- Renata and Silvio form a general partnership, each contributing $50,000 cash. The partnership agreement allocates profits and losses equally. After two years, Renata sells her entire 50% interest to Tomas for $80,000. Which of the following correctly describes the tax consequences to Renata?
Answer: Renata recognizes $30,000 of capital gain on the sale of her partnership interest.
Renata's outside basis = $50,000 (original cash contribution, adjusted for her share of income, losses, and distributions over two years, but assuming basis remains at $50,000 for this problem). Gain on sale = $80,000 - $50,000 = $30,000. Under Section 741, the gain on sale of a partnership interest is generally treated as capital gain. However, under Section 751 (hot assets), gain attributable to unrealized receivables and substantially appreciated inventory is recharacterized as ordinary income. Answer A correctly identifies the Section 751 hot asset rule, but the question stem does not specify that hot assets exist, so Answer B (pure capital gain) is the default treatment absent hot assets. Answer C is incorrect because gain is recognized on the sale. Answer D is incorrect because partnership interest sales are generally capital, not ordinary.
- Marlow transfers property with an adjusted basis of $50,000 and fair market value of $120,000 to a new corporation in exchange for stock worth $120,000. Marlow is the sole shareholder immediately after the transfer. What is Marlow's basis in the stock received?
Answer: $50,000, the adjusted basis of the property transferred.
Under Section 358, when a shareholder transfers property in a qualifying Section 351 exchange, the shareholder's basis in the stock received equals the adjusted basis of the property transferred, decreased by any boot received and increased by any gain recognized. Since no boot was received and no gain was recognized, Marlow's stock basis = $50,000 (the adjusted basis of the property transferred). Answer D is correct. Answer A ($120,000) is the FMV of the stock received and would apply only if gain had been fully recognized. Answer B ($85,000) has no basis in the Section 358 formula. Answer C ($70,000) represents the deferred gain, not the stock basis.
- Which of the following events will cause a technical termination of a partnership for federal tax purposes under pre-2018 law (before the Tax Cuts and Jobs Act repeal)?
Answer: Within a 12-month period, 50% or more of the total interest in partnership capital and profits is sold or exchanged.
Under pre-TCJA Section 708(b)(1)(B), a partnership was considered terminated for federal tax purposes if within a 12-month period there was a sale or exchange of 50% or more of the total interest in partnership capital and profits. The TCJA repealed this technical termination rule for tax years beginning after December 31, 2017. Answer A is incorrect because a partner's retirement with a liquidating distribution does not trigger a technical termination; the partnership continues if at least two partners remain. Answer B is incorrect because a conversion from a general to a limited liability partnership generally does not cause a termination if the same entity continues. Answer C is incorrect because a bankruptcy filing does not automatically terminate a partnership for tax purposes.
- Under Section 351, a shareholder transfers property to a corporation in exchange for stock. Which of the following conditions must be met for the transfer to qualify for nonrecognition treatment?
Answer: Immediately after the exchange, the transferring shareholders must be in control of the corporation, defined as owning at least 80% of total combined voting power and 80% of total shares of each class of nonvoting stock.
Section 351 nonrecognition applies when property is transferred to a corporation solely in exchange for stock, and immediately after the exchange, the transferring shareholders are in control of the corporation. Control means owning at least 80% of total combined voting power of all classes of voting stock and at least 80% of total shares of each class of nonvoting stock. Answer A is incorrect because shareholders may receive preferred stock as well as common stock and still qualify, as long as no boot is received. Answer B is incorrect because Section 351 applies regardless of whether the property has a built-in gain or loss. Answer D is incorrect because Section 351 applies to transfers to both new and existing corporations, provided the control requirement is met immediately after the exchange.
- What is the initial tax basis of a partner's interest received in exchange for a cash contribution of $50,000 and property with an adjusted basis of $20,000 and fair market value of $35,000?
Answer: $70,000
Under Section 722, the basis of a partner's interest acquired by contribution equals the sum of money contributed plus the adjusted basis of any property contributed. Cash contribution = $50,000; property basis = $20,000; total basis = $70,000. The fair market value of the contributed property is irrelevant to the partner's outside basis calculation. Answer B ($85,000) incorrectly substitutes the FMV of the property ($35,000) for its adjusted basis. Answer C ($50,000) counts only the cash and ignores the property contribution entirely. Answer D ($35,000) uses only the property's FMV and ignores the cash contribution.
