Module 38: Corporate Taxation

Overview

This module covers corporate taxation and reviews the rules that apply throughout the life cycle of a corporation. The tax consequences of corporate formation are covered first, followed by a review of some of the special rules that apply to the income and deductions of a corporation, including the charitable contributions deduction and the dividends received deduction. The Schedule M-1 reconciliation of book income to taxable income, and the tax concepts of affiliated and controlled groups are next reviewed. This is followed by a review of the tax treatment of corporate distributions to shareholders and their taxability as dividends. Next reviewed are the tax consequences of a complete liquidation, as well as the accumulated earnings and personal holding company penalty taxes. The module then continues with a review of the special rules that apply to S corporations and their shareholders, and the tax effects of corporate reorganizations. The module concludes with a comparison of C corporations, S corporations, and partnerships.

I. Corporations

A. Transfers to a Controlled Corporation (Sec. 351)

B. Section 1244–Small Business Corporation (SBC) Stock

C. Variations from Individual Taxation

D. Affiliated and Controlled Corporations

E. Dividends and Distributions

F. Personal Holding Company and Accumulated Earnings Taxes

G. S Corporations

H. Corporate Reorganizations

II. Comparison of C Corporations, S Corporations, and Partnerships

Key Terms

Multiple-Choice Questions

Multiple-Choice Answers and Explanations

Simulations

Simulation Solutions

I. CORPORATIONS

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

A. Transfers to a Controlled Corporation (Sec. 351)

1. No gain or loss is recognized if property is transferred to a corporation solely in exchange for stock and immediately after the exchange those persons transferring property control the corporation.

a. Property includes everything but services.

b. Control means ownership of at least 80% of the total combined voting power and 80% of each class of nonvoting stock.

c. Receipt of boot (e.g., cash, short-term notes, securities, etc.) will cause recognition of gain (but not loss).

(1) Corporation’s assumption of liabilities is treated as boot only if there is a tax avoidance purpose, or no business purpose.

(2) Shareholder recognizes gain if liabilities assumed by corporation exceed the total basis of property transferred by the shareholder.

2. Shareholder’s basis for stock = Adjusted basis of property transferred

a. + Gain recognized

b. − Boot received (assumption of liability always treated as boot for purposes of determining stock basis)

3. Corporation’s basis for property = Transferor’s adjusted basis + Gain recognized to transferor.

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EXAMPLE

Individuals A, B, & C form ABC Corp. and make the following transfer to their corporation:

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a. If the aggregate adjusted basis of transferred property exceeds its aggregate FMV, the corporate transferee’s aggregate basis for the property is generally limited to its aggregate FMV immediately after the transaction. Any required basis reduction is allocated among the transferred properties in proportion to their built-in loss immediately before the transaction.

b. Alternatively, the transferor and the corporate transferee are allowed to make an irrevocable election to limit the basis in the stock received by the transferor to the aggregate FMV of the transferred property.

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EXAMPLE

Amy transferred Lossacre with a basis of $6,000 (FMV of $2,000) and Gainacre with a basis of $4,000 (FMV of $5,000) to ABE Corp. in exchange for stock in a Sec. 351 transaction. Since the aggregate adjusted basis of the transferred property ($10,000) exceeds its aggregate FMV ($7,000), ABE’s aggregate basis for the property is limited to $7,000. The required basis reduction of $3,000 would reduce ABE’s basis for Lossacre to $3,000 ($6,000 − $3,000). Amy’s basis for her stock would equal the total basis of the transferred property, $10,000.

Alternatively, if Amy and ABE elect, ABE’s basis for the transferred property will be $6,000 for Lossacre and $4,000 for Gainacre, and Amy’s basis for her stock will be limited to its FMV of $7,000.

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 1 THROUGH 7

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B. Section 1244–Small Business Corporation (SBC) Stock

C. Variations from Individual Taxation

1. Filing and payment of tax

a. A corporation generally must file a Form 1120 every year even though it has no taxable income. A short-form Form 1120-A may be filed if gross receipts, total income, and total assets are each less than $500,000.

b. The return must be filed by the fifteenth day of the third month following the close of its taxable year (e.g., March 15 for calendar-year corporation).

(1) An automatic six-month extension may be obtained by filing Form 7004.

(2) Any balance due on the corporation’s tax liability must be paid with the request for extension.

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

(1) Quarterly payments are due on the fifteenth day of the fourth, sixth, ninth, and twelfth months of its taxable year (April 15, June 15, September 15, and December 15 for a calendar-year corporation). Any balance due must be paid by the due date of the return.

(2) No penalty for underpayment of estimated tax will be imposed if payments at least equal the lesser of

(a) 100% of the current year’s tax (determined on the basis of actual income or annualized income), or

(b) 100% of the preceding year’s tax (if the preceding year was a full twelve months and showed a tax liability).

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

(4) If any amount of tax is not paid by the original due date, interest must be paid from the due date until the tax is paid.

(5) A failure-to-pay tax delinquency penalty will be owed if the amount of tax paid by the original due date of the return is less than 90% of the tax shown on the return. The failure-to-pay penalty is imposed at a rate of 0.5% per month (or fraction thereof), with a maximum penalty of 25%.

2. Corporations are subject to

a. Regular tax rates

	Taxable income	Rate
(1)	$0–$50,000	15%
(2)	$50,001–$75,000	25
(3)	$75,001–$10 million	34
(4)	Over $10 million	35

(5) The less-than-34% brackets are phased out by adding an additional tax of 5% of the excess of taxable income over $100,000, up to a maximum additional tax of $11,750.

(6) The 34% bracket is phased out for corporations with taxable income in excess of $15 million by adding an additional 3% of the excess of taxable income over $15 million, up to a maximum additional tax of $100,000.

b. Certain personal service corporations are not eligible to use the less-than-35% brackets and their taxable income is taxed at a flat 35% rate.

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 12 THROUGH 20

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c. Alternative minimum tax (AMT)

(1) Computation. The AMT is generally the amount by which 20% of alternative minimum taxable income (AMTI) as reduced by an exemption and the alternative minimum tax foreign tax credit, exceeds the regular tax (i.e., regular tax liability reduced by the regular tax foreign tax credit). AMTI is equal to taxable income computed with specified adjustments and increased by tax preferences.

(2) Exemption. AMTI is offset by a $40,000 exemption. However, the exemption is reduced by 25% of AMTI over $150,000, and completely phased out once AMTI reaches $310,000.

(3) AMT formula

+	Regular taxable income before Net Operation Loss (NOL) deduction Tax preference items
+(–)	Adjustments other than Adjusted Current Earnings (ACE) and NOL deduction
	Pre-ACE AMTI
+(–)	ACE adjustment (75% of difference between pre-ACE AMTI and ACE)
–	AMT NOL deduction (limited to 90% of pre-NOL AMTI)
–	AMTI Exemption ($40,000 less 25% of AMTI over $150,000)
×	Alternative minimum tax base 20% rate
–	Tentative AMT before foreign tax credit AMT foreign tax credit
–	Tentative minimum tax (TMT) Regular income tax (less regular tax foreign tax credit)
	Alternative minimum tax (if positive)

(4) Preference items. The following are examples of items added to regular taxable income in computing pre-ACE AMTI:

(a) Tax-exempt interest on private activity bonds (net of related expenses). However, tax-exempt interest on private activity bonds issued in 2009 and 2010 is not an item of tax preference.

(b) Excess of accelerated over straight-line depreciation on real property and leased personal property placed in service before 1987

(c) The excess of percentage depletion deduction over the property’s adjusted basis

(d) The excess of intangible drilling costs using a ten-year amortization over 65% of net oil and gas income

(5) Adjustments. The following are examples of adjustments to regular taxable income in computing pre-ACE AMTI:

(a) For real property placed in service after 1986 and before 1999, the difference between regular tax depreciation and straight-line depreciation over forty years

(b) For personal property placed in service after 1986, the difference between regular tax depreciation using the 200% declining balance method and depreciation using the 150% declining balance method

(c) The installment method cannot be used for sales of inventory-type items

(d) Income from long-term contracts must be determined using the percentage of completion method

(6) Adjusted Current Earnings (ACE). ACE is a concept based on a corporation’s earnings and profits, and is calculated by making adjustments to pre-ACE AMTI.

AMTI before ACE adjustment and NOL deduction

Add:	Tax-exempt interest on municipal bonds (less expenses); except not interest on tax-exempt bonds issued in 2009 or 2010. Tax-exempt life insurance death benefits (less expenses) 70% dividends-received deduction
Deduct:	Depletion using cost depletion method Depreciation using ADS straight-line for all property (this adjustment eliminated for property placed in service after 1993)
Other:	Capitalize organizational expenditures and circulation expenses Add increase (subtract decrease) in LIFO recapture amount (i.e., excess of FIFO value over LIFO basis) Installment method cannot be used for non dealer sales of property Amortize intangible drilling costs over five years
ACE (Adjusted Current Earnings)	– Pre-ACE AMTI
Balance (positive or negative)	× 75%
	ACE adjustment (positive or negative)

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EXAMPLE

Acme, Inc. has adjusted current earnings (ACE) of $100,000 and alternative minimum taxable income (before this adjustment) of $60,000. Since adjusted current earnings exceeds pre-ACE AMTI by $40,000, 75% of this amount must be added to Acme’s AMTI. Thus, Acme’s AMTI before exemption for the year is [$60,000 + ($40,000 × 75%)] = $90,000.

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(a) The ACE adjustment can be positive or negative, but a negative ACE adjustment is limited in amount to prior years’ net positive ACE adjustments.

(b) The computation of ACE is not the same as the computation of a corporation’s E&P. For example, federal income taxes, penalties and fines, and the disallowed portion of business meals and entertainment would be deductible in computing E&P, but are not deductible in computing ACE.

(7) Minimum tax credit. The amount of AMT paid is allowed as a credit against regular tax liability in future years.

(a) The credit can be carried forward indefinitely, but not carried back.

(b) The AMT credit can only be used to reduce regular tax liability, not future AMT liability.

(8) Small corporation exemption. A corporation is exempt from the corporate AMT for its first tax year (regardless of income levels). After the first year, it is exempt from AMT if it passes a gross receipts test. It is exempt for its second year if its first year’s gross receipts do not exceed $5 million. To be exempt for its third year, the corporation’s average gross receipts for the first two years must not exceed $7.5 million. To be exempt for the fourth year (and subsequent years), the corporation’s average gross receipts for all prior three-year periods must not exceed $7.5 million.

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EXAMPLE

Zero Corp., a calendar-year corporation, was formed on January 2, 2010, and had gross receipts for its first four taxable years as follows:

Year	Gross receipts
2010	$ 4,500,000
2011	9,000,000
2012	8,000,000
2013	6,500,000

Zero is automatically exempt from AMT for 2010. It is exempt for 2011 because its gross receipts for 2010 do not exceed $5 million. Zero also is exempt for 2012 because its average gross receipts for 2010-2011 do not exceed $7.5 million. Similarly, it is exempt for 2013 because its average gross receipts for 2010–2012 do not exceed $7.5 million. However, Zero will lose its exemption from AMT for 2014 and all subsequent years because its average gross receipts for 2011–2013 exceed $7.5 million.

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 21 THROUGH 28

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3. Gross income for a corporation is computed much the same as for individual taxpayers. However, there are a few differences.

a. A corporation does not recognize gain or loss on the issuance of its own stock (including treasury stock), or on the lapse or acquisition of an option to buy or sell its stock (including treasury stock).

(1) It generally recognizes gain (but not loss) if it distributes appreciated property to its shareholders.

(2) Contributions to capital are excluded from a corporation’s gross income, whether received from shareholders or non shareholders.

(a) If property is received from a shareholder, the shareholder recognizes no gain or loss, the shareholder’s basis for the contributed property transfers to the corporation, and the shareholder’s stock basis is increased by the basis of the contributed property.

(b) If property is received as a capital contribution from a non shareholder, the corporation’s basis for the contributed property is zero.

1] If money is received, the basis of property purchased within one year afterwards is reduced by the money contributed.

2] Any money not used reduces the basis of the corporation’s existing property beginning with depreciable property.

b. No gain or loss is recognized on the issuance of debt.

(1) Premium or discount on bonds payable is amortized as income or expense over the life of bonds.

