Reg 3 Flashcards
(167 cards)
1
Q
A C corporation’s net capital losses are:
a.
Carried forward indefinitely until fully utilized.
b.
Deductible in full from the corporation’s ordinary income.
c.
Deductible from the corporation’s ordinary income only to the extent of $3,000.
d.
Carried back 3 years and forward 5 years.
A
Choice “d” is correct. A C corporation’s net capital losses are carried back 3 years and forward 5 years; they expire after 5 years. In addition, a C corporation cannot deduct net capital losses from ordinary income.
2
Q
Baker Corp., a calendar year C corporation, realized taxable income of $36,000 from its regular business operations for the calendar year. In addition, Baker had the following capital gains and losses during the year. Short-term capital gain $ 8,500 Short-term capital loss (4,000) Long-term capital gain 1,500 Long-term capital loss (3,500) Baker did not realize any other capital gains or losses since it began operations. What is Baker's total taxable income for the year? a. $42,000 b. $40,500 c. $38,500 d. $46,000
A
Choice "c" is correct. Capital losses offset capital gains. If a corporation has net capital gains, they are taxed at ordinary (corporate) income tax rates. Taxable income from business operations $ 36,000 Short-term capital gain $ 8,500 Short-term capital loss (4,000) Net short-term capital gain $ 4,500 Long-term capital gain 1,500 Long-term capital loss (3,500) Net capital gain 2,500 Taxable income $ 38,500
3
Q
At the beginning of the year, Westwind, a C corporation, had a deficit of $45,000 in accumulated earnings and profits. For the current year, Westwind reported earnings and profits of $15,000. Westwind distributed $12,000 during the year. What was the amount of Westwind's accumulated earnings and profits at year-end? a. $45,000 b. $57,000 c. $30,000 d. $42,000
A
Choice "d" is correct. Accumulated earnings and profits include all prior and current year earnings and profits at year-end. The key here is recognizing that the beginning accumulated earnings and profits is a deficit. Thus the calculation would be as follows: Beginning deficit in Accumulated E&P $ (45,000) Plus: Current year E&P 15,000 Less: Amounts distributed (12,000) End of year Accumulated E&P $ 42,000 Note: The examiners did not ask whether or not the accumulated earnings and profits at year-end was a deficit, rather they asked solely for the dollar amount.
4
Q
A corporation’s capital loss carryback or carryover is:
a.
Limited to $3,000.
b.
Always treated as a long-term capital loss.
c.
Not allowable under current law.
d.
Always treated as a short-term capital loss.
A
Choice “d” is correct. A corporation’s capital loss carryback or carryover is always treated as a short-term capital loss.
Rule: Corporations may not deduct any capital loss from ordinary income, but instead only carry it back 3 years and forward 5 years as a “short-term” capital loss to deduct from net capital or Section 1231 gains.
5
Q
Jackson, a single individual, inherited Bean Corp. common stock from Jackson’s parents. Bean is a qualified small business corporation under Code Section 1244. The stock cost Jackson’s parents $20,000 and had a fair market value of $25,000 at the parents’ date of death. During the year, Bean declared bankruptcy and Jackson was informed that the stock was worthless. What amount may Jackson deduct as an ordinary loss in the current year? a. $0 b. $20,000 c. $25,000 d. $3,000
A
Choice “a” is correct. Losses resulting from the sale, exchange or worthlessness of Section 1244 qualifying stock (also called small business stock) are treated as ordinary losses up to $50,000 in any tax year. However, this loss is available only to original owners of the stock. Because Jackson inherited the stock, he is not the original owner. Therefore, in this case, no ordinary loss may be deducted. (Note that Jackson would be allowed a capital loss in the year the stock was deemed entirely worthless. The capital loss would be deducted under the personal capital loss rules and calculated using the likely transfer basis of $25,000.)
6
Q
Which of the following is not true with regard to personal holding companies (PHCs)?
a.
There is no penalty if net earnings are distributed, as the penalty only applies to income that has not been distributed.
b.
The additional tax (penalty) is self-assessed by the PHC.
c.
Personal holding companies are not subject to the accumulated earnings tax.
d.
Personal holding companies, as specifically defined by the Code, are corporations that meet certain “closely-held” ownership criteria and have over 50% of their adjusted gross income consisting of net rent (less than 50% of ordinary gross income), taxable interest, most royalties, and dividends from an unrelated domestic corporation.
A
Choice “d” is correct. While most of the information in the item is correct, it is when over 60% of the adjusted gross income of a closely-held (more than 50% owned by 5 or fewer individuals either directly or indirectly at any time during the last half of the tax year) corporation consists of “NIRD” that it is defined as a personal holding company, not over 50% (as in the selection).
7
Q
Mock operates a retail business selling illegal narcotic substances. Which of the following item(s) may Mock deduct in calculating business income? I. Cost of merchandise. II. Business expenses other than the cost of merchandise. a. Both I and II. b. I only. c. Neither I nor II. d. II only.
A
Choice “b” is correct. A gain from an illegal activity is includible in income. To determine the gain, a deduction is permitted for cost of merchandise. Business expenses for operating an illegal business, other than the cost of merchandise, are not permitted as deduction.
8
Q
Which of the following taxpayers may use the cash method of accounting?
a.
A tax shelter.
b.
A manufacturer.
c.
A C corporation with annual gross receipts of $50,000,000.
d.
A qualified personal service corporation.
A
Choice “d” is correct.
Rule: The general rule is that the accrual method of accounting will be required by tax shelters, large C corporations and manufacturers. The IRS has the authority to require that a taxpayer use a method of accounting to accurately reflect the proper income and expenses. Personal Service Corporations are permitted the use of the cash method.
9
Q
On January 1, Year 1, Locke Corp., an accrual-basis, calendar-year C corporation, had $30,000 in accumulated earnings and profits. For Year 1, Locke had current earnings and profits of $20,000, and made two $40,000 cash distributions to its shareholders, one in April and one in September of Year 1. What amount of the Year 1 distributions is classified as dividend income to Locke's shareholders? a. $50,000 b. $80,000 c. $0 d. $20,000
A
Choice “a” is correct. Dividends are distributions of a corporation’s earnings & profits, including accumulated (prior year) and current year E&P. Because the corporation had both accumulated E&P of $30,000 and current E&P of $20,000, the total amount of distributions classified as dividends is $50,000.
10
Q
On January 2 of the current year, Shaw Corp., an accrual-basis, calendar-year C corporation, purchased all the assets of a sole proprietorship, including $300,000 in goodwill. Current-year federal income tax expense of $110,100 and $7,500 for goodwill impairment were deducted to arrive at Shaw's reported book income of $239,200. What should be the amount of Shaw's current-year taxable income, as reconciled on Shaw's Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return? a. $329,300 b. $349,300 c. $336,800 d. $239,200
A
Choice "c" is correct. $336,800 should be reported as Shaw's current-year taxable income, reconciled as follows on Shaw's Schedule M-1 on the Form 1120: Book income $ 239,200 Add: Federal income tax expense 110,100 [1] Less: Excess of tax amortization over book impairment of goodwill (12,500) [2] Taxable income $ 336,800 [1] Federal income taxes paid are not deductible for tax purposes. [2] The excess amortization is determined as follows: Total purchased goodwill $ 300,000 Divided by 15 years ÷ 15 [tax amortization period] Tax amortization $ 20,000 Less: Book impairment (given) (7,500) Excess tax amortization for the current year $ 12,500
11
Q
How are a C corporation’s net capital losses used?
a.
Carried back three years and forward five years.
b.
Deducted from the corporation’s ordinary income only to the extent of $3,000.
c.
Deductible in full from the corporation’s ordinary income.
d.
Carried forward 20 years.
A
Choice “a” is correct. A C corporation’s net capital losses are carried back three years and forward five years.
12
Q
If a corporation’s charitable contributions exceed the limitation for deductibility in a particular year, the excess:
a.
May be carried back or forward for one year at the corporation’s election.
b.
Is not deductible in any future or prior year.
c.
May be carried back to the third preceding year.
d.
May be carried forward to a maximum of five succeeding years.
A
Choice “d” is correct.
Rule: A corporate charitable deduction that exceeds the limit for deduction in one year can be carried over to the succeeding five tax years. It cannot be carried back.
13
Q
A corporation may reduce its regular income tax by taking a tax credit for: a. Accelerated depreciation. b. State income taxes. c. Foreign income taxes. d. Dividends-received exclusion.
A
Choice “c” is correct. Under certain conditions a taxpayer may take a credit against its U.S. income tax for foreign income taxes paid.
14
Q
The accumulated earnings tax can be imposed:
a.
On both partnerships and corporations.
b.
Regardless of the number of stockholders in a corporation.
c.
On personal holding companies.
d.
On companies that make distributions in excess of accumulated earnings.
A
Choice “b” is correct. The imposition of the accumulated earnings tax does not depend on the number of shareholders a corporation has.
15
Q
The following information pertains to Dahl Corp.:
Accumulated earnings and profits at January 1, Year 1 $ 120,000
Earnings and profits for the year ended December 31, Year 1 160,000
Cash distributions to individual stockholders during Year 1 360,000
What is the total amount of distributions taxable as dividend income to Dahl’s stockholders in Year 1?
a.
$160,000
b.
$280,000
c.
$360,000
d.
$0
A
Choice “b” is correct. Distributions out of the sum of current and accumulated earnings and profits are taxable as dividends to the recipients.
Accumulated E&P at 1/1/Year 1 $ 120,000
Earnings in Year 1 160,000
Taxable dividends to recipients 280,000
Excess distributed 80,000
Total distributed $ 360,000
Any excess reduces the shareholder’s basis in Dahl stock, and any amount beyond that required to reduce the shareholder’s basis to zero is treated as received on the sale or exchange of the stock and is capital gain.
16
Q
A corporation's tax year can be reopened after all statutes of limitations have expired if: I. The tax return has a 50% nonfraudulent omission from gross income. II. The corporation prevails in a determination allowing a deduction in an open tax year that was taken erroneously in a closed tax year. a. I only. b. Neither I nor II. c. Both I and II. d. II only.
A
Choice “d” is correct. If the prior omission was nonfraudulent, the statute of limitations cannot be reopened after it has expired.
To mitigate the unfair effects of the statute of limitations in some rare cases, a tax year can be reopened to avoid hardship for the taxpayer or the IRS. In the case in which an item is ruled deductible in a subsequent year after having been taken in a year now closed by the statute of limitations, the IRS will reopen the statute of limitations to disallow the deduction in the previous year.
17
Q
Edge Corp. met the stock ownership requirements of a personal holding company. What sources of income must Edge consider to determine if the income requirements for a personal holding company have been met? I. Interest earned on tax-exempt obligations. II. Dividends received from an unrelated domestic corporation. a. I only. b. II only. c. Both I and II. d. Neither I nor II.
A
Choice “b” is correct.
I.
Interest is normally included in personal holding company income, but only if it is included in the receiving corporation’s gross income. Since interest income from tax-exempt obligations is not included in gross income, it is not personal holding company income.
II.
Dividend income from unrelated domestic corporations is personal holding company income.
18
Q
Banks Corp., a calendar year corporation, reimburses employees for properly substantiated qualifying business meal expenses. The employees are present at the meals, which are neither lavish nor extravagant, and the reimbursement is not treated as wages subject to withholdings. What percentage of the meal expense may Banks deduct? a. 100% b. 0% c. 80% d. 50%
A
Choice “d” is correct. Only 50% of business meal and entertainment expense is deductible.
19
Q
In Year 1, Best Corp., an accrual-basis calendar-year C corporation, received $100,000 in dividend income from the common stock that it held in an unrelated domestic corporation. The stock was not debt-financed and was held for over a year. Best recorded the following information for Year 1: Loss from Best's operations $ (10,000) Dividends received 100,000 Taxable income (before dividends-received deduction) 90,000 Best's dividends-received deduction on its Year 1 tax return was: a. $100,000 b. $80,000 c. $63,000 d. $70,000
A
Choice “c” is correct. The dividends-received deduction (“DRD”) is generally calculated as 70% of dividends received which would be $70,000 (70% × $100,000). However, the deduction is limited to 70% × dividends received deduction (DRD) modified taxable income. DRD modified taxable income is calculated as taxable income before the dividends received deduction, any NOL carryover or carryback deduction, capital loss carryback deduction, and the domestic production activities deduction. Because the loss of $10,000 is a current year loss and not a carryover or carryback, it is not an adjustment to taxable income when calculating modified taxable income. DRD modified taxable income is $90,000. Best’s DRD deduction on its Year 1 tax return is limited to $63,000 (70% × $90,000).
20
Q
In Year 2, Cable Corp., a calendar year C corporation, contributed $80,000 to a qualified charitable organization. Cable's Year 2 taxable income before the deduction for charitable contributions was $820,000 after a $40,000 dividends-received deduction. Cable also had carryover contributions of $10,000 from Year 1. In Year 2, what amount can Cable deduct as charitable contributions? a. $82,000 b. $90,000 c. $86,000 d. $80,000
A
Choice “c” is correct. A C corporation can deduct charitable contributions up to 10% of its taxable income after adding back the dividends-received deduction; $820,000 taxable income + $40,000 dividends-received deduction = $860,000. 10% × $860,000 = $86,000, the maximum allowable charitable contribution deduction. $4,000 is carried forward to Year 3. A corporate charitable deduction that exceeds the limit for deduction in one year can be carried over to the succeeding five tax years. It cannot be carried back.
21
Q
If a corporation’s charitable contributions exceed the limitation for deductibility in a particular year, the excess:
a.
May be carried back to the third preceding year.
b.
May be carried forward to a maximum of five succeeding years.
c.
May be carried back or forward for one year at the corporation’s election.
d.
Is not deductible in any future or prior year.
A
Choice “b” is correct.
Rule: A corporate charitable deduction that exceeds the limit for deduction in one year can be carried over to the succeeding five tax years. It cannot be carried back.
22
Q
In Year 1, Stewart Corp. properly accrued $5,000 for an income item on the basis of a reasonable estimate. In Year 2, after filing its Year 1 federal income tax return, Stewart determined that the exact amount was $6,000. Which of the following statements is correct?
a.
No further inclusion of income is required as the difference is less than 25% of the original amount reported and the estimate had been made in good faith.
b.
Stewart is required to file an amended return to report the additional $1,000 of income.
c.