- Under Section 721, which of the following contributions to a partnership will result in gain recognition by the contributing partner?
Answer: A contribution of property where the liabilities assumed by the partnership exceed the partner's outside basis in the partnership.
Under Section 752(b), when a partnership assumes a partner's liability, the assumption is treated as a cash distribution to that partner. If the deemed cash distribution exceeds the partner's outside basis, the excess is treated as gain under Section 731(a)(1). This is one of the key exceptions to Section 721 nonrecognition. Answer B is incorrect because contributing appreciated property for any partnership interest percentage does not trigger gain recognition under Section 721; the gain is deferred. Answer C is incorrect because cash contributions to a partnership do not trigger gain regardless of amount. Answer D is incorrect because the percentage of appreciation relative to basis is irrelevant to Section 721; nonrecognition applies regardless of the size of the built-in gain.
- Dunmore Corp contributes property with an adjusted basis of $70,000 and fair market value of $95,000 to Newco Corp in exchange for 90% of Newco's stock. What is the corporation's basis in the stock received under Section 358, assuming no boot and no gain recognized?
Answer: $70,000
Under Section 358(a), the transferor's basis in stock received in a Section 351 exchange equals the adjusted basis of the property transferred, decreased by any money received or liabilities assumed, and increased by any gain recognized. Since no boot was received and no gain was recognized, Dunmore's basis in the Newco stock = $70,000 (the adjusted basis of the property transferred). Answer A ($95,000) is the FMV of the stock received and would apply only if gain were fully recognized. Answer B ($25,000) represents the unrealized appreciation, not the stock basis. Answer C ($85,500) represents 90% of the FMV, which has no basis in Section 358.
- A transferor contributes services, rather than property, to a corporation in exchange for stock in a Section 351 exchange. How is the stock received for services treated?
Answer: The stock received for services is excluded from the Section 351 exchange but the property contributors may still qualify if they meet the control requirement without counting the service contributor.
Under Section 351 and its regulations, a person who transfers only services to a corporation does not qualify for nonrecognition - the stock received for services is taxable as ordinary compensation income. For purposes of the 80% control test, service-only contributors are excluded from the Section 351 group; property contributors must independently satisfy the control requirement without counting the service contributor. Answer C is correct. Answer A is incorrect because stock received for services is still taxable as ordinary income even when the contributor also transfers property in the same exchange. Answer B is incorrect because service income is ordinary income, not capital gain. Answer D is incorrect; neither new formation nor majority-shareholder status exempts the service contributor from ordinary income recognition.
- Under Section 331, a shareholder receives a liquidating distribution of $200,000 from a corporation in complete liquidation. The shareholder's adjusted basis in the stock is $80,000. How is this distribution treated for federal income tax purposes?
Answer: The $120,000 gain is treated as capital gain from the sale or exchange of the stock.
Under Section 331, amounts received by a shareholder in a complete liquidation of a corporation are treated as full payment in exchange for the shareholder's stock. The shareholder recognizes gain or loss equal to the difference between the fair market value of property received and the adjusted basis of the stock. Here, the $120,000 gain ($200,000 - $80,000) is capital gain. Answer A is incorrect because Section 331 provides sale-or-exchange treatment, resulting in capital gain rather than ordinary income. Answer B is incorrect because the dividend rules apply to non-liquidating distributions; Section 331 expressly overrides the dividend rules for complete liquidations. Answer D is incorrect because gain is recognized to the extent proceeds exceed stock basis; only the return of basis portion ($80,000) is tax-free.
- Fairview Corp, a C corporation, is undergoing a complete liquidation under Section 331. It distributes land with an adjusted basis of $200,000 and a fair market value of $350,000 subject to a mortgage of $80,000 to its sole shareholder. What amount does the shareholder include as the amount realized under Section 331?
Answer: $270,000
Under Section 331, the shareholder's amount realized equals the fair market value of property received minus any liabilities assumed by the shareholder. When encumbered property is distributed, the shareholder takes the property subject to the existing mortgage. Amount realized = $350,000 - $80,000 = $270,000. The shareholder then computes gain by comparing $270,000 to the stock basis. Answer B is correct. Answer A ($350,000) ignores the mortgage reduction to amount realized. Answer C ($150,000) would result from subtracting the corporate basis ($200,000) from FMV ($350,000), which is not the correct computation. Answer D ($430,000) incorrectly adds the mortgage rather than subtracting it.