(2) Ordinary income/loss is recognized by a corporation on the repurchase of its bonds, determined by the relationship of the repurchase price to the net carrying value of the bonds (issue price plus or minus the discount or premium amortized).

(3) Interest earned and gains recognized in a bond sinking fund are income to the corporation.

c. Gains are treated as ordinary income on sales of property to or from a more than 50% shareholder, or between corporations which are more than 50% owned by the same individual, if the property is subject to depreciation in the hands of the buyer.

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 29 THROUGH 33

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4. Deductions for a corporation are much the same as for individuals. However, there are some major differences.

a. Adjusted gross income is not applicable to corporations.

b. A corporation may elect to deduct up to $5,000 of organizational expenditures for the tax year in which the corporation begins business. The $5,000 amount must be reduced (but not below zero) by the amount by which organizational expenditures exceed $50,000. Remaining expenditures can be deducted ratably over the 180-month period beginning with the month in which the corporation begins business.

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EXAMPLE

A calendar-year corporation was organized and began business during 2013 incurring $4,800 or organizational expenditures. The corporation may deduct the $4,800 of organizational expenditures for 2013.

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EXAMPLE

A calendar-year corporation was organized during February 2013 incurring organizational expenditures of $6,000. Assuming the corporation begins business during April 2013, its maximum deduction for organizational expenditures for 2013 would be $5,000 + [($6,000 − $5,000) × 9/180] = $5,050.

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EXAMPLE

A calendar-year corporation was organized during February 2013 incurring organizational expenditures of $60,000. Assuming the corporation begins business during April 2013, its maximum deduction for organizational expenditures for 2013 would be $60,000 × 9/180 = $3,000.

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(1) For amounts paid or incurred after September 8, 2008, the corporation is deemed to have made the election, but instead may choose to forgo the deemed election by clearly electing to capitalize its costs on a timely filed return (including extensions) for the taxable year in which the corporation begins business.

(2) Organizational expenditures include expenses of temporary directors and organizational meetings, state fees for incorporation, accounting and legal service costs incident to incorporation (e.g., drafting bylaws, minutes of organizational meetings, and terms of original stock certificates).

(3) Expenditures connected with issuing or selling shares of stock, or listing stock on an exchange are neither deductible nor amortizable. Expenditures connected with the transfer of an asset to the corporation must be capitalized as part of the cost of the asset.

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 34 THROUGH 37

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c. The deduction for charitable contributions is limited to 10% of taxable income before the contributions deduction, the dividends received deduction, a NOL carryback (but after carryover), a capital loss carryback (but after carryover), and before the domestic production activities deductions (DPAD).

(1) Generally the same rules apply for valuation of contributed property as for individuals except

(a) Deduction for donations of inventory and other appreciated ordinary income-producing property is the donor’s basis plus one-half of the unrealized appreciation but limited to twice the basis, provided

1] Donor is a corporation (but not an S corporation)

2] Donee must use property for care of ill, needy, or infants

3] Donor must obtain a written statement from the donee that the use requirement has been met

4] No deduction allowed for unrealized appreciation that would be ordinary income under recapture rules

(b) Deduction for donation of appreciated scientific personal property to a college or university is the donor’s basis plus one-half the unrealized appreciation but limited to twice the basis, provided

1] Donor is a corporation (but not an S corporation, personal holding company, or service organization)

2] Property was constructed by donor and contributed within two years of substantial completion, and donee is original user of property

3] Donee must use property for research or experimentation

4] Donor must obtain a written statement from the donee that the use requirement has been met

5] No deduction allowed for unrealized appreciation that would be ordinary income under recapture rules

(2) Contributions are deductible in period paid (subject to 10% limitation) unless corporation is an accrual method taxpayer and then deductible (subject to 10% limitation) when authorized by board of directors if payment is made within 2 1/2 months after tax year end, and corporation elects to deduct contributions when authorized.

(3) Excess contributions over the 10% limitation may be carried forward for up to five years.

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EXAMPLE

The books of a calendar-year, accrual method corporation for 2013 disclose net income of $350,000 after deducting a charitable contribution of $50,000. The contribution was authorized by the Board of Directors on December 24, 2013, and was actually paid on January 31, 2014. The allowable charitable contribution deduction for 2013 (if the corporation elects to deduct it when accrued) is $40,000, calculated as follows: ($350,000 + $50,000) × .10 = $40,000. The remaining $10,000 is carried forward for up to five years.

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 38 THROUGH 44

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d. A 100% Dividends Received Deduction (DRD) for dividends received from affiliated (i.e., at least 80% owned) corporations if a consolidated tax return is not filed.

(1) If a consolidated tax return is filed, intercompany dividends are eliminated in the consolidation process and not included in consolidated gross income.

(2) See Section D. for discussion of affiliated corporations

e. An 80% DRD is allowed for qualified dividends from taxable domestic unaffiliated corporations that are at least 20% owned (but less than 80% owned).

(1) DRD may be limited to 80% of taxable income before the 80% dividends received deduction, the net operating loss deduction, a capital loss carryback, and the domestic production activities deduction (DPAD).

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EXAMPLE

A corporation has income from sales of $20,000, dividend income of $10,000, and business expenses of $22,000, resulting in taxable income before the DRD of $8,000. Since taxable income before the DRD ($8,000) is less than dividend income ($10,000), the DRD is limited to $8,000 x 80% = $6,400. As a result, taxable income would be $8,000 − $6,400 = $1,600.

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(2) Exception: The 80% of taxable income limitation does not apply if the full 80% DRD creates or increases a net operating loss.

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EXAMPLE

In the example above, assume the same facts except that business expenses are $22,001, resulting in taxable income before the DRD of $7,999. Since the full DRD ($8,000) would create a $1 net operating loss ($7,999 − $8,000), the taxable income limitation does not apply and the full DRD ($8,000) would be allowed.

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f. Only a 70% dividends received deduction (instead of 80%) is allowed for qualified dividends from taxable domestic unaffiliated corporations that are less than 20% owned.

(1) A 70% of taxable income limitation (instead of 80%) and a limitation exception for a net operating loss apply as in e.(1) and (2) above.

(2) If dividends are received from both 20% owned corporations and corporations that are less than 20% owned, the 80% DRD and 80% DRD limitation for dividends received from 20% owned corporations is computed first. Then the 70% DRD and 70% DRD limitation is computed for dividends received from less than 20% owned corporations. For purposes of computing the 70% DRD limitation, taxable income is reduced by the total amount of dividends received from 20% owned corporations.

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EXAMPLE

A corporation has taxable income before the dividends received deduction of $100,000. Included in taxable income are $65,000 of dividends from a 20% owned corporation and $40,000 of dividends from a less than 20% owned corporation. First, the 80% DRD for dividends received from the 20% owned corporation is computed. That deduction equals $52,000 [i.e., the lesser of 80% of the dividends received (80% × $65,000), or 80% of taxable income (80% × $100,000)].

Second, the 70% DRD for the dividends received from the less than 20% owned corporation is computed. That deduction is $24,500 [i.e., the lesser of 70% of the dividends received (70% × $40,000), or 70% of taxable income after deducting the amount of dividends from the 20% owned corporation (70% × [$100,000 − $65,000])].

Thus, the total dividends received deduction is $52,000 + $24,500 = $76,500.

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g. A portion of a corporation’s 80% (or 70%) DRD will be disallowed if the dividends are directly attributable to debt-financed portfolio stock.

(1) “Portfolio stock” is any stock (except stock of a corporation if the taxpayer owns at least 50% of the voting power and at least 50% of the total value of such corporation).

(2) The DRD percentage for debt-financed portfolio stock = [80% (or 70%) × (100% − average % of indebtedness on the stock)].

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EXAMPLE

P, Inc. purchased 25% of T, Inc. for $100,000, paying with $50,000 of its own funds and $50,000 borrowed from its bank. During the year P received $9,000 in dividends from T, and paid $5,000 in interest expense on the bank loan. No principal payments were made on the loan during the year. If the stock were not debt financed, P’s DRD would be $9,000 × 80% = $7,200. However, because half of the stock investment was debt financed, P’s DRD is $9,000 × [80% × (100% − 50%)] = $3,600.

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(3) The reduction in the DRD cannot exceed the interest deduction allocable to the portfolio stock indebtedness.

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EXAMPLE

Assume the same facts as above except that the interest expense on the bank loan was only $3,000. The reduction in the DRD would be limited to the $3,000 interest deduction on the loan. The DRD would be ($9,000 × 80%) − $3,000 = $4,200.

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h. No DRD is allowed if the dividend paying stock is held less than 46 days during the 91-day period that begins 45 days before the stock becomes ex-dividend. In the case of preferred stock, no DRD is allowed if the dividends received are for a period or periods in excess of 366 days and the stock has been held for less than 91 days during the 181-day period that begins 90 days before the stock becomes ex-dividend.

i. The basis of stock held by a corporation must be reduced by the nontaxed portion of a non liquidating extraordinary dividend received with respect to the stock, unless the corporation has held the stock for more than two years before the dividend is announced. To the extent the nontaxed portion of an extraordinary dividend exceeds the adjusted basis of the stock, the excess is recognized as gain for the taxable year in which the extraordinary dividend is received.

(1) The nontaxed portion of a dividend is generally the amount that is offset by the DRD.

(2) A dividend is considered “extraordinary” when it equals or exceeds 10% (5% for preferred stock) of the stock’s adjusted basis (or FMV if greater on the day preceding the ex-dividend date).

(3) Aggregation of dividends

(a) All dividends received that have ex-dividend dates that occur within a period of 85 consecutive days are treated as one dividend.

(b) All dividends received within 365 consecutive days are treated as extraordinary dividends if they in total exceed 20% of the stock’s adjusted basis.

(4) This provision is not applicable to dividends received from an affiliated corporation, and does not apply if the stock was held during the entire period the paying corporation (and any predecessor) was in existence.

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EXAMPLE

Corporation X purchased 30% of the stock of Corporation Y for $10,000 during June 2013. During December 2013 X received a $20,000 dividend from Y. X sold its Y stock for $5,000 in February 2014.

Because the dividend from Y is an extraordinary dividend, the nontaxed portion (equal to the DRD allowed to X) $20,000 × 80% = $16,000 has the effect of reducing the Y stock basis from $10,000 to $0, with the remaining $6,000 recognized as gain for 2013. When the stock is sold in 2014, the excess of sale proceeds over the reduced stock basis $5,000 − $0 = $5,000 is also recognized as gain.

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 45 THROUGH 50

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j. Losses in the ordinary course of business are deductible.

(1) Loss is disallowed if the sale or exchange of property is between--

(a) A corporation and a more than 50% shareholder.

(b) A C corporation and an S corporation if the same persons own more than 50% of each.

(c) A corporation and a partnership if the same persons own more than 50% of the corporation, and more than 50% of the capital and profits interest in the partnership.

(d) Constructive ownership rules apply for purposes of determining stock ownership. Family constructive ownership includes an individual’s brothers and sisters, spouse, ancestors, and lineal descendants.

(e) In the event of a disallowed loss, the transferee on a subsequent disposition only recognizes gain to the extent it exceeds the disallowed loss.

(2) Any loss from the sale or exchange of property between corporations that are members of the same controlled group is deferred (instead of disallowed) until the property is sold outside the group. See controlled group definition in Section D.2., except substitute “more than 50%” for “at least 80%.”

(3) An accrual method C corporation is effectively placed on the cash method of accounting for purposes of deducting accrued interest and other expenses owed to a related cash method payee. No deduction is allowable until the year the amount is actually paid.

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EXAMPLE

A calendar-year corporation accrues $10,000 of salary to an employee (a 60% shareholder) during 2013 but does not make payment until February 2014. The $10,000 will be deductible by the corporation and reported as income by the employee-shareholder in 2014.

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(4) Capital losses are deductible only to the extent of capital gains (i.e., may not offset ordinary income).

(a) Unused capital losses are carried back three years and then carried forward five years to offset capital gains.

(b) All corporate capital loss carrybacks and carry forwards are treated as short-term.

(5) Bad debt losses are treated as ordinary deductions.

(6) Casualty losses are treated the same as for an individual except

(a) There is no $100 floor

(b) If property is completely destroyed, the amount of loss is the property’s adjusted basis

(c) A partial loss is measured the same as for an individual’s nonbusiness loss (i.e., the lesser of the decrease in FMV, or the property’s adjusted basis)

(7) A corporation’s NOL is computed the same way as its taxable income.