Stewart is required to notify the IRS within 30 days of the determination of the exact amount of the item.
d.
The $1,000 difference is includible in Stewart’s Year 2 income tax return.
A
Choice “d” is correct. Under these facts the estimate was accurate based on information available when the return was filed. When the exact amount is known, the difference is included in income in the year the amount is received or the exact amount is determined.
23
Q
A personal holding company deducts federal income taxes in computing undistributed personal holding company income.
A
A personal holding company deducts net long-term capital gain less related federal income taxes in computing undistributed personal holding company income.
24
Q
From question:
In filing a consolidated federal income tax return, a corporate group eliminates the dividends from group members. Shore would have to be included in Bank’s group consolidated income tax return because Bank owns 80% of Shore.
A
No dividend income reported when own 80%
25
```
Dart Corp., a calendar year domestic C corporation, is not a personal holding company. For purposes of the accumulated earnings tax, Dart has accumulated taxable income for Year 1. Which step(s) can Dart take to eliminate or reduce any Year 1 accumulated earnings tax?
I.
Demonstrate that the "reasonable needs" of its business require the retention of all or part of the Year 1 accumulated taxable income.
II.
Pay dividends by March 15, Year 2.
a.
II only.
b.
I only.
c.
Both I and II.
d.
Neither I nor II.
```
Choice "c" is correct. Dart can take both actions to eliminate or reduce any Year 1 accumulated earnings tax. A corporation that can demonstrate that its reasonable business needs require it to accumulate earnings can escape the accumulated earnings tax on the portion reasonably accumulated. Dividends paid by the 15th day of the third month after the close of the corporation's tax year reduce the accumulated earnings subject to the accumulated earnings tax.
26
Eastern Corp., a calendar year corporation, was formed January 3, Year 1, and on that date placed five-year property in service. The property was depreciated under the general MACRS system. Eastern did not elect to use the straight-line method. The following information pertains to Eastern:
Eastern's Year 1 taxable income $ 300,000
Adjustment for the accelerated depreciation taken on Year 1 five-year property 1,000
Year 1 tax-exempt interest from specified private activity bonds issued 5,000
What was Eastern's Year 1 alternative minimum taxable income before the adjusted current earnings (ACE) adjustment?
a.
$304,000
b.
$301,000
c.
$305,000
d.
$306,000
Choice "d" is correct. Eastern's alternative minimum taxable income before the ACE adjustment (and ignoring the exemption allowable) is $306,000:
Taxable income $ 300,000
Adjustment for regular tax accelerated depreciation 1,000
Tax preference for private activity bond interest 5,000
AMTI $ 306,000
27
The accumulated earnings tax can be imposed:
a.
On personal holding companies.
b.
On companies that make distributions in excess of accumulated earnings.
c.
On both partnerships and corporations.
d.
Regardless of the number of stockholders in a corporation.
Choice "d" is correct. The imposition of the accumulated earnings tax does not depend on the number of shareholders a corporation has.
28
The following information pertains to Dahl Corp.:
Accumulated earnings and profits at January 1, Year 1 $ 120,000
Earnings and profits for the year ended December 31, Year 1 160,000
Cash distributions to individual stockholders during Year 1 360,000
What is the total amount of distributions taxable as dividend income to Dahl's stockholders in Year 1?
a.
$360,000
b.
$0
c.
$160,000
d.
$280,000
Choice "d" is correct. Distributions out of the sum of current and accumulated earnings and profits are taxable as dividends to the recipients.
Accumulated E&P at 1/1/Year 1 $ 120,000
Earnings in Year 1 160,000
Taxable dividends to recipients 280,000
Excess distributed 80,000
Total distributed $ 360,000
Any excess reduces the shareholder's basis in Dahl stock, and any amount beyond that required to reduce the shareholder's basis to zero is treated as received on the sale or exchange of the stock and is capital gain.
29
```
Bass Corp., a calendar year C corporation, made qualifying Year 2 estimated tax deposits based on its actual Year 1 tax liability. On March 15, Year 3, Bass filed a timely automatic extension request for its Year 2 corporate income tax return. Estimated tax deposits and the extension payment totaled $7,600. This amount was 95% of the total tax shown on Bass' final Year 2 corporate income tax return. Bass paid $400 additional tax on the final Year 2 corporate income tax return filed before the extended due date. For the Year 2 calendar year, Bass was subject to pay:
I.
Interest on the $400 tax payment made in Year 3.
II.
A tax delinquency penalty.
a.
I only.
b.
II only.
c.
Neither I nor II.
d.
Both I and II.
```
Choice "a" is correct. A taxpayer does not extend the time for payment of tax by extending the filing deadline for the return. If there is tax owed when the return is filed, interest must be paid at the rate prescribed by IRC §6621; therefore, Bass was subject to pay interest on the $400 tax payment made in Year 3. There is no delinquency penalty if the taxpayer files its return, pays at least 90% of the tax due by the due date, and pays the balance due on or before the extended due date (all of which Bass Corp. complied with).
30
```
A corporation's tax year can be reopened after all statutes of limitations have expired if:
I.
The tax return has a 50% nonfraudulent omission from gross income.
II.
The corporation prevails in a determination allowing a deduction in an open tax year that was taken erroneously in a closed tax year.
a.
Both I and II.
b.
II only.
c.
I only.
d.
Neither I nor II.
```
Choice "b" is correct. If the prior omission was nonfraudulent, the statute of limitations cannot be reopened after it has expired.
To mitigate the unfair effects of the statute of limitations in some rare cases, a tax year can be reopened to avoid hardship for the taxpayer or the IRS. In the case in which an item is ruled deductible in a subsequent year after having been taken in a year now closed by the statute of limitations, the IRS will reopen the statute of limitations to disallow the deduction in the previous year.
31
```
Edge Corp. met the stock ownership requirements of a personal holding company. What sources of income must Edge consider to determine if the income requirements for a personal holding company have been met?
I.
Interest earned on tax-exempt obligations.
II.
Dividends received from an unrelated domestic corporation.
a.
Both I and II.
b.
Neither I nor II.
c.
I only.
d.
II only.
```
Just 2
32
Jaxson Corp. has 200,000 shares of voting common stock issued and outstanding. King Corp. has decided to acquire 90 percent of Jaxson's voting common stock solely in exchange for 50 percent of its voting common stock and retain Jaxson as a subsidiary after the transaction. Which of the following statements is true?
a.
Jaxson must surrender assets for the transaction to qualify as a tax-free reorganization.
b.
King must issue at least 60 percent of its voting common stock for the transaction to qualify as a tax-free reorganization.
c.
King must acquire 100 percent of Jaxson stock for the transaction to be a tax-free reorganization.
d.
The transaction will qualify as a tax-free reorganization.
Choice "d" is correct. The acquisition of a controlling (usually 80%) interest by one corporation in the stock of another corporation solely for stock is a tax-free (Type B) reorganization.
33
For the current year, 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 (taxableincome 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 current year?
a.
$330,000
b.
$345,000
c.
$250,000
d.
$380,000
```
Choice "b" is correct.
Book net income $ 300,000
Nondeductible bad debt expense 80,000
Dividends received deduction (35,000)
$ 345,000
```
34
```
For the year ended December 31, Year 6, Taylor Corp. had a net operating loss of $200,000. Taxable income for the earlier years of corporate existence, computed without reference to the net operating loss, was as follows:
Taxable income
Year 1
$ 5,000
Year 2
10,000
Year 3
20,000
Year 4
30,000
Year 5
40,000
What amount of net operating loss will be available to Taylor for the year ended December 31, Year 7?
a.
$110,000
b.
$200,000
c.
$130,000
d.
$95,000
```
Choice "c" is correct. Year 4 to Year 5, Taylor will carry its NOL back two years and forward until it is used (but not more than 20 years). Carrying the NOL back to Year 4 to Year 5 absorbs $70,000 of the $200,000 NOL generated in Year 6 leaving $130,000 to be absorbed in Year 7 and later years.
35
Axis Corp. is an accrual basis calendar year corporation. On December 13, Year 1, the Board of Directors declared a two percent of profits bonus to all employees for services rendered during Year 1 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, Year 2. Axis' bonus expense may:
a.
Not be deducted on Axis' Year 1 tax return because the per share employee amount cannot be determined with reasonable accuracy at the time of the declaration of the bonus.
b.
Not be deducted on Axis' tax return because payment is a disguised dividend.
c.
Be deducted on Axis' Year 2 tax return.
d.
Be deducted on Axis' Year 1 tax return.
Choice "d" is correct. The deduction is an ordinary and necessary business expense treated just as any other compensation expense is treated. Axis is an accrual basis taxpayer, and the deduction is taken on the return for the year in which the expense accrued because it was paid within 2-1/2 months of year-end.
36
Tapper Corp., an accrual basis calendar year corporation, was organized on January 2, Year 1. During Year 1, 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, Year 1 $ 500,000
Tapper's matching contribution to employee-designated qualified universities made during Year 1 10,000
Board of Directors' authorized contribution to a qualified charity (authorized December 1, Year 1, made February 1, Year 2) 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, Year 1?
a.
$0
b.
$10,000
c.
$30,000
d.
$40,000
Choice "d" is correct. Tapper's college matching contributions are deductible; Tapper made the contributions; the employees merely directed the proceeds. The Board's authorized contribution is also deductible since it satisfies the two rules under which an accrual-basis corporation can deduct an accrued contribution: 1) it was authorized to a qualified charity by Board resolution before the end of the taxable year and 2) it was paid by the 15th day of the 3rd month after the end of the taxable year of accrual.
37
Which of the following costs are expensable/amortizable organizational expenditures?
a.
Printing costs to issue the corporate stock.
b.
Commissions paid by the corporation to an underwriter.
c.
Legal fees for drafting the corporate charter.
d.
Professional fees to issue the corporate stock.
Choice "c" is correct. The costs of organizing the corporation are expensable (subject to the $5,000 limitation) and amortizable, but the costs of selling stock are not. The only expense listed that qualifies for expense/amortization is the legal fees for drafting the corporate charter; the others relate to the sale of stock.
38
With regard to consolidated tax returns, which of the following statements is correct?
a.
The common parent must directly own 51% or more of the total voting power of all corporations included in the consolidated return.
b.
Of all intercompany dividends paid by the subsidiaries to the parent, 70% are excludible from taxable income on the consolidated return.
c.
Operating losses of one group member may be used to offset operating profits of the other members included in the consolidated return.
d.
Only corporations that issue their audited financial statements on a consolidated basis may file consolidated returns.
Choice "c" is correct. A significant advantage of consolidated tax returns is the ability to offset gains and losses among group members as if they were a single taxpayer.
39
In the filing of a consolidated tax return for a corporation and its wholly owned subsidiaries, intercompany dividends between the parent and subsidiary corporations are:
a.
Not taxable.
b.
Fully taxable.
c.
Included in taxable income to the extent of 20%.
d.
Included in taxable income to the extent of 80%
Choice "a" is correct. Dividends received from other group members are eliminated from the parent's taxable income in consolidation; no dividends received deduction is allowed. Since the parent eliminates the subsidiary dividends in consolidation, they are effectively not taxable.
40
```
A corporation's penalty for underpaying federal estimated taxes is:
a.
Fully deductible if reasonable cause can be established for the underpayment.
b.
Partially deductible.
c.
Fully deductible in the year paid.
d.
Not deductible.
```
Choice "d" is correct.
| Rule: The penalty for underpayment of federal estimated taxes is not deductible.
41
```
Which of the following credits is a combination of several tax credits to provide uniform rules for the current and carryback-carryover years?
a.
Enhanced oil recovery credit.
b.
Foreign tax credit.
c.
Minimum tax credit.
d.
General business credit.
```
Choice "d" is correct. The general business credit combines several nonrefundable tax credits and provides rules for their absorption against the taxpayer's liability.
42
```
Blink Corp., an accrual basis calendar year corporation, carried back a net operating loss for the tax year ended December 31, Year 1. Blink's gross revenues have been under $500,000 since inception. Blink expects to have profits for the tax year ending December 31, Year 2. Which method(s) of estimated tax payment can Blink use for its quarterly payments during the Year 2 tax year to avoid underpayment of federal estimated taxes?
I.
100% of the preceding tax year method.
II.
Annualized income method.
a.
I only.
b.
II only.
c.
Neither I nor II.
d.
Both I and II.
```
Choice "b" is correct. Blink cannot use the 100% of preceding tax year method in Year 2 because it did not pay income tax in Year 1. Blink can use the annualized income method.
43
```
Tank Corp., which had earnings and profits of $500,000, made a nonliquidating distribution of property to its shareholders in Year 1 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?
a.
$10,000
b.
$20,000
c.
$30,000
d.
$0
```
Choice "a" is correct. The property distributed by Tank is treated as if it were sold to the shareholder at its fair market value on the date of distribution. Tank recognizes gain to the extent of the fair market value ($30,000) over the adjusted basis ($20,000) or $10,000.
44
```
In a Type B reorganization, as defined by the Internal Revenue Code, the:
I.
Stock of the target corporation is acquired solely for the voting stock of either the acquiring corporation or its parent.
II.
Acquiring corporation must have control of the target corporation immediately after the acquisition.
a.
Neither I nor II.
b.
I only.
c.
II only.
d.
Both I and II.
```
Choice "d" is correct. Both requirements listed are necessary in a Type B reorganization. In a Type B reorganization, the target is acquired using the stock of the acquiring corporation or the acquiring corporation's parent (triangular acquisition). In a Type B reorganization, the acquiring corporation must be in control of the target immediately after the acquisition.
45
```
Jackson Corp., a calendar year corporation, mailed its Year 1 tax return to the Internal Revenue Service by certified mail on Friday, March 11, Year 2. The return, postmarked March 11, Year 2, was delivered to the Internal Revenue Service on March 18, Year 2. The statute of limitations (for assessments) on Jackson's corporate tax return begins on:
a.
December 31, Year 1.
b.
March 11, Year 2.
c.
March 16, Year 2.
d.
March 18, Year 2.
```
Choice "c" is correct. The Year 1 return of a calendar year corporation is due on March 15, Year 2, so the statute of limitations begins on the next day, March 16, Year 2.
46
```
Tech Corp. files a consolidated return with its wholly-owned subsidiary, Dow Corp. During the year, Dow paid a cash dividend of $20,000 to Tech. What amount of this dividend is taxable on the current year's consolidated return?
a.