- Holloway Corp transfers equipment with an adjusted basis of $90,000 and a fair market value of $130,000 to Newco Corp in exchange for 85% of Newco's stock valued at $130,000. The transfer qualifies under Section 351. What basis does Newco take in the equipment under Section 362?
Answer: $90,000, the adjusted basis of the property in the hands of the transferor.
Under Section 362(a), when a corporation receives property in a Section 351 exchange, it takes a carryover basis equal to the property's adjusted basis in the hands of the transferor, increased by any gain recognized by the transferor. Since Holloway recognized no gain (no boot received), Newco's basis in the equipment = $90,000. This preserves the built-in gain inside the corporation until the property is disposed of. Answer B (FMV) would be the basis only if the gain had been fully recognized at transfer. Answer C ($40,000) is the deferred gain, not the basis. Answer D ($110,000) has no basis in Section 362 and represents no valid computation.
- A partner contributes a building with an adjusted basis of $100,000, fair market value of $180,000, and a mortgage of $60,000 to a partnership. The partnership assumes the mortgage. Under Section 752, what is the partner's initial outside basis in the partnership interest, assuming the partner's share of the assumed liability is $15,000?
Answer: $55,000
When a partner contributes property subject to a liability, the partner's outside basis is computed as follows: start with the adjusted basis of contributed property ($100,000), decrease by the liability transferred to the partnership ($60,000), and increase by the partner's share of the assumed liability ($15,000). Outside basis = $100,000 - $60,000 + $15,000 = $55,000. Answer B ($100,000) ignores the liability entirely. Answer C ($40,000) would result from $100,000 - $60,000 with no addback for the partner's share. Answer D ($120,000) incorrectly adds both the FMV and some adjustment rather than working from adjusted basis and liability adjustments.
- Petra transfers land with an adjusted basis of $40,000 and a fair market value of $100,000 to Newco Corp in exchange for stock worth $90,000 and cash of $10,000. The transfer otherwise qualifies under Section 351. How much gain must Petra recognize?
Answer: $10,000, the amount of boot received.
Under Section 351(b), when a transferor receives boot (cash or property other than stock) in addition to stock, gain is recognized to the extent of the lesser of (1) realized gain or (2) boot received. Petra's realized gain = $100,000 FMV - $40,000 basis = $60,000. Boot received = $10,000 cash. Recognized gain = lesser of $60,000 or $10,000 = $10,000. Answer A is incorrect because receipt of boot triggers partial gain recognition. Answer B ($60,000) would be the recognized gain only if boot received equaled or exceeded the full realized gain. Answer D ($50,000) has no valid basis in the Section 351(b) computation.
- Which of the following is an ineligible shareholder that would cause an S corporation election to be invalid or terminated?
Answer: A nonresident alien individual.
Under Section 1361(b)(1), an S corporation may not have a nonresident alien as a shareholder. If a nonresident alien acquires stock in an S corporation, the S election is immediately terminated. Answer A is incorrect because a grantor trust whose grantor is a U.S. citizen is an eligible S corporation shareholder under Section 1361(c)(2). Answer C is incorrect because the estate of a deceased U.S. shareholder is an eligible shareholder and may hold S corporation stock during the administration of the estate. Answer D is incorrect because a QSST that has filed a valid election under Section 1361(d) is an eligible S corporation shareholder.
- Which of the following best describes the built-in gains (BIG) tax under Section 1374 applicable to an S corporation that was formerly a C corporation?
Answer: The BIG tax is imposed at the highest corporate rate on net recognized built-in gains during the recognition period following the S election.
Under Section 1374, when a C corporation converts to an S corporation, the BIG tax is imposed at the highest corporate tax rate (currently 21%) on net recognized built-in gains during the recognition period (5 years under current law, as modified by the Tax Cuts and Jobs Act). The tax applies to gains that were built into the corporation's assets on the conversion date but recognized during the recognition period. Answer A is incorrect because the recognition period is currently 5 years, not 3, and the rate is the corporate rate, not individual rates. Answer B is incorrect because the recognition period is 5 years (not 7) and the tax applies only to built-in gains, not all S corporation income. Answer D is incorrect because the BIG tax is a corporate-level entity tax, not a shareholder-level tax.
