C- Corporations, S-Corporations, Exempt Organizaitons, Depreciation, MACRS

Question 1

For assets acquired after 1986, what is the recovery method for 3-, 5-, 7-, and 10-year property (MACRS)?

Answer 1

200% Declining Balance - Estimated salvage value is not considered.

Notes:
1) Taxpayer may choose straight-line depreciation in lieu of 200% declining balance.

2) 20-year property uses the 150% declining balance method.

Question 2

What is the half-year convention?

Answer 2

6 months of depreciation is taken in the year of acquisition and the year of disposal.

   Note: When straight-line depreciation is elected, the half-year convention is still applicable.

The method of depreciation used must be used for ALL personal property acquired that year in a given property class.

Question 3

What is the mid-quarter convention?

Answer 3

Mid-Quarter convention replaces the half-year convention if greater than 40% of a taxpayer’s property (other than real property) is placed in service during the last three months of a tax year.

The mid-quarter convention treats all property placed in service during any quarter of the tax year as being placed in service on the mid-point of the quarter.

Question 4

What is the mid-month convention?

Answer 4

Mid-month convention is used for calculating depreciation of real property (27.5-year residential rental real estate and 39-year nonresidential real property).

The real property is treated as placed in service in the middle of the month of acquisition.

Question 5

What is the expense deduction (Section 179) in lieu of depreciation?

Answer 5

$125,000 (2012) of acquisition cost of personal property used in trade or business may be deducted in any one year.

Limitations

1) Reduced $1 for each $1 of qualified property placed in service in excess of $500,000 (2012).
2) Deduction is not permitted when a net loss exits or if the deduction would create a net loss (limited to taxpayer’s taxable income from trade or business)

Question 6

What are Section 1231 assets?

Answer 6

Generally, depreciable or real property used in a trade or business held over 12 months.

• Net all Section 1231 gains and losses.
• If gains > losses, treat the net amount as long-term capital gain.
• If losses > gains, treat the net amount as ordinary loss.

Question 7

What is the tax treatment of Section 1245 assets?

Answer 7

Generally depreciable personal property or amortizable personal property (patents, copyrights, leaseholds, and professional sports contracts) used in a business over one year.

Nonresidential real property acquired after 1980 but before 1987 if ACRS depreciation was claimed.

• Recapture all accumulated depreciation as ordinary income under Section 1245.
• Any excess gain is Section 1231 gain.

Question 8

Identify the tax treatment given Section 1250 assets.

Answer 8

Generally, real property used in a business and held for more than one year.
- Gain/Loss is treated (“recaptured”) as ordinary income to the extent of the excess of accelerated depreciation over straight-line depreciation.

• Note that, because MACRS uses straight-line depreciation for real property, there is no Section 1250 recapture on disposition of real property placed in service after 1986 and depreciated under the MACRS rules.

Question 9

What are the eligibility requirements for an S Corporation election?

Answer 9

• Domestic Corporation
• One class of stock (differences in common stock voting rights are allowed)
• Eligible shareholders must be individuals (no nonresident alien shareholders), estates, or certain types of trusts (not corporations or partnerships).
• One hundred shareholder limit.

Question 10

Describe the two requirements for election of S corporation status.

Answer 10

1) All shareholders must consent.
2) Election must be made either at any time during the year immediately preceding the year for which the election will be effective or on or before the 15th day of the third month of the election year (and the election will be retroactive to the first day of the election year.

Question 11

How can S corporation status be terminated?

Answer 11

S-Corp. status will terminate as a result of the following:

• Holders of a majority of the stock consent to a voluntary termination.
• The corp. fails to meet any or all of the eligibility requirements.
• More than 25% of the corp. gross receipts come from passive activities for three consecutive years and the Corp had C-Corp earnings and profits at the end of the year.

Question 12

What tax year must an S Corp. adopt?

Answer 12

An S-Corp must adopt a calendar year unless a valid business purpose for a different tax year (fiscal year) is established.

Question 13

What does an unrealized built-in gain result?

Answer 13

An unrealized built-in gain results when a C-Corp elects S-Corp status and the FMV of corporate assets exceeds the adjusted basis of the corporate assets at the election date.

Question 14

When is an S-Corp exempt from a tax on built-in gains?

Answer 14

• The sale or transfer does not occur within 10 years of the first day of the first year that the S-Corp election is made.
• S Corp was never a C-Corp.
• S-Corp can demonstrate that the distributed asset was acquired after the S-Corp election
• S-Corp can demonstrate that the appreciation occurred after the S election.
• The net unrealized built in gain has been completely recognized in prior tax years.

Question 15

How is the tax on built-in gains calculated?