$14,000
b.
$0
c.
$6,000
d.
$20,000
```
Choice "b" is correct. Intercompany dividends are eliminated when preparing a consolidated return. The $20,000 came from income of Dow and is reported as part of consolidated income. The receipt of the dividend by Tech is not included again.
47
```
On January 1, Year 1, Kee Corp., a C corporation, had a $50,000 deficit in earnings and profits. For Year 1, 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?
a.
$10,000
b.
$0
c.
$20,000
d.
$30,000
```
Choice "a" is correct. Taxable dividend income is paid out of the corporation's current or accumulated earnings and profits. Since Kee had a deficit, only current earnings and profits of $10,000 are available for dividends.
48
In Year 1, Brun Corp. properly accrued $10,000 for an income item on the basis of a reasonable estimate. In Year 2, Brun determined that the exact amount was $12,000. Which of the following statements is correct?
a.
No further inclusion of income is required as the difference is less than 25% of the original amount reported and the estimate had been made in good faith.
b.
The $2,000 difference is includible in Brun's Year 2 income tax return.
c.
Brun is required to notify the IRS within 30 days of the determination of the exact amount of the item.
d.
Brun is required to file an amended return to report the additional $2,000 of income.
Choice "b" is correct. Under the accrual basis of accounting, when you include an amount in gross income on the basis of a reasonable estimate, and you later determine the exact amount, the difference (if any) is taken into account in the tax year in which the determination is made. Therefore, in this case, the additional $2,000 is included in Brun's Year 2 income.
49
```
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?
a.
$140,000
b.
$205,000
c.
$190,000
d.
$150,000
```
Choice "b" is correct. The M-1 reconciliation of book income to taxable income would be as follows:
Book income
$ 140,000
Federal income tax expense deductible from book income, but not deductible for tax purposes
40,000
180,000
50% × $50,000 meals and entertainment expenses not deductible for tax purposes, but deductible from book income
25,000
Taxable income
$ 205,000
50
When computing a corporation's income tax expense for estimated income tax purposes, which of the following should be taken into account?
When computing a corporation's income tax expense for estimated income tax purposes, both corporate tax credits and the alternative minimum tax should be taken into account.
51
Jones incorporated a sole proprietorship by exchanging all the proprietorship's assets for the stock of Nu Co., a new corporation. To qualify for tax-free incorporation, Jones must be in control of Nu immediately after the exchange. What percentage of Nu's stock must Jones own to qualify as "control" for this purpose?
a.
66. 67%
b.
50. 00%
c.
80. 00%
d.
51. 00%
Choice "c" is correct.
Rule: In a tax-free incorporation, the percentage for "control" is 80%, (i.e., control exists if the transferor/shareholder owns at least 80% of the total voting power and at least 80% of the total number of shares of all other classes of stock).
52
A corporation was completely liquidated and dissolved during the year. The filing fees, professional fees, and other expenditures incurred in connection with the liquidation and dissolution are:
a.
Not deductible either by the corporation or shareholders.
b.
Treated as capital losses by the corporation.
c.
Deductible in full by the dissolved corporation.
d.
Deductible by the shareholders and not by the corporation.
Choice "c" is correct. The corporation generally deducts its liquidation expenses (i.e., filing fees, professional fees) on its final tax return.
53
```
Brown Corp., a calendar-year taxpayer, was organized and actively began operations on July 1, Year 1, and incurred the following costs:
Legal fees to obtain corporate charter
$ 41,000
Commission paid to underwriter
25,000
Other stock issue costs
10,000
Brown wishes to amortize its organizational costs over the shortest period allowed for tax purposes. In Year 1, what amount should Brown deduct for the organizational expenses?
a.
$5,000
b.
$6,200
c.
$1,200
d.
$8,600
```
Choice "b" is correct. Organizational costs are amortizable over a minimum period of 15 years (180 months). In addition, subject to a $50,000 total expenditure limitation, a $5,000 deduction is allowed in Year 1. Allowable costs in connection with the corporate organization are legal fees to obtain the corporate charter, necessary accounting services, expenses of temporary directors, and incorporation fees paid to the state. Organizational costs exclude stock issue costs and commissions paid to underwriters to help sell the shares. Only the legal fees of $41,000 qualify as organizational costs. $41,000 − $5,000 = $36,000/180 months = $200 × 6 months = $1,200 + $5,000 (expense in Year 1) = $6,200.
54
```
Acorn Inc. had the following items of income and expense:
Sales $ 500,000
Cost of sales 250,000
Dividends received 25,000
The dividends were received from a corporation of which Acorn owns 30%. In Acorn's corporate income tax return, what amount should be reported as income before special deductions?
a.
$525,000
b.
$250,000
c.
$505,000
d.
$275,000
```
Choice "d" is correct. Income before special deductions includes sales, dividends received and cost of sales. It excludes the dividends received deduction, which is a "special" deduction.
Sales $ 500,000
Cost of sales (250,000)
Gross profit 250,000
Dividends received 25,000
Income before special deductions $ 275,000
55
```
Ace Rentals Inc., an accrual-basis taxpayer, reported rent receivable of $35,000 and $25,000 in its Year 2 and Year 1 balance sheets, respectively. During Year 2, Ace received $50,000 in rent payments and $5,000 in nonrefundable rent deposits. In Ace's Year 2 corporate income tax return, what amount should Ace include as rent revenue?
a.
$55,000
b.
$60,000
c.
$50,000
d.
$65,000
```
Choice "d" is correct. Rent revenue under the accrual basis would include the cash received ($50,000) plus the increase in the rent receivable ($10,000 = $35,000 - 25,000), or $60,000. In addition, the $5,000 nonrefundable rent deposit is additional rent revenue, for a total of $65,000.
56
```
During the year, Portal Corp. received $100,000 in dividends from Sal Corp., its 80%-owned subsidiary. What net amount of dividend income should Portal include in its current year consolidated tax return?
a.
$0
b.
$80,000
c.
$70,000
d.
$100,000
```
Choice "a" is correct. If a corporation owns 80% or more of another corporation, the dividends received deduction is 100% as the dividend income is eliminated in consolidation. Therefore, the net amount of dividend income is $0.
57
```
In Year 2, Garland Corp. contributed $40,000 to a qualified charitable organization. Garland's Year 2 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 Year 2, what amount can Garland deduct as charitable contributions?
a.
$40,000
b.
$43,000
c.
$45,000
d.
$41,000
```
Choice "b" is correct. The charitable contribution deduction is limited to 10% of taxable income before the dividends received deduction and the charitable contribution deduction. 10% ($410,000 + $20,000) = $43,000. The deduction consists of $40,000 from the current year and $3,000 from the prior year contribution carryover. That leaves a $2,000 carryover from Year 1 to Year 3.
58
When a corporation has an unused net capital loss that is carried back or carried forward to another tax year:
a.
It is treated as a long-term capital loss whether or not it was long-term when sustained.
b.
It is treated as a short-term capital loss whether or not it was short-term when sustained.
c.
It retains its original identity as short-term or long-term.
d.
It can be used to offset ordinary income up to the amount of the carryback or carryover.
Choice "b" is correct.
Rule: Unused capital losses of a corporation that are carried back or forward are treated as short-term capital losses whether or not they were short-term or long-term when sustained. Capital losses can only be used to offset capital gains up to the amount of the carryback or carryover, not ordinary income.
59
```
Soma Corp. had $600,000 in compensation expense for book purposes in Year 1. Included in this amount was a $50,000 accrual for Year 1 nonshareholder bonuses. Soma paid the actual Year 1 bonus of $60,000 on March 1, Year 2. In its Year 1 tax return, what amount should Soma deduct as compensation expense?
a.
$540,000
b.
$600,000
c.
$610,000
d.
$550,000
```
Choice "c" is correct. An accrual basis employer may deduct bonuses paid to nonshareholder employees in the year of accrual if the bonuses are subsequently paid within 2 ½ months after the close of the tax year. Since the $50,000 accrued at year-end Year 1 was paid by March 15, Year 2 (2 ½ months), the $50,000 accrual is deductible as compensation expense. The additional $10,000 bonus paid on March 1, Year 2 is also deductible in Year 1, even though it was not accrued at year-end Year 1. Therefore, the total compensation is $600,000 + $10,000, or $610,000.
60
```
Which of the following tax credits cannot be claimed by a corporation?
a.
Alternative fuel production credit.
b.
Foreign tax credit.
c.
General business credit.
d.
Earned income credit.
```
Choice "d" is correct. The earned income credit can only be claimed by individuals, not corporations.
61
Acme Corp. has two common stockholders. Acme derives all of its income from investments in stocks and securities, and it regularly distributes 51% of its taxable income as dividends to its stockholders. Acme is a:
a.
Corporation subject to tax only on income not distributed to stockholders.
b.
Regulated investment company.
c.
Corporation subject to the accumulated earnings tax.
d.
Personal holding company.
Choice "d" is correct. A corporation is a personal holding company (PHC) if (1) at any time during the last half of the taxable year more than 50% of the value of the outstanding stock is owned by 5 or fewer individuals, and (2) at least 60% of its adjusted ordinary gross income for the year is investment-type income.
62
```
n the current year, 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:
a.
$34,500
b.
$30,500
c.
$40,500
d.
$30,000
```
Choice "b" is correct. In a corporate formation, the corporation's basis in the transferred assets is the carryover adjusted basis from the shareholder, $500 + $30,000 = $30,500.
63
```
What is the usual result to the shareholders of a distribution in complete liquidation of a corporation?
a.
No taxable effect.
b.
Capital gain or loss.
c.
Ordinary gain to the extent of cash received.
d.
Ordinary gain or loss.
```
Choice "b" is correct.
Rule: Shareholders treat property received in a complete liquidation of a corporation as full payment for their stock. Therefore, the shareholder must recognize capital gain or loss equal to the difference between the fair market value of the property received and the basis of the stock surrendered.
64
```
Kari Corp., a manufacturing company, was organized on January 2, Year 1. Its Year 1 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 Year 1 if Kari takes only the minimum accumulated earnings credit?
a.
$50,000
b.
$0
c.
$150,000
d.
$300,000
```
Choice "a" is correct. For the accumulated earnings tax, in this case, accumulated taxable income would equal taxable income ($400,000) minus federal income taxes ($100,000) minus the minimum accumulated earnings credit ($250,000) for manufacturing companies or $50,000.
65
Corporations A and B combine in a qualifying reorganization and form Corporation C, the only surviving corporation. This reorganization is tax-free to the:
Choice "a" is correct. This is a Type A reorganization in the form of a consolidation (e.g., A + B = C). Generally, no gain or loss is recognized by the shareholders of the various corporations except when they receive cash or other consideration in addition to the stock or securities. In addition, no gain or loss is recognized by the acquired corporations or the acquiring corporation pursuant to a tax-free reorganization.
66
If a corporation's tentative minimum tax exceeds the regular tax, the excess amount is:
a.
Payable in addition to the regular tax.
b.
Carried back to the first preceding taxable year.
c.
Carried back to the third preceding taxable year.
d.
Subtracted from the regular tax.
Choice "a" is correct. If a corporation's tentative minimum tax exceeds the regular tax, the excess amount is the alternative minimum tax which is payable in addition to the regular tax.
67
The following information pertains to Lamb Corp.:
Accumulated earnings and profits at January 1, Year 1 $ 60,000
Earnings and profits for the year ended December 31, Year 1 80,000
Cash distributions to individual stockholders during Year 1 180,000
What is the total amount of distributions taxable as dividend income to Lamb's stockholders in Year 1?
a.
$180,000
b.
$80,000
c.
$0
d.
$140,000
Choice "d" is correct. Dividend income is distributions to shareholders first out of current earnings and profits, then out of accumulated earnings and profits. After earnings and profits have been depleted, the distribution is a liquidating return of capital. Since there is a total of $140,000 in earnings and profits ($80,000 + $60,000), $140,000 is dividend income. The remaining $40,000 is a liquidating return of capital.
68
```
Tan Corp. calculated the following taxes for the current year:
Regular tax liability $ 210,000
Tentative minimum tax 240,000
Personal holding company tax 65,000
What is Tan's total tax liability for the year?
a.
$275,000
b.
$240,000
c.
$210,000
d.
$305,000
```
Choice "d" is correct. Tan's tax liability is calculated as follows:
Tan's regular tax liability $ 210,000
Plus: Tan's AMT ($240,000 − 210,000)* 30,000
Plus: Tan's PHC tax** 65,000
Tan's tax liability $ 305,000
*Tan will pay alternative minimum tax (AMT) to the extent that AMT exceeds regular tax.
**Tan will pay personal holding company tax in addition to its regular and alternative minimum taxes.
69
```
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?
a.
$40,000
b.
$65,000
c.
$0
d.
$5,000
```
Choice "a" is correct. As a general rule, a shareholder who contributes property to a corporation in exchange for common stock will not recognize gain or loss if immediately after the transaction when the transferring shareholders (there can be more than one transferor) own at least 80% of the corporation and the shareholder does not receive any boot. In this case, Dole as the sole shareholder owns more than 80% but receives boot, cash of $40,000. Therefore, Dole will recognize gain to the lesser of cash received or realized gain as follows:
Amount Realized*
$ 100,000
Adjusted basis**
(35,000)
Realized Gain
$ 65,000
Recognized gain = Lesser of realized gain ($65,000) or boot received ($40,000)
$ 40,000
*Amount Realized = Cash $40,000 + Common stock $60,000
** Adjusted basis = the adjusted basis (NBV) of the building = $35,000
70
```
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?
a.
$0
b.
$10,000
c.
$5,000
d.
$15,000
```
Choice "d" is correct. When a corporation distributes assets to a shareholder, the corporation recognizes a gain as if it had sold the asset. The gain is calculated as follows:
Amount realized - greater of FMV of asset = $30,000 or the amount of liability assumed by the shareholder
$ 40,000
Less: Adjusted basis of property sold
(25,000)
Realized and recognized gain
$ 15,000
71
```
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?
a.
$100,000
b.
$0
c.
$50,000
d.
