South-Western Federal Taxation 2015: Corporations, Partnerships, Estates and Trusts, 38th Edition solutions manual test bank
- William H. Hoffman, Jr. University of Houston
- William A. Raabe University of Wisconsin - Whitewater
- David M. Maloney University of Virginia
- James C. Young Northern Illinois University
- James E. Smith College of William and Mary
- ISBN-10: 1285438299
- ISBN-13: 9781285438290
Course Support
CHAPTER
2: CORPORATIONS: INTRODUCTION AND OPERATING RULES
1. Tomas owns a sole
proprietorship, and Lucy is the sole shareholder of a C corporation. In the
current year both businesses make a net profit of $60,000. Neither business
distributes any funds to the owners in the year. For the current year, Tomas
must report $60,000 of income on his individual tax return, but Lucy is not
required to report any income from the corporation on her individual tax
return.
a. True
b. False
ANSWER: True
RATIONALE: Proprietorship profits
flow through to the owner and are reported on the owner’s individual income tax
return. It does not matter how much of the profit is withdrawn from the
proprietorship. Thus, Tomas must report the net profit of $60,000 on his Form
1040 (Schedule C). Shareholders are required to report income from a C
corporation only to the extent of dividends received. Consequently, Lucy has no
income to report from the corporation for the current year.
2. Carol and Candace are
equal partners in Peach Partnership. In the current year, Peach had a net
profit of $75,000 ($250,000 gross income – $175,000 operating expenses) and
distributed $25,000 to each partner. Peach must pay tax on $75,000 of income.
a. True
b. False
ANSWER: False
RATIONALE: A partnership is not a
taxpaying entity. Its profit (loss) and separate items flow through to the
partners. The partnership’s Form 1065 reports net profit of $75,000. Carol and
Candace both receive a Schedule K-1 reporting net profit of $37,500. Each
partner reports net profit of $37,500 on her own return (Form 1040).
3. Rajib is the sole
shareholder of Robin Corporation, a calendar year S corporation. Robin earned
net profit of
$350,000 ($520,000 gross income
– $170,000 operating expenses) and distributed $80,000 to Rajib. Rajib must report
Robin Corporation profit of $350,000 on his Federal income tax return.
a. True
b. False
ANSWER: True
RATIONALE: Similar to
partnerships, the net profit or loss of an S corporation flows through to the
shareholders to be reported on their individual tax returns. Robin’s net income
of $350,000 is allocated entirely to Rajib, as the sole shareholder, and Rajib
reports the $350,000 of income on his Federal income tax return, regardless of
how much of the income was withdrawn from the S corporation.
4. Donald owns a 45%
interest in a partnership that earned $130,000 in the current year. He also
owns 45% of the stock in a C corporation that earned $130,000 during the year.
Donald received $20,000 in distributions from each of the two entities during
the year. With respect to this information, Donald must report $78,500 of
income on his individual income tax return for the year.
a. True
b. False
ANSWER: True
RATIONALE: On his individual
income tax return for the year, Donald must report his $58,500 ($130,000 ×
45%) share of the partnership income plus the
$20,000 of dividends he received from the C corporation, or $78,500 of total
income. The partnership income is taxed to a partner in the year earned, and
distributions do not affect a partner’s share of income. A C corporation’s
income is taxed to a shareholder only when distributed as dividends and to the
extent thereof.
5. Quail Corporation is
a C corporation with net income of $125,000 during the current year. If Quail
paid dividends of $25,000 to its shareholders, the corporation must pay tax on
$100,000 of net income. Shareholders must report the $25,000 of dividends as
income.
a. True
b. False
ANSWER: False
RATIONALE: Quail
Corporation must pay tax on the $125,000 of corporate net income. Dividends
paid are not deductible by the corporation. Shareholders must pay tax on the
$25,000 of dividends received from the corporation. This is commonly referred
to as double taxation.
6. Eagle Company, a
partnership, had a short-term capital loss of $10,000 during the year. Aaron,
who owns 25% of Eagle, will report $2,500 of Eagle’s shortterm capital loss on
his individual tax return.
a. True
b. False
ANSWER: True
RATIONALE: Capital losses of a partnership pass through to the partners
and are reported on such partners’ tax returns.
7. Don, the sole
shareholder of Pastel Corporation (a C corporation), has the corporation pay
him a salary of $600,000 in the current year. The Tax Court has held that
$200,000 represents unreasonable compensation. Don must report a salary of
$400,000 and a dividend of $200,000 on his individual tax return.
a. True
b. False
ANSWER: True
RATIONALE: To the extent a salary
paid to a shareholder/employee is considered reasonable, the corporation is
allowed a salary deduction, which reduces corporate taxable income. To the
extent a salary payment is not considered reasonable, the payment is treated as
a dividend, which does not reduce corporate taxable income. The shareholder/employee
is taxed on both salary ($400,000) and dividends ($200,000). (Pastel’s taxable
income increases by $200,000, the amount of the unreasonable compensation paid
to Don.)
