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A C corporation's net capital losses are:
a. Carried forward indefinitely until fully utilized.
b. Carried back 3 years and forward 5 years.
c. Deductible in full from the corporation's ordinary income.
d. Deductible from the corporation's ordinary income only to the extent of $3,000.
Choice "b" 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.
A corporation's capital loss carryback or carryover is:
a. Not allowable under current law.
b. Limited to $3,000.
c. Always treated as a long-term capital loss.
d. Always treated as a short-term capital loss.
Choice "d" is correct. A corporation's capital loss carryback or carryover is always treated as a short-term
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
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?
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.)
Which of the following is not true with regard to personal holding companies (PHCs)?
a. The additional tax (penalty) is self-assessed by the PHC.
b. Personal holding companies are not subject to the accumulated earnings tax.
c. 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.
d. There is no penalty if net earnings are distributed, as the penalty only applies to income that has not been
Choice "c" 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).
Which of the following taxpayers may use the cash method of accounting?
a. A tax shelter.
b. A qualified personal service corporation.
c. A C corporation with annual gross receipts of $50,000,000.
d. A manufacturer.
Choice "b" 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.
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?
Choice "c" 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.
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?
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
 Federal income taxes paid are not deductible for tax purposes.
 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
Mintee Corp. , an accrual-basis calendar-year C corporation, had no corporate shareholders when it liquidated in Year 1. In cancellation of all their Mintee stock, each Mintee shareholder received in Year 1 a liquidating distribution of $2,000 cash and land with tax basis of $5,000 and a fair market value of $1 0,500. Before the
distribution , each shareholder's tax basis in Mintee stock was $6,500. What amount of gain should each
Mintee shareholder recognize on the liquidating distribution?
+ fmv land 10,500
-Basis in stock 6500
= 6,000 recognized gain
Choice "d" is correct. When a corporation liquidates and distributes assets to shareholders, gain is
recognized to the extent that the fair market value of assets distributed to a shareholder exceeds the
shareholder's basis in the corporation's stock.
Which of the following conditions must be satisfied for a taxpayer to expense, in the year of purchase, under
Internal Revenue Code Section 179, the cost of new or used tangible depreciable personal property?
I. The property must be purchased for use in the taxpayer's active trade or business.
II. The property must be purchased from an unrelated party.
a. I only.
b. II only.
c. Both I and II.
d. Neither I nor II.
Choice "c" is correct. To qualify for IRC Section 179, the property must be tangible personal property
acquired by purchase from an unrelated party for use in the active conduct of a trade or business.
In Year 1, Starke Corp., an accrual-basis calendar year corporation, reported book income of $380,000.
Included in that amount was $50,000 municipal bond interest income, $170,000 for federal income tax
expense, and $2,000 interest expense on the debt incurred to carry the municipal bonds. What amount
should Starke's taxable income be as reconciled on Starke's Schedule M-1 of Form 1120, U.S. Corporation
Income Tax Return?
Choice "c" is correct. Municipal bond interest, interest on debt incurred to carry the municipal bonds, and
federal income tax expense are not included in taxable income.
Reported book income $ 380,000
Municipal bond interest (50,000)
Federal income tax expense 170,000
Interest to carry municipal bonds 2,000
Taxable income $ 502,000
Bent Corp., a calendar-year C corporation, purchased and placed into service residential real property during
February Year 1. No other property was placed into service during Year 1. What convention must Bent use
to determine the depreciation deduction for the alternative minimum tax?
Choice "d" is correct. Real property (buildings) is subject to the mid-month convention under MACRS. Only
personal property (machinery & equipment) is subject to the half-year and/or mid-quarter conventions
Data Corp. , a calendar year corporation, purchased and placed into service office equipment during
November Year 1. No other equipment was placed into service during Year 1. Under the general MACRS
depreciation system, what convention must Data use?
Choice "c" is correct. When a taxpayer places 40% or more of its property (other than certain qualifying real
property) into service in the last quarter of the taxable year, the corporation must use the mid-quarter
convention for MACRS depreciation purposes. With this method the acquisitions are segregated by quarter
and treated as if placed in service in the middle of each respective quarter.
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:
Choice "d" is correct. The dividends-received deduction (ORO) is 70% of the lesser of: i) taxable income
(70% x $90,000 = $63,000), or ii) dividends received (70% x $100,000 = $70,000). In this case, $63,000 is
the dividends-received deduction. 70% is used in this case because the question indicates the corporations
are "unrelated" (i.e., less than 20% owned).
