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Oriole Corporation wholly owns Canary Corporation, which was formed six years ago with the transfer of several assets and a substantial amount of cash. Oriole's basis in the Canary stock is $11.5 million. Since it was formed, Canary has been a very successful manufacturing company and currently has accumulated E & P of $8 million. The company's principal assets are property, plant, and equipment (worth $11 million) and cash marketable securities of $805 million, for a total fair market value of $19.5 million.

Oriole and Canary are members of an affiliated group and have made the election under §243(b) to entitle Oriole to a 100% dividends received deduction. From a strategic perspective, Oriole is no longer interested in manufacturing and is considering a sale of Canary. In anticipation of a sale in the next year or two, the management of Oriole has contacted you for advice. If Canary is sold outright, Oriole will have a capital gain of $8 million ($195 million fair market value less a basis of $11.5 million). As an alternative, taxes on a future sale would be minimized if Canary first pays Oriole an $8 million dividend equal to its E & P. With the 100% dividends received deduction, the payment would be tax-free to Oriole. Subsequent to the dividend payment, Canary can be sold for its remaining value of $11.5 million ($11 million in property, plant, and equipment plus $500,000 in cash), resulting in no gain or loss to Oriole.

A. Prepare a letter to Louis Jones, the president of Oriole Corporation, describing the results of the proposed plan. Oriole's address is 974 State Street, La Crosse, WI 53786.

B. Prepare a memo for your firm's client files.

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