$30,000
```
```
Choice "c" is correct. Net capital losses are not allowable deductions for corporations. A corporation can only use capital losses to offset capital gains. Further, the deduction for charitable contributions may be limited in some cases, and no charitable contribution deduction is allowed in calculating the NOL. The facts of this question indicate that there are no reported capital gains or losses or charitable contributions for any of the consolidated entities; therefore, we know that we are able to use the total income (loss) identified in the facts to calculate the net operating loss. When entities file consolidated income tax returns, 100% of their net income (losses) is consolidated. The facts do not indicate that any inter-company transactions exist; therefore, there are no elimination entries to make before consolidating the net income (loss). The consolidated net operating loss is calculated as follows:
ParentCo. $ 50,000
SubOne (60,000)
SubTwo (40,000)
NOL $ (50,000)
```
72
```
Which of the following types of entities is entitled to the net operating loss deduction?
a.
Partnerships.
b.
Not-for-profit organizations.
c.
Trusts and estates.
d.
S corporations.
```
Rule: A Net Operating Loss (NOL) exists if there is a net loss on the following tax returns:
Form 1040, Line 41 for Individuals
Form 1041, Line 22 for Estates and Trusts
Form 1120, Line 28 for Taxable C Corporations
A net operating loss exists on tax returns of taxable entities.
Choice "c" is correct. Per the above rule, trusts and estates are entitled to a net operating loss deduction. Trusts and estates can be taxable entities, even though, at times, they may also have pass-through effects.
73
Rule: Filing a consolidated return is a privilege afforded to affiliated groups of corporations (Code Sections 1501 and 1504(b)), and it can only be filed if all of the affiliated corporations consent to such a filing. An affiliated group has ownership through a common parent. The common parent must directly own at least 80% of the voting power of at least one of the affiliated (includible) corporations and at least 80% of the value of the stock of that corporation, and the other corporations not controlled by the parent must be controlled under the 80% ownership test by an includible corporation. Not all corporations are allowed the privilege of filing a consolidated return.
Examples of those that are denied the privilege include:
```
S corporations,
Foreign corporations,
Most real estate investment trusts (REITs),
Some insurance companies, and
Most exempt organizations.
```
To summarize the facts in the question, the ownership percentage rules are met for all corporations. A, C, and D are all C corporations, and B Corp is an S corporation. Jans owns A and B; A owns C; and B owns D. Per the rules above, S corporations are denied the privilege of filing a consolidated return. Therefore, B Corp. cannot file a consolidated return. A and C may file a consolidated return, as Jans controls A, and A controls C in the required percentages and both are includible corporations. However, the control of D rests with B, an S corporation. Therefore, D cannot be consolidated with A or C, and because B cannot file a consolidated return (as it is an S corporation), D cannot file consolidated with B. Therefore, A and C may file as a group, but B and D may not file as a group.
74
```
In the current year, Brown, a C corporation, has gross income (before dividends) of $900,000 and deductions of $1,100,000 (excluding the dividends received deduction). Brown received dividends of $100,000 from a Fortune 500 corporation during the current year. What is Brown's net operating loss?
a.
$130,000
b.
$170,000
c.
$100,000
d.
$200,000
```
```
Rules:
A net operating loss (NOL) for corporations is the excess of deductions over gross income; however, the dividends received deduction is allowed to be deducted before calculating the NOL.
The dividends received deduction (DRD) for entities that are controlled 0% to s net operating loss is calculated as follows:
Gross income before dividends
$ 900,000
Add: Dividends received
100,000
Less: Deductions (excluding DRD)
(1,100,000)
Less: DRD
(70,000)
[$100,000 × 70%]
NOL
$ 170,000
```
75
```
Which of the following items should be included on the Schedule M-1, Reconciliation of Income (Loss) per Books With Income per Return, of Form 1120, U.S. Corporation Income Tax Return to reconcile book income to taxable income?
a.
Premiums paid on key-person life insurance policy.
b.
Cash distributions to shareholders.
c.
Ending balance of retained earnings.
d.
Corporate bond interest.
```
Choice "a" is correct. The Schedule M-1 reports the reconciliation of income (loss) per books to income (loss) per the tax return [Note: It reports both permanent and temporary differences that are discussed in the Financial textbook for deferred taxes.]. Items that are included on this schedule are those that are (1) reported as income for book purposes but not for tax purposes; (2) reported as an expense for book purposes but not for tax purposes; (3) reported as taxable income for tax purposes but not as income for book purposes; and (4) reported as deductible for tax purposes but not as an expense for book purposes. The only option above that falls into one of these four categories is option b. Premiums paid on a key-person life insurance policy are proper GAAP expenses for book purposes, but they are not allowable deductions for tax purposes.
76
```
Taylor owns 1,000 shares of Media Corporation common stock with a basis of $22,000 and a fair market value of $33,000. Media paid a nontaxable 10% common stock dividend. What is the basis for each share of Media common stock owned by Taylor after receipt of the dividend?
a.
$20
b.
$22
c.
$30
d.
$33
```
```
Choice "a" is correct. A stock dividend is a distribution by a corporation of its own stock to its shareholders. Stock dividends are generally not taxable unless the shareholder has a choice of receiving cash or other property, and the facts indicate that this is a nontaxable 10% dividend. The basis of a nontaxable stock dividend, where old and new shares are identical, is determined by dividing the basis of the old stock by the number of new shares. The calculation is as follows:
Original basis of 1,000 shares
$ 22,000
Divided by new # of shares [1000 × 1.1]
÷ 1,100
Basis per share after 10% stock dividend
$ 20.00
```
77
```
Beta, a C corporation, reported the following items of income and expenses for the year:
Gross income
$ 600,000
Dividend income from a 30% owned domestic corporation
100,000
Operating expenses
400,000
What is Beta's taxable income for the year?
a.
$230,000
b.
$200,000
c.
$300,000
d.
$220,000
```
Choice "d" is correct. Corporate taxable income is calculated as follows for a corporation:
Choice "b" is incorrect. The dividends received deduction allows for a special deduction of 80% of the dividends received from a 20% to amount for the calculation of taxable income should include dividend income; however, it does not appear that the $100,000 of dividends is included in the $600,000 gross income amount given. If it were, the answer options would be $100,000 less than they are.
78
A C corporation must use the accrual method of accounting in which of the following circumstances?
a.
The business is a service company and has over $1 million in sales.
b.
The business is a personal service business with over $15 million in sales.
c.
The business had average sales for the past three years of less than $1 million.
d.
The business has more than $10 million in average sales.
Choice "d" is correct. While the cash basis of accounting is used for tax purposes by most individuals, qualified personal service corporations (which are treated as individuals for purposes of these rules), and taxpayers whose average annual gross receipts do not exceed $1,000,000, the accrual basis method of accounting for tax purposes is required for the following:
The accounting purchase and sales of inventory (and inventories must be maintained)
Tax shelters
Certain farming corporations (other farming or tree-raising businesses may generally use the cash basis)
C Corporations, trusts with unrelated trade or business income, and partnerships having a C corporation as a partner PROVIDED the business has GREATER than $5 million of average annual gross receipts for the three-year period ending with the prior tax year
79
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?
a.
Preferred―$20,000 return of capital; Common―$10,000 return of capital.
b.
Preferred―$20,000 dividend income; Common―$5,000 dividend income, $5,000 return of capital.
c.
Preferred―$15,000 dividend income; Common―$10,000 dividend income.
d.
Preferred―$20,000 dividend income; Common―$10,000 dividend income.
Choice "b" is correct. A dividend to a preferred shareholder is based on that shareholder's fixed percentage at purchase. Preferred shareholders are not common equity owners of a corporation, and they only get paid based on their preferred percentage; therefore, any dividend payments to a preferred shareholder are considered dividend income to the preferred shareholder. Preferred shareholders are paid in full before common shareholders receive dividends.
Common shareholders are residual owners of a corporation and share in the retained earnings ("earnings and profits" is the tax term) of the corporation as well as the net assets. A "dividend" distribution to a common shareholder may or may not be classified as a taxable dividend. A dividend is defined by the Internal Revenue Code as a distribution of property by a corporation out of its earnings and profits (E & P). Dividends come first from current E&P and then from accumulated E&P. Any distributions in excess of current or accumulated E&P are first return of capital (up to the basis of the common stock) and then capital gain distribution.
In this case, the facts tell us that the company has a deficit in accumulated E&P as of the beginning of the year and that current E&P is $25,000. The facts do not tell us the amount of common shareholder capital in the corporation, but none of the answer choices provide for capital gain distributions, so we have to assume that the capital is in excess of the balance of the distribution after the current E&P is allocated. Because preferred shareholders are paid first, the $20,000 paid to them reduces available current E&P to distribute to $5,000 [$25,000 - $20,000]. The preferred shareholders are taxed on $20,000 of dividends. The common shareholders would report $5,000 in dividend income (the remaining amount of current E&P) and would have $5,000 in return of capital [$5,000 + $5,000 = $10,000 paid to the common shareholders].
80
```
One of the elections a new corporation must make is its choice of an accounting period. Which of the following entities has the most flexibility in choosing an accounting period?
a.
S corporation.
b.
Personal service corporation.
c.
Partnership.
d.
C corporation.
```
Choice "d" is correct. A C corporation has considerable flexibility in choosing an accounting period. A C corporation generally has the same choice of accounting periods as do individual taxpayers. All of the other forms have some limitations (and these are identified in the textbook in chapters R3 and R4).
81
```
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 of 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?
a.
$270,000
b.
$70,000
c.
$500,000
d.
$0
```
Choice "d" is correct. No gain or loss is recognized by either the parent corporation (Forrest) or the subsidiary corporation (Diamond) when the parent, who owns at least 80% of the stock (Forrest owns 100% of the stock), liquidates its subsidiary. The parent assumes the basis of the subsidiary's assets as well as any unused NOL carryover, capital loss carryover, or charitable contribution carryover.
82
```
Nare, an accrual-basis, calendar-year taxpayer, owns a building that was rented to Mott under a 10-year lease expiring August 31, Year 3. On January 2, Year 1, Mott paid $30,000 as consideration for canceling the lease. On November 1, Year 1, Nare leased the building to Pine under a five-year lease. Pine paid Nare $5,000 rent for each of the two months of November and December, and an additional $5,000 for the last month's rent. What amount of rental income should Nare report in its Year 1 income tax return?
a.
$10,000
b.
$45,000
c.
$15,000
d.
$40,000
```
Choice "b" is correct. Payments for cancelling a lease ($30,000) are rental income in Year 1. The two month's rent for November and December ($5,000 for each month) are rental income. In addition, the last month's rent ($5,000, which is not indicated is a refundable security deposit) is rental income. The total is $45,000.
83
```
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 dividends-received deduction?
a.
$3,000
b.
$2,400
c.
$0
d.
$2,100
```
Choice "d" is correct. With a 15% ownership, the percentage for the dividends-received deduction is 70%, or $2,100 (70% x $3,000).
84
```
U Co. had cash purchases and payments on account during the current year totaling $455,000. U's beginning and ending accounts payable balances for the year were $64,000 and $50,000, respectively. What amount represents U's accrual basis purchases for the year?
a.
$519,000
b.
$505,000
c.
$469,000
d.
$441,000
```
```
Choice "d" is correct. This question is a simple financial accounting Account Analysis Format (BASE mnemonic, or AAF) question for the accounts payable account. The purchases are a plug and can be determined as follows:
Beginning balance
$ 64,000
(given)
Add: Purchases
441,000
(plug)
Subtract: Cash payments
(455,000)
(given)
Ending balance
$ 50,000
(given)
```
85
```
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 in the current year. What is the corporation's taxable income?
a.
$87,000
b.
$90,000
c.
$115,000
d.
$65,000
```
Choice "b" is correct. The C corporation's income before net long-term capital loss is $90,000 ($150,000 + $35,000 - $95,000). For a corporation, a net long-term capital loss is not deductible in the current year (3-year carryback and 5-year carryforward allowed), so the taxable income is the same amount.
86
```
Jagdon Corp.'s book income was $150,000 for the current year, including interest income from municipal bonds of $5,000 and excess capital losses over capital gains of $10,000. Federal income tax expense of $50,000 was also included in Jagdon's books. What amount represents Jagdon's taxable income for the current year?
a.
$205,000
b.
$185,000
c.
$215,000
d.
$195,000
```
Choice "a" is correct. Taxable income is accounting (book) income adjusted for other items. In this question, the book income is $150,000. That book income includes $50,000 federal income tax expense, and that amount should be added back for taxable income. The $5,000 interest income from municipal bonds should be subtracted because it is not taxable, and the $10,000 excess capital losses over capital gains should be added back because the excess is not a deduction in the current year. The net result is $205,000.
87
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?
Rule: The taxable amount of a dividend to a shareholder from a corporation's earnings and profits is the amount received in cash or the fair market value of the property received.
Rule: The general rule is the payment of a dividend does not create a taxable event, unless the distribution is appreciated property. When the distribution is of appreciated property, the corporation recognizes gain as if the property were sold at fair market value.
Choice "c" is correct. If Brisk Corp. were to distribute $200,000 of accumulated earnings and profits in cash as a dividend, the shareholder would recognize $200,000 in dividend income, and the corporation would reduce its earnings and profits by $200,000. If, instead, the dividend were the $200,000 FMV land with a basis of $75,000, the shareholder would still recognize $200,000 of dividend income (the FMV of the property received, as per the above rule), but the corporation would recognize a gain of $125,000 on the distribution ($200,000 FMV - $75,000 basis, per the above rule), the corporation's earnings and profits would increase $125,000, and the corporation would reduce its earnings and profits by the $200,000 dividend distribution. Thus, Brisk's taxable income would increase if the land were distributed, but the shareholder's taxable income would not change.
88
```
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?
a.
$30,000
b.
$27,000
c.
$35,000
d.
$38,000
```
Choice "d" is correct. Absent information to the contrary, we should assume this distribution is in the form of a dividend (especially because Fox is the sole shareholder). If the shareholder is an individual, the taxable amount of a property dividend from a corporation's earnings and profits is the fair market value of the property received (and the property's basis then becomes that fair market value). In this case, the shareholder is also taking on the responsibility for the mortgage on the property, but this affects only the amount of taxable income, as the debt is reported as a separate line item and does not affect the basis of the land. The tax journal entry follows and indicates that the basis of the land is $38,000:
89
Dart, a C corporation, distributes software over the Internet and has had average revenues in excess of $20 million dollars per year for the past three years. To purchase software, customers key-in their credit card number to a secure web site and receive a password that allows the customer to immediately download the software. As a result, Dart doesn't record accounts receivable or inventory on its books. Which of the following statements is correct?
a.
