Question 1

If an S corporation has no accumulated earnings and profits, the amount distributed to a shareholder: a. Must be returned to the S corporation. b. Decreases the shareholder's basis for the stock. c. Increases the shareholder's basis for the stock. d. Has no effect on the shareholder's basis for the stock.

Accepted Answer

Choice "b" is correct. If an S corporation has no accumulated earnings and profits, the amount distributed to a shareholder decreases the shareholder's basis for the stock. The distribution is nontaxable to the extent of the shareholder's basis. Choice "a" is incorrect. The amount distributed to a shareholder does not need to be returned to the S corporation. Choice "c" is incorrect. Distributions do not increase a shareholder's basis. Choice "d" is incorrect. Distributions have no effect on a shareholder's basis ifthey are out of accumulated earnings and profits and are therefore taxable. They would also have no effect on a shareholder's basis if the basis is already zero, which would result in the shareholder recognizing a gain to the extent of the distribution. In this case, we are not told whether or not the basis is already zero.

Question 2

Stahl, an individual, owns 100% of Talon, an S corporation. At the beginning of the year, Stahl's basis in Talon was $65,000. Talon reported the following items from operations during the current year: Ordinary loss $ 10,000 Municipal interest income 6,000 Long-term capital gain 4,000 Short-term capital loss 9,000 What was Stahl's basis in Talon at year-end? a. $55,000 b. $50,000 c. $56,000 d. $61,000

Accepted Answer

Explanation Choice "c" is correct. Stahl's basis would be computed as follows: Beginning basis: $ 65,000 + Income 6,000 (Tax-free income increases basis) − Loss (10,000) − Net capital loss _(5,000)_ ($4,000 gain netted with $9,000 loss) $ 56,000 Choice "b" is incorrect. This choice excludes the $6,000 of municipal interest income from the above calculation. Remember, both taxable and tax exempt items of income give the taxpayer additional basis. Choice "a" is incorrect. This choice excludes both the municipal interest income and the net capital loss from the above calculation. Remember, both taxable and tax exempt and separately and non-separately stated items (stated on the K-1) of income or loss affect a shareholder's basis. Choice "d" is incorrect. This choice excludes the net capital loss from the above calculation. Remember, both separately and non-separately stated items (stated on the K-1) of loss affect a shareholder's basis.

Question 3

Baker, an individual, owned 100% of Alpha, an S corporation. At the beginning of the year, Baker's basis in Alpha Corp. was $25,000. Alpha realized ordinary income during the year in the amount of $1,000 and a long-term capital loss in the amount of $3,000 for this year. Alpha distributed $30,000 in cash to Baker during the year. What amount of the $30,000 cash distribution is taxable to Baker? a. $5,000 b. $0 c. $30,000 d. $7,000

Accepted Answer

Choice "d" is correct. The taxability of distributions to shareholders in S corporations with no C corporation earnings and profits is as follows: To the extent of basis in stock - tax free; treated as return of capital. Any distributions in excess of the shareholder's basis - taxable; treated as capital gain. Based upon this rule and the information in the question, Baker's basis is calculated as follows: Beginning basis $ 25,000 Plus: Ordinary income 1,000 _Less: Long-term capital loss (3,000)_ Baker's Basis $ 23,000 Baker's basis should then be compared to the amount distributed to determine how much constitutes return of capital. In this instance, $23,000 would be nontaxable return of basis, and the remaining $7,000 would be taxable capital gain to Baker. Choice "b" is incorrect. Baker's basis is less than the cash distributed so there would be some gain. Choice "a" is incorrect. This choice does not take into account the current year activity of the S corporation in determining Baker's basis. Choice "c" is incorrect. Based upon the above rule, amounts distributed to the extent of the shareholder's basis are not taxable. Note: This question is the official released question of the AICPA. The question appears to assume that the S corporation was organized as such and has no prior C corporation earnings and profits. If this were the case (i.e., corporation E&P exist), ordering rules for distributions would apply, and an election would have had to be made to obtain the same tax effects as in the provided choice.

