Skip to main content
Sign in Create a free account
Varsity Tutors
Sign in

Account For Corporate Distributions - CPA Reg

  1. Cedar, Inc. is a C corporation. Cedar redeems 30% of a shareholder's stock for $200,000 cash; the shareholder's basis in the redeemed shares is $80,000. After the redemption, the shareholder owns 70% of Cedar (down from 100%). Which section of the Internal Revenue Code applies to determine whether the redemption is treated as a sale or exchange versus a dividend?
    Answer: IRC §302. IRC §302 governs stock redemptions and determines whether a redemption is treated as a sale or exchange (capital gain treatment) or as a distribution under §301 (potentially dividend treatment). The redemption of 30% of the shareholder's stock, reducing ownership from 100% to 70%, must be tested under §302(b) to determine if it qualifies for exchange treatment. Answer B (§301) applies to distributions, not redemptions. Answer C (§331) applies to complete liquidations, not partial redemptions. Answer D (§1368) applies to S corporation distributions, not C corporation redemptions. The §302 tests include complete termination, substantially disproportionate redemption, and not essentially equivalent to a dividend.
  2. Summit Corp. (a C corporation) makes a nonliquidating distribution of $50,000 cash to its shareholder. Summit has current E&P of $15,000 and accumulated E&P of $10,000 at the beginning of the year. The shareholder's basis in Summit stock is $30,000. Under IRC §301, what amount is treated as a dividend?
    Answer: $25,000, limited to total current plus accumulated E&P. IRC §301(c)(1) treats distributions as dividends to the extent of current and accumulated earnings and profits. Summit's total E&P is $25,000 ($15,000 current plus $10,000 accumulated), so $25,000 of the $50,000 distribution is dividend income. The remaining $25,000 is treated under §301(c)(2) as a return of capital, reducing the shareholder's stock basis from $30,000 to $5,000. Answer A incorrectly uses only current E&P. Answer C incorrectly treats the entire distribution as a dividend. Answer D incorrectly ignores E&P because of sufficient basis. The ordering rule requires dividend treatment to the extent of total E&P before basis recovery.
  3. Delta Corp. (a C corporation) completely liquidates and distributes $400,000 cash to a shareholder who has an adjusted basis of $260,000 in Delta stock. Delta has $150,000 of earnings and profits (E&P) at the time of liquidation. Under IRC §331, how should the shareholder report the liquidating distribution?
    Answer: $140,000 capital gain ($400,000 amount realized minus $260,000 basis). IRC §331 provides that amounts received by a shareholder in complete liquidation of a corporation are treated as full payment in exchange for the stock. The $400,000 cash received in complete liquidation is compared to the shareholder's $260,000 stock basis, resulting in $140,000 capital gain. The corporation's E&P of $150,000 is irrelevant in a complete liquidation under §331, as the entire transaction is treated as a sale of stock. Answer A incorrectly applies §301 distribution rules to a liquidation. Answer C incorrectly characterizes the gain as ordinary income. Answer D incorrectly states that liquidating distributions cannot create gain. The key distinction is that §331 liquidations receive exchange treatment regardless of E&P.
  4. Timber, Inc. is a C corporation with current and accumulated E&P of $45,000. Timber distributes $60,000 cash to its shareholder whose stock basis is $8,000. Under IRC §301, what is the shareholder's stock basis immediately after the distribution?
    Answer: $0, because the distribution includes a return of capital that reduces basis to zero. IRC §301 establishes the treatment of distributions in a specific order that affects stock basis. Timber's $60,000 distribution is first treated as a $45,000 dividend to the extent of E&P, which does not reduce stock basis. The remaining $15,000 is a return of capital under §301(c)(2), reducing the shareholder's basis from $8,000 to zero, with $7,000 treated as capital gain under §301(c)(3). Answer A incorrectly states dividends don't affect basis calculations. Answer C incorrectly allows negative basis. Answer D incorrectly increases basis for dividends. The shareholder's basis after the distribution is zero, as basis cannot go below zero for stock.
  5. Vista Corp. is a C corporation that completely liquidates and distributes marketable securities with FMV $150,000 to a shareholder with an adjusted basis of $180,000 in Vista stock. Vista has $60,000 of earnings and profits (E&P) at liquidation. Under IRC §331, what is the shareholder's recognized gain or loss?
    Answer: $30,000 capital loss ($150,000 amount realized minus $180,000 basis). IRC §331 treats amounts received in complete liquidation as payment in exchange for stock, allowing capital gain or loss recognition. The shareholder receives securities worth $150,000 in exchange for stock with basis of $180,000, resulting in a $30,000 capital loss. The corporation's E&P of $60,000 is irrelevant in complete liquidations, as the entire transaction is treated as a stock sale. Answer B incorrectly applies dividend treatment in a liquidation. Answer C incorrectly denies loss recognition. Answer D incorrectly characterizes the loss as ordinary. Complete liquidations under §331 generate capital gain or loss based on the difference between amount realized and stock basis.
