Rex and Felix are the sole shareholders of the Dogs and Cats Corporation (DCC).

Question

Rex and Felix are the sole shareholders of the Dogs and Cats Corporation (DCC). After several years of operations using the accrual method, they decided to liquidate the corporation and operate the business as a partnership. Rex and Felix hired a lawyer to draw up the legal papers to dissolve the corporation, but they need some tax advice from you, their trusted accountant. They are hoping you will find a way for them to liquidate the corporation while minimizing their total income tax liability.

Rex has a tax basis in his shares of $72,000 and Felix has a tax basis in his shares of $36,000. The DCC’s tax accounting balance sheet at the date of liquidation is as follows: (Negative amounts should be indicated by a minus sign. Leave no answer blank. Enter zero if applicable.) Corporate tax rate

Required:

A. Compute the gain or loss recognized by Rex, Felix, and DCC on a complete liquidation of the corporation assuming each shareholder receives a pro rata distribution of the corporation’s assets and assumes a pro rata amount of the liabilities.

B. Compute the gain or loss recognized by Rex, Felix, and DCC on a complete liquidation of the corporation assuming Felix receives $35,000 in cash and Rex receives the remainder of the assets and assumes all of the liabilities.

For parts c and d: Assume Felix received the accounts receivable and equipment and assumed the accounts payable.

C. Will Felix recognize any income when he collects the accounts receivable?

D. Will Felix be able to take a deduction when he pays the accounts payable?

For parts e and f: Assume Rex is a corporate shareholder of DCC.

E. Compute the gain or loss recognized by Rex, Felix, and DCC on a complete liquidation of the corporation assuming each shareholder receives a pro rata distribution of the corporation’s assets and assumes a pro rata amount of the liabilities.

F. Compute the gain or loss recognized by Rex, Felix, and DCC on a complete liquidation of the corporation assuming Felix receives $36,000 in cash and Rex receives the remainder of the assets and assumes all of the liabilities.

Adjusted Basis FMV Assets Cash $ 34,000 $ 34,000 Accounts receivable 11,000 11,000 Inventory 11,000 22,000 Equipment 34,000 22,000 Building 17,000 34,000 Land 13,000 50,000 Total assets $ 120,000 $ 173,000 Liabilities Accounts payable $ 5,000 Mortgage payable—Building 7,500 Mortgage payable—Land 7,500 Total liabilities $ 20,000 Shareholders’ Equity Common stock—Rex (80%) $ 72,000 $ 118,000 Common stock—Felix (20%) 36,000 35,000 Total shareholders equity $ 108,000 $ 153,000

Explanation / Answer

As per policy only first four questions will be answered

Part A

Rex:

FMV of assets received (80% ×$173000)= $138400

-Liabilities assumed (80% ×$20,000)=( 16000)

Amount realized = $122400

-Tax basis of stock= (72,000)

Gain recognized =$50400

Felix:

FMV of assets received (20% ×$173,000) = $34600

-Liabilities assumed (20% ×$20000) = (4000)

Amount realized =$30600

-Tax basis of stock(36,000)

Loss recognized = $( 5,400)

DCC:

Gain recognized:

Inventory ($22,000 - $11,000) = $11,000

Building ($34,000 - $17,000) =17,000

Land ($50,000 - $13,000) =37,000

Total gain recognized = $65000

Loss recognized:

Equipment ($22,000 - $34,000) = $(12000)

The loss is deductible because the loss property is distributed pro rata to each of the shareholders.

Part B

Rex and Felix both recognize the same gain and loss as in the previous set of facts. DCC recognizes the same $65000 gain as before, but DCC cannot recognize the loss on the distribution of the equipment because the loss property is distributed to a related person in a non pro rata distribution.

Part C

Felix will not recognize any income when he collects the accounts receivable because his basis in the accounts receivable will be $11,000, which is equal to the amount to be collected (DCC already recognized income under the accrual method when the receivable was created).

Part D

Felix will not get a second deduction when he pays the accounts payable because DCC already took this deduction under the accrual method when the liability was created.

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