Dart may use either the cash or accrual method of accounting as long as Dart elects a calendar year end.
b.
Dart may utilize any method of accounting Dart chooses as long as Dart consistently applies the method it chooses.
c.
Dart may utilize the cash basis method of accounting until it incurs an additional $10 million to develop additional software.
d.
Dart must use the accrual method of accounting.
Choice "d" is correct. While the cash basis of accounting is used by most taxpayers for tax purposes, the accrual basis method of accounting for tax purposes is required for the following:
The accounting for purchases and sales of inventory,
Tax shelters,
Certain farming corporations, and
C corporations, trusts with unrelated trade or business income, and partnerships having a C corporation as a partner provided the business has greater than $5 million average annual gross receipts for the three-year period ending with the tax year.
The information in the facts tells us that Dart does not maintain inventory, so the first item that requires accrual method of accounting does not apply. However, the facts also tell us that Dart is a C corporation with average annual gross receipts in excess of $20 million for the last three years (all of its sales are via credit card, which is turned into cash immediately; thus, gross receipts for the year are over $20 million). The fourth requirement above indicates that accrual method of accounting for tax purposes is required if a C corporation has annual average gross receipts in excess of $5 million for the three-year period ending with the tax year-thus, Dart must use the accrual method of accounting for tax purposes.
90
```
In April, X and Y formed Z Corp. X contributed $50,000 cash, and Y contributed land worth $70,000 (with an adjusted basis of $40,000). Y also received $20,000 cash from the corporation. X and Y each receives 50% of the corporation's stock. What is the tax basis of the land to Z Corp.?
a.
$40,000
b.
$60,000
c.
$70,000
d.
$50,000
```
Rule: There is no gain or loss to the corporation issuing stock in exchange for property for the issuance of stock. The general rule is that the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation.
Choice "b" is correct. X and Y form Z Corporation so that each receives a 50% interest in the corporation. X contributes $50,000 in cash, and Y contributes land worth $70,000 and receives $20,000 from the corporation [note that each has contributed a net $50,000]. Z Corporation will record the basis of the land at the basis of Y ($40,000) plus any cash it paid to secure the land ($20,000), or $60,000 total basis. Per the above general rule, the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. As there is no indicated debt on the land nor any gain recognized by Y on the transfer [because X and Y own at least 80% of the voting stock immediately after the transaction and there is no taxable boot (no cash withdrawn and no cancellation of debt) on the transaction], the basis is the adjusted net book value of Y ($40,000) plus any cash Z Corporation pays for the land ($20,000). [Note that we have not addressed the shareholder consequences in this question.]
91
Which of the following groups may elect to file a consolidated corporate return?
a.
Members of an affiliated group.
b.
A brother/sister-controlled group.
c.
A parent corporation and all more-than-10%-controlled partnerships.
d.
A parent corporation and all more-than-50%-controlled subsidiaries.
Rule: An affiliated group of corporations may elect to be taxed as a single unit, thereby eliminating intercompany gains and losses. To be entitled to file a consolidated return, all the corporations in the group (1) must have been members of an affiliated group at some time during the tax year and (2) must have filed a consent (the act of filing a consolidated return qualifies as consent). An affiliated group means that a common parent owns (1) 80% or more of the voting power of all outstanding stock and (2) 80% or more of the value of all outstanding stock of each corporation.
Rule: Not all corporations are allowed the privilege of filing a consolidated return. Examples of those denied the privilege include S corporations, foreign corporations, most real estate investment trusts (REITs), some insurance companies, brother-sister corporations where an individual (not a corporation) owns 80% or more of the stock of two or more corporations, and most exempt organizations.
Choice "a" is correct. An affiliated group of corporations may file a consolidated return (electing to be taxed as a single unit and eliminating intercompany gains and losses). This answer option comes right out and defines the entities as an "affiliated group," thereby removing the need to determine if the group is actually affiliated!
92
```
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?
a.
$80,000
b.
$70,000
c.
$20,000
d.
$60,000
```
Rules: Distributions from corporations to shareholders are taxable to such shareholders if the distributions are classified as dividends. A dividend is defined by the IRC as a distribution of property by a corporation out if its earnings and profits. An individual shareholder will be taxed on dividends in cash for the amount received and on dividends of property for the fair market value of the property received. Distributions are deemed to come from earnings and profits first. Any distribution in excess of earnings and profits ("E&P," accumulated and current) is treated as a nontaxable return of capital that reduces the shareholder's basis in the stock. Distributions in excess of basis are capital gain distributions taxable as capital gains instead of dividends.
Choice "b" is correct. Per the above rules, an individual shareholder will be taxed on dividends in cash for the amount received and on dividends of property for the fair market value of the property received, but any distribution in excess of earnings and profits (accumulated and current) is treated as a nontaxable return of capital that reduces the shareholder's basis in the stock. The corporation has $70,000 in current and accumulated earnings and profits. Therefore, the shareholders will be taxed on the $20,000 in cash received plus the $60,000 in FMV of the property received ($80,000), but only to the extent there is E&P, and that means a taxable amount of dividends of $70,000. The remaining $10,000 will either be a nontaxable return of capital (assuming basis exists), a taxable capital gain (assuming no basis exists), or something in between (assuming basis is positive but less than $10,000).
[Note: The question indicates that the basis of the property equals the fair market value. This avoids the impact on the E&P on the corporation's books for the gain on the dividend to the shareholders and keeps the E&P at $70,000.]
93
```
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?
a.
$5,500
b.
$0
c.
$6,000
d.
$8,000
```
Rules: There is no gain or loss to the corporation issuing stock in exchange for property for the issuance of stock. The general rule is that the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. A shareholder recognizes gain when at least 80% of the voting stock is not owned by the shareholders immediately after the transaction and there is no taxable boot (cash is withdrawn or cancellation of debt exists) on the transaction.
Choice "a" is correct. The general rule is that the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. Applying the information in the fact pattern and the above rules, there is no "shareholder gain" on this transaction. Further, there is no indication of any debt being assumed by the corporation. Thus, Homerun's basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors.
94
An S corporation engaged in manufacturing has a year end of June 30. Revenue consistently has been more than $10 million under both cash and accrual basis of accounting. The stockholders would like to change the tax status of the corporation to a C corporation using the cash basis with the same year end. Which of the following statements is correct if it changes to a C corporation?
a.
The year end will be June 30, using the accrual basis of accounting.
b.
The year end will be December 31, using the cash basis of accounting.
c.
The year end will be December 31, using the accrual basis of accounting.
d.
The year end will be June 30, using the cash basis of accounting.
Rule: While the cash basis of accounting is used by most taxpayers for tax purposes, the accrual basis method of accounting for tax purposes is required for the following:
The accounting for purchases and sales of inventory,
Tax shelters,
Certain farming corporations, and
C corporations, trusts with unrelated trade or business income, and partnerships having a C corporation as a partner provided the business has greater than $5 million average annual gross receipts for the three-year period ending with the tax year.
Choice "a" is correct. The facts tell us that the shareholders would like to change the status to a C corporation using the same year end as the S corporation (June 30). Per the above rule, C corporations with greater than $5 million average annual gross receipts must use the accrual basis of accounting for tax purposes. When this corporation changes to a C corporation status, therefore, it must report on the accrual basis of accounting for tax purposes. It will be able to stay on the June 30 year end, as the shareholders desire.
95
The accumulated earnings tax can be imposed:
a.
Only on parent-subsidiary affiliated groups.
b.
On companies that make distributions in excess of accumulated earnings.
c.
On both partnerships and corporations.
d.
On regular corporations not classified as personal holding companies.
Choice "d" is correct. The accumulated earnings tax can be imposed on regular corporations not classified as personal holding companies.
96
```
On June 1, Year 2, Green Corp. adopted a plan of complete liquidation. On December 1, Year 2, Green distributed to its stockholders installment notes receivable that Green had acquired in connection with the sale of land in Year 1. The following information pertains to these notes:
Green's basis $ 90,000
Fair market value 162,000
Face amount 185,000
How much gain must Green recognize in Year 2 as a result of this distribution?
a.
$95,000
b.
$72,000
c.
$23,000
d.
$0
```
Choice "b" is correct. Distributions in complete liquidation of a corporation are subject to two levels of taxation. First, the corporation must recognize gain or loss as if it sold the assets for the fair market value. The gain on the sale would be the fair market value of $162,000 less $90,000 basis for a gain of $72,000. Secondly, the shareholders would report gain or loss determined by the difference between the fair market value of the assets received and the shareholders' adjusted basis of the stock.
97
```
n Year 4, Superior Corp. an accrual-basis calendar year corporation, reported book income of $500,000. Included in that amount was $25,000 of municipal bond interest income, $100,000 of federal income tax expense, $10,000 of political party contributions, and $8,000 of tax penalty paid as a result of the audit of the Year 1 tax return which was completed during Year 4. What amount should Superior Corp.'s taxable income be on the Form 1120, U.S. Corporation Income Tax Return for Year 4?
a.
$600,000
b.
$585,000
c.
$593,000
d.
$618,000
```
Choice "c" is correct. Certain items are treated differently for book and tax purposes. The corporation's book income was $500,000. For tax purposes, the $25,000 of municipal bond interest income is non-taxable, the $100,000 of federal income tax expense is non-deductible, and both the $10,000 of political party contributions and the $8,000 tax penalty are nondeductible.
Book income $ 500,000
Federal taxes (add) 100,000
Political expenses (add) 10,000
Penalties (add) 8,000
Municipal bond income (subtract) (25,000)
$ 593,000
98
```
Dale Corporation's book income before federal income taxes was $435,000 for the year ended December 31, Year 1. Dale was organized on January 1, Year 1. Organization costs of $50,000 are being written off over a ten-year period for financial statement purposes. For tax purposes, the corporation has elected to take advantage of the maximum benefit for expensing organizational costs. No additional book/tax differences exist. For the year ended December 31, Year 1, Dale Corporation's taxable income was:
a.
$435,000
b.
$437,000
c.
$395,000
d.
$432,000
```
```
Choice "d" is correct. For tax purposes, if elected, a maximum expense deduction of $5,000 is allowed for organizational costs in the year of organization. The remainder must be amortized over 180 months. The book income of $435,000 must be adjusted for the difference between the book amortization and tax amortization allowed. Book amortization would be $5,000 per year ($50,000 divided by 10 years). Tax amortization/expense is calculated as follows:
$ 50,000
(5,000)
expensed
$ 45,000
÷ 180
months
250
per month
Tax expense/amortization would be $8,000 in this year ($50,000 − 5,000 ÷ 45,000/180 = 250 x 12 = 3,000 + 5,000 initial expense). The difference would be a $3,000 higher tax deduction than book. Thus, $435,000 less 3,000 = $432,000
```
99
```
Roger Corp. had operating income of $300,000 after deducting $12,000 for charitable contributions made during the fiscal year, but not including dividends of $10,000 received from 10%-owned domestic taxable corporation. How much is the base amount to which the percentage limitation should be applied in computing the maximum deduction for the charitable contribution?
a.
$312,000
b.
$300,000
c.
$322,000
d.
$315,000
```
Choice "c" is correct. The percentage threshold limit for charitable contributions for a corporation is 10% of adjusted taxable income. Total taxable income is calculated before the deduction of any charitable contributions, the dividends received deduction, any net operating loss carryback, or any capital loss carryback. Thus, the $300,000 must be adjusted to add back the charitable contribution deduction of $12,000 plus the $10,000 of dividend income not included in the $300,000. The base equals $322,000.
100
Dreamscape, Inc., a widget retailer, had taxable income of $150,000 from operations during its taxable year. In addition, Dreamscape incurred a $35,000 loss from the sale of investment land, a capital asset. No other gains or losses were generated during the taxable year, nor had been in past years. In Dreamscape's tax return for that year, what is the proper treatment of the $35,000 loss?
a.
Use $3,000 of the loss to reduce the taxable income to $147,000 and carry the remaining $32,000 forward for 5 years.
b.
Use $3,000 of the loss to reduce the taxable income of $147,000 carry the remaining $32,000 forward for 3 years.
c.
The $35,000 capital loss can be used in the current year to reduce taxable income to $115,000.
d.
Carry the $35,000 capital loss forward for five years.
Choice "d" is correct. Capital gains are taxed at the same rate as ordinary income for a corporation. However, capital losses can only be used to offset capital gains. Any amount not utilized in the year of generation can either be carried back 3 years to offset prior capital gains or carried forward for 5 years.
101
n calculating the tax of a corporation for a short period, which of the following processes is correct?
a.
Compute tax on short-period income, then multiply the result by 12 divided by the number of months in the short period.
b.
Annualize income and calculate the tax on annualized income, then multiply the computed tax by the number of months in the short period divided by 12.
c.
Divide current-year income by prior-year income, then multiply the result by prior-year tax.
d.
Determine the average taxable income for the past three years, then multiply the result by the number of months in the short period divided by 12.
Choice "b" is correct. Corporations are required to pay estimated taxes on the fifteenth day of the fourth, sixth, ninth, and twelfth months of their tax year. One-fourth of the estimated tax is due with each payment. Unequal quarterly payments may be made using the annualized income method.
102
```
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?
a.
$5,000
b.
$15,000
c.
$10,000
d.
$0
```
Choice "c" is correct. Dividends are a distribution of property by a corporation out of its earnings and profits (E&P). Dividends come from current E&P and then from accumulated E&P. If current E&P is positive and accumulated E&P is negative, distributions are dividends only to the extent of current E&P. Any excess distribution above E&P reduces the shareholders basis in the stock, if any. If the shareholder has no basis, then the excess distribution is reported as a capital gain.
103
```
On January 1 of the current year, Locke Corp., an accrual-basis calendar-year C corporation, had $30,000 in accumulated earnings and profits. For the current year, Locke had current earnings and profits of $20,000, and made two $40,000 cash distributions to its shareholders, one in April and one in September. What amount of the distributions is classified as dividend income to Locke's shareholders?
a.
$50,000
b.
$80,000
c.
$20,000
d.