(a) The dividends received deduction is allowed without limitation.

(b) No deduction is allowed for a NOL carryback or carryover from other years, and no deduction is allowed for the domestic production activities deduction (DPAD).

(c) A NOL is generally carried back two years and forward twenty years to offset taxable income in those years. However, a three-year carryback is permitted for the portion of a NOL that is attributable to a presidentially declared disaster and is incurred by a small business corporation (i.e., a corporation whose average annual gross receipts are $5 million or less for the three-tax-year period preceding the loss year). A corporation may elect to forego carryback and only carry forward twenty years.

k. Depreciation and depletion computations are same as for individuals.

l. Research and development expenditures of a corporation (or individual) may be treated under one of three alternatives

(1) Currently expensed in year paid or incurred

(2) Amortized over a period of sixty months or more if life not determinable

(3) Capitalized and depreciated over determinable life

m. Contributions to a pension or profit-sharing plan

(1) Defined benefit plans

(a) Maximum deductible contribution is actuarially determined.

(b) There also are minimum funding standards.

(2) Defined contribution plans

(a) Maximum deduction for contributions to qualified profit-sharing or stock bonus plans is generally limited to 25% of the compensation paid or accrued during the year to covered employees.

(b) If more than 25% is paid, the excess can be carried forward as part of the contributions of succeeding years to the extent needed to bring the deduction up to 25%.

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 51 THROUGH 58

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5. In working a corporate problem, certain calculations must be made in a specific order [e.g., charitable contributions (CC) must be computed before the DRD]. The following memory device is quite helpful:

Gross income

–	Deductions (except CC, DRD, and DPAD)
–	Taxable income before CC, DRD, and DPAD CC (limited to 10% of TI before CC, DRD, capital loss and NOL carrybacks, and DPAD)
–	Taxable income before DRD and DPAD DRD (may be limited* to 80% or 70%) of TI before DRD, capital loss carryback, NOL carryover or carryback, and the DPAD)
–	Taxable income before DPAD DPAD (limited to 9% of TI before DPAD)
×	Taxable income Applicable rates
= –	Tax liability before tax credits Tax credits
	Tax liability

* Limitation not applicable if full 80% (or 70%) of dividends received creates or increases an NOL.

6. A person sitting for the CPA examination should be able to reconcile book and taxable income.

a. If you begin with book income to calculate taxable income, make the following adjustments:

(1) Increase book income by

(a) Federal income tax expense

(b) Excess of capital losses over capital gains because a net capital loss is not deductible

(c) Income items in the tax return not included in book income (e.g., prepaid rents, royalties, interest)

(d) Charitable contributions in excess of the 10% limitation

(e) Expenses deducted on the books but not on the tax return (e.g., amount of business gifts in excess of $25, nondeductible life insurance premiums paid, 50% of business meals and entertainment)

(2) Deduct from book income

(a) Income reported on the books but not on the tax return (e.g., tax-exempt interest, life insurance proceeds)

(b) Expenses deducted on the tax return but not on the books (e.g., MACRS depreciation above straight-line, charitable contribution carryover)

(c) The dividends received deduction

(d) The domestic production activities deduction

b. When going from taxable income to book income, the above adjustments would be reversed.

c. Schedule M-1 of Form 1120 provides a reconciliation of income per books with taxable income before the NOL deduction and DRD, and must be completed by corporations with less than $10 million of total assets. Schedule M-1 items are either permanent book-to-tax differences (e.g., tax-exempt interest) or temporary differences (e.g., accelerated depreciation used on tax return while straight-line used per books). The starting point on Schedule M-1 is net income (or loss) per books. Additions and subtractions are then made to reflect the differences between financial and tax accounting. The end result is the amount of taxable income before the NOL deduction and DRD that is reported on the current year return.

(1) Items added to book income include

(a) Federal income tax expense that was deducted per books

(b) Excess of capital losses over capital gains deducted per books but not deductible for tax purposes

(c) Income subject to tax in the current year but not included in current year book income (e.g., receipt of prepaid rent)

(d) Expenses deducted per books but not allowed in computing taxable income (e.g., 50% of business meals and entertainment, expenses incurred in the production of tax-exempt income, charitable contributions in excess of the 10% of taxable income limitation).

(2) Items subtracted from book income include

(a) Income reported on books this year not included in the tax return (e.g., tax-exempt interest, nontaxable life insurance proceeds)

(b) Deductions on the return not charged against book income this year (e.g., tax depreciation in excess of book depreciation, domestic production activities deduction)

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EXAMPLE

A corporation discloses that it had net income after taxes of $36,000 per books. Included in the computation were deductions for charitable contributions of $10,000, a net capital loss of $5,000, and federal income taxes paid of $9,000. What is the corporation’s TI?

Net income per books after tax	$36,000
Nondeductible net capital loss	+ 5,000
Federal income tax expense	+ 9,000
Charitable contributions	+ 10,000
Taxable income before CC	$60,000
CC (limited to 10% × 60,000)	– 6,000
Taxable income	$54,000

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d. Schedule M-2 of Form 1120 analyzes changes in a corporation’s Unappropriated Retained Earnings per books between the beginning and end of the year.

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 59 THROUGH 72

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e. Schedule M-3 Net Income (Loss) Reconciliation must be completed and attached to a corporation’s Form 1120 if the corporation’s total assets at the end of the tax year equal or exceed $10 million. A corporation filing Schedule M-3 must not complete Schedule M-1. A corporation with total assets less than $10 million can elect to complete Schedule M-3 instead of completing Schedule M-1.

(1) Total assets at the end of the year must be determined using the same method as used for financial statement purposes. If a corporation uses the accrual method for financial statement purposes and the cash method for tax purposes, the corporation’s total assets must be determined using the accrual method.

(a) In the case of a US consolidated tax group, total assets at the end of the tax year must be determined based on the total year-end assets of all includible corporations, net of eliminations for intercompany transactions and balances between the includible corporations.

(b) A corporation is not required to file Schedule M-3 if total assets at the end of the current year are less than $10 million, even though the corporation was required to file Schedule M-3 for the preceding tax year.

(c) No schedule M-3 is required for taxpayers filing Form 1120-REIT (Real Estate Investment Trusts); Form 1120-RIC (Regulated Investment Companies); Form 1120-H (Homeowners Associations); and Form 1120-SF (Settlement Funds).

(2) Schedule M-3 consists of three parts: Part I adjusts worldwide income per books to worldwide book income for only those corporations includible on the tax return; Part II reconciles income and loss items for includible corporations; and Part III reconciles expense and deduction items. The total of items for Part III carry over to Part II for the overall reconciliation.

(a) Schedule M-3 requires much greater detail (Parts II and III contain a total of 66 line items) than Schedule M-1 (10 line items) because it requires taxpayers to separately list each type of transaction that gives rise to a book-tax difference and to identify whether each difference is permanent or temporary.

(b) Parts II and III each contain four columns: (a) income statement items; (b) temporary differences; (c) permanent differences; and, (d) tax return items. Part III requires a corporation to separate its book federal income tax expense between its current income tax expense and its deferred income tax expense. If its financial statements do not separately report current and deferred income tax expense, all income tax expense should be reported as current income tax expense in Part III.

(c) A US consolidated tax group required to file Schedule M-3 must file multiple Schedules M-3. It must file one Schedule M-3, Parts I, II, and III to reflect the activity of the entire US consolidated tax group. Additionally, a separate Schedule M-3 Parts II and III must be completed for the parent corporation and each subsidiary to reflect each corporation’s separate activity. Lastly, it generally is necessary to complete Parts II and III of a separate Schedule M-3 to eliminate differences related to intercompany transactions, and to include limitations on deductions (e.g., charitable contributions and capital loss limitations) and carryover amounts. As a result, a US consolidated group consisting of a parent corporation and three subsidiary corporations would have to complete a total of six Schedules M-3.

(d) A corporation or group of corporations that files a Form 1120 and is required to file Schedule M-3, must also file Schedule B (Form 1120), Additional Information for Schedule M-3 Filers. In the case of a consolidated group, a parent corporation files only one Schedule B (Form 1120) for the entire consolidated group.

(e) Schedule UTP (Uncertain Tax Positions) must be completed and attached to Form 1120 if the corporation (1) has total assets of at least $100 million, and (2) the corporation has taken a tax position on its return and the corporation or a related party has either recorded a reserve with respect to that position in audited financial statements, or did not record a reserve because the corporation expects to litigate the position.

1] A tax position taken on a tax return is a tax position that would result in an adjustment to a line item on that return if the position is not sustained.

2] Schedule UTP requires a concise description of each uncertain tax position. Additionally, the corporation must rank each listed tax position by size, must indicate whether each position is temporary or permanent, and must disclose whether a tax position is greater than 10% of the aggregate amount of reserves for all tax positions.

3] If the corporation or a related party determined that, under applicable accounting standards, either no reserve was required for a tax position taken on a return because the amount was immaterial for audited financial statement purposes, or that a tax position was sufficiently certain so that no reserve was required, then the tax position is not required to be reported on Schedule UTP.

D. Affiliated and Controlled Corporations

1. An affiliated group is a parent-subsidiary chain of corporations in which at least 80% of the combined voting power and total value of all stock (except nonvoting preferred) are owned by includible corporations.

a. They may elect to file a consolidated return. Election is binding on all future returns.

b. If affiliated corporations file a consolidated return, intercompany dividends are eliminated in the consolidation process. If separate tax returns are filed, dividends from affiliated corporations are eligible for a 100% dividends received deduction.

c. Possible advantages of a consolidated return include the deferral of gain on intercompany transactions and offsetting operating/capital losses of one corporation against the profits/capital gains of another.

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EXAMPLE

P Corp. owns 80% of the stock of A Corp., 40% of the stock of B Corp., and 45% of the stock of C Corp. A Corp. owns 40% of the stock of B Corp. A consolidated tax return could be filed by P, A, and B.

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EXAMPLE

Parent and Subsidiary file consolidated tax returns using a calendar year. During 2012, Subsidiary paid a $10,000 dividend to Parent. Also during 2012, Subsidiary sold land with a basis of $20,000 to Parent for its FMV of $50,000. During 2013, Parent sold the land to an unrelated taxpayer for $55,000.

The intercompany dividend is eliminated in the consolidation process and is excluded from consolidated taxable income. Additionally, Subsidiary’s $30,000 of gain from the sale of land to Parent is deferred for 2012. The $30,000 will be included in consolidated taxable income for 2013 when Parent reports $5,000 of income from the sale of that land to the unrelated taxpayer.

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2. A controlled group of corporations is limited to an aggregate of $75,000 of taxable income taxed at less than 35%, one $250,000 accumulated earnings credit, one Sec. 179 expense election, and one $40,000 AMT exemption. There are three basic types of controlled groups.

a. Parent-subsidiary–Basically same as P-S group eligible to file consolidated return, except ownership requirement is 80% of combined voting power or total value of stock. Affiliated corporations are subject to the controlled group limitations if the corporations file separate tax returns.

b. Brother-sister–Two or more corporations if 5 or fewer persons who are individuals, estates, or trusts own stock possessing more than 50% of the total combined voting power, or more than 50% of the total combined voting power, or more than 50% of the total value of all shares of stock of each corporation, taking into account the stock ownership of each person only to the extent such stock ownership is identical with respect to each corporation.

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EXAMPLE

Corporations W and X are a controlled group since five or fewer individuals own more than 50% of each corporation when counting only identical ownership.

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EXAMPLE

Corporations Y and Z are not a controlled group since shareholders F, G, and H do not own more than 50% of Y and Z when counting only identical stock ownership.

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c. Combined–The parent in a P-S group is also a member of a brother-sister group of corporations.

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EXAMPLE

Individual H owns 100% of the stock of Corporations P and Q. Corporation P owns 100% of the stock of Corporation S. P, S, and Q are members of one controlled group.

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 73 THROUGH 79

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E. Dividends and Distributions

F. Personal Holding Company and Accumulated Earnings Taxes

G. S Corporations

An S corporation generally pays no corporate income taxes. Instead, it functions as a pass-through entity (much like a partnership) with its items of income, gain, loss, deduction, and credit passed through and directly included in the tax computations of its shareholders. Electing small business corporations are designated as S corporations; all other corporations are referred to as C corporations.

