Chapter 3 - C and S Corporation Taxation and Exempt Organizations Flashcards
A C corporation’s Net Capital losses are:
a. Carried back 3 years and forward 5 years.
b. Deductible in full from the corporation’s ordinary income.
c. Carried forward indefinitely until fully utilized.
d. Deductible from the corporation’s ordinary income only to the extent of $3,000.
Net CAPITAL losses are Carried back 3 years and forward 5 years.
Explanation:
Choice “a” is correct. A C corporation’s net capital losses are carried back 3 years and forward 5 years; they expire after 5 years. In addition, a C corporation cannot deduct net capital losses from ordinary income.
Choice “c” is incorrect. A C corporation’s net capital losses cannot be carried forward indefinitely. They expire after 5 years.
Choices “b” and “d” are incorrect. A C corporation cannot deduct net capital losses from ordinary income.
Baker Corp., a calendar year C corporation, realized taxable income of $36,000 from its regular business operations for the calendar year. In addition, Baker had the following capital gains and losses during the year. Short-term capital gain - $ 8,500 Short-term capital loss - (4,000) Long-term capital gain - 1,500 Long-term capital loss - (3,500) Baker did not realize any other capital gains or losses since it began operations. What is Baker's total taxable income for the year? a.$40,500 b.$42,000 c.$46,000 d.$38,500
$38,500.
Explanation:
Choice “d” is correct. Capital losses offset capital gains. If a corporation has net capital gains, they are taxed at ordinary (corporate) income tax rates.
Taxable income from business operations - $ 36,000
Short-term capital gain - $ 8,500
Short-term capital loss - (4,000)
Net short-term capital gain - $ 4,500
Long-term capital gain - $1,500
Long-term capital loss - (3,500)
Net capital gain - 2,500
Taxable income - $ 38,500
At the beginning of the year, Westwind, a C corporation, had a deficit of $45,000 in accumulated earnings and profits. For the current year, Westwind reported earnings and profits of $15,000. Westwind distributed $12,000 during the year. What was the amount of Westwind’s accumulated earnings and profits at year-end?
a. $57,000 b. $45,000 c. $42,000 d. $30,000
$42,000.
beg E&P (Deficit) + current E&P - amount distributed = end of year accum E&P
Explanation:
Choice “c” is correct. Accumulated earnings and profits include all prior and current year earnings and profits at year-end. The key here is recognizing that the beginning accumulated earnings and profits is a deficit. Thus the calculation would be as follows:
Beginning deficit in Accumulated E&P - $ (45,000)
Plus: Current year E&P - 15,000
Less: Amounts distributed- (12,000)
End of year Accumulated E&P - $ 42,000
Note: The examiners did not ask whether or not the accumulated earnings and profits at year-end was a deficit, rather they asked solely for the dollar amount.
Choice “d” is incorrect. This choice does not take into consideration the amounts distributed during the year.
Choice “b” is incorrect. This choice does not take into account any of the current year activity that becomes part of accumulated earnings and profits at year-end.
Choice “a” is incorrect. This choice treats the distributions of $12,000 as an addition to the deficit, making it $57,000. It ignores the current year earnings and profits entirely.
A corporation’s capital loss carryback or carryover is:
a. Always treated as a long-term capital loss. b. Limited to $3,000. c. Always treated as a short-term capital loss. d. Not allowable under current law.
Always treated as a short-term capital loss.
Explanation:
Choice “c” is correct. A corporation’s capital loss carryback or carryover is always treated as a short-term capital loss.
Rule: Corporations may not deduct any capital loss from ordinary income, but instead only carry it back 3 years and forward 5 years as a “short-term” capital loss to deduct from net capital or Section 1231 gains.
Jackson, a single individual, inherited Bean Corp. common stock from Jackson’s parents. Bean is a qualified small business corporation under Code Section 1244. The stock cost Jackson’s parents $20,000 and had a fair market value of $25,000 at the parents’ date of death. During the year, Bean declared bankruptcy and Jackson was informed that the stock was worthless. What amount may Jackson deduct as an ordinary loss in the current year?
a. $3,000 b. $20,000 c. $0 d. $25,000
$0, only available to original owners of stock.
Explanation:
Choice “c” is correct. Losses resulting from the sale, exchange or worthlessness of Section 1244 qualifying stock (also called small business stock) are treated as ordinary losses up to $50,000 in any tax year. However, this loss is available only to original owners of the stock. Because Jackson inherited the stock, he is not the original owner. Therefore, in this case, no ordinary loss may be deducted. (Note that Jackson would be allowed a capital loss in the year the stock was deemed entirely worthless. The capital loss would be deducted under the personal capital loss rules and calculated using the likely transfer basis of $25,000.)
Choice “a” is incorrect. An ordinary loss is allowed on the worthlessness of Sec. 1244 stock if taken by an original owner. It appears as if this answer was attempting to “trick” the candidate into choosing this option (a $3,000 deduction as would be the case if the loss were a capital loss, rather than an ordinary loss) and not considering that the question referenced the deductibility of an ordinary loss.
Choices “b” and “d” are incorrect. Both these answers utilize either the basis of Jackson’s parents or the fair market value to determine the ordinary loss. In this instance, no ordinary loss is available to Jackson because he is not the original owner of the stock.
Which of the following is not true with regard to personal holding companies (PHCs)?
a. The additional tax (penalty) is self-assessed by the PHC.
b. Personal holding companies, as specifically defined by the Code, are corporations that meet certain “closely-held” ownership criteria and have over 50% of their adjusted gross income consisting of net rent (less than 50% of ordinary gross income), taxable interest, most royalties, and dividends from an unrelated domestic corporation.
c. There is no penalty if net earnings are distributed, as the penalty only applies to income that has not been distributed.
d. Personal holding companies are not subject to the accumulated earnings tax.
Personal holding companies, as specifically defined by the Code, are corporations that meet certain “closely-held” ownership criteria and have over 50% of their adjusted gross income consisting of net rent (less than 50% of ordinary gross income), taxable interest, most royalties, and dividends from an unrelated domestic corporation.
Explanation:
Choice “b” is correct. While most of the information in the item is correct, it is when over 60% of the adjusted gross income of a closely-held (more than 50% owned by 5 or fewer individuals either directly or indirectly at any time during the last half of the tax year) corporation consists of “NIRD” that it is defined as a personal holding company, not over 50% (as in the selection).
Choice “a” is incorrect, as the additional tax is self-assessed by the taxpayer by filing a separate schedule 1120PH along with the Form 1120.
Choice “d” is incorrect, as the accumulated earnings tax indeed does not apply to personal holding companies (which are not allowed to accumulate any earnings without penalty!).
Choice “c” is incorrect. Provided the net earnings are distributed, there is no penalty.
Mock operates a retail business selling illegal narcotic substances. Which of the following item(s) may Mock deduct in calculating business income?
I.Cost of merchandise.
II.Business expenses other than the cost of merchandise.
a. II only.
b. Neither I nor II.
c. I only.
d. Both I and II.
I only.
Explanation:
Choice “c” is correct. A gain from an illegal activity is includible in income. To determine the gain, a deduction is permitted for cost of merchandise. Business expenses for operating an illegal business, other than the cost of merchandise, are not permitted as deduction.
Choices “a”, “d”, and “b” are incorrect. Each of these answers does not answer either I or II correctly.
Which of the following taxpayers may use the cash method of accounting?
a. A manufacturer.
b. A tax shelter.
c. A C corporation with annual gross receipts of $50,000,000.
d. A qualified personal service corporation.
