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Flashcards in Corporate Taxation Deck (130):
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?

  1. $0
  2. $5,500
  3. $6,000
  4. $8,000

$5,500

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.

2

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?

  1. $0
  2. $6,000
  3. $8,000
  4. $12,000

$6,000

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).

Liabilities assumed are generally not boot, however there is an exception for when the liability assumed is greater than the basis in the assets.  

3

Feld, the sole stockholder of Maki Corp., paid $50,000 for Maki's stock in 2007. In 2015, Feld contributed a parcel of land to Maki but was not given any additional stock for this contribution.
Feld's basis for the land was $10,000, and its fair market value was $18,000 on the date of the transfer of title.

What is Feld's adjusted basis for the Maki stock?

  1. $50,000
  2. $52,000
  3. $60,000
  4. $68,000

$60,000

A shareholder's initial basis in the stock of a corporation is the amount the shareholder paid for the stock.

Thus, Feld's initial basis in the Maki Corp.'s stock is $50,000, the amount that Feld paid for the stock. Contributions of property to corporations results in the contributing shareholder's basis for the corporation's stock to increase by the amount of the shareholder's adjusted basis in the property. Thus, Feld's basis in the Maki Corp.'s stock increased by $10,000 due to Feld's property contribution.

Hence, Feld's adjusted basis for the Maki Corp. stock is $60,000, the sum of his initial $50,000 basis and the $10,000 adjusted basis of the contributed property.

4

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?

  1. 50.00%
  2. 51.00%
  3. 66.67%
  4. 80.00%

80.00%

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.

5

In 2015, Stone, a cash basis taxpayer, incorporated her CPA practice. No liabilities were transferred. The following assets were transferred to the corporation:

  • Cash (checking account) $500
  • Computer equipment Adjusted basis $30,000
  • Fair market value $34,000
  • Cost $40,000

Immediately after the transfer, Stone owned 100% of the corporation's stock. The corporation's total basis for the transferred assets is

  1. $30,000
  2. $30,500
  3. $34,500
  4. $40,500

$30,500

When a shareholder transfers property to a corporation, the corporation takes the shareholders basis in the property.

Stone's basis of the property transferred into the corporation was $30,500, the adjusted basis of the computer equipment ($30,000) plus the cash ($500).

Hence, the corporation's basis in the property also would be $30,500.

6

Section 351 Transaction

Under Section 351, no gain or loss is recognized if the property (or cash) is transferred solely for the exchange of stock of the corporation, if immediately after the transfer the transferring taxpayer or taxpayers have control over the corporation. Control is defined as owning at least 80 percent of corporation's voting stock and at least 80 percent of the corporation's other classes of stock.

  • No stock rights
  • No stock warrants
  • No debt

7

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.?

  1. $40,000
  2. $50,000
  3. $60,000
  4. $70,000

$60,000

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.

8

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)?

  1. $239,200
  2. $329,300
  3. $336,800
  4. $349,300

$336,800

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).

9

Soma Corp. had $600,000 in compensation expense for book purposes in 2014
Included in this amount was a $50,000 accrual for 2014 nonshareholder bonuses. Soma paid the actual 2014 bonus of $60,000 on March 1, 2015.

In its 2014 tax return, what amount should Soma deduct as compensation expense?

  1. $600,000
  2. $610,000
  3. $550,000
  4. $540,000

$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 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 2014, the corporation may deduct all of the nonshareholder bonuses ($60,000) on its 2014 tax return because the bonuses were paid within the first 2 1/2 months of the end of its 2014 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.

10

Axis Corp. is an accrual basis calendar year corporation. 
On December 13, 2015, the Board of Directors declared a two percent of profits bonus to all employees for services rendered during 2015 and notified them in writing. None of the employees own stock in Axis.

The amount represents reasonable compensation for services rendered and was paid on March 13, 2016. Axis' bonus expense may

  1. Not be deducted on Axis' 2015 tax return because the per share employee amount cannot be determined with reasonable accuracy at the time of the declaration of the bonus.
  2. Be deducted on Axis' 2015 tax return.
  3. Be deducted on Axis' 2016 tax return.
  4. Not be deducted on Axis' tax return because payment is a disguised dividend.

Be deducted on Axis' 2015 tax return.

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.

This response correctly indicates that Axis' bonus expense would be deducted on the corporation's 2015. All the events occurred to establish the liability for the bonuses when the corporation declared the dividends and notified the employees. The bonuses are for services rendered in 2015, indicating that economic performance has occurred with respect to the liability, and the amount of the bonuses can be determined with reasonable accuracy. Paying the dividends on March 13, 2016 is within the first 2 1/2 months of the close of Axis' 2015 tax year. Hence, the liability to pay the dividends became fixed in 2015 and they were paid within the first 2 1/2 months of the 2016 tax year.

11

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

NEITHER...

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.

Added back to book income:

  1. Federal income taxes;
  2. excess capital losses over capital gains;
  3. income subject to tax not recorded on the books;
  4. and expenses recorded on the books not deducted on the retur 

Subtracted from Book income:

  1. Income recorded on the books but not included on the return, including tax-exempt interest, and
  2. 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.

12

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?

  1. $528,000
  2. $543,000
  3. $544,000
  4. $559,000

$544,000

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

13

For the year ended December 31, 2015, 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, 2015?

  1. $250,000
  2. $330,000
  3. $345,000
  4. $380,000

$345,000

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.

14

Brown Corp., a calendar-year taxpayer, was organized and actively began operations on July 1, 2015, and incurred the following costs:

  • Legal fees to obtain corporate charter $40,000
  • Commission paid to underwriter $25,000
  • Other stock issue costs $10,000

Brown wishes to deduct and amortize its organizational costs over the shortest period allowed for tax purposes. In 2015, what amount should Brown deduct (ignoring amortization expenses) for the organizational expenses?

  1. $40,000
  2. $25,000
  3. $10,000
  4. $5,000

 

$5,000 of organizational expenses may be deducted, but the $5,000 is reduced by the amount of expenditures incurred that exceed $50,000. Expenses not deducted must be capitalized and amortized over 180 months, beginning with the month that the corporation begins its business operations. Organizational expenditures qualifying for the election are:

  1. Legal expenditures incurred by the corporation;
  2. necessary accounting services;
  3. expenditures of temporary directors and of organizational meeting directors and shareholders; and
  4. fees paid to the state of incorporation. Expenditures for issuing or selling shares of stock and for transferring the assets to the corporation do not qualify for the election.

Hence, only the $40,000 in legal fees expended to obtain the corporate charter qualified as an organizational expense. Commission paid to an underwriter and other stock issue costs do not qualify for the election as they are syndication costs. Ignoring amortization, $5,000 of the costs may be deducted this year.

15

Tapper Corp., an accrual basis calendar year corporation, was organized on January 2, 2015. During 2015, revenue was exclusively from sales proceeds and interest income.
The following information pertains to Tapper:

  • Taxable income before charitable contributions for the year ended December 31, 2014 $500,000
  • Tapper's matching contribution to employee-designated qualified universities made during 2015 $10,000
  • Board of Directors' authorized contribution to a qualified charity (authorized December 1, 2015, made February 1, 2016) $30,000

What is the maximum allowable deduction that Tapper may take as a charitable contribution on its tax return for the year ended December 31, 2015?

  1. $0
  2. $10,000
  3. $30,000
  4. $40,000

$40,000

A corporation's charitable contributions are deductible in the tax year paid, subject to a 10 percent of taxable income limitation. For the charitable contributions deduction, taxable income is calculated absent deductions for charitable contributions, dividends received, net operating losses and capital loss carrybacks.

Hence, Tapper Corp.'s charitable contributions would be limited to 10 percent of its $500,000 in taxable income before the charitable contributions deduction or $50,000. However, Tapper Corp. would not be subject to the limitation and may only deduct $40,000 because it only has $40,000 in contributions to charitable contributions. Tapper Corp. may deduct the employee-designated charities as the employees are viewed as performing only an administrative duty.

Question #8 (AICPA.900534REG-P2-AR)

16

Which of the following cannot be amortized for tax purposes?

  1. Incorporation costs.
  2. Temporary directors' fees.
  3. Stock issuance costs.
  4. Organizational meeting costs.

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

17

The corporate dividends-received deduction

  1. Must exceed the applicable percentage of the recipient shareholder's taxable income.
  2. Is affected by a requirement that the investor corporation must own the investee's stock for a specified minimum holding period.
  3. Is unaffected by the percentage of the investee's stock owned by the investor corporation.
  4. May be claimed by S corporations.

Is affected by a requirement that the investor corporation must own the investee's stock for a specified minimum holding period.

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.

18

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

  1. Is not deductible in any future or prior year.
  2. May be carried back or forward for one year at the corporation's election.
  3. May be carried forward to a maximum of five succeeding years.
  4. May be carried back to the third preceding year.

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

When a corporation's charitable contributions exceed the limitation for deductibility in a particular year (i.e., 10 percent of taxable income for the year), the excess may be carried over and deducted for five years. This response states the correct carryover period and is, therefore, correct.

19

For year 2, Quest Corp., an accrual-basis calendar-year C corporation, had an $8,000 unexpired charitable contribution carryover from year 1. Quest's year 2 taxable income before the deduction for charitable contributions was $200,000. On December 12, year 2, Quest's board of directors authorized a $15,000 cash contribution to a qualified charity, which was made on January 6, year 3. What is the maximum allowable deduction that Quest may take as a charitable contribution on its year 2 income tax return?

  1. $23,000
  2. $20,000
  3. $15,000
  4. $8,000

$20,000

Charitable contributions are limited to 10% of taxable income before the charitable contribution deduction, which is $20,000 ($200,000 x 10%). Total contributions are $15,000 + $8,000 = $23,000. The deduction is limited to $20,000 and $3,000 of the contribution from Year 1 is carried forward to Year 3.

Note - the carryforward may be utilized once the current year contribution is used fully.  The remaining amount from the carryforward continues on to be carried forward to the succeeding years.  

20

If a corporation's tentative minimum tax exceeds the regular tax, the excess amount is

  1. Subtracted from the regular tax.
  2. Payable in addition to the regular tax.
  3. Carried back to the third preceding taxable year.
  4. Carried back to the first preceding taxable year.

Payable in addition to the regular tax.

The amount that the tentative minimum tax exceeds the regular tax is the alternative minimum tax (AMT). This tax was enacted to ensure that taxpayers cannot avoid their fair share of the tax burden. The AMT prevents taxpayers with significant income from avoiding a similar tax liability. The AMT is payable in addition to the regular tax.

21

Widget Corporation was formed in Year 1. Gross receipts for its first four years of operations are as follows

  • Year 1 $6,000,000
  • Year 2 $7,000,000
  • Year 3 $5,000,000
  • Year 4 $4,000,000

For each year, is Widget Corporation exempt from the AMT under the small corporation exemption?

Year 1 - YES

Year 2 - NO

Year 3 - NO

Year 4 - NO

In the first year of a corporation's existence it is automatically exempt from the AMT (Yes). Widget's first testing window to determine if it is subject to the AMT in Year 2 is just Year 1 gross receipts of $6,000,000. Since this exceeds the $5,000,000 threshold for the first three-year testing window (or portion thereof), Widget is NOT exempt from the AMT in Year 2. Once the small corporation exemption test is failed, then the corporation is NOT exempt for all future tax years, so the answer is NO for Years 3 and 4 also.

 

22

Tan Corporation calculated the following taxes for the year:

Regular tax liability$210,000

Tentative minimum tax240,000

Personal Holding Company Tax65,000

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

  1. $210,000
  2. $240,000
  3. $275,000
  4. $305,000

$305,000

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.

The total tax liability is $305,000 ($210,000 + $30,000 + $65,000).

23

Rona Corp.'s 2015 alternative minimum taxable income was $200,000. 
The exempt portion of Rona's 2015 alternative minimum taxable income was

  1. $0
  2. $12,500
  3. $27,500
  4. $52,500

$27,500

When computing alternative minimum taxable income, corporations may take an exemption of $40,000 minus 25 percent of alternative minimum taxable income exceeding $150,000.

Thus, this exemption is equal to zero when alternative minimum taxable income is equal to or exceeds $310,000.

Rona Corp.'s exempt portion of its 2015 alternative minimum taxable income was $27,500 = $40,000 − [25 percent * ($200,000 − $150,000)].

24

The accumulated earnings tax can be imposed

  1. Regardless of the number of stockholders of a corporation.
  2. On personal holding companies.
  3. On companies that make distributions in excess of accumulated earnings.
  4. On both partnerships and corporations.

Regardless of the number of stockholders of a corporation.

The accumulated earnings tax is a tax imposed on corporations that accumulate earnings beyond reasonable amount. This tax was imposed to prevent corporations from accumulating earnings and profits with the purpose of avoiding income tax on its shareholders.

Any corporation accumulating earnings beyond the point of reasonable needs of the business is considered to have accumulated the earnings for the tax benefit of its shareholders, unless a preponderance of the evidence indicates otherwise. Only the shareholders of closely-held corporations would tend to have the power to retain corporate earnings for their benefit. As a result, the accumulated earnings tax tends to be applied more often to closely-held corporations.

However, the number of shareholders in a corporation is not a determining factor in imposing the tax. Hence, the accumulated earnings tax may be applied regardless of the number of shareholders in a corporation.