1. Eligibility requirements for S corporation status

a. Domestic corporation

b. An S corporation may own any percent of the stock of a C corporation, and 100% of the stock of a qualified subchapter S subsidiary.

(1) An S corporation cannot file a consolidated return with an affiliated C corporation.

(2) A qualified subchapter S subsidiary (QSSS) is any domestic corporation that qualifies as an S corporation and is 100% owned by an S corporation parent, which elects to treat it as a QSSS. A QSSS is not treated as a separate corporation and all of its assets, liabilities, and items of income, deduction, and credit are treated as belonging to the parent S corporation.

c. Only one class of stock issued and outstanding. A corporation will not be treated as having more than one class of stock solely because of differences in voting rights among the shares of common stock (i.e., both voting and nonvoting common stock may be outstanding).

d. Shareholders must be individuals, estates, or trusts created by will (only for a two-year period), voting trusts, an Electing Small Business Trust (ESBT), a Qualified Subchapter S Trust (QSST), or a trust all of which is treated as owned by an individual who is a citizen or resident of the US (i.e., Subpart E trust).

(1) A QSST and a Subpart E trust may continue to be a shareholder for two years beginning with the date of death of the deemed owner.

(2) Code Sec. 401(a) qualified retirement plan trusts and Code Sec. 501(c) charitable organizations that are exempt from tax under Code Sec. 501(a) are eligible to be shareholders of an S corporation. The S corporation’s items of income and deduction will flow through to the tax-exempt shareholder as unrelated business taxable income (UBIT).

e. No nonresident alien shareholders

f. The number of shareholders is limited to 100.

(1) Husband and wife (and their estates) are counted as one shareholder.

(2) Each beneficiary of a voting trust is considered a shareholder.

(3) If a trust is treated as owned by an individual, that individual (not the trust) is treated as the shareholder.

(4) All members of a family can elect to be treated as one shareholder. The election may be made by any family member and will remain in effect until terminated. Members of a family include the common ancestor, the lineal descendants of the common ancestor, and the spouses (or former spouses) of the common ancestor and lineal descendants. The common ancestor cannot be more than six generations removed from the youngest generation of shareholders at the time the S election is made.

2. An election must be filed anytime in the preceding taxable year or on or before the fifteenth day of the third month of the year for which effective.

a. All shareholders on date of election, plus any shareholders who held stock during the taxable year but before the date of election, must consent to the election.

(1) If an election is made on or before the fifteenth day of the third month of taxable year, but either (1) a shareholder who held stock during the taxable year and before the date of election does not consent to the election, or (2) the corporation did not meet the eligibility requirements during the part of the year before the date of election, then the election is treated as made for the following taxable year.

(2) An election made after the fifteenth day of the third month of the taxable year is treated as made for the following year.

b. A newly formed corporation’s election will be timely if made within two and one-half months of the first day of its taxable year (e.g., a calendar-year corporation formed on April 6, 2013, could make an S corporation election that would be effective for its 2013 calendar year if the election is filed on or before June 20, 2013).

c. A valid election is effective for all succeeding years until terminated.

d. The IRS has the authority to waive the effect of an invalid election caused by a corporation’s inadvertent failure to qualify as a small business corporation or to obtain required shareholder consents (including elections regarding qualified subchapter S trusts), or both. Additionally, the IRS may treat late-filed subchapter S elections as timely filed if there is reasonable cause justifying the late filing.

3. LIFO recapture. A C corporation using LIFO that converts to S status must recapture the excess of the inventory’s value using a FIFO cost flow assumption over its LIFO tax basis as of the close of its last tax year as a C corporation.

a. The LIFO recapture is included in the C corporation’s gross income and the tax attributable to its inclusion is payable in four equal installments.

b. The first installment must be paid by the due date of the tax return for the last C corporation year, with the three remaining installments due by the due dates of the tax returns for the three succeeding taxable years.

4. A corporation making an S election is generally required toadopt or change to (1) a year ending December 31, or (2) a fiscal year that is the same as the fiscal year used by shareholders owning more than 50% of the corporation’s stock.

a. An S corporation may use a different fiscal year if a valid business purpose can be established (i.e., natural business year) and IRS permission is received. The business purpose test will be met if an S corporation receives at least 25% of its gross receipts in the last two months of the selected fiscal year, and this 25% test has been satisfied for three consecutive years.

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EXAMPLE

An S corporation, on a calendar year, has received at least 25% of its gross receipts during the months of May and June for each of the last three years. The S corporation may be allowed to change to a fiscal year ending June 30.

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b. An S corporation that otherwise would be required to adopt or change its tax year (normally to the calendar year) may elect to use a fiscal year if the election does not result in a deferral period longer than three months, or, if less, the deferral period of the year currently in use.

(1) The “deferral period” is the number of months between the close of the fiscal year elected and the close of the required year (e.g., if an S corporation elects a tax year ending September 30 and a tax year ending December 31 is required, the deferral period of the year ending September 30 is three months).

(2) An S corporation that elects a tax year other than a required year must make a “required payment” which is in the nature of a refundable, noninterest-bearing deposit that is intended to compensate the government for the revenue lost as a result of tax deferral. The required payment is due on May 15 each year and is recomputed for each subsequent year.

5. An S corporation must file Form 1120S by the fifteenth day of the third month following the close of its taxable year (e.g., March 15 for a calendar-year S corporation).

a. An automatic six-month extension may be obtained by filing Form 7004.

b. Estimated tax payments must be made if estimated tax liability (e.g., built-in gains tax, excess net passive income tax) is expected to be $500 or more.

6. Termination of S corporation status may be caused by

a. Shareholders owning more than 50% of the shares of stock of the corporation consent to revocation of the election.

(1) A revocation made on or before the fifteenth day of the third month of the taxable year is generally effective on the first day of such taxable year.

(2) A revocation made after the fifteenth day of the third month of the taxable year is generally effective as of the first day of the following taxable year.

(3) Instead of the dates mentioned above, a revocation may specify an effective date on or after the date on which the revocation is filed.

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EXAMPLE

For a calendar-year S corporation, a revocation not specifying a revocation date that is made on or before 3/15/13 is effective as of 1/1/13. A revocation not specifying a revocation date that is made after 3/15/13 is effective as of 1/1/14. If a revocation is filed 3/11/13 and specifies a revocation date of 7/1/13, the corporation ceases to be an S corporation on 7/1/13.

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b. The corporation’s failing to satisfy any of the eligibility requirements listed in 1. Termination is effective on the date an eligibility requirement is failed.

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EXAMPLE

A calendar-year S corporation with common stock outstanding issues preferred stock on April 1, 2013. Since its S corporation status terminates on April 1, it must file an S corporation tax return (Form 1120S) for the period January 1 through March 31, and a C corporation tax return (Form 1120) for the period April 1 through December 31, 2013. Both tax returns would be due by March 15, 2014.

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c. Passive investment income exceeding 25% of gross receipts for three consecutive taxable years if the corporation has subchapter C earnings and profits at the end of each of those years.

(1) Subchapter C earnings and profits are earnings and profits accumulated during a taxable year for which the corporation was a C corporation.

(2) Termination is effective as of the first day of the taxable year beginning after the third consecutive year of passive investment income in excess of 25% of gross receipts.

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EXAMPLE

An S corporation with subchapter C earnings and profits had passive investment income in excess of 25% of its gross receipts for its calendar years 2011, 2012, and 2013. Its S corporation status would terminate 1/1/14.

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d. Generally once terminated, S corporation status can be reelected only after five non–S corporation years.

(1) The corporation can request IRS for an earlier reelection.

(2) IRS may treat an inadvertent termination as if it never occurred.

7. An S corporation generally pays no federal income taxes, but may have to pay a tax on its built-in gain, or on its excess passive investment income if certain conditions are met.

a. The S corporation is treated as a pass-through entity; the character of any item of income, expense, gain, loss, or credit is determined at the corporate level, and passes through to shareholders, retaining its identity.

b. An S corporation must recognize gain on the distribution of appreciated property (other than its own obligations) to its shareholders. Gain is recognized in the same manner as if the property had been sold to the distributee at its FMV.

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EXAMPLE

An S corporation distributes property with an FMV of $900 and an adjusted basis of $100 to its sole shareholder. Gain of $800 will be recognized by the corporation. The character of the gain will be determined at the corporate level, and passed through and reported by its shareholder. The shareholder is treated as receiving a $900 distribution, subject to the distribution rules discussed in Section G.11.

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c. Expenses and interest owed to any cash-method shareholder are deductible by an accrual-method S corporation only when paid.

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EXAMPLE

An accrual-method calendar-year S corporation accrues $2,000 of salary to a cash-method employee (a 1% shareholder) during 2013, but does not make payment until February 2014. The $2,000 will be deductible by the corporation in 2014, and reported by the shareholder-employee as income in 2014.

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d. An S corporation will not generate any earnings and profits. All items are reflected in adjustments to the basis of shareholders’ stock and/or debt.

e. S corporations must make estimated tax payments for the tax liability attributable to the built-in gains tax, excess passive investment income tax, and the tax due to investment credit recapture.

f. The provisions of subchapter C apply to an S corporation, except where inconsistent with subchapter S. For example, an S corporation can use Secs. 332 and 337 to liquidate an acquired subsidiary, and can make a Sec. 338 election if otherwise qualified.

8. A shareholder of an S corporation must separately take into account (for the shareholder’s taxable year in which the taxable year of the S corporation ends) (1) the shareholder’s pro rata share of the corporation’s items of income (including tax-exempt income), loss, deduction, or credit the separate treatment of which could affect the tax liability of any shareholder, plus (2) the shareholder’s pro rata share of all remaining items which are netted together into “ordinary income (loss) from trade or business activity.”

a. Some of the items which must be separately passed through to retain their identity include

(1) Net long-term capital gain (loss)

(2) Net short-term capital gain (loss)

(3) Net gain (loss) from Sec. 1231 casualty or theft

(4) Net gain (loss) from other Sec. 1231 transactions

(5) Tax-exempt interest

(6) Charitable contributions

(7) Foreign income taxes

(8) Depletion

(9) Investment interest expense

(10) Dividend, interest, and royalty income

(11) Net income (loss) from real estate activity

(12) Net income (loss) from other rental activity

(13) Sec. 179 expense deduction (limited to $500,000 for 2012 and 2013)

b. All separately stated items plus the ordinary income or loss are allocated on a per share, per day basis to anyone who was a shareholder during the year. Items are allocated to shareholders’ stock (both voting and nonvoting) but not to debt.

(1) A shareholder who disposes of stock in an S corporation is treated as the shareholder for the day of disposition. A shareholder who dies is treated as the shareholder for the day of the shareholder’s death.

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EXAMPLE

Alan owned 100% of a calendar-year S corporation’s stock on January 1, 2013. Alan sold all his stock to Betty on January 31. Assuming the S corporation had $365,000 of ordinary income for the entire 2013 calendar year, the amount allocated to Alan would be $31,000 (31 days × $1,000 per day), and the amount allocated to Betty would be $334,000 (334 days × $1,000 per day).

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(2) The per share, per day rule will not apply if

(a) A shareholder’s interest is completely terminated and all affected shareholders consent to allocate items as if the corporation’s taxable year consisted of two years, the first of which ends on the date the shareholder’s interest was terminated. The closing of the books method applies only to the affected shareholders. Affected shareholders include the shareholder whose interest was terminated and shareholders to whom the terminating shareholder transferred shares during the year.

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EXAMPLE

Assume in the above example that the S corporation had net income of $40,000 for the month of January. If both Alan and Betty consent, $40,000 would be allocated to Alan, and $325,000 would be allocated to Betty.

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(b) An S corporation’s election is terminated on other than the first day of the taxable year, and all shareholders during the S short year and all persons who were shareholders on the first day of the C short year consent to allocate items using the corporation’s financial accounting records.

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EXAMPLE

Bartec Corporation, with ordinary income of $365,000 for calendar year 2013, had its S status terminated on February 1, 2013, when the Post Partnership became a shareholder. Assuming Bartec’s shareholders do not elect to allocate items using Bartec’s financial accounting records, the ordinary income for calendar year 2013 of $365,000 would be allocated on a daily basis between Bartec’s S short year and its C short year. Thus, the amount of income to be reported on Bartec’s S return would be $365,000/365 days (31 days) = $31,000. The remaining $365,000 − $31,000 = $334,000 of ordinary income would be reported on Bartec’s C return for 2013.