A qualified personal service corporation.
Explanation:
Choice “d” is correct.
Rule: The general rule is that the accrual method of accounting will be required by tax shelters, large C corporations and manufacturers. The IRS has the authority to require that a taxpayer use a method of accounting to accurately reflect the proper income and expenses. Personal Service Corporations are permitted the use of the cash method.
Choices “b”, “c”, and “a” are incorrect, per the above rule.
On January 1, Year 1, Locke Corp., an accrual-basis, calendar-year C corporation, had $30,000 in accumulated earnings and profits. For Year 1, Locke had current earnings and profits of $20,000, and made two $40,000 cash distributions to its shareholders, one in April and one in September of Year 1. What amount of the Year 1 distributions is classified as dividend income to Locke’s shareholders?
a. $20,000 b. $50,000 c. $0 d. $80,000
$50,000.
Explanation:
Choice “b” is correct. Dividends are distributions of a corporation’s earnings & profits, including accumulated (prior year) and current year E&P. Because the corporation had both accumulated E&P of $30,000 and current E&P of $20,000, the total amount of distributions classified as dividends is $50,000.
Choice “c” is incorrect. If a corporation has accumulated E&P or current year E&P, the distribution (depending upon amount) would be taxable as a dividend.
Choice “a” is incorrect. The amount taxable as a dividend is total E&P, not the difference between one distribution and current E&P.
Choice “d” is incorrect. The total distributions exceeds E&P. The excess will be treated as a return of basis and any remaining excess will be capital gain.
On January 2 of the current year, Shaw Corp., an accrual-basis, calendar-year C corporation, purchased all the assets of a sole proprietorship, including $300,000 in goodwill. Current-year federal income tax expense of $110,100 and $7,500 for goodwill impairment were deducted to arrive at Shaw’s reported book income of $239,200. What should be the amount of Shaw’s current-year taxable income, as reconciled on Shaw’s Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return?
a. $239,200 b. $336,800 c. $349,300 d. $329,300
$336,800.
Explanation:
Tax amortization period for goodwill is 15 years.
Choice “b” is correct. $336,800 should be reported as Shaw’s current-year taxable income, reconciled as follows on Shaw’s Schedule M-1 on the Form 1120:
Book income $ 239,200
Add: Federal income tax expense $110,100
Less: Excess of tax amortization over book impairment of goodwill (12,500)
Taxable income $ 336,800
[1] Federal income taxes paid are not deductible for tax purposes.
[2] The excess amortization is determined as follows:
Total purchased goodwill $ 300,000
Divided by 15 years ÷ 15 [tax amortization period]
Tax amortization $ 20,000
Less: Book impairment (given) (7,500)
Excess tax amortization for the current year $ 12,500
Choice “a” is incorrect. This answer is the amount of book income without any adjustments.
Choice “d” is incorrect. This answer adds back the federal income tax expense paid of $110,100 (as is proper) and also deducts the entire $20,000 of tax amortization as additional expense (which is not proper because $7,500 of this amount is already deducted from the book income).
Choice “c” is incorrect. This answer adds back the federal income tax expense of $110,100 but does not deduct the additional $12,500 of tax amortization for the year.
How are a C corporation’s net capital losses used?
a. Deducted from the corporation’s ordinary income only to the extent of $3,000.
b. Carried forward 20 years.
c. Deductible in full from the corporation’s ordinary income.
d. Carried back three years and forward five years.
Carried back three years and forward five years.
Explanation:
Choice “d” is correct. A C corporation’s net capital losses are carried back three years and forward five years.
Choice “a” is incorrect. This is incorrect because it states the rule for an individual taxpayer.
Choice “c” is incorrect. A corporation’s capital losses can be used only to offset capital gains, and any excess is carried back three years and forward five years.
Choice “b” is incorrect. A C corporation’s net operating losses may be carried back two years and forward twenty years.
Elm Corp. is an accrual-basis calendar-year C corporation with 100,000 shares of voting common stock issued and outstanding as of December 28, Year 1. On Friday, December 29, Year 1, Hall surrendered 2,000 shares of Elm stock to Elm in exchange for $33,000 cash. Hall had no direct or indirect interest in Elm after the stock surrender.
Additional information follows:
Hall’s adjusted basis in 2,000 shares of Elm on December 29, Year 1 ($8 per share) - $ 16,000
Elm’s accumulated earnings and profits at January 1, Year 1- $25,000
Elm’s Year 1 net operating loss - ($7,000)
What amount of income did Hall recognize from the stock surrender?
a.$25,000 dividend.
b.$18,000 capital gain.
c.$17,000 capital gain.
d.$33,000 dividend.
$17,000 capital gain.
Explanation:
Choice “c” is correct. Hall’s gain is the difference in the $33,000 he received for his stock and his basis of $16,000, for a gain of $17,000 which is a capital gain.
Choice “d” is incorrect. Because this is a sale of Hall’s interest in Elm, this is not a dividend.
Choice “a” is incorrect. The accumulated earnings of Elm have no relationship to the stock surrender.
Choice “b” is incorrect. The amount of the capital gain calculated on the stock surrender is not based on the end of year amount of accumulated earnings and profits.
Mintee Corp., an accrual-basis calendar-year C corporation, had no corporate shareholders when it liquidated in Year 1. In cancellation of all their Mintee stock, each Mintee shareholder received in Year 1 a liquidating distribution of $2,000 cash and land with tax basis of $5,000 and a fair market value of $10,500. Before the distribution, each shareholder’s tax basis in Mintee stock was $6,500. What amount of gain should each Mintee shareholder recognize on the liquidating distribution?
a. $6,000 b. $500 c. $0 d. $4,000
$6,000 ($12,500 FMV received - $6,500 basis in stock).
Explanation:
Choice “a” is correct. When a corporation liquidates and distributes assets to shareholders, gain is recognized to the extent that the fair market value of assets distributed to a shareholder exceeds the shareholder’s basis in the corporation’s stock.
Choice “c” is incorrect. In a corporate liquidation, gain is recognized to the extent that the fair market value of the assets received exceeds the shareholder’s basis in the stock.
Choice “b” is incorrect. The gain is calculated using the fair market value of assets received, not the basis of the assets received.
Choice “d” is incorrect. This is simply the difference in the fair market value of the land and the shareholder’s basis in the stock, and is not how the gain is computed.
Lind and Post organized Ace Corp., which issued voting common stock with a fair market value of $120,000. They each transferred property in exchange for stock as follows: Lind: Property - building Adjusted basis - $40,000 Fair market value - $82,000 Percentage of Ace stock acquired - 60%
Post: Propert - Land Adjusted basis - $5,000 Fair market value - $48,000 Percentage of Ace stock acquired - 40% The building was subject to a $10,000 mortgage that was assumed by Ace. What amount of gain did Lind recognize on the exchange? a.$52,000 b.$42,000 c.$0 d.$10,000
$0.
Explanation:
Choice “c” is correct. The formation of a corporation under these circumstances is a nontaxable event. Thus Lind would report zero gain upon the formation of the corporation.
Choices “d”, “b”, and “a” are incorrect. Because the formation of this corporation is a nontaxable event, no gain or loss would be reported by Lind.
