Cook's Outlet has been an S corporation since its inception six years ago. On January 1 of the current year, the corporation's two equal shareholders, Davis and Dane, had adjusted bases of $150,000 and $175,000, respectively, for their S corporation's stock. The shareholders plan to have the corporation distribute land with a $50,000 adjusted basis and a $200,000 FMV in the current year. Ordinary

Question

income is expected to be $180,000 in the current year. What tax issues should Davis and Dane consider with respect to the distribution?

What will be an ideal response?

Answer 1

• What gain or loss does Cook's Outlet recognize on making the distribution? Does the gain or loss trigger any built-in gains tax liability? Excess net passive income tax liability?
• What is each shareholder's basis for the Cook's Outlet stock immediately preceding the distribution?
• What basis reduction does the distribution cause for each shareholder? Does the basis reduction trigger the recognition of any income by the shareholder (e.g., if the distribution reduces the shareholder's basis to zero)?
• What is each shareholder's basis for the Cook's Outlet stock immediately following the distribution?
• What is each shareholder's basis and holding period for the land received?

Cook's Outlet will recognize a $150,000 ($200,000 - $50,000) gain on the distribution. This gain may be subject to the Sec. 1374 or Sec. 1375 tax, but insufficient facts are provided to make such a determination. This gain and Cook's Outlet's ordinary income from operations will flow through to the shareholders and increase their stock bases. Davis and Dane take $315,000 ($150,000 + $75,000 + $90,000) and $340,000 ($175,000 + $75,000 + $90,000) bases, respectively, assuming no corporate-level taxes are imposed. Each shareholder will reduce his basis by $100,000 (0.50 × $200,000) for the distribution.