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(3) The per share, per day rule cannot be used if

(a) There is a sale or exchange of 50% or more of the stock of the corporation during an S termination year. Financial accounting records must be used to allocate items.

(b) A Sec. 338 election is made. Then the gains and losses resulting from the Sec. 338 election must be reported on a C corporation return.

9. Three sets of rules may limit the amount of S corporation loss that a shareholder can deduct.

a. A shareholder’s allocation of the aggregate losses and deductions of an S corporation can be deducted by the shareholder to the extent of theshareholder’s basis for stock plus basis of any debt owed the shareholder by the corporation [Sec. 1366 (d)].

(1) An excess of loss over combined basis for stock and debt can be carried forward indefinitely and deducted when there is basis to absorb it.

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EXAMPLE

An S corporation incurred losses totaling $50,000. Its sole shareholder (who materially participates in the business and is at-risk) had a stock basis of $30,000 and debt with a basis of $15,000. The shareholder’s loss deduction is limited to $45,000. The losses first reduce stock basis to zero, then debt basis is reduced to zero. The excess loss of $5,000 can be carried forward and deducted when there is basis to absorb it.

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(2) Once reduced, the basis of debt is later increased (but not above its original basis) by net undistributed income.

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EXAMPLE

An S corporation incurred a loss of $20,000 for 2012. Its sole shareholder (who materially participates in the business and is at-risk) had a stock basis of $10,000 and debt with a basis of $15,000. The pass-through of the $20,000 loss would first reduce stock basis to zero, and then reduce debt basis to $5,000.

Assume that for 2013, the same S corporation had ordinary income of $10,000, and made a $4,000 cash distribution to its shareholder during the year. The first $4,000 of basis increase resulting from the pass-through of income would be allocated to stock in order to permit the $4,000 distribution to be nontaxable. The remaining basis increase (net undistributed income of $6,000) would restore debt basis to $11,000 (from $5,000).

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b. The deductibility of S corporation losses is also limited to the amount of the shareholder’s at-risk basis at the end of the taxable year [Sec. 465].

(1) A shareholder’s amount at-risk includes amounts borrowed and re-loaned to the S corporation if the shareholder is personally liable for repayment of the borrowed amount, or has pledged property not used in the activity as security for the borrowed amount.

(2) A shareholder’s amount at-risk does not include any debt of the S corporation to any person other than the shareholder, even if the shareholder guarantees the debt.

c. The deductibility of S corporation losses may also be subject to the passive activity loss limitations [Sec. 469]. Passive activity losses are deductible only to the extent of the shareholder’s income from other passive activities (See Module 36).

(1) Passive activities include (a) any S corporation trade or business in which the shareholder does not materially participate, and (b) any rental activity.

(2) If a shareholder “actively participates” in a rental activity and owns (together with spouse) at least 10% of the value of an S corporation’s stock, up to $25,000 of rental losses may be deductible against earned income and portfolio income.

10. A shareholder’s S corporation stock basis is increased by all income items (including tax-exempt income), plus depletion in excess of the basis of the property subject to depletion; decreased by all loss and deduction items, nondeductible expenses not charged to capital, and the shareholder’s deduction for depletion on oil and gas wells; and decreased by distributions that are excluded from gross income. Stock basis is adjusted in the following order:

a. Increased for all income items

b. Decreased for distributions that are excluded from gross income

c. Decreased for nondeductible, noncapital items

d. Decreased for deductible expenses and losses

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EXAMPLE

An S corporation has tax-exempt income of $5,000, and an ordinary loss from business activity of $6,000 for calendar year 2013. Its sole shareholder had a stock basis of $2,000 on January 1, 2013. The $5,000 of tax-exempt income would pass through to the shareholder, increasing the shareholder’s stock basis to $7,000, and would permit the pass-through and deduction of the $6,000 of ordinary loss, reducing the shareholder’s stock basis to $1,000.

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EXAMPLE

An S corporation had an ordinary loss from business activity of $6,000 and made a $7,000 cash distribution to its sole shareholder during calendar year 2013. The sole shareholder had a stock basis of $8,000 on January 1, 2013. The $7,000 cash distribution would be nontaxable and would reduce stock basis to $1,000. As a result, only $1,000 of the $6,000 ordinary loss would be allowable as a deduction to the shareholder for 2013. The remaining $5,000 of ordinary loss would be carried forward and deducted by the shareholder when there is stock or debt basis to absorb it.

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11. The treatment of distributions (Cash + FMV of other property) to shareholders is determined as follows:

a. Distributions are nontaxable to the extent of the Accumulated Adjustments Account (AAA) and are applied to reduce the AAA and the shareholder’s stock basis.

(1) The AAA represents the cumulative total of undistributed net income items for S corporation taxable years beginning after 1982.

(2) If there is more than one distribution during the year, a pro rata portion of each distribution is treated as made from the AAA.

(3) The AAA can have a negative balance if expenses and losses exceed income.

(4) No adjustment is made to the AAA for tax-exempt income and related expenses, and Federal taxes attributable to a year in which the corporation was a C corporation. Tax-exempt income and related expenses are reflected in the corporation’s Other Adjustments Account (OAA).

(5) For purposes of determining the treatment of a distribution, the amount in the AAA at the close of any taxable year is determined without regard to any net negative adjustment (i.e., the excess of reductions over increases to the AAA for the taxable year) for such taxable year.

b. Distributions in excess of the AAA are treated as ordinary dividends to the extent of the corporation’s accumulated earnings and profits (AEP). These amounts represent earnings and profits that were accumulated (and never taxed to shareholders) during C corporation taxable years.

c. Distributions are next nontaxable to the extent of remaining stock basis and are applied to reduce the OAA and paid-in capital.

d. Distributions in excess of stock basis are treated as gain from the sale of stock.

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EXAMPLE

A calendar year S corporation had subchapter C accumulated earnings and profits of $10,000 at December 31, 2012. During calendar year 2013, the corporation had net income of $20,000, and distributed $38,000 to its sole shareholder on June 20, 2013. Its shareholder had a stock basis of $15,000 at January 1, 2013.

The $20,000 of net income passes through and is includible in gross income by the shareholder for 2013. The shareholder’s stock basis is increased by the $20,000 of income (to $35,000), as is the AAA which is increased to $20,000. Of the $38,000 distribution, the first $20,000 is nontaxable and (1) reduces stock basis to $15,000, and (2) the AAA to zero; the next $10,000 of distribution is reported as dividend income (no effect on stock basis); while the remaining $8,000 of distribution is nontaxable and reduces stock basis to $7,000.

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12. Health and accident insurance premiums and other fringe benefits paid by an S corporation on behalf of a more than 2% shareholder-employee are deductible by the S corporation as compensation and includible in the shareholder-employee’s gross income on Form W-2.

13. An S corporation (that previously was a C corporation) is taxed on its net recognized built-in gain if the gain is (1) attributable to an excess of the FMV of its assets over their aggregate adjusted basis as of the beginning of its first taxable year as an S corporation, and (2) is recognized within ten years after the effective date of its S corporation election.

a. This provision generally applies to C corporations that make an S corporation election after December 31, 1986.

b. For an S corporation taxable years beginning in 2012 and 2013, the recognition period is reduced to five years (e.g., the recognition period will end at the beginning of 2013 if the S election was made for the 2008 tax year).

c. To determine the tax, (1) take the lesser of (a) the net recognized built-in gain for the taxable year, or (b) taxable income determined as if the corporation were a C corporation (except the NOL and dividends-received deductions are not allowed); (2) subtract any NOL and capital loss carry forwards from C corporation years; (3) multiply the resulting amount by the highest corporate tax rate (currently 35%); and (4) subtract any general business credit carryovers from C corporation years and the special fuels tax credit.

d. Any net recognized built-in gain that escapes the built-in gains tax because of the taxable income limitation is carried forward and is subject to the built-in gains tax to the extent the corporation subsequently has other taxable income (that is not already subject to the built-in gains tax) for any taxable year within the ten-year recognition period.

e. Recognized built-in gain does not include gain from the disposition of an asset if

(1) The asset was not held by the corporation when its S election became effective (e.g., an asset was purchased after the first day of its S election), or

(2) The gain is attributable to appreciation that occurred after the S election became effective (e.g., an asset is sold for a gain of $1,000, but $600 of its appreciation occurred after the first day of its S election; the corporation would be taxed on only $400 of gain).

f. The total amount of net recognized built-in gain that will be taxed to an S corporation is limited to the aggregate net unrealized built-in gain when the S election became effective.

g. The built-in gains tax that is paid by an S corporation is treated as a loss sustained by the S corporation during the taxable year. The character of the loss is determined by allocating the loss proportionately among the recognized built-in gains giving rise to such tax.

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EXAMPLE

For 2013, an S corporation has taxable income of $100,000, which includes a $40,000 long-term capital gain that is also a recognized built-in gain. Since its recognized built-in gain of $40,000 is less than its taxable income, its built-in gains tax for 2013 is $40,000 × 35% = $14,000. Since the built-in gain was a long-term capital gain, the built-in gains tax paid of $14,000 is treated as a long-term capital loss. As a result, a net long-term capital gain of $26,000 ($40,000 LTCG − $14,000 LTCL) passes through to shareholders for 2013.

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EXAMPLE

For 2012, an S corporation has taxable income of $10,000, which includes a $40,000 long-term capital gain that is also a recognized built-in gain. Since its taxable income of $10,000 is less than its recognized built-in gain of $40,000, its built-in gains tax for 2012 is limited to $10,000 × 35% = $3,500. As a result, a net long-term capital gain of $40,000 − $3,500 = $36,500 passes through to shareholders for 2012.

The remaining $30,000 of untaxed recognized built-in gain would be suspended and carried forward to 2013, where it would again be treated as a recognized built-in gain. If the S corporation has at least $30,000 of taxable income in 2013 that is not already subject to the built-in gains tax, the suspended gain from 2012 will be taxed. As a result, the amount of built-in gains tax paid by the S corporation for 2013 will be $30,000 × 35% = $10,500, and will pass through to shareholders as a long-term capital loss, since the original gain in 2012 was a long-term capital gain.

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14. If an S corporation has subchapter C accumulated earnings and profits, and its passive investment income exceeds 25% of gross receipts, a tax is imposed at the highest corporate rate on the lesser of (1) excess net passive income (ENPI), or (2) taxable income.

a.

b. Passive investment income means gross receipts derived from dividends, interest, royalties, rents, annuities, and gains from the sale or exchange of stock or securities. However, dividends from an affiliated C corporation subsidiary are not treated as passive investment income to the extent the dividends are attributable to the earnings and profits derived from the active conduct of a trade or business by the C corporation.

c. The tax paid reduces the amount of passive investment income passed through to shareholders.

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EXAMPLE

An S corporation has gross receipts of $80,000, of which $50,000 is interest income. Expenses incurred in the production of this passive income total $10,000. The ENPI is $24,000.

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 123 THROUGH 152

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H. Corporate Reorganizations

Certain exchanges, usually involving the exchange of one corporation’s stock for the stock or property of another, result in deferral of gain or loss.

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

a. Type A–statutory mergers or consolidations

(1) Merger is one corporation absorbing another by operation of law

(2) Consolidation is two corporations combining in a new corporation, the former ones dissolving

b. Type B–the use of solely voting stock of the acquiring corporation (or its parent) to acquire at least 80% of the voting power and 80% of each class of nonvoting stock of the target corporation

(1) No boot can be used by the acquiring corporation to acquire the target’s stock

(2) Results in the acquisition of a controlled subsidiary

c. Type C–the use of solely voting stock of the acquiring corporation (or its parent) to acquire substantially all of the target’s properties

(1) In determining whether the acquisition is made for solely voting stock, the assumption by the acquiring corporation of a liability of the target corporation, or the fact that the property acquired is subject to a liability is disregarded.

(2) “Substantially all” means at least 90% of the FMV of the target’s net assets, and at least 70% of its gross assets.

(3) The target (acquired) corporation must distribute the consideration it receives, as well as all of its other properties, in pursuance of the plan of reorganization.

d. Type D–a transfer by a corporation of part or all of its assets to another if immediately after the transfer the transferor corporation, or its shareholders, control the transferee corporation (i.e., own at least 80% of the voting power and at least 80% of each class of nonvoting stock)

(1) Although it may be acquisitive, this type of reorganization is generally used to divide a corporation.

