Final answer:
The tax consequence of the distribution is that no loss is recognized and Paladin Corporation's earnings and profits are reduced by $225,000, which is the net distribution ($200,000 FMV of land less $25,000 liability assumed by the shareholder).
Step-by-step explanation:
The correct answer to the question of the tax consequences of Paladin Corporation's distribution to Maria Mendez is: A) No loss recognized and a reduction in E&P of $225,000. According to tax laws, corporations may not recognize a loss on the distribution of property to a shareholder. When the distribution takes the form of property rather than cash, for tax purposes, the earnings and profits (E&P) are reduced by the property's fair market value, but not below the property's adjusted basis to the corporation. In this case, the land had a fair market value of $200,000, which is lower than its basis to Paladin of $250,000. However, since losses are not recognized, the basis is not considered, and the liability assumed by Maria Mendez reduces the distribution amount. Therefore, the E&P reduction is the fair market value minus the liability assumed ($200,000 - $25,000 = $175,000) but, for distribution purposes, the E&P is reduced by the fair market value which is $200,000, adjusted by the assumed liability to get the net distribution of $175,000. The property's adjusted basis or the E&P can only be reduced by either the fair market value or the amount of distribution, whichever is lower, hence, resulting in $225,000 ($200,000 initial E&P +$25,000 liability assumed) reduction in E&P rather than the full property basis of $250,000 or the fair market value alone.