Answer 15

Built-in gains tax is 35% (the highest corporate tax rate) times the lesser of the following:

• Net recognized built-in gains for current year, or
• Taxable income of S-Corp as if the corporation were a C-Corp.

Question 16

What items must be separately listed on an S-Corp tax return (Schedule K)?

Answer 16

Some items that must be separately listed on an S-Corp tax return include the following:

• Ordinary Income
• Rental income/loss
• Portfolio income (including interest, dividends, royalties, and all capital gains/losses.)
• Section 1231 gains and losses
• Charitable contributions
• Section 179 deduction
• Depreciation
• Foreign Taxes
• Tax-Exempt interest

Question 17

When does a shareholder contributing property in exchange for corporate common stock have no gain or loss recognized?

Answer 17

The following two conditions must be met:

1) Transferors/shareholders own at least 80% of the voting and nonvoting stock; and
2) Boot (cash or other property) or cancelation of debt is not involved.

Question 18

Generally, what is the basis of common stock received by the shareholder?

Answer 18

Basis of common stock received:

Cash - amount contributed
Property - Adjusted Basis (Net Book Value)
Services - Fair Value

PLUS any gain recognized by the shareholder

Question 19

For C-Corp’s are bad debts deductible?

Answer 19

For taxpayers in general (including Corp’s), bad debts are deductible to the extent the bad debts were previously included in income. The charge-off method (not allowance method) must be used.

Question 20

How are charitable contributions treated by corporations?

Answer 20

The maximum deduction is up to 10% of taxable income before the deduction of the following deductions:

1) The charitable contribution deduction
2) Dividends Received deduction
3) NOL carryback
4) Capital loss carryback
5) U.S. production activities deduction (DPAD)

Question 21

When are life insurance premiums deductible?

Answer 21

Policies on key employees are not deductible when the corporation is directly or indirectly the beneficiary.

If insured employees name the beneficiaries, premiums are deductible as an employee benefit.

Note: If life insurance coverage exceeds $50,000, payment of premiums may represent income to the employees.

Question 22

Identify the corporate tax treatment of capital gains/losses.

Answer 22

• Capital gains are taxed the same as ordinary corporate income.
• Corporations may not deduct any capital losses from ordinary income.
• Capital losses are deductible to the extent of capital gains.
• Net capital losses may be carried back 3 years and forward 5 years as a short-term capital loss.

Question 23

State the general NOL carryforward/carryback rules.

Answer 23

NOL can be carried back 2 years and/or forward 20 years.

Question 24

Name some nondeductible trade or business expenses.

Answer 24

• Bad debts, allowance method (only specific write-off method is deductible).
• Illegal activities (bribes, penalties)
• Business gifts exceeding $25 per person per year
• Business meals and entertainment are limited to 50% of total expenses
• Political contributions
• Club dues
• Executive compensation in excess of $1 Million per year for each of the top five executives in publicly held corporations, unless compensation is performance based.

Question 25

Identify the three levels of the dividend received deduction.

Answer 25

1) 70% - Less than 20% ownership; 70% of dividends received are deducted from taxable income up to a limit of 70% of taxable income.
2) 80% - 20%-80% ownership; can claim 80% dividends received are deducted from taxable income up to a limit of 80% of taxable income.
3) 100% Affiliated companies (80% or more common ownership).

Question 26

What are the requirements to file a consolidated return?

Answer 26

All corporations in group:

• Must have been members of an affiliated group at some time during the tax year.
• Each member must file a consent (act of filing a consolidated return is considered consent).

Affiliated group:

Common parent owns 80% or more of the voting power of all outstanding stock and 80% or more of the value of all outstanding stock of each corporation.

Question 27

Identify the advantages of filing a consolidated return.

Answer 27

• Capital losses of one Corp offset capital gains of another Corp.
• Operating losses of one Corp offset profits of another Corp.
• Elimination of tax on intercompany transactions
• Use of excess foreign tax credit by the Corp. group
• Designation of parent company as agent for the group.

Question 28

Describe the corporate AMT.

Answer 28

• AMT rate of 20% on AMTI
• Exemption is $40,000 less 25% x (AMTI - $150,000)
• Exemption is completely eliminated at AMTI of $310,000
• Calculated similarly to individual AMT

Question 29

Name some corporate AMT preferences.

Answer 29

• Percentage depletion
• Private activity bonds
• Pre-1987 ACRS depreciation

Question 30

What is the adjusted current earnings (ACE) adjustment?

“MIND”

Answer 30

75% of the difference (positive or negative) between ACE and AMTI before this adjustment and the alternative tax NOL deduction.