(2) Generally results in a spin-off, split-off, or split-up

e. Type E–a recapitalization to change the capital structure of a single corporation (e.g., bondholders exchange old bonds for new bonds or stock)

f. Type F–a mere change in identity, form, or place of organization (e.g., name change, change of state of incorporation)

g. Type G–a transfer of assets by an insolvent corporation or pursuant to bankruptcy proceedings, with the result that former creditors often become the owners of the corporation

2. For the reorganization to be tax-free, it must meet one of the above definitions and the exchange must be made under a plan of reorganization involving the affected corporations as parties to the reorganization. It generally must satisfy the judicial doctrines of continuity of shareholder interest, business purpose, and continuity of business enterprise.

a. Continuity of shareholder interest–The shareholders of the transferor (acquired) corporation must receive stock in the transferee (acquiring) corporation at least equal in value to 50% of the value of all of the transferor’s formerly outstanding stock. This requirement does not apply to Type E and Type F reorganizations.

b. Continuity of business enterprise–The transferor’s historic business must be continued, or a significant portion (e.g., 1/3) of the transferor’s historic assets must be used in a business. This requirement does not apply to Type E and Type F reorganizations.

3. No gain or loss is generally recognized to a transferor corporation on the transfer of its property pursuant to a plan of reorganization.

a. The transferee corporation’s basis for property received equals the transferor’s basis plus gain recognized (if any) to the transferor.

b. Gain is recognized on the distribution to shareholders of any property other than stock or securities of a party to the reorganization (e.g., property the transferor retained and did not transfer to the acquiring corporation), as if such property were sold for its FMV.

4. No gain or loss is recognized by a corporation on the disposition of stock or securities in another corporation that is a party to the reorganization.

a. No gain or loss is generally recognized on the distribution of stock or securities of a controlled subsidiary in a qualifying spin-off, split-off, or split-up. However, the distributing corporation must recognize gain on the distribution of its subsidiary’s stock if immediately after the distribution, any person holds a 50% or greater interest in the distributing corporation or a distributed subsidiary that is attributable to stock acquired by purchase during the five-year period ending on date of distribution.

b. Gain is recognized on the distribution of appreciated boot property.

5. If a shareholder receives boot in a reorganization, gain is recognized (but not loss).

a. Boot includes the FMV of an excess of principal (i.e., face) amount of securities received over the principal amount of securities surrendered.

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EXAMPLE

In a recapitalization, a bondholder exchanges a bond with a face amount and basis of $1,000, for a new bond with a face amount of $1,500 and a fair market value of $1,575. Since an excess face amount of security ($500) has been received, the bondholder’s realized gain of $575 will be recognized to the extent of the fair market value of the excess [($500/$1,500) × $1,575] = $525.

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b. Recognized gain will be treated as a dividend to the extent of the shareholder’s ratable share of earnings and profits of the acquired corporation if the receipt of boot has the effect of the distribution of a dividend.

(1) Whether the receipt of boot has the effect of a dividend is determined by applying the Sec. 302(b) redemption tests based on the shareholder’s stock interest in the acquiring corporation (i.e., as if only stock had been received, and then the boot was used to redeem the stock that was not received).

(2) The receipt of boot will generally not have the effect of a dividend, and will thus result in capital gain.

6. A shareholder’s basis for stock and securities received equals the basis of stock and securities surrendered, plus gain recognized, and minus boot received.

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EXAMPLE

Pursuant to a merger of Corporation T into Corporation P, Smith exchanged 100 shares of T that he had purchased for $1,000, for 80 shares of P having an FMV of $1,500 and also received $200 cash. Smith’s realized gain of $700 is recognized to the extent of the cash received of $200, and is treated as a capital gain. Smith’s basis for his P stock is $1,000 ($1,000 + $200 recognized gain − $200 cash received).

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7. Carryover of tax attributes

a. The tax attributes of the acquired corporation (e.g., NOL carryovers, earnings and profits, accounting methods, etc.) generally carry over to the acquiring corporation in an acquisitive reorganization.

b. The amount of an acquired corporation’s NOL carryovers that can be utilized by the acquiring corporation for its first taxable year ending after the date of acquisition islimited by Sec. 381 to

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EXAMPLE

Corporation P (on a calendar year) acquired Corporation T in a statutory merger on October 19, 2013, with the former T shareholders receiving 60% of P’s stock. If T had an NOL carryover of $70,000, and P has taxable income (before an NOL deduction) of $91,500, the amount of T’s $70,000 NOL carryover that can be deducted by P for 2013 would be limited to

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c. If there is a more than 50% change in ownership of a loss corporation, the taxable income for any year of the new loss (or surviving) corporation may be reduced by an NOL carryover from the old loss corporation only to the extent of the value of the old loss corporation’s stock on the date of the ownership change multiplied by the “long-term tax-exempt rate” (Sec. 382 limitation).

(1) An ownership change has occurred when the percentage of stock owned by an entity’s 5% or more shareholders has increased by more than 50 percentage points relative to the lowest percentage owned by such shareholders at any time during the preceding 3-year testing period.

(2) For the year of acquisition, the Sec. 382 limitation amount is available only to the extent allocable to days after the acquisition date.

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EXAMPLE

If T’s former shareholders received only 30% of P’s stock in the preceding example, there would be a more than 50 percentage point change in ownership of T Corporation, and T’s NOL carryover would be subject to a Sec. 382 limitation. If the FMV of T’s stock on October 19, 2013, was $500,000 and the long-term tax-exempt rate were 3%, the Sec. 382 limitation for 2013 would be ($500,000 × 3%) × (73/365 days) = $3,000.

Thus, only $3,000 of T’s NOL carryover could be deducted by P for 2013. The remaining $70,000 − $3,000 = $67,000 of T’s NOL would be carried forward by P and can be used to offset P’s taxable income for 2014 to the extent of the Sec. 382 annual limitation (i.e., $500,000 × 3% = $15,000).

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NOW REVIEW MULTIPLE-CHOICE QUESTIONS 153 THROUGH 162

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II. COMPARISON OF C CORPORATIONS, S CORPORATIONS, AND PARTNERSHIPS

KEY TERMS

Accumulated adjustments account. An S corporation account that reflects the cumulative total of undistributed net income previously taxed to shareholders. Distributions from the AAA are generally treated as nontaxable and are a return of a shareholder’s stock basis.

Accumulated earnings tax. A penalty tax imposed on a corporation (in addition to regular income tax) if it accumulates earnings in excess of reasonable business needs in order to avoid a shareholder tax on dividend distributions. The tax is not self-assessing, and does not apply to personal holding companies.

Affiliated corporations. A parent-subsidiary chain of corporations in which at least 80% of the voting power (and total value) of stock is owned by includable corporations. An affiliated group may elect to file a consolidated tax return.

Controlled group. Two or more corporations owned by the same individuals or entities. Controlled groups include parent-subsidiary corporations, brother-sister corporations, and combined groups. The two or more corporations that make up a controlled group are in the aggregate limited to the tax benefits available to a single corporation.

Dividend. A corporate distribution of property to shareholders on their stock that is made from the corporation’s current or accumulated earnings and profits.

Dividends received deduction (DRD). A deduction allowed a corporation for dividends received from other taxable domestic corporations. The percentage used varies according to the percentage of stock owned in the dividend paying corporation. If the stock ownership percentage is less than 20%, the DRD is 70% of the dividends received. If the stock ownership percentage is at least 20% but less than 80%, the DRD is 80% of the dividends received. If the stock ownership percentage is at least 80%, the DRD percentage is 100% (if a consolidated return is not filed).

Organizational expenditures. Include expenses of temporary directors and organizational meetings, state fees for incorporation, and accounting and legal service costs incident to incorporation. A corporation may immediately expense the first $5,000 (subject to phaseout) of organizational expenditures and generally amortize the remainder over a period of 180 months beginning with the month that business begins.

Personal holding company tax. A penalty tax imposed on a personal holding company (in addition to regular income tax) to discourage individuals from placing investment property in a corporation in order to have investment income taxed at lower corporate rates. The tax is self-assessing.

S corporation. A qualifying small business corporation for which an election has been made to be taxed under the provisions of Subchapter S of the IRC. An S corporation generally pays no corporate income tax and is treated as a pass-through entity. An S corporation’s items of income, gain, loss, deduction, and credit pass through to shareholders and are reported on the tax returns of its shareholders.

Sec. 1244 stock. Stock issued by a qualifying small business corporation that entitles the original holder to deduct an ordinary loss (rather than a capital loss) if the stock is disposed of at a loss or becomes worthless. The annual ceiling on ordinary loss treatment is $50,000 ($100,000 for married individuals filing jointly).

Multiple-Choice Questions (1–162)

A. Transfers to a Controlled Corporation

1. Alan, Baker, and Carr formed Dexter Corporation during 2013. Pursuant to the incorporation agreement, Alan transferred property with an adjusted basis of $30,000 and a fair market value of $45,000 for 450 shares of stock, Baker transferred cash of $35,000 in exchange for 350 shares of stock, and Carr performed services valued at $25,000 in exchange for 250 shares of stock. Assuming the fair market value of Dexter Corporation stock is $100 per share, what is Dexter Corporation’s tax basis for the property received from Alan?

a. $0

b. $30,000

c. $45,000

d. $65,000

2. Clark and Hunt organized Jet Corp. with authorized voting common stock of $400,000. Clark contributed $60,000 cash. Both Clark and Hunt transferred other property in exchange for Jet stock as follows:

What was Clark’s basis in Jet stock?

a. $0

b. $100,000

c. $110,000

d. $160,000

3. Adams, Beck, and Carr organized Flexo Corp. with authorized voting common stock of $100,000. Adams received 10% of the capital stock in payment for the organizational services that he rendered for the benefit of the newly formed corporation. Adams did not contribute property to Flexo and was under no obligation to be paid by Beck or Carr. Beck and Carr transferred property in exchange for stock as follows:

What amount of gain did Carr recognize from this transaction?

a. $40,000

b. $15,000

c. $10,000

d. $0

4. Jones incorporated a sole proprietorship by exchanging all the proprietorship’s assets for the stock of Nu Co., a new corporation. To qualify for tax-free incorporation, Jones must be in control of Nu immediately after the exchange. What percentage of Nu’s stock must Jones own to qualify as “control” for this purpose?

a. 50.00%

b. 51.00%

c. 66.67%

d. 80.00%

5. Feld, the sole stockholder of Maki Corp., paid $50,000 for Maki’s stock in 2007. In 2013, Feld contributed a parcel of land to Maki but was not given any additional stock for this contribution. Feld’s basis for the land was $10,000, and its fair market value was $18,000 on the date of the transfer of title. What is Feld’s adjusted basis for the Maki stock?

a. $50,000

b. $52,000

c. $60,000

d. $68,000

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

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

b. Gain on the assumption of Rela’s liabilities by the corporation.

c. Gain or loss on the transfer of its assets to the corporation.

d. Gain, but not loss, on the transfer of its assets to the corporation.

7. Roberta Warner and Sally Rogers formed the Acme Corporation on October 1, 2013. On the same date Warner paid $75,000 cash to Acme for 750 shares of its common stock. Simultaneously, Rogers received 100 shares of Acme’s common stock for services rendered. How much should Rogers include as taxable income for 2013 and what will be the basis of her stock?

B. Sec. 1244 Stock

8. Jackson, a single individual, inherited Bean Corp. common stock from Jackson’s parents. Bean is a qualified small business corporation under Code Sec. 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. $ 3,000

c. $20,000

d. $25,000

9. Which of the following is not a requirement for stock to qualify as Sec. 1244 small business corporation stock?

a. The stock must be issued to an individual or to a partnership.

b. The stock was issued for money or property (other than stock and securities).

c. The stock must be common stock.

d. The issuer must be a domestic corporation.

10. During the current year, Dinah sold Sec. 1244 small business corporation stock that she owned for a loss of $125,000. Assuming Dinah is married and files a joint income tax return for 2013, what is the character of Dinah’s recognized loss from the sale of the stock?

a. $125,000 capital loss.

b. $25,000 capital loss; $100,000 ordinary loss.

c. $75,000 capital loss; $50,000 ordinary loss.

d. $0 capital loss; $125,000 ordinary loss.