Question 4

Lane Inc., an S corporation, pays single coverage health insurance premiums of $4,800 per year and family coverage premiums of $7,200 per year. Mill is a ten percent shareholder-employee in Lane. On Mill's behalf, Lane pays Mill's family coverage under the health insurance plan. What amount of insurance premiums is includible in Mill's gross income? a. $720 b. $4,800 c. $7,200 d. $0

Accepted Answer

Choice "c" is correct. $7,200 of insurance premiums (the amount of family coverage premiums, as indicated in the question) is includible in Mill's gross income. Rule: Fringe benefits paid by an S corporation are deductible by the S corporation only for non-shareholder employees and those employee-shareholders owning 2% or less of the S corporation. Other fringe benefits paid are deductible by the S corporation if included as part of gross income from the S corporation for the individual receiving the benefits (i.e., included as part of income on the shareholder's W-2). Choices "d", "a", and "b" are incorrect, per the above rule.

Question 5

Beck Corp. has been a calendar-year S corporation since its inception on January 2, Year 1. On January 1, Year 4, Lazur and Lyle each owned 50% of the Beck stock, in which their respective tax bases were $12,000 and $9,000. For the year ended December 31, Year 4, Beck had $81,000 in ordinary business income and $10,000 in tax-exempt income. Beck made a $51,000 cash distribution to each shareholder on December 31, Year 4. What was Lazur's tax basis in Beck after the distribution? a. $52,500 b. $1,500 c. $57,500 d. $6,500

Accepted Answer

Choice "d" is correct. Lazur's tax basis after the distribution was $6,500. Rule: The adjusted basis of S corporation stock goes up for undistributed earnings (including tax-exempt income) and vice-versa, as it would in a partnership. Rule: Amounts distributed (including distributions not taxable as dividends) reduce the adjusted basis of the stock. Lazur's basis at 1/1/Year 4 $ 12,000 Add: 50% of ordinary income 40,500 [$81,000 × 50%] 50% of tax-exempt income 5,000 [$10,000 × 50%] Less: _Distribution to Lazur (51,000)_ Basis at 12/31/Year 4 $ 6,500

Question 6

Village Corp., a calendar year corporation, began business in Year 1. Village made a valid S corporation election on December 5, Year 3, with the unanimous consent of its shareholders. The eligibility requirements for S status continued to be met throughout Year 4. On what date did Village's S status become effective? a. December 5, Year 4. b. December 5, Year 3. c. January 1, Year 3. d. January 1, Year 4. Explanation Choice "d" is correct. Rule: In order to be effective for the current taxable year, the S corporation election must be made by the 15th day of the third month of the taxable year. If the election is made after that date, it becomes effective on the first day of the next taxable year, January 1, Year 4, in this case. Choices "c", "b", and "a" are incorrect, per the above rules.

Accepted Answer

Choice "d" is correct. Rule: In order to be effective for the current taxable year, the S corporation election must be made by the 15th day of the third month of the taxable year. If the election is made after that date, it becomes effective on the first day of the next taxable year, January 1, Year 4, in this case. Choices "c", "b", and "a" are incorrect, per the above rules.

Question 7

A shareholder's basis in the stock of an S corporation is increased by the shareholder's pro rata share of income from: ~Tax-exempt interest ~Taxable interest a. No No b. Yes Yes c. No Yes d. Yes No

Accepted Answer

Choice "b" is correct. Rule: Both tax-exempt and taxable interest income increase a shareholder's basis in S corporation stock. Choices "a", "c", and "d" are incorrect, per the above rule.