25

Kari Corp., a manufacturing company, was organized on January 2, 2015. Its 2015 federal taxable income was $400,000 and its federal income tax was $100,000.

What is the maximum amount of accumulated taxable income that may be subject to the accumulated earnings tax for 2015 if Kari takes only the minimum accumulated earnings credit?

  1. $300,000
  2. $150,000
  3. $50,000
  4. $0

$50,000

The accumulated earnings tax is a penalty tax imposed on corporations that accumulates earnings and profits for the purpose of avoiding income tax for its shareholders. The accumulated earnings tax is equivalent to 20 percent of the corporation's accumulated taxable income.

Accumulated taxable income is composed of taxable income adjusted downward for federal income and excess profits taxes, charitable deduction in excess of the ceiling, net capital gains and losses, and taxes of foreign countries and U.S. possessions and upward for certain corporate deductions, net operating loss deduction and capital loss carryback or carryover.

When calculating the accumulated earnings tax, corporations are given a credit, the accumulated earnings credit, of $250,000 ($150,000 for certain service corporations) plus dividends paid within the first 2 1/2 months of the corporation's tax year less accumulated earnings and profits at the end of the preceding tax year.

Hence, the maximum amount of accumulated taxable income that may be subject to the accumulated earnings tax for 2015 if Kari Corp. takes only the minimum accumulated earnings credit is $50,000. This amount is composed of $400,000 in taxable income less both a downward adjustment of $100,000 for federal income taxes and the $250,000 accumulated earnings credit.

26

Zero Corp. is an investment company authorized to issue only common stock.

During the last half of 2015, Edwards owned 450 of the 1,000 outstanding shares of stock in Zero. Another 350 shares of stock outstanding were owned, 10 shares each, by 35 shareholders who are neither related to each other nor to Edwards.

Zero could be a personal holding company if the remaining 200 shares of common stock were owned by

  1. An estate where Edwards is the beneficiary.
  2. Edwards' brother-in-law.
  3. A partnership where Edwards is not a partner.
  4. Edwards' cousin.

An estate where Edwards is the beneficiary.

Domestic and foreign corporations satisfying the personal holding company stock ownership and income tests are personal holding companies. As such, the corporation will be subject a 15 percent penalty tax on undistributed personal holding company income. The stock ownership test is satisfied if, at some time during the corporation's tax year, 50 percent or more of the corporation's stock was directly or indirectly owned by five or fewer individuals.

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 percent or more of the corporation's adjusted ordinary gross income is personal holding company income.

With 450 shares, Edwards already directly owns 45 percent of Zero Corp.'s outstanding stock. If an estate where Edwards is the beneficiary owns the remainder of the corporation's 200 shares of stock, Edwards would directly or indirectly own 65 percent of the corporation. An ownership exceeding the 50 percent direct or indirect ownership percentage is needed to satisfy the stock ownership test.

Hence, Zero Corp. could be a personal holding company if the remaining 200 shares were owned by an estate where Edwards is the beneficiary. Each response given to this question satisfies the stock ownership test for a personal holding company because, in each response, 5 or fewer individuals would own more than 50 percent of the corporation's stock. However, this response is the best as it concentrates over 50 percent ownership under the control of one individual.

27

Tech Corp. files a consolidated return with its wholly-owned subsidiary, Dow Corp. During 2015, Dow paid a cash dividend of $20,000 to Tech.

What amount of this dividend is taxable on the 2015 consolidated return?

A.  $20,000

B.  $14,000

C.  $6,000

D.  $0

$0

When filing a consolidated return the intercompany dividends between the parent and its subsidiaries are not taxable. To be permitted to file a consolidated return, the parent and its subsidiaries must be members of an affiliated group.

Corporations qualify as members of an affiliated group by having a common parent that directly owns at least 80 percent of the total voting stock and at least 80 percent of the total value of the stock in at least one other includible corporation. In addition, a minimum of one of the other includible corporations must own at least 80 percent in each of the remaining includible corporations. The primary advantages of filing a consolidated return are that: 

  1. intercompany dividends are excludable from taxable income; 
  2. losses of one affiliated member offset gains of another member; and 
  3. intercompany profits are deferred until realized.

28

When a consolidated return is filed by an affiliated group of includible corporations connected from inception through the requisite stock ownership with a common parent,

  1. Intercompany dividends are excludable to the extent of 80%.
  2. Operating losses of one member of the group offset operating profits of other members of the group.
  3. The parent's basis in the stock of its subsidiaries is unaffected by the earnings and profits of its subsidiaries.
  4. Each of the subsidiaries is entitled to an accumulated earnings tax credit.

Operating losses of one member of the group offset operating profits of other members of the group.

The primary advantages of filing a consolidated return are that: 

  1. intercompany dividends are 100 percent excludable from taxable income; 
  2. losses of one affiliated member offset gains of another member; and
  3. intercompany profits are deferred until realized.

This response correctly states that the operating losses of one member of the group offset operating profits of other members of the group. The response is, therefore, correct.

29

ParentCo, SubOne, and SubTwo have filed consolidated returns since their inception. The members reported the following taxable incomes (losses) for the year:

  • ParentCo $50,000
  • SubOne ($60,000)
  • SubTwo( $40,000)

No member reported a capital gain or loss or charitable contributions. What is the amount of the consolidated net operating loss?

  1. $0
  2. $30,000
  3. $50,000
  4. $100,000

$50,000

On the consolidated tax return the income and losses of all the corporations are netted. Therefore, the net loss for the year is $50,000 ($100,000 of losses less $50,000 of income from ParentCo).

30

Commerce Corp. elects S corporation status as of the beginning of year 2015.  At the time of Commerce’s election, it held a machine with a basis of $20,000 and a fair market value of $30,000.  In March of 2015, Commerce sells the machine for $35,000.  What amount of Commerce’s gain would be subject to the built-in gains tax?

  1. $0
  2. $ 5,000
  3. $10,000
  4. $15,000

$10,000

The requirement is to determine the amount of an S corporation’s gain that is subject to the built-in gains tax. A C corporation that makes an S election is subject to a built-in gains tax to the extent that its recognized gain is attributable to a net unrealized built-in gain as of the first day of its S status. Here, assuming that Commerce Corp. was a C corporation prior to the year 2015, its recognized gain of $35,000 — $20,000 = $15,000 from the sale of the machine during March of 2015 will be subject to a built-in gains tax to the extent of the machine’s unrealized built-in gain of $30,000 — $20,000 = $10,000 as of the beginning of 2015.

31

On January 1, 2015, Kee Corp., a C corporation, had a $50,000 deficit in earnings and profits. For 2015 Kee had current earnings and profits of $10,000 and made a $30,000 cash distribution to its stockholders. What amount of the distribution is taxable as dividend income to Kee's stockholders?

  1. $30,000
  2. $20,000
  3. $10,000
  4. $0

$10,000

Corporate distributions to shareholders are taxable to the shareholder as dividend income to the extent earnings and profits, current and accumulated. Distributions in excess of earnings and profits are treated as returns of capital that are nontaxable except to the extent that the distribution exceeds the shareholders basis in the property.

Since Kee Corp. had current earnings of $10,000, the shareholders would be viewed as receiving $10,000 in dividend income. The remaining $20,000 of the distribution would be treated as a return of capital. Distributions are deemed to be paid from current earnings and profits and then from accumulated earnings and profits.

32

This year ABC corporation, a calendar-year, accrual-basis corporation, made a nonliquidating cash distribution to its shareholders of $1,000,000 with respect to its stock. At that time ABC's current and accumulated E&P totaled $750,000 and its total paid-in capital for tax purposes was $10,000,000. Since ABC had no corporate shareholders, the distribution:

  • I. Was taxable as $750,000 of dividend income to its shareholders.
  • II. Reduced its shareholders' adjusted bases in Ridge stock by $250,000.
  1. I only.
  2. II only.
  3. Both I and II.
  4. Neither I nor II.

Both I and II.

Corporate distributions to shareholders are taxable to the shareholder as dividend income only to the extent of earnings and profits, current and accumulated. Distributions in excess of earnings and profits are treated as returns of capital.

A return of capital reduces a shareholder's basis in the property and is a nontaxable event except to the extent that the distribution exceeds the shareholders basis in the property.

Hence, this response is correct in stating $750,000 of the distribution will be treated as dividend income, an amount equal to current and accumulated earnings. In addition, this response correctly indicates that the amount of the distribution in excess of earnings and profits would be treated as a return of capital and, accordingly, result in a reduction of the shareholders' adjusted basis in Ridge Corp. stock.

33

Tank Corp., which had earnings and profits of $500,000, made a nonliquidating distribution of property to its shareholders in 2015 as a dividend in kind. This property, which had an adjusted basis of $20,000 and a fair market value of $30,000 at the date of distribution, did not constitute assets used in the active conduct of Tank's business.

How much gain did Tank recognize on this distribution?

  1. $30,000
  2. $20,000
  3. $10,000
  4. $0

$10,000

When a corporation makes a nonliquidating distribution of appreciated property to its shareholders, the corporation recognizes a taxable gain. The property is viewed to have been sold to its shareholders for its fair market value at the date of the distribution. Corporations do not recognize losses from nonliquidating distributions of property. Since Tank Corp.'s basis in the property was $20,000 and the fair market value of the property was $30,000, the corporation must recognize a gain of $10,000.

34

Simon, a C corporation, had a deficit in accumulated earnings and profits of $50,000 at the beginning of the year and had current earnings and profits of $10,000. At year end, Simon paid a dividend of $15,000 to its sole shareholder. What amount of the dividend is reported as income?

  1. $0
  2. $5,000
  3. $10,000
  4. $15,000

$10,000

When accumulated E&P is negative and current E&P is positive, distributions are treated as dividends to the extent of current E&P. Thus, $10,000 is reported as dividend income and the other $5,000 is a return of capital.

35

Brisk Corp. is an accrual-basis, calendar-year C corporation with one individual shareholder. At year end, Brisk had $600,000 accumulated and current earnings and profits as it prepared to make its only dividend distribution for the year to its shareholder. Brisk could distribute either cash of $200,000 or land with an adjusted tax basis of $75,000 and a fair market value of $200,000. How would the taxable incomes of both Brisk and the shareholder change if land were distributed instead of cash?

  1. Brisk's taxable income   
  2. Shareholder's taxable income  

  1. Brisk's taxable income - INCREASE
  2. Shareholder's taxable income - NO CHANGE

If Brisk distributes $200,000 cash the shareholder will have $200,000 of dividend income (since sufficient earnings and profits exist). It the land is distributed, the amount of the distribution is the land's fair market value of $200,000 so the shareholder would still have $200,000 of dividend income. Thus, there is no change for the shareholder's taxable income.

If Brisk distributes appreciated property as a dividend, it must recognize the appreciation in the property as income ($200,000 − $75,000 = $125,000). Therefore, Brisk would have higher taxable income if the land was distributed in comparison to the cash.

36

Webster, a C corporation, has $70,000 in accumulated and no current earnings and profits. Webster distributed $20,000 cash and property with an adjusted basis and fair market value of $60,000 to its shareholders. What amount should the shareholders report as dividend income?

  1. $20,000
  2. $60,000
  3. $70,000
  4. $80,000

$70,000

Dividend income must be reported for the distribution to the extent of Webster's current and accumulated earnings and profits ($70,000). The amount of the distribution is the cash of $20,000 plus the fair market value ($60,000) of the property distributed, or $80,000. This distribution is taxed as $70,000 of dividend income with the remaining $10,000 treated as a return of the shareholders' bases in their stock.

37

Fox, the sole shareholder in Fall, a C corporation, has a tax basis of $60,000. Fall has $40,000 of accumulated positive earnings and profits at the beginning of the year and $10,000 of current positive earnings and profits for the current year. At year end, Fall distributed land with an adjusted basis of $30,000 and a fair market value (FMV) of $38,000 to Fox. The land has an outstanding mortgage of $3,000 that Fox must assume. What is Fox's tax basis in the land?

  1. $38,000
  2. $35,000
  3. $30,000
  4. $27,000

$38,000

For dividends, the amount distributed is the fair market value of the property received less any liabilities assumed by the shareholder, or $35,000 ($38,000 − $3,000). Fox would have $35,000 of dividend income since earnings and profits is at least this amount. However, the basis in the property received as a taxable dividend is always the fair market value of the property, or $38,000.

38

At the beginning of the year, West Wind, a C corporation, had a deficit of $45,000 in accumulated earnings and profits. For the current year, West wind reported earnings and profits of $15,000. West wind distributed $12,000 during the year.

What was the amount of West Wind's accumulated earnings and profits at year-end?

  1. $30,000 deficit
  2. $42,000 deficit
  3. $45,000 deficit
  4. $57,000 deficit

$42,000 deficit

(45,000) is E&P at beginning of the year, plus 15,000 earnings, less 12,000 distribution = ($42,000). Note that this distribution of $12,000 does not increase the deficit in E&P since there was $15,000 of earnings for the current year.

39

Dahl Corp. was organized and commenced operations in 1930. At December 31, 2015, Dahl had accumulated earnings and profits of $9,000 before dividend declaration and distribution. 
On December 31, 2015 Dahl distributed cash of $9,000 and a vacant parcel of land to Green, Dahl's only stockholder. At the date of distribution, the land had a basis of $5,000 and a fair market value of $40,000.

What was Green's taxable dividend income in 2015 from these distributions?