Lind and Post organized Ace Corp., which issued voting common stock with a fair market value of $120,000. They each transferred property in exchange for stock as follows: Lind: Property - building Adjusted basis - $40,000 Fair market value - $82,000 Percentage of Ace stock acquired - 60%
Post: Propert - Land Adjusted basis - $5,000 Fair market value - $48,000 Percentage of Ace stock acquired - 40%
The building was subject to a $10,000 mortgage that was assumed by Ace. What was Ace’s basis in the building?
a. $72,000 b. $82,000 c. $40,000 d. $30,000
$40,000.
Explanation:
Choice “c” is correct. Ace’s basis in the building is the same as Lind’s basis immediately prior to its contribution to the corporation.
Choice “d” is incorrect. Ace’s basis in the building is computed separately from any debt that it assumes related to the building.
Choice “a” is incorrect. Ace uses Lind’s basis, not the building’s fair market value, as its basis. Furthermore, the debt assumed by Ace does not affect the basis of the building to Ace.
Choice “b” is incorrect. Ace uses Lind’s basis, not the building’s fair market value, as its basis.
Lind and Post organized Ace Corp., which issued voting common stock with a fair market value of $120,000. They each transferred property in exchange for stock as follows: Lind: Property - building Adjusted basis - $40,000 Fair market value - $82,000 Percentage of Ace stock acquired - 60%
Post: Propert - Land Adjusted basis - $5,000 Fair market value - $48,000 Percentage of Ace stock acquired - 40%
The building was subject to a $10,000 mortgage that was assumed by Ace. What was Lind’s basis in Ace stock?
a. $0 b. $40,000 c. $30,000 d. $82,000
$30,000.
Explanation:
Choice “c” is correct. Lind computes his basis as the basis of property and cash (none here) contributed, less the amount of any debt he is relieved of. Here he contributes property with an adjusted basis of $40,000, but the $10,000 debt he is relieved of must be subtracted, resulting in a net basis of $30,000. This can also be thought of as giving Lind a basis equivalent to the amount of equity he had in the contributed building.
Choice “d” is incorrect. The basis of Lind’s stock is based on his basis in the contributed property, not its fair market value.
Choice “b” is incorrect. Lind must subtract the $10,000 of debt he is relieved of from his $40,000 basis in the property to arrive at his basis in the stock.
Choice “a” is incorrect. Because Lind contributed property with a basis above zero, his basis in the stock is greater than zero.
In Year 1, Starke Corp., an accrual-basis calendar year corporation, reported book income of $380,000. Included in that amount was $50,000 municipal bond interest income, $170,000 for federal income tax expense, and $2,000 interest expense on the debt incurred to carry the municipal bonds. What amount should Starke’s taxable income be as reconciled on Starke’s Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return?
a. $550,000 b. $502,000 c. $500,000 d. $330,000
$502,000.
Explanation:
Choice “b” is correct. Municipal bond interest, the interest expense on debt incurred to carry the municipal bonds, and federal income tax expense will be adjustments to taxable income.
Reported book income - $ 380,000
Municipal bond interest - (50,000)
Federal income tax expense - $170,000
Interest to carry municipal bonds - $2,000
Taxable income - $ 502,000
Choices “d”, “c”, and “a” are incorrect. Each of these answers does not take into account at least one of the items of the above calculation.
Lake Corp., an accrual-basis calendar year corporation, had the following Year 1 receipts:
Year 2 advanced rental payments where the lease ends in Year 3 - $ 125,000
Lease cancellation payment from a 5-year lease tenant - $50,000
Lake had no restrictions on the use of the advanced rental payments and renders no services. What amount of income should Lake report on its Year 1 tax return?
a.$0
b.$50,000
c.$125,000
d.$175,000
$175,000.
Explanation:
Choice “d” is correct. Assuming these were Lake’s only transactions for the year, its taxable income was $175,000. The advanced rental payments are taxable when received even though they are not included in financial income because there is no restriction on their use. The lease cancellation payment is also included in taxable income in Year 1, when received.
Choices “a”, “b”, and “c” are incorrect, per the above explanation.
In Year 1, Best Corp., an accrual-basis calendar-year C corporation, received $100,000 in dividend income from the common stock that it held in an unrelated domestic corporation. The stock was not debt-financed and was held for over a year. Best recorded the following information for Year 1:
Loss from Best’s operations $ (10,000)
Dividends received $100,000
Taxable income (before dividends-received deduction)
$90,000
Best’s dividends-received deduction on its Year 1 tax return was:
a.$80,000
b.$63,000
c.$70,000
d.$100,000
$63,000.
Explanation:
Choice “b” is correct. The dividends-received deduction (“DRD”) is generally calculated as 70% of dividends received which would be $70,000 (70% × $100,000). However, the deduction is limited to 70% × dividends received deduction (DRD) modified taxable income. DRD modified taxable income is calculated as taxable income before the dividends received deduction, any NOL carryover or carryback deduction, capital loss carryback deduction, and the domestic production activities deduction. Because the loss of $10,000 is a current year loss and not a carryover or carryback, it is not an adjustment to taxable income when calculating modified taxable income. DRD modified taxable income is $90,000. Best’s DRD deduction on its Year 1 tax return is limited to $63,000 (70% × $90,000).
Choice “d” is incorrect. The 100% DRD is available only when 80−100% of the stock is owned (making these entities related).
Choice “a” is incorrect. The 80% DRD is used when at least 20% but less than 80% of the stock is owned.
Choice “c” is incorrect. The deduction is limited to 70% of the lesser of dividends received deduction modified taxable income or the dividends received.
In Year 2, Cable Corp., a calendar year C corporation, contributed $80,000 to a qualified charitable organization. Cable’s Year 2 taxable income before the deduction for charitable contributions was $820,000 after a $40,000 dividends-received deduction. Cable also had carryover contributions of $10,000 from Year 1. In Year 2, what amount can Cable deduct as charitable contributions?
a. $80,000 b. $82,000 c. $90,000 d. $86,000
$86,000.
Explanation:
Choice “d” is correct. A C corporation can deduct charitable contributions up to 10% of its taxable income after adding back the dividends-received deduction; $820,000 taxable income + $40,000 dividends-received deduction = $860,000. 10% × $860,000 = $86,000, the maximum allowable charitable contribution deduction. $4,000 is carried forward to Year 3. A corporate charitable deduction that exceeds the limit for deduction in one year can be carried over to the succeeding five tax years. It cannot be carried back.
If a corporation’s charitable contributions exceed the limitation for deductibility in a particular year, the excess:
a. Is not deductible in any future or prior year.
b. May be carried back to the third preceding year.
c. May be carried back or forward for one year at the corporation’s election.
d. May be carried forward to a maximum of five succeeding years.
May be carried forward to a maximum of five succeeding years.
Explanation:
Choice “d” is correct.
Rule: A corporate charitable deduction that exceeds the limit for deduction in one year can be carried over to the succeeding five tax years. It cannot be carried back.
Choices “a”, “c”, and “b” are incorrect, per the above rule.
In Year 1, Stewart Corp. properly accrued $5,000 for an income item on the basis of a reasonable estimate. In Year 2, after filing its Year 1 federal income tax return, Stewart determined that the exact amount was $6,000. Which of the following statements is correct?
a. The $1,000 difference is includible in Stewart’s Year 2 income tax return.
b. Stewart is required to notify the IRS within 30 days of the determination of the exact amount of the item.
c. No further inclusion of income is required as the difference is less than 25% of the original amount reported and the estimate had been made in good faith.
d. Stewart is required to file an amended return to report the additional $1,000 of income.
The $1,000 difference is includible in Stewart’s Year 2 income tax return.
