REG 36 - Corporate Taxation 1 - Formation/Income/Spec Deductions

Question 1

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.  	$0
	B.  	$6,000
	C.  	$8,000
	D.  	$12,000

Answer 1

B. On a corporate formation, gain is recognized to the extent that the liabilities assumed by the corporation exceed the basis in the assets contributed by the shareholder. The gain for this shareholder is $6,000 ($12,000 debt less $6,000 basis).

Question 2

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.  	51.00%
	C.  	66.67%
	D.  	80.00%

Answer 2

D. Immediately after the exchange, Jones must control at least 80 percent of the corporation’s voting stock and 80 percent of all the other classes of stock issued by the corporation for the incorporation to be tax-free.

Question 3

In April, A and B formed X Corp. A contributed $50,000 cash, and B contributed land worth $70,000 (with an adjusted basis of $40,000). B also received $20,000 cash from the corporation. A and B each receives 50% of the corporation's stock. What is the tax basis of the land to X Corp.?
	A. $40,000
	B. $50,000
	C. $60,000
	D. $70,000

Answer 3

C. X Corp’s basis in the land is B’s basis in the land ($40,000) plus any gain recognized by B. B’s recognized gain is the lower of 1) the realized gain, or 2) the boot received. The realized gain is $30,000 ($70,000 - $40,000). The boot received is the cash of $20,000. Thus, the gain recognized is $20,000. X Corp’s basis in the land is $60,000 ($40,000 + $20,000).

B’s amount realized is computed as follows: The corporation received cash of $50,000 and land of $70,000 for a total of $120,000. But it also gave $20,000 cash back to B as part of the formation. This is subtracted from above - - so the net value of what the corporation received is $100,000. $100,000 x 50% = $50,000, so that is the value of the stock received by B. His amount realized is $50,000 + cash received of $20,000 = $70,000.

Question 4

For the shareholder: If assets are transferred to the corporation during formation, when does the holding period include the amount of time that it was held by the shareholder? In addition, when is it not included?

Answer 4

The shareholder’s holding period for the stock received in a corporate formation may or may not include the amount of time he held the property given to the corporation.

If the asset transferred to the corporation is a capital asset or Section 1231 asset in the shareholder’s hands, then the property’s holding period is tacked on to the stock’s holding period.

For all other property transferred to the corporation, the holding period of the property transferred is not included in the stock’s holding period. The holding period for the stock begins on the day after the transfer.

Question 5

For the corporation: If assets are transferred to the corporation during formation, when does the holding period include the amount of time that it was held by the shareholder? In addition, when is it not included?

Answer 5

For holding period, the corporation’s holding period in the property received always includes the period that the transferor held the property before the exchange.

Question 6

Would the following expense items be reported on Schedule M-1 of the corporation income tax return showing the reconciliation of income per books with income per return?
Interest incurred on loan to carry U.S. obligations
Provision for state corporation income tax

Answer 6

No, no
The purpose of Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return is to reconcile book income (loss) with income per the return. Certain items need to be added to and subtracted from book income to reconcile with income per the tax return. Federal income taxes; excess capital losses over capital gains; income subject to tax not recorded on the books; and expenses recorded on the books not deducted on the return must be added to book income. Income recorded on the books but not included on the return, including tax-exempt interest, and deductions on the return not charged against the books must be subtracted from book income.

Both the interest incurred on loan to carry U.S. obligations and the provision for state corporation income tax are deductible for GAAP. and for income tax purposes. Hence, since both of the expenses would be included in book income and in income per the return, there is no difference to reconcile and, as a result, neither expense would appear on the Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return.

Question 7

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.  	$543,000
	C.  	$544,000
	D.  	$559,000

Answer 7

Taxable income is computed as follows:
Pretax book income 	$543,000
Excess depreciation 	(20,000)
Prepaid rental income 	36,000
Fines 	10,000
Municipal interest income 	  (25,000)
Taxable income 	$544,000

Question 8

Soma Corp. had $600,000 in compensation expense for book purposes in 2013
Included in this amount was a $50,000 accrual for 2013 nonshareholder bonuses. Soma paid the actual 2013 bonus of $60,000 on March 1, 2014.

