R3-1 Flashcards
A C corporation’s net capital losses are:
a.
Carried forward indefinitely until fully utilized.
b.
Deductible from the corporation’s ordinary income only to the extent of $3,000.
c.
Deductible in full from the corporation’s ordinary income.
d.
Carried back 3 years and forward 5 years.
Choice “d” 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 “a” is incorrect. A C corporation’s net capital losses cannot be carried forward indefinitely. They expire after 5 years.
Choices “c” and “b” 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.
$42,000
b.
$38,500
c.
$40,500
d.
$46,000
Choice “b” 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.
$45,000
b.
$30,000
c.
$57,000
d.
$42,000
Choice “d” 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 “b” is incorrect. This choice does not take into consideration the amounts distributed during the year.
Choice “a” 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 “c” 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.
Limited to $3,000.
b.
Always treated as a short-term capital loss.
c.
Not allowable under current law.
d.
Always treated as a long-term capital loss.
Choice “b” 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.
$0
b.
$25,000
c.
$20,000
d.
$3,000
Choice “a” 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 “d” 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 “c” and “b” 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.
There is no penalty if net earnings are distributed, as the penalty only applies to income that has not been distributed.
b.
Personal holding companies are not subject to the accumulated earnings tax.
c.
The additional tax (penalty) is self-assessed by the PHC.
d.
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.
Choice “d” 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 “c” is incorrect, as the additional tax is self-assessed by the taxpayer by filing a separate schedule 1120PH along with the Form 1120.
Choice “b” 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 “a” 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.
Both I and II.
b.
II only.
c.
Neither I nor II.
d.
I only.
Choice “d” 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 “b”, “a”, and “c” 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 tax shelter.
b.
A qualified personal service corporation.
c.
A C corporation with annual gross receipts of $50,000,000.
d.
A manufacturer.
Explanation
Choice “b” 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 “a”, “c”, and “d” 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.
$50,000
b.
$0
c.
$80,000
d.
$20,000
Choice “a” 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 “b” 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 “d” is incorrect. The amount taxable as a dividend is total E&P, not the difference between one distribution and current E&P.
Choice “c” 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.
$329,300
b.
$239,200
c.
$336,800
d.
$349,300
Choice “c” 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 [1]
Less: Excess of tax amortization over book impairment of goodwill (12,500) [2]
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 “b” is incorrect. This answer is the amount of book income without any adjustments.
Choice “a” 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 “d” 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.
Carried back three years and forward five years.
b.
Deductible in full from the corporation’s ordinary income.
c.
Deducted from the corporation’s ordinary income only to the extent of $3,000.
d.
Carried forward 20 years.
Choice “a” is correct. A C corporation’s net capital losses are carried back three years and forward five years.
Choice “c” is incorrect. This is incorrect because it states the rule for an individual taxpayer.
Choice “b” 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 “d” 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.
$18,000 capital gain.
b.
$33,000 dividend.
c.
$25,000 dividend.
d.
$17,000 capital gain.
Choice “d” 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 “b” is incorrect. Because this is a sale of Hall’s interest in Elm, this is not a dividend.
Choice “c” is incorrect. The accumulated earnings of Elm have no relationship to the stock surrender.
Choice “a” 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.
$0
b.
$4,000
c.
$6,000
d.
$500
Choice “c” 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 “a” 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 “d” is incorrect. The gain is calculated using the fair market value of assets received, not the basis of the assets received.
Choice “b” 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:
Property Adj Basis FMV % of Ace Stock Acquired
Lind Building 40000 82,000 60%
Post Land 5,000 48,000 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.
$0
b.
$52,000
c.
$42,000
d.
$10,000
Choice “a” 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”, “c”, and “b” 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:
Property Adj Basis FMV % of Ace Stock Acquired
Lind Building 40000 82,000 60%
Post Land 5,000 48,000 40%
The building was subject to a $10,000 mortgage that was assumed by Ace. What was Ace’s basis in the building?
a.
$82,000
b.
$40,000
c.
$30,000
d.
$72,000
Choice “b” is correct. Ace’s basis in the building is the same as Lind’s basis immediately prior to its contribution to the corporation.
Choice “c” is incorrect. Ace’s basis in the building is computed separately from any debt that it assumes related to the building.
Choice “d” 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 “a” 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:
Property Adj Basis FMV % of Ace Stock Acquired
Lind Building 40000 82,000 60%
Post Land 5,000 48,000 40%
The building was subject to a $10,000 mortgage that was assumed by Ace. What was Lind’s basis in Ace stock?
a.
$82,000
b.
$30,000
c.
$40,000
d.
$0
Choice “b” 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 “a” is incorrect. The basis of Lind’s stock is based on his basis in the contributed property, not its fair market value.
Choice “c” 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 “d” 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.
$330,000
b.
$550,000
c.
$500,000
d.
$502,000
Choice “d” 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 “a”, “c”, and “b” 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.
$50,000
b.
$175,000
c.
$0
d.
$125,000
Choice “b” 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 “c”, “a”, and “d” 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.
$70,000
b.
$80,000
c.
$100,000
d.
$63,000
Choice “d” 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 “c” is incorrect. The 100% DRD is available only when 80−100% of the stock is owned (making these entities related).
Choice “b” is incorrect. The 80% DRD is used when at least 20% but less than 80% of the stock is owned.
Choice “a” 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.
$90,000
b.
$80,000
c.
$82,000
d.
$86,000
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.
May be carried back or forward for one year at the corporation’s election.
b.
May be carried forward to a maximum of five succeeding years.
c.
May be carried back to the third preceding year.
d.
Is not deductible in any future or prior year.
Choice “b” 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 “d”, “a”, and “c” 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.
Stewart is required to notify the IRS within 30 days of the determination of the exact amount of the item.
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.
Stewart is required to file an amended return to report the additional $1,000 of income.
d.
The $1,000 difference is includible in Stewart’s Year 2 income tax return.
Choice “d” 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 “b” is incorrect. The income must be reported despite the good-faith error in estimate.
Choice “a” is incorrect. There is no need to notify the IRS of the error.
Choice “c” 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 income taxes
~~Net long-term capital gain less related federal income taxes
a.
No
No
b.
No
Yes
c.
Yes
Yes
d.
Yes
No
Choice “c” 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 “d”, “b”, and “a” 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:
Investment in Shore Corp CS (debit) 112,000
Equity in earings of subsidiary (credit) 112,000
Cash (Debit) 48000
Investment in Shore Corp. CS (Credit) 48000
In its Year 1 consolidated tax return, Bank should report dividend revenue of:
a.
$0
b.
$48,000
c.
$9,600
d.
$14,400
Choice “a” 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 “b”, “d”, and “c” 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.
Neither I nor II.
b.
II only.
c.
Both I and II.
d.
I only.
Choice “c” 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 “d”, “b”, and “a” 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.
$306,000
b.
$304,000
c.
$301,000
d.
$305,000
Choice “a” 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 “d”, “b”, and “c” 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.
Accelerated depreciation.
b.
Dividends-received exclusion.
c.
Foreign income taxes.
d.
State income taxes.
Choice “c” is correct. Under certain conditions a taxpayer may take a credit against its U.S. income tax for foreign income taxes paid.
Choice “b” is incorrect. The dividends-received deduction (not exclusion) reduces taxable income; it is not a tax credit.
Choice “d” is incorrect. State income taxes reduce taxable income; they are not tax credits.
Choice “a” is incorrect. Accelerated depreciation reduces taxable income; it is not a tax credit.
The accumulated earnings tax can be imposed:
a.
On both partnerships and corporations.
b.
On companies that make distributions in excess of accumulated earnings.
c.
On personal holding companies.
d.
Regardless of the number of stockholders in a corporation.
Choice “d” is correct. The imposition of the accumulated earnings tax does not depend on the number of shareholders a corporation has.
Choice “a” is incorrect. Partnerships are not liable for the accumulated earnings tax, but most corporations are potentially liable.
Choice “b” 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.
$160,000
b.
$360,000
c.
$280,000
d.
$0
Choice “c” 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 “d”, “a”, and “b” 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:
Other property
Adj basis FMV % of Jet stock acq
Clark $50,000 $100,000 40%
Hunt 120,000 240,000 60%
What was Clark’s basis in Jet stock?
a.
$160,000
b.
$0
c.
$110,000
d.
$100,000
Choice “c” 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 “b” is incorrect. Clark contributed both cash and property. Thus, Clark’s basis in Jet’s stock is greater than zero.
Choice “d” is incorrect. The amount of cash that Clark contributed must also be considered in determining Clark’s basis in Jet stock.
Choice “a” 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.
Both I and II.
b.
II only.
c.
I only.
d.
Neither I nor II.
Choice “c” 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, pays at least 90% of the tax due by the due date, and pays the balance due on or before the extended due date (all of which Bass Corp. complied with).
Choices “b”, “a”, and “d” 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 income method
~Preceding year method
a.
No
No
b.
Yes
Yes
c.
Yes
No
d.
No
Yes
Choice “c” 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 “b”, “d”, and “a” 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.
I only.
b.
II only.
c.
Both I and II.
d.
Neither I nor II.
Choice “b” 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 “a”, “c”, and “d” 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.
I only.
b.
Both I and II.
c.
II only.
d.
Neither I nor II.
Choice “c” 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 “a”, “b”, and “d” 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.
$150,000
b.
$60,000
c.
$185,000
d.
$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 “b” 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 “a” 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 “c” 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.
The transaction will qualify as a tax-free reorganization.
b.
King must issue at least 60 percent of its voting common stock for the transaction to qualify as a tax-free reorganization.
c.
King must acquire 100 percent of Jaxson stock for the transaction to be a tax-free reorganization.
d.
Jaxson must surrender assets for the transaction to qualify as a tax-free reorganization.
Choice “a” 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 “c” is incorrect. King need not acquire 100% of Jaxson’s stock, just a controlling interest.
Choice “b” 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 “d” 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.
100%
b.
50%
c.
80%
d.
0%
Choice “b” is correct. Only 50% of business meal and entertainment expense is deductible.
Choices “d”, “c”, and “a” 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.
$380,000
b.
$345,000
c.
$330,000
d.
$250,000
Choice “b” is correct.
Book net income $ 300,000
Nondeductible bad debt expense 80,000
Dividends received deduction (35,000)
$ 345,000
Choice “d” 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 “a” 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.
$200,000
b.
$95,000
c.
$110,000
d.
$130,000
Choice “d” 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 “a” is incorrect. Taylor does not waive the two year carryback; therefore, the NOL will carry back to the second preceding tax year.
Choice “c” is incorrect. The NOL carryback goes first to the second preceding tax year (Year 4), not the third preceding year (Year 3).
Choice “b” 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 March 13, Year 2. Axis’ bonus expense may:
a.
Be deducted on Axis’ Year 2 tax return.
b.
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.
c.
Not be deducted on Axis’ tax return because payment is a disguised dividend.
d.
Be deducted on Axis’ Year 1 tax return.
Choice “d” 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 2-1/2 months of year-end.
Choice “b” 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 “a” 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.
$30,000
b.
$10,000
c.
$40,000
d.
$0
Choice “c” 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 3rd month after the end of the taxable year of accrual.
Choices “d”, “b”, and “a” 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.
Commissions paid by the corporation to an underwriter.
b.
Professional fees to issue the corporate stock.
c.
Legal fees for drafting the corporate charter.
d.
Printing costs to issue the corporate stock.
Choice “c” 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 “b”, “d”, and “a” 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.
Only corporations that issue their audited financial statements on a consolidated basis may file consolidated returns.
b.
Of all intercompany dividends paid by the subsidiaries to the parent, 70% are excludible from taxable income on the consolidated return.
c.
Operating losses of one group member may be used to offset operating profits of the other members included in the consolidated return.
d.
The common parent must directly own 51% or more of the total voting power of all corporations included in the consolidated return.
Choice “c” 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 “a” is incorrect. Corporations need not have audited financial statements issued on a consolidated basis to file a consolidated tax return.
Choice “b” is incorrect. 100% of dividends received by the parent are eliminated on a consolidated tax return.
Choice “d” 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 80%.
b.
Not taxable.
c.
Included in taxable income to the extent of 20%.
d.
Fully taxable.
Choice “b” 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 “c”, “a”, and “d” are incorrect. The regulations require elimination of intercompany dividends in consolidation.
A corporation’s penalty for underpaying federal estimated taxes is:
a.
Not deductible.
b.
Fully deductible if reasonable cause can be established for the underpayment.
c.
Partially deductible.
d.
Fully deductible in the year paid
Choice “a” is correct.
Rule: The penalty for underpayment of federal estimated taxes is not deductible.
Choices “d”, “b”, and “c” 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.
Foreign tax credit.
b.
General business credit.
c.
Enhanced oil recovery credit.
d.
Minimum tax credit.
Choice “b” is correct. The general business credit combines several nonrefundable tax credits and provides rules for their absorption against the taxpayer’s liability.
Choice “a” is incorrect. The foreign tax credit does not combine more than one credit.
Choice “d” 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.
II only.
b.
Neither I nor II.
c.
I only.
d.
Both I and II.
Choice “a” 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 “c”, “d”, and “b” 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.
$30,000
b.
$20,000
c.
$10,000
d.
$0
Choice “c” 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 “a” is incorrect. Gain is computed as the difference between the FMV and adjusted basis of the property.
Choice “b” is incorrect. Gain is not equal to the adjusted basis of the property.