• Municipal bond interest income other than interest income from private activity bonds issued after 1986
• Increase in life insurance cash surrender value
• Non-straight-line depreciation after 1989 vs. ADS
• Dividends received deduction (less than 20% ownership/70% deduction)

Question 31

What is the accumulated earnings tax?

Answer 31

The accumulated earnings tax is a tax on accumulated earnings beyond the reasonable needs of the business.

Corporations can accumulate up to $250,000 or an amount reasonable to the needs of the business without penalty. For personal service corporations, the amount is up to $150,000.

The tax is flat 15% of the unreasonable accumulated earnings.

Question 32

Define a personal holding company.

Answer 32

A personal holding company must meet both of the following:

• At any time during the last half of the taxable year, more than 50% of the value of the corporations outstanding stock is owned by five or fewer individuals, and
• At least 60% of the corporation’s adjusted ordinary gross income consists of personal holding company income (dividends, rents, royalties, annuities, interest, adjusted rental income, and certain other investment income sources). (NIRD)

The penalty tax is 15% of the undistributed personal holding company income.
The company is given a 90-day grace period to pay a deficiency dividend.

Question 33

What is a personal service corporation? What is the tax rate?

Answer 33

A personal service corporation is a corporation primarily involved in the performance of one of the following fields:

Accounting, law, consulting, engineering, architecture, health, and actuarial science.

The tax rate is a flat 35%

Question 34

What are the tax implications of a tax-free reorganization?

Answer 34

A tax-free reorganization is a nontaxable transaction except to the extent of boot received.

Question 35

Other than for a 501(c)(1) corporation, which is created through an act of Congress, what are the general requirements for a corporation to obtain tax-exempt status?

Answer 35

• Make a written application for exempt status
• Be approved by the IRS
• Become incorporated under the standard procedures
• Issue capital stock
• Include in the Articles of Organization the fact that the articles limit the purpose of the entity to the charitable/exempt purpose.

Question 36

What are the general requirements for a 501(c)(3) corporation to maintain its tax-exempt status?

Answer 36

• No part of the net earnings may insure to the benefit of any private foundation or individual.
• No substantial part of the activities may be nonexempt activities (e.g. propaganda or influencing legislation).
• The organization may not directly participate or intervene in any political campaign.

Note: The organization must also file the required annual information tax forms (if applicable). If the organization fails to file for three consecutive years, the tax-exempt status will be revokes.

Question 37

When does a private foundation terminate involuntarily?

Answer 37

• It becomes a public charity (it cannot be both) or

- It commits repeated violations or a willful and flagrant violation of any of the private foundation provisions.

Question 38

What are the categories of private foundations that are excluded from the provisions of Section 509 (i.e., they are deemed “public organizations:)?

Answer 38

• Maximum (50%-type) charitable donees
• Broadly publicly supported organizations receiving more than 1/3 of their annual support from members of the public and less than 1/3 from investment income and unrelated business income.
• Supporting organizations
• Public safety testing organizations.

Question 39

What is the definition of “unrelated business income” (UBI)?

Answer 39

• Gross income from any unrelated trade or business “regularly” carried on, minus business deductions connected therewith. UBI is

1) Derived from an activity that constitutes a trade or business;
2) Regularly carried on; and
3) Not substantially related to the organization’s tax-exempt purposes.

Question 40

How is UBI taxed for an exempt organization?

Answer 40

Although an organization may have tax-exempt status, the organization may become subject to regular corporate income tax on its unrelated business income (UBI).

• The organization is allowed a $1,000 specific deduction from UBI; thus, only UBI in excess of $1,000 is subject to tax.
• Further, there are other types of income that are specifically excluded from tax.

Question 41

What are some items of income (other than the $1,000 that is specifically excluded from tax) that are excluded from tax for the exempt organizations?

Answer 41

• Royalties, dividends, interest, and most annuities
• Rents from real property and rents from personal property leased with real property (subject to limitations), other than income from debt-financed property
• Gains and losses from the sale/exchange of property not held primarily for sale to customers
• Income from research of a college or hospital.
• Income from labor unions used to establish exclusive-use facilities
• Activities limited to exempt organizations by state law
• Income from the exchange of rental of membership lists

Question 42

What are the three types of exempt organizations that do not have an annual filing requirement of an information return with the IRS?

Answer 42

1) Churches and exclusively religious activities of a religious order or internally supported auxiliaries.
2) Certain organizations (educational organizations, religious organizations, public-type charities, fraternal organizations, and those organized to prevent cruelty to children or animals) that normally have less than $5,000 in annual gross receipts; and
3) Organizations that normally have less than $50,000 in annual gross receipts.