Question 8

Zinco Corp. was a calendar year S corporation. Zinco's S status terminated on April 1, Year 1, when Case Corp. became a shareholder. During Year 1 (365-day calendar year), Zinco had nonseparately computed income of $310,250. If no election was made by Zinco, what amount of the income, if any, was allocated to the S short year for Year 1? a. $233,750 b. $155,125 c. $0 d. $76,500

Accepted Answer

Choice "d" is correct. ($310,250/365) x 90 = $76,500. Zinco will be taxed as an S corporation from January 1 to March 31, Year 1, and a C corporation from April 1 to December 31, Year 1. Absent the election to calculate the incomes of the S and C corporation portions of the year separately, Zinco's income is allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year. Year 1 has 365 days, 90 of which occurred before April 1. Choice "a" is incorrect. Absent the election to calculate the incomes of the S and C corporation portions of the year separately, Zinco's income is allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year. This is the income allocated to the C corporation portion of the year. Choice "b" is incorrect. Absent the election to calculate the incomes of the S and C corporation portions of the year separately, Zinco's income is allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year, not on a 50/50 split. Choice "c" is incorrect. Zinco's income must be allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year.

Question 9

Bristol Corp. was formed as a C corporation on January 1, Year 1, and elected S corporation status on January 1, Year 3. At the time of the election, Bristol had accumulated C corporation earnings and profits, which have not been distributed. Bristol has had the same 25 shareholders throughout its existence. In Year 6, Bristol's S election will terminate if it: a. Adds a decedent's estate as a shareholder to the existing shareholders. b. Has passive investment income exceeding 90% of gross receipts in each of the three consecutive years ending December 31, Year 5. c. Increases the number of shareholders to 100. d. Takes a charitable contribution deduction.

Accepted Answer

Choice "b" is correct. S corporations that are former C corporations with undistributed C corporation earnings and profits are restricted in the amount of passive investment income they can realize without terminating their S election. The restriction is 25% of total gross receipts from passive investment income. The S election is terminated if the S corporation has passive investment income greater than 25% of gross receipts for three consecutive years. After 3 years with 90% of its gross receipts from passive sources, Bristol will lose its S corporation status on the first day of its Year 6 taxable year. Choice "c" is incorrect. An S corporation can have as many as 100 shareholders. Choice "a" is incorrect. A decedent's estate may be an S corporation shareholder. Choice "d" is incorrect. S corporations pass their charitable contribution deductions through to their shareholders.

Question 10

As of January 1 of the current year, Kane owned all the 100 issued shares of Manning Corp., a calendar year S corporation. On the 41st day of the year, Kane sold 25 of the Manning shares to Rodgers. For the current year ended December 31 (a 365-day calendar year), Manning had $73,000 in nonseparately stated income and made no distributions to its shareholders. What amount of nonseparately stated income from Manning should be reported on Kane's current year tax return? a. $56,750 b. $0 c. $16,250 d. $54,750

Accepted Answer

Choice "a" is correct. The mid-year change of ownership causes Manning's S corporation income to be allocated between the shareholders on a per-share, per-day basis. The first 40 days' income is allocated 100% to Kane: 40 x ($73,000/365) = $8,000. 75% of the remaining 325 days' income is allocated to Kane: 75% x 325 x ($73,000/365) = $48,750. The total income allocated to Kane is $56,750 ($8,000 + $48,750). Choice "d" is incorrect. Manning's income will be allocated on a per-share, per-day basis; although Kane owned 75% of the shares starting on April 1, he owned 100% of the shares through March 31. Choice "c" is incorrect. This is the income that should be allocated to Rodgers; the question asks how much should be allocated to Kane. Choice "b" is incorrect. The mid-year change of ownership causes Manning's S corporation income to be allocated between the shareholders on a per-share, per-day basis.

Question 11

On February 10, Year 1, Ace Corp., a calendar-year corporation, elected S corporation status and all shareholders consented to the election. There was no change in shareholders in Year 1. Ace met all eligibility requirements for S status during the preelection portion of the year. What is the earliest date on which Ace can be recognized as an S corporation? a. January 1, Year 1. b. February 10, Year 1. c. February 10, Year 2. d. January 1, Year 2.