Explanation:
Choice “a” is correct. Under these facts the estimate was accurate based on information available when the return was filed. When the exact amount is known, the difference is included in income in the year the amount is received or the exact amount is determined.
Choice “c” is incorrect. The income must be reported despite the good-faith error in estimate.
Choice “b” is incorrect. There is no need to notify the IRS of the error.
Choice “d” is incorrect. An amended return is not filed. Stewart based the estimate on information known at the time.
Kane Corp. is a calendar year domestic personal holding company. Which deduction(s) must Kane make from Year 1 taxable income to determine undistributed personal holding company income prior to the dividend-paid deduction?
Federal Net long-term
Income Taxes capital gain
less related
federal income taxes
a. No Yes
b. Yes Yes
c. Yes No
d. No No
Yes, Yes.
Explanation:
Choice “b” is correct. A personal holding company deducts federal income taxes in computing undistributed personal holding company income. A personal holding company deducts net long-term capital gain less related federal income taxes in computing undistributed personal holding company income.
Choices “c”, “a”, and “d” are incorrect, per the above explanation.
Bank Corp. owns 80% of Shore Corp.’s outstanding capital stock. Shore’s capital stock consists of 50,000 shares of common stock issued and outstanding. Shore’s Year 1 net income was $140,000. During Year 1, Shore declared and paid dividends of $60,000. In conformity with generally accepted accounting principles, Bank recorded the following entries in Year 1:
Debit (Dr) Credit (Cr)
Investment in Shore Corp. common stock $ 112,000
Equity in earnings of subsidiary $ 112,000
Cash 48,000
Investment in Shore Corp. common stock 48,000
In its Year 1 consolidated tax return, Bank should report dividend revenue of:
a.$9,600
b.$14,400
c.$48,000
d.$0
$0. Explanation
Choice “d” is correct. In filing a consolidated federal income tax return, a corporate group eliminates the dividends from group members. Shore would have to be included in Bank’s group consolidated income tax return because Bank owns 80% of Shore.
Choices “c”, “b”, and “a” are incorrect, per the above explanation.
Dart Corp., a calendar year domestic C corporation, is not a personal holding company. For purposes of the accumulated earnings tax, Dart has accumulated taxable income for Year 1. Which step(s) can Dart take to eliminate or reduce any Year 1 accumulated earnings tax?
I. Demonstrate that the “reasonable needs” of its business require the retention of all or part of the Year 1 accumulated taxable income.
II. Pay dividends by March 15, Year 2.
a. Both I and II.
b. Neither I nor II.
c. I only.
d. II only.
Both I and II.
Explanation:
Choice “a” is correct. Dart can take both actions to eliminate or reduce any Year 1 accumulated earnings tax. A corporation that can demonstrate that its reasonable business needs require it to accumulate earnings can escape the accumulated earnings tax on the portion reasonably accumulated. Dividends paid by the 15th day of the third month after the close of the corporation’s tax year reduce the accumulated earnings subject to the accumulated earnings tax.
Choices “c”, “d”, and “b” are incorrect. Each of these answers treats either I or II (or both) incorrectly.
Eastern Corp., a calendar year corporation, was formed January 3, Year 1, and on that date placed five-year property in service. The property was depreciated under the general MACRS system. Eastern did not elect to use the straight-line method. The following information pertains to Eastern:
Eastern’s Year 1 taxable income - $ 300,000
Adjustment for the accelerated depreciation taken on Year 1 five-year property - $1,000
Year 1 tax-exempt interest from specified private activity bonds issued - $5,000
What was Eastern’s Year 1 alternative minimum taxable income before the adjusted current earnings (ACE) adjustment?
a. $301,000
b. $305,000
c. $306,000
d. $304,000
$306,000.
Explanation:
Choice “c” is correct. Eastern’s alternative minimum taxable income before the ACE adjustment (and ignoring the exemption allowable) is $306,000:
Taxable income $ 300,000
Adjustment for regular tax accelerated depreciation -
$1,000
Tax preference for private activity bond interest -
$5,000
AMTI - $ 306,000
Choices “b”, “d”, and “a” are incorrect. Both the adjustment for accelerated depreciation and the preference for private activity bond interest are addbacks to taxable income to arrive at AMTI.
A corporation may reduce its regular income tax by taking a tax credit for:
a. State income taxes. b. Foreign income taxes. c. Accelerated depreciation. d. Dividends-received exclusion.
Foreign income taxes.
Explanation:
Choice “b” is correct. Under certain conditions a taxpayer may take a credit against its U.S. income tax for foreign income taxes paid.
Choice “d” is incorrect. The dividends-received deduction (not exclusion) reduces taxable income; it is not a tax credit.
Choice “a” is incorrect. State income taxes reduce taxable income; they are not tax credits.
Choice “c” is incorrect. Accelerated depreciation reduces taxable income; it is not a tax credit.
The accumulated earnings tax can be imposed:
a. Regardless of the number of stockholders in a corporation.
b. On both partnerships and corporations.
c. On personal holding companies.
d. On companies that make distributions in excess of accumulated earnings.
Regardless of the number of stockholders in a corporation.
Explanation:
Choice “a” is correct. The imposition of the accumulated earnings tax does not depend on the number of shareholders a corporation has.
Choice “b” is incorrect. Partnerships are not liable for the accumulated earnings tax, but most corporations are potentially liable.
Choice “d” is incorrect. Corporations that make distributions in excess of accumulated earnings are not liable for the accumulated earnings tax. There would be no accumulated earnings left to tax.
Choice “c” is incorrect. Personal holding companies are not liable for the accumulated earnings tax.
The following information pertains to Dahl Corp.:
Accumulated earnings and profits at January 1, Year 1 - $ 120,000
Earnings and profits for the year ended December 31, Year 1 - $160,000
Cash distributions to individual stockholders during Year 1 - $360,000
What is the total amount of distributions taxable as dividend income to Dahl’s stockholders in Year 1?
a.$0
b.$160,000
c.$360,000
d.$280,000
$280,000.
Explanation:
Choice “d” is correct. Distributions out of the sum of current and accumulated earnings and profits are taxable as dividends to the recipients.
Accumulated E&P at 1/1/Year 1 $ 120,000
Earnings in Year 1 $ 160,000
Taxable dividends to recipients $ 280,000
Excess distributed $ 80,000
Total distributed $ 360,000
Any excess reduces the shareholder’s basis in Dahl stock, and any amount beyond that required to reduce the shareholder’s basis to zero is treated as received on the sale or exchange of the stock and is capital gain.
Choices “a”, “b”, and “c” are incorrect, per the above calculation and explanation.
Clark and Hunt organized Jet Corp. with authorized voting common stock of $400,000. Clark contributed $60,000 cash. Both Clark and Hunt transferred other property in exchange for Jet stock as follows: Clark : Adjusted basis - $50,000 Fair market value - $100,000 Percentage of Jet stock acquired - 40%
Hunt:
Adjusted basis - $120,000
Fair market value - $240,000
Percentage of Jet stock acquired - 60%
What was Clark’s basis in Jet stock?
a. $110,000 b. $100,000 c. $0 d. $160,000
$110,000.
Explanation:
Choice “a” is correct. The formation of a corporation under these conditions is a nontaxable event. Clark’s basis will be the $60,000 cash he contributed plus the $50,000 adjusted basis of the non-cash property for a total of $110,000.
Choice “c” is incorrect. Clark contributed both cash and property. Thus, Clark’s basis in Jet’s stock is greater than zero.