Choice “d” 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.
II only.
b.
Neither I nor II.
c.
Both I and II.
d.
I only.
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 “d”, “a”, and “b” 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, March 11, Year 2. The return, postmarked March 11, Year 2, was delivered to the Internal Revenue Service on March 18, Year 2. The statute of limitations (for assessments) on Jackson’s corporate tax return begins on:
a.
March 16, Year 2.
b.
March 11, Year 2.
c.
March 18, Year 2.
d.
December 31, Year 1.
Choice “a” is correct. The Year 1 return of a calendar year corporation is due on March 15, Year 2, so the statute of limitations begins on the next day, March 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”, “b”, and “c” 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.
$0
b.
$20,000
c.
$6,000
d.
$14,000
Choice “a” is correct. Intercompany dividends are eliminated when preparing a consolidated return. 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 “b” is incorrect. As the two corporations file a consolidated return, 100% of the dividends are eliminated, not taxable.
Choice “d” is incorrect. This answer is 70% of the $20,000 dividend. 100% of the dividend is eliminated when a consolidated return is filed.
Choice “c” 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.
$10,000
b.
$10,750
c.
$15,750
d.
$12,500
Choice “b” 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: Dividends received deduction (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 “a”, “d”, and “c” 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.
$30,000
b.
$10,000
c.
$0
d.
$20,000
Choice “b” 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 “a” 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 “d” 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 “c” 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
Adj basis FMV %-Flexo stock acq
Beck $5,000 $20,000 20%
Carr 60,000 70,000 70%
What amount of gain did Carr recognize from this transaction?
a.
$40,000
b.
$0
c.
$10,000
d.
$15,000
Choice “b” is correct. Carr has no taxable income because he transferred property to Flexo in a transaction that qualifies as nontaxable.
Choices “a”, “d”, and “c” 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 notify the IRS within 30 days of the determination of the exact amount of the item.
b.
The $2,000 difference is includible in Brun’s Year 2 income tax return.
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.
Brun is required to file an amended return to report the additional $2,000 of income.
Choice “b” 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 “d” 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 “a” is incorrect. There is no requirement to notify the IRS.
Choice “c” 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.
$190,000
b.
$140,000
c.
$150,000
d.
$205,000
Choice “d” 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 “a” 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 “b” 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
Yes
b.
Yes
No
c.
No
No
d.
No
Yes
Choice “a” 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 “c”, “d”, and “b” 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.
50.00%
b.
80.00%
c.
51.00%
d.
66.67%
Choice “b” 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 “a”, “c”, and “d” 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 by the shareholders and not by the corporation.
b.
Treated as capital losses by the corporation.
c.
Deductible in full by the dissolved corporation.
d.
Not deductible either by the corporation or shareholders.
Choice “c” is correct. The corporation generally deducts its liquidation expenses (i.e., filing fees, professional fees) on its final tax return.
Choice “a” is incorrect. These expenditures are deductible by the liquidating corporation, not its shareholders.
Choice “b” is incorrect. These expenditures are ordinary deductions, not capital losses.
Choice “d” 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.
$8,600
b.
$6,200
c.
$5,000
d.
$1,200
Choice “b” 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.
$275,000
b.
$525,000
c.
$505,000
d.
$250,000
Choice “a” 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 “b” is incorrect. Cost of sales must be deducted.
Choice “c” 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.
$65,000
b.
$60,000
c.
$55,000
d.
$50,000
Choice “a” 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 “d” 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 “b” is incorrect. This answer ignores the nonrefundable deposit.
During the year, Portal Corp. received $100,000 in dividends from Sal Corp., its 80%-owned subsidiary. What net amount of dividend income should Portal include in its current year consolidated tax return?
a.
$80,000
b.
$100,000
c.
$0
d.
$70,000
Choice “c” is correct. If a corporation owns 80% or more of another corporation, the dividends received deduction is 100% as the dividend income is eliminated in consolidation. Therefore, the net amount of dividend income is $0.
Choice “b” is incorrect. 100% of the dividend is eliminated, not included in the consolidated tax return.
Choice “a” is incorrect. This answer is 80% of the dividend received. In a consolidated return, 100% of the dividend is eliminated.
Choice “d” is incorrect. This answer is 70% of the dividend received. In a consolidated return, 100% of the dividend is eliminated.
In Year 2, Garland Corp. contributed $40,000 to a qualified charitable organization. Garland’s Year 2 taxable income before the deduction for charitable contributions was $410,000. Included in that amount is a $20,000 dividends received deduction. Garland also had carryover contributions of $5,000 from the prior year. In Year 2, what amount can Garland deduct as charitable contributions?
a.
$43,000
b.
$45,000
c.
$40,000
d.
$41,000
Explanation
Choice “a” is correct. The charitable contribution deduction is limited to 10% of taxable income before the dividends received deduction and the charitable contribution deduction. 10% ($410,000 + $20,000) = $43,000. The deduction consists of $40,000 from the current year and $3,000 from the prior year contribution carryover. That leaves a $2,000 carryover from Year 1 to Year 3
When a corporation has an unused net capital loss that is carried back or carried forward to another tax year:
a.
It retains its original identity as short-term or long-term.
b.
It is treated as a short-term capital loss whether or not it was short-term when sustained.
c.
It is treated as a long-term capital loss whether or not it was long-term when sustained.
d.
It can be used to offset ordinary income up to the amount of the carryback or carryover.
Choice “b” is correct.
Rule: Unused capital losses of a corporation that are carried back or forward are treated as short-term capital losses whether or not they were short-term or long-term when sustained. Capital losses can only be used to offset capital gains up to the amount of the carryback or carryover, not ordinary income.
Choices “a”, “c”, and “d” are incorrect, per the above rule.
Soma Corp. had $600,000 in compensation expense for book purposes in Year 1. Included in this amount was a $50,000 accrual for Year 1 nonshareholder bonuses. Soma paid the actual Year 1 bonus of $60,000 on March 1, Year 2. In its Year 1 tax return, what amount should Soma deduct as compensation expense?
a.
$610,000
b.
$540,000
c.
$550,000
d.
$600,000
Choice “a” is correct. An accrual basis employer may deduct bonuses paid to nonshareholder employees in the year of accrual if the bonuses are subsequently paid within 2 ½ months after the close of the tax year. Since the $50,000 accrued at year-end Year 1 was paid by March 15, Year 2 (2 ½ months), the $50,000 accrual is deductible as compensation expense. The additional $10,000 bonus paid on March 1, Year 2 is also deductible in Year 1, even though it was not accrued at year-end Year 1. Therefore, the total compensation is $600,000 + $10,000, or $610,000.
Choice “d” is incorrect. The additional $10,000 of bonus that was paid by March 15 of the next year is deductible in Year 1.
Choice “c” is incorrect. Both the $50,000 accrual and the additional $10,000 bonus paid is deductible, assuming it is paid by March 15, Year 2.
Choice “b” is incorrect. This answer assumes that the candidate is subtracting the entire $60,000 of bonus paid by March 15 from deductible compensation expense. This is incorrect because both the $50,000 accrual and the additional $10,000 paid by March 15, Year 2 are deductible.
Potter Corp. and Sly Corp. file consolidated tax returns. In January Year 1, Potter sold land, with a basis of $60,000 and a fair value of $75,000, to Sly for $100,000. Sly sold the land in December Year 2 for $125,000. In its Year 2 and Year 1 tax returns, what amount of gain should be reported for these transactions in the consolidated return?
~Year 2
~Year 1
a.
$50,000
$25,000
b.
$50,000
$0
c.
$65,000
$0
d.
$25,000
$40,000
Choice “c” is correct. The $40,000 gain realized by Potter ($100,000 − $60,000) on the sale to Sly is an intercompany gain that is eliminated in consolidation. Therefore, the Year 1 consolidated return gain is $0. In Year 2 when Sly sells the land to an outside party, the full gain of $65,000 is recognized ($125,000 − $60,000 original basis) on the consolidated return.
Choice “d” is incorrect. The $40,000 gain on the sale from Potter to Sly is intercompany gain and would be eliminated during consolidation. Once the sale is completed from Sly to another party (not in the consolidated return), the full $65,000 gain would be recognized in the tax return.
Choice “b” is incorrect. The gain recognized by Sly on the sale should be calculated as the difference between the original basis to Potter, $60,000, and not the fair market value of $75,000.
Choice “a” is incorrect. The Year 1 gain in this question is utilizing the fair market value of the land instead of the basis. The gain reported in Year 2 is also incorrect as discussed in the explanation to choice “b” above.
Which of the following tax credits cannot be claimed by a corporation?
a.
Foreign tax credit.
b.
General business credit.
c.
Earned income credit.
d.
Alternative fuel production credit.
Explanation
Choice “c” is correct. The earned income credit can only be claimed by individuals, not corporations.
Choice “a” is incorrect. Corporations can claim the foreign tax credit.
Choice “d” is incorrect. Corporations can claim the alternative fuel production credit.
Choice “b” is incorrect. Corporations can claim the general business credit.
Acme Corp. has two common stockholders. Acme derives all of its income from investments in stocks and securities, and it regularly distributes 51% of its taxable income as dividends to its stockholders. Acme is a:
a.
Regulated investment company.
b.
Personal holding company.
c.
Corporation subject to the accumulated earnings tax.
d.
Corporation subject to tax only on income not distributed to stockholders.
Choice “b” is correct. A corporation is a personal holding company (PHC) if (1) at any time during the last half of the taxable year more than 50% of the value of the outstanding stock is owned by 5 or fewer individuals, and (2) at least 60% of its adjusted ordinary gross income for the year is investment-type income.
Choice “d” is incorrect. A PHC is subject to the regular tax on corporate income as well as a 20% tax on its undistributed PHC income.
Choice “c” is incorrect. As a personal holding company, Acme is not subject to the accumulated earnings tax.
Choice “a” is incorrect. A regulated investment company must be registered under the Investment Company Act of 1940 or file an election to be a regulated investment company.
What is the usual result to the shareholders of a distribution in complete liquidation of a corporation?
a.
Ordinary gain or loss.
b.
No taxable effect.
c.
Ordinary gain to the extent of cash received.
d.
Capital gain or loss.
Choice “d” is correct.
Rule: Shareholders treat property received in a complete liquidation of a corporation as full payment for their stock. Therefore, the shareholder must recognize capital gain or loss equal to the difference between the fair market value of the property received and the basis of the stock surrendered.
Choices “b”, “c”, and “a” are incorrect, per the above rule.
Kari Corp., a manufacturing company, was organized on January 2, Year 1. Its Year 1 federal taxable income was $400,000 and its federal income tax was $100,000. What is the maximum amount of accumulated taxable income that may be subject to the accumulated earnings tax for Year 1 if Kari takes only the minimum accumulated earnings credit?
a.
$300,000
b.
$50,000
c.
$0
d.
$150,000
Choice “b” is correct. For the accumulated earnings tax, in this case, accumulated taxable income would equal taxable income ($400,000) minus federal income taxes ($100,000) minus the minimum accumulated earnings credit ($250,000) for manufacturing companies or $50,000.
Choice “a” is incorrect. Generally, the accumulated earnings tax is imposed when a corporation has accumulated earnings in excess of $250,000. Thus, the amount of earnings subject to the accumulated earnings tax must first be reduced by the $250,000.
Choice “d” is incorrect. Federal income tax is subtracted from the earnings of a corporation in calculating the amount of excess earnings subject to the accumulated earnings tax.
Choice “c” is incorrect. Accumulated taxable income is $400,000. This amount ($400,000) minus federal income tax ($100,000) minus the credit of $250,000 equals $50,000, which is the excess subject to the accumulated earnings tax.
Corporations A and B combine in a qualifying reorganization and form Corporation C, the only surviving corporation. This reorganization is tax-free to the:
~Shareholders
~Corporation
a.
No
No
b.
Yes
No
c.
Yes
Yes
d.
No
Yes
Choice “c” is correct. This is a Type A reorganization in the form of a consolidation (e.g., A + B = C). Generally, no gain or loss is recognized by the shareholders of the various corporations except when they receive cash or other consideration in addition to the stock or securities. In addition, no gain or loss is recognized by the acquired corporations or the acquiring corporation pursuant to a tax-free reorganization.
Choices “b”, “a”, and “d” are incorrect, per the above explanation.
If a corporation’s tentative minimum tax exceeds the regular tax, the excess amount is:
a.
Carried back to the first preceding taxable year.
b.
Subtracted from the regular tax.
c.
Payable in addition to the regular tax.
d.
Carried back to the third preceding taxable year.
Choice “c” is correct. If a corporation’s tentative minimum tax exceeds the regular tax, the excess amount is the alternative minimum tax which is payable in addition to the regular tax.
Choice “a” is incorrect. There is no carryback of the alternative minimum tax.
Choice “d” is incorrect. There is no carryback of the alternative minimum tax.
Choice “b” is incorrect. The excess amount is added to the regular tax to get the total tax liability.
The following information pertains to Lamb Corp.:
Accumulated earnings and profits at January 1, Year 1 $ 60,000
Earnings and profits for the year ended December 31, Year 1 80,000
Cash distributions to individual stockholders during Year 1 180,000
What is the total amount of distributions taxable as dividend income to Lamb’s stockholders in Year 1?
a.
$80,000
b.
$0
c.
$180,000
d.