- Under Section 332, a parent corporation receives a liquidating distribution from its 100%-owned subsidiary. Which of the following correctly describes the tax treatment to the parent corporation?
Answer: The parent recognizes no gain or loss on the receipt of the liquidating distribution from the subsidiary.
Section 332 provides that no gain or loss is recognized by a parent corporation when it receives property in complete liquidation of a subsidiary, provided the parent owns at least 80% of the subsidiary's voting stock and total share value throughout the liquidation period. The parent takes a carryover basis in the subsidiary's assets under Section 334(b). Answer B is incorrect because Section 332 specifically provides nonrecognition of gain to the parent. Answer C is incorrect because Section 332 also disallows recognition of loss by the parent; losses on subsidiary liquidations are deferred or permanently disallowed. Answer D is incorrect because Section 332 liquidations are not treated as dividend distributions; they receive special nonrecognition treatment.
- Vesper Corp elects S corporation status on March 15 of Year 1 for the current tax year beginning January 1. Vesper had been a C corporation for its entire prior history. Which of the following requirements must Vesper meet to make a valid S election?
Answer: Vesper must obtain consent of all shareholders who held stock at any time during the portion of the year before the election.
Under Section 1362, an S election must be consented to by all persons who are shareholders on the date the election is made. If the election is to be effective for the entire current tax year, it must also be consented to by all shareholders who held stock during the portion of the taxable year before the election date. Answer D is correct. Answer A is incorrect because the S corporation shareholder limit is 100, not 150. Answer B is incorrect because accumulated C corporation E&P does not have to be distributed before the S election; it remains as C corporation E&P and is subject to built-in gains and passive income rules after conversion. Answer C is incorrect because an S corporation must use a permitted tax year, but conversion to a calendar year is not a prerequisite for the election itself.
- Tarvil Corp, a C corporation, is liquidating and distributes property with an adjusted basis of $60,000 and a fair market value of $150,000 to its sole shareholder, whose stock basis is $40,000. What gain does the shareholder recognize under Section 331?
Answer: $110,000
Under Section 331, the shareholder treats the liquidating distribution as proceeds from the sale of stock. The amount realized equals the fair market value of the property received ($150,000). Gain = $150,000 - $40,000 stock basis = $110,000. Answer B is correct. Answer A ($150,000) ignores the shareholder's stock basis entirely. Answer C ($90,000) has no valid basis in the computation. Answer D ($60,000) is the corporate-level adjusted basis in the distributed property, which is irrelevant to the shareholder's Section 331 gain calculation.
- Under Section 721, a partner contributes property with an adjusted basis of $30,000 and a fair market value of $80,000 to a partnership in exchange for a 25% partnership interest. What is the amount of gain the partner recognizes on this contribution?
Answer: $0, because Section 721 provides nonrecognition for contributions to a partnership.
Section 721 provides that no gain or loss is recognized by a partner upon contribution of property to a partnership in exchange for a partnership interest, except in certain limited circumstances such as disguised sales or contribution of services. The contributing partner's basis in the partnership interest equals the adjusted basis of the contributed property ($30,000) under Section 722, and the partnership takes a carryover basis in the property under Section 723. Answer B is incorrect because the built-in gain is deferred, not recognized, on formation. Answer C is incorrect because Section 721 nonrecognition is not limited to a percentage; no gain is recognized. Answer D is incorrect for the same reason; the entire built-in gain is deferred under Section 721.
- An S corporation election is automatically terminated when which of the following occurs?
Answer: The S corporation has passive investment income exceeding 25% of gross receipts for three consecutive years while it has accumulated C corporation earnings and profits.
Under Section 1362(d)(3), an S corporation's election is terminated if it has accumulated earnings and profits from C corporation years and has passive investment income exceeding 25% of gross receipts for three consecutive tax years. The termination is effective at the start of the tax year following the third consecutive year. Answer C is correct. Answer A is incorrect because net operating losses do not cause S election termination. Answer B is incorrect because a transfer to an eligible individual shareholder - such as a U.S. citizen spouse - does not trigger S election termination; the spouse is an eligible shareholder under Section 1361. Answer D is incorrect because payroll tax compliance issues do not affect S election status.