  1. $9,000
  2. $14,000
  3. $44,000
  4. $49,000

$44,000

Corporate distributions to shareholders are taxed to shareholders as dividend income to the extent that the distribution does not exceed current and accumulated earnings and profits. Distributions in excess of current and accumulated earnings and profits are treated as returns of capital. The distribution of appreciated property increases a corporation's earnings and profits increase by the amount of the difference between the distributed property's fair market value and the corporation's adjusted basis in the distributed property.

Thus, while Dahl Corp. had earnings and profits totaling $9,000 before the dividend declaration and distribution, the corporation's earnings and profits increased by $35,000, the land's $40,000 fair market value less its adjusted basis of $5,000, to $44,000 due to the distribution of the land.

Green received $49,000 of property in the distribution - $9,000 in cash and land with a fair market value of $40,000. The amount of the distribution classified as dividend income is limited to the corporation's earnings and profits. Thus, Green would report $44,000 of dividend income from the distribution.

40

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

  1. No taxable effect.
  2. Ordinary gain to the extent of cash received.
  3. Ordinary gain or loss.
  4. Capital gain or loss.

Capital gain or loss.

In a complete liquidation, shareholders generally recognize capital gains and losses from corporate distributions. The amount of assets received by a shareholder is treated as full payment in exchange for the stock.

The capital gain or loss recognized by a shareholder equals the total distribution less the shareholder's basis.

41

A corporation was completely liquidated and dissolved during 2015. The filing fees, professional fees, and other expenditures incurred in connection with the liquidation and dissolution are

  1. Deductible in full by the dissolved corporation.
  2. Deductible by the shareholders and not by the corporation.
  3. Treated as capital losses by the corporation.
  4. Not deductible either by the corporation or shareholders.

Deductible in full by the dissolved corporation.

Filing, professional fees (accounting and legal) and other expenditures incurred in connection with liquidations and dissolutions are fully deductible for the dissolving corporation.

42

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

  1. Entirely as a capital gain.
  2. Entirely as a dividend.
  3. Partly as a capital gain and partly as a return of capital.
  4. Entirely as a tax-free transaction.

Entirely as a capital gain.

Non-corporate shareholders treat the gain on a redemption of stock that qualifies as a partial liquidation of the distributing corporation as a capital gain, just as if they had sold their stock. Corporate shareholders receive dividend treatment on a partial liquidation.

43

S Corporation was a wholly-owned subsidiary of P Corporation. Both corporations were domestic C corporations. P received a liquidating distribution of property (worth $250 and a basis of $135) from S in cancellation of the stock. What amount of gain will P recognize if P had a basis of $100 in the S stock before the receipt of the property?

  1. $0
  2. $35
  3. $150
  4. $250

$0

If stock of a subsidiary is liquidated by its parent company, any realized gain on the transaction is, in general, not recognized. The realized gain to parent is $150 ($250 property received - $100 basis). The recognized gain is zero.

44

Brooke, Inc., an S corporation, was organized on January 2, 2015, with two equal shareholders.  Each shareholder invested $5,000 in Brooke’s capital stock, and each loaned $15,000 to the corporation.  Brooke then borrowed $60,000 from a bank for working capital.  Brooke sustained an operating loss of $90,000 for the year ended December 31, 2015.  If each shareholder materially participates in the corporation’s business, how much loss can each shareholder claim on his 2015 income tax return?

  1. $ 5,000
  2. $20,000
  3. $45,000
  4. $50,000

$20,000

An S corporation loss is passed through to shareholders and is deductible to the extent of a shareholder’s basis for stock plus the basis for any debt owed the shareholder by the corporation. Here, each shareholder’s allocated loss of $45,000 ($90,000/2) is deductible to the extent of stock basis of $5,000 plus debt basis of $15,000, or $20,000. The remainder of the loss ($25,000 for each shareholder) can be carried forward indefinitely by each shareholder and deducted when there is basis for stock or debt to absorb it.

45

Darien Corp. was a calendar-year S corporation. Darien’s S status terminated on February 1, 2015, when Aspar Corp. became a shareholder.  During 2015 (365-day calendar year), Darien had nonseparately computed income of $273,750.  If no election is made by Darien, what amount of the income, if any, would be allocated to the S short year for 2015?

  1. $0
  2. $22,500
  3. $22,813
  4. $23,250

$23,250

The requirement is to determine the amount of income that should be allocated to Darien Corp.’s short S year when its S election is terminated on February 1, 2015. When a corporation’s subchapter S election is terminated during a taxable year, its income for the entire year must be allocated between the resulting S short year and C short year. If no special election is made, the income must be allocated on a daily basis between the S and C short years. In this case the daily income equals $273,750/365 days = $750/day. Since the election was terminated on February 1, there would be 31 days in the S short year, and $750 × 31 = $23,250 of income would be allocated to the tax return for the S short year to be passed through and taxed to shareholders.

46

Pursuant to a plan of corporate reorganization adopted in the current year, Myra Eber exchanged 1,000 shares of Faro Corp. common stock that she had purchased for $75,000, for 1,800 shares of Judd Corp. common stock having a fair market value of $86,000. As a result of this exchange, Eber’s recognized gain and her basis in the Judd stock should be?

 

Recognized Gain = $0

Basis = $75,000

No gain or loss is recognized if stock is exchanged solely for stock in a corporation that is a party to the reorganization. Thus, Eber’s basis in the Judd stock received is the same as her basis in the Faro stock transferred, $75,000.

47

Easy Corporation’s earnings and profits for 2015, its first year of operations, were $22,000.  In December 2015, it distributed to its individual stockholders, cash of $10,000 and land with a fair market value of $25,000 at the date of distribution.  Prior to the distribution, the stockholders’ tax basis for their stock in the corporation was $76,000.  What is the stockholders’ basis for their Easy stock at the end of 2015?

  1. $51,000
  2. $52,000
  3. $63,000
  4. $74,000

$63,000

The amount of a distribution is the amount of cash plus the fair value of other property distributed. Therefore, Easy Corporation’s total distribution to shareholders is $35,000 ($10,000 cash + $25,000 FMV of the property). This distribution is treated as a dividend to the shareholders to the extent of the corporation’s earnings and profits ($22,000), while the remaining $13,000 ($35,000 — $22,000) is considered a nontaxable return of stock basis and as such results in a reduction of the shareholders’ stock basis. Thus, the shareholders’ stock basis at the end of 2015 is $63,000 ($76,000 — $13,000).

48

Aztec, a C corporation, distributed an asset to Burn, a shareholder.  The asset had a fair market value of $30,000 and was subject to a $40,000 liability, assumed by Burn.  The asset had an adjusted basis of $25,000.  What amount of gain must Aztec recognize?

  1. $0
  2. $ 5,000
  3. $10,000
  4. $15,000

$15,000

The requirement is to determine the amount of gain that Aztec corporation must recognize on the distribution of property and liability to a shareholder. Generally, a corporation must recognize gain on the distribution of appreciated property to a shareholder. The gain is measured by treating the corporation as if it had sold the property to the shareholder for fair market value. However, if there is a liability on the property that is assumed by the shareholder and the amount of liability exceeds the property’s fair market value, then the amount of liability is used to measure the gain. Here, Aztec’s recognized gain would be the $40,000 liability — $25,000 basis = $15,000.

Question 17:

49

With regard to the federal estate tax, all of the following statements concerning the alternate valuation are correct, except:

  1. The alternate valuation can be elected only if its use decreases both the value of the gross estate and the estate tax liability.
  2. The alternate valuation election is irrevocable and applies to all property in the estate.
  3. The alternate valuation is generally a date 6 months subsequent to the decedent’s death.
  4. If the alternate valuation is elected, property disposed of within 6 months of death is valued at fair market value at date of decedent’s death.

If the alternate valuation is elected, property disposed of within 6 months of death is valued at fair market value at date of decedent’s death.

Property is included at FMV at date of decedent’s death; or executor may elect to use FMV at alternate valuation date (generally a date six months subsequent to death), if such election will reduce both the gross estate and the federal estate tax liability.

  • If alternate valuation is elected, but property is disposed of within six months of death, then use FMV on date of disposition.
  • Election is irrevocable and applies to all property in estate; cannot be made on an individual property basis.

50

For the current year, Cape Co. reported book income of $140,000.  Included in that amount was $50,000 for meals and entertainment expense and $40,000 for federal income tax expense.  In Cape’s Schedule M-1 of Form 1120, which reconciles book income and taxable income, what amount should be reported as taxable income?

  1. $205,000
  2. $190,000
  3. $180,000
  4. $140,000

$205,000

The $50,000 of meals and entertainment expense and the $40,000 of federal income tax expense were deducted in arriving at book income of $140,000. Since only 50% of business meals and entertainment are deductible for tax purposes, 50% × $50,000 = $25,000 must be added back to book income. Similarly, the $40,000 of federal income tax expense is not tax deductible and must be added back to book income. Thus, Cape’s taxable income would be $140,000 + $25,000 + $40,000 = $205,000.

51

Richards Corporation had taxable income of $280,000 before deducting charitable contributions for its tax year ended December 31, 2015, but after deducting a dividends-received deduction of $34,000.  Richards made cash contributions of $35,000 to charitable organizations.  How much can Richards deduct as contributions for 2015?

  1. $28,000
  2. $31,400
  3. $32,000
  4. $35,000

$31,400

 

Since charitable contributions (CC) are limited to 10% of taxable income (TI) before the contributions and dividends-received deduction (DRD), the DRD of $34,000 must be added back to TI to arrive at the contributions base against which to apply the 10% limitation:

  • TI before CC $280,000   
  • Add back DRD  $34,000   
  • TI before CC and DRD $314,000   
  • % limitation × 10%
  • Allowable contributions $31,400   

52

A C corporation must use the accrual method of accounting in which of the following circumstances?

  1. The business had average sales for the past three years of less than $1 million.
  2. The business is a service company and has over $1 million in sales.
  3. The business is a personal service business with over $15 million in sales.
  4. The business has more than $10 million in average sales.

The business has more than $10 million in average sales.

C corporations generally are not entitled to use the cash method and instead must use the accrual method of accounting. One exception to this rule permits a C corporation that is a qualified personal service corporation to use the cash method regardless of gross receipts. A second exception permits a C corporation to use the cash method if for every year it has average annual gross receipts of $5 million or less for any prior 3-year period, provided it does not have inventories for sale to customers. A third exception permits a C corporation to use the cash method if it has average annual gross receipts of $1 million or less for any prior 3-year period.

53

Bellamy Corporation reported Retained Earnings—Unappropriated of $1,500,000 at December 31, 2014, on its 2014 tax return. Information for 2015 is available as follows:

  • Net income per books $600,000
  • Taxable income $850,000
  • Dividends paid on common stock $450,000
  • Debit adjustment to the beginning balance of retained earnings for correction of an accounting error $500,000

What amount should Bellamy report for Retained Earnings—Unappropriated at December 31, 2015, on its 2015 tax return?

  1. $1,150,000
  2. $1,400,000
  3. $1,650,000
  4. $1,900,000

$1,150,000

This answer is correct. Retained Earnings--Unappropriated is a "per books" figure found on Schedules L and M-2 of the corporate tax return Form 1120. The beginning balance is increased by the net income per books and decreased by the dividends paid and the debit adjustment.

54

April Corporation’s book income before taxes for 2015 was $60,000.  During 2015, April paid $3,000 in cash dividends on its outstanding cumulative preferred stock and paid $8,000 as a contribution to a qualified charitable organization.  For 2015, April’s taxable income was

  1. $54,000
  2. $61,200
  3. $63,900
  4. $65,000

$61,200

The cash dividends paid on the preferred stock were not deducted in computing book income, and can be eliminated from the solution because dividends paid do not affect taxable income.  The charitable contribution should be added back to book income, because the deduction for charitable contributions is limited to 10% of taxable income before the contribution deduction.

  • Book income $60,000
  • Add charitable contributions $8,000
  • TI before contributions $68,000
  • Less contributions deduction (limited to 10% × $68,000) $6,800
  • Taxable income $61,200

55

For the current year, Marshall Corporation reported book income, before federal income taxes, of $200,000.  The following items were included in the determination of income before federal income taxes.

  • Provision for state corporate income tax $15,000
  • Interest earned on United States obligation $20,000
  • Net long-term capital loss from the sale of marketable securities $10,000
  • Interest paid on loan to purchase United States obligations $12,000

Marshall’s taxable income on its current year federal income tax return would be

  1. $192,000
  2. $193,000
  3. $210,000
  4. $225,000

$210,000

The only reconciling item is the NLTCL of $10,000 which was deducted per books, but is not deductible in computing taxable income. Taxable income is $200,000 + $10,000 = $210,000.

56

For the year ended December 31, 2015, Haya Corp. had gross business income of $600,000 and expenses of $800,000. Contributions of $5,000 to qualified charities were included in expenses. In addition to the expenses, Haya had a net operating loss carryover of $9,000 from 2014. What was Haya’s net operating loss for 2015?