$140,000
Choice “d” is correct. Dividend income is distributions to shareholders first out of current earnings and profits, then out of accumulated earnings and profits. After earnings and profits have been depleted, the distribution is a liquidating return of capital. Since there is a total of $140,000 in earnings and profits ($80,000 + $60,000), $140,000 is dividend income. The remaining $40,000 is a liquidating return of capital.
Choice “c” is incorrect. Distributions are considered dividends to the shareholders to the extent a corporation has current or accumulated earnings and profits. Therefore, the dividend treatment is limited to $140,000 of the distribution.
Choice “a” is incorrect. The corporation had accumulated earnings and profits of $60,000 that must also be considered.
Choice “b” is incorrect. Distributions from a corporation to its shareholders are considered dividend income to the extent the corporation has current and accumulated earnings and profits. Any additional amounts are a return of capital and any excess beyond capital are considered capital gain.
Bridge, a C corporation, had $15,000 in accumulated earnings and profits at the beginning of the current year. During the current year, Bridge reported earnings and profits of $10,000 and paid $20,000 in cash distributions to its shareholders in both March and July. What amount of the July distribution should be classified as dividend income to Bridge’s shareholders?
a.
$15,000
b.
$10,000
c.
$5,000
d.
$20,000
Choice “c” is correct. When a corporation makes multiple distributions during the taxable year, current E&P is first allocated to each distribution on a pro rata basis; then, accumulated E&P is applied in chronological order beginning with the earliest distribution. In this example, where there are two distributions made by Bridge, the current and accumulated E&P are allocated as follows:
March distribution
$20,000
Current E&P − $20,000 (March distribution) / $40,000 (total distributions) × $10,000 (Current E&P) = Amount out of Current E&P
5,000
Accumulated E&P = allocate first come first serve = chronological until either Acc E&P is used up or entire distribution is dividend. Here $15,000 Accumulated E&P = $15,000 remaining distribution; thus use $0 remaining in Accumulated E&P
15,000
Entire distribution is a dividend
20,000
July distribution
20,000
Current E&P − $20,000 (July distribution)/$40,000 (total distributions) × $10,000 (Current E&P) = Amount out of Current E&P
5,000
Accumulated E&P = all used in March distribution =
0
Dividend amount
5,000
Choices “d”, “a”, and “b” are incorrect per the above explanation.
Tan Corp. calculated the following taxes for the current year:
Regular tax liability $ 210,000
Tentative minimum tax 240,000
Personal holding company tax 65,000
What is Tan’s total tax liability for the year?
a.
$210,000
b.
$240,000
c.
$275,000
d.
$305,000
Choice “d” is correct. Tan’s tax liability is calculated as follows:
Tan’s regular tax liability $ 210,000
Plus: Tan’s AMT ($240,000 − 210,000)* 30,000
Plus: Tan’s PHC tax** 65,000
Tan’s tax liability $ 305,000
*Tan will pay alternative minimum tax (AMT) to the extent that AMT exceeds regular tax.
**Tan will pay personal holding company tax in addition to its regular and alternative minimum taxes.
Choices “a”, “b”, and “c” are incorrect, per the above explanation.
Dole, the sole owner of Enson Corp., transferred a building to Enson. The building had an adjusted tax basis of $35,000 and a fair market value of $100,000. In exchange for the building, Dole received $40,000 cash and Enson common stock with a fair market value of $60,000. What amount of gain did Dole recognize?
a.
$0
b.
$40,000
c.
$5,000
d.
$65,000
Choice “b” is correct. As a general rule, a shareholder who contributes property to a corporation in exchange for common stock will not recognize gain or loss if immediately after the transaction when the transferring shareholders (there can be more than one transferor) own at least 80% of the corporation and the shareholder does not receive any boot. In this case, Dole as the sole shareholder owns more than 80% but receives boot, cash of $40,000. Therefore, Dole will recognize gain to the lesser of cash received or realized gain as follows:
Amount Realized*
$ 100,000
Adjusted basis**
(35,000)
Realized Gain
$ 65,000
Recognized gain = Lesser of realized gain ($65,000) or boot received ($40,000)
$ 40,000
*Amount Realized = Cash $40,000 + Common stock $60,000
** Adjusted basis = the adjusted basis (NBV) of the building = $35,000
Choices “a”, “c”, and “d” are incorrect per the above explanation.
Aztec, a C corporation, distributed an asset to Burn, a shareholder. The asset had a fair market value of $30,000 and was subject to a $40,000 liability, assumed by Burn. The asset had an adjusted basis of $25,000. What amount of gain must Aztec recognize?
a.
$10,000
b.
$15,000
c.
$5,000
d.
$0
Choice “b” is correct. When a corporation distributes assets to a shareholder, the corporation recognizes a gain as if it had sold the asset. The gain is calculated as follows:
Amount realized - greater of FMV of asset = $30,000 or the amount of liability assumed by the shareholder
$ 40,000
Less: Adjusted basis of property sold
(25,000)
Realized and recognized gain
$ 15,000
Choices “d”, “c”, and “a” are incorrect per the above explanation.
ParentCo, SubOne, and SubTwo have filed consolidated returns since their inception. The members reported the following taxable incomes (losses) for the year:
ParentCo $ 50,000
SubOne (60,000)
SubTwo (40,000)
No member reported a capital gain or loss or charitable contributions. What is the amount of the consolidated net operating loss?
a.
$30,000
b.
$100,000
c.
$0
d.
$50,000
Choice “d” is correct. Net capital losses are not allowable deductions for corporations. A corporation can only use capital losses to offset capital gains. Further, the deduction for charitable contributions may be limited in some cases, and no charitable contribution deduction is allowed in calculating the NOL. The facts of this question indicate that there are no reported capital gains or losses or charitable contributions for any of the consolidated entities; therefore, we know that we are able to use the total income (loss) identified in the facts to calculate the net operating loss. When entities file consolidated income tax returns, 100% of their net income (losses) is consolidated. The facts do not indicate that any inter-company transactions exist; therefore, there are no elimination entries to make before consolidating the net income (loss). The consolidated net operating loss is calculated as follows:
ParentCo. $ 50,000
SubOne (60,000)
SubTwo (40,000)
NOL $ (50,000)
Choice “c” is incorrect. A consolidated net loss of $50,000 exists, as calculated above.
Choice “a” is incorrect. A consolidated net loss of $50,000 exists, as calculated above.
Choice “b” is incorrect. The income from ParentCo. ($50,000) is netted with the losses from the subsidiaries ($100,000) to arrive at the consolidated net operating loss of $50,000.
Which of the following types of entities is entitled to the net operating loss deduction?
a.
Trusts and estates.
b.
Partnerships.
c.
Not-for-profit organizations.
d.
S corporations.
Rule: A Net Operating Loss (NOL) exists if there is a net loss on the following tax returns:
Form 1040, Line 41 for Individuals
Form 1041, Line 22 for Estates and Trusts
Form 1120, Line 28 for Taxable C Corporations
A net operating loss exists on tax returns of taxable entities.
Choice “a” is correct. Per the above rule, trusts and estates are entitled to a net operating loss deduction. Trusts and estates can be taxable entities, even though, at times, they may also have pass-through effects.
Choice “b” is incorrect. Partnerships are pass-through entities; thus, they do not pay tax at the entity level. Therefore, NOLs are not allowed at the partnership level. [Note: If the partnership has a pass-through loss, however, an NOL may exist, for example, on the personal tax return of an individual partner.]
Choice “d” is incorrect. S corporations are pass-through entities; thus, they do not pay tax at the entity level. Therefore, NOLs are not allowed at the S corporation level. [Note: If the S corporation has a pass-through loss, however, an NOL may exist, for example, on the personal tax return of an individual shareholder.]
Choice “c” is incorrect. Not-for-profit organizations are not taxable entities (although they may generate some taxable income, called unrelated business taxable income); therefore, they do not generate net operating losses, unless it is only for the unrelated business taxable income effect (which may create an NOL for the unrelated business taxable income portion only). Thus, choice “a” is the best answer to this question.
Jans, an individual, owns 80% and 100% of the total value and voting power of A and B Corps., respectively, which in turn own the following (both value and voting power):
Ownership
Property A Corp. B Corp.
C Corp. 80% -
D Corp. - 100%
All companies are C corporations, except B Corp., which had elected S status since inception. Which of the following statements is correct with respect to the companies’ ability to file a consolidated return?
a.
A, C, and D may file as a group.
b.
A and C may file as a group, and B and D may file as a group.
c.
A and C may not file as a group, and B and D may not file as a group.
d.
A and C may file as a group, but B and D may not file as a group.
Rule: Filing a consolidated return is a privilege afforded to affiliated groups of corporations (Code Sections 1501 and 1504(b)), and it can only be filed if all of the affiliated corporations consent to such a filing. An affiliated group has ownership through a common parent. The common parent must directly own at least 80% of the voting power of at least one of the affiliated (includible) corporations and at least 80% of the value of the stock of that corporation, and the other corporations not controlled by the parent must be controlled under the 80% ownership test by an includible corporation. Not all corporations are allowed the privilege of filing a consolidated return.
Examples of those that are denied the privilege include:
S corporations,
Foreign corporations,
Most real estate investment trusts (REITs),
Some insurance companies, and
Most exempt organizations.
Choice “d” is correct. To summarize the facts in the question, the ownership percentage rules are met for all corporations. A, C, and D are all C corporations, and B Corp is an S corporation. Jans owns A and B; A owns C; and B owns D. Per the rules above, S corporations are denied the privilege of filing a consolidated return. Therefore, B Corp. cannot file a consolidated return. A and C may file a consolidated return, as Jans controls A, and A controls C in the required percentages and both are includible corporations. However, the control of D rests with B, an S corporation. Therefore, D cannot be consolidated with A or C, and because B cannot file a consolidated return (as it is an S corporation), D cannot file consolidated with B. Therefore, A and C may file as a group, but B and D may not file as a group.
Choice “a” is incorrect. Per the above rules, D cannot file as a group with A and C, as the control of D rests with B, an S corporation that is not deemed an includible corporation.
Choice “c” is incorrect. A and C may file a consolidated return, as Jans controls A, and A controls C in the required percentages and both are includible corporations. The control of D rests with B, an S corporation. Therefore, D cannotbe consolidated with A or C, and because B cannot file a consolidated return (as it is an S corporation), D cannot file consolidated with B. Therefore, A and C may file as a group, but B and D may not file as a group.
Choice “b” is incorrect. A and C may file a consolidated return, as Jans controls A, and A controls C in the required percentages and both are includible corporations. The control of D rests with B, an S corporation. Therefore, D cannot be consolidated with A or C, and because B cannot file a consolidated return (as it is an S corporation), D cannot file consolidated with B. Therefore, A and C may file as a group, but B and D may not file as a group.
In the current year, Brown, a C corporation, has gross income (before dividends) of $900,000 and deductions of $1,100,000 (excluding the dividends received deduction). Brown received dividends of $100,000 from a Fortune 500 corporation during the current year. What is Brown’s net operating loss?
a.
$200,000
b.
$170,000
c.
$130,000
d.
$100,000
Rules:
A net operating loss (NOL) for corporations is the excess of deductions over gross income; however, the dividends received deduction is allowed to be deducted before calculating the NOL.
The dividends received deduction (DRD) for entities that are controlled 0% to <20% (which is how a Fortune 500 corporation would be controlled) is the LESSER of 70% of dividends received or 70% of taxable income computed without regard to the DRD, and NOL deduction, or any capital loss carryback (but this does not apply in the case when deducting the full DRD results in an NOL).
Choice “b” is correct. Applying the rules above, Brown’s net operating loss is calculated as follows:
Gross income before dividends
$ 900,000
Add: Dividends received
100,000
Less: Deductions (excluding DRD)
(1,100,000)
Less: DRD
(70,000)
[$100,000 × 70%]
NOL
$ 170,000
Choice “d” is incorrect. The dividends received deduction ($70,000 in this case) is allowed to be deducted before calculating the NOL [$900,000 + $100,000 − $1,100,000 = ($100,000)].
Choice “c” is incorrect. The DRD is 70% of the dividends received ($70,000), not 30% (or, $30,000) [$900,000 + $100,000 − $1,100,000 − $30,000 = ($130,000)].
Choice “a” is incorrect. The DRD for ownership of a Fortune 500 company is 70% of the dividends received, not 100% [$900,000 + $100,000 − $1,100,000 − $100,000 = ($200,000)].
Which of the following items should be included on the Schedule M-1, Reconciliation of Income (Loss) per Books With Income per Return, of Form 1120, U.S. Corporation Income Tax Return to reconcile book income to taxable income?
a.
Ending balance of retained earnings.
b.
Premiums paid on key-person life insurance policy.
c.
Cash distributions to shareholders.
d.
Corporate bond interest.
Choice “b” is correct. The Schedule M-1 reports the reconciliation of income (loss) per books to income (loss) per the tax return [Note: It reports both permanent and temporary differences that are discussed in the Financial textbook for deferred taxes.]. Items that are included on this schedule are those that are (1) reported as income for book purposes but not for tax purposes; (2) reported as an expense for book purposes but not for tax purposes; (3) reported as taxable income for tax purposes but not as income for book purposes; and (4) reported as deductible for tax purposes but not as an expense for book purposes. The only option above that falls into one of these four categories is option b. Premiums paid on a key-person life insurance policy are proper GAAP expenses for book purposes, but they are not allowable deductions for tax purposes.
