REVIEW PROBLEMS

WILLIAM MITCHELL COLLEGE OF LAW

FINAL EXAMINATION--TAKE-HOME

BUSINESS ENTITY TAX, SPRING 1999

Professor DENISE ROY

Handout Date: Available as of Thursday, April 29, 1999, 8:30 a.m.

Due Date: Seven days after pick-up (including pick-up and drop-off days),

but no later than Thurs., May 6, 1999, 8 p.m., if you are a graduating senior,

or Thurs., May 13, 1999, 5 p.m., if you are not a graduating senior.

ADDITIONAL INSTRUCTIONS:

1. ONCE YOU HAVE PICKED UP THIS EXAM, YOU MAY DISCUSS THE EXAM WITH OTHER MEMBERS OF THE CLASS WHO ALSO HAVE AN EXAM CHECKED OUT AT THE TIME OF THE DISCUSSION. DURING THE TIME YOU HAVE THE EXAM CHECKED OUT (FROM TIME OF PICK-UP TO TIME OF DROP-OFF), 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 WHO ALSO HAVE AN EXAM CHECKED OUT AND ME. DURING ANY TIME FROM APRIL 29, 1999, THROUGH MAY 13, 1999, THAT YOU DO NOT HAVE AN EXAM CHECKED OUT, DO NOT DISCUSS THE EXAM, THE ISSUES RAISED IN THE COURSE OR ANY OTHER ASPECT OF THE COURSE WITH ANY PERSON. 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), except as otherwise indicated. There is a total 11-page length limitation on the exam. In addition, each section of the exam is subject to a length 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) and may be hand-drawn. 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 6 PAGES OF SECTION I). 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, and (2) taxpayers use the cash method of accounting and a calendar-year accounting period, 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 (60%)

Write no more than 6 pages total (not including diagrams) on the questions in this section.

You are a lobbyist hired by a consortium of oil and gas partnerships to seek repeal of the Section 704(c)(1)(B) "mixing bowl" provision. Your clients are concerned about the effect of the provision in situations represented by the following example:

On January 1, 1998, A and B formed a general partnership, with A and B each contributing "Section 1245 property" worth $200,000. ("Section 1245 property" is depreciable personal property used in a trade or business and subject to depreciation recapture under Section 1245.) A's basis in the property she contributed ("Property A") was $20,000. B's basis in the property he contributed ("Property B") was $60,000. In 1999, the partnership was surprised to determine that it would not be able to obtain regulatory approval to conduct its business and decided to liquidate. For valid business reasons, the partners would like to distribute Property A to B and Property B to A in complete liquidation of the partnership, which has no other assets or liabilities.

(a) Diagram the formation and proposed liquidation of the partnership in this example, as well as the positions of the parties before and after the events described.

(b) Explain the tax consequences to A, B and the partnership from the formation and proposed liquidation of the partnership under current law. For this purpose, you may assume that (1) any fair market value and basis information you need to do this analysis will remain unchanged from the time of the contributions to the time of the distributions, (2) the liquidation and distributions were not planned or anticipated when the partnership was formed, and (3) the proposed liquidation will take place on June 30, 1999.

(c) Can you suggest any idea(s) for modifying the liquidation proposal to improve the tax consequences to the parties? Explain your idea(s).

(d) Explain how your analysis in (b) would change if 704(c)(1)(B) were repealed.

(e) In your role as lobbyist, argue that Section 704(c)(1)(B) is (i) generally unnecessary to ensure that partners will eventually recognize the appropriate amount and character of gain, and (ii) contrary to the theory of aggregation taxation underlying Subchapter K.

(f) Explain how your analysis in (b) would change if A and B instead formed a Subchapter S corporation, with each receiving 50 percent of the corporation's stock in exchange for the contributed property. Do these results seem sensible to you? Explain.

End of Section I. Go to the next page.

II (40%)

Write no more than 5 pages total on the questions in this section.

A. Naomi, Wynonna and Faith own all the common stock in Divas Incorporated, a Subchapter C corporation. Naomi owns 225 shares (22.5 percent), Wynonna owns 375 shares (37.5 percent) and Faith owns 400 shares (40 percent). Naomi's will leaves all her Divas stock to her daughter Wynonna (none to Ashley!). She anticipates that her estate will redeem the Divas stock and distribute the proceeds to Wynonna. Applying current law, explain the tax consequences of the anticipated redemption of Naomi's stock by her estate, assuming that Divas has ample E&P.

B. Below is a list of circumstances individual business owners may encounter over the life of a business entity. For each, indicate (with an "X" in the appropriate space) whether, focusing on the tax consequences associated with the particular circumstance, the parties' overall tax outcome would generally be most favorable if the business were operated as a Subchapter C corporation, Subchapter S corporation or partnership. If two options would be equally favorable, check both. If no option is more favorable than the others, check "no difference." For each circumstance, provide a brief explanation for your choice, including any caveats or limitations on any advantage(s) you identify. Your explanations must be included with the rest of the exam answers and are subject to the total page limitation for this section II.

(1) The business will retain earnings to reinvest for business growth.