  1. $209,000
  2. $204,000
  3. $200,000
  4. $195,000

$195,000

This answer is correct.  A deduction for a net operating loss carryover is not allowed in computing a NOL. Furthermore, a deduction for charitable contributions is generally not allowed, since the charitable contributions deduction is limited to 10% of taxable income before the charitable contributions and dividends-received deductions.  Thus, Haya’s NOL for 2015 would be computed as follows:

  • Gross income$ 600,000
  • Less expenses  (800,000)
  • $(200,000)
  • Add back contributions included in expenses $5,000
  • NOL for 2015 $(195,000)

57

Nelson Harris had adjusted gross income in 2015 of $60,000. During the year his personal summer home was completely destroyed by a hurricane.  Pertinent data with respect to the home follows:

  • Cost basis $39,000
  • Value before casualty $45,000
  • Value after casualty $3,000

Harris was partially insured for his loss and in 2015 he received a $15,000 insurance settlement.  What is Harris’ allowable casualty loss deduction for 2015?

  1. $17,900
  2. $18,000
  3. $26,900
  4. $27,000

$17,900

The deduction for a nonbusiness casualty loss is computed as the lesser of (1) the adjusted basis of property, or (2) the decline in FMV; reduced by any insurance recovery, a $100 floor, and 10% of the taxpayer’s AGI.

Lesser of:  

1) Adjusted basis $39,000 or 

2) Decline in FMV ($45,000 − $3,000) = $42,000

$39,000 

Decreased by:  

Insurance recovery ($15,000)

$100 floor ($100)

10% of $60,000 ($6,000)

Casualty loss deduction $17,900 

58

In the reconciliation of income per books with income per return

  1. Only temporary differences are considered.
  2. Only permanent differences are considered.
  3. Both temporary and permanent differences are considered.
  4. Neither temporary nor permanent differences are considered.

Both temporary and permanent differences are considered.

The reconciliation of income per books with income per return is accomplished on Schedule M-1 of Form 1120. Both temporary differences (e.g., accelerated depreciation on tax return and straight-line on books) and permanent differences (e.g., tax-exempt interest) must be considered to convert book income to taxable income.

59

Which of the following is a characteristic of a C corporation?

  1. Includes most privately held businesses.
  2. Pays taxes on profits after paying dividends to shareholders.
  3. Subject to double taxation on profits if dividends are paid.
  4. Must have only one class of stock.

Subject to double taxation on profits if dividends are paid.

Profits of a C corporation are taxable to the corporation and taxed again when distributed as dividends to shareholders.

Corporations are separate taxable entities, organized under state law.  Although corporations may have many of the same income and deduction items as individuals, corporations are taxed at different rates and some tax rules are applied differently.  There also are special provisions applicable to transfers of property to a corporation, and issuance of stock.

60

Which of the following groups may elect to file a consolidated corporate return?

  1. A brother/sister-controlled group.
  2. A parent corporation and all more-than-10%-controlled partnerships.
  3. A parent corporation and all more-than-50%-controlled subsidiaries.
  4. Members of an affiliated group.

Members of an affiliated group.

The election to file a consolidated return is limited to affiliated corporations. Affiliated corporations are parent-subsidiary corporations that are connected through stock ownership wherein at least 80% of the combined voting power and value (except the common parent’s) is directly owned by other includible corporations. Brother-sister corporations do not own stock in each other and would not constitute an affiliated group.

61

Sandy is the sole shareholder of Swallow, an S corporation.  Sandy’s adjusted basis in Swallow stock is $60,000 at the beginning of the year.  During the year, Swallow reports the following income items:

  • Ordinary income $30,000
  • Tax-exempt income $5,000
  • Capital gains $10,000

In addition, Swallow makes a nontaxable distribution to Sandy of $20,000 during the year.  What is Sandy’s adjusted basis in the Swallow stock at the end of the year?

  1. $60,000
  2. $70,000
  3. $80,000
  4. $85,000

$85,000

A shareholder’s basis for S corporation stock is increased by all income items (including tax-exempt income), and is decreased by all loss and deduction items and distributions that are excluded from the shareholder’s gross income. Here, Sandy’s beginning stock basis of $60,000 is increased by the $30,000 of ordinary income, $5,000 of tax-exempt income, and $10,000 of capital gains, and is decreased by the $20,000 nontaxable distribution, resulting in a stock basis of $85,000 at the end of the year.

62

Euclid Corp.’s 2015 alternative minimum taxable income before exemption was $250,000.  The exempt portion of Euclid’s 2015 alternative minimum taxable income was

  1. $0
  2. $15,000
  3. $25,000
  4. $40,000

$15,000

A corporation is allowed an exemption of $40,000 in computing its alternative minimum taxable income (AMTI). However, the $40,000 exemption is reduced by 25% of the corporation’s AMTI in excess of $150,000. Here, the amount of exemption is $40,000 − [($250,000 − $150,000) × 25%] = $15,000.

63

For the first taxable year in which a corporation has qualifying research and experimental expenditures, the corporation

  1. Has a choice of either deducting such expenditures as current business expenses, or capitalizing these expenditures.
  2. Has to treat such expenditures in the same manner as they are accounted for on the corporation’s financial statements.
  3. Is required to deduct such expenditures currently as business expenses or lose the deductions.
  4. Is required to capitalize such expenditures and amortize them ratably over a period of not less than 60 months.

Has a choice of either deducting such expenditures as current business expenses, or capitalizing these expenditures.

A taxpayer can elect to deduct qualifying research and experimentation expenditures as a current expense if the taxpayer so elects for the first taxable year in which the expenditures are incurred. Otherwise, the taxpayer must capitalize the expenditures. Then, if the capitalized costs are not subject to depreciation (because there is no determinable life), the taxpayer can amortize them over a period of 60 months or longer beginning with the month in which benefits from the expenditures are first realized.

64

Page Corp. owns 80% of Saga Corp.’s outstanding capital stock.  Saga’s capital stock consists of 50,000 shares of common stock issued and outstanding.  Saga’s 2015 net income was $70,000.  During 2015 Saga declared and paid dividends of $30,000.  In conformity with generally accepted accounting principles, Page recorded the following entries in 2015:

  • Debit / (Credit)
  • Investment in Saga Corp. common stock $56,000
    • Equity in earnings of subsidiary ($56,000)
  • Cash $24,000 
    • Investment in Saga Corp. common stock   ($24,000)

In its 2015 consolidated tax return, Page should report dividend revenue of

  1. $0
  2. $ 4,800
  3. $ 7,200
  4. $24,000

$0

An affiliated group of corporations (i.e., corporations connected through 80% or more stock ownership) can elect to file a consolidated tax return, instead of filing separate tax returns. If a consolidated return is filed, dividends received from affiliated group members are eliminated in the consolidation process, and are not reported on the consolidated tax return.

65

Tau Corp. which has been operating since 2011, has an October 31 year-end, which coincides with its natural business year.  On May 15, 2015, Tau filed the required form to elect S corporation status. All of Tau’s stockholders consented to the election, and all other requirements were met. The earliest date that Tau can be recognized as an S corporation is

  1. November 1, 2014.
  2. May 15, 2015.
  3. November 1, 2015.
  4. January 1, 2016.

November 1, 2015.

A subchapter S election that is filed on or before the 15th day of the third month of a corporation’s taxable year is generally effective as of the beginning of the taxable year in which filed. If the S election is filed after the 15th day of the third month, the election is generally effective as of the first day of the corporation’s next taxable year. Tau Corp. uses a fiscal year which begins November 1 and ends October 31 of each year. Here, its S election was filed on May 15, 2015, which is beyond the 15th day of the third month of its taxable year (January 15th). Therefore, Tau Corp.’s Subchapter S election will become effective as of the first day of its next taxable year, November 1, 2015.

66

Yuki Corporation, which began business in 2015, incurred the following costs in 2015 in connection with organizing the corporation:

  • Printing of stock certificates $5,000
  • Underwriters’ commissions on sale of stock $100,000

What portion of these costs qualifies as amortizable organizational expenditures?

  1. $105,000
  2. $100,000
  3. $ 5,000
  4. $0

$0

Expenses incurred for printing and selling stock certificates are neither deductible, nor amortizable as organization expenditures. These expenses of issuing stock are treated as a reduction of paid-in capital.

67

A corporation will not be subject to the alternative minimum tax for calendar year 2015 if

  1. The corporation has fewer than 100 shareholders.
  2. The corporation’s net assets do not exceed $7.5 million.
  3. The 2015 calendar year is the corporation’s first tax year.
  4. The corporation had a net operating loss for 2014.

The 2015 calendar year is the corporation’s first tax year.

A corporation is exempt from the AMT for its first tax year. After the first year, a corporation is exempt from the AMT for each year that it passes a gross receipts test. A corporation is exempt for its second year if its gross receipts for the first year did not exceed $5 million. For all subsequent years, a corporation is exempt if its average annual gross receipts for the testing period do not exceed $7.5 million. Exemption from the AMT is not based on asset size nor number of shareholders.

68

Fox, the sole shareholder in Fall, a C corporation, has a tax basis of $60,000.  Fall has $40,000 of accumulated positive earnings and profits at the beginning of the year and $10,000 of current positive earnings and profits for the current year.  At year-end, Fall distributed land with an adjusted basis of $30,000 and a fair market value (FMV) of $38,000 to Fox.  The land has an outstanding mortgage of $3,000 that Fox must assume.  What is Fox’s tax basis in the land?

  1. $38,000
  2. $35,000
  3. $30,000
  4. $27,000

$38,000

A shareholder’s tax basis for property received in a corporate distribution will be the property’s fair market value, which in this case is $38,000. Note that the shareholder’s tax basis is unaffected by the mortgage assumed. That is, the shareholder will be taxed on a dividend of $38,000 — $3,000 = $35,000, but will have a tax basis for the land of $38,000.

69

No penalty will be imposed on a corporation for underpayment of estimated tax for a particular year if

  1. The tax for that year is less than $500.
  2. Estimated tax payments for the year equal at least 93% of the tax shown on the return for that year.
  3. The corporation is a personal holding company.
  4. The alternative minimum tax is at least $1,000.

The tax for that year is less than $500.

No penalty will be imposed on a corporation for underpayment of estimated tax for a particular year if the tax for that year is less than $500.

Estimated tax payments must be made by every corporation whose estimated tax is expected to be $500 or more. A corporation’s estimated tax is its expected tax liability (including alternative minimum tax and environmental tax) less its allowable tax credits.

A corporation with $1 million or more of taxable income in any of its three preceding tax years (i.e., large corporation) can use its preceding year’s tax only for its first installment and must base its estimated payments on 100% of its current year’s tax to avoid penalty.

70

Chicago Corp., a calendar-year C corporation, had accumulated earnings and profits of $100,000 as of January 1, 2014, and had a deficit in its current earnings and profits for the entire 2014 tax year in the amount of $140,000. Chicago Corp. distributed $30,000 cash to its shareholders on December 31, 2014. What would be the balance of Chicago Corp.’s accumulated earnings and profits as of January 1, 2015?

  1. $0
  2. $(30,000)
  3. $(40,000)
  4. $(70,000)

($40,000)

The AEP beginning balance of $100,000 would be reduced by the 2014 deficit of $140,000, resulting in a deficit of $40,000. Since distributions only pay out a corporation’s positive AEP, the AEP deficit of $40,000 is not affected by the $30,000 distributed to shareholders.

71

During the current year, Aca Corp. adopted a plan of complete liquidation.  Distributions to stockholders during the current year, under this plan of complete liquidation, included marketable securities purchased in 2012 with a basis of $100,000 and a fair market value of $120,000 at the date of distribution.  In Aca’s current year return, what amount should be reported as long-term capital gain?

  1. $20,000
  2. $10,000
  3. $ 8,000
  4. $0

$20,000

A corporation will recognize gain or loss on the distribution of its property in liquidation just as if the property were sold to the distributee at its fair market value. Since the marketable securities were held more than 12 months, their distribution results in a long-term capital gain of $120,000 − $100,000 = $20,000.

  • Amounts received by shareholders in liquidation of a corporation are treated as received in exchange for stock, generally resulting in capital gain or loss.  Property received will have a basis equal to FMV.
  • A liquidating corporation generally recognizes gain or loss on the sale or distribution of its assets in complete liquidation.
  1. If a distribution, gain or loss is computed as if the distributed property were sold to the distributee for FMV.
  2. If distributed property is subject to a liability (or a shareholder assumes a liability) in excess of the basis of the distributed property, FMV is deemed to be not less than the amount of liability.

72

Forrest Corp. owned 100% of both the voting stock and total value of Diamond Corp.  Both corporations were C corporations. Forrest’s basis in the Diamond stock was $200,000 when it received a lump sum liquidating distribution of property as a result of the redemption of all Diamond stock.  The property had an adjusted basis of $270,000 and a fair market value of $500,000.  What amount of gain did Forrest recognize on the distribution?

  1. $0
  2. $70,000
  3. $270,000
  4. $500,000

$0

The requirement is to determine the amount of gain recognized by Forrest Corp. as a result of the receipt of property in liquidation of its 100%-owned subsidiary, Diamond Corp. No gain or loss will be recognized by a parent corporation (Forrest Corp.) on the receipt of property in complete liquidation of an 80% or more owned subsidiary (Diamond Corp.). The property would have a transferred basis of $270,000 to Forrest Corp.

73

Rela Associates, a partnership, transferred all of its assets, with a basis of $300,000, along with liabilities of $50,000, to a newly formed corporation in return for all of the corporation’s stock.  The corporation assumed the liabilities.  Rela then distributed this stock to its partners in liquidation. In connection with this incorporation of the partnership, Rela recognizes

  1. No gain or loss on the transfer of its assets, nor on the assumption of Rela’s liabilities by the corporation.
  2. Gain on the assumption of Rela’s liabilities by the corporation.
  3. Gain or loss on the transfer of its assets to the corporation.
  4. Gain, but not loss, on the transfer of its assets to the corporation.