Choice “c” is incorrect. Cash distributions to shareholders are not reported on the income statement for book purposes and are not deductible for tax purposes. They do not enter into the calculation of income in either case and are not reported on the Schedule M-1. Cash distributions actually are reported on Schedule M-2, which is a reconciliation of unappropriated retained earnings.
Choice “d” is incorrect. Corporate bond interest is not reported differently for GAAP and tax purposes. It is included as income for GAAP purposes and for tax purposes. Therefore, no reconciliation of book income to taxable income is required for this item.
Choice “a” is incorrect. The ending balance of retained earnings is not reported on a GAAP income statement, nor is it included as part of taxable income. Therefore, it is not part of the Schedule M-1. Unappropriated retained earnings are reconciled on Schedule M-2 of the Form 1120.
Taylor owns 1,000 shares of Media Corporation common stock with a basis of $22,000 and a fair market value of $33,000. Media paid a nontaxable 10% common stock dividend. What is the basis for each share of Media common stock owned by Taylor after receipt of the dividend?
a.
$30
b.
$22
c.
$33
d.
$20
Choice “d” is correct. A stock dividend is a distribution by a corporation of its own stock to its shareholders. Stock dividends are generally not taxable unless the shareholder has a choice of receiving cash or other property, and the facts indicate that this is a nontaxable 10% dividend. The basis of a nontaxable stock dividend, where old and new shares are identical, is determined by dividing the basis of the old stock by the number of new shares. The calculation is as follows:
Original basis of 1,000 shares
$ 22,000
Divided by new # of shares [1000 × 1.1]
÷ 1,100
Basis per share after 10% stock dividend
$ 20.00
Choice “b” is incorrect. This choice divides the original basis of $22,000 by the old number of shares, without considering the 10% stock dividend. [$22,000 / 1,000 = $22/share]
Choice “a” is incorrect. This choice uses the fair market value rather than the proper basis as the allocation base for the stock, but it does use the proper (new) amount of shares after the stock dividend. [$33,000 / 1,100 shares = $30/share]
Choice “c” is incorrect. This answer choice uses the fair market value rather than the proper basis as the allocation base for the stock, and it also improperly uses the old number of shares, without considering the stock dividend. [$33,000 / 1,000 shares = $33/share]
Beta, a C corporation, reported the following items of income and expenses for the year:
Gross income
$ 600,000
Dividend income from a 30% owned domestic corporation
100,000
Operating expenses
400,000
What is Beta’s taxable income for the year?
a.
$200,000
b.
$300,000
c.
$220,000
d.
$230,000
Choice “c” is correct. Corporate taxable income is calculated as follows for a corporation:
Choice “a” is incorrect. The dividends received deduction allows for a special deduction of 80% of the dividends received from a 20% to <80% owned domestic corporation, not 100% of the dividends received (which applies only to ownership of 80% or more). [$600,000 + $100,000 − $400,000 − $100,000 DRD = $200,000]
Gross income
$ 600,000
Dividend income
100,000*
Operating expenses
(400,000)
Dividends received deduction
(80,000)
[80% DRD]
Taxable income
$ 220,000
* Note that the “gross income” amount for the calculation of taxable income should include dividend income; however, it does not appear that the $100,000 of dividends is included in the $600,000 gross income amount given. If it were, the answer options would be $100,000 less than they are.
Choice “d” is incorrect. The dividends received deduction allows for a special deduction of 80% of the dividends received from a 20% to <80% owned domestic corporation, not 70% of the dividends received (which applies only to ownership of 0% to <20%). [$600,000 + $100,000 − $400,000 − $70,000 DRD = $230,000]
Choice “b” is incorrect. This answer option does not include the special dividends received deduction [$600,000 + $100,000 − $400,000 − $0 DRD = $300,000].
A C corporation must use the accrual method of accounting in which of the following circumstances?
a.
The business has more than $10 million in average sales.
b.
The business is a personal service business with over $15 million in sales.
c.
The business is a service company and has over $1 million in sales.
d.
The business had average sales for the past three years of less than $1 million.
Choice “a” is correct. While the cash basis of accounting is used for tax purposes by most individuals, qualified personal service corporations (which are treated as individuals for purposes of these rules), and taxpayers whose average annual gross receipts do not exceed $1,000,000, the accrual basis method of accounting for tax purposes is required for the following:
The accounting purchase and sales of inventory (and inventories must be maintained)
Tax shelters
Certain farming corporations (other farming or tree-raising businesses may generally use the cash basis)
C Corporations, trusts with unrelated trade or business income, and partnerships having a C corporation as a partner PROVIDED the business has GREATER than $5 million of average annual gross receipts for the three-year period ending with the prior tax year
Choice “d” is incorrect. A C corporation with average annual sales for the past three years of less than $1,000,000 would not be required to file income taxes using the accrual basis method of accounting, as generally, taxpayers whose annual average annual gross receipts do not exceed $1,000,000 are exempt from the requirement.
Choice “c” is incorrect. A service company with more than $1,000,000 in annual sales will generally not be required to file income taxes using the accrual basis of accounting because it likely has not met the test of $5 million in average annual gross receipts for the three-year period ending with the prior tax year. The facts do not disclose all relevant information; however, remember, the BEST answer is what we are looking for (and that is choice option “a”).
Choice “b” is incorrect. Personal service corporations are treated as individuals for purposes of the rules for accrual basis tax reporting; therefore, personal service corporations (regardless of the amount of gross receipts), may use the cash basis of reporting for income tax purposes.
A corporation that has both preferred and common stock has a deficit in accumulated earnings and profits at the beginning of the year. The current earnings and profits are $25,000. The corporation makes a dividend distribution of $20,000 to the preferred shareholders and $10,000 to the common shareholders. How will the preferred and common shareholders report these distributions?
a.
Preferred―$20,000 dividend income; Common―$5,000 dividend income, $5,000 return of capital.
b.
Preferred―$20,000 dividend income; Common―$10,000 dividend income.
c.
Preferred―$20,000 return of capital; Common―$10,000 return of capital.
d.
Preferred―$15,000 dividend income; Common―$10,000 dividend income.
Choice “a” is correct. A dividend to a preferred shareholder is based on that shareholder’s fixed percentage at purchase. Preferred shareholders are not common equity owners of a corporation, and they only get paid based on their preferred percentage; therefore, any dividend payments to a preferred shareholder are considered dividend income to the preferred shareholder. Preferred shareholders are paid in full before common shareholders receive dividends.
Common shareholders are residual owners of a corporation and share in the retained earnings (“earnings and profits” is the tax term) of the corporation as well as the net assets. A “dividend” distribution to a common shareholder may or may not be classified as a taxable dividend. A dividend is defined by the Internal Revenue Code as a distribution of property by a corporation out of its earnings and profits (E & P). Dividends come first from current E&P and then from accumulated E&P. Any distributions in excess of current or accumulated E&P are first return of capital (up to the basis of the common stock) and then capital gain distribution.
In this case, the facts tell us that the company has a deficit in accumulated E&P as of the beginning of the year and that current E&P is $25,000. The facts do not tell us the amount of common shareholder capital in the corporation, but none of the answer choices provide for capital gain distributions, so we have to assume that the capital is in excess of the balance of the distribution after the current E&P is allocated. Because preferred shareholders are paid first, the $20,000 paid to them reduces available current E&P to distribute to $5,000 [$25,000 - $20,000]. The preferred shareholders are taxed on $20,000 of dividends. The common shareholders would report $5,000 in dividend income (the remaining amount of current E&P) and would have $5,000 in return of capital [$5,000 + $5,000 = $10,000 paid to the common shareholders].
Choice “b” is incorrect. Please refer to the discussion above for choice “a”. $20,000 is taxable to the preferred stockholders as dividend income. However, there is not enough E&P to provide for $10,000 of dividend income to the common shareholders. After the preferred shareholders are paid their $20,000, only $5,000 of E&P is available for distribution as a taxable dividend. The balance of the common shareholder distribution ($5,000) is return of capital.
Choice “d” is incorrect. Please refer to the discussion above for choice “a”. As mentioned, preferred shareholders are paid before common shareholders are paid. This answer choice incorrectly assumes that the common shareholders are allocated their $10,000 first as dividend income and the preferred shareholders receive the balance of E&P ($15,000) as dividend income.
Choice “c” is incorrect. Please refer to the discussion above for choice “a”. The corporation has $25,000 of available E&P from which to distribute to the shareholders. Distributions are deemed to come from current E&P first and then from accumulated E&P (of which there is zero in this case). Only the excess is allocated to return of capital (to the extent of capital) and then to capital gain distribution, if excess remains.
One of the elections a new corporation must make is its choice of an accounting period. Which of the following entities has the most flexibility in choosing an accounting period?
a.
Personal service corporation.
b.
C corporation.
c.
Partnership.
d.
S corporation.
Choice “b” is correct. A C corporation has considerable flexibility in choosing an accounting period. A C corporation generally has the same choice of accounting periods as do individual taxpayers. All of the other forms have some limitations (and these are identified in the textbook in chapters R3 and R4).
Choice “d” is incorrect. An S corporation must adopt the calendar year unless a valid business purpose for a different taxable year is established. There are thus some restrictions on S corporations.
Choice “c” is incorrect. A partnership is significantly limited in what accounting period (taxable year) it can select. Generally, a calendar year is required, unless the partnership meets a set of rules or unless the partnership can establish a valid business purpose for a different taxable year. For example, if one or more of the partners having a majority interest in the partnership’s capital and profits have the same taxable year, the partnership must use that taxable year. If the partners owning a majority interest in partnership profits and capital do not have the same taxable year, the partnership must use the same taxable year as all of its “principal” partners. If neither of those two rules applies, the partnership must use the taxable year that results in the least aggregate deferral of income to the partners.
Choice “a” is incorrect. A personal service corporation must generally use a calendar year unless a valid business purpose for a different taxable year is established. There are also other restrictions.
Forrest Corp. owned 100% of both the voting stock and total value of Diamond Corp. Both corporations were C corporations. Forrest’s basis in the Diamond stock was $200,000 when it received a lump sum liquidating distribution of property as a result of the redemption of all of Diamond stock. The property had an adjusted basis of $270,000 and a fair market value of $500,000. What amount of gain did Forrest recognize on the distribution?
a.
$0
b.
$70,000
c.
$500,000
d.
$270,000
Choice “a” is correct. No gain or loss is recognized by either the parent corporation (Forrest) or the subsidiary corporation (Diamond) when the parent, who owns at least 80% of the stock (Forrest owns 100% of the stock), liquidates its subsidiary. The parent assumes the basis of the subsidiary’s assets as well as any unused NOL carryover, capital loss carryover, or charitable contribution carryover.
Choice “b” is incorrect. The $70,000 is the difference between the $270,000 adjusted basis of the property received in the distribution and Forest’s $200,000 basis in the Diamond stock. That difference does not represent the amount of gain recognized by Forrest on the distribution.
Choice “d” is incorrect. The $270,000 is the adjusted basis to Diamond of the property received in the distribution. That amount does not represent the amount of gain recognized by Forrest on the distribution.
Choice “c” is incorrect. The $500,000 is the fair market value of the property received in the distribution. That amount does not represent the amount of gain recognized by Forest on the distribution.
Nare, an accrual-basis, calendar-year taxpayer, owns a building that was rented to Mott under a 10-year lease expiring August 31, Year 3. On January 2, Year 1, Mott paid $30,000 as consideration for canceling the lease. On November 1, Year 1, Nare leased the building to Pine under a five-year lease. Pine paid Nare $5,000 rent for each of the two months of November and December, and an additional $5,000 for the last month’s rent. What amount of rental income should Nare report in its Year 1 income tax return?
a.
$40,000
b.
$10,000
c.
$15,000
d.
$45,000
Choice “d” is correct. Payments for cancelling a lease ($30,000) are rental income in Year 1. The two month’s rent for November and December ($5,000 for each month) are rental income. In addition, the last month’s rent ($5,000, which is not indicated is a refundable security deposit) is rental income. The total is $45,000.
Choice “b” is incorrect. The $10,000 is everything but the payment for cancelling the lease and the last month’s rent. Those amounts should be included in the rental income in Year 1.
Choice “c” is incorrect. The $15,000 is everything but the payment for cancelling the lease. That amount should be included in the rental income in Year 1.
Choice “a” is incorrect. The $40,000 is everything but the last month’s rent. That amount should be included in the rental income in Year 1.
Pope, a C corporation, owns 15% of Arden Corporation. Arden paid a $3,000 cash dividend to Pope. What is the amount of Pope’s dividends-received deduction?
a.
$2,100
b.
$2,400
c.
$3,000
d.
$0
Choice “a” is correct. With a 15% ownership, the percentage for the dividends-received deduction is 70%, or $2,100 (70% x $3,000).
Choice “c” is incorrect. With a 15% ownership, the percentage for the dividends-received deduction is 70%, not 100% ($3,000).
Choice “b” is incorrect. With a 15% ownership, the percentage for the dividends-received deduction is 70%, not 80% (80% x $3,000 = $2,400).
Choice “d” is incorrect. There will be a dividends-received deduction with a 15% ownership.
U Co. had cash purchases and payments on account during the current year totaling $455,000. U’s beginning and ending accounts payable balances for the year were $64,000 and $50,000, respectively. What amount represents U’s accrual basis purchases for the year?
a.
$469,000
b.
$505,000
c.
$519,000
d.
