposing to Cass that Ice Cream distribute the old growth forest property to her in exchange for all of her stock. Although the property is worth more than her stock, they don't want to break up the parcel, and they are happy to be able to provide her with a piece of wilderness on which she can retire with her tent, snowshoes, etc. Ben and Jerry would like to continue retaining Mama Cass as an Ice Cream New Flavor Consultant after the redemption. (They are excited about her idea for a new flavor of sorbet called "Yellow Snow.") The redemption would take place in 1999, a year in which Ben and Jerry anticipate that Ice Cream will generate net taxable income from operations of $400,000. Assume that immediately before the proposed exchange the corporation's outstanding common stock will be worth $5,000,000 and the old growth forest property will be worth $600,000 with a basis to Ice Cream of $440,000.
(a) Diagram the positions of the parties before and after the proposed redemption as well as the transaction itself.
(b) Discuss and diagram alternative ways the transfer of excess value (property value in excess of stock value) to Mama Cass could be characterized.
(c) Explain the tax consequences to the shareholders and the corporation from the exchange of Mama Cass' $500,000 in stock for $600,000 in old growth forest property.
(d) Would a closing of the books election be available in the year of Mama Cass' redemption?
(e) How would your analysis in (c) change, if at all, if the old growth forest property had a basis of $700,000?
(f) How would your analysis in (e) change, if at all, if the corporation sold the property and distributed the cash to Mama Cass?
(g) How would your analysis in (c) change, if at all, if Ice Cream were, and had always been, a C corporation? Assume ample E&P.
(h) How would your analysis in (c) change, if at all, if Ice Cream had acquired the old growth forest property, worth $525,000 at the time, in a 1993 tax-free merger of a C corporation into Ice Cream in which Ice Cream took a carryover (transferred) basis of $450,000 in the property and inherited tax attributes of the target corporation, including $300,000 of E&P? Assume AAA at the beginning of 1999 is $0. (A tax-free merger is a nonrecognition transaction in which the acquiring corporation acquires assets of the target corporation with a carryover basis and inherits the tax attributes of the target corporation. Answering this question does not require outside research or any further understanding of mergers or the tax-free merger rules.)
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.