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?
c. $82 ,000
Choice "b" 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% x $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
Browne, a self-employed taxpayer, had business net income of $100,000 in Year 1 prior to any expense
deduction for equipment purchases. In Year 1, Browne purchased and placed into service, for business use,
office machinery (5-year MACRS property) costing $30,000. This was Browne's only Year 1 capital
expenditure. Browne's business establishment was not in an economically distressed area. Browne made a
proper and timely expense election to deduct the maximum amount under code Sec. 179. Browne was not a
member of any pass through entity. What is Browne's deduction under the election?
Choice "d" is correct. A taxpayer who spends less than $800,000 on equipment can deduct the cost of
equipment purchases up to a maximum of $250,000 per tax year. The deduction is limited to the amount that
will reduce taxable income to zero. Because Brown's net income is greater than the $30,000 allowable
deduction , the limitation does not apply
On August 1, Year 1, Graham purchased and placed into service an office building costing $264,000 including
$30,000 for the land. What was Graham's MACRS deduction for the office building in Year 1?
Choice "d" is correct. Only the building is depreciable, so the depreciable portion is $264,000 less $30,000
land , for a net of $234,000. The MACRS rules provide a 39-year life, straight-line depreciation, and a "midmonth" acquisition convention that treats the property as acquired in the middle of the month, regardless of the actual date of acquisition. Therefore, the August 1, Year 1, service date provides a half-month's depreciation for August, plus a full month for September through December, for a total of 4.5 months for Year
1. ($234,000/39 years) x (4.5/12) = $2,250.
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. I only.
b. II 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.
Platt owns land that is operated as a parking lot. A shed was erected on the lot for the related transactions
with customers. With regard to capital assets and Section 1231 assets, how should these assets be
a. Capital Capital
b. Section 1231 Capital
c. Capital Section 1231
d. Section 1231 Section 1231
Choice "d" is correct. Because the parking lot and the shed constitute real estate and depreciable assets
used in a trade or business, they are not capital assets per the definition below.
Note: The parking lot and shed will fall under Section 1231 (provided they are used in the business over 12
months) and possibly Section 1250 and 1245, respectively, upon sale of the assets.
Capital assets are defined as all property held by the taxpayer except:
1. Property normally included in inventory or held for sale to customers in the ordinary course of business.
2. Depreciable property and real estate used in business.
3. Accounts and notes receivable arising from sales or services in the taxpayer's business.
4. Copyrights, literary, musical or artistic compositions.
5. Treasury stock
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
Adjustment for the accelerated depreciation taken on Year 1 five -year property
Year 1 tax-exempt interest from specified private activity bonds issued
What was Eastern's Year 1 alternative minimum taxable income before the adjusted current earnings (ACE)
Choice "a" 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
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?
Choice "c" 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 1111Year 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.
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.
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.
Kent Corp. is a calendar year accrual basis C corporation. In Year 1, Kent made a nonliquidating distribution of property with an adjusted basis of $150,000 and a fair market value of $200,000 to Reed, its sole shareholder.
The following information pertains to Kent:
Reed's basis in Kent stock at January 1, Year 1 $500,000
Accumulated earn ings and profits at January 1, Year 1 125,000
Current earnings and profits for Year 1 (from operations) 60,000
What was taxable as dividend income to Reed for Year 1?
Choice "d" is correct. A dividend paid in property other than money is taxable to an individual taxpayer to the extent of the property's fair market value, but not in excess of the current and accumulated earnings and profits of the distributing corporation. In this case the fair market value of the dividend is $200,000. It is taxable to the extent that Kent had current earnings ($60,000) plus accumulated earnings and profits ($125,000) plus any gain generated on the distribution itself ($50,000); thus the dividend is taxable to the extent of $200,000.
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
a. King must acquire 100 percent of Jaxson stock for the transaction to be a tax-free reorganization.
b. The transaction will qualify as a tax-free reorganization.
c. King must issue at least 60 percent of its voting common stock for the transaction to qualify as a tax-free
d. Jaxson must surrender assets for the transaction to qualify as a tax-free reorganization .
Choice "b" is correct. The acquisition of a controlling (usually 80%) interest by one corporation in the stock ofanother corporation solely for stock is a tax-free (Type B) reorganization .
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 with holdings. What percentage of the meal expense may Banks deduct?
Choice "b" is correct. Only 50% of business meal and entertainment expense is deductible.
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 (taxable
income limitation does not apply and there is no portfolio indebtedness) $50,000
Bad debt expense (represents the increase in the allowance for doubtful accounts)
Assuming no bad debt was written off, what is Kelly's taxable income for the current year?
Book net income $300,000
Nondeductible bad debt expense 80,000
Dividends received deduction (35,000)
Choice "a" is incorrect. The bad debt expense taken on the allowance method is disallowed. For tax purposes, the corporation must use the direct write-off method. In addition , Kelly Corp. is allowed a 70% dividends received deduction.
