R3: C and S Corporation Taxation and Exempt Organizations

Question 1

How are the dividends that are recorded as income reported?

Answer 1

Dividends are a distribution of property by a corporation out of its 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.

Question 2

What is the dividends received deduction?

Answer 2

Requirements
1. 1st corporation is taxed
2. Owned 45 days before or after
Dividend Income Limitation
1. 100% (own 80 - 100%) (consolidate)
2. 80% (own 20-79.9%) (large investment)
3. 70% (own under 20%) (small investment)

Question 3

What is the exception to the dividends received deduction?

Answer 3

If taking the full percentage of the dividend income creates or adds to the corporate loss, it is not allowed.

Question 4

If S corporation status is revoked or terminated, how many years is the corporation required to wait before making a new S election?

Answer 4

The corporation is required to wait 5 years before making a new S election unless the IRS consents to an earlier election.

Question 5

What amount of distributions are classified as dividend income?

Answer 5

The general rule is that distributions are taxable dividends to the extent of current 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 or capital.

Question 6

What percentage qualifies for control of a corporation for a tax-free incorporation?

Answer 6

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).

Question 7

With regard to S corporations and their stockholders, to whom do the “at risk” rules for losses apply?

Answer 7

The “at risk” rules limit the deductibility of the distributive share of the losses of an S corporation to the amount the taxpayer has “at risk” (as opposed to non recourse loans) and could actually lose from an activity.

Question 8

What are the requirements for S corporation status to be revoked by the shareholders?

Answer 8

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 9

What is the Advance Pricing Agreement Program?

Answer 9

The APA is a binding contract between the IRS and the taxpayer by which the IRS agrees not to seek a transfer pricing adjustment for a covered transaction if the taxpayer files its return for a covered year consistent with the agreed transfer pricing method.

Question 10

What is the Section 482 study?

Answer 10

A section 482 study is prepared by the taxpayer based upon allowable pricing methods set forth by the IRS and is completed by the time the taxpayer files the federal income tax return. The taxpayer must determine that the prices for controlled transactions and controlled transfers are in accordance with the allowable pricing methods and that the use of such method was reasonable.

Question 11

What is a request for competent authority?

Answer 11

A “request for competent authority” is a request by the taxpayer that the IRS and taxing officials in the other jurisdiction together determine the appropriate transfer price so that the taxpayer group is not taxed twice on the same income.

Question 12

What is an advantage of a LLC over an S corp?

Answer 12

Appreciated property can be distributed tax-free to an owner (because it is taxed like a partnership).

Question 13

What are the rules concerning distributions of cash or land to shareholders?

Answer 13

Rule 1: 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 2: The general rule is the payment of a dividend does not create a taxable event for the corporation, unless the distribution is appreciated property. When the distribution is of appreciated property, the corporation recognizes gain as if the property were sold at FMV.

Question 14

How does asset trade-ins affect a company?

Answer 14

Generally, no gain or loss is recognized on the trade-in of an old asset for tax purposes; hence, there is no tax effect. The traded-in asset’s book value becomes a portion of the depreciable basis of the new asset, resulting in additional depreciation for tax purposes in later years and the reduction of taxes payable in those later years. Therefore, the cash outflows in later years will decline.

Question 15

Which entity can adopt any tax year end?

Answer 15

C corporations may adopt any year end, provided the year end is approved by the IRS.

Question 16

What entities are entitled to the net operating loss deduction?

Answer 16

A NOL exists if there is a net loss on the tax returns for individuals (1040), estate and trusts (1041), taxable C Corporations (1120). A NOL can only exist on tax returns of taxable entities.

Question 17

Who is required to use the accrual method of accounting?

Answer 17

The accrual method of accounting for tax purposes is REQUIRED for the following:

1. The accounting purchase and sales of inventories (and inventories must be maintained)
2. Tax shelters
3. Certain farming corporations (other farming or tree-raising businesses may generally use the cash basis)
4. 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.

Question 18

What are the deduction requirements for Code Section 1244 stock?

Answer 18

The maximum section 1244 loss that can be deducted by a single taxpayer in any year is $50,000. All loses designated as Section 1244 (worthless stock) losses are ordinary by definition.

Question 19

Is rental income received in advance taxable in the year received?

Answer 19

Yes, GAAP requires that rental revenue received in advance is taxable in the year of receipt as opposed to over the term of the lease.

Question 20

What amounts of insurance premiums can be included in gross income?

Answer 20

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).

Question 21

What is deductible for an illegal business?

Answer 21

A gain from an illegal activity is includible in income. To determine the gain, a deduction is permitted for the cost of the merchandise. Business expenses for operating an illegal business, other than the cost of merchandise, are NOT permitted as a deduction.