In its 2013 tax return, what amount should Soma deduct as compensation expense?
	A.  	$600,000
	B.  	$610,000
	C.  	$550,000
	D.  	$540,000

Answer 8

B. While cash based taxpayers deduct deferred compensation in the tax year that the compensation is actually paid to employees, accrual basis taxpayers deduct deferred compensation in the tax year that the liability to pay the compensation becomes fixed. The liability to pay the deferred compensation becomes fixed when: 1) all events have occurred to establish the liability to pay the compensation; 2) economic performance has occurred with respect to the liability; and 3) the amount can be determined with reasonable accuracy. In addition, accrual based taxpayers must pay the deferred compensation within the first 2 1/2 months of a tax year to deduct the compensation in the preceding year.

Assuming Soma Corp. fixed the liability to pay the compensation in 2013, the corporation may deduct all of the nonshareholder bonuses ($60,000) on its 2013 tax return because the bonuses were paid within the first 2 1/2 months of the end of its 2013 tax year. Since an additional $10,000 of bonuses were paid than accrued, this amount may be added to the corporation’s compensation expense, putting that expense at $610,000.

Question 9

In 2014, 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.  	$500,000
	C.  	$502,000
	D.  	$550,000

Answer 9

C. The purpose of Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return is to reconcile book income (loss) with income per the return. Certain items need to be added to and subtracted from book income to reconcile with income per the tax return.

Federal income taxes; excess capital losses over capital gains; income subject to tax not recorded on the books; and expenses recorded on the books not deducted on the return must be added to book income. Income recorded on the books but not included on the return, including tax-exempt interest, and deductions on the return not charged against the books must be subtracted from book income.

This response correctly subtracts the tax-exempt municipal bond interest from and adds federal income tax and interest expense on the debt to carry the municipal bonds to book income.

Question 10

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. Cash distributions to shareholders.
B. Premiums paid on key-person life insurance policy.
C. Corporate bond interest.
D. Ending balance of retained earnings.

Answer 10

B. Premiums paid on key-person life insurance policies reduce book income but not taxable income, so this is a reconciling item for Schedule M-1.

Question 11

For the year ended December 31, 2014, 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 (taxable income 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 year ended December 31, 2014?
	A.  	$250,000
	B.  	$330,000
	C.  	$345,000
	D.  	$380,000

Answer 11

C. If a C corporation owns less than 20 percent of a domestic corporation, 70 percent of dividends received or accrued from corporation may be deducted. A C corporation owning 20 percent or more but less than 80 percent of a domestic corporation may deduct 80 percent of the dividends received or accrued from the corporation. Similarly, C corporation owning 80 percent or more of a domestic corporation may deduct 100 percent of the dividends received or accrued from the corporation. However, the dividend received deduction is limited to a percentage of the taxable income of the corporation, unless the corporation sustains a net operating loss. If the corporation has a net operating loss, the dividend received deduction may be taken without limiting the deduction to a percentage of the corporation’s taxable income.

Since Kelly Corp. is not affiliated with the corporation paying the dividends, it owns less than 20 percent of the corporation paying the dividends and, as a result, may take a 70 percent (or $35,000) dividend received deduction. Bad debts are deductible with no percentage limitation. However, Kelly Corp. cannot take a deduction for its bad debt expense because no bad debt was actually incurred. Instead, the expense represents an increase in allowances for doubtful accounts. The corporation’s bad debt expense must be added back to net income.

Hence, Kelly Corp.’s taxable income is $345,000 - net income of $300,000 minus dividend received deduction of $35,000 and plus the bad debts expense of $80,000.

