Taxation of Corporations

Question 1

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?

Answer 1

When property is contributed to a corporation in exchange for stock, the corporation takes the same basis in the property that the shareholder had, increased by any gain recognized by the shareholder. Ames had a cost basis in the balls of $500 and Roth had a basis of $5,000 in the bats, so the total basis for Homerun is $5,500.

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?

Answer 2

80%

Question 3

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?

Answer 3

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 4

Soma Corp. had $600,000 in compensation expense for book purposes in 2017. Included in this amount was a $50,000 accrual for 2017 nonshareholder bonuses. Soma paid the actual 2017 bonus of $60,000 on March 1, 2018.

In its 2017 tax return, what amount should Soma deduct as compensation expense?

Answer 4

$610,000

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−basis 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.

Question 5

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?

Answer 5

Premiums paid on key-person life insurance policy

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 6

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)?

Answer 6

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 goodwill is deducted. This results in taxable income of $336,800 ($349,300 + $7,500 − $20,000).

Question 7

Lite-Mart, a C corporation, had a beginning credit balance in its warranty reserve account of $120,000. During the year, Lite-Mart accrued estimated warranty expense of $16,000. At the end of the year, Lite-Mart’s warranty reserve had a $90,000 credit balance. What amount of warranty expense should Lite-Mart deduct?

Answer 7

$46,000

For tax purposes, businesses cannot deduct estimated warranty expense. Warranty expense can be deducted only when it is actually incurred with respect to a specific product.

Question 8

The selection of an accounting method for tax purposes by a newly incorporated C corporation

Answer 8

Is made on the initial tax return by using the chosen method.

Question 9

If a corporation’s charitable contributions exceed the limitation for deductibility in a particular year, the excess

Answer 9

May be carried forward to a maximum of five succeeding years.

Question 10

What is Tan’s total tax liability for the year?

Answer 10

A corporation must pay the alternative minimum tax (AMT) to the extent that the tentative minimum tax liability exceeds the regular tax liability. Therefore, Tan must pay an AMT of $30,000 ($240,000 − $210,000) in addition to the regular tax liability of $210,000. The personal holding company tax is an excise tax that penalizes companies who have excess investment income. The $65,000 PHC tax is in addition to the regular tax.

Question 11

Indirect ownership for PHC

Answer 11

An individual indirectly owns stock if it is owned by the individual’s family or partner. Family includes the individual’s brothers, sisters, spouse and lineal descendants and ancestors. An individual will not be considered to be the constructive owner of the stock owned by nephews, cousins, uncles, aunts, and any of his/hers spouses relatives. Constructive ownership also may exist if the individual is a partner in a partnership or the beneficiary of an estate that is a shareholder. The income test is satisfied if 60% or more of the corporation’s adjusted ordinary gross income is personal holding company income.

Question 12

A corporation distributed land with a basis of $20,000 and a fair market value of $60,000, but was subject to a non-recourse liability of $70,000 to its sole shareholder. What amount represents the corporation’s recognized gain?

Answer 12

If the non-recourse liability attached to property exceeds the property’s fair market value, the fair market value is deemed to be equal to the amount of the liability ($70,000). When the corporation distributes appreciated property, it must recognize gain equal to the liability ($70,000) over the property’s basis ($20,000).

Question 13

What is the usual result to the shareholders of a distribution in complete liquidation of a corporation?

Answer 13

Capital gain or loss

Question 14

How does a noncorporate shareholder treat the gain on a redemption of stock that qualifies as a partial liquidation of the distributing corporation?

Answer 14

Entirely as a capital gain

Treated just as if they sold their stock.

Question 15

Pursuant to a plan of corporate reorganization adopted in July 2017, Gow exchanged 500 shares of Lad Corp. common stock that he had bought in January 2017 at a cost of $5,000 for 100 shares of Rook Corp. common stock having a fair market value of $6,000.

Gow’s recognized gain on this exchange was

Answer 15

$0

If taxpayer receives stocks or securities under a plan of reorganization from a corporation included in the reorganization, the taxpayer does not recognize a gain or loss from the transaction. However, if the taxpayer receives boot, the transaction is taxable up to the amount of the boot.

Question 16

The interest income was from a Spanish money market account. Mr. Travel also was provided housing from his employer that had a fair market value of $40,000 (not subject to Spanish tax). Total U.S.-source earned income for Mr. Travel was $60,000. What is Mr. Travel’s minimum includible United States gross income from these transactions? The housing exclusion is $14,294 and foreign earned income exclusion is $102,100 in 2017.