Choice “b” is incorrect. The amount of cash that Clark contributed must also be considered in determining Clark’s basis in Jet stock.
Choice “d” is incorrect. When property is contributed to form a corporation, it is contributed at its adjusted basis, not at its fair market value.
Bass Corp., a calendar year C corporation, made qualifying Year 2 estimated tax deposits based on its actual Year 1 tax liability. On March 15, Year 3, Bass filed a timely automatic extension request for its Year 2 corporate income tax return. Estimated tax deposits and the extension payment totaled $7,600. This amount was 95% of the total tax shown on Bass’ final Year 2 corporate income tax return. Bass paid $400 additional tax on the final Year 2 corporate income tax return filed before the extended due date. For the Year 2 calendar year, Bass was subject to pay:
I. Interest on the $400 tax payment made in Year 3.
II. A tax delinquency penalty.
a. II only.
b. Neither I nor II.
c. Both I and II.
d. I only.
I only.
Explanation:
Choice “d” is correct. A taxpayer does not extend the time for payment of tax by extending the filing deadline for the return. If there is tax owed when the return is filed, interest must be paid at the rate prescribed by IRC §6621; therefore, Bass was subject to pay interest on the $400 tax payment made in Year 3. There is no delinquency penalty if the taxpayer files its return, the amount owed on the return is not $500 or more, and the taxpayer pays the balance due on or before the extended due date (all of which Bass Corp. complied with).
Choices “a”, “c”, and “b” are incorrect, per the above discussion.
Edge Corp., a calendar-year C corporation, had a net operating loss and zero tax liability for its Year 1 tax year. To avoid the penalty for underpayment of estimated taxes, Edge could compute its first quarter Year 2 estimated income tax payment using the:
Annualized Preceeding
income method Year method
a. No Yes
b. Yes No
c. No No
d. Yes Yes
Yes, No.
Explanation:
Choice “b” is correct. Edge should use the annualized income method for calculating its estimated tax payments. Edge cannot use the preceding year method because it did not have an income tax liability in the preceding taxable year.
Choices “d”, “a”, and “c” are incorrect, per the above discussion.
A corporation’s tax year can be reopened after all statutes of limitations have expired if:
I. The tax return has a 50% nonfraudulent omission from gross income.
II. The corporation prevails in a determination allowing a deduction in an open tax year that was taken erroneously in a closed tax year.
a. Neither I nor II.
b. I only.
c. Both I and II.
d. II only.
II only.
Explanation:
Choice “d” is correct. If the prior omission was nonfraudulent, the statute of limitations cannot be reopened after it has expired.
To mitigate the unfair effects of the statute of limitations in some rare cases, a tax year can be reopened to avoid hardship for the taxpayer or the IRS. In the case in which an item is ruled deductible in a subsequent year after having been taken in a year now closed by the statute of limitations, the IRS will reopen the statute of limitations to disallow the deduction in the previous year.
Choices “b”, “c”, and “a” are incorrect. Each of these answers incorrectly addresses I and/or II.
Edge Corp. met the stock ownership requirements of a personal holding company. What sources of income must Edge consider to determine if the income requirements for a personal holding company have been met?
I. Interest earned on tax-exempt obligations.
II. Dividends received from an unrelated domestic corporation.
a. Neither I nor II.
b. II only.
c. Both I and II.
d. I only.
II only.
Explanation:
Choice “b” is correct.
I. Interest is normally included in personal holding company income, but only if it is included in the receiving corporation’s gross income. Since interest income from tax-exempt obligations is not included in gross income, it is not personal holding company income.
II. Dividend income from unrelated domestic corporations is personal holding company income.
Choices “d”, “c”, and “a” are incorrect. Each of these answers treats I or II incorrectly.
Kent Corp. is a calendar year accrual basis C corporation. In Year 1, Kent made a nonliquidating distribution of property with an adjusted basis of $150,000 and a fair market value of $200,000 to Reed, its sole shareholder.
The following information pertains to Kent:
Reed’s basis in Kent stock at January 1, Year 1 $ 500,000
Accumulated earnings and profits at January 1, Year 1 - $125,000
Current earnings and profits for Year 1 (from operations) - $60,000
What was taxable as dividend income to Reed for Year 1?
a.$60,000
b.$185,000
c.$150,000
d.$200,000
$200,000.
Choice “d” is correct. A dividend paid in property other than money is taxable to an individual taxpayer to the extent of the property’s fair market value, but not in excess of the current and accumulated earnings and profits of the distributing corporation. In this case the fair market value of the dividend is $200,000. It is taxable to the extent that Kent had current earnings ($60,000) plus accumulated earnings and profits ($125,000) plus any gain generated on the distribution itself ($50,000); thus the dividend is taxable to the extent of $200,000.
Choice “a” is incorrect. The maximum taxable amount of a property dividend is equal to the sum of both current earnings and profits and accumulated earnings and profits (plus any gain to the corporation on the distribution itself).
Choice “c” is incorrect. A dividend paid in property other than money is taxable to an individual taxpayer to the extent of the property’s fair market value (not its basis). However, the taxable dividend amount is no more than the current and accumulated earnings and profits of the distributing corporation (plus any gain to the corporation on the distribution itself).
Choice “b” is incorrect. This answer did not take into account the gain generated on the distribution of the appreciated property.
Jaxson Corp. has 200,000 shares of voting common stock issued and outstanding. King Corp. has decided to acquire 90 percent of Jaxson’s voting common stock solely in exchange for 50 percent of its voting common stock and retain Jaxson as a subsidiary after the transaction. Which of the following statements is true?
a. King must acquire 100 percent of Jaxson stock for the transaction to be a tax-free reorganization.
b. Jaxson must surrender assets for the transaction to qualify as a tax-free reorganization.
c. The transaction will qualify as a tax-free reorganization.
d. King must issue at least 60 percent of its voting common stock for the transaction to qualify as a tax-free reorganization.
The transaction will qualify as a tax-free reorganization.
Choice “c” is correct. The acquisition of a controlling (usually 80%) interest by one corporation in the stock of another corporation solely for stock is a tax-free (Type B) reorganization.
Choice “a” is incorrect. King need not acquire 100% of Jaxson’s stock, just a controlling interest.
Choice “d” is incorrect. There is no specific amount of acquiring corporation stock that must be issued in a tax-free reorganization; the acquiring corporation must acquire 80% or more of the target’s stock, however.
Choice “b” is incorrect. There is no requirement that Jaxson surrender assets for the reorganization to qualify as tax-free.
Banks Corp., a calendar year corporation, reimburses employees for properly substantiated qualifying business meal expenses. The employees are present at the meals, which are neither lavish nor extravagant, and the reimbursement is not treated as wages subject to withholdings. What percentage of the meal expense may Banks deduct?
a. 80% b. 100% c. 50% d. 0%
50%.
Choice “c” is correct. Only 50% of business meal and entertainment expense is deductible.
Choices “d”, “a”, and “b” are incorrect. Each of these is an incorrect percentage.
For the current year, Kelly Corp. had net income per books of $300,000 before the provision for Federal income taxes. Included in the net income were the following items:
Dividend income from an unaffiliated domestic taxable corporation (taxableincome limitation does not apply and there is no portfolio indebtedness) - $ 50,000
Bad debt expense (represents the increase in the allowance for doubtful accounts) - $80,000
Assuming no bad debt was written off, what is Kelly’s taxable income for the current year?
a.$345,000
b.$250,000
c.$330,000
d.$380,000
$345,000.