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. Be deducted on Axis' Year 1 tax return.
c. Be deducted on Axis' Year 2 tax return .
d. Not be deducted on Axis' tax return because payment is a disguised dividend
Choice "b" 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 2-112 months of year-end.
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. Included in taxable income to the extent of 20%.
c. Included in taxable income to the extent of 80%.
d. Fully taxable
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
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?
Choice "c" 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.
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
II. Acquiring corporation must have control of the target corporation immediately after the acquisition.
a. I only.
b. II only.
c. Both I and II.
d. Neither I nor II.
Choice "c" 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.
Kisco Corp.'s taxable income before taking the dividends received deduction was $70,000. This includes
$10,000 in dividends from an unrelated taxable domestic corporation. Given the following tax rates, what
would Kisco's income tax be before any credits?
Partial rate table Tax rate
Up to $50,000 15%
Over $50,000 but not over $75,000 25%
Choice "b" is correct. The $10,000 dividend is from an unrelated corporation. This means less than 20% of
the company is owned. A 70% dividends received deduction is available.
Taxable income $ 70,000
Less: Dividends received
deduction (70% x 10,000) (7,000)
Taxable income $ 63,000
15% x $50,000 $ 7,500
+ [25% x ($63,000 - $50,000)] 3,250
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?
Choice "d" is correct.
Ru/e: 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).
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?
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.
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? 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 x 6 months = $1,200 + $5,000 (expense in Year 1) = $6,200.
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?
An accrual basis employer may deduct bonuses paid to nonshareholder employees in
the year of accrual if the bonuses are subsequently paid within 2 Y, 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 Y, 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.
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. Corporation subject to the accumulated earnings tax.
c. Regulated investment company.
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.
What is the usual result to the shareholders of a distribution in complete liquidation of a corporation?
a. No taxable effect.
b. Ordinary gain to the extent of cash received .
c. Ordinary gain or loss.
d. Capital gain or loss
Choice "d" 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.
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?
Choice "c" 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.
Bridge, a C corporation, had $15,000 in accumulated earnings and profits at the beginning of the current year. During the current year, Bridge reported earnings and profits of $1 0,000 and paid $20,000 in cash
distributions to its shareholders in both March and July. What amount of the July distribution should be
classified as dividend income to Bridge's shareholders?
Choice "d" is correct. When a corporation makes multiple distributions during the taxable year, current E&P is first allocated to each distribution on a pro rata basis; then , accumulated E&P is applied in chronological order beginning with the earliest distribution . In this example, where there are two distributions made by Bridge, the current and accumulated E&P are allocated as follows :
March distribution $20,000
Current E& P - $20,000 (March distribution)/$40,000 (total distributions) x $10,000 (Current E&P) = Amount out of Current E&P =$5,000
Accumulated E&P = allocate first come first serve = chronological until
either Acc E&P is used up or entire distribution is dividend. Here $15,000 $15,000
Accumulated E&P = $15,000 remaining distribution; thus use
$0 remaining in Accumulated E&P
Entire distribution is a dividend $20,000
July distribution $20,000
Current E& P - $20,000 (July distribution)/$40,000 (total distributions)
x $10,000 (Current E&P) = Amount out of Current E&P $5,000
Accumulated E&P = all used in March distribution = $0
Dividend amount $5,000
Dole, the sale 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?
Choice "c" 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 sale 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:
Dole *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
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?
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
Which of the following types of entities is entitled to the net operating loss deduction?
b. S corporations.
c. Trusts and estates.
d. Not-for-profit organizations.
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.
Which of the following items should be included on the Schedule M-1, Reconciliation of Income (Loss) per
Books With Income per Return , of Form 1120, U.S. Corporation Income Tax Return to reconcile book income
to taxable income?
a. Cash distributions to shareholders.
b. Premiums paid on key-person life insurance policy.
c. Corporate bond interest.
d. Ending balance of retained earnings
Choice "b" 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
A C corporation must use the accrual method of accounting in which of the following circumstances?
a. The business had average sales for the past three years of less than $1 million .
b. The business is a service company and has over $1 million in sales.
c. The business is a personal service business with over $15 million in sales.
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 to the cash
• C Corporations, trusts with unrelated trade or business income, and partnerships having a C
corporations 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
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?
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 mayor 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].
A taxpayer sold for $200,000 equipment that had an adjusted basis of $180,000. Through the date of the
sale, the taxpayer had deducted $30,000 of depreciation. Of this amount, $17,000 was in excess of straightline
depreciation. What amount of gain would be recaptured under Section 1245 (Gain from Dispositions of
Certain Depreciable Property)?