No gain or loss on the transfer of its assets, nor on the assumption of Rela’s liabilities by the corporation.

The requirement is to determine whether gain or loss is recognized on the incorporation of Rela Associates (a partnership). No gain or loss is recognized if property is transferred to a corporation solely in exchange for stock, if immediately after the transfer, the transferor is in control of the corporation. For purposes of determining whether consideration other than stock (boot) has been received, the assumption of liabilities by the transferee corporation is not to be treated as the receipt of money or other property by the transferor. Thus, Rela Associates recognizes no gain or loss on the transfer of its assets and liabilities to a newly formed corporation in return for all of the corporation’s stock. Also note that no gain or loss will be recognized by Rela Associates on the distribution of the corporation’s stock to its partners in liquidation, and no gain or loss will be recognized by the partners when they receive the corporation’s stock in liquidation of their partnership interests.

74

In 2015, Garland Corp. contributed $40,000 to a qualified charitable organization. Garland’s 2015 taxable income before the deduction for charitable contributions was $410,000. Included in that amount is a $20,000 dividends-received deduction. Garland also had carryover contributions of $5,000 from the prior year. In 2015, what amount can Garland deduct as charitable contributions?

  1. $40,000
  2. $41,000
  3. $43,000
  4. $45,000

$43,000

A corporation’s charitable contribution deduction is limited to 10% of its taxable income before the charitable contribution and dividends-received deductions. Since Garland’s taxable income of $410,000 already included a $20,000 dividends-received deduction, $20,000 must be added back to arrive at Garland’s contribution base of $430,000. Thus, Garland’s maximum contribution deduction for 2015 would be $430,000 × 10% = $43,000. Garland would deduct the $40,000 contributed during 2015, plus $3,000 of its $5,000 carryover from 2014. As a result, Garland will have a $2,000 contribution carryover from 2014 to 2016.

75

Boone Corporation, which is not exempt from the alternative minimum tax, reported adjusted current earnings (ACE) of $500,000 for 2015.  Its alternative minimum taxable income (before the alternative minimum tax NOL deduction and ACE adjustment) was $200,000.  Boone Corporation’s alternative minimum taxable income (after exemption) for 2015 was

  1. $237,500
  2. $372,500
  3. $425,000
  4. $500,000

$425,000

Boone’s pre-ACE AMTI of $200,000 would be increased by an ACE adjustment of [($500,000 − $200,000) × 75%] = $225,000, resulting in an alternative minimum taxable income of $425,000. No AMT exemption would be available because Boone’s $40,000 exemption would be reduced (to zero) by 25% of AMTI in excess of $150,000.

76

Catchem Corp., a calendar-year corporation, was formed on January 2, 2011, and had gross receipts for its first four taxable years as follows:

  • YearGross Receipts
  • 2012 $4,000,000
  • 2013 $9,000,000
  • 2014 $10,000,000
  • 2015 $7,000,000

What is the first taxable year that Catchem Corp. is not exempt from the alternative minimum tax (AMT)?

  1. 2013
  2. 2014
  3. 2015
  4. Catchem is exempt from AMT for its first four taxable years

2015

  • 1st Tax Year - A Corporation is exempt from the corporate AMT for its first tax year.
  • 2nd Tax Year - It is exempt for its second year if its first year’s gross receipts were $5 million or less.
  • 3rd Tax Year - To be exempt for its third year, the corporation’s average gross receipts for the first two years must be $7.5 million or less.
  • 4th Tax Year - To be exempt for the fourth year (and subsequent years), the corporation's average gross receipts for all prior three-year periods also must be $7.5 million or less.

Here, Catchem is exempt for 2014 because its average gross receipts for 2012-2013 were $6.5 million. However, Catchem loses its exemption for 2015 and all subsequent years because its average gross receipts for 2012-2014 were in excess of $7.5 million ($7.67 million).

77

Magic Corp., a regular C corporation, elected S corporation status at the beginning of the current calendar year.  It had an asset with a basis of $40,000 and a fair market value (FMV) of $85,000 on January 1. The asset was sold during the year for $95,000.  Magic’s corporate tax rate was 35%.  What was Magic’s tax liability as a result of the sale?

  1. $0
  2. $3,500
  3. $15,750
  4. $19,250

$15,750

The requirement is to determine the amount of an S corporation’s tax liability that resulted from the sale of an asset. A C corporation that makes an S election is subject to a corporate level tax of 35% on its net recognized built-in gain if the gain is attributable to its net unrealized built-in gain as of the first day of its S status and the gain is recognized within 10 years after the effective day of its S election. Here, Magic’s net unrealized built-in gain on January 1 was $85,000 — $40,000 = $45,000. When Magic subsequently sold the asset for a $55,000 gain, $45,000 of the gain is a recognized built-in gain subject to tax at a rate of 35%, resulting in a built-in gains tax of $45,000 × 35% = $15,750.

78

Consolidated returns may be filed

  1. Either by parent-subsidiary corporations or by brother-sister corporations.
  2. Only by corporations that formally request advance permission from the IRS.
  3. Only by parent-subsidiary affiliated groups.
  4. Only by corporations that issue their financial statements on a consolidated basis.

Only by parent-subsidiary affiliated groups

The election to file consolidated returns is limited to affiliated corporations. Affiliated corporations are parent-subsidiary corporations that are connected through stock ownership wherein at least 80% of the combined voting power and value of all stock (except the common parent’s) is directly owned by other includable corporations. Brother-sister corporations are not affiliated corporations. Therefore, this answer is correct.

79

Certain adjustments must be made to a corporation’s pre-ACE alternative minimum taxable income (AMTI) to arrive at adjusted current earnings (ACE).  Which one of the following adjustments increases pre-ACE AMTI to arrive at ACE?

  1. 80% dividends-received deduction.
  2. Excess of capital losses over capital gains.
  3. Amortization of organizational expenditures.
  4. Private activity bond interest income.

Amortization of organizational expenditures

A corporation’s organizational expenditures are not deductible and must be capitalized for purposes of converting a corporation’s pre-ACE alternative minimum taxable income (AMTI) to its adjusted current earnings (ACE). Private activity bond interest is a tax preference item and is added to regular taxable income in the process of computing a corporation’s pre-ACE AMTI.

80

Blu Corp. had operating income of $80,000 after deducting $5,000 for contributions to the state university but not including dividends of $1,000 received from nonaffiliated taxable domestic corporations. In computing the maximum allowable deduction for contributions, how much is the base amount to which Blu should apply the percentage limitation?

  1. $81,000
  2. $85,000
  3. $85,150
  4. $86,000

$86,000

The charitable contributions base for a corporation is its taxable income computed before the charitable contributions deduction, the dividends-received deduction, a NOL carryback (but after carryover), and a capital loss carryback (but after carryover). In this case, Blu Corp.’s contribution base is its operating income ($80,000), adjusted by adding back the charitable contributions ($5,000), and including the dividends ($1,000). Thus, the contributions base amount is $80,000 + $5,000 + $1,000 = $86,000.

81

Jarovsky Corp., an accrual-basis calendar-year corporation, carried back a net operating loss for the tax year ended December 31, 2014 Jarovsky’s gross revenues have been under $500,000 since inception. Jarovsky expects to have profits for the tax year ending December 31, 2015.  Which method(s) of estimated tax payment can Jarovsky use for its quarterly payments during the 2015 tax year to avoid a penalty for the underpayment of federal estimated taxes?

  •       I.100% of the preceding tax year method
  •      II.Annualized income method
  1. I only
  2. II only
  3. Both I and II
  4. Neither I nor II

II only

The requirement is to determine which methods of estimated tax payment can be used by Jarovsky Corp. to avoid the penalty for underpayment of federal estimated taxes. Generally, to avoid a penalty for the underpayment of estimated taxes, a corporation’s quarterly estimated payments must be at least equal to the least of

  1. 100% of the tax shown on the current year’s tax return,
  2. 100% of the tax that would be due by placing income for specified monthly periods on an annualized basis, or
  3. 100% of the tax shown on the corporation’s return for the preceding year, provided the preceding year showed a positive tax liability and consisted of 12 months.

In this case, Jarovsky cannot base its estimated payments on its preceding year because Jarovsky had a net operating loss for 2014.

82

The following information pertains to Lamb Corp.:

  • Accumulated earnings and profits at January 1, 2015 - $60,000
  • Earnings and profits for the year ended December 31, 2015 - 80,000
  • Cash distributions to individual stockholders during 2015 - $180,000

What is the total amount of distributions taxable as dividend income to Lamb’s stockholders for 2015?

  1. $180,000
  2. $140,000
  3. $80,000
  4. $0

$140,000

A corporation’s distributions to shareholders on their stock will be treated as dividend income to the extent of the corporation’s (1) earnings and profits for its current taxable year, plus, (2) any earnings and profits accumulated before the beginning of the current taxable year. Here, Lamb Corp.’s accumulated earnings and profits at 1/1/15 were $60,000, and its earnings and profits for the year ended 12/31/15 were $80,000. Thus, of the $180,000 of cash distributed during 2015, a total of $140,000 would be taxable as dividend income to Lamb’s stockholders. The remaining $40,000 would be treated as a nontaxable return of stock basis.

83

Lark Corp. and its wholly owned subsidiary, Day Corp., both operated on a calendar year.  In January 2015 Day adopted a plan of complete liquidation.  Two months later, Day paid all of its liabilities and distributed its remaining assets to Lark.  These assets consisted of the following:

  • Cash - $50,000
  • Land (at cost) - $10,000

Fair market value of the land was $30,000.  Upon distribution of Day’s assets to Lark, all of Day’s capital stock was cancelled.  Lark’s basis for the Day stock was $7,000.  Lark’s recognized gain in 2015 on receipt of Day’s assets in liquidation was

  1. $0
  2. $50,000
  3. $53,000
  4. $73,000

$0

No gain or loss will be recognized by a parent corporation (Lark Corp.) on the receipt of property in complete liquidation of an 80% or more owned subsidiary (Day Corp.).

No gain or loss is recognized to a parent corporation under Sec. 332 on the receipt of property in complete liquidation of an 80% or more owned subsidiary. The subsidiary’s basis for its assets along with all tax accounting attributes (e.g., earnings and profits, NOL and charitable contribution carryforwards) will carry over to the parent corporation.

No gain or loss is recognized to a subsidiary corporation on the distribution of property to its parent if Sec. 332 applies to the parent corporation.

84

Carr, Inc., a calendar-year corporation incorporated in January 2010, had a net operating loss (NOL) of $75,000 in 2014. For each of the years 2010-2013, Carr reported taxable income (loss) before NOL deduction as follows:

  1. 2010 - $15,000
  2. 2011 - ($20,000)
  3. 2012 - $10,000
  4. 2013 - $30,000

When filing its tax return for 2014, Carr did not elect to give up the carryback of its loss for 2014. Carr’s taxable income before net operating loss deduction for 2015 was $80,000.  Carr should report a NOL deduction on its tax return for 2015 of

  1. $30,000
  2. $35,000
  3. $40,000
  4. $55,000

$40,000

An NOL is generally carried back 2 years and forward 20 years. Here the 2011 NOL of $20,000 would offset the 2010 taxable income (TI) of $15,000 plus $5,000 TI from 2012. Then, the 2014 NOL of $75,000 would be used to offset the remaining $5,000 TI of 2012 and the $30,000 TI of 2013, leaving $40,000 as an NOL deduction for 2015.

85

Denison Corp., a calendar-year domestic C corporation, is not a personal holding company.  For purposes of the accumulated earnings tax, Denison has accumulated taxable income for 2015. Which step(s) can Denison take to eliminate or reduce any 2015 accumulated earnings tax?

  •   I.Demonstrate that the "reasonable needs" of its business require the retention of all or part of the 2015 accumulated taxable income.
  •  II.Pay dividends by March 15, 2016.
  1. I only.
  2. II only.
  3. Both I and II.
  4. Neither I nor II.

Both I and II.

The requirement is to determine which step(s) Denison Corp. can take to eliminate or reduce any 2015 accumulated earnings tax (AET). The AET is a penalty tax that can be imposed (in addition to regular income tax) on a corporation if it accumulates earnings in excess of reasonable business needs.

To avoid the AET, Denison can demonstrate that the reasonable needs of its business require the retention of all or part of the 2015 accumulated taxable income. Additionally, Denison can reduce its accumulated taxable income by paying a dividend to its shareholders. For this purpose, any dividends paid within the first 2 1/2 months of the tax year are treated as if paid on the last day of the preceding tax year. Thus, Denison’s payment of dividends by March 15, 2016, would reduce its exposure to the AET for 2015.

86

Which of the following entities may adopt any tax year-end?

  1. C corporation.
  2. S corporation.
  3. Limited liability company (LLC).
  4. Trust.

C corporation

The requirement is to determine which entity is free to adopt any tax year it chooses. A C corporation is free to adopt a calendar year or any fiscal year that it chooses. On the other hand, restrictions apply to the adoption of a taxable year by S corporations, LLCs, and trusts in order to prevent the deferral of income to owners and beneficiaries that could otherwise be achieved. An S corporation’s income is generally passed through to shareholders at the end of the S corporation year. As a result, an S corporation generally must adopt a calendar year, and can request permission to adopt a fiscal year only if the corporation establishes a business purpose. An LLC that does not elect to be taxed as an association is a partnership for tax purposes and is subject to the same restrictions regarding the adoption of a taxable year that apply to other partnerships. Generally, an LLC must adopt the same taxable year as used by its one or more owners who have an aggregate interest in LLC profits and capital exceeding 50%. Distributions from trusts are taxed to beneficiaries in the beneficiaries’ tax year in which the trust’s year ends. As a result, trusts are generally required to adopt a calendar year.