  6. Orchid Corp. is a C corporation. Orchid redeems 10% of a shareholder's stock for $60,000 cash; the shareholder's basis in the redeemed shares is $20,000, and the shareholder continues to own 90% after the redemption. Which section of the IRC applies to analyze whether the redemption is treated as a dividend under the redemption rules versus a sale or exchange?
    Answer: IRC §302. IRC §302 governs stock redemptions and establishes tests to determine whether a redemption qualifies for sale or exchange treatment versus dividend treatment under §301. The redemption of 10% of the shareholder's stock must be analyzed under §302(b) tests, including substantially disproportionate redemption and not essentially equivalent to a dividend. Answer A (§1368) applies to S corporations, not C corporations. Answer C (§331) applies to complete liquidations. Answer D (§721) applies to partnership contributions. Since the shareholder still owns 90% after redemption, careful analysis under §302 is required to determine if exchange treatment is available.
  7. Ironwood, Inc. is a C corporation. Ironwood redeems all of a shareholder's shares for $500,000 cash; the shareholder's basis in the redeemed stock is $310,000. Which section of the IRC generally governs the shareholder-level characterization of the redemption as a sale or exchange versus a dividend?
    Answer: IRC §302. IRC §302 governs the tax treatment of stock redemptions, determining whether they qualify for sale or exchange treatment (capital gain) or are treated as distributions under §301 (potentially dividends). The complete redemption of all shares for $500,000 cash must be analyzed under §302(b)(3) for complete termination of interest, which generally qualifies for exchange treatment. Answer B (§301) applies to distributions, not redemptions. Answer C (§331) applies to corporate liquidations, not redemptions of individual shareholders. Answer D (§351) applies to transfers to corporations in exchange for stock. The complete termination typically receives favorable capital gain treatment unless attribution rules apply.
  8. Juniper Corp. is a C corporation with current and accumulated E&P of $0. Juniper distributes $25,000 cash to its shareholder whose adjusted basis in Juniper stock is $18,000. Under IRC §301, what is the tax treatment to the shareholder?
    Answer: $18,000 return of capital reducing basis to zero and $7,000 capital gain. IRC §301 requires distributions to be treated as dividends only to the extent of current and accumulated E&P. With Juniper's E&P at zero, the entire $25,000 distribution is governed by §301(c)(2) and (c)(3). First, $18,000 reduces the shareholder's stock basis to zero as a tax-free return of capital under §301(c)(2). The remaining $7,000 exceeding basis is treated as gain from the sale of stock under §301(c)(3), which is capital gain. Answer A incorrectly assumes all distributions are dividends. Answer C incorrectly treats the entire amount as capital gain. Answer D reverses the correct ordering. The statutory scheme prioritizes E&P, then basis reduction, then gain recognition.
  9. Kite, Inc. is a C corporation with current and accumulated E&P of $40,000. Kite distributes to its shareholder a machine with FMV $65,000 and adjusted basis to Kite of $80,000 (no liabilities). What amount of gain or loss is recognized by Kite on the distribution?
    Answer: $0; no loss is recognized on a nonliquidating distribution of property. IRC §311(a) provides the general rule that a corporation recognizes no gain or loss on the distribution of property to shareholders with respect to its stock. However, §311(b) creates an exception requiring gain recognition on appreciated property. Since Kite's property has declined in value (FMV $65,000 < basis $80,000), the general rule of §311(a) applies and no loss is recognized. Answer B incorrectly allows loss recognition. Answer C incorrectly calculates a gain on depreciated property. Answer D incorrectly limits recognition to E&P. The policy prevents corporations from selectively recognizing losses through distributions while retaining appreciated property.
  10. Granite, Inc. is a C corporation with current and accumulated E&P of $55,000. Granite distributes $70,000 cash to its shareholder whose adjusted basis in Granite stock is $20,000. Under IRC §301, what amount is treated as a dividend?
    Answer: $55,000, limited to current and accumulated E&P. IRC §301(c)(1) treats corporate distributions as dividends to the extent of current and accumulated earnings and profits. Granite's $70,000 cash distribution is analyzed against its E&P of $55,000, resulting in $55,000 of dividend income to the shareholder. The remaining $15,000 is treated under §301(c)(2) as a return of capital, reducing the shareholder's stock basis from $20,000 to $5,000. Answer A incorrectly treats the entire distribution as a dividend. Answer C incorrectly limits dividends to stock basis. Answer D incorrectly states no dividend treatment applies. The ordering rule requires dividend treatment to the extent of E&P before any basis recovery.