$441,000
Choice “d” is correct. This question is a simple financial accounting Account Analysis Format (BASE mnemonic, or AAF) question for the accounts payable account. The purchases are a plug and can be determined as follows:
Beginning balance $ 64,000 (given)
Add: Purchases 441,000 (plug)
Subtract: Cash payments (455,000) (given)
Ending balance $ 50,000 (given)
Choice “a” is incorrect. This choice is incorrect per the analysis above. The $469,000 appears to be the $455,000 cash payments plus the $64,000 beginning of year balance less the $50,000 end of year balance. If the AAF format is rearranged (not the suggested way of working with an AAF), that is backwards.
Choice “b” is incorrect. This choice is incorrect per the analysis above. The $505,000 appears to be the $455,000 cash payments plus the $50,000 end of year balance.
Choice “c” is incorrect. This choice is incorrect given the analysis above. The $519,000 appears to be the $455,000 cash payments plus the $64,000 beginning of year balance.
A C corporation has gross receipts of $150,000, $35,000 of other income, and deductible expenses of $95,000. In addition, the corporation incurred a net long-term capital loss of $25,000 in the current year. What is the corporation’s taxable income?
a.
$115,000
b.
$90,000
c.
$65,000
d.
$87,000
Choice “b” is correct. The C corporation’s income before net long-term capital loss is $90,000 ($150,000 + $35,000 - $95,000). For a corporation, a net long-term capital loss is not deductible in the current year (3-year carryback and 5-year carryforward allowed), so the taxable income is the same amount.
Choice “c” is incorrect. The $65,000 is the $90,000 less the $25,000 net long-term capital loss. The net long-term capital loss is not deductible in the current year, but it may be carried back 3 years and forward 5 years.
Choice “d” is incorrect. The $87,000 is the $90,000 reduced by a $3,000 long-term capital loss. Unfortunately, the $3,000 deduction is available only for individuals, not for C corporations.
Choice “a” is incorrect. The $115,000 is the $90,000 plus the $25,000 net long-term capital loss. The net long-term capital loss should not be deducted or added.
Jagdon Corp.’s book income was $150,000 for the current year, including interest income from municipal bonds of $5,000 and excess capital losses over capital gains of $10,000. Federal income tax expense of $50,000 was also included in Jagdon’s books. What amount represents Jagdon’s taxable income for the current year?
a.
$185,000
b.
$215,000
c.
$195,000
d.
$205,000
Choice “d” is correct. Taxable income is accounting (book) income adjusted for other items. In this question, the book income is $150,000. That book income includes $50,000 federal income tax expense, and that amount should be added back for taxable income. The $5,000 interest income from municipal bonds should be subtracted because it is not taxable, and the $10,000 excess capital losses over capital gains should be added back because the excess is not a deduction in the current year. The net result is $205,000.
Choice “a” is incorrect. The $185,000 is the $205,000 with the $10,000 excess capital losses subtracted and not added.
Choice “c” is incorrect. The $195,000 is the $205,000 with the $10,000 ignored.
Choice “b” is incorrect. The $215,000 is the $205,000 with the $5,000 interest income from municipal bonds added and not subtracted.
Brisk Corp. is an accrual-basis, calendar-year C corporation with one individual shareholder. At year end, Brisk had $600,000 accumulated and current earnings and profits as it prepared to make its only dividend distribution for the year to its shareholder. Brisk could distribute either cash of $200,000 or land with an adjusted tax basis of $75,000 and a fair market value of $200,000. How would the taxable incomes of both Brisk and the shareholder change if land were distributed instead of cash?
~Brisk’s taxable income
~Shareholder’s taxable income
a.
No change
Decrease
b.
No change
No change
c.
Increase
No change
d.
Increase
Decrease
Rule: The taxable amount of a dividend to a shareholder from a corporation’s earnings and profits is the amount received in cash or the fair market value of the property received.
Rule: The general rule is the payment of a dividend does not create a taxable event, unless the distribution is appreciated property. When the distribution is of appreciated property, the corporation recognizes gain as if the property were sold at fair market value.
Choice “c” is correct. If Brisk Corp. were to distribute $200,000 of accumulated earnings and profits in cash as a dividend, the shareholder would recognize $200,000 in dividend income, and the corporation would reduce its earnings and profits by $200,000. If, instead, the dividend were the $200,000 FMV land with a basis of $75,000, the shareholder would still recognize $200,000 of dividend income (the FMV of the property received, as per the above rule), but the corporation would recognize a gain of $125,000 on the distribution ($200,000 FMV - $75,000 basis, per the above rule), the corporation’s earnings and profits would increase $125,000, and the corporation would reduce its earnings and profits by the $200,000 dividend distribution. Thus, Brisk’s taxable income would increase if the land were distributed, but the shareholder’s taxable income would not change.
Fox, the sole shareholder in Fall, a C corporation, has a tax basis of $60,000. Fall has $40,000 of accumulated positive earnings and profits at the beginning of the year and $10,000 of current positive earnings and profits for the current year. At year end, Fall distributed land with an adjusted basis of $30,000 and a fair market value (FMV) of $38,000 to Fox. The land has an outstanding mortgage of $3,000 that Fox must assume. What is Fox’s tax basis in the land?
a.
$38,000
b.
$30,000
c.
$27,000
d.
$35,000
Choice “a” is correct. Absent information to the contrary, we should assume this distribution is in the form of a dividend (especially because Fox is the sole shareholder). If the shareholder is an individual, the taxable amount of a property dividend from a corporation’s earnings and profits is the fair market value of the property received (and the property’s basis then becomes that fair market value). In this case, the shareholder is also taking on the responsibility for the mortgage on the property, but this affects only the amount of taxable income, as the debt is reported as a separate line item and does not affect the basis of the land. The tax journal entry follows and indicates that the basis of the land is $38,000:
Debit (Dr) Credit (Cr)
Land $ 38,000
Debt $ 3,000
Taxable income 35,000
Choice “d” is incorrect. This is the amount of the taxable income on the dividend ($35,000), not the basis in the land, as per the above journal entry.
Choice “b” is incorrect. This amount of $30,000 is the basis of the land on the corporation’s books. In a dividend situation, assets are transferred from the corporation using the fair market value of the assets at the date of distribution.
Choice “c” is incorrect. This amount of $27,000 was arrived at by using the basis of the land on the corporation’s books ($30,000) and subtracting the mortgage assumed by the shareholder ($3,000). As is discussed in the explanation of the answer for item “a” (above), the fair market value should be used as the basis, and the debt does not have an effect on basis (debt affects taxable income, as shown in the journal entry above).
Dart, a C corporation, distributes software over the Internet and has had average revenues in excess of $20 million dollars per year for the past three years. To purchase software, customers key-in their credit card number to a secure web site and receive a password that allows the customer to immediately download the software. As a result, Dart doesn’t record accounts receivable or inventory on its books. Which of the following statements is correct?
a.
Dart must use the accrual method of accounting.
b.
Dart may utilize any method of accounting Dart chooses as long as Dart consistently applies the method it chooses.
c.
Dart may use either the cash or accrual method of accounting as long as Dart elects a calendar year end.
d.
Dart may utilize the cash basis method of accounting until it incurs an additional $10 million to develop additional software.
Choice “a” is correct. While the cash basis of accounting is used by most taxpayers for tax purposes, the accrual basis method of accounting for tax purposes is required for the following:
The accounting for purchases and sales of inventory,
Tax shelters,
Certain farming corporations, and
C corporations, trusts with unrelated trade or business income, and partnerships having a C corporation as a partner provided the business has greater than $5 million average annual gross receipts for the three-year period ending with the tax year.
The information in the facts tells us that Dart does not maintain inventory, so the first item that requires accrual method of accounting does not apply. However, the facts also tell us that Dart is a C corporation with average annual gross receipts in excess of $20 million for the last three years (all of its sales are via credit card, which is turned into cash immediately; thus, gross receipts for the year are over $20 million). The fourth requirement above indicates that accrual method of accounting for tax purposes is required if a C corporation has annual average gross receipts in excess of $5 million for the three-year period ending with the tax year-thus, Dart must use the accrual method of accounting for tax purposes.
Choices “c”, “b”, and “d” are incorrect, per the above explanation.
In April, X and Y formed Z Corp. X contributed $50,000 cash, and Y contributed land worth $70,000 (with an adjusted basis of $40,000). Y also received $20,000 cash from the corporation. X and Y each receives 50% of the corporation’s stock. What is the tax basis of the land to Z Corp.?
a.
$60,000
b.
$70,000
c.
$40,000
d.
$50,000
Rule: There is no gain or loss to the corporation issuing stock in exchange for property for the issuance of stock. The general rule is that the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation.
Choice “a” is correct. X and Y form Z Corporation so that each receives a 50% interest in the corporation. X contributes $50,000 in cash, and Y contributes land worth $70,000 and receives $20,000 from the corporation [note that each has contributed a net $50,000]. Z Corporation will record the basis of the land at the basis of Y ($40,000) plus any cash it paid to secure the land ($20,000), or $60,000 total basis. Per the above general rule, the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. As there is no indicated debt on the land nor any gain recognized by Y on the transfer [because X and Y own at least 80% of the voting stock immediately after the transaction, the basis is the adjusted net book value of Y ($40,000) plus any cash Z Corporation pays for the land ($20,000). [Note that we have not addressed the shareholder consequences in this question.]
Choice “c” is incorrect. The answer includes only Y’s $40,000 basis in the land. Z Corporation will record the basis of the land at the basis of Y ($40,000) plus any cash it paid to secure the land ($20,000), or $60,000 total basis.
Choice “d” is incorrect. This answer option is the amount of fair market value each shareholder was to contribute to form the corporation at inception. Because Y contributed land worth $70,000, the corporation paid Y $20,000 in cash to make each shareholder contribute $50,000 in FMV of assets.
Choice “b” is incorrect. This answer option is the amount of the fair market value of the land at the date of transfer. Per the above general rule, the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. Refer to the calculation for answer option “a”.
Which of the following groups may elect to file a consolidated corporate return?
a.
A parent corporation and all more-than-10%-controlled partnerships.
b.
Members of an affiliated group.
c.
A parent corporation and all more-than-50%-controlled subsidiaries.
d.
A brother/sister-controlled group.v
Rule: An affiliated group of corporations may elect to be taxed as a single unit, thereby eliminating intercompany gains and losses. To be entitled to file a consolidated return, all the corporations in the group (1) must have been members of an affiliated group at some time during the tax year and (2) must have filed a consent (the act of filing a consolidated return qualifies as consent). An affiliated group means that a common parent owns (1) 80% or more of the voting power of all outstanding stock and (2) 80% or more of the value of all outstanding stock of each corporation.
Rule: Not all corporations are allowed the privilege of filing a consolidated return. Examples of those denied the privilege include S corporations, foreign corporations, most real estate investment trusts (REITs), some insurance companies, brother-sister corporations where an individual (not a corporation) owns 80% or more of the stock of two or more corporations, and most exempt organizations.
Choice “b” is correct. An affiliated group of corporations may file a consolidated return (electing to be taxed as a single unit and eliminating intercompany gains and losses). This answer option comes right out and defines the entities as an “affiliated group,” thereby removing the need to determine if the group is actually affiliated!
Choice “d” is incorrect. Per the above rule, not all corporations are allowed the privilege of filing a consolidated return. Examples of those denied the privilege include S corporations, foreign corporations, most real estate investment trusts (REITs), some insurance companies, brother-sister corporations where an individual (not a corporation) owns 80% or more of the stock of two or more corporations, and most exempt organizations.
Choice “a” is incorrect. Per the above rule, an affiliated group means that a common parent owns (1) 80% or more of the voting power of all outstanding stockand (2) 80% or more of the value of all outstanding stock of each corporation. In this answer option, the parent owns partnerships, not corporations [and, even if it did own corporations, the percentage ownership is too small at “more than 10%”].
Choice “c” is incorrect. Per the above rule, an affiliated group means that a common parent owns (1) 80% or more of the voting power of all outstanding stockand (2) 80% or more of the value of all outstanding stock of each corporation. In this answer option, the parent owns only “more than 50%” of the controlled corporations.
Webster, a C corporation, has $70,000 in accumulated and no current earnings and profits. Webster distributed $20,000 cash and property with an adjusted basis and fair market value of $60,000 to its shareholders. What amount should the shareholders report as dividend income?
a.
$60,000
b.
$70,000
c.
$20,000
d.
$80,000
Rules: Distributions from corporations to shareholders are taxable to such shareholders if the distributions are classified as dividends. A dividend is defined by the IRC as a distribution of property by a corporation out if its earnings and profits. An individual shareholder will be taxed on dividends in cash for the amount received and on dividends of property for the fair market value of the property received. Distributions are deemed to come from earnings and profits first. Any distribution in excess of earnings and profits (“E&P,” accumulated and current) is treated as a nontaxable return of capital that reduces the shareholder’s basis in the stock. Distributions in excess of basis are capital gain distributions taxable as capital gains instead of dividends.
Choice “b” is correct. Per the above rules, an individual shareholder will be taxed on dividends in cash for the amount received and on dividends of property for the fair market value of the property received, but any distribution in excess of earnings and profits (accumulated and current) is treated as a nontaxable return of capital that reduces the shareholder’s basis in the stock. The corporation has $70,000 in current and accumulated earnings and profits. Therefore, the shareholders will be taxed on the $20,000 in cash received plus the $60,000 in FMV of the property received ($80,000), but only to the extent there is E&P, and that means a taxable amount of dividends of $70,000. The remaining $10,000 will either be a nontaxable return of capital (assuming basis exists), a taxable capital gain (assuming no basis exists), or something in between (assuming basis is positive but less than $10,000).