Answer 16

The $90,000 of salary is completely excluded. Foreign-earned income from personal services is excluded up to 102,100 in 2017. The housing is excludable to the extent it exceeds 16% × $101,100, or $16,336. This excess is $23,664 ($40,000 − $16,336). However, the housing exclusion may never exceed $14,294 in 2017, so the includible housing income is $25,706 ($40,000 − $14,294). The interest income is fully includible as is the U.S. source earned income of $60,000. Therefore, includible income is $25,706 + $20,000 + $60,000, or $105,706.

Question 17

The organizational test to qualify a public service charitable entity as tax exempt requires the articles of organization to

Answer 17

I. Limit the purpose of the entity to the charitable purpose.

Question 18

Which of the following exempt organizations must file annual information returns?

Answer 18

Private foundations must file Form 990-PF annually.

Question 19

Hope is a tax-exempt religious organization. Which of the following activities is (are) consistent with Hope’s tax-exempt status?

I. Conducting weekend retreats for business organizations.

II. Providing traditional burial services that maintain the religious beliefs of its members.

Answer 19

II only

Question 20

The private foundation status of an exempt organization will terminate if it

Answer 20

Becomes a public charity.

A private foundation is a tax-exempt organization which receives less than one-third of its annual support from its members and the general public. Therefore, public charities that solicit broad public support do not meet this definition.

Question 21

Which of the following types of business may not qualify for a 501(c)(3) exemption from federal income taxes?

Answer 21

A partnership

Corporations, community chests, funds, or foundations having religious, charitable, scientific, testing for public safety, literary, or educational purposes or organized for prevention of cruelty to children or animals, or to foster national or international amateur sports competition are tax-exempt. Partnerships are not included on this list.

Question 22

A $100,000 increase in partnership liabilities is treated in which of the following ways?

Answer 22

Increases each partner’s basis in proportion to their ownership.

Question 23

When a partner’s share of partnership liabilities increases, that partner’s basis in the partnership

Answer 23

Increases by the partner’s share of the increase.

When a partner’s share of a partnership’s liabilities increases, the increase is treated as a contribution to the partnership.

As a result of such a contribution, the partner’s basis in the partnership would increase by a corresponding amount.

Question 24

Guaranteed payments made by a partnership to partners for services rendered to the partnership, that are deductible business expenses under the Internal Revenue Code, are

I. Deductible expenses on the U.S. Partnership Return of Income, Form 1065, in order to arrive at partnership income (loss).

II. Included on schedules K-1 to be taxed as ordinary income to the partners.

Answer 24

BOTH

Question 25

As a general partner in Greenland Associates, an individual’s share of partnership income for the current tax year is $25,000 ordinary business income and a $10,000 guaranteed payment. The individual also received $5,000 in cash distributions from the partnership. What income should the individual report from the interest in Greenland?

Answer 25

The partner must report $25,000 of ordinary income and the $10,000 guaranteed payment. The distribution does not generate additional income since the partner has sufficient basis to absorb it.

Question 26

Which of the following statements concerning S corporations is False?

Answer 26

S corporations are subject to the alternative minimum tax.

Since S corporation income flows directly to the shareholders, the corporation is not subject to the AMT.

Question 27

Which of the following types of entities is entitled to the net operating loss deduction?

Answer 27

Trusts and estates.

Question 28

For which of the following entities is the owner’s basis increased by the owner’s share of profits and decreased by the owner’s share of losses but is NOT affected by the entity’s bank loan increases or decreases?

Answer 28

S corp

The owner’s basis is increased for her distributive share of profits and losses for S corporations, partnerships, and limited liability companies. However, owner’s basis is not affected by the debt of S corporations, while it is for partnerships and limited liability companies.

Question 29

The rule limiting the allowability of passive activity losses and credits applies to

Answer 29

Passive activity limits are applied to the following entities: individuals, estates, trust, personal service corporations and closely-held personal service corporations.

Question 30

Lane Inc., an S corporation, pays single coverage health insurance premiums of $4,800 per year and additional premiums of $7,200 per year for family coverage. 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?

Answer 30

The cost of health and accident insurance premiums paid on behalf of the greater than 2% S corporation shareholder-employee (hereafter referred to as “shareholder”) is deductible by the S corporation and reportable as additional compensation to the shareholder. Note that the problem indicates that “additional” premium for family coverage is $7,200, so this must be added to the $4,800 to get the total premium of $12,000.

Question 31

A sole proprietor wants to incorporate and has requested a projection of the first-year tax results as a C corporation and as an S corporation. Taxable income from ordinary operations is projected to be $100,000. The company expects to make a $20,000 charitable contribution and projects a long-term capital loss on stock of $7,000. Which of the following projections is correct?