$0
```
Choice "a" is correct. The general rule is that distributions are taxable dividends to the extent of current earnings and profits (E&P) by year end and to the extent of accumulated E&P as of the distribution date. If both are positive and if distributions exceed the sum of current E&P and accumulated E&P, then the distributions in excess of the sum are treated as a return of capital. In this example, both current E&P and accumulated E&P are positive (the total is $50,000), and total distributions during the year are $80,000; so, $50,000 of the total distributions will be taxable dividends.
104
```
Gem Corp. purchased all the assets of a sole proprietorship, including the following intangible assets:
Goodwill
$ 50,000
Covenant not to compete
13,000
For tax purposes, what amount of these purchased intangible assets should Gem amortize over the specific statutory cost recovery periods?
a.
$63,000
b.
$50,000
c.
$0
d.
$13,000
```
Choice "a" is correct. Post-August 10, 1993, acquisitions of goodwill, covenants not-to-compete, franchises, trademarks, and trade names must be amortized on a straight-line basis over a fifteen-year period (180 months) beginning with the month of acquisition. So, both the $50,000 acquisition of the goodwill and the $13,000 acquisition of the covenant not-to-compete – for a total cost of $63,000 -- are amortized over the fifteen-year period statutory cost recovery period.
105
```
Nichol Corp. gave gifts to 15 individuals who were customers of the business. The gifts were not in the nature of advertising. The market values of the gifts were as follows:
5 gifts @ $15 each
9 gifts @ $30 each
1 gift @ $100
What amount is deductible as business gifts?
a.
$75
b.
$445
c.
$0
d.
$325
```
Choice "d" is correct. Business gifts are deductible up to a maximum deduction of $25 per recipient per year.
Computation:
5 x lesser of (i) $15 value of each gift or (ii) $25 maximum per recipient per year
$ 75
9 x lesser of (i) $30 value of each gift or (ii) $25 maximum per recipient per year
225
1 x lesser of (i) $100 value of the gift or (ii) $25 maximum per recipient per year
25
Amount deductible for business gifts
$ 325
106
n the current year, Fitz, a single taxpayer, sustained a $48,000 loss on Code Sec. 1244 stock in JJJ Corp., a qualifying small business corporation, and a $20,000 loss on Code Sec. 1244 stock in MMM Corp., another qualifying small business corporation. What is the maximum amount of loss that Fitz can deduct for the current year?
a.
$50,000 ordinary loss and $18,000 capital loss.
b.
$18,000 ordinary loss and $50,000 capital loss.
c.
$68,000 capital loss.
d.
$50,000 capital loss.
Choice "a" is correct. The stock in each corporation is a capital asset. The general rule is that a loss on the sale or exchange of a capital asset will be a capital loss (either a short-term capital loss or a long-term capital loss, depending upon the holding period). However, a special rule applies to "section 1244 small business stock." When a corporation's stock is sold or becomes worthless, an original stockholder can be treated as having an ordinary loss (fully deductible), instead of a capital loss, up to $50,000 ($100,000 if married filing jointly) for the year. Any loss(es) in excess of this amount is (are) a capital loss.
In this question, the taxpayer, who is not married, during the year has $68,000 of losses from the sale of section 1244 small business stock. As such, the taxpayer will treat as an ordinary loss $50,000 of the total loss; the taxpayer will treat as a capital loss the remaining $18,000 of the total loss.
107
Azure, a C corporation, reports the following:
Pretax book income of $543,000.
Depreciation on the tax return is $20,000 greater than depreciation on the financial statements.
Rent income reportable on the tax return is $36,000 greater than rent income per the financial statements.
Fines for pollution appear as a $10,000 expense in the financial statements.
Interest earned on municipal bonds is $25,000.
```
What is Azure's taxable income?
a.
$528,000
b.
$544,000
c.
$559,000
d.
$543,000
```
Choice "b" is correct. Azure's taxable income is calculated as follows:
Pretax book income
$ 543,000
Depreciation for tax purposes in excess of book depreciation
(20,000)
Rent income for tax purposes in excess of book rent income
36,000
Fines expensed for book purposes but not deductible for tax purposes
10,000
Municipal bond interest not taxable for tax purposes
(25,000)
Taxable income
$ 544,000
108
A corporate taxpayer plans to switch from the FIFO method to the LIFO method of valuing inventory. Which of the following statements is accurate regarding the use of the LIFO method?
a.
Under the LIFO method, the inventory on hand at the end of the year is treated as being composed of the earliest acquired goods.
b.
The taxpayer is required to receive permission each year from the Internal Revenue Service to continue the use of the LIFO method.
c.
In periods of rising prices, the LIFO method results in a lower cost of sales and higher taxable income, when compared to the FIFO method.
d.
The LIFO method can be used for tax purposes even if the FIFO method is used for financial statement purposes.
Choice "a" is correct. Under the LIFO method, the inventory on hand at the end of the year is treated as being composed of the earliest acquired goods.
109
```
The sole shareholder of an S corporation contributed equipment with a fair market value of $20,000 and a basis of $6,000 subject to $12,000 liability. What amount is the gain, if any, that the shareholder must recognize?
a.
$0
b.
$12,000
c.
$6,000
d.
$8,000
```
Choice "c" is correct. Generally, this is a nontaxable transaction. However, the liabilities assumed by the corporation of $12,000 are in excess of the basis of the property contributed of $6,000. The amount of the excess, which is $6,000 ($12,000 − $6,000) is a gain that must be recognized. Note that the fact that this is an S Corporation does not affect the answer. The rules for the formation of an S Corporation are the same as for a C Corporation.
110
```
ndividual Lark's Year 2 brokerage account statement listed the following capital gains and losses from the sale of stock investments:
Short-term capital gain
$ 6,000
Long-term capital gain
14,000
Short-term capital loss
4,000
Long-term capital loss
8,000
In addition, two stock investments became worthless in Year 2. Public Company X stock was purchased in December, Year 1, for $5,000, and formal notification was received by Lark on July, Year 2, that it was worthless. Private company Section 1244 stock was issued to Lark for $10,000 in January, Year 1, and was determined to be worthless in December, Year 2. What is Lark's Year 2 net capital gain or loss before any capital loss limitation?
a.
$2,000 net capital loss.
b.
$7,000 net capital loss.
c.
$8,000 net capital gain.
d.
$3,000 net capital gain.
```
Choice "d" is correct. First, the long-term capital gain of $14,000 is netted with the long-term capital loss of $8,000. This results in a net long-term capital gain of $6,000. Next, the short-term capital gain of $6,000 is netted with the short-term capital loss of $4,000. This results in a net short-term capital gain of $2,000. Now add the net long-term capital gain of $6,000 and the net short-term capital gain of $2,000 to arrive at a net capital gain of $8,000. This amount is reduced by the $5,000 worthless stock. So the final net capital gain is $3,000. Note that the Section 1244 loss of $10,000 does not affect this calculation because it is an ordinary loss and not a capital loss.
111
n which of the following circumstances does the three-year statute of limitations on additional tax assessments apply?
a.
The IRS files a substitute income tax return when it learns that a taxpayer failed to file a return.
b.
A taxpayer willfully attempts to evade tax in filing income tax returns.
c.
A taxpayer inadvertently overstates deductions equal to 15% of gross income.
d.
A taxpayer inadvertently omits from gross income an amount in excess of 25% of the gross income stated on the income tax return.
Choice "c" is correct. With respect to a timely filed return, the general rule is that the IRS can assess additional tax within three years from the later of the return's due date (plus extensions, if any) or the date the return was filed. A taxpayer's inadvertently overstating deductions in an amount equal to 15% of gross income will not trigger any of the exceptions to the general rule.
112
```
What is the maximum amount of capital losses in excess of capital gains that a C corporation may deduct in a year?
a.
$10,000
b.
$3,000
c.
$5,000
d.
$0
```
Choice "d" is correct. Unlike individuals, corporations may not deduct any capital losses in excess of capital gains in a year.
113
Prime Corporation's building was destroyed by a tornado. The fair market value of the building at the time of the tornado was $400,000 and its adjusted basis was $350,000. The insurance proceeds totaled $500,000 as follows:
$400,000 for the building
$100,000 for lost profits during rebuilding
Prime does not defer any gain under the involuntary conversion provisions of Code Sec. 1033.
What amount of the insurance proceeds is taxable to Prime?
a.
$50,000
b.
$100,000
c.
$150,000
d.
$0
Choice "c" is correct. The building had an adjusted basis of $350,000 and $400,000 proceeds were received for it. That results in a taxable gain of $50,000, because none of it was deferred. The $100,000 received for lost profits is taxable as well. The total taxable amount is $150,000 ($50,000 + $100,000).
114
```
Which of the following corporations would be taxed as a personal service corporation?
a.
A groundskeeping firm.
b.
An architecture and engineering firm.
c.
A real estate brokerage.
d.
A catering service.
```
Choice "b" is correct. A personal service corporation (PSC) is primarily involved in the performance of one of the following fields: accounting, law, consulting, engineering, architecture, health, and actuarial science.
115
If an S corporation has no accumulated earnings and profits, the amount distributed to a shareholder:
a.
Decreases the shareholder's basis for the stock.
b.
Increases the shareholder's basis for the stock.
c.
Has no effect on the shareholder's basis for the stock.
d.
Must be returned to the S corporation
Choice "a" is correct. If an S corporation has no accumulated earnings and profits, the amount distributed to a shareholder decreases the shareholder's basis for the stock. The distribution is nontaxable to the extent of the shareholder's basis.
116
```
Stahl, an individual, owns 100% of Talon, an S corporation. At the beginning of the year, Stahl's basis in Talon was $65,000. Talon reported the following items from operations during the current year:
Ordinary loss $ 10,000
Municipal interest income 6,000
Long-term capital gain 4,000
Short-term capital loss 9,000
What was Stahl's basis in Talon at year-end?
a.
$61,000
b.
$50,000
c.
$56,000
d.
$55,000
```
```
Choice "c" is correct. Stahl's basis would be computed as follows:
Beginning basis:
$ 65,000
+ Income
6,000
(Tax-free income increases basis)
− Loss
(10,000)
− Net capital loss
(5,000)
($4,000 gain netted with $9,000 loss)
$ 56,000
Choice "b" is incorrect. This choice excludes the $6,000 of municipal interest income from the above calculation. Remember, both taxable and tax exempt items of income give the taxpayer additional basis.
```
117
```
Baker, an individual, owned 100% of Alpha, an S corporation. At the beginning of the year, Baker's basis in Alpha Corp. was $25,000. Alpha realized ordinary income during the year in the amount of $1,000 and a long-term capital loss in the amount of $3,000 for this year. Alpha distributed $30,000 in cash to Baker during the year. What amount of the $30,000 cash distribution is taxable to Baker?
a.
$30,000
b.
$0
c.
$5,000
d.
$7,000
```
Choice "d" is correct. The taxability of distributions to shareholders in S corporations with no C corporation earnings and profits is as follows:
To the extent of basis in stock - tax free; treated as return of capital.
Any distributions in excess of the shareholder's basis - taxable; treated as capital gain.
Based upon this rule and the information in the question, Baker's basis is calculated as follows:
Beginning basis $ 25,000
Plus: Ordinary income 1,000
Less: Long-term capital loss (3,000)
Baker's Basis $ 23,000
Baker's basis should then be compared to the amount distributed to determine how much constitutes return of capital. In this instance, $23,000 would be nontaxable return of basis, and the remaining $7,000 would be taxable capital gain to Baker.
118
```
Lane Inc., an S corporation, pays single coverage health insurance premiums of $4,800 per year and family coverage premiums of $7,200 per year. Mill is a ten percent shareholder-employee in Lane. On Mill's behalf, Lane pays Mill's family coverage under the health insurance plan. What amount of insurance premiums is includible in Mill's gross income?
a.
$7,200
b.
$720
c.
$0
d.
$4,800
```
Choice "a" is correct. $7,200 of insurance premiums (the amount of family coverage premiums, as indicated in the question) is includible in Mill's gross income.
Rule: Fringe benefits paid by an S corporation are deductible by the S corporation only for non-shareholder employees and those employee-shareholders owning 2% or less of the S corporation. Other fringe benefits paid are deductible by the S corporation if included as part of gross income from the S corporation for the individual receiving the benefits (i.e., included as part of income on the shareholder's W-2).
119
```
Village Corp., a calendar year corporation, began business in Year 1. Village made a valid S corporation election on December 5, Year 3, with the unanimous consent of its shareholders. The eligibility requirements for S status continued to be met throughout Year 4. On what date did Village's S status become effective?
a.
January 1, Year 4.
b.
January 1, Year 3.
c.
December 5, Year 3.
d.
December 5, Year 4.
```
Choice "a" is correct.
Rule: In order to be effective for the current taxable year, the S corporation election must be made by the 15th day of the third month of the taxable year. If the election is made after that date, it becomes effective on the first day of the next taxable year, January 1, Year 4, in this case.
120
A shareholder's basis in the stock of an S corporation is increased by the shareholder's pro rata share of income from:
Choice "b" is correct.
| Rule: Both tax-exempt and taxable interest income increase a shareholder's basis in S corporation stock.
121
```
Zinco Corp. was a calendar year S corporation. Zinco's S status terminated on April 1, Year 1, when Case Corp. became a shareholder. During Year 1 (365-day calendar year), Zinco had nonseparately computed income of $310,250. If no election was made by Zinco, what amount of the income, if any, was allocated to the S short year for Year 1?
a.
$76,500
b.
$233,750
c.
$155,125
d.
$0
```
Choice "a" is correct. ($310,250/365) x 90 = $76,500. Zinco will be taxed as an S corporation from January 1 to March 31, Year 1, and a C corporation from April 1 to December 31, Year 1. Absent the election to calculate the incomes of the S and C corporation portions of the year separately, Zinco's income is allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year. Year 1 has 365 days, 90 of which occurred before April 1.
122
Bristol Corp. was formed as a C corporation on January 1, Year 1, and elected S corporation status on January 1, Year 3. At the time of the election, Bristol had accumulated C corporation earnings and profits, which have not been distributed. Bristol has had the same 25 shareholders throughout its existence. In Year 6, Bristol's S election will terminate if it:
a.
Has passive investment income exceeding 90% of gross receipts in each of the three consecutive years ending December 31, Year 5.
b.
Takes a charitable contribution deduction.
c.
Adds a decedent's estate as a shareholder to the existing shareholders.
d.
Increases the number of shareholders to 100.
