REG 3

Question 1

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

Answer 1

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

Notes:

• Taxpayer may choose straight-line depreciation in lieu of 200% declining balance.
• 15- and 20- year property uses the 150% declining balance method.

Question 2

What is the half-year convention?

Answer 2

Six months of depreciation is taken in the year of acquisition and the year of disposal.
Note: When straight-line depreciation is elected, the half-year convention is still applicable.

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

Question 3

What is the mid-quarter convention?

Answer 3

Mid-quarter convention replaces the half-year convention if greater than 40% of a taxpayer’s property (other than real property) is placed in service during the last 3 months of a tax year.

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

Question 4

What is the mid-month convention?

Answer 4

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

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

Question 5

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

Answer 5

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

Limitations:

1. Reduced dollar for dollar of qualifying property placed in service in excess of $500,000.
2. Deduction is not permitted when a net loss exists or if the deduction would create a net loss.

Question 6

What are Section 1231 assets?

Answer 6

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

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

Question 7

What is the tax treatment of Section 1245 assets?

Answer 7

Generally, depreciable personal property or amortizable personal property used in a business over one year (Machinery and equipment).

Upon sale of Section 1245 asset:

• Recapture as ordinary income the lesser of gain recognized or all accumulated depreciation
• Any remaining gain is a Section 1231 gain.

Question 8

Identify the tax treatment given Section 1250 assets.

Answer 8

Generally real property used in a business greater than one year.

• Gain/loss is treated as ordinary income to the extent of the excess of accelerated depreciation over straight-line depreciation. The straight-line amount results in a 25% tax on the gain.
• Excess gain is Section 1231 gain

There is no Section 1250 recapture on disposition of real property under the MACRS rules

Question 9

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

Answer 9

Following two conditions must be met:

• Transferors/shareholders own at least 80% of the voting and non-voting stock
• Boot (cash or other property) or cancellation of debt is not involved

Question 10

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

Answer 10

Basis of common stock received:

• Cash: amount contributed
• Property contributed: adjusted basis (NBV)
• Services: fair market value (taxable as ordinary income)

PLUS any gain recognized by the shareholder

Question 11

For corporations, are bad debts deductible?

Answer 11

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

Question 12

How are charitable contributions treated by corporations?

Answer 12

The maximum deduction is up to 10% of taxable income before the deduction of the charitable contribution, the dividends received deduction, any NOL carryback, any capital loss carryback, and the US production activities deduction.

Question 13

When are life insurance premiums deductible?

Answer 13

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

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

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

Question 14

Identify the corporate tax treatment of capital gains/losses.

Answer 14

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

Question 15

State the general NOL carryforward/carryback rules.

Answer 15

Net operating losses can be carried back 2 years and/or forward 20 years.

Question 16

Name some nondeductible trade or business expenses.

Answer 16

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

Question 17

Identify the three levels of the dividends received deduction.

Answer 17

70%
-Less than 20% ownership; 70% of dividends received are deducted from taxable income up to a limit of 70% of taxable income.
80%
-20-79% ownership; 80% dividends received are deducted from taxable income up to a limit of 80% of taxable income.
100%
-Affiliated companies (80% of more common ownership)

Question 18

What are the requirements to file a consolidated return?

Answer 18

All corporations in group:

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

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

Note: S corporations, foreign corporations, most REITs, insurance companies, and most exempt organizations can NOT file consolidated returns.

Question 19

Identify the advantages of filing a consolidated return.

Answer 19

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

Question 20

Describe the corporate AMT.

Answer 20

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

Question 21

Name some corporate AMT preferences.

Answer 21

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

Question 22

What is the adjusted current earnings (ACE) adjustment?

Hint: MIND

Answer 22

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

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

Question 23

What is the accumulated earnings tax?

Answer 23

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

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

Tax is a flat 15% of the unreasonable accumulated earnings.

Question 24

Define a personal holding company.

Answer 24

A personal holding company must meet both of the following:

• At any time during the last hald of the taxable year, more than 50% of the value of the corporation’s outstanding stock is owned by 5 or fewer individuals, and
• At least 60% of the corporation’s adjusted ordinary gross income consists of personal holding company income (dividends, rents, royalties, annuities, interest, adjusted rental income, and certain other investment income sources). (NIRD)

The penalty tax is 15% of the undistributed personal holding company income.

Question 25

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

Answer 25

A personal service corporation is a corporation primarily involved in the performance of one of the following fields: Accounting, law, consulting, engineering, architecture, health, and actuarial science.

Tax rate is a flat 35%.

Question 26

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

Answer 26

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

Question 27

What are the eligibility requirements for an S corporation election?

Answer 27

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

Question 28

Describe the two requirements for election of S corporation status.

Answer 28

• All shareholders must consent
• Election must be made at any time during the preceding year or on or before the fifteenth day of the third month of the election year.

Question 29

How can S corporation status be terminated?

Answer 29

S corporation status will terminate as a result of the following:

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

Question 30

What tax year must an S corporation adopt?

Answer 30

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

Question 31

When does an unrealized built-in gain result?

Answer 31

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

Question 32

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

Answer 32

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

Question 33

How is the tax on built-in gains calculated?

Answer 33

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

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

Question 34

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

Answer 34

Some items that must be separately listed on an S corporation tax return include:

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

Question 35

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

Answer 35

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

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

Question 36

What are the general requirements for a 501(c)(1) corporation to maintain its tax exempt status?

Answer 36

The general requirements for a corporation to maintain its tax exempt status are:

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

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

Question 37

When does a private foundation terminate involuntarily?

Answer 37

A private foundation terminates involuntarily when:

• It becomes a public charity (i.e., it cannot be both).
• It commits repeated violations or a willful and flagrant violation of any of the private foundation provisions.

Question 38

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

Answer 38

The categories or organizations that are excluded from the provisions of Section 509 are:

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

Question 39

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

Answer 39

Unrelated business income (UBI) is gross income from any unrelated trade or business “regularly” carried on, minus business deductions connected therewith. UBI is:

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

Question 40

How is UBI taxed for an exempt organization?

Answer 40

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

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

Question 41

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

Answer 41

Items of income that are specifically excluded from tax for the exempt organization include:

• Royalties, dividends, interest, and most annuities
• Rents from real property and rents from personal property leased with real property (if less than 50% is attributable to the personal property), other than income from debt-financed property
• Gains and losses from the sale/exchange of property not held primarily for sale to customers
• Income from research of a college or hospital
• Income from labor unions used to establish exclusive-use facilities
• Activities limited to exempt organizations by state law
• Income from the exchange or rental of membership lists

Question 42

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

Answer 42

The three types of organizations that do not have an annual filing requirement of an information return with the IRS are:

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