R3

Question 1

C Corporation

Answer 1

PUBLICALLY TRADED
Gross income is recognized when received

Temporary book and tax differences:
Interest income received in advance
Rental income received in advance (including rent deposit and cancellation payments)
Royalty income received in advance

Permanent book and tax differences:
Interest income from municipal or state bonds
Proceed from life insurance on life of key person when corporation is the beneficiary (GAAP treats premiums as expense, no tax is paid on the tax benefit so no tax deduction can be on the premiums)

Question 2

When would a C Corporation use accrual basis?

Answer 2

1. Accounting for purchases and sale of inventory (business more than $31 million (2025) of average annual gross receipts for 3 year period)
2. Tax shelter (legal ways to reduce taxable income), prevents manipulation
3. Farming corporations (business more than $31 million (2025) of average annual gross receipts for 3 year period)
4. C corporations, trusts with unrelated trade or business income, partnership having a c corporation as a partner (business more than $31 million (2025) of average annual gross receipts for 3 year period)
5. Manufactures

Question 3

Ordinary and necessary expenses in trade or business

Answer 3

Can be deductible when paid or incurred during the taxable year in carrying on a business

Ordinary and necessary: common in the business and relate to the production of current year’s income

Question 4

Executive Compensation

Answer 4

C corporations cannot deduct more than $1,000,000 paid to covered employees (CEO, CFO, 3 other most-highly compensated officers)

Entertainment expenses for officers, directors, 10% or greater shareholder can only deduct these expenses if included in individuals gross income

Reasonable compensation to share-holder employees

If shareholder’s salary is unreasonable, excess will be reclassified as a dividend distribution (not a deductible expense)

Question 5

Bonus Accruals

Answer 5

C Corporations using accrual basis can deduct the bonus expense in the year it is accrued

As long as (1) paid within 2.5 months of taxpayer year-end (2) all events occurred that established liability of the bonus

Question 6

Bad Debt Expense

Answer 6

GAAP: allowance method

Tax accrual: direct write off method
Tax Cash: no bad debt unless its a check bounce

Excludes financial institutions like small banks or thrift

Question 7

Business Interest Expense

Answer 7

Debt incurred for business purposes are deductible

If average gross receipts are more than $31 million (2025) for 3 years. Deduction Is sum of (1) business interest income (2) 30% of ATI (3) floor plan financing

Excess (disallowed) business interests expense can be carry forward indefinitely

Question 8

Prepaid interest expense

Answer 8

Allocated to the proper period it relates for accrual AND CASH taxpayers

Question 9

Charitable Contributions

Answer 9

Max deduction of 10% of their taxable income (Before any charitable deductions, dividend-received deductions, or capital loss carry back

Excess (Disallowed) contributions can be carry forward 5 years

If contributions are not given in cash immediately, accrual must be paid within 3.5 months of taxable year end to be deductible

Question 10

Business or casualty loss

Answer 10

Partially destroyed: lesser of (1) decline in FMV (2) adjusted bodied of property immediately before casualty (NBV)

Fully destroyed: Adjusted basis of property before casualty (NBV)

Subtract both from insurance reimbursements

Question 11

Organizational and start-up costs

Answer 11

Up to $5,000 for both

If costs exceed $50,000, $5,000 is reduced dollar for dollar

Excess costs are amortized over 180 months (15 years) beginning month active business began

Org costs: legal services drafting charter or bylaws, accounting fees, state incorporation fees

Start-up costs: training, advertising, testing costs

Not included: raising capital, commission, underwriter fee, transfer assets to corporation costs

Question 12

Life Insurance Premiums

Answer 12

Corporation is the beneficiary = not deductible

Employee is beneficiary = deductible

Question 13

Business gifts, meals, entertainment

Answer 13

Gifts: max $25 deduction per recipient per year
Meals: 50% deduction for client portion
Entertainment: not deductible

Question 14

Sexual harassment or abuse payments

Answer 14

Not deductible if payment is subject to a nondisclosure agreement

Question 15

Taxes

Answer 15

State and local and federal payroll are deductible when incurred on property or business income

Federal income tax = not deductible

Foreign income tax can b a credit

Question 16

Uniform Capitalization Rules (IRC Section 263A)

Answer 16

Require certain costs normally expensed be capitalized as part of inventory for tax purposes

May cause the corporation to make an M-1 or M3 adjustment on their tax return

Question 17

Exception to the General rule: Accrual basis corporation deducts expenses when they are incurred, regardless of when payment is made