[Note: The question indicates that the basis of the property equals the fair market value. This avoids the impact on the E&P on the corporation’s books for the gain on the dividend to the shareholders and keeps the E&P at $70,000.]
Choice “c” is incorrect. This answer option incorrectly includes only the cash received ($20,000) as the dividend and excludes the property received.
Choice “a” is incorrect. This answer option incorrectly includes only the fair market value of the property received ($60,000) as the dividend and excludes the cash received.
Choice “d” is incorrect. This answer option includes both the $20,000 cash received and the $60,000 fair market value of the property received [$20,000 + $60,000 = $80,000], but it (incorrectly) does not limit the dividend income to the total amount of corporate E&P, which is $70,000.
Ames and Roth form Homerun, a C corporation. Ames contributes several autographed baseballs to Homerun. Ames purchased the baseballs for $500, and they have a total fair market value of $1,000. Roth contributes several autographed baseball bats to Homerun. Roth purchased the bats for $5,000, and they have a fair market value of $7,000. What is Homerun’s basis in the contributed bats and balls?
a.
$8,000
b.
$5,500
c.
$6,000
d.
$0
Rules: There is no gain or loss to the corporation issuing stock in exchange for property for the issuance of stock. The general rule is that the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. A shareholder recognizes gain when at least 80% of the voting stock is not owned by the shareholders immediately after the transaction and there is no taxable boot (cash is withdrawn or cancellation of debt exists) on the transaction.
Choice “b” is correct. The general rule is that the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. Applying the information in the fact pattern and the above rules, there is no “shareholder gain” on this transaction. Further, there is no indication of any debt being assumed by the corporation. Thus, Homerun’s basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors.
Choice “d” is incorrect. Homerun’s basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors.
Choice “c” is incorrect. This answer option incorrectly adds the fair market value of the baseballs ($1,000) to the basis of the bats ($5,000). Homerun’s basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors.
Choice “a” is incorrect. This answer option incorrectly adds the fair market value of the baseballs ($1,000) to the fair market value of the bats ($7,000). Homerun’s basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors.
An S corporation engaged in manufacturing has a year end of June 30. Revenue consistently has been more than $10 million under both cash and accrual basis of accounting. The stockholders would like to change the tax status of the corporation to a C corporation using the cash basis with the same year end. Which of the following statements is correct if it changes to a C corporation?
a.
The year end will be December 31, using the cash basis of accounting.
b.
The year end will be June 30, using the cash basis of accounting.
c.
The year end will be June 30, using the accrual basis of accounting.
d.
The year end will be December 31, using the accrual basis of accounting.
Rule: While the cash basis of accounting is used by most taxpayers for tax purposes, the accrual basis method of accounting for tax purposes is required for the following:
The accounting for purchases and sales of inventory,
Tax shelters,
Certain farming corporations, and
C corporations, trusts with unrelated trade or business income, and partnerships having a C corporation as a partner provided the business has greater than $5 million average annual gross receipts for the three-year period ending with the tax year.
Choice “c” is correct. The facts tell us that the shareholders would like to change the status to a C corporation using the same year end as the S corporation (June 30). Per the above rule, C corporations with greater than $5 million average annual gross receipts must use the accrual basis of accounting for tax purposes. When this corporation changes to a C corporation status, therefore, it must report on the accrual basis of accounting for tax purposes. It will be able to stay on the June 30 year end, as the shareholders desire.
Choice “a” is incorrect. The year will be June 30 (not December 31) with the accrual (not cash) basis of accounting.
Choice “d” is incorrect. The year will be June 30 (not December 31), but the accrual basis of accounting will be used.
Choice “b” is incorrect. The year will be June 30, but the accrual (not cash) basis of accounting will be used.
The accumulated earnings tax can be imposed:
a.
On both partnerships and corporations.
b.
On companies that make distributions in excess of accumulated earnings.
c.
Only on parent-subsidiary affiliated groups.
d.
On regular corporations not classified as personal holding companies.
Choice “d” is correct. The accumulated earnings tax can be imposed on regular corporations not classified as personal holding companies.
Choice “a” is incorrect. The accumulated earnings tax can be imposed on regular corporations (C corporations) or on personal service corporations.
Choice “b” is incorrect. The accumulated earnings tax may be imposed on a corporation whose accumulated (retained) earnings is in excess of $250,000 (less for personal service corporations) and for which no justified reason for the retention exists.
Choice “c” is incorrect. A parent-subsidiary group is not a requirement for the imposition of the accumulated earnings tax.
On June 1, Year 2, Green Corp. adopted a plan of complete liquidation. On December 1, Year 2, Green distributed to its stockholders installment notes receivable that Green had acquired in connection with the sale of land in Year 1. The following information pertains to these notes:
Green’s basis $ 90,000
Fair market value 162,000
Face amount 185,000
How much gain must Green recognize in Year 2 as a result of this distribution?
a.
$23,000
b.
$72,000
c.
$95,000
d.
$0
Choice “b” is correct. Distributions in complete liquidation of a corporation are subject to two levels of taxation. First, the corporation must recognize gain or loss as if it sold the assets for the fair market value. The gain on the sale would be the fair market value of $162,000 less $90,000 basis for a gain of $72,000. Secondly, the shareholders would report gain or loss determined by the difference between the fair market value of the assets received and the shareholders’ adjusted basis of the stock.
Choices “d”, “a”, and “c” are incorrect, per the above explanation.
In Year 4, Superior Corp. an accrual-basis calendar year corporation, reported book income of $500,000. Included in that amount was $25,000 of municipal bond interest income, $100,000 of federal income tax expense, $10,000 of political party contributions, and $8,000 of tax penalty paid as a result of the audit of the Year 1 tax return which was completed during Year 4. What amount should Superior Corp.’s taxable income be on the Form 1120, U.S. Corporation Income Tax Return for Year 4?
a.
$593,000
b.
$600,000
c.
$585,000
d.
$618,000
Choice “a” is correct. Certain items are treated differently for book and tax purposes. The corporation’s book income was $500,000. For tax purposes, the $25,000 of municipal bond interest income is non-taxable, the $100,000 of federal income tax expense is non-deductible, and both the $10,000 of political party contributions and the $8,000 tax penalty are nondeductible.
Book income $ 500,000
Federal taxes (add) 100,000
Political expenses (add) 10,000
Penalties (add) 8,000
Municipal bond income (subtract) (25,000)
$ 593,000
Choices “b”, “d”, and “c” are incorrect, per the above calculation.
Dale Corporation’s book income before federal income taxes was $435,000 for the year ended December 31, Year 1. Dale was organized on January 1, Year 1. Organization costs of $50,000 are being written off over a ten-year period for financial statement purposes. For tax purposes, the corporation has elected to take advantage of the maximum benefit for expensing organizational costs. No additional book/tax differences exist. For the year ended December 31, Year 1, Dale Corporation’s taxable income was:
a.
$395,000
b.
$435,000
c.
$432,000
d.
$437,000
Choice “c” is correct. For tax purposes, if elected, a maximum expense deduction of $5,000 is allowed for organizational costs in the year of organization. The remainder must be amortized over 180 months. The book income of $435,000 must be adjusted for the difference between the book amortization and tax amortization allowed. Book amortization would be $5,000 per year ($50,000 divided by 10 years). Tax amortization/expense is calculated as follows:
$ 50,000
(5,000)
expensed
$ 45,000
÷ 180
months
250
per month
Tax expense/amortization would be $8,000 in this year ($50,000 − 5,000 ÷ 45,000/180 = 250 x 12 = 3,000 + 5,000 initial expense). The difference would be a $3,000 higher tax deduction than book. Thus, $435,000 less 3,000 = $432,000.
Choice “a” is incorrect. This answer assumes 100% of the organizational expenses are deductible in the first year instead of the $5,000.
Choice “b” is incorrect. The book income must be adjusted for the book/tax difference due to the different amortization methods.
Choice “d” is incorrect. This answer deducted only $3,000 from book income, disregarding the initial $5,000 immediate deduction.
Roger Corp. had operating income of $300,000 after deducting $12,000 for charitable contributions made during the fiscal year, but not including dividends of $10,000 received from 10%-owned domestic taxable corporation. How much is the base amount to which the percentage limitation should be applied in computing the maximum deduction for the charitable contribution?
a.
$322,000
b.
$300,000
c.
$315,000
d.
$312,000
Choice “a” is correct. The percentage threshold limit for charitable contributions for a corporation is 10% of adjusted taxable income. Total taxable income is calculated before the deduction of any charitable contributions, the dividends received deduction, any net operating loss carryback, or any capital loss carryback. Thus, the $300,000 must be adjusted to add back the charitable contribution deduction of $12,000 plus the $10,000 of dividend income not included in the $300,000. The base equals $322,000.
Choice “d” is incorrect. This answer does not take into account the dividend income not included in the $300,000.
Choice “b” is incorrect. This answer considers operating income without adjustments.
Choice “c” is incorrect. This answer reduced the $322,000 for the $7,000 dividends received deduction that Roger Corp. is entitled to, but this should not go into the calculation of the allowable charitable contribution deduction.
On March 1, Year 4, Nader Corp. adopted a plan of complete liquidation. On June 30, Nader distributed the assets it held at the time as listed below to its shareholders:
Asset Basis FMV
Cash $10,000 $10,000
Installment notes $80,000 $135,000
receivable
How much gain must Nader recognize as a result of this distribution?
a.
$145,000
b.
$0
c.
$55,000
d.
$45,000
Choice “c” is correct. In a corporate liquidation, distributions are subject to two levels of taxation. First, the corporation must recognize gain or loss as if it sold the assets for the fair market value. Second, the shareholders would report gain or loss determined by the difference between the fair market value of the assets received and the shareholders’ adjusted basis of the stock. The gain at the corporate level would be calculated as the combined fair market value of $145,000 less the combined basis of $90,000 or $55,000.
Choices “b”, “d”, and “a” are incorrect, per the above explanation.
Dreamscape, Inc., a widget retailer, had taxable income of $150,000 from operations during its taxable year. In addition, Dreamscape incurred a $35,000 loss from the sale of investment land, a capital asset. No other gains or losses were generated during the taxable year, nor had been in past years. In Dreamscape’s tax return for that year, what is the proper treatment of the $35,000 loss?
a.
Carry the $35,000 capital loss forward for five years.
b.
Use $3,000 of the loss to reduce the taxable income of $147,000 carry the remaining $32,000 forward for 3 years.
c.
The $35,000 capital loss can be used in the current year to reduce taxable income to $115,000.
d.
Use $3,000 of the loss to reduce the taxable income to $147,000 and carry the remaining $32,000 forward for 5 years.
Choice “a” is correct. Capital gains are taxed at the same rate as ordinary income for a corporation. However, capital losses can only be used to offset capital gains. Any amount not utilized in the year of generation can either be carried back 3 years to offset prior capital gains or carried forward for 5 years.
Choice “c” is incorrect. The capital loss cannot be used to offset the taxable income from operations.
Choices “b” and “d” are incorrect. The $3,000 rule is only available to individual taxpayers and not corporations. The inclusion of this in both answers makes them both incorrect. The appropriate carryback and carryforward rule is 3 back and 5 forward.
Buster-Copper Corp. received the following dividends during the taxable year. Each investment has been owned for the previous 5 years.
Received from Amount Percentage Owned
Ronald Corp. $10,000 10%
Donald Corp. $6,000 25%
Fence Corp. $1,000 2%
What amount is the dividends received deduction?
a.
$13,600
b.
$11,900
c.
$12,500
d.
$0
Choice “c” is correct. The dividends received from Ronald Corp. and Fence Corp. are subject to the 70% DRD (thus 30% would be taxable). The dividends from Donald Corp. are subject to the 80% DRD (thus 20% would be taxable). The total DRD is $11,000 x 70% plus $6,000 x 80% = $12,500.
Choice “d” is incorrect. The receipt of these dividends by Buster-Copper Corp. qualifies for the dividends received deduction.
Choice “b” is incorrect. This amount is obtained by taking the total dividends of $17,000 x 70% DRD; however the Donald Corp. dividends are subject to the 80% DRD.
Choice “a” is incorrect. This amount is obtained by taking the total dividends of $17,000 x 80% DRD; however the Ronald and Fence Co., dividends are only eligible for the 70% DRD.
Quigley, Roberk, and Storm form a corporation. Quigley exchanges $25,000 of legal fees for 30 shares of stock. Roberk exchanges land with a basis of $10,000 and a fair market value of $100,000 for 60 shares of stock. Storm exchanges $10,000 cash for 10 shares of stock. What amount of income should each shareholder recognize?
~Quigley
~Roberk
~Storm
a.
$25,000
$90,000
$10,000
b.
$0
$90,000
$0
c.
$0
$0
$0
d.
$25,000
$90,000
$0
Rule: IRC Section 351 controls the taxation of transfers to controlled corporations. No gain or loss is recognized to the transferors/shareholders on the property transferred if certain conditions are satisfied.