Choice "a" is correct. S corporations that are former C corporations with undistributed C corporation earnings and profits are restricted in the amount of passive investment income they can realize without terminating their S election. The restriction is 25% of total gross receipts from passive investment income. The S election is terminated if the S corporation has passive investment income greater than 25% of gross receipts for three consecutive years. After 3 years with 90% of its gross receipts from passive sources, Bristol will lose its S corporation status on the first day of its Year 6 taxable year.
123
```
As of January 1 of the current year, Kane owned all the 100 issued shares of Manning Corp., a calendar year S corporation. On the 41st day of the year, Kane sold 25 of the Manning shares to Rodgers. For the current year ended December 31 (a 365-day calendar year), Manning had $73,000 in nonseparately stated income and made no distributions to its shareholders. What amount of nonseparately stated income from Manning should be reported on Kane's current year tax return?
a.
$16,250
b.
$0
c.
$56,750
d.
$54,750
```
Choice "c" is correct. The mid-year change of ownership causes Manning's S corporation income to be allocated between the shareholders on a per-share, per-day basis. The first 40 days' income is allocated 100% to Kane: 40 x ($73,000/365) = $8,000. 75% of the remaining 325 days' income is allocated to Kane: 75% x 325 x ($73,000/365) = $48,750. The total income allocated to Kane is $56,750 ($8,000 + $48,750).
124
```
On February 10, Year 1, Ace Corp., a calendar-year corporation, elected S corporation status and all shareholders consented to the election. There was no change in shareholders in Year 1. Ace met all eligibility requirements for S status during the preelection portion of the year. What is the earliest date on which Ace can be recognized as an S corporation?
a.
February 10, Year 1.
b.
January 1, Year 1.
c.
January 1, Year 2.
d.
February 10, Year 2.
```
Choice "b" is correct.
Rule: An S election made by the 15th day of the third month of the taxable year is retroactively effective on the first day of the taxable year.
125
Choice "a" is correct. S corporation status can be revoked if shareholders owning more than 50% of the total number of issued and outstanding shares consent.
The specific percentage of voting and nonvoting shareholders is not considered, just the total.
126
```
The Haas Corp., a calendar year S corporation, has two equal shareholders. For the current year, Haas had taxable income and current earnings and profits of $60,000, which included $50,000 from operations and $10,000 from investment interest income. There were no other transactions that year. Each shareholder's basis in the stock of Haas will increase by:
a.
$0
b.
$30,000
c.
$25,000
d.
$50,000
```
Choice "b" is correct. The basis of a shareholder's stock in an S corporation is increased by any item of income and decreased by any item of loss or deduction that passes through to the shareholder. Each shareholder reports ½ of $60,000.
127
Which of the following conditions will prevent a corporation from qualifying as an S Corporation?
a.
The corporation has both common and preferred stock.
b.
One shareholder is an estate.
c.
One shareholder is a grantor trust.
d.
The corporation has one class of stock with different voting rights.
Choice "a" is correct. An S corporation can only have one class of stock outstanding. Common and preferred stock would constitute two classes of stock.
128
```
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 $ 50,000
Dividend income from investments 5,000
Supplies expense 2,000
Utilities expense 1,500
What amount of net business income should Boles report on its Form 1120S, U.S. Income Tax Return for an S corporation, Schedule K?
a.
$46,500
b.
$53,000
c.
$53,500
d.
$48,000
```
```
Choice "a" is correct. An S corporation reports both separately stated and non-separately stated (net business) items of income. The dividend income is a separately stated item and is not included in the calculation of net business income. Therefore, net business income is calculated as follows:
Gross receipts $ 50,000
Supplies expense (2,000)
Utilities expense (1,500)
Net business income $ 46,500
```
129
```
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 Year 1, Boles recorded the following:
Gross receipts $ 50,000
Dividend income from investments 5,000
Supplies expense 2,000
Utilities expense 1,500
On Bole's Year 1 S corporation Form Schedule K, Shareholders' Shares of Income, Credits Deductions, etc., what amount of income should be separately stated from business income?
a.
$50,000
b.
$0
c.
$5,000
d.
$48,000
```
Choice "c" is correct. An S corporation reports both separately stated and non-separately stated (net business) items of income. The dividend income is a separately stated item and is not included in the calculation of net business income.
130
```
Which of the following entities may adopt any tax year end?
a.
C corporation.
b.
Trust.
c.
Limited liability company.
d.
S corporation.
```
Choice "a" is correct. C corporations may adopt any year end, provided the year end is approved by the IRS.
131
```
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?
a.
$40,000
b.
$118,000
c.
$80,000
d.
$38,000
```
Choice "c" is correct. Like partnerships, S corporations report both separately and non-separately stated items of income and/or loss. Allocations to shareholders are made on a per-share, per-day basis in accordance with ownership percentage. Shareholders in an S corporation must include on their personal income tax return their distributive share of each separate "pass-through" item. Shareholders are taxed on these items, regardless of whether or not these items have been distributed to them during the year.
EF's operating income $ 200,000
x Evan's ownership % 40%
Gross income for Evan $ 80,000
132
```
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?
a.
$0
b.
$19,250
c.
$3,500
d.
$15,750
```
```
Choice "d" is correct. A distribution or a sale of an S corporation's assets may result in a tax on any "built-in gain" at the corporate level. An unrealized "built-in gain" results when the following two conditions occur: (1) a C corporation elects S corporation status, and (2) the fair market value of the corporate assets exceeds the adjusted basis of corporate assets on the election date. The two conditions exist in the facts of the question. The net unrealized built-in gain is the excess of the fair market value of corporate assets over the adjusted basis of corporate assets at the beginning of the year in which the S corporation status is elected.
FMV at January 1
$ 85,000
Adjusted basis at January 1
(40,000)
Excess
45,000
× 35% tax rate
35%
Corporate tax liability
$ 15,750
Note: The gain to the corporation is a total of $55,000 ($95,000 − $40,000). An S corporation generally does not pay tax at the corporate level; however, in this case, there was built-in gain of $45,000 upon the election to become an S corporation, so the related C corporation tax must be paid upon the sale of the asset.
```
133
```
Commerce Corp. elects S corporation status as of the beginning of the current year. 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 the current year, Commerce sells the machine for $35,000. What would be the amount subject to the built-in gains tax?
a.
$0
b.
$15,000
c.
$10,000
d.
$5,000
```
Choice "c" is correct. The built-in gain for the machine is $10,000, the difference, on the date of the election of S status, between the $20,000 adjusted basis of the machine to the C corporation and the $30,000 fair market value. That is the amount of the gain that occurred while the corporation was a C corporation, and it is also the amount that is subject to the built-in gains tax.
134
```
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?
a.
$70,000
b.
$80,000
c.
$85,000
d.
$60,000
```
Rules: The rules for determining a shareholder's basis in S corporation stock follow:
Initial basis (or beginning of year)
+
Income items (separately and non-separately stated items)
+
Additional shareholder investments in corporation stock
-
Distributions to shareholders
-
Loss or expense items
Ending basis
Choice "c" is correct.
Initial basis (or beginning of year amount) $ 60,000
Income items (separately and non-separately stated items) 45,000
Additional shareholder investments in corporation stock −
Distributions to shareholders (20,000)
Loss or expense items −
Ending basis $ 85,000
135
Which of the following can be an advantage of a limited liability company over an S corporation?
a.
Incentive stock options can be used to compensate owners.
b.
Double taxation of profits is avoided.
c.
Owners receive limited liability protection.
d.
Appreciated property can be distributed tax-free to an owner.
Rule: IRC Section 311 controls the taxability of corporate distributions. An S corporation (and a C corporation) recognizes a gain on any distribution of appreciated property (a property dividend) in the same manner as if the asset had been sold to the shareholder at its fair market value.
Choice "d" is correct. An S corporation cannot distribute appreciated property to its shareholders without gain. In general, a partnership can distribute appreciated property tax-free to its partners (in general, a non liquidating distribution to a partner is nontaxable). Since a limited liability company (LLC) is taxed like a partnership (an LLC properly structured and with two or more owners is taxed like a limited partnership with no general partners), a limited liability company can distribute appreciated property to its owners tax-free.
136
```
Tap, a calendar-year S corporation, reported the following items of income and expense in the current year:
Revenue $ 44,000
Operating expenses 20,000
Long-term capital loss 6,000
Charitable contributions 1,000
Interest expense 4,000
What is the amount of Tap's ordinary income?
a.
$13,000
b.
$19,000
c.
$20,000
d.
$24,000
```
Rule: IRC Section 1366 controls the pass-through of S corporation income items to shareholders. In general, items are divided into separately stated items (items that could potentially affect the tax liability of the shareholders) and non-separately stated items. Non-separately stated items are lumped together and constitute the S corporation's ordinary income. Separately stated items are passed through to the shareholders (in a manner similar to partnerships) and retain their tax attributes to the shareholders.
Choice "c" is correct. Tap's ordinary income is calculated as follows:
Revenue $ 44,000
Operating expenses (20,000)
Interest expense (4,000)
Ordinary income $ 20,000
The long-term capital loss and the charitable contributions are not included in Tap's ordinary income. They are separately stated items and thus are passed through to the shareholders and retain their tax attributes.
137
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?
a.
In Year 1 only, the excess distributions are tax free.
b.
In Year 1 and Year 2 only, the excess distributions are taxed as capital gain.
c.
In all three years, the excess distributions are taxed as capital gains.
d.
In Year 3 only, the excess distributions are taxed as capital gain
Rule: Per IRC Section 1368, the amount of any distribution to an S corporation shareholder is equal to the cash plus the fair market value of any other property distributed. How the distribution is taxed depends on whether the S corporation has C corporation accumulated earnings and profits (E&P). If the S corporation has never been a C corporation or if it has no C corporation accumulated E&P, the distribution is a tax-free recovery of capital to the extent it does not exceed the shareholder's adjusted basis in the stock of the S corporation. When the amount of the distribution exceeds the shareholder's adjusted basis of the stock, the excess is treated as a gain from the sale or exchange of property (normally a long-term capital gain).
Choice "c" is correct. In each of the years, Stone made distributions in excess of each shareholder's basis. These distributions will normally be taxed as capital gains.
138
```
Stone owns 100% of an S corporation and materially participates in its operations. The stock basis at the beginning of the year is $5,000. During the year, the corporation makes a distribution of $3,500 and passes through a loss from operations of $2,000 for the year. What loss can Stone deduct on Stone's personal tax return?
a.
$0
b.
$1,500
c.
$5,500
d.
$2,000
```
```
Choice "b" is correct. An S Corporation shareholder's basis is reduced by distributions to the shareholders as well as loss or expense items. However, loss deductions are limited to a shareholder's adjusted basis in S corporation stock plus direct shareholder loans to the corporation. Any losses disallowed may be carried forward indefinitely and will be deductible as the shareholder's basis is increased.
Beginning Basis
$ 5,000
Less: Distributions to Shareholder
(3,500)
Less: Shareholder share of losses
(1,500)
Excess $500 carried forward indefinitely.
Ending Shareholder Basis
$ 0
```
139
Absent an election to close the books, the allocation of nonseparately stated income or loss for an S corporation shareholder that changed his ownership interest during the year is computed based on which of the following ownership percentages?
a.
Ownership percentage at the end of the S corporation year.
b.
Ownership percentage computed on a per-share per-day basis.
c.
Ownership percentage determined as an average of the beginning and ending ownership percentages.
d.
Ownership percentage at the beginning of the S corporation year.
Choice "b" is correct. Allocations to shareholders are made on a per-share, per-day basis.
140
```
Miyasyke, Inc., a calendar year S corporation, has 5 equal shareholders at the end of the tax year. Miyasyke had $75,000 of taxable income. Miyasyke made distributions to its shareholders of $32,000 each, for a total of $160,000. Each shareholder's basis in the S corporation is $100,000 at the beginning of the tax year. What amount from Miyasyke should be included in each shareholder's gross income?
a.
$0
b.
$32,000
c.
$47,000
d.
$15,000
```
Choice "d" is correct. Each shareholder reports his/her pro rata share of the S corporation's taxable income in his or her gross income. The distributions are not taxable to the extent the shareholders' basis exceeds the distribution (and increased for any income reported by them during the year).
141
An S corporation is subject to the "built-in gains" tax (as well as the "LIFO Recapture" tax and the "Passive Investment Income" tax) only if the S corporation had previously been a C corporation.
In this question, the corporation elected "S" status on the day or incorporation; hence, the corporation was never a C corporation. So, the "built-in gains" tax doesn't apply to the facts presented.
142
```
Which of the following items must be separately stated on Form 1120S, U.S. Income Tax Return for an S Corporation, Schedule K-1?
a.
Gain or loss from the sale of collectibles.
b.
Section 1245 Gain.
c.
Mark-to-market income.
d.
Unearned revenue.
```
Choice "a" is correct. Gain or loss from the S corporation's sale of collectibles is separately reported on the Schedule K-1 of IRS form 1120S.
143
```
For which of the following entities is the owner's basis increased by the owner's share of profits and decreased by the owner's share of losses but is not affected by the entity's bank loan increases or decreases?
a.
C corporation.
b.
S corporation.
c.
Partnership.
d.
Limited liability company.
```
Choice "b" is correct. The owner's basis in an S Corporation is increased by the owner's share of profits and decreased by the owner's share of losses. It is not affected by any bank loans increased or decreased by the corporation. It is only increased by direct loans made to the corporation by the owner.
144
```
Frank is a 1/3 shareholder in an S corporation. At the beginning of the year, Frank's basis in his S corporation stock was $10,000. Frank's share of the S corporation items of income included $35,000 of income from operations; $1,000 of charitable contributions, and $1,000 of capital gains. During the year, Frank also contributed $15,000 of additional capital and received a $3,000 distribution from the S corporation. What is Frank's basis at the end of the tax year?
a.
$46,000
b.
$57,000
c.
$60,000
d.
$65,000
```
```
Choice "b" is correct. Frank's basis is calculated as follows:
Beginning basis
$ 10,000
Add: Separate and non-separate items
Income
35,000
Capital gains
1,000
Additional contributions
15,000
Less: Distributions
(3,000)
Loss or expense items
(1,000)
Frank's ending basis
$ 57,000
```
145
```
Carson owned 40% of the outstanding stock of a C corporation. During a tax year, the corporation reported $400,000 in taxable income and distributed a total of $70,000 in cash dividends to its shareholders. Carson accurately reported $28,000 in gross income on Carson's individual tax return. If the corporation had been an S corporation and the distributions to the owners had been proportionate, how much income would Carson have reported on Carson's individual return?
a.