Answer 17

Exception: When made to a related party - owns more than 50% of corporation’s stock and is a cash-basis shareholder - do not deduct accrued expenses until paid

Question 18

Illegal Business

Answer 18

Must report business income and can deduct cost of merchandise ONLY

Question 19

Schedule M-1 & M-3

Answer 19

Included on Form 1120

M-1: reconciliation of book income to taxable income

M-3: M-1 AND M-3 for for large corporations with assets of $10 million or more (more detailed because of distinguishes of temporary vs permanent differences

Question 20

C Corporation Filing Requirements

Answer 20

December 31 year-end: 15th day of fourth month = April 15 (6 month extension)
June 30 year-end: 15th day of third month = September 15th (7 month extension)

Question 21

C Corporation Estimated Payments

Answer 21

15th of the fourth, sixth, ninth, and 12th month

Unequal payments allowed

Underpayment penalty if: not made timely or off by $500 or more

Large Corporations ($1 million taxable income for any 3 preceding years): 100% of tax shown on current year return

Not Large Corporations: Lesser of: 100% of tax shown on current year return or 100% of tax shown on preceding year

Question 22

General Business Credit limitation

Answer 22

Cannot exceed:
Net income tax (reg tax - nonrefundable tax credit) - (25% of net reg tax)

Unused credits can be carry back one year or carry forward 20 years

Question 23

Foreign tax credit

Answer 23

Can choose either credit or deduction (once credit is elected, you cannot use the deduction)

Calculation steps:
(1) Given qualified foreign income taxes paid for tax year
(2) WTI * US % = US Tax
(3) FI/ WTI = Ratio
(4) Ratio * US Tax = Limitation
(5) Lesser of step (1) or (4)

Unused tax credits can be carry forward 10 years or back 1 year

Question 24

Accumulated Earnings Tax

Answer 24

C Corporations with over $250,000 RE are taxed 20% of excess Personal Service Corporations with over $150,000 RE are taxed 20% excess Not imposed on: personnel holding companies, tax-exempt organizations, passive foreign investment corporations Can have more in RE for valid reasons IRS Assessed due to IRS audit

Question 25

Personal Holding Company

Answer 25

Corporations with 50% owned by 5 or fewer individuals and has 60% of adjusted ordinary gross income of: N: Net Rent I: Interest that is taxable R: Royalties (not mineral, gas, oil) D: Dividends from unrelated domestic corporations 20% on net income not distributed or consent dividends Net income: deduct federal income taxes and LTCG - related federal tax Self-assessed

Question 26

Required to qualify as an S Corporation?

Answer 26

(1) Domestic corporation (2) All shareholders (voting and nonvoting) must consent to election on form 2552 and file with IRS - No more than 1 class of common stock outstanding - No consolidated tax returns with C Corporations (Exception: S Corporation can create a subsidiary in which they own 100%, file as one entity though)

Question 27

S Corporation Shareholders

Answer 27

No more than 100 (Spouse 1 & 2, Son and Daughter = 1 shareholder) Individuals, estates, certain trusts, qualified retirement plans, 501(c)(3) charitable organizations NOT partners or C Corporations or nonresident aliens

Question 28

When does an S Corporation election take effect?

Answer 28

Calendar year: Before March 15th = January 1st of that year After March 15th = January 1st of following year Non-calendar year: Before 15th day of the third month = first day of fiscal year After 15th day of the third month = first day of next fiscal year

Question 29

Filing taxes for an S Corporation

Answer 29

Form 1120S Must be calendar-year unless valid reason Due 15th day of third month (March 15th) after tax year No corporation level tax (some exceptions: C Corp first, and then S Corp)

Question 30

Termination of S Corporation Election

Answer 30

1. Shareholder is holding more than 50% of the stock concept to voluntary revocation (Filed by March 15th = January 1st of current year, after = January 1 of following year) 2. Corporation or partner becomes owner, Foreign owner, more than 100 owners (Immediate) 3. Excess passive investment income of 25% of gross receipts for three consecutive years AND has prior C Corporation RE (Beginning of forth year)

Question 31

When can you reelect S Status after termination?