87

Corporations A and B combine in a qualifying reorganization, and form Corporation C, the only surviving corporation. This reorganization is tax-free to the

  • Shareholders
  • Corporations

BOTH.

Corporate reorganizations are generally nontaxable under the theory that they represent a mere change in form since there is an underlying continuity of shareholder interests and a continuity of the business enterprise. In this case, Corporations A and B combined to form Corporation C, the only surviving corporation. This is called a consolidation-a qualifying Type-A corporate reorganization. Assuming no boot is received, no gain or loss is recognized by the Corporation A and B shareholders when they exchange their A and B stock for stock of Corporation C. Similarly, no gain or loss is recognized by Corporations A and B when they transfer their assets to Corporation C pursuant to the plan of corporate reorganization.

88

Brisk Corp. is an accrual-basis, calendar-year C corporation with one individual shareholder.  At year-end, Brisk had $600,000 accumulated and current earnings and profits as it prepared to make its only dividend distribution for the year to its shareholder.  Brisk could distribute either cash of $200,000 or land with an adjusted tax basis of $75,000 and a fair market value of $200,000.  How would the taxable incomes of both Brisk and the shareholder change if land were distributed instead of cash?

  • Brisk's taxable income
  • Shareholder's taxable income

  • Brisk's taxable income - INCREASE
  • Shareholder's taxable income - NO CHANGE

The requirement is to determine how the taxable incomes of Brisk Corp. and the shareholder would change if appreciated land were distributed instead of cash. If a corporation distributes appreciated property, it must recognize gain to the extent that the property’s fair market value exceeds its basis. Here, Brisk’s taxable income would increase because it would have to recognize a gain of $200,000 — $75,000 = $125,000. On the other hand, the amount of distribution to a shareholder is measured by the amount of cash and fair market value of noncash property received. As a result, the taxable income of the shareholder would not change since receiving $200,000 of cash or alternatively receiving the land worth $200,000 would result in a $200,000 dividend to the shareholder.

89

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.?

  1. $40,000
  2. $50,000
  3. $60,000
  4. $70,000

$60,000

The requirement is to determine the tax basis of the land to X Corp. that was received at the time of its incorporation. Sec. 351 applies to the formation of X Corp., because both A and B transferred property to X Corp. in exchange for stock, and in the aggregate owned at least 80% of X Corp. after the exchange. This means that B’s realized gain on the transfer of the land of $70,000 — $40,000 = $30,000 will be recognized only to the extent of the $20,000 cash boot that B received. This is important because a transferee corporation’s basis for property acquired in a Sec. 351 transaction is equal to the transferor’s basis, increased by any gain recognized by the transferor. Here, X Corp.’s basis for the land acquired from B will be the same as B’s basis of $40,000 increased by the $20,000 of gain recognized by B, a total of $60,000.

90

Viking Corp. manufactures action figures for children. During 2014, Viking purchased $2,300,000 of used production machinery to be used in its business. For 2014, Viking’s taxable income before any Sec. 179 expense deduction was $140,000. What is the maximum amount of Sec. 179 expense election Viking will be allowed to deduct for 2014 and the maximum amount of Sec. 179 expense election that can carry over to 2015?

  1. Expense of $140,000 and carryover of $60,000.
  2. Expense of $140,000 and carryover of $360,000.
  3. Expense of $200,000 and carryover of $300,000.
  4. Expense of $500,000 and carryover of $0.

Expense of $140,000 and carryover of $60,000.

Sec. 179 permits a taxpayer to treat up to $500,000 of the cost of qualifying depreciable personal property as an expense rather than as a capital expenditure. However, the $500,000 maximum is reduced dollar-for-dollar by the cost of qualifying property placed in service during the taxable year that exceeds $2 million. Here, the maximum amount that can be expensed is $500,000 − ($2,300,000 − $2,000,000) = $200,000 for 2014. However, this amount is further limited as a deduction for 2014 to Viking's taxable income of $140,000 before the Sec. 179 expense deduction. The remainder ($200,000 − $140,000 = $60,000) that is not currently deductible because of the taxable income limitation can be carried over and will be deductible subject to the taxable income limitation in 2015.

91

A corporation that has both preferred and common stock has a deficit in accumulated earnings and profits at the beginning of the year.  The current earnings and profits are $25,000.  The corporation makes a dividend distribution of $20,000 to the preferred shareholders and $10,000 to the common shareholders.  How will the preferred and common shareholders report these distributions?

  1. Preferred—$20,000 dividend income; common—$10,000 dividend income.
  2. Preferred—$20,000 dividend income; common—$5,000 dividend income, $5,000 return of capital.
  3. Preferred—$15,000 dividend income; common—$10,000 dividend income.
  4. Preferred—$20,000 return of capital; common—$10,000 return of capital.

Preferred—$20,000 dividend income; common—$5,000 dividend income, $5,000 return of capital.

The requirement is to determine how the $20,000 distributed to preferred shareholders and $10,000 distributed to common shareholders should be treated when a corporation has a deficit in accumulated earnings and profits and has only $25,000 of current earnings and profits (CEP). When current earnings and profits are less than the total amount distributed to preferred and common shareholders, current earnings and profits must first be allocated to distributions to preferred shareholders, with only the remainder available to tax distributions to common shareholders. Here, the $25,000 of current earnings and profits are first allocated to the distribution to preferred shareholders making all $20,000 taxable as a dividend. That leaves only $5,000 of earnings and profits to be allocated to the $10,000 distribution to common shareholders, making $5,000 taxable as a dividend and the remaining $5,000 of distribution a nontaxable return of stock basis.

92

In 2013, Celia Mueller bought a $1,000 bond issued by Disco Corporation, for $1,100.  Instead of paying off the bondholders in cash, Disco issued 100 shares of preferred stock in 2015 for each bond outstanding.  The preferred stock had a fair market value of $15 per share.  What is the recognized gain to be reported by Mueller in 2015?

  1. $0.
  2. $400 dividend.
  3. $400 long-term capital gain.
  4. $500 long-term capital gain.

$0.

The issuance by Disco Corporation of its preferred stock in exchange for its bonds is a nontaxable "Type E" reorganization (i.e., a recapitalization). Since Mueller did not receive any boot, no part of her $400 realized gain is recognized.

There are seven different types of reorganizations which generally result in nonrecognition treatment.

  • Type A—statutory mergers or consolidations
    • Merger is one corporation absorbing another by operation of law
    • Consolidation is two corporations combining in a new corporation, the former ones dissolving
  • Type B—the use of solely voting stock of the acquiring corporation (or its parent) to acquire at least 80% of the voting power and 80% of each class of nonvoting stock of the target corporation
    • No boot can be used by the acquiring corporation to acquire the target’s stock
    • Results in the acquisition of a controlled subsidiary
  • Type C—the use of solely voting stock of the acquiring corporation (or its parent) to acquire substantially all of the target’s properties
    • In determining whether the acquisition is made for solely voting stock, the assumption by the acquiring corporation of a liability of the target corporation, or the fact that the property acquired is subject to a liability is disregarded.
    • "Substantially all" means at least 90% of the FMV of the target’s net assets, and at least 70% of its gross assets.
    • The target (acquired) corporation must distribute the consideration it receives, as well as all of its other properties, in pursuance of the plan of reorganization.
  • Type D—a transfer by a corporation of part or all of its assets to another if immediately after the transfer the transferor corporation, or its shareholders, control the transferee corporation (i.e., own at least 80% of the voting power and at least 80% of each class of nonvoting stock)
  • Although it may be acquisitive, this type of reorganization is generally used to divide a corporation.
  • Generally results in a spin-off, split-off, or split-up.
  • Type E—a recapitalization to change the capital structure of a single corporation (e.g., bondholders exchange old bonds for new bonds or stock)
  • Type F—a mere change in identity, form, or place of organization (e.g., name change, change of state of incorporation)
  • Type G—a transfer of assets by an insolvent corporation or pursuant to bankruptcy proceedings, with the result that former creditors often become the owners of the corporation

93

Washington, Lincoln, and Roosevelt formed President Corporation during the current year. Pursuant to the incorporation agreement, Washington transferred cash of $60,000 for 600 shares of stock, Lincoln transferred property with an adjusted basis of $5,000 and a fair market value of $15,000 for 150 shares of stock, and Roosevelt performed services valued at $25,000 in exchange for 250 shares of stock. Assuming the fair market value of President Corporation’s stock is $100 per share, what is President Corporation’s tax basis for the property received from Lincoln?

  1. $0
  2. $5,000
  3. $15,000
  4. $25,000

$15,000

The requirement is to determine President Corporation’s tax basis for the property received in the incorporation from Lincoln. Since Washington and Lincoln are the only transferors of property and they in the aggregate own only 750 of the 1000 shares outstanding immediately after the exchange, Sec. 351 does not apply to provide nonrecognition treatment to Lincoln’s transfer of property. As a result, Lincoln is taxed on his realized gain of $10,000, and President Corporation has a cost basis of $15,000, (i.e., FMV) for the transferred property.

94

Lyle Corp. is a distributor of pharmaceuticals and sells only to retail drug stores.  During 2015, Lyle received unsolicited samples of nonprescription drugs from a manufacturer. Lyle donated these drugs in 2015 to a qualified exempt organization and deducted their fair market value as a charitable contribution. What should be included as gross income in Lyle’s 2015 return for receipt of these samples?

  1. $0
  2. $25 nominal value assigned to gifts.
  3. Net discounted wholesale price.
  4. Fair market value.

Fair market value

The requirement is to determine the amount to be included as gross income in Lyle Corp.’s 2015 return for the receipt of nonprescription drug samples that were later donated to an exempt organization. When unsolicited samples of items that are normally inventoried and sold in the ordinary course of business are received from a supplier, and later donated as a charitable contribution, the fair market value of the items received must be included in gross income. The taxpayer is then allowed a charitable contribution equal to the fair market value of the items donated.

95

Monahan Corp. owns stock in Zimmerman Corp.  For Monahan and Zimmerman to qualify for the filing of consolidated returns, at least what percentage of Zimmerman’s total voting power and total value of stock must be directly owned by Monahan?

  • Total voting power
  • Total value of stock

  • Total voting power = 80%
  • Total value of stock = 80%

96

Paul Benson and Arthur Kronk each own one-half of the stock of Bekro Corporation, which has earnings and profits of $15,000.  Bekro distributes property with a fair market value of $24,000 to its stockholders, each stockholder receiving property with a fair market value of $12,000.  The gross amount reportable by each stockholder as a dividend is

$0

$4,500

$7,500

$12,000

$7,500

The amount of distribution is the $24,000 FMV of the property distributed. The $24,000 will be a dividend to the extent of the corporation’s earnings and profits of $15,000. Since each shareholder received half the property, each shareholder would report $15,000 / 2 = $7,500 as a dividend.

97

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 - $5,000
  • Dividend income from investments - $5,000
  • Supplies expense - $2,000
  • Utilities expense - $1,500

What amount of ordinary business income should Boles report on its current year Form 1120S, US Income Tax Return for an S Corporation, Schedule K?

  1. $53,500
  2. $53,000
  3. $48,000
  4. $46,500

$46,500

The requirement is to determine the amount of ordinary business income that Boles Corporation should report on its Form 1120S, US Income Tax Return for an S corporation, Schedule K. As a pass-through entity, an S corporation’s items must be divided into (1) nonseparately stated income or loss from trade or business activities, and (2) items of income, loss, deduction, and credit, the separate treatment of which could affect the tax liability of any shareholder. Boles’ $50,000 of gross receipts, $2,000 of supplies expense, and $1,500 of utilities expense are all ordinary income and deduction items and are netted in arriving at Boles’ nonseparately stated business income of $46,500. In contrast, the $5,000 of dividend income from investments must be separately stated and passed through to shareholders in order to preserve its characteristic as an item of portfolio income.

98

Prime Corp., which had earnings and profits of $250,000, made a nonliquidating distribution of property to its shareholders as a dividend.  This property, which had an adjusted basis of $25,000 and a fair market value of $10,000 at date of distribution, did not constitute assets used in the active conduct of Prime’s business.  How much loss did Prime recognize as a result of this distribution?

  1. $0
  2. $10,000
  3. $15,000
  4. $25,000

$0

The requirement is to determine the amount of loss recognized by Prime Corporation on the nonliquidating distribution of property to shareholders. Although a gain would be recognized if the property had been appreciated, no loss can be recognized on nonliquidating corporate distributions to shareholders.

99

Davies Corporation (a C corporation) had a deficit of $160,000 at December 31, 2014. Its net income per books was $80,000 for 2015. Cash dividends on common stock totaling $40,000 were paid in December 2015. Davies should report the distribution to its shareholders as

  1. Return of capital 100%.
  2. Ordinary dividends 25%; return of capital 75%.
  3. Ordinary dividends 50%; return of capital 50%.
  4. Ordinary dividends 100%.

Ordinary dividends 100%. - note Net Income per Books can normally be used to approximate a corporation's current E&P.