$28,000
b.
$188,000
c.
$160,000
d.
$132,000
```
Choice "c" is correct. S Corporations work in a similar fashion to partnerships. The income is passed through to the shareholder and included in taxable income whether or not it is actually distributed. Therefore, Carson will report 40% of the $400,000 taxable income, or $160,000. The $28,000 distribution will not affect the taxable income, but will reduce Carson's basis in the S Corporation stock.
146
```
Beech Corp., an accrual-basis, calendar-year S corporation, has been an S corporation since its inception. At the beginning of the current year, Gold owned 50% of the 100 issued shares of Beech stock, and had a $3,000 tax basis in the Beech stock. During the current year, Beech had $200,000 in net business income and $4,000 in Oak County municipal bond interest income. Beech made no distributions to its shareholders. What was Gold's tax basis in Beech stock at year end?
a.
$102,000
b.
$105,000
c.
$104,000
d.
$103,000
```
Choice "b" is correct. A shareholder's basis in an S corporation is increased by his or her proportionate share of all income, including tax-free income. Gold's ending basis in Beech is $105,000. $3,000 beginning basis + $100,000 (50% of net business income) + $2,000 (50% of municipal bond interest income).
147
```
Which of the following increases the accumulated adjustments account of an S corporation?
a.
Interest and dividends.
b.
Capital contributions by the shareholders.
c.
Distribution to shareholders.
d.
Charitable contributions.
```
Choice "a" is correct. The accumulated adjustments account (AAA) is increased by separately stated and non-separately stated income and gains (except tax-exempt income and certain life insurance proceeds).
148
Which one of the following types of organizations qualifies as an organization exempt from income tax?
a.
A social club organized and operated exclusively for the pleasure and recreation of its members, supported solely by membership fees, dues, and assessments.
b.
All "feeder" organizations, primarily conducting business for profit, but distributing 100% of their profits to organizations exempt from income tax.
c.
An "action" organization established for the purpose of influencing legislation pertaining to protection of animal rights.
d.
An organization whose purpose is to foster national or international amateur sports competition by providing athletic facilities and equipment.
Choice "a" is correct. A social club organized and operated exclusively for the pleasure and recreation of its members, supported "solely" by membership fees, dues, and assessments is exempt from income tax.
149
With regard to unrelated business income of an exempt organization, which one of the following statements is correct?
a.
An unrelated trade or business activity that results in a loss is excluded from the definition of unrelated business.
b.
An exempt organization that earns any unrelated business income in excess of $100,000 during a particular year will lose its exempt status for that particular year.
c.
An exempt organization is not taxed on unrelated business income of less than $1,000.
d.
The tax on unrelated business income can be imposed even if the unrelated business activity is intermittent and is carried on once a year.
Choice "c" is correct. An exempt organization is not taxed on unrelated business income of less than $1,000.
150
An incorporated exempt organization subject to tax on its unrelated business income:
a.
Must pay at least 70% of the tax due as shown on the return when filed, with the balance of tax payable in the following quarter.
b.
May defer payment of the tax for up to nine months following the due date of the return.
c.
Must make estimated tax payments if its tax can reasonably be expected to be $100 or more.
d.
Must comply with the Code provisions regarding installment payments of estimated income tax by corporations.
Choice "d" is correct. An incorporated exempt organization must comply with the code provisions regarding installment payments of estimated income tax by corporations.
151
The private foundation status of an exempt organization will terminate if it:
a.
Is governed by a charter that limits the exempt purposes.
b.
Does not distribute all of its net assets to one or more public charities.
c.
Is a foreign corporation.
d.
Becomes a public charity
Choice "d" is correct. The private foundation status of an exempt organization will terminate if it becomes a public (50% type) charity.
Rule: Section 509 private foundations include all Code 501(C)(3) organizations, except:
Max 50% charitable deduction donees
Broadly publicly-supported organizations
Supporting organizations
Public safety organizations
152
To qualify as an exempt organization, the applicant:
a.
Must not be classified as a social club.
b.
May be organized and operated for the primary purpose of carrying on a business for profit, provided that all of the organization's net earnings are turned over to one or more tax exempt organizations.
c.
Must not be a private foundation organized and operated exclusively to influence legislation pertaining to protection of the environment.
d.
Need not be specifically identified as one of the classes upon which exemption is conferred by the Internal Revenue Code, provided that the organization's purposes and activities are of a non-profit nature.
Choice "c" is correct. To qualify as an exempt organization, an applicant must not be a private foundation organized and operated exclusively to influence legislation.
153
```
Salud Welfare Associates is an exempt organization that operates under a corporate charter granted by the state in which Salud's principal office is located. Salud's tax on unrelated business taxable income is:
a.
Abated.
b.
Computed at rates applicable to trusts.
c.
Credited against the tax on recognized gains.
d.
Computed at corporate income tax rates.
```
Rule: Unless the organization is taxable as a trust, its unrelated business taxable income is subject to regular corporate taxes.
Choice "d" is correct. Salud's tax on unrelated business taxable income is computed at corporate income tax rates.
154
Which of the following statements is correct regarding the unrelated business income of exempt organizations?
a.
An unrelated business does not include any activity where all the work is performed for the organization by unpaid volunteers.
b.
Unrelated business income relates to the performance of services, but not to the sale of goods.
c.
Unrelated business income tax will not be imposed if profits from the unrelated business are used to support the exempt organization's charitable activities.
d.
If an exempt organization has any unrelated business income, it may result in the loss of the organization's exempt status.
Choice "a" is correct. An unrelated business does not include any activity where all the work is performed by the organization by unpaid volunteers.
155
To qualify as an exempt organization other than a church or an employee's qualified pension or profit sharing trust, the applicant:
a.
Cannot operate under the "lodge system" under which payments are made to its members for sick benefits.
b.
Must file a written application with the Internal Revenue Service.
c.
Need not be specifically identified as one of the classes on which exemption is conferred by the Internal Revenue Code, provided that the organization's purposes and activities are of a non-profit nature.
d.
Is barred from incorporating and issuing capital stock.
Choice "b" is correct. To qualify as an exempt organization other than a church or an employee's qualified pension or profit sharing trust, the applicant must file a written application with the Internal Revenue Service.
156
Which of the following activities regularly carried out by an exempt organization will not result in unrelated business income?
a.
Accounting and tax services performed by a local chapter of a labor union for its members.
b.
The sale of a trade association of publications used as course materials for the association's seminars, which are oriented towards its members.
c.
The sale of heavy-duty appliances to senior citizens by an exempt senior citizens center.
d.
The sale of laundry services by an exempt hospital to other hospitals.
Rule: Unrelated business income is:
Derived from an activity that constitutes a trade or business,
Is regularly carried on, and
Is not substantially related to the organization's tax-exempt purpose.
Note: An unrelated business does not include any activity where all the work is performed for the organization by unpaid volunteers. Thus, using unpaid volunteers makes that business or activity "related."
Choice "b" is correct. The sale of a trade association of publications used as course materials for the association's seminars, which are oriented towards its members, will not result in unrelated business income.
157
An organization that operates for the prevention of cruelty to animals will fail to meet the operational test to qualify as an exempt organization if:
Rule: Organizations qualify as tax-exempt if:
It is both organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes; for public safety testing; for the prevention of cruelty to children or animals; or to foster national or international amateur sports competition,
No part of its net earnings goes to any private shareholder or individual, and
No substantial part of its activities consists of carrying on propaganda or otherwise attempting to influence legislation (direct participation in a political campaign is prohibited).
Choice "d" is correct. Organizations that carry on insubstantial non-exempt activities may still qualify for its tax-exempt purpose.
158
Which of the following exempt organizations must file annual information returns?
a.
Churches.
b.
Private foundations.
c.
Those with gross receipts of less than $50,000 in each taxable year.
d.
Internally supported auxiliaries of churches.
Note: An annual return that discloses substantial contributors and amounts contributed is required of most organizations exempt from income tax under Section 501, including private foundations.
Exempt from this filing requirement are:
Churches,
The exclusively religious activities of a religious order, and church, denomination, or interdenominational sponsored foreign mission societies, and
Certain organizations that normally have annual gross receipts of $50,000 or less.
Choice "b" is correct. Private foundations must file annual information returns.
159
```
The organizational test to qualify a public service charitable entity as tax exempt requires the articles of organization to:
I.
Limit the purpose of the entity to the charitable purpose.
II.
State that an information return should be filed annually with the Internal Revenue Service.
a.
Both I and II.
b.
II only.
c.
I only.
d.
Neither I nor II.
```
Note: The articles of organization must limit the purpose of the entity to the charitable purpose. "Annual information returns" are not required for all exempt organizations.
Choice "c" is correct. The organizational test to qualify as a public service entity as tax exempt only requires the articles of organization to limit the purpose of the entity to the charitable purpose, but not state that an information return should be filed annually with the Internal Revenue Service.
160
```
Which of the following activities regularly conducted by a tax-exempt organization will result in unrelated business income?
I.
Selling articles made by disabled persons as part of their rehabilitation, when the organization is involved exclusively in their rehabilitation.
II.
Operating a grocery store almost fully staffed by emotionally disabled persons as part of a therapeutic program.
a.
I only.
b.
Neither I nor II.
c.
Both I and II.
d.
II only.
```
Rule: Unrelated business taxable income must be derived from an activity that constitutes a trade or business that is regularly carried on and is not substantially related to the organization's tax-exempt purpose.
Both of the above options appear to be substantially related to the organization's tax-exempt purpose and, therefore, are not taxable.
Choice "b" is correct, per the above explanation.
161
```
Maple Avenue Assembly, a tax-exempt religious organization, operates an outreach program for the poor in its community. A candidate for the local city council has endorsed Maple's anti-poverty program. Which of the following activities is (are) consistent with Maple's tax-exempt status?
I.
Endorsing the candidate to members.
II.
Collecting contributions from members to the candidate.
a.
Both I and II.
b.
Neither I nor II.
c.
I only.
d.
II only.
```
Rule: An exempt organization may not:
Directly participate or intervene in any political campaign,
Have any part of net earnings inure to the benefit of any private shareholder or individual, and
Have substantial part of its activities for non-exempt activities.
Choice "b" is correct. Neither endorsing the candidate nor collecting contributions for the candidate is allowed, per the above explanation.
162
During Year 1, Help Others, Inc., an exempt organization, derived income of $15,000 from conducting bingo games. Conducting bingo games is legal in Help Others' locality and is confined to exempt organizations in Help Others' state. Which of the following statements is true regarding this income?
a.
The entire $15,000 is subject to tax at a lower rate than the corporate income tax rate.
b.
The entire $15,000 is exempt from tax on unrelated business income.
c.
Only the first $5,000 is exempt from tax on unrelated business income.
d.
Because Help Others, Inc. has unrelated business income; it automatically forfeits its exempt status for Year 1.
Choice "b" is correct. The entire $15,000 is exempt from tax on unrelated business income because the bingo games are legal and are confined to exempt organizations in that state.
163
Which of the following exempt organizations must file annual information returns?
a.
Churches.
b.
Those with gross receipts of less than $5,000 in each taxable year.
c.
Internally supported auxiliaries of churches.
d.
Private foundations.
Choice "d" is correct. Section 509 private foundations require an annual information return which discloses substantial contributors and amounts of contributions received.
164
The IRS often makes adjustments when there are transfer pricing issues. Transfer pricing issues exist under which of the following circumstances?
a.
A U.S.-based taxpayer shares costs with an affiliate that is not subject to U.S. income tax and does not file a consolidated income tax return with the U.S.-based taxpayer.
b.
A U.S.-based taxpayer sells tangible property to an affiliate that is subject to U.S. income tax.
c.
A U.S.-based taxpayer enters into a service contract with an affiliate that is subject to U.S. income tax and files a consolidated income tax return with the U.S.-based taxpayer.
d.
A U.S.-based taxpayer leases intangible property from an affiliate that is subject to U.S. income tax.
Choice "a" is correct. Transfer pricing issues exist when a U.S.-based taxpayer shares costs with an affiliate that either (i) is not subject to the U.S. income tax or (ii) does not file a consolidated income tax return with the U.S.-based taxpayer.
165
The IRS has the authority to adjust upward or downward the gross income and deductions between or among certain organizations to prevent the evasion of taxes or to clearly reflect the income of two or more organizations. Which one of the following is a characteristic of these organizations?
a.
The organizations must be incorporated.
b.
The organizations must be organized in the United States.
c.
The organizations may be members of an affiliated group that file a consolidated U.S. tax return.
d.
The organizations must be directly owned by the same interests.
Choice "c" is correct. The organizations that are subject to these provisions of the IRC extend to members of an affiliated group that file a consolidated U.S. income tax return.
166
```
A binding contract between the IRS and the taxpayer by which the IRS agrees not to seek a transfer pricing adjustment for a covered transaction if the taxpayer files its return for a covered year consistent with the agreed transfer pricing method is called a(n):
a.
Request for competent authority.
b.
Advance Pricing Agreement Program.
c.
Section 482 study.
d.
Controlled transaction analysis agreement.
```
Choice "b" is correct. The APA is a binding contract between the IRS and the taxpayer by which the IRS agrees not to seek a transfer pricing adjustment for a covered transaction if the taxpayer files its return for a covered year consistent with the agreed transfer pricing method.
167
Martin & Sons is seeking tax advice from the company's CPA regarding a possible investment in a new production facility. Which of the following statements is likely to be good advice for the company?
a.
Asset trade-ins could result in lower taxes payable in later years.
b.
Asset purchases for the new facility will be analyzed in light of future pretax cash flows.
c.
Asset abandonments from the old production facility will not have a tax effect because those assets were purchased in the past, and are almost fully depreciated.
d.
Asset sales from the old facility may result in a loss on sale, and the tax effect will be treated as an increase in the recorded amount of the new investment.
Choice "a" is correct. Generally, no gain or loss is recognized on the trade-in of an old asset for tax purposes; hence, there is no tax effect. The traded-in asset's book value becomes a portion of the depreciable basis of the new asset, resulting in additional depreciation for tax purposes in later years and the reduction of taxes payable in those later years. Therefore, the cash outflows in later years will decline.