  11. River Co. is an S corporation with no accumulated earnings and profits. River distributes $80,000 cash to a shareholder whose stock basis immediately before the distribution is $10,000. The shareholder has no debt basis. How should the distribution be reported by the shareholder?
    Answer: $10,000 reduces stock basis to zero and $70,000 is capital gain. S corporation distributions without accumulated E&P follow IRC §1368(b), providing tax-free treatment to the extent of stock basis. River's $80,000 distribution to a shareholder with only $10,000 stock basis results in $10,000 tax-free return of capital reducing basis to zero, with the excess $70,000 treated as gain from the sale of property (capital gain) under §1368(b)(2). Answer A incorrectly applies C corporation dividend rules. Answer C incorrectly allows negative basis. Answer D incorrectly splits the excess between ordinary income and capital gain. The entire excess over basis is capital gain for S corporation distributions without E&P.
  12. Harbor Co. is an S corporation with no accumulated earnings and profits. In the current year, Harbor distributes $30,000 cash to a shareholder with stock basis of $38,000 immediately before the distribution. How should the distribution be reported by the shareholder?
    Answer: $30,000 return of capital reducing stock basis to $8,000, with no gain recognized. S corporation distributions without accumulated E&P are governed by IRC §1368(b), which provides tax-free treatment to the extent of stock basis. Harbor's $30,000 distribution to a shareholder with $38,000 stock basis is entirely a tax-free return of capital, reducing the shareholder's basis from $38,000 to $8,000. No gain is recognized because the distribution does not exceed basis. Answer A incorrectly applies C corporation dividend rules requiring E&P. Answer B incorrectly characterizes all S corporation distributions as capital gain. Answer D incorrectly treats S corporation distributions as wages. The key principle is that S corporation distributions without E&P reduce basis first before generating gain.
  13. Falcon Co. is a C corporation with current and accumulated E&P of $100,000. Falcon distributes property to its shareholder with FMV $140,000 and Falcon's adjusted basis of $90,000. The shareholder's basis in Falcon stock is $60,000. What is the shareholder's basis in the property received, assuming the distribution is governed by IRC §301?
    Answer: $140,000, the property's fair market value. Under IRC §301(d), a shareholder's basis in property received in a corporate distribution equals the property's fair market value on the distribution date. The shareholder receives property with FMV of $140,000, which becomes the shareholder's basis regardless of the corporation's basis ($90,000) or the shareholder's stock basis ($60,000). This FMV basis rule ensures proper measurement of future gain or loss when the shareholder disposes of the property. Answer A incorrectly uses the corporation's basis. Answer B incorrectly limits basis to stock basis. Answer D incorrectly limits basis to E&P. The distribution itself is taxed under §301(c) based on E&P and stock basis, but the property basis is always FMV.
  14. Maple Co. is an S corporation with no accumulated earnings and profits. Maple distributes $52,000 cash to a shareholder whose stock basis immediately before the distribution is $52,000. How should the distribution be reported by the shareholder?
    Answer: No income; the distribution reduces stock basis to $0 with no gain recognized. S corporation distributions without accumulated E&P are governed by IRC §1368(b), providing tax-free treatment to the extent of stock basis. Maple's $52,000 distribution exactly equals the shareholder's $52,000 stock basis, resulting in a complete return of capital that reduces basis to zero with no income recognition. This is the optimal outcome for S corporation distributions. Answer B incorrectly applies C corporation dividend rules. Answer C incorrectly generates capital gain when distribution equals basis. Answer D incorrectly characterizes S corporation distributions as wages. The key principle is that S corporation distributions are tax-free to the extent of the shareholder's basis in stock.
  15. Noble, Inc. is a C corporation with current and accumulated E&P of $110,000. Noble distributes $95,000 cash to its shareholder whose adjusted basis in Noble stock is $40,000. Under IRC §301, what portion of the distribution is treated as a return of capital?
    Answer: $0, because E&P exceeds the distribution and the full amount is a dividend. IRC §301(c) establishes the ordering rules for corporate distributions: dividends to the extent of E&P, then return of capital to the extent of basis, then capital gain. Noble's E&P of $110,000 exceeds the $95,000 distribution, so the entire distribution is treated as a dividend under §301(c)(1). No portion is treated as a return of capital because the dividend characterization exhausts the entire distribution. Answer B incorrectly limits return of capital to stock basis. Answer C incorrectly applies basis reduction before E&P. Answer D incorrectly calculates a return of capital amount. The shareholder's $40,000 basis remains unchanged after receiving a dividend distribution.
  16. Yarrow, Inc. is a C corporation with current and accumulated E&P of $65,000. Yarrow distributes $50,000 cash to its shareholder whose adjusted basis in Yarrow stock is $22,000. Under IRC §301, what is the tax treatment of the distribution?