11. Nancy, who is single, formed a corporation during 2007 using a tax-free asset transfer that qualified under Sec. 351. She transferred property having an adjusted basis of $80,000 and a fair market value of $60,000, and in exchange received Sec. 1244 small business corporation stock. During February 2013, Nancy sold all of her stock for $35,000. What is the amount and character of Nancy’s recognized loss resulting from the sale of the stock in 2013?

a. $0 ordinary loss; $45,000 capital loss.

b. $25,000 ordinary loss; $10,000 capital loss.

c. $25,000 ordinary loss; $20,000 capital loss.

d. $45,000 ordinary loss; $0 capital loss.

C.1. Filing and Payment of Tax

12. A civil fraud penalty can be imposed on a corporation that underpays tax by

a. Omitting income as a result of inadequate recordkeeping.

b. Failing to report income it erroneously considered not to be part of corporate profits.

c. Filing an incomplete return with an appended statement, making clear that the return is incomplete.

d. Maintaining false records and reporting fictitious transactions to minimize corporate tax liability.

13. Bass Corp., a calendar-year C corporation, made qualifying 2012 estimated tax deposits based on its actual 2011 tax liability. On March 15, 2013, Bass filed a timely automatic extension request for its 2012 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 2012 corporate income tax return. Bass paid $400 additional tax on the final 2012 corporate income tax return filed before the extended due date. For the 2012 calendar year, Bass was subject to pay

I. Interest on the $400 tax payment made in 2013.

II. A tax delinquency penalty.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

14. Edge Corp., a calendar-year C corporation, had a net operating loss and zero tax liability for its 2013 tax year. To avoid the penalty for underpayment of estimated taxes, Edge could compute its first quarter 2014 estimated income tax payment using the

15. 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. II only.

c. Both I and II.

d. Neither I nor II.

16. A corporation’s penalty for underpaying federal estimated taxes is

a. Not deductible.

b. Fully deductible in the year paid.

c. Fully deductible if reasonable cause can be established for the underpayment.

d. Partially deductible.

17. Blink Corp., an accrual-basis calendar-year corporation, carried back a net operating loss for the tax year ended December 31, 2013. Blink’s gross revenues have been under $500,000 since inception. Blink expects to have profits for the tax year ending December 31, 2014. Which method(s) of estimated tax payment can Blink use for its quarterly payments during the 2014 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. Both I and II.

c. II only.

d. Neither I nor II.

18. When computing a corporation’s income tax expense for estimated income tax purposes, which of the following should be taken into account?

19. Finbury Corporation’s taxable income for the year ended December 31, 2013, was $2,000,000 on which its tax liability was $680,000. In order for Finbury to escape the estimated tax underpayment penalty for the year ending December 31, 2014, Finbury’s 2014 estimated tax payments must equal at least

a. 90% of the 2014 tax liability.

b. 93% of the 2014 tax liability.

c. 100% of the 2014 tax liability.

d. The 2013 tax liability of $680,000.

C.2.a. Corporate Tax Rates

20. Kisco Corp.’s taxable income for 2013 before taking the dividends received deduction was $70,000. This includes $10,000 in dividends from a 15%-owned taxable domestic corporation. Given the following tax rates, what would Kisco’s income tax be before any credits?

a. $10,000

b. $10,750

c. $12,500

d. $15,750

C.2.c. Alternative Minimum Tax (AMT)

21. Green Corp. was incorporated and began business in 2011. In computing its alternative minimum tax for 2012, it determined that it had adjusted current earnings (ACE) of $400,000 and alternative minimum taxable income (prior to the ACE adjustment) of $300,000. For 2013, it had adjusted current earnings of $100,000 and alternative minimum taxable income (prior to the ACE adjustment) of $300,000. What is the amount of Green Corp.’s adjustment for adjusted current earnings that will be used in calculating its alternative minimum tax for 2013?

a. $ 75,000

b. $ (75,000)

c. $(100,000)

d. $(150,000)

22. Eastern Corp., a calendar-year corporation, was formed during 2012. On January 3, 2013, Eastern 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, and elected not to use bonus depreciation. The following information pertains to Eastern:

What was Eastern’s 2013 alternative minimum taxable income before the adjusted current earnings (ACE) adjustment?

a. $306,000

b. $305,000

c. $304,000

d. $301,000

23. If a corporation’s tentative minimum tax exceeds the regular tax, the excess amount is

a. Carried back to the first preceding taxable year.

b. Carried back to the third preceding taxable year.

c. Payable in addition to the regular tax.

d. Subtracted from the regular tax.

24. Rona Corp.’s 2013 alternative minimum taxable income was $200,000. The exempt portion of Rona’s 2013 alternative minimum taxable income was

a. $0

b. $12,500

c. $27,500

d. $52,500

25. A corporation’s tax preference items that must be taken into account for 2013 alternative minimum tax purposes include

a. Use of the percentage-of-completion method of accounting for long-term contracts.

b. Casualty losses.

c. Tax-exempt interest on private activity bonds issued in 2008.

d. Capital gains.

26. In computing its 2013 alternative minimum tax, a corporation must include as an adjustment

a. The dividends received deduction.

b. The difference between regular tax depreciation and straight-line depreciation over forty years for real property placed in service in 1998.

c. Charitable contributions.

d. Interest expense on investment property.

27. A corporation will not be subject to the alternative minimum tax for calendar year 2013 if

a. The corporation’s net assets do not exceed $7.5 million.

b. The corporation’s average annual gross receipts do not exceed $10 million.

c. The corporation has less than ten shareholders.

d. 2013 is the corporation’s first tax year.

28. Bradbury Corp., a calendar-year corporation, was formed on January 2, 2010, and had gross receipts for its first four taxable years as follows:

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

a. 2011

b. 2012

c. 2013

d. Bradbury is exempt from AMT for its first four taxable years.

C.3. Gross Income

29. Which of the following entities must include in gross income 100% of dividends received from unrelated taxable domestic corporations in computing regular taxable income?

30. Andi Corp. issued $1,000,000 face amount of bonds in 2005 and established a sinking fund to pay the debt at maturity. The bondholders appointed an independent trustee to invest the sinking fund contributions and to administer the trust. In 2013, the sinking fund earned $60,000 in interest on bank deposits and $8,000 in net long-term capital gains. All of the trust income is accumulated with Andi’s periodic contributions so that the aggregate amount will be sufficient to pay the bonds when they mature. What amount of trust income was taxable to Andi in 2013?

a. $0

b. $ 8,000

c. $60,000

d. $68,000

31. The following information pertains to treasury stock sold by Lee Corp. to an unrelated broker in 2013:

What amount of capital gain should Lee recognize in 2013 on the sale of this treasury stock?

a. $0

b. $ 8,000

c. $20,000

d. $30,500

32. During 2013, Ral Corp. exchanged 5,000 shares of its own $10 par common stock for land with a fair market value of $75,000. As a result of this exchange, Ral should report in its 2013 tax return

a. $25,000 Section 1245 gain.

b. $25,000 Section 1231 gain.

c. $25,000 ordinary income.

d. No gain.

33. Pym, Inc., which had earnings and profits of $100,000, distributed land to Kile Corporation, a shareholder. Pym’s adjusted basis for this land was $3,000. The land had a fair market value of $12,000 and was subject to a mortgage liability of $5,000, which was assumed by Kile Corporation. The dividend was declared and paid during March 2013.

How much of the distribution would be reportable by Kile as a dividend, before the dividends received deduction?

a. $0

b. $ 3,000

c. $ 7,000

d. $12,000

C.4.b. Organizational Expenditures

34. Which of the following costs are deductible organizational expenditures?

a. Professional fees to issue the corporation’s stock.

b. Commissions paid by the corporation to underwriters for stock issue.

c. Printing costs to issue the corporation’s stock.

d. Expenses of temporary directors meetings.

35. Brown Corp., a calendar-year taxpayer, was organized and actively began operations on July 1, 2013, and incurred the following costs:

For 2013, what amount should Brown Corp. deduct for organizational expenses?

a. $1,980

b. $2,814

c. $5,940

d. $6,812

36. The costs of organizing a corporation during 2013

a. May be deducted in full in the year in which these costs are incurred if they do not exceed $5,000.

b. May be deducted only in the year in which these costs are paid.

c. May be amortized over a period of 120 months even if these costs are capitalized on the company’s books.

d. Are nondeductible capital expenditures.

37. Silo Corp. was organized on March 1, 2013, began doing business on September 1, 2013, and elected to file its income tax return on a calendar-year basis. The following qualifying organizational expenditures were incurred in organizing the corporation:

The maximum allowable deduction for organizational expenditures for 2013 is

a. $ 600

b. $3,000

c. $5,000

d. $5,080

C.4.c. Charitable Contributions

38. During 2013, Jackson Corp. had the following income and expenses:

What is the amount of Jackson Corp.’s charitable contribution carryover to 2014?

a. $0

b. $2,500

c. $5,500

d. $6,300

39. In 2013, Cable Corp., a calendar-year C corporation, contributed $80,000 to a qualified charitable organization. Cable’s 2013 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 the prior year. In 2013, what amount can Cable deduct as charitable contributions?

a. $90,000

b. $86,000

c. $82,000

d. $80,000

40. Tapper Corp., an accrual-basis calendar-year corporation, was organized on January 2, 2013. During 2013, revenue was exclusively from sales proceeds and interest income. The following information pertains to Tapper:

What is the maximum allowable deduction that Tapper may take as a charitable contribution on its tax return for the year ended December 31, 2013?

a. $0

b. $10,000

c. $30,000

d. $40,000

41. Lyle Corp. is a distributor of pharmaceuticals and sells only to retail drug stores. During 2013, Lyle received unsolicited samples of nonprescription drugs from a manufacturer. Lyle donated these drugs in 2013 to a qualified exempt organization and deducted their fair market value as a charitable contribution. What should be included as gross income in Lyle’s 2013 return for receipt of these samples?

a. Fair market value.

b. Net discounted wholesale price.

c. $25 nominal value assigned to gifts.

d. $0.

42. During 2013, Nale Corp. received dividends of $1,000 from a 10%-owned taxable domestic corporation. When Nale computes the maximum allowable deduction for contributions in its 2013 return, the amount of dividends to be included in the computation of taxable income is

a. $0

b. $ 200

c. $ 300

d. $1,000

43. Gero Corp. had operating income of $160,000, after deducting $10,000 for contributions to State University, but not including dividends of $2,000 received from nonaffiliated taxable domestic corporations.

In computing the maximum allowable deduction for contributions, Gero should apply the percentage limitation to a base amount of

a. $172,000

b. $170,400

c. $170,000

d. $162,000

44. Norwood Corporation is an accrual-basis taxpayer. For the year ended December 31, 2013, it had book income before tax of $500,000 after deducting a charitable contribution of $100,000. The contribution was authorized by the Board of Directors in December 2013, but was not actually paid until March 1, 2014. How should Norwood treat this charitable contribution for tax purposes to minimize its 2013 taxable income?

a. It cannot claim a deduction in 2013, but must apply the payment against 2014 income.

b. Make an election claiming a deduction for 2013 of $50,000 and carry the remainder over a maximum of five succeeding tax years.

c. Make an election claiming a deduction for 2013 of $60,000 and carry the remainder over a maximum of five succeeding tax years.

d. Make an election claiming a 2013 deduction of $100,000.

C.4.e. Dividends Received Deduction (DRD)

45. In 2013, Best Corp., an accrual-basis calendar-year C corporation, received $100,000 in dividend income from the common stock that it held in a 15%-owned domestic corporation. The stock was not debt-financed, and was held for over a year. Best recorded the following information for 2013:

Best’s dividends received deduction on its 2013 tax return was

a. $100,000

b. $ 80,000

c. $ 70,000

d. $ 63,000

46. In 2013, Acorn, Inc. had the following items of income and expense:

The dividends were received from a corporation of which Acorn owns 30%. In Acorn’s 2013 corporate income tax return, what amount should be reported as income before special deductions?

a. $525,000

b. $505,000

c. $275,000

d. $250,000

47. The corporate dividends received deduction

a. Must exceed the applicable percentage of the recipient shareholder’s taxable income.