Question 12

On January 2 of this year, BIG, an accrual basis, calendar-year C corporation, purchased all of the assets of a sole proprietorship, including $300,000 of goodwill. Current-year federal income tax expense of $110,100 and $7,500 for goodwill amortization (based upon 40 year amortization period) were deducted to arrive at Big's book income of $239,200. What is Big's current-year taxable income (as reconciled on Schedule M-1)?
	A.  	$239,200
	B.  	$329,300
	C.  	$336,800
	D.  	$349,300

Answer 12

C. The purpose of Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return is to reconcile book income (loss) with income per the return. Federal income tax is not deductible for tax purposes so it must be added back to book income, giving $349,300 ($239,200 + $110,100). The goodwill is amortized over 15 years for tax purposes, or $20,000 per year ($300,000/15 years). Thus, the book goodwill amortization is added back and the tax good will is deducted. This results in taxable income of $336,800 ($349,300 + $7,500 - $20,000).

Question 13

T/F: If the corporation assumes shareholder debt as part of a corporate formation, the shareholder must recognize income equal to the value of the debt.

Answer 13

False.
The shareholder’s basis in the stock received from the corporation is:
Basis of all property transferred to the corporation
+ Gain recognized by shareholder
- Boot received by shareholder
- Liabilities assumed by corporation

Therefore if the shareholder has an adjusted basis of $100,000 in the property and a $25,000 loan on it, then his adjusted basis in the stock would be $75,000. Note, for the corporation, the adjusted basis taken for the property would be $100,000.

Question 14

T/F: Non-economic deductions, such as the dividends-received deduction, are added to book income in reconciling book income to taxable income.

Answer 14

False.
Deductions not expensed in book income are subtracted from book income (including dividends received deduction, election to expense, etc.).

Question 15

T/F: Federal income tax is added to book income in reconciling book income to taxable income.

Answer 15

True

Question 16

Which of the following cannot be amortized for tax purposes?
	A.  	Incorporation costs.
	B.  	Temporary directors' fees.
	C.  	Stock issuance costs.
	D.  	Organizational meeting costs.

Answer 16

C. Stock issuance costs are a syndication cost. Therefore, they are not deductible.

Question 17

The corporate dividends-received deduction
A. Must exceed the applicable percentage of the recipient shareholder’s taxable income.
B. Is affected by a requirement that the investor corporation must own the investee’s stock for a specified minimum holding period.
C. Is unaffected by the percentage of the investee’s stock owned by the investor corporation.
D. May be claimed by S corporations.

Answer 17

B. A C corporation owning less than 20 percent of a domestic corporation may deduct 70 percent of dividends received or accrued from that corporation. Owning 20 percent or more but less than 80 percent of a domestic corporation allows for the deduction of 80 percent of the dividends received or accrued from that corporation. Similarly, if a C corporation owns 80 percent or more of a domestic corporation, it may deduct 100 percent of the dividends received or accrued from that corporation.

However, the dividend received deduction is limited to a percentage of the taxable income of the corporation, unless the corporation sustains a net operating loss. If the corporation has a net operating loss, the dividend received deduction may be taken without limiting the deduction to a percentage of the corporation’s taxable income. To qualify for the dividends received deduction, the C corporation must hold the stock or securities for at least 46 days.

Since this response indicates that the corporate dividend received deduction is affected by a requirement that the investor corporation must own the investee’s stock for a specified minimum holding period, it is correct.

Question 18

During 2014, Nale Corp. received dividends of $1,000 from a 10%-owned taxable domestic corporation.

When Nale computes the maximum allowable deduction for contributions in its 2014 return, the amount of dividends to be included in the computation of taxable income is
	A.  	$0
	B.  	$200
	C.  	$300
	D.  	$1,000

Answer 18

D. A corporation’s charitable contributions are subject to a 10 percent of taxable income limitation. For the charitable contributions deduction, taxable income is calculated without deductions for dividends received, charitable contributions, net operating losses and capital loss carrybacks.

When calculating taxable income for regular tax purposes, Nale Corp. may deduct 70 percent of the dividends received from the 10 percent owned domestic corporation. However, when computing taxable income for Nale Corp.’s charitable contributions, there is no deduction for dividends received.

Hence, when Nale Corp. computes the maximum allowable deduction for contributions in its 2014 return, the amount of dividends to be included in the computation of taxable income is $1,000.