Choice “a” is correct.
Book net income $ 300,000
Nondeductible bad debt expense 80,000
Dividends received deduction (35,000)
$ 345,000
The Dividends Received Deduction, or DRD, is a tax deduction that only C corporations receive on the dividends distributed to them by other companies whose stock they own. As a C corporation’s equity interest in a dividend-paying company increases, so does the amount of the DRD.
50,000/300,000 = $16.67%, which is less than 20%, therefore the DRD = 70%
$50,000 x 70% = $35,000
Choice “b” is incorrect. The bad debt expense taken on the allowance method is disallowed. For tax purposes, the corporation must use the direct write-off method. In addition, Kelly Corp. is allowed a 70% dividends received deduction.
Choice “c” is incorrect. Only 70% of the DRD is allowed as a deduction.
Choice “d” is incorrect. Kelly Corp. is allowed a 70% DRD.
For the year ended December 31, Year 6, Taylor Corp. had a net operating loss of $200,000. Taxable income for the earlier years of corporate existence, computed without reference to the net operating loss, was as follows: Taxable income Year 1 - $ 5,000 Year 2 - $10,000 Year 3 - $20,000 Year 4 - $30,000 Year 5 - $40,000 What amount of net operating loss will be available to Taylor for the year ended December 31, Year 7? a.$95,000 b.$110,000 c.$130,000 d.$200,000
$130,000, Net OPERATING Losses are carried back 2 years and forwards 20 years.
Choice “c” is correct. Year 4 to Year 5, Taylor will carry its NOL back two years and forward until it is used (but not more than 20 years). Carrying the NOL back to Year 4 to Year 5 absorbs $70,000 of the $200,000 NOL generated in Year 6 leaving $130,000 to be absorbed in Year 7 and later years.
Choice “d” is incorrect. Taylor does not waive the two year carryback; therefore, the NOL will carry back to the second preceding tax year.
Choice “b” is incorrect. The NOL carryback goes first to the second preceding tax year (Year 4), not the third preceding year (Year 3).
Choice “a” is incorrect. The NOL carryback goes first to the second preceding tax year (Year 4), not the fifth preceding year (Year 1).
Axis Corp. is an accrual basis calendar year corporation. On December 13, Year 1, the Board of Directors declared a two percent of profits bonus to all employees for services rendered during Year 1 and notified them in writing. None of the employees own stock in Axis. The amount represents reasonable compensation for services rendered and was paid on April 13, Year 2. Axis’ bonus expense may:
a. Be deducted on Axis’ Year 1 tax return.
b. Be deducted on Axis’ Year 2 tax return.
c. Not be deducted on Axis’ tax return because payment is a disguised dividend.
d. Not be deducted on Axis’ Year 1 tax return because the per share employee amount cannot be determined with reasonable accuracy at the time of the declaration of the bonus.
Be deducted on Axis’ Year 1 tax return.
Choice “a” is correct. The deduction is an ordinary and necessary business expense treated just as any other compensation expense is treated. Axis is an accrual basis taxpayer, and the deduction is taken on the return for the year in which the expense accrued because it was paid within 3-1/2 months of year-end.
Choice “d” is incorrect. The bonus was declared 11-1/2 months into the taxable year, so the amount, while not precisely known, could be determined with reasonable accuracy.
Choice “b” is incorrect. The deduction accrued is in Year 1 and is taken on the Year 1 return. An accrual-basis taxpayer deducts expenses in the year in which they accrue, not the year in which they are paid.
Choice “c” is incorrect. Since none of the recipient employees are shareholders of Axis, the bonus will not be a disguised dividend.
Tapper Corp., an accrual basis calendar year corporation, was organized on January 2, Year 1. During Year 1, revenue was exclusively from sales proceeds and interest income. The following information pertains to Tapper:
Taxable income before charitable contributions for the year ended December 31, Year 1 - $ 500,000
Tapper’s matching contribution to employee-designated qualified universities made during Year 1 - $10,000
Board of Directors’ authorized contribution to a qualified charity (authorized December 1, Year 1, made February 1, Year 2) - $30,000
What is the maximum allowable deduction that Tapper may take as a charitable contribution on its tax return for the year ended December 31, Year 1?
a.$10,000
b.$40,000
c.$30,000
d.$0
$40,000.
Choice “b” is correct. Tapper’s college matching contributions are deductible; Tapper made the contributions; the employees merely directed the proceeds. The Board’s authorized contribution is also deductible since it satisfies the two rules under which an accrual-basis corporation can deduct an accrued contribution: 1) it was authorized to a qualified charity by Board resolution before the end of the taxable year and 2) it was paid by the 15th day of the 4th month after the end of the taxable year of accrual.
Choices “d”, “a”, and “c” are incorrect. Based on the above explanation, both items are allowable as charitable contributions.
Which of the following costs are expensable/amortizable organizational expenditures?
a. Legal fees for drafting the corporate charter.
b. Printing costs to issue the corporate stock.
c. Commissions paid by the corporation to an underwriter.
d. Professional fees to issue the corporate stock.
Legal fees for drafting the corporate charter.
Choice “a” is correct. The costs of organizing the corporation are expensable (subject to the $5,000 limitation) and amortizable, but the costs of selling stock are not. The only expense listed that qualifies for expense/amortization is the legal fees for drafting the corporate charter; the others relate to the sale of stock.
Choices “d”, “b”, and “c” are incorrect. These are expenses of selling the corporation’s stock and are not a cost of organizing the corporation and therefore cannot be amortized.
With regard to consolidated tax returns, which of the following statements is correct?
a. Operating losses of one group member may be used to offset operating profits of the other members included in the consolidated return.
b. The common parent must directly own 51% or more of the total voting power of all corporations included in the consolidated return.
c. Only corporations that issue their audited financial statements on a consolidated basis may file consolidated returns.
d. Of all intercompany dividends paid by the subsidiaries to the parent, 70% are excludible from taxable income on the consolidated return.
Operating losses of one group member may be used to offset operating profits of the other members included in the consolidated return.
Choice “a” is correct. A significant advantage of consolidated tax returns is the ability to offset gains and losses among group members as if they were a single taxpayer.
Choice “c” is incorrect. Corporations need not have audited financial statements issued on a consolidated basis to file a consolidated tax return.
Choice “d” is incorrect. 100% of dividends received by the parent are eliminated on a consolidated tax return.
Choice “b” is incorrect. The common parent must own directly or indirectly 80% of the total voting power of all corporations included in the consolidated tax return.
In the filing of a consolidated tax return for a corporation and its wholly owned subsidiaries, intercompany dividends between the parent and subsidiary corporations are:
a. Included in taxable income to the extent of 20%. b. Included in taxable income to the extent of 80%. c. Not taxable. d. Fully taxable.
Not taxable.
Choice “c” is correct. Dividends received from other group members are eliminated from the parent’s taxable income in consolidation; no dividends received deduction is allowed. Since the parent eliminates the subsidiary dividends in consolidation, they are effectively not taxable.
Choices “a”, “b”, and “d” are incorrect. The regulations require elimination of intercompany dividends in consolidation.
A corporation’s penalty for underpaying federal estimated taxes is:
a. Partially deductible.
b. Fully deductible in the year paid.
c. Fully deductible if reasonable cause can be established for the underpayment.
d. Not deductible.
Not deductible.
Choice “d” is correct.
Rule: The penalty for underpayment of federal estimated taxes is not deductible.