    Answer: $50,000 is a dividend under IRC §301(c)(1). Under IRC §301, corporate distributions are taxed based on the corporation's earnings and profits (E&P), with distributions first treated as dividends to the extent of current and accumulated E&P. Yarrow has $65,000 in E&P and distributes $50,000 cash, which is less than the available E&P, making the entire distribution taxable as a dividend under §301(c)(1). The shareholder's $22,000 basis in the stock is irrelevant for determining dividend treatment, as basis only matters after E&P is exhausted. Option B incorrectly applies the ordering rules by treating part of the distribution as return of capital when E&P exceeds the distribution amount. Option C is incorrect because this is a non-redemptive distribution governed by §301, not a stock redemption under §302. Option D misunderstands the §301 ordering rules by prioritizing basis recovery over E&P. When analyzing corporate distributions, always compare the distribution amount to available E&P first—if E&P covers the entire distribution, it's all dividend income regardless of shareholder basis.
  17. Xylem Co. is an S corporation with no accumulated earnings and profits. Xylem distributes $18,000 cash to a shareholder whose stock basis immediately before the distribution is $5,000. How should the distribution be reported by the shareholder?
    Answer: $5,000 return of capital reducing stock basis to zero and $13,000 capital gain. S corporation distributions without accumulated E&P are governed by IRC §1368(b), providing tax-free return of capital to the extent of stock basis. Xylem's $18,000 distribution first reduces the shareholder's stock basis from $5,000 to zero (tax-free), with the excess $13,000 treated as gain from the sale of property under §1368(b)(2), which is capital gain. Answer A incorrectly allows full basis offset when basis is only $5,000. Answer C incorrectly allows negative basis. Answer D incorrectly characterizes the income types. The correct treatment follows the statutory ordering: basis reduction first, then capital gain for any excess.
  18. Umber Co. is a C corporation. Umber distributes to its shareholder a building with FMV $200,000 and adjusted basis to Umber of $130,000; the building is subject to a $220,000 mortgage that the shareholder assumes. What amount of gain or loss is recognized by Umber on the distribution?
    Answer: $90,000 gain, because the amount realized is treated as at least the liability assumed ($220,000) minus basis $130,000. IRC §311(b) requires gain recognition on distributed appreciated property, with special rules when liabilities exceed fair market value. When the liability ($220,000) exceeds FMV ($200,000), the amount realized is treated as the greater of FMV or liability assumed. Umber recognizes gain of $90,000, calculated as $220,000 (liability) minus $130,000 (basis). Answer A incorrectly allows no recognition. Answer B incorrectly uses only FMV. Answer D incorrectly allows loss recognition on a distribution. The rule prevents tax avoidance through distributions of encumbered property and ensures gain recognition on appreciated property leaving corporate solution.
  19. Eagle, Inc. is a C corporation with current and accumulated E&P of $30,000. Eagle distributes to its shareholder a parcel of land with fair market value (FMV) $50,000 and adjusted basis to Eagle of $18,000; the land is subject to a liability of $10,000 assumed by the shareholder. What amount of gain or loss is recognized by the corporation on the distribution?
    Answer: $32,000 gain, equal to FMV $50,000 minus basis $18,000. IRC §311(b) requires a corporation to recognize gain on the distribution of appreciated property as if the property were sold to the shareholder at fair market value. Eagle must recognize gain equal to the FMV of $50,000 minus its basis of $18,000, resulting in $32,000 gain. The $10,000 liability assumed by the shareholder does not reduce the amount realized by the corporation for purposes of §311(b). Answer A incorrectly states the general rule that corporations don't recognize gain, which has exceptions for appreciated property. Answer C incorrectly reduces FMV by the liability. Answer D incorrectly uses only the liability in the gain calculation. The policy rationale is to prevent corporations from distributing appreciated property to avoid corporate-level gain.
  20. Pine, Inc. is a C corporation with current and accumulated E&P of $25,000. Pine distributes property with FMV $60,000 and adjusted basis to Pine of $10,000 (no liabilities) to its shareholder. Under the property distribution rules, what amount of gain or loss is recognized by Pine?
    Answer: $50,000 gain, equal to FMV $60,000 minus basis $10,000. IRC §311(b) requires a corporation to recognize gain on the distribution of appreciated property as if sold to the shareholder at fair market value. Pine must recognize gain of $50,000, calculated as FMV of $60,000 minus adjusted basis of $10,000. The amount of E&P ($25,000) does not limit the corporation's recognized gain. Answer A incorrectly applies the general no-recognition rule that has exceptions. Answer C incorrectly limits gain to E&P amount. Answer D confuses the shareholder's dividend with the corporation's gain. The policy ensures that appreciation is taxed at the corporate level before assets leave corporate solution.

Start this quiz