Reference no: EM132661915

Problem - Taxing Corporate Distributions

Plainwell Ice Cream Corporation (Plainwell), a premium ice cream manufacturer, has had a very profitable year. To share its profits with its two equal shareholders, Waffle Cone Corporation and Luis, it distributes cash of $200,000 to Waffle Cone and real estate worth $300,000 (adjusted basis of $20,000) to Luis (a married taxpayer filing a joint return). The real estate is subject to a mortgage of $100,000, which Luis assumes. The distribution is made on December 31, Plainwell's year-end.

Plainwell has had both good and bad years in the past. More often than not, however, it has lost money. Despite this year's record profits, the GAAP-based balance sheet for Plainwell indicates a year-end deficit in retained earnings. Consequently, the distribution of cash and land is treated as a liquidating distribution for financial reporting purposes, resulting in a reduction of Plainwell's paid-in capital account.

The tax consequences of the distributions to Plainwell and its shareholders depend on a variety of factors that are not directly related to the financial reporting treatment. Identify these factors, and explain the tax effects of the distributions to both Plainwell Ice Cream Corporation and its two shareholders.