Choices “b”, “c”, and “a” are incorrect, per the above rule.
Which of the following credits is a combination of several tax credits to provide uniform rules for the current and carryback-carryover years?
a. General business credit. b. Minimum tax credit. c. Enhanced oil recovery credit. d. Foreign tax credit.
General business credit.
Choice “a” is correct. The general business credit combines several nonrefundable tax credits and provides rules for their absorption against the taxpayer’s liability.
Choice “d” is incorrect. The foreign tax credit does not combine more than one credit.
Choice “b” is incorrect. The minimum tax credit does not combine more than one credit.
Choice “c” is incorrect. The enhanced oil recovery credit does not combine more than one credit.
Blink Corp., an accrual basis calendar year corporation, carried back a net operating loss for the tax year ended December 31, Year 1. Blink's gross revenues have been under $500,000 since inception. Blink expects to have profits for the tax year ending December 31, Year 2. Which method(s) of estimated tax payment can Blink use for its quarterly payments during the Year 2 tax year to avoid underpayment of federal estimated taxes? I.100% of the preceding tax year method. II.Annualized income method. a.Both I and II. b.I only. c.Neither I nor II. d.II only.
II only.
Choice “d” is correct. Blink cannot use the 100% of preceding tax year method in Year 2 because it did not pay income tax in Year 1. Blink can use the annualized income method.
Choices “b”, “a”, and “c” are incorrect. Each of these answers treats I and/or II incorrectly.
Tank Corp., which had earnings and profits of $500,000, made a nonliquidating distribution of property to its shareholders in Year 1 as a dividend in kind. This property, which had an adjusted basis of $20,000 and a fair market value of $30,000 at the date of distribution, did not constitute assets used in the active conduct of Tank’s business. How much gain did Tank recognize on this distribution?
a. $0 b. $30,000 c. $20,000 d. $10,000
$10,000.
Choice “d” is correct. The property distributed by Tank is treated as if it were sold to the shareholder at its fair market value on the date of distribution. Tank recognizes gain to the extent of the fair market value ($30,000) over the adjusted basis ($20,000) or $10,000.
Choice “b” is incorrect. Gain is computed as the difference between the FMV and adjusted basis of the property.
Choice “c” is incorrect. Gain is not equal to the adjusted basis of the property.
Choice “a” is incorrect. Gain is recognized.
In a Type B reorganization, as defined by the Internal Revenue Code, the:
I. Stock of the target corporation is acquired solely for the voting stock of either the acquiring corporation or its parent.
II. Acquiring corporation must have control of the target corporation immediately after the acquisition.
a.I only.
b.II only.
c.Both I and II.
d.Neither I nor II.
Both I and II.
Choice “c” is correct. Both requirements listed are necessary in a Type B reorganization. In a Type B reorganization, the target is acquired using the stock of the acquiring corporation or the acquiring corporation’s parent (triangular acquisition). In a Type B reorganization, the acquiring corporation must be in control of the target immediately after the acquisition.
Choices “a”, “b”, and “d” are incorrect. Each of these answers treats I or II incorrectly.
Jackson Corp., a calendar year corporation, mailed its Year 1 tax return to the Internal Revenue Service by certified mail on Friday, April 11, Year 2. The return, postmarked April 11, Year 2, was delivered to the Internal Revenue Service on April 18, Year 2. The statute of limitations (for assessments) on Jackson’s corporate tax return begins on:
a. April 11, Year 2. b. April 18, Year 2. c. April 16, Year 2. d. December 31, Year 1.
April 16, Year 2.
Choice “c” is correct. The Year 1 return of a calendar year corporation is due on April 15, Year 2, so the statute of limitations begins on the next day, April 16, Year 2.
Rule: The statute of limitations for assessments runs from the date of the filing of the return, or, if later, the due date of the return.
Choices “d”, “a”, and “b” are incorrect, per the above rule.
Tech Corp. files a consolidated return with its wholly-owned subsidiary, Dow Corp. During the year, Dow paid a cash dividend of $20,000 to Tech. What amount of this dividend is taxable on the current year’s consolidated return?
a. $6,000 b. $14,000 c. $0 d. $20,000
$0.
Choice “c” is correct.
Intercompany dividends are eliminated when preparing a consolidated return, therefore none of intercompany dividends are taxable.
The $20,000 came from income of Dow and is reported as part of consolidated income. The receipt of the dividend by Tech is not included again.
Choice “d” is incorrect. As the two corporations file a consolidated return, 100% of the dividends are eliminated, not taxable.
Choice “b” is incorrect. This answer is 70% of the $20,000 dividend. 100% of the dividend is eliminated when a consolidated return is filed.
Choice “a” is incorrect. This answer is 30% of the $20,000 dividend. 100% is eliminated upon consolidation. This answer assumes Tech is entitled to a 70% dividends received deduction.
Kisco Corp.’s taxable income before taking the dividends received deduction was $70,000. This includes $10,000 in dividends from an unrelated taxable domestic corporation. Given the following tax rates, what would Kisco’s income tax be before any credits?
Partial rate table Tax rate
Up to $50,000 15%
Over $50,000 but not over $75,000 25%
a.$15,750
b.$10,000
c.$12,500
d.$10,750
$10,750.
Choice “d” is correct. The $10,000 dividend is from an unrelated corporation. This means less than 20% of the company is owned. A 70% dividends received deduction is available.
Taxable income - $70,000
Less: DRD (70% × 10,000) - ($7,000)
Taxable income - $63,000
Income tax 15% × $50,000 - $7,500
+ [25% × ($63,000 − $50,000)] - $3,250
Total - $ 10,750
Choices “b”, “c”, and “a” are incorrect. The $10,000 dividend is from an unrelated corporation. [This means less than 20% of the company is owned. A 70% dividends received deduction is available.]
On January 1, Year 1, Kee Corp., a C corporation, had a $50,000 deficit in earnings and profits. For Year 1, Kee had current earnings and profits of $10,000 and made a $30,000 cash distribution to its stockholders. What amount of the distribution is taxable as dividend income to Kee’s stockholders?
a. $0 b. $20,000 c. $10,000 d. $30,000
$10,000.
Choice “c” is correct. Taxable dividend income is paid out of the corporation’s current or accumulated earnings and profits. Since Kee had a deficit, only current earnings and profits of $10,000 are available for dividends.
Choice “d” is incorrect. Taxable dividend income is paid out of the corporation’s current or accumulated earnings and profits; it is not based solely on the distributed property’s fair market value (cash in this instance).
Choice “b” is incorrect. Taxable dividend income is paid out of the corporation’s current or accumulated earnings and profits; it is not calculated as the difference between current E&P and the cash distributed.
Choice “a” is incorrect. Taxable dividend income is paid out of the corporation’s current or accumulated earnings and profits.
Adams, Beck, and Carr organized Flexo Corp. with authorized voting common stock of $100,000. Adams received 10% of the capital stock in payment for the organizational services that he rendered for the benefit of the newly formed corporation. Adams did not contribute property to Flexo and was under no obligation to be paid by Beck or Carr. Beck and Carr transferred property in exchange for stock as follows:
Adjusted basis FMV % of Flexo stock acquired
Beck $5,000 $20,000 20%
Carr $60,000 $70,000 70%
What amount of gain did Carr recognize from this transaction?
a.$0
b.$10,000
c.$15,000
d.$40,000
$0.
Choice “a” is correct. Carr has no taxable income because he transferred property to Flexo in a transaction that qualifies as nontaxable.