Choice “d” is correct. The transaction in this question does not satisfy the conditions of Section 351, and gain or loss can be recognized for each of the shareholders. For Section 351 to apply, the shareholders contributing property, including cash, must own, immediately after the transaction, at least 80% of the voting stock and at least 80% of the nonvoting stock of the corporation. A shareholder who contributes only services (Quigley in this question) is not counted as part of the control group. Thus, only Roberk and Storm are counted, and they together own only 70 shares out of the 100 shares (70%). The $25,000 of legal fees to Quigley is compensation for services rendered and is recognized as income by Quigley. A gain of $90,000 (the fair market value of the land of $100,000 - its adjusted basis of $10,000) is recognized to Roberk. Storm bought shares for cash and has no gain.
Choice “c” is incorrect. This is what would happen if Section 351 applies to all of the transferors/shareholders.
Choice “a” is incorrect. Storm recognizes no gain of any kind since he/she merely bought shares for cash.
Choice “b” is incorrect. Quigley recognizes gain since transferors who contribute only services are not counted as part of the control group for Section 351 purposes. Gain is recognized by transferors who are not part of the control group.
Which of the following entities must pay taxes for federal income tax purposes?
a.
Limited partnership.
b.
C corporation.
c.
General partnership.
d.
Joint venture.
Choice “b” is correct. A C corporation (a regular corporation) must pay federal income tax. A C corporation is not a pass-through entity like the other entities listed.
Choice “c” is incorrect. A general partnership is a pass-through entity and does not pay federal income tax.
Choice “a” is incorrect. A limited partnership is a pass-through entity and does not pay federal income tax.
Choice “d” is incorrect. A joint venture is a pass-through entity (a joint venture is similar to and is treated as a partnership) and does not pay federal income tax. A joint venture is a combination of two or more (tax) persons who jointly seek a profit from some business venture without designating themselves as an actual partnership or corporation.
Quail, Inc. manufactures consumer products and sells them to distributors. Quail advertises its products to increase sales and enhance the value of its trade name. What is the appropriate tax treatment for the advertising costs?
a.
Deduct the costs currently as ordinary and necessary business expenses.
b.
Amortize the costs over 60 months.
c.
Amortize the costs over 36 months.
d.
Amortize the costs over 15 years.
Rule: IRC Section 162 controls the deductibility of trade or business expenses. There is nothing special about advertising costs, except for certain foreign advertising costs. Any business expenses have to be reasonable and related to the taxpayer’s business activities.
Choice “a” is correct. Advertising costs which are in the nature of selling expenses (which these expenses appear to be) are deductible if they are reasonable and are related to the taxpayer’s business activities.
Choice “d” is incorrect. Advertising costs are expensed, not amortized over 15 years (180 months). Amortization over such a period is for goodwill and covenants not to compete, for example.
Choice “c” is incorrect. Advertising costs are expensed, not amortized over 36 months.
Choice “b” is incorrect. Advertising costs are expensed, not amortized over 60 months.
On June 30, Gold and Silver are calendar-year C corporations. The corporations have merged, with Gold as a subsidiary of Silver. Silver owns 85% of Gold’s voting stock and fair market value (FMV). Which of the following tax return filings would be appropriate for the two companies?
a.
Two separate returns, because the merger took place before the close of the second quarter.
b.
Two separate returns, because Silver owns at least 80% of both the voting stock and FMV of Gold.
c.
A consolidated return, because the merger took place before the close of the second quarter.
d.
A consolidated return, because Silver owns at least 80% of both the voting stock and FMV of Gold.
Rule: IRC Sections 1501 and 1504 allow certain combinations of corporations (an affiliated group) to file a consolidated income tax return. An affiliated group is one or more chains of corporations connected through stock ownership with a common parent if that parent directly owns stock possessing at least 80% of the total voting power of at least one of the other corporations and having a value equal to at least 80% of the total value of the stock of the corporation.
Choice “d” is correct. Since Silver owns 85% of the voting stock and fair market value of Gold, they can file a consolidated return.
Choice “b” is incorrect. A consolidated return, not two separate returns, is appropriate with the 85% ownership.
Choice “a” is incorrect. A consolidated return, not two separate returns, is appropriate with the 85% ownership. The timing of the merger has nothing to do with the decision.
Choice “c” is incorrect. A consolidated return is appropriate with the 85% ownership. The timing of the merger has nothing to do with the decision.
Ace Corp. and Bate Corp. combine in a qualifying reorganization and form Carr Corp., the only surviving corporation. This reorganization is tax-free to the:
~Shareholders
~Corporations
a.
No
No
b.
No
Yes
c.
Yes
Yes
d.
Yes
No
Choice “c” is correct.
Rule: A qualifying corporate reorganization is tax-free to all corporations involved and to all their shareholders.
Choices “d”, “b”, and “a” are incorrect, per the above rule.
On January 1, Fast, Inc. entered into a covenant not to compete with Swift, Inc. for a period of five years, with an option by Swift to extend it to seven years. What is the amortization period of the covenant for tax purposes?
a.
15 years.
b.
17 years.
c.
7 years.
d.
5 years.
Choice “a” is correct. Intangibles such as goodwill, licenses, franchises, trademarks and covenants not to compete may be amortized using the straight line basis over a period of 15 years, starting with the month of acquisition. Note, the difference for GAAP purposes: Intangible assets with indefinite lives are subject only to an impairment test, and intangible assets with finite lives are amortized over those lives and also subject to an impairment test.
Choice “d” is incorrect. The time certain does not impact the amortization period.
Choice “c” is incorrect. The option to extend does not impact the amortization period.
Choice “b” is incorrect. 17 years is longer than required to amortize intangible assets.
Robin, a C corporation, had revenues of $200,000 and operating expenses of $75,000. Robin also received a $20,000 dividend from a domestic corporation and is entitled to a $14,000 dividend-received deduction. Robin donated $15,000 to a qualified charitable organization in the current year. What is Robin’s contribution deduction?
a.
$13,100
b.
$13,900
c.
$14,500
d.
$15,000
Choice “c” is correct. Corporations making contributions to recognized charitable organizations are allowed a maximum deduction of 10% of their taxable income. Taxable income is calculated before the deduction of: (1) any charitable contribution; (2) the dividends received deduction; (3) any net operating loss carryback; (4) any capital loss carryback; or, (5) U.S. production activities deduction.
Revenues $ 200,000
Dividends Received 20,000
Less: Operating expenses (75,000)
Income before the dividends received deduction 145,000
x 10%
Maximum allowable charitable deduction $ 14,500
Note: Excess charitable contributions not allowed as a deduction due to the 10% limitation may be carried forward up to five years.
Choice “d” is incorrect. The full $15,000 would not be allowed due to the 10% limitation illustrated above.
Choice “b” is incorrect. The dividends received are considered in taxable income for purposes of the 10% limitation.
Choice “a” is incorrect. The 10% limitation is applied before the dividends received deduction.
In calculating the tax of a corporation for a short period, which of the following processes is correct?
a.
Determine the average taxable income for the past three years, then multiply the result by the number of months in the short period divided by 12.
b.
Compute tax on short-period income, then multiply the result by 12 divided by the number of months in the short period.
c.
Annualize income and calculate the tax on annualized income, then multiply the computed tax by the number of months in the short period divided by 12.
d.
Divide current-year income by prior-year income, then multiply the result by prior-year tax.
Choice “c” is correct. Corporations are required to pay estimated taxes on the fifteenth day of the fourth, sixth, ninth, and twelfth months of their tax year. One-fourth of the estimated tax is due with each payment. Unequal quarterly payments may be made using the annualized income method.
Choice “d” is incorrect. The annualized income method should be used.
Choice “b” is incorrect. The annualized income method should be used.
Choice “a” is incorrect. Using the past three years could yield an estimated tax liability lower than required.
Simon, a C corporation, had a deficit in accumulated earnings and profits of $50,000 at the beginning of the year and had current earnings and profits of $10,000. At year end, Simon paid a dividend of $15,000 to its sole shareholder. What amount of the dividend is reported as income?
a.
$10,000
b.
$5,000
c.
$0
d.
$15,000
Choice “a” is correct. Dividends are a distribution of property by a corporation out of its earnings and profits (E&P). Dividends come from current E&P and then from accumulated E&P. If current E&P is positive and accumulated E&P is negative, distributions are dividends only to the extent of current E&P. Any excess distribution above E&P reduces the shareholders basis in the stock, if any. If the shareholder has no basis, then the excess distribution is reported as a capital gain.
Choice “c” is incorrect. A distribution is a dividend to the extent of E&P.
Choice “b” is incorrect. The dividend would be the distribution to the extent of E&P, not the distribution above E&P.
Choice “d” is incorrect. The full distribution can only be a dividend if the corporation has sufficient E&P.
On January 1 of the current year, Locke Corp., an accrual-basis calendar-year C corporation, had $30,000 in accumulated earnings and profits. For the current year, 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. What amount of the distributions is classified as dividend income to Locke’s shareholders?
a.
$80,000
b.
$20,000
c.
$0
d.
$50,000
Choice “d” is correct. The general rule is that distributions are taxable dividends to the extent of current earnings and profits (E&P) by year end and to the extent of accumulated E&P as of the distribution date. If both are positive and if distributions exceed the sum of current E&P and accumulated E&P, then the distributions in excess of the sum are treated as a return of capital. In this example, both current E&P and accumulated E&P are positive (the total is $50,000), and total distributions during the year are $80,000; so, $50,000 of the total distributions will be taxable dividends.
Choices “c”, “b”, and “a” are incorrect per the above rule.
Gem Corp. purchased all the assets of a sole proprietorship, including the following intangible assets:
Goodwill
$ 50,000
Covenant not to compete
13,000
For tax purposes, what amount of these purchased intangible assets should Gem amortize over the specific statutory cost recovery periods?
a.
$50,000
b.
$0
c.
$13,000
d.
$63,000
Choice “d” is correct. Post-August 10, 1993, acquisitions of goodwill, covenants not-to-compete, franchises, trademarks, and trade names must be amortized on a straight-line basis over a fifteen-year period (180 months) beginning with the month of acquisition. So, both the $50,000 acquisition of the goodwill and the $13,000 acquisition of the covenant not-to-compete – for a total cost of $63,000 – are amortized over the fifteen-year period statutory cost recovery period.
Choices “a”, “c”, and “b” are incorrect per the above rule.
For year 2, Quest Corp., an accrual-basis calendar-year C corporation, had an $8,000 unexpired charitable contribution carryover from year 1. Quest’s year 2 taxable income before the deduction for charitable contributions was $200,000. On December 12, year 2, Quest’s board of directors authorized a $15,000 cash contribution to a qualified charity, which was made on January 6, year 3. What is the maximum allowable deduction that Quest may take as a charitable contribution on its year 2 income tax return?
a.
$8,000
b.
$15,000
c.
$23,000
d.
$20,000
Choice “d” is correct. C corporations are allowed a maximum charitable contribution deduction of 10% of taxable income computed before the following deductions:
Any charitable contribution,
The dividend received deduction,
Any net operating loss carryback,
Any net capital loss carryback, and
The U.S. production activities deduction.
Accrued charitable contributions not paid by the end of the year are deductible in the year of accrual if (i) the board of directors authorizes the contribution during the tax year and (ii) the accrual-basis corporation pays the accrued amount by the fifteenth day of the third month (generally 2½ months) following the end of the tax year.
Any amount in excess of the “10% limitation” may be carried forward for five years.
In this question, the corporation has: (i) an $8,000 unexpired charitable contribution carryover from the previous year, (ii) -0- charitable contributions paid during the current year, and (iii) a $15,000 contribution which the board of directors authorized by the end of the year and which the corporation paid by the fifteenth day of the third month following the end of the tax year. Hence, the deduction before application of the “10% limit” is $23,000: $8,000 + 0 + $15,000. However, the taxable income before the five deductions listed above is $200,000. So, the deduction is limited to $20,000: the lesser of (i) the $23,000 amount before application of the “10% limit” or (ii) $20,000 which is 10% of the $200,000 taxable income before the five deductions listed above.
Choices “c”, “b”, and “a” are incorrect per the above rule and per the above computations.
Nichol Corp. gave gifts to 15 individuals who were customers of the business. The gifts were not in the nature of advertising. The market values of the gifts were as follows:
5 gifts @ $15 each
9 gifts @ $30 each
1 gift @ $100
What amount is deductible as business gifts?
a.
$75
b.
$0
c.
$325
d.
$445
Explanation
Choice “c” is correct. Business gifts are deductible up to a maximum deduction of $25 per recipient per year.
Computation:
5 x lesser of (i) $15 value of each gift or (ii) $25 maximum per recipient per year
$ 75
9 x lesser of (i) $30 value of each gift or (ii) $25 maximum per recipient per year
225
1 x lesser of (i) $100 value of the gift or (ii) $25 maximum per recipient per year
25
Amount deductible for business gifts
$ 325
Choices “b”, “a”, and “d” are incorrect per the above rule and per the above computations.
In the current year, Fitz, a single taxpayer, sustained a $48,000 loss on Code Sec. 1244 stock in JJJ Corp., a qualifying small business corporation, and a $20,000 loss on Code Sec. 1244 stock in MMM Corp., another qualifying small business corporation. What is the maximum amount of loss that Fitz can deduct for the current year?
a.
$50,000 ordinary loss and $18,000 capital loss.
b.
$50,000 capital loss.
c.
$18,000 ordinary loss and $50,000 capital loss.
d.
$68,000 capital loss.