Choice "c" is correct. Under Section 1245, the amount of depreciation in excess of straight-line depreciation
is irrelevant (the "excess depreciation" rule is a Section 1250 rule and applies to real property). In this
question, $30,000 of depreciation was deducted and, at first glance, the answer would appear to be $30,000.
However, Section 1245 actually only requires that the lesser of the depreciation taken ($30,000) or the gain
recognized ($200,000 - $180,000 = $20,000) be recaptured .
Four years ago, a self-employed taxpayer purchased office furniture for $30,000. During the current tax year,
the taxpayer sold the furniture for $37,000. At the time of the sale, the taxpayer's depreciation deductions
totaled $20,700. What part of the gain is taxed as long-term capital gain?
Choice "b" is correct. When property is sold, the realized gain is the difference between the proceeds and the
adjusted basis, in this question, the difference between the $37,000 and $9,300 ($30,000 - $20,700), or
$27,700. Under Section 1245 (office furniture qualifies as Section 1245 property because it is not real
property), the total depreciation deducted will be recaptured as ordinary income, and the remainder (any
amount in excess of the original cost) will be Section 1231 (taxed as a long-term capital) gain. In this
question , the $20,700 of depreciation deductions is ordinary income and $7,000 ($37,000 - $30,000) is
Section 1231 (taxed as a long-term capital) gain.
[Note: Section 1245 actually requires that the lesser of the depreciation taken ($20,700) or the gain
recognized ($37,000 - an assumed $9,300 = $20,700) be recaptured . Normally, the two steps of the formula
produce the same result.]
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?
Choice "c" 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.
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
Choice "c" 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.
Brisk Corp. is an accrual-basis, calendar-year C corporation with one individual shareholder. At year end,
Brisk had $600,000 accumulated and current earnings and profits as it prepared to make its only dividend
distribution for the year to its shareholder. Brisk could distribute either cash of $200,000 or land with an
adjusted tax basis of $75,000 and a fair market value of $200,000. How would the taxable incomes of both
Brisk and the shareholder change if land were distributed instead of cash?
1. Brisks taxable income
2. Shareholders taxable income
Increase/no effect/ stay the same
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 "b" 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.
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?
Choice "a" 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:
Debt $ 3,000
Taxable income $ 35,000
Which of the following groups may elect to file a consolidated corporate return?
a. A brotherlsister-controlled group.
b. A parent corporation and all more-than-10%-controlled partnerships.
c. A parent corporation and all more-than-50%-controlled subsidiaries.
d. Members of an affiliated group.
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.
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?
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 "b" 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 that above rules, there is no "shareholder gain" on this transaction.
Further, there is not 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.
Danielson invested $2,000,000 in DEC, a qualified small business corporation. Six years later, Danielson
sold all of the DEC stock for $16,000,000, and purchased an office building with the proceeds. Danielson had
not previously excluded any gain on the sale of small business stock. What is Danielson's taxable gain after
Rule: Per IRC Section 1202, a non-corporate taxpayer can exclude from gross income (and thus taxable
income) 50% of any gain from the sale of exchange of qualified small business stock held for more than 5
years. There are all sorts of special rules including special rules for property acquired between 2009 and but the rule stated is the general rule.
Choice "c" is correct. DEC is a qualified small business corporation and the stock has been held by
Danielson for more than 5 years. Danielson is not a corporation. The realized gain on the sale of the stock is
$14,000,000 ($16,000,000 - $2,000,000). The amount of this gain that is excluded from gross income is 50%
of the $14,000,000, or $7,000,000. That means that $7,000,000 of the gain is taxable.
Quigley, Roberk, and Storm form a corporation. Quigley exchanges $25,000 of legal fees for 30 shares of
stock. Roberk exchanges land with a basis of $10,000 and a fair market value of $100,000 for 60 shares of
stock. Storm exchanges $10,000 cash for 10 shares of stock. What amount of income should each
Ru/e: IRC Section 351 controls the taxation of transfers to controlled corporations. No gain or loss is
recognized to the transferors/shareholders on the property transferred if certain conditions are satisfied.
Choice "b" is correct. The transaction in this question does not satisfy the conditions of Section 351, and gain or loss can be recognized for each of the shareholders. For Section 351 to apply, the shareholders
contributing property, including cash, must own, immediately after the transaction, at least 80% of the voting
stock and at least 80% of the nonvoting stock of the corporation. A shareholder who contributes only services (Quigley in this question) is not counted as part of the control group. Thus, only Roberk and Storm are
counted, and they together own only 70 shares out of the 100 shares (70%). The $25,000 of legal fees to
Quigley is compensation for services rendered and is recognized as income by Quigley. A gain of $90,000
(the fair market value of the land of $100,000 - its adjusted basis of $10,000) is recognized to Roberk. Storm
bought shares for cash and has no gain.
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