Corporate distributions to shareholders on their stock are taxed as dividends to the extent of current and/or accumulated earnings and profits. Since Davies Corporation had current earnings of $80,000 for 2015, the cash of $40,000 paid in December 2015 is treated as ordinary dividends 100%

Corporate distributions of property to shareholders on their stock are subject to a three-step treatment.

  1. Dividend—To be included in gross income
  2. Return of stock basis—Nontaxable and reduces shareholder’s basis for stock
  3. Gain—To extent distribution exceeds shareholder’s stock basis

The amount of distribution to a shareholder is the cash plus the FMV of other property received, reduced by liabilities assumed.

A shareholder’s tax basis for distributed property is the property’s FMV at date of distribution (not reduced by liabilities).

A dividend is a distribution of property by a corporation to its shareholders out of

  1. Earnings and profits of the current taxable year (CEP), computed at the end of the year, without regard to the amount of earnings and profits at the date of distribution; or,
  2. Earnings and profits accumulated after February 28, 1913 (AEP).

100

Evan, an individual, has a 40% interest in EF, an S corporation. At the beginning of the year, Evan’s basis in EF was $2,000. During the year, EF distributed $100,000 and reported operating income of $200,000. What amount should Evan include in gross income?

  1. $38,000
  2. $40,000
  3. $80,000
  4. $118,000

$80,000

The requirement is to determine the amount that Evan should include in gross income from his 40% interest in an S corporation. An S corporation is a pass-through entity and its items of income pass through to be reported on shareholder returns. Here, Evan must include in gross income his share of the S corporation’s operating income which is 40% × $200,000 = $80,000. This pass-through of $80,000 of income to Evan increases his stock basis to $82,000, and permits the $40,000 of cash that Evan received from the S corporation to be treated as a nontaxable return of stock basis. Evan’s ending stock basis would be $2,000 + $80,000 — $40,000 = $42,000.

101

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

  1. As a tax-free transaction.
  2. Partly as capital gain and partly as a dividend.
  3. Entirely as a dividend.
  4. Entirely as capital gain.

Entirely as capital gain.

The requirement is to determine how the gain resulting from a stock redemption should be treated by a noncorporate shareholder if the redemption qualifies as a partial liquidation of the distributing corporation. A corporate stock redemption is treated as an exchange, generally resulting in capital gain or loss treatment to a shareholder if the redemption meets any one of five tests. Redemptions qualifying for exchange treatment include (1) a redemption that is not essentially equivalent to a dividend, (2) a redemption that is substantially disproportionate, (3) a redemption that completely terminates a shareholder’s interest, (4) a redemption of a noncorporate shareholder in a partial liquidation, and (5) a redemption to pay death taxes. If none of the above five tests are met, the redemption proceeds are generally treated as a dividend.

A stock redemption is treated as an exchange, generally resulting in capital gain or loss treatment to the shareholder if at least one of the following five tests is met.

102

Sec. 1244 stock permits shareholders to deduct an ordinary loss on sale or worthlessness of stock. Which of the following is correct with respect to qualifying for Sec. 1244 ordinary loss treatment?

  1. The shareholder must be the original holder of stock, and an individual or corporation.
  2. The stock can be common or preferred, voting or nonvoting.
  3. The amount of ordinary loss is limited to $100,000 ($200,000 on joint return); any excess is treated as a capital loss.
  4. The corporation during the 3-year period before the year of loss received more than 50% of its total gross receipts from royalties, rents, dividends, interest, annuities, and gains from sales or exchanges of stock or securities.

The stock can be common or preferred, voting or nonvoting.

In order to deduct an ordinary loss on sale or worthlessness of stock under Sec. 1244, (1) the shareholder must be the original holder of stock, and an individual or partnership; (2) the stock can be common or preferred, voting or nonvoting; (3) the amount of ordinary loss is limited to $50,000 ($100,000 on joint return); (4) the corporation during the 5-year period before the year of loss received less than 50% of its total gross receipts from royalties, rents, dividends, interest, annuities, and gains from sales or exchanges of stock or securities; and (5) the corporation’s aggregate amount of money and adjusted basis of other property received for stock as a contribution to capital and paid-in surplus does not exceed $1,000,000.

103

Grant Corporation, an S corporation, had income of $36,000 for the year ended December 31, 2015. Included in the above is $24,000 of long-term capital gain.  Cash distributions to Mr. Hamlin, the sole shareholder, totaled $12,000 during 2015.  What amount should Hamlin report on his 2015 individual income tax return as long-term gain passed through from Grant?

  1. $0
  2. $8,000
  3. $12,000
  4. $24,000

$24,000

The long-term capital gain of an S corporation is passed through as long-term capital gain to shareholders. Since shareholders are taxed on their distributive share of S corporation income (even though not actually distributed), the full $24,000 passes through as long-term capital gain.

104

The following statements pertain either to the accumulated earnings tax, or to the personal holding company tax, or to both:

  1. Imposition of the tax depends on a stock ownership test specified in the statute.
  2. Imposition of the tax can be mitigated by sufficient dividend distributions.
  3. The tax should be self-assessed by filing a separate schedule along with the regular tax return.

Which of the foregoing statements pertain to the accumulated earnings tax?

  1. (1) only.
  2. (2) only.
  3. (3) only.
  4. (1), (2), and (3).

(2) only.

The imposition of the accumulated earnings tax (AET) does not depend on a stock ownership test, nor is the tax self-assessing. The AET is imposed on a corporation’s retention of earnings in excess of reasonable business needs, but may be mitigated by sufficient dividend distributions.

105

Kneenober Corp., an accrual-basis calendar-year C corporation, liquidated in during the current year.  In cancellation of all their Kneenober stock, each Kneenober shareholder received a liquidating distribution of $5,000 cash and land with a tax basis of $4,000 and a fair market value of $8,750.  Before the distribution, each shareholder’s tax basis in Kneenober stock was $7,000.  What amount of gain should each Kneenober shareholder recognize on the liquidating distribution?

  1. $0
  2. $1,750
  3. $2,000
  4. $6,750

$6,750

The requirement is to determine the amount of gain that each Kneenober Corp. shareholder should recognize as a result of a liquidating distribution from Kneenober. Amounts received by shareholders in complete liquidation of a corporation are treated as received in exchange for stock, generally resulting in capital gain or loss because the stock was held as an investment. Here the amount realized by each shareholder consists of $5,000 cash plus the $8,750 FMV of the land, for a total of $13,750. Since each shareholder’s stock basis was $7,000, each shareholder has a gain of $13,750 — $7,000 = $6,750.

106

Edan Corp. made a pro rata distribution of marketable securities in redemption of its stock in a complete liquidation during the current year.  These securities, which had been purchased in 2011 for $80,000, had a fair market value of $40,000 when distributed.  What loss does Edan Corp. recognize as a result of the distribution?

  1. $0
  2. $40,000 long-term capital loss.
  3. $40,000 Section 1231 loss.
  4. $40,000 ordinary loss.

$40,000 long-term capital loss.

The requirement is to determine the amount of Edan Corp.’s recognized loss resulting from the distribution of marketable securities in complete liquidation. Generally, a corporation will recognize gain or loss on the distribution of its property in complete liquidation just as if the property were sold to the distributee for its fair market value. Since the marketable securities were a capital asset and held for more than one year, the distribution results in a long-term capital loss of $80,000 — $40,000 = $40,000.

107

A C corporation has gross receipts of $150,000, $35,000 of other income, and deductible expenses of $95,000.  In addition, the corporation incurred a net long-term capital loss of $25,000 during the current year. What is the corporation’s taxable income?

  1. $ 65,000
  2. $ 87,000
  3. $ 90,000
  4. $115,000

$90,000

The requirement is to determine a C corporation’s taxable income. The corporation’s taxable income would consist of the $150,000 of gross receipts plus $35,000 of other income, reduced by the $95,000 of deductible expenses, resulting in taxable income of $90,000. Note that the corporation is not allowed to deduct a net capital loss in computing its taxable income. Instead, the net capital loss of $25,000 would be carried back 3 years and forward 5 years as a short-term capital loss to offset capital gains in the carryback and carryforward years.

108

The following statements pertain either to the accumulated earnings tax, or to the personal holding company tax, or to both:

  1. Imposition of the tax depends on a stock ownership test specified in the statute.
  2. Imposition of the tax can be mitigated by sufficient dividend distributions.
  3. The tax should be self-assessed by filing a separate schedule along with the regular tax return.

Which of the foregoing statements pertain to the personal holding company tax?

  1. (1) only.
  2. (2) only.
  3. (3) only.
  4. (1), (2), and (3).

ALL THREE.

The personal holding company (PHC) tax is self-assessed by a corporation filing a Schedule PH along with its regular Form 1120 tax return. The PHC tax may be imposed if more than 50% of a corporation’s stock is owned by 5 or fewer individuals, and 60% or more of the corporation’s adjusted ordinary gross income is PHC income. The penalty tax is assessed against undistributed PHC income, which may be reduced by dividend distributions.

109

Genetic Corp.’s operating income for the year ended December 31, 2015, amounted to $100,000. Also in 2015, a machine owned by Genetic was completely destroyed in an accident. This machine's adjusted basis immediately before the casualty was $20,000. The machine was not insured and had no salvage value. In Genetic's 2015 tax return, what amount should be deducted for the casualty loss?

  1. $9,900
  2. $10,000
  3. $19,900
  4. $20,000

$20,000

The requirement is to determine the amount of casualty loss deduction available to Genetic Corp. due to the complete destruction of its machine. If business property is completely destroyed, the amount of casualty loss deduction is the property’s adjusted basis immediately before the casualty, less any insurance reimbursement. Note that the "$100 floor" and "10% of adjusted gross income" limitations that apply to nonbusiness casualty losses of individuals do not apply to business casualty losses.

110

Tap, a calendar-year S corporation, reported the following items of income and expense in the current year:

  • Revenue$44,000
  • Operating expenses20,000
  • Long-term capital loss6,000
  • Charitable contributions1,000
  • Business interest expense4,000

What is the amount of Tap’s ordinary income?

  1. $13,000
  2. $19,000
  3. $20,000
  4. $24,000

$20,000

An S corporation's ordinary income. The computation of an S corporation's ordinary income excludes any item that must be separately stated and separately passed through to shareholders in order to retain the item's special tax characteristics. Here, the long-term capital loss must be separately stated and passed through as long-term capital loss to shareholders in order to be included in the netting of a shareholder's capital gains and losses. Similarly, charitable contributions must be separately stated and passed through to shareholders in order to apply the appropriate percentage limitations at the shareholder level. Tap's ordinary income consists of $44,000 of revenue, reduced by its $20,000 of operating expenses and $4,000 of interest expense, resulting in ordinary income of $20,000.

111

When a corporation has an unused net capital loss that is carried back or carried forward to another tax year

  1. It retains its original identity as short-term or long-term.
  2. It is treated as a short-term capital loss whether or not it was short-term when sustained.
  3. It is treated as a long-term capital loss whether or not it was long-term when sustained.
  4. It can be used to offset ordinary income up to the amount of the carryback or carryover.

It is treated as a short-term capital loss whether or not it was short-term when sustained.

The requirement is to determine the correct statement regarding the carryback or carryforward of an unused net capital loss. A corporation’s unused net capital loss is carried back 3 years and forward up to 5 years to offset capital gains in the carryback and carryforward years. An unused net capital loss is always carried back and forward as a short-term capital loss whether or not it was short-term when sustained.

112

Morris Corporation’s income tax return for 2015 shows deductions exceeding gross income by $75,000.  Included in the tax return are the following items:

  • Net operating loss deduction (carryover from 2014) - $13,400
  • Dividends received deduction - $6,600

What is Morris’ net operating loss for 2015?

  1. $75,000
  2. $68,400
  3. $61,600
  4. $55,000

$61,600

The requirement is to determine the NOL for 2015 given that deductions in the tax return exceed gross income by $75,000. In computing the NOL for 2015, the DRD of $6,600 would be fully allowed, but the $13,400 NOL deduction (carryover from 2014) would not be allowed. $75,000 — $13,400 = $61,600.

A corporation’s net operating loss is computed the same way as its taxable income.

  • The dividends received deduction is allowed without limitation.
  • No deduction is allowed for a NOL carryback or carryover from other years.
  • A NOL is generally carried back two years and forward twenty years to offset taxable income in those years.  However, a three-year carryback is permitted for the portion of a NOL that is attributable to a presidentially declared disaster and is incurred by a small business corporation (i.e., a corporation whose average annual gross receipts are $5 million or less for the three-tax-year period preceding the loss year).
  • A corporation may elect to forego carryback and only carry forward twenty years.

113

Donna Andersen and Dana Marwick formed the Northern Corporation on July 5, 2015. On the same date Andersen paid $90,000 cash to Northern for 900 shares of its common stock. Simultaneously, Marwick received 100 shares of Northern’s common stock for services rendered. How much should Marwick include as taxable income for 2015 and what will be the basis of her stock?

  • Taxable income
  • Basis of stock

  • Taxable income = $10,000
  • Basis of stock = $10,000

The requirement is to determine the taxable income to Marwick and the basis of her stock. Since services are excluded from the definition of "property," Marwick’s transfer does not fall under the nonrecognition provisions of Sec. 351, but instead is a taxable exchange. As a result, Marwick must report $10,000 of compensation income and her basis for the stock will be $10,000, the amount reported as income.