Choice “a” is correct. The stock in each corporation is a capital asset. The general rule is that a loss on the sale or exchange of a capital asset will be a capital loss (either a short-term capital loss or a long-term capital loss, depending upon the holding period). However, a special rule applies to “section 1244 small business stock.” When a corporation’s stock is sold or becomes worthless, an original stockholder can be treated as having an ordinary loss (fully deductible), instead of a capital loss, up to $50,000 ($100,000 if married filing jointly) for the year. Any loss(es) in excess of this amount is (are) a capital loss.
In this question, the taxpayer, who is not married, during the year has $68,000 of losses from the sale of section 1244 small business stock. As such, the taxpayer will treat as an ordinary loss $50,000 of the total loss; the taxpayer will treat as a capital loss the remaining $18,000 of the total loss.
Choices “b”, “d”, and “c” are incorrect per the above rule.
Azure, a C corporation, reports the following:
Pretax book income of $543,000.
Depreciation on the tax return is $20,000 greater than depreciation on the financial statements.
Rent income reportable on the tax return is $36,000 greater than rent income per the financial statements.
Fines for pollution appear as a $10,000 expense in the financial statements.
Interest earned on municipal bonds is $25,000.
What is Azure’s taxable income?
a.
$528,000
b.
$559,000
c.
$543,000
d.
$544,000
Choice “d” is correct. Azure’s taxable income is calculated as follows:
Pretax book income
$ 543,000
Depreciation for tax purposes in excess of book depreciation
(20,000)
Rent income for tax purposes in excess of book rent income
36,000
Fines expensed for book purposes but not deductible for tax purposes
10,000
Municipal bond interest not taxable for tax purposes
(25,000)
Taxable income
$ 544,000
Choices “a”, “c”, and “b” are incorrect per the above calculation.
Which of the following cannot be amortized for tax purposes?
a.
Stock issuance costs.
b.
Organizational meeting costs.
c.
Temporary directors’ fees.
d.
Incorporation costs.
Choice “a” is correct. All costs of issuing stock are not eligible to be deducted or amortized as an organizational expenditure or start-up cost.
Choice “d” is incorrect. All incorporation costs are eligible to be deducted or amortized as an organizational expenditure.
Choice “c” is incorrect. All temporary director fees are eligible to be deducted or amortized as a start-up cost.
Choice “b” is incorrect. All organizational meeting costs are eligible to be deducted or amortized as an organizational expenditure.
A corporate taxpayer plans to switch from the FIFO method to the LIFO method of valuing inventory. Which of the following statements is accurate regarding the use of the LIFO method?
a.
The LIFO method can be used for tax purposes even if the FIFO method is used for financial statement purposes.
b.
The taxpayer is required to receive permission each year from the Internal Revenue Service to continue the use of the LIFO method.
c.
In periods of rising prices, the LIFO method results in a lower cost of sales and higher taxable income, when compared to the FIFO method.
d.
Under the LIFO method, the inventory on hand at the end of the year is treated as being composed of the earliest acquired goods.
Choice “d” is correct. Under the LIFO method, the inventory on hand at the end of the year is treated as being composed of the earliest acquired goods.
Choice “c” is incorrect. In periods of rising prices, the LIFO method results in ahigher cost of sales and lower taxable income when compared to the FIFO method.
Choice “b” is incorrect. The taxpayer is not required to receive permission each year from the Internal Revenue Service to continue the use of the LIFO method.
Choice “a” is incorrect. The LIFO method can be used for tax purposes only if the LIFO method is used for financial statement purposes.
Summer, a single individual, had a net operating loss of $20,000 three years ago. A Code Section 1244 stock loss made up three-fourths of that loss. Summer had no taxable income from that year until the current year. In the current year, Summer has gross income of $80,000 and sustains another loss of $50,000 on Code Section 1244 stock. Assuming that Summer can carry the entire $20,000 net operating loss to the current year, what is the amount and character of the Code Section 1244 loss that Summer can deduct for the current year?
a.
$35,000 ordinary loss.
b.
$35,000 capital loss.
c.
$50,000 ordinary loss.
d.
$50,000 capital loss.
Choice “c” is correct. The maximum Section 1244 loss that can be deducted by a single taxpayer in any year is $50,000. All losses designated as Section 1244 losses are ordinary by definition. Note that most of the information in this question is not required to solve for the correct answer.
Choices “a”, “b”, and “d” are incorrect per the above explanation.
The sole shareholder of an S corporation contributed equipment with a fair market value of $20,000 and a basis of $6,000 subject to $12,000 liability. What amount is the gain, if any, that the shareholder must recognize?
a.
$8,000
b.
$0
c.
$12,000
d.
$6,000
Choice “d” is correct. Generally, this is a nontaxable transaction. However, the liabilities assumed by the corporation of $12,000 are in excess of the basis of the property contributed of $6,000. The amount of the excess, which is $6,000 ($12,000 − $6,000) is a gain that must be recognized. Note that the fact that this is an S Corporation does not affect the answer. The rules for the formation of an S Corporation are the same as for a C Corporation.
Choices “b”, “a”, and “c” are incorrect per the above explanation.
The selection of an accounting method for tax purposes by a newly incorporated C corporation:
a.
Is made by filing a request for a private letter ruling from the IRS.
b.
Must first be approved by the company’s board of directors.
c.
Is made on the initial tax return by using the chosen method.
d.
Must be disclosed in the company’s organizing documents.
Choice “c” is correct. The selection of an accounting method for tax purposes is made on the initial tax return by using the chosen method.
Choice “a” is incorrect. The selection of an accounting method for tax purposes is not made by filing a request for a private letter ruling from the IRS. A private letter ruling is a request for the IRS to rule in advance on a special set of facts.
Choice “b” is incorrect. The selection of an accounting method for tax purposes does not have to be first approved by the company’s board of directors.
Choice “d” is incorrect. The selection of an accounting method for tax purposes does not have to be disclosed in the company’s organizing documents.
Individual Lark’s Year 2 brokerage account statement listed the following capital gains and losses from the sale of stock investments:
Short-term capital gain
$ 6,000
Long-term capital gain
14,000
Short-term capital loss
4,000
Long-term capital loss
8,000
In addition, two stock investments became worthless in Year 2. Public Company X stock was purchased in December, Year 1, for $5,000, and formal notification was received by Lark on July, Year 2, that it was worthless. Private company Section 1244 stock was issued to Lark for $10,000 in January, Year 1, and was determined to be worthless in December, Year 2. What is Lark’s Year 2 net capital gain or loss before any capital loss limitation?
a.
$3,000 net capital gain.
b.
$7,000 net capital loss.
c.
$2,000 net capital loss.
d.
$8,000 net capital gain.
Choice “a” is correct. First, the long-term capital gain of $14,000 is netted with the long-term capital loss of $8,000. This results in a net long-term capital gain of $6,000. Next, the short-term capital gain of $6,000 is netted with the short-term capital loss of $4,000. This results in a net short-term capital gain of $2,000. Now add the net long-term capital gain of $6,000 and the net short-term capital gain of $2,000 to arrive at a net capital gain of $8,000. This amount is reduced by the $5,000 worthless stock. So the final net capital gain is $3,000. Note that the Section 1244 loss of $10,000 does not affect this calculation because it is an ordinary loss and not a capital loss.
Choices “c”, “b”, and “d” are incorrect per the above explanation.
At the beginning of the year, Data, a C corporation, had a $45,000 deficit in accumulated earnings and profits. For the current year, Data reported earnings and profits of $15,000. Data distributed $18,000 to its shareholders during the current year. What amount of the distribution is treated as a taxable dividend?
a.
$18,000
b.
$15,000
c.
$0
d.
$3,000
Choice “b” is correct. Corporate distributions are taxable dividends first to the extent of current earnings and profits (E&P) and then to the extent of accumulated E&P. Current and accumulated E&P are not netted. Current E&P is $15,000 and there is no accumulated E&P. So only $15,000 of the $18,000 distribution is a taxable dividend. Note that the remaining $3,000 distribution is a nontaxable return of capital up to shareholder basis. After that, it is a taxable capital gain distribution.
Choice “c” is incorrect. $0 would only be correct if there were not any current or accumulated E&P.
Choice “d” is incorrect. $3,000 is the amount of the distribution in excess of current E&P. This is the amount of the distribution that is not a taxable dividend.
Choice “a” is incorrect. $18,000 is the entire distribution. However, it is only a taxable distribution to the extent of current and accumulated E&P.
In which of the following circumstances does the three-year statute of limitations on additional tax assessments apply?
a.
The IRS files a substitute income tax return when it learns that a taxpayer failed to file a return.
b.
A taxpayer inadvertently overstates deductions equal to 15% of gross income.
c.
A taxpayer willfully attempts to evade tax in filing income tax returns.
d.
A taxpayer inadvertently omits from gross income an amount in excess of 25% of the gross income stated on the income tax return.
Choice “b” is correct. With respect to a timely filed return, the general rule is that the IRS can assess additional tax within three years from the later of the return’s due date (plus extensions, if any) or the date the return was filed. A taxpayer’s inadvertently overstating deductions in an amount equal to 15% of gross income will not trigger any of the exceptions to the general rule.
Choice “c” is incorrect. There is no statute of limitations when a taxpayer willfully attempts to evade tax in filing income tax returns.
Choice “d” is incorrect. A six year statute of limitations applies when a taxpayer omits from gross income an amount in excess of 25% of the gross income stated on the income tax return. For purposes of the “six year” statute, gross income is not reduced by cost of goods sold.
Choice “a” is incorrect. There is no statute of limitations when the IRS files (actually, “executes”) a substitute income tax return when the IRS learns that a taxpayer failed to file a return.
What is the maximum amount of capital losses in excess of capital gains that a C corporation may deduct in a year?
a.
$10,000
b.
$0
c.
$5,000
d.
$3,000
Explanation
Choice “b” is correct. Unlike individuals, corporations may not deduct any capital losses in excess of capital gains in a year.
Choices “d”, “c”, and “a” are incorrect, per the above rule.
Prime Corporation’s building was destroyed by a tornado. The fair market value of the building at the time of the tornado was $400,000 and its adjusted basis was $350,000. The insurance proceeds totaled $500,000 as follows:
$400,000 for the building
$100,000 for lost profits during rebuilding
Prime does not defer any gain under the involuntary conversion provisions of Code Sec. 1033.
What amount of the insurance proceeds is taxable to Prime?
a.
$50,000
b.
$0
c.
$150,000
d.
$100,000
Choice “c” is correct. The building had an adjusted basis of $350,000 and $400,000 proceeds were received for it. That results in a taxable gain of $50,000, because none of it was deferred. The $100,000 received for lost profits is taxable as well. The total taxable amount is $150,000 ($50,000 + $100,000).
Choice “b” is incorrect. $0 would be the taxable amount just on the building if the gain were deferred.
Choice “a” is incorrect. $50,000 is the taxable amount of the proceeds for the building only.
Choice “d” is incorrect. $100,000 is the taxable amount of the proceeds for lost profits only.
A corporate taxpayer’s capital gains and losses are as follows:
Short-term capital gain
$ 7,000
Short-term capital loss
$ (43,000)
Long-term capital gain
$ 9,000
Long-term capital loss
$ (21,000)
What amount of capital loss deduction is the taxpayer entitled to use to offset against ordinary income?
a.
$48,000
b.
$0
c.
$3,000
d.
$12,000
Choice “b” is correct. First, the long-term capital gains and losses are netted to arrive at a net long-term capital loss of $12,000. Next, the short-term capital gains and losses are netted to arrive at a net short-term capital loss of $36,000. The next step is to net the net long-term capital loss of $12,000 with the net short-term capital loss of $36,000. This results in a net capital loss of $48,000. None of that loss is currently deductible against ordinary income. It can be carried back three years and forward five years.
Choice “c” is incorrect. $3,000 is the deductible amount of capital loss against ordinary income for an individual, not a corporation.
Choice “d” is incorrect. $12,000 is just the net long-term capital loss.
Choice “a” is incorrect. $48,000 is the net capital loss, but it is not deductible against ordinary income.
Which of the following corporations would be taxed as a personal service corporation?
a.
An architecture and engineering firm.
b.
A real estate brokerage.
c.
A groundskeeping firm.
d.
A catering service.
Choice “a” is correct. A personal service corporation (PSC) is primarily involved in the performance of one of the following fields: accounting, law, consulting, engineering, architecture, health, and actuarial science.
Choices “b”, “d”, and “c” are incorrect, per the above rule.
Porter, the sole shareholder of Preston Corp., transferred property to the corporation as a contribution to capital. Two years later, Corley transferred property to the corporation in exchange for a 10% interest in corporate stock. The property transferred was valued as follows:
Porter’s transfer Corley’s transfer
Basis $50,000 $250,000
Fair market value 200,000 500,000
What amount represents the corporation’s basis in the property received?
a.
$700,000
b.
$450,000
c.
$550,000
d.
$300,000
Explanation
Choice “c” is correct. Porter’s transfer is not taxable because the 80% control test is met. The corporation’s basis in the property is the basis of $50,000. Corley’s transfer is taxable because the 80% control test is not met. The corporation’s basis in the property is $500,000. The corporation’s total basis in the properties is $550,000 ($50,000 + $500,000).
Choice “a” is incorrect. $700,000 would be correct if the basis of both properties used fair market value.
Choice “b” is incorrect. $450,000 would be correct if Porter’s property used fair market value and Corley’s property used carryover basis.
Choice “d” is incorrect. $300,000 would be correct if the basis of both properties used carryover basis.