Answer 31

C corporation, $90,000 taxable income; S corporation, $100,000 ordinary business income; remaining items are separately stated.

C corporations can deduct $10,000 of charitable contributions (limited to 10% of taxable income) and none of the capital losses since net capital losses are not deductible. Net income is $100,000 ordinary income less $10,000 equals $90,000. For S corporation, the charitable contribution and capital loss are separately stated. The ordinary income is reported on page 1 of form 1120S.

Question 32

Which of the following is an eligibility requirement in 2017 to file a valid election to be taxed as an S corporation?

Answer 32

Must have no more than 100 shareholders, and a husband and wife who each own stock are counted as one shareholder.

Question 33

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?

Answer 33

The year end will be June 30, using the accrual basis of accounting.

Once the S corporation completes the steps necessary to become a C corporation, it will be allowed to retain its June 30 year-end since C corporations are not subject to the tax-year limitations to which partnerships and S corporations are. However, C corporations cannot use the cash method of accounting unless their average annual gross receipts for the previous three years do not exceed $5,000,000

Question 34

Which of the following items must be separately stated on Form 1120S, U.S. Income Tax Return for a Corporation, Schedule K-1?

Answer 34

Collectible gain is taxed at a maximum rate of 28% and can be offset with collectible losses, so it needs to be separately stated.

Question 35

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?

Answer 35

Calculate basis in an S corporation as follows: The current basis of $25,000 is increased by the $1,000 of income to $26,000, then reduced for the distribution of $30,000 which would reduce the basis to $0 and produce a $4,000 gain. The $3,000 loss is suspended until there is more basis in the future.

Question 36

If an exempt organization is a corporation, the tax on unrelated business taxable income is

Answer 36

Computed at corporate income tax rates.

Question 37

Which of the following statements is correct regarding the unrelated business income of exempt organizations?

Answer 37

An unrelated business does not include any activity where all the work is performed for the organization by unpaid volunteers.

Question 38

At the close of the prior year, an individual taxpayer transferred assets into an irrevocable trust, retaining the right to the income from the trust for life. During the year, the assets earned ordinary dividends and interest income. The tax liability on the income earned will be paid

Answer 38

Entirely by the individual taxpayer.

Income earned by a trust that is distributed to the income beneficiary, such as the dividends and interest, is taxed to the income beneficiary. If the income is retained by the trust, it is taxed to the trust.

Question 39

The Simone Trust reported distributable net income of $120,000 for the current year. The trustee is required to distribute $60,000 to Kent and $90,000 to Lind each year. If the trustee distributes these amounts, what amount is includible in Lind’s gross income?

Answer 39

The amount of income recognized by the beneficiaries is the lower of the amount distributed ($150,000) or distributable net income ($120,000). Thus, Kent and Lind will recognize income of $120,000. Since they received total distributions of $150,000, the income recognized is 80% ($120,000/$150,000) of the amount received. Thus, Lind’s income is 80% × $90,000, or $72,000.

Question 40

Pat created a trust, transferred property to this trust, and retained certain interests. For income tax purposes, Pat was treated as the owner of the trust. Pat has created which of the following types of trusts?

Answer 40

Grantor

When the individual creating a trust retains certain interests in the trust, the trust is known as a grantor trust and the income from the trust is taxed to the grantor.

Question 41

Which of the following items is(are) properly allocable to principal for a trust?

Answer 41

Only extraordinary items are allocated to principal; that is, payments that are made irregularly. Regular payments are allocated to interest. The insurance proceeds are unusual and were made only once. They are allocated to principal. The interest payments are made at regular intervals and so are allocated to interest.

Question 42

Which of the following statements concerning tax credits is true?

Answer 42

The work opportunity tax credit is 40% of the first $6,000 of wages per employee, so the maximum credit is $2,400.

Question 43

A business owner who also plans to work in the business wants to take maximum advantage of the favorable fringe benefit rules provided in the tax law. Which entity type should the owner choose?

Answer 43

C corp

C corporation shareholders who also work in the business as employees are eligible to participate in all of the fringe benefit rules provided in the tax law.

Question 44

A business is expecting large losses in the first three years of its life. The owner would like to maximize the benefit from these losses on her personal tax return. Which entity type should the owner choose?

Answer 44

Partnership

Partners can increase basis in partnership interest with partnership debt so that additional losses can be used by partners on their tax returns.

Question 45

The standard deduction for a trust or an estate in the fiduciary income tax return is

Answer 45

$0

Question 46

An executor of a decedent’s estate that has only U.S. citizens as beneficiaries is required to file a fiduciary income tax return, if the estate’s gross income for the year is at least

Answer 46

$600