114

On July 1, 2015, in connection with a recapitalization of Yorktown Corporation, Robert Moore exchanged 1,000 shares of stock which cost him $95,000 for 1,000 shares of new stock worth $108,000 and bonds in the principal amount of $10,000 with a fair market value of $10,500.  What is the amount of Moore’s recognized gain during 2015?

  1. $0
  2. $10,500
  3. $23,000
  4. $23,500

$10,500

Since a recapitalization is a reorganization, a realized gain is recognized only to the extent that consideration other than stock or securities is received, including the FMV of an excess of the principal amount of securities received over the principal amount of securities surrendered. Since no securities were surrendered, the excess principal amount of securities received is $10,000, and Moore’s realized gain of $23,500 [($108,000 + $10,500) — $95,000] is recognized to the extent of the $10,500 FMV of the excess principal amount of securities received.

115

Cooma Corporation’s book income before income taxes for the year ended December 31, 2015, was $260,000. The company began business during March 2015 and organizational costs of $130,500 were expensed when incurred during 2015 for financial statement purposes. For tax purposes these costs are being written off over the minimum allowable period. For the year ended December 31, 2015, Cooma’s taxable income was

  1. $260,000
  2. $368,750
  3. $383,250
  4. $390,500

$383,250

A corporation’s organizational expenditures can be deducted ratably over the 180-month period beginning with the month in which the corporation begins business. Here, the $130,500 of organizational expenditures expensed per books must be added back to the $260,000 of book income, and then the proper tax amortization deducted ($130,500 × 10/180 = $7,250), resulting in taxable income of $383,250.

116

On October 1, 2014, Derek Corporation sold 4,000 shares of its $10 par value treasury stock for $60,000.  These shares were reacquired by Derek on January 2, 2015, for $50,000.  For 2015, Derek should report

  1. Neither income nor capital gain.
  2. A long-term capital gain of $10,000.
  3. A short-term capital gain of $10,000.
  4. A long-term capital gain of $20,000.

Neither income nor capital gain.

No gain or loss is recognized by a corporation on the receipt of money or other property in exchange for its stock (including treasury stock). The excess of selling price over cost is treated as an addition to paid-in capital.

117

Would the following expense items be reported on Schedule M-1 of the corporate income tax return (Form 1120) showing the reconciliation of income per books with income per return?

  • Deduction for a net capital loss
  • Business meals for executive out-of-town travel

  • Deduction for a net capital loss - YES
  • Business meals for executive out-of-town travel - YES

The requirement is to determine whether the deduction for net capital loss and business meals for executive out-of-town travel would be reported on Schedule M-1 of the US corporate income tax return (Form 1120). Schedule M-1 generally provides a reconciliation of a corporation’s income per books with the corporation’s taxable income before the net operating loss and dividends-received deduction. Since a net capital loss per books would not be deductible for tax purposes, the net capital loss would be added back to book income on Schedule M-1. Since only 50% of business meals is deductible for tax purposes, 50% of business meals would be added back to book income to arrive at taxable income on Schedule M-1.

118

Quigley, Roberk, and Storm form a corporation.  Quigley exchanges $25,000 of legal services for 30 shares of stock.  Roberk exchanges land with a basis of $10,000 and a fair market value of $100,000 for 60 shares of stock.  Storm exchanges $10,000 cash for 10 shares of stock.  What amount of income should each shareholder recognize?

  • Quigley
  • Roberk
  • Storm

 

  • Quigley - $25,000
  • Roberk - $90,000
  • Storm - $0

The requirement is to determine the income recognized by Quigley, Roberk, and Storm as a result of their formation of a corporation. No gain or loss is recognized if property is transferred to a corporation solely in exchange for stock if the transferors of property, in the aggregate, own at least 80% of the stock of the corporation after the exchange. Although the term property includes cash, it does not include services. Here, although Roberk and Storm transfer property, they own only 70 of the corporation's 100 outstanding shares after the exchange and fail the 80% control test. As a result, the formation of the corporation is taxable and Roberk must recognize a gain of $100,000 − $10,000 = $90,000 on the transfer of land. Of course Storm doesn't recognize any gain on the transfer of cash, and Quigley must recognize compensation income of $25,000 on the receipt of stock in exchange for services.

119

Stone Corp. has been an S corporation since inception.  In each of year 1, year 2, and year 3, Stone made distributions in excess of each shareholder’s basis.  Which of the following statements is correct concerning these three years?

  1. In year 1 and year 2 only, the excess distributions are taxed as capital gain.
  2. In year 1 only, the excess distributions are tax-free.
  3. In year 3 only, the excess distributions are taxed as capital gain.
  4. In all three years, the excess distributions are taxed as capital gain.

In all three years, the excess distributions are taxed as capital gain.

The requirement is to determine the correct statement regarding an S corporation's distributions that are in excess of each shareholder's stock basis. Because Stone has been an S corporation since inception, it does not have any earnings and profits and its distributions will not be taxed as dividends. Instead, all of Stone's distributions will be treated as a nontaxable return of stock basis for each shareholder until the shareholder's stock basis is fully recovered. Thereafter, distributions in excess of stock basis will be taxed as capital gain, just as if the shareholder had sold the stock.

120

Which of the following itemized deductions are deductible when computing the alternative minimum tax (AMT) for individuals?

  1. State income taxes.
  2. Home equity mortgage interest when the loan proceeds were used to purchase an auto.
  3. Medical expenses amounting to 10% of adjusted gross income.
  4. Home equity mortgage interest when the loan proceeds were used to add an additional room to the house.

Home equity mortgage interest when the loan proceeds were used to add an additional room to the house.

State income taxes, medical expenses amounting to 10% of AGI, and home equity mortgage interest expense when the loan proceeds are not used to buy, build, or substantially improve the home are not deductible in computing AMT for individuals. In contrast, home equity mortgage interest expense is deductible in computing the AMT for individuals if the loan proceeds were used to buy, build, or substantially improve the home.

121

Webster, a C corporation, has $70,000 in accumulated and no current earnings and profits.  Webster distributed $20,000 cash and property with an adjusted basis and fair market value of $60,000 to its shareholders.  What amount should the shareholders report as dividend income?

  1. $20,000
  2. $60,000
  3. $70,000
  4. $80,000

$70,000

The requirement is to determine the amount of dividend income to be reported by shareholders. Amounts distributed to shareholders are dividends to the extent paid out of current or accumulated earnings and profits. Here the $20,000 cash and $60,000 property distribution will be a dividend to the extent of the $70,000 of accumulated earnings and profits.

122

On July 1, 2015, Mr. Grey formed Dover Corporation.  The same date Grey paid $100,000 cash and transferred land with an adjusted basis of $50,000 to Dover in exchange for 3,000 shares of its common stock. The land had a fair market value of $85,000 on the date of the exchange. Dover had no other shares of common stock outstanding on July 1, 2015.  As a result of the above transaction, Grey’s basis in his stock and Dover’s basis in the land, respectively, are

  1. $150,000 and $50,000.
  2. $150,000 and $85,000.
  3. $185,000 and $50,000.
  4. $185,000 and $85,000.

$150,000 and $50,000.

Since Grey has transferred land to an at least 80% owned corporation solely in exchange for stock, no gain is recognized. Grey’s basis in the stock equals the $50,000 adjusted basis of land plus the $100,000 cash transferred, a total of $150,000. Dover’s basis for the land equals Grey’s adjusted basis plus any gain recognized on the transfer. Since no gain was recognized by Grey, the basis of the land to Dover is $50,000.

123

Simpson incorporated a sole proprietorship by exchanging all the assets for the stock of Wawa Co., a new corporation.  To qualify for tax-free incorporation, Simpson must be in control of Wawa immediately after the exchange.  What minimum percentage of Wawa’s stock must Simpson own to have "control" for this purpose?

  1. 50.00%
  2. 51.00%
  3. 80.00%
  4. 81.00%

80.00%

The requirement is to determine the percentage of Wawa’s stock that Simpson must own to qualify for a tax-free incorporation. No gain or loss is recognized if property is transferred to a corporation solely in exchange for stock, and the transferor(s) are in control of the corporation immediately after the exchange. For this purpose, the term "control" means the ownership of at least 80% of the combined voting power of stock entitled to vote, and at least 80% of each class of nonvoting stock.

124

Which one of the following statements concerning the eligibility requirements for S corporations is not correct?

  1. A partnership is not permitted to be a shareholder of an S corporation.
  2. An S corporation is permitted to own 75% of the stock of another S corporation.
  3. An S corporation is permitted to be a partner in a partnership.
  4. An S corporation is permitted to own 100% of the stock of a C corporation.

An S corporation is permitted to own 75% of the stock of another S corporation.

The eligibility requirements restrict S corporation shareholders to individuals (other than nonresident aliens), estates, and certain trusts. Partnerships and C corporations are not permitted to own stock in an S corporation. However, an S corporation is permitted to be a partner in a partnership, and may own any percentage of stock of a C corporation, as well as own 100% of the stock of a qualified subchapter S subsidiary.

125

Dole, the sole owner of Enson Corp., transferred a building to Enson. The building had an adjusted tax basis of $35,000 and a fair market value of $100,000. In exchange for the building, Dole received $40,000 cash and Enson common stock with a fair market value of $60,000.  What amount of gain did Dole recognize?

  1. $0
  2. $5,000
  3. $40,000
  4. $65,000

$40,000

The requirement is to determine the amount of gain recognized by Dole on the transfer of a building with a basis of $35,000 to his solely owned corporation in exchange for $40,000 cash and stock with a value of $60,000. No gain or loss is recognized if property is transferred to a corporation solely in exchange for stock if the transferor is in control of the corporation immediately after the exchange. If consideration other than stock is received, a realized gain must be recognized to the extent of the boot received. Here, Dole realized a gain of ($40,000 + $60,000 stock) — $35,000 basis = $65,000 on the transfer of the building, and must recognize the gain to the extent of the $40,000 of cash received.

126

Gold and Silver are calendar-year C corporations.  On June 30th of the current year, Silver Corporation acquired 85% of the outstanding stock of Gold Corporation.  As a result, Gold is now a subsidiary of Silver, with Silver Corporation owning 85% of Gold’s voting stock and fair market value (FMV).  Which of the following tax return filings would be appropriate for the two companies?

  1. Two separate returns, because Silver owns at least 80% of both the voting stock and FMV of Gold.
  2. Two separate returns, because the acquisition of Gold took place before the close of the second quarter.
  3. A consolidated return, because Silver owns at least 80% of both the voting stock and FMV of Gold.
  4. A consolidated return, because the acquisition of Gold took place before the close of the second quarter.

A consolidated return, because Silver owns at least 80% of both the voting stock and FMV of Gold.

The requirement is to determine the appropriate tax return filing for Silver and Gold. Because Silver Corporation directly owns at least 80% of the voting power and total value of all Gold Corporation stock at the end of the calendar year, the corporations are affiliated and may elect to file a consolidated return.

127

In 2014, Roe Corp. purchased and placed in service a used machine to be used in its manufacturing operations. This machine cost $2,200,000.  What portion of the cost may Roe elect to treat as an expense rather than as a capital expenditure?

  1. $0
  2. $200,000
  3. $300,000
  4. $500,000

$300,000

For 2014, Sec. 179 permits a taxpayer to elect to treat up to $500,000 of the cost of qualifying depreciable personal property as an expense rather than as a capital expenditure.  However, the $500,000 maximum is reduced dollar-for-dollar by the cost of qualifying property placed in service during the taxable year that exceeds $2 million.  Here, the maximum amount that can be expensed is [$500,000 − ($2,200,000 − $2,000,000)] = $300,000.

128

Pope, a C corporation, owns 15% of Arden Corporation.  Arden paid a $3,000 cash dividend to Pope. What is the amount of Pope’s dividend-received deduction?

  1. $3,000
  2. $2,400
  3. $2,100
  4. $0

$2,100

The requirement is to determine Pope’s dividend-received deduction for the $3,000 dividend received from a 15%-owned corporation. Dividends received from a less than 20%-owned taxable domestic corporation are generally eligible for a 70% DRD. Here, Pope’s DRD would be $3,000 × 70% = $2,100

129

Mem Corp., which had earnings and profits of $500,000, made a nonliquidating distribution of property to its stockholders during the current year.  This property had an adjusted basis of $10,000 and a fair market value of $15,000 at the date of distribution. The property was subject to a liability of $12,000, which its stockholders assumed.  How much gain did Mem have to recognize as a result of this distribution?

  1. $0
  2. $2,000
  3. $5,000
  4. $7,000

$5,000

If a corporation makes a nonliquidating distribution of appreciated property to a shareholder, the corporation must recognize gain just as if the property were sold at its fair market value. Here, Mem must recognize a gain of $15,000 — $10,000 = $5,000. A liability increases the recognized gain only when the amount of liability exceeds fair market value.

130

Which of the following is an eligibility requirement in 2015 to file a valid election to be taxed as an S corporation?

  • Must have no more than 75 shareholders, and a husband and wife who each own stock are counted as two shareholders.
  • Must have no more than 100 shareholders, and a husband and wife who each own stock are counted as two shareholders.
  • Must have no more than 100 shareholders, and a husband and wife who each own stock are counted as one shareholder.
  • Must have no more 75 shareholders, and a husband and wife who each own stock are counted as one shareholder.

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

The shareholder limit is 100 and members of the same family count as one shareholder.