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

c. Is unaffected by the percentage of the investee’s stock owned by the investor corporation.

d. May be claimed by S corporations.

48. In 2013, Ryan Corp. had the following income:

Ryan had no portfolio indebtedness. In Ryan’s 2013 taxable income, what amount should be included for the dividends received?

a. $ 400

b. $ 600

c. $1,400

d. $1,600

49. In 2013, Daly Corp. had the following income:

In Daly’s 2013 taxable income, how much should be included for the dividends received?

a. $0

b. $ 200

c. $ 800

d. $1,000

50. Cava Corp., which has no portfolio indebtedness, received the following dividends during the current year:

How much of these dividends qualifies for the 80% dividends received deduction?

a. $9,000

b. $7,500

c. $1,500

d. $0

C.4.j. Losses

51. During 2013, Stark Corp. reported gross income from operations of $350,000 and operating expenses of $400,000. Stark also received dividend income of $100,000 (not included in gross income from operations) from an investment in a taxable domestic corporation in which it owns 10% of the stock. Additionally, Stark had a net operating loss carryover from 2012 of $30,000. What is the amount of Stark Corp.’s net operating loss for 2013?

a. $0

b. $(20,000)

c. $(30,000)

d. $(50,000)

52. A C corporation’s net capital losses are

a. Carried forward indefinitely until fully utilized.

b. Carried back three years and forward five 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.

53. For the year ended December 31, 2013, 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:

If Taylor makes no special election to waive a net operating loss carryback period, what amount of net operating loss will be available to Taylor for the year ended December 31, 2014?

a. $200,000

b. $130,000

c. $110,000

d. $ 95,000

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

a. It retains its original identity as short-term or long-term.

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

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

d. It can be used to offset ordinary income up to the amount of the carryback or carryover.

55. For the year ended December 31, 2013, Haya Corp. had gross business income of $600,000 and expenses of $800,000. Contributions of $5,000 to qualified charities were included in expenses. In addition to the expenses, Haya had a net operating loss carryover of $9,000. What was Haya’s net operating loss for 2013?

a. $209,000

b. $204,000

c. $200,000

d. $195,000

56. Dorsett Corporation’s income tax return for 2013 shows deductions exceeding gross income by $56,800. Included in the tax return are the following items:

What is Dorsett’s net operating loss for 2013?

a. $56,800

b. $50,000

c. $41,800

d. $35,000

57. Ram Corp.’s operating income for the year ended December 31, 2013, amounted to $100,000. Also in 2013, a machine owned by Ram was completely destroyed in an accident. This machine’s adjusted basis immediately before the casualty was $15,000. The machine was not insured and had no salvage value.

In Ram’s 2013 tax return, what amount should be deducted for the casualty loss?

a. $ 5,000

b. $ 5,400

c. $14,900

d. $15,000

C.4.l. R&D Expenditures

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

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

b. Has to treat such expenditures in the same manner as they are accounted for in the corporation’s financial statements.

c. Is required to deduct such expenditures currently as business expenses or lose the deductions.

d. Is required to capitalize such expenditures and amortize them ratably over a period of not less than sixty months.

C.6. Reconcile Book and Taxable Income

59. For the year ended December 31, 2013, 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:

Assuming no bad debt was written off, what is Kelly’s taxable income for the year ended December 31, 2013?

a. $250,000

b. $330,000

c. $345,000

d. $380,000

60. For the year ended December 31, 2013, Maple Corp.’s book income, before federal income tax, was $100,000. Included in this $100,000 were the following:

Maple’s taxable income for 2013 was

a. $ 96,000

b. $ 97,000

c. $100,000

d. $101,000

61. For the year ended December 31, 2013, Dodd Corp. had net income per books of $100,000. Included in the computation of net income were the following items:

Dodd’s 2013 taxable income was

a. $127,000

b. $130,000

c. $132,000

d. $135,000

62. For the year ended December 31, 2013, Bard Corp.’s income per accounting records, before federal income taxes, was $450,000 and included the following:

Bard’s 2013 taxable income was

a. $435,000

b. $451,000

c. $455,000

d. $470,000

63. Dewey Corporation’s book income before federal income taxes was $520,000 for the year ended December 31, 2013. Dewey was incorporated during 2013 and began business in June. Organization costs of $257,400 were expensed for financial statement purposes during 2013. For tax purposes these costs are being written off over the minimum allowable period. For the year ended December 31, 2013, Dewey’s taxable income was

a. $520,000

b. $747,900

c. $767,390

d. $778,000

64. Bishop Corporation reported taxable income of $700,000 on its federal income tax return for calendar year 2013. Selected information for 2013 is available from Bishop’s records as follows:

Bishop reported net income per books for 2013 of

a. $855,000

b. $595,000

c. $575,000

d. $475,000

65. For the year ended December 31, 2013, Ajax Corporation had net income per books of $1,200,000. Included in the determination of net income were the following items:

What should Ajax report as its taxable income for 2013?

a. $1,492,000

b. $1,524,000

c. $1,684,000

d. $1,692,000

C.6.c. Schedule M-1

66. For its taxable year 2013, Rogers Corp. had net income per books of $80,000, which included municipal bond interest of $5,000, dividend income of $10,000, a deduction for a net capital loss of $6,000, a deduction for business meals of $4,000, and a deduction for federal income taxes of $18,000. What is the amount of income that would be shown on the last line of Schedule M-1 (Reconciliation of Income [Loss] Per Books with Income [Loss] Per Return) of Rogers Corp.’s corporate income tax return for 2013?

a. $ 90,000

b. $ 93,000

c. $ 99,000

d. $101,000

67. For the current taxable year, 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, US Corporation Income Tax Return?

a. $330,000

b. $500,000

c. $502,000

d. $550,000

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

69. In the reconciliation of income per books with income per return in Schedule M-1 of Form 1120

a. Only temporary differences are considered.

b. Only permanent differences are considered.

c. Both temporary and permanent differences are considered.

d. Neither temporary nor permanent differences are considered.

70. Media Corp. is an accrual-basis, calendar-year C corporation. Its 2013 reported book income included $6,000 in municipal bond interest income. Its expenses included $1,500 of interest incurred on indebtedness used to carry municipal bonds and $8,000 in advertising expense. What is Media’s net M-1 adjustment on its 2013 Form 1120, US Corporation Income Tax Return, to reconcile to its 2013 taxable income?

a. $(4,500)

b. $1,500

c. $3,500

d. $9,500

C.6.d. Schedule M-2

71. Barbaro Corporation’s retained earnings at January 1, 2013, was $600,000. During 2013 Barbaro paid cash dividends of $150,000 and received a federal income tax refund of $26,000 as a result of an IRS audit of Barbaro’s 2010 tax return. Barbaro’s net income per books for the year ended December 31, 2013, was $274,900 after deducting federal income tax of $183,300. How much should be shown in the reconciliation Schedule M-2, of Form 1120, as Barbaro’s retained earnings at December 31, 2013?

a. $443,600

b. $600,900

c. $626,900

d. $750,900

72. Olex Corporation’s books disclosed the following data for the current taxable year:

What amount should appear on the last line of reconciliation Schedule M-2 of Form 1120?

a. $102,000

b. $120,000

c. $128,000

d. $138,000

D. Affiliated and Controlled Corporations

73. Bank Corp. owns 80% of Shore Corp.’s outstanding capital stock. Shore’s capital stock consists of 50,000 shares of common stock issued and outstanding. Shore’s 2013 net income was $140,000. During 2013, Shore declared and paid dividends of $60,000. In conformity with generally accepted accounting principles, Bank recorded the following entries in 2013:

In its 2013 consolidated tax return, Bank should report dividend revenue of

a. $48,000

b. $14,400

c. $ 9,600

d. $0

74. During the current 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. $100,000

b. $ 80,000

c. $ 70,000

d. $0

75. Potter Corp. and Sly Corp. file consolidated tax returns. In January 2012, Potter sold land, with a basis of $60,000 and a fair value of $100,000, to Sly for $100,000. Sly sold the land in June 2013 for $125,000. In its 2013 and 2012 tax returns, what amount of gain should be reported for these transactions in the consolidated return?

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

a. Intercompany dividends are excludable to the extent of 80%.

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

c. Each of the subsidiaries is entitled to an alternative minimum tax exemption.

d. Each of the subsidiaries is entitled to an accumulated earnings tax credit.

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

78. Consolidated returns may be filed

a. Either by parent-subsidiary corporations or by brother-sister corporations.

b. Only by corporations that formally request advance permission from the IRS.

c. Only by parent-subsidiary affiliated groups.

d. Only by corporations that issue their financial statements on a consolidated basis.

79. Parent Corporation and Subsidiary Corporation file consolidated returns on a calendar-year basis. In January 2012, Subsidiary sold land, which it had used in its business, to Parent for $50,000. Immediately before this sale, Subsidiary’s basis for the land was $30,000. Parent held the land primarily for sale to customers in the ordinary course of business. In July 2013, Parent sold the land to Adams, an unrelated individual. In determining consolidated taxable income for 2013, how much should Subsidiary take into account as a result of the 2012 sale of the land from Subsidiary to Parent?

a. $0

b. $20,000

c. $30,000

d. $50,000

E. Dividends and Distributions

80. 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 deficit at year-end?

a. $(30,000)

b. $(42,000)

c. $(45,000)

d. $(57,000)

81. At the beginning of the year, Cable, a C corporation, had accumulated earnings and profits of $100,000. Cable reported the following items on its current year tax return:

What is Cable’s accumulated earnings and profits at the end of the year?

a. $142,000

b. $145,000

c. $147,000

d. $150,000

82. On January 1, 2013, Locke Corp., an accrual-basis, calendar-year C corporation, had $30,000 in accumulated earnings and profits. For 2013, 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 2013. What amount of the 2013 distributions is classified as dividend income to Locke’s shareholders?

a. $0

b. $20,000

c. $50,000

d. $80,000

83. Chicago Corp., a calendar-year C corporation, had accumulated earnings and profits of $100,000 as of January 1, 2013 and had a deficit in its current earnings and profits for the entire 2013 tax year in the amount of $140,000. Chicago Corp. distributed $30,000 cash to its shareholders on December 31, 2013. What would be the balance of Chicago Corp.’s accumulated earnings and profits as of January 1, 2014?

a. $0

b. $(30,000)

c. $(40,000)

d. $(70,000)

84. Salon, Inc. distributed cash and personal property to its sole shareholder. Using the following facts, determine the amount of gain that would be recognized by Salon, Inc. as the result of making the distribution to its shareholder?

a. $ 3,000

b. $ 4,000

c. $ 7,000

d. $23,000

85. Kent Corp. is a calendar-year, accrual-basis C corporation. In 2013, 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:

What was taxable as dividend income to Reed for 2013?

a. $ 60,000

b. $150,000

c. $185,000

d. $200,000

86. Ridge Corp., a calendar-year C corporation, made a nonliquidating cash distribution to its shareholders of $1,000,000 with respect to its stock. At that time, Ridge’s current and accumulated earnings and profits totaled $750,000 and its total paid-in capital for tax purposes was $10,000,000. Ridge had no corporate shareholders. Ridge’s cash distribution

I. Was taxable as $750,000 of dividend income to its shareholders.

II. Reduced its shareholders’ adjusted bases in Ridge stock by $250,000.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

87. Tour Corp., which had earnings and profits of $400,000, made a nonliquidating distribution of property to its shareholders during the current year. This property, which had an adjusted basis of $30,000 and a fair market value of $20,000 at date of distribution, did not constitute assets used in the active conduct of Tour’s business. How much loss did Tour recognize on this distribution?

a. $30,000

b. $20,000

c. $10,000

d. $0

88. On January 1, 2013, Kee Corp., a C corporation, had a $50,000 deficit in earnings and profits. For 2013 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. $30,000

b. $20,000

c. $10,000

d. $0

89. Dahl Corp. was organized and commenced operations in 2002. At December 31, 2013, Dahl had accumulated earnings and profits of $9,000 before dividend declaration and distribution. On December 31, 2013, Dahl distributed cash of $9,000 and a vacant parcel of land to Green, Dahl’s only stockholder. At the date of distribution, the land had a basis of $5,000 and a fair market value of $40,000. What was Green’s taxable dividend income in 2013 from these distributions?

a. $ 9,000

b. $14,000

c. $44,000

d. $49,000