Accepted Answer

Choice "a" is correct. Rule: An S election made by the 15th day of the third month of the taxable year is retroactively effective on the first day of the taxable year. Choices "c", "b", and "d" are incorrect, per the above rule.

Question 12

An S corporation has 30,000 shares of voting common stock and 20,000 shares of non-voting common stock issued and outstanding. The S election can be revoked voluntarily with the consent of the shareholders holding, on the day of the revocation: ~Shares of voting stock ~Shares of nonvoting stock a. 0 20,000 b. 10,000 16,000 c. 7,500 5,000 d. 20,000 0

Accepted Answer

Choice "b" is correct. S corporation status can be revoked if shareholders owning more than 50% of the total number of issued and outstanding shares consent. The specific percentage of voting and nonvoting shareholders is not considered, just the total. Holders of more than 25,000 total shares must approve the revocation. Choices "a", "c", and "d" are incorrect. S corporation status can be revoked if shareholders owning more than 50% of the total number of issued and outstanding shares consent. The specific percentage of voting and nonvoting shareholders is not considered, just the total.

Question 13

The Haas Corp., a calendar year S corporation, has two equal shareholders. For the current year, Haas had taxable income and current earnings and profits of $60,000, which included $50,000 from operations and $10,000 from investment interest income. There were no other transactions that year. Each shareholder's basis in the stock of Haas will increase by: a. $30,000 b. $25,000 c. $50,000 d. $0

Accepted Answer

Choice "a" is correct. The basis of a shareholder's stock in an S corporation is increased by any item of income and decreased by any item of loss or deduction that passes through to the shareholder. Each shareholder reports ½ of $60,000. Choice "c" is incorrect. The S corporation had $50,000 income from operations, of which ½ is reported by each shareholder. However, investment income must also be considered. Choice "b" is incorrect. Investment income must also be considered. Choice "d" is incorrect. The basis of a shareholder's stock in an S corporation is increased by any item of income and decreased by any item of loss or deduction that passes through to the shareholder.

Question 14

Which of the following conditions will prevent a corporation from qualifying as an S Corporation? a. One shareholder is an estate. b. The corporation has both common and preferred stock. c. The corporation has one class of stock with different voting rights. d. One shareholder is a grantor trust.

Accepted Answer

Choice "b" is correct. An S corporation can only have one class of stock outstanding. Common and preferred stock would constitute two classes of stock. Choice "c" is incorrect. One class of stock with different voting rights is allowed for S corporations. Choice "a" is incorrect. Individuals, estates, and certain trusts may be shareholders in an S corporation. Choice "d" is incorrect. Grantor trusts, Section 678 trusts, qualified Subchapter S trusts (QSSTs), certain testamentary trusts, and voting trusts are allowed to be shareholders in an S corporation.

Question 15

Boles Corp., an accrual-basis calendar-year S corporation, has been an S corporation since its inception and is not subject to the uniform capitalization rules. In the current year, Boles recorded the following: Gross receipts $ 50,000 Dividend income from investments 5,000 Supplies expense 2,000 Utilities expense 1,500 What amount of net business income should Boles report on its Form 1120S, U.S. Income Tax Return for an S corporation, Schedule K? a. $53,000 b. $48,000 c. $46,500 d. $53,500

Accepted Answer

Choice "c" is correct. An S corporation reports both separately stated and non-separately stated (net business) items of income. The dividend income is a separately stated item and is not included in the calculation of net business income. Therefore, net business income is calculated as follows: Gross receipts $ 50,000 Supplies expense (2,000) _Utilities expense (1,500)_ Net business income $ 46,500 Choice "d" is incorrect. Dividend income is not included in net business income. Supplies expense is included in net business income. Choice "a" is incorrect. Dividend income is not included in net business income. Utilities expense is included in net business income. Choice "b" is incorrect. Utilities expense is included in net business income.

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