Answer 31

Wait until the beginning of the 5th year

Question 32

Short Tax Years

Answer 32

When S Status is terminated, corporation will be an S Corporation for part of the year and C Corporation for other part of year Allocate income and expenses based on days (one tax return) or close the books on date of conversion (two tax return)

Question 33

Compare Partnerships and S Corporations

Answer 33

Similar: flow-through entity, allocation made on per-share, per-day basis Different: (1) Self employemeent tax: S Corporations NO, Partnerships YES (2) Debt: S Corporations have separate debt baiss for loans madee to S Corp, Partnership includes partner's share of liabilitis (3) Fringe Benefits & Health Insurance Premiums: S Corporation 2% rules, Partnership treated as guaranteed payments (4) Guarenteed payments: S Corporation is not a thing, Partnership is included in ordinary income (5) Retirement plan contributions: S Corporation are ordinary business expense and not separately stated, Partnerships are nondeductible and separately stated

Question 34

S Corporation Separately Stated Items

Answer 34

These items are taxed differently than ordinary income so you must report them separately Rental RE Income (Sch E, passive) Interest and dividend Income (Sch B, passive) Royalties (Sch E) Net STCG, LTCG (Sch D) Net Section 1231 gain/loss (Sch D) Charitable Contributions (Sch A, itemized deduction) Section 179 expense deduction These separately stated items are taxed when EARNED, not when distributed to shareholders

Question 35

Deductible vs Nondeductible Fringe benefits for S Corporations

Answer 35

Non-shareholder employees and shareholder employees owning less than 2% are deductible by the S Corporation Shareholders owning more than 2% are not deductible by the S Corporation, unless S Corporation includes the benefits on the employees W-2

Question 36

Accumulated Adjustments Accounts (AAA)

Answer 36

Account to hold RE for S corporations Withdraws are tax-free when distributed to shareholders (they already pay this in their K-1, when they get money it just reduces their basis, if it exceeds their basis it is a taxable gain and taxed) Distributions cannot reduce AAA below zero, only losses and deductions can Increase: Ordinary business income, separately stated income, gain items Decrease: Ordinary business loss, separately stated loss, nondeductible expenses (charity), Distributions

Question 37

S Corporation Stock basis and Debt basis

Answer 37

Added together = taxable basis Stock: Beginning balance (+) income, contributions (-) distributions and losses Ending balance Debt: Debt basis from shareholder loan (-) principal payments Ending debt basis Review example in Exhibits

Question 38

Schedule K

Answer 38

Indicates all separately state items of the partnership or S Corporation Schedule K-1 then breaks it up by amount and type for each partner/ shareholder

Question 39

Partnership's debt depends on...

Answer 39

General partner (Accept all debt responsibility) Limited partner or LLC member (Limited responsibility) Nonrecourse (secured) recourse (personal guaranteed)

Question 41

Limited Liability Company (LLC)

Answer 41

Separate legal entity from its owners Owned by Members, not personally liable for business obligations Taxed as: (1) At least two owners = partnership unless C Corporation election (2) Single member LLC = Sole proprietorship (disregarded entity)

Question 42

Limited Partnership

Answer 42

Different from general partnership At least one or more general partners who have unlimited personal liability At least one or more limited partners have no personal liability

Question 43

501(c)(3)

Answer 43

Religious, charitable, scientific. testing for public safety, literacy, educational, fostering amateur sports competitions (cannot provide athletic facilities or equipment), Cruelty to children or animals Can be private or public charities Private: (1) distribute income each year as required (2) not engage in acts of self-dealing or retain business holdings Common to be a single major funding source that contributes to other charitable programs Private: at least 1/3 of support must come from government or public Churches, schools, hospitals, testing public safety, NFP supporting public charities

Question 44

Other tax exempt organizations

Answer 44

Federal credit unions Title holding corporations (holding property title, collecting income, donating it) Civic leagues and social welfare organizations Labor, agriculttural organizaitons Business leagues Social and recreational clubs Fraternity and sororities Mutual insurance companies Cemetery companies Veterans' organizations

Question 45

Political Organizations

Answer 45

Tax exempt income from Section 527 Contributions are not deductible

Question 46

Nexus

Answer 46

Must be state tax if it has nexus Minimum level of contract a taxpayer may have with a jurisdiction to be subject to its tax Not subject if business was of tangible personal property, orders are sent outside the state for acceptance/ rejection, if those orders are accepted, they are filled by shipment or delivery from a point outside the state Common examples: owning or leasing personal or real property, sending employees for trainings, installation. maintenance to customers within the state, accepting or rejecting sales orders in the state, accepting returns in the state, collection of delinquent accounts

Question 47

Allocation vs Apportionment of state sales

Answer 47

Allocation: nonbusiness income assigned to state where it is domiciled Apportionment: business income is distributed among state (view exhibit for example)