Choices “d”, “c”, and “b” are incorrect. Beck and Carr have no taxable income because they transferred property to Flexo. However, Adams’ contribution of services is not “property” for this purpose, so the receipt of stock is taxable.
In Year 1, Brun Corp. properly accrued $10,000 for an income item on the basis of a reasonable estimate. In Year 2, Brun determined that the exact amount was $12,000. Which of the following statements is correct?
a. Brun is required to file an amended return to report the additional $2,000 of income.
b. No further inclusion of income is required as the difference is less than 25% of the original amount reported and the estimate had been made in good faith.
c. The $2,000 difference is includible in Brun’s Year 2 income tax return.
d. Brun is required to notify the IRS within 30 days of the determination of the exact amount of the item.
The $2,000 difference is includible in Brun’s Year 2 income tax return.
Choice “c” is correct. Under the accrual basis of accounting, when you include an amount in gross income on the basis of a reasonable estimate, and you later determine the exact amount, the difference (if any) is taken into account in the tax year in which the determination is made. Therefore, in this case, the additional $2,000 is included in Brun’s Year 2 income.
Choice “a” is incorrect. There is no requirement to file an amended return as a result of an inaccurate but reasonable estimate of income in a prior year.
Choice “d” is incorrect. There is no requirement to notify the IRS.
Choice “b” is incorrect. The additional $2,000 must be included in income in Year 2. The 25% rule cited pertains to unintentional underreporting of income and its effect on the statute of limitations, increasing it from 3 to 6 years.
Cape Co. reported book income of $140,000. Included in that amount was $50,000 for meals and entertainment expense and $40,000 for federal income tax expense. In Cape’s Schedule M-1 of Form 1120, which reconciles book income and taxable income, what amount should be reported as taxable income?
a. $205,000 b. $190,000 c. $150,000 d. $140,000
$205,000.
Choice “a” is correct. The M-1 reconciliation of book income to taxable income would be as follows:
Book income $ 140,000
Federal income tax expense deductible from book income, but not deductible for tax purposes $40,000
$180,000
50% × $50,000 meals and entertainment expenses not deductible for tax purposes, but deductible from book income $25,000
Taxable income $ 205,000
Choice “b” is incorrect. 50% of the $50,000 meals and entertainment expenses are disallowed for tax purposes.
Choice “c” is incorrect. The $40,000 federal income tax expense is not deductible for tax purposes.
Choice “d” is incorrect. The $40,000 federal income tax expense and 50% of the $50,000 meals and entertainment expenses are not deductible for tax purposes.
When computing a corporation’s income tax expense for estimated income tax purposes, which of the following should be taken into account?
Corporate tax credits Alternative minimum tax
a. Yes No
b. No No
c. Yes Yes
d. No Yes
Yes, Yes.
Choice “c” is correct. When computing a corporation’s income tax expense for estimated income tax purposes, both corporate tax credits and the alternative minimum tax should be taken into account.
Choices “b”, “d”, and “a” are incorrect. Each of these answers treats one of the above items incorrectly.
Jones incorporated a sole proprietorship by exchanging all the proprietorship’s assets for the stock of Nu Co., a new corporation. To qualify for tax-free incorporation, Jones must be in control of Nu immediately after the exchange. What percentage of Nu’s stock must Jones own to qualify as “control” for this purpose?
a. 80.00% b. 66.67% c. 50.00% d. 51.00%
80.00%
Choice “a” is correct.
Rule: In a tax-free incorporation, the percentage for “control” is 80%, (i.e., control exists if the transferor/shareholder owns at least 80% of the total voting power and at least 80% of the total number of shares of all other classes of stock).
Choices “c”, “d”, and “b” are incorrect, per the above rule.
A corporation was completely liquidated and dissolved during the year. The filing fees, professional fees, and other expenditures incurred in connection with the liquidation and dissolution are:
a. Deductible in full by the dissolved corporation.
b. Not deductible either by the corporation or shareholders.
c. Deductible by the shareholders and not by the corporation.
d. Treated as capital losses by the corporation.
Deductible in full by the dissolved corporation.
Choice “a” is correct. The corporation generally deducts its liquidation expenses (i.e., filing fees, professional fees) on its final tax return.
Choice “c” is incorrect. These expenditures are deductible by the liquidating corporation, not its shareholders.
Choice “d” is incorrect. These expenditures are ordinary deductions, not capital losses.
Choice “b” is incorrect. These expenditures are deductible by the liquidating corporation, on its final tax return.
Brown Corp., a calendar-year taxpayer, was organized and actively began operations on July 1, Year 1, and incurred the following costs:
Legal fees to obtain corporate charter - $ 41,000
Commission paid to underwriter - $25,000
Other stock issue costs - $10,000
Brown wishes to amortize its organizational costs over the shortest period allowed for tax purposes. In Year 1, what amount should Brown deduct for the organizational expenses?
a. $6,200
b. $1,200
c. $5,000
d. $8,600
$6,200.
Choice “a” is correct. Organizational costs are amortizable over a minimum period of 15 years (180 months). In addition, subject to a $50,000 total expenditure limitation, a $5,000 deduction is allowed in Year 1.
Allowable costs in connection with the corporate organization are legal fees to obtain the corporate charter, necessary accounting services, expenses of temporary directors, and incorporation fees paid to the state. Organizational costs exclude stock issue costs and commissions paid to underwriters to help sell the shares.
Only the legal fees of $41,000 qualify as organizational costs. $41,000 − $5,000 = $36,000/180 months = $200 × 6 months = $1,200 + $5,000 (expense in Year 1) = $6,200.
Acorn Inc. had the following items of income and expense: Sales $ 500,000 Cost of sales $ 250,000 Dividends received $ 25,000 The dividends were received from a corporation of which Acorn owns 30%. In Acorn's corporate income tax return, what amount should be reported as income before special deductions? a. $505,000 b. $275,000 c. $525,000 d. $250,000
$275,000.
Choice “b” is correct. Income before special deductions includes sales, dividends received and cost of sales. It excludes the dividends received deduction, which is a “special” deduction.
Sales $ 500,000
Cost of sales (250,000)
Gross profit 250,000
Dividends received 25,000
Income before special deductions $ 275,000
Choice “c” is incorrect. Cost of sales must be deducted.
Choice “a” is incorrect. Cost of sales must be deducted and 100%, not 80%, of the dividends received are included in income before special deductions.
Choice “d” is incorrect. The $25,000 dividend must be included in income before special deductions.
Ace Rentals Inc., an accrual-basis taxpayer, reported rent receivable of $35,000 and $25,000 in its Year 2 and Year 1 balance sheets, respectively. During Year 2, Ace received $50,000 in rent payments and $5,000 in nonrefundable rent deposits. In Ace’s Year 2 corporate income tax return, what amount should Ace include as rent revenue?
a. $60,000 b. $50,000 c. $55,000 d. $65,000
$65,000.
Choice “d” is correct. Rent revenue under the accrual basis would include the cash received ($50,000) plus the increase in the rent receivable ($10,000 = $35,000 - 25,000), or $60,000. In addition, the $5,000 nonrefundable rent deposit is additional rent revenue, for a total of $65,000.
Choice “b” is incorrect. This answer ignores the change in the rent receivable account and the nonrefundable deposit.
Choice “c” is incorrect. This answer ignores the rent receivable account.
Choice “a” is incorrect. This answer ignores the nonrefundable deposit.