8. Double taxation of
corporate income results because dividend distributions are included in a
shareholder’s gross income but are not deductible by the corporation.
a. True
b. False
ANSWER: True
9. Jake, the sole
shareholder of Peach Corporation, a C corporation, has the corporation pay him
$100,000. For tax purposes, Jake would prefer to have the payment treated as
dividend instead of salary.
a. True
b. False
ANSWER: True
RATIONALE: Jake
must include in gross income both salary and dividends, but he would prefer
dividend income due to the preferential tax rate accorded such income.
10. Thrush Corporation
files Form 1120, which reports taxable income of $200,000. The corporation’s
tax is $56,250.
a. True
b. False
ANSWER: False
RATIONALE: The tax is equal to
$61,250 [($50,000 × 15%) +
($25,000 × 25%) +
($25,000 × 34%) +
($100,000 ×
39%)].
11. The corporate
marginal income tax rates range from 15% to 39%, while the individual marginal
income tax rates range from 10% to 39.6%.
a. True
b. False
ANSWER: True
12. Employment taxes
apply to all entity forms of operating a business. As a result, employment
taxes are a neutral factor in selecting the most tax effective form of
operating a business.
a. True
b. False
ANSWER: False
RATIONALE: Employment
taxes applicable to payments to owners of businesses are not neutral in the
selection of a business form. The self-employment tax applies to the net
earnings of a proprietorship and, often, to partnership allocations of income
to a partner. Individuals can deduct one-half of the self-employment tax paid.
Conversely, payroll taxes (employer and employee) apply to wages paid to a
shareholder-employee of a corporation (regular or S), and the corporation can
deduct the employer share of payroll taxes paid. Any analysis of the most tax
effective form of operating a business must consider these differences in the
treatment of employment taxes.
13. Under the
“checkthebox” Regulations, a twoowner LLC that fails to elect to be to
treated as a corporation will be taxed as a sole proprietorship.
a. True
b. False
ANSWER: False
RATIONALE: Partnership
is the default classification for a two-owner LLC that does not elect to be
treated as a corporation under the “checkthebox”
Regulations.
14. A personal service
corporation must use a calendar year, and is not permitted to use a fiscal
year.
a. True
b. False
ANSWER: False
RATIONALE: As
a general rule, a personal service corporation (PSC) must use a calendar year.
However, under certain circumstances (e.g., business purpose exception,
§ 444 election) a PSC may use a fiscal year.
15. As a general rule, C
corporations must use the cash method of accounting. However, under several
exceptions to this rule (e.g., average annual gross receipts of $5 million or
less for the most recent 3-year period), a C corporation can use the accrual
method.
a. True
b. False
ANSWER: False
RATIONALE: The
opposite is true. As a general rule, C corporations must use the accrual method of accounting. However,
under several exceptions to the rule (e.g., average annual gross receipts of $5
million or less for the most recent 3-year period), a C corporation can use the
cash method.
16. On December 31, 2014,
Lavender, Inc., an accrual basis C corporation, accrues a $50,000 bonus to
Barry, its vice president and a 40% shareholder. Lavender pays the bonus to
Barry, who is a cash basis taxpayer, on March 13, 2015. Lavender can deduct the
bonus in 2015, the year in which it is included in Barry’s gross income.
a. True
b. False
ANSWER: False
RATIONALE: Because Barry is not a related party (more than 50%
shareholder), Lavender’s deduction for the bonus occurs in 2014, the year in
which the $50,000 is incurred and accrued.
17. Azure Corporation, a
C corporation, had a long-term capital gain of $50,000 in the current year. The
maximum amount of tax applicable to the capital gain is $7,500 ($50,000 × 15%).
a. True
b. False
ANSWER: False
RATIONALE: While the maximum rate
on long-term capital gains of individuals is generally limited to 15% or 20%,
there is no tax rate preference applicable to long-term capital gains of C
corporations. Thus, the maximum amount of tax applicable to Azure Corporation’s
capital gain is $19,500 [$50,000 × 39%
(highest marginal rate)].
18. Albatross, a C
corporation, had $140,000 net income from operations and a $25,000 short-term
capital loss in the current year. Albatross Corporation’s taxable income is
$140,000.
a. True
b. False
ANSWER: True
RATIONALE: A corporation cannot deduct a net capital loss in the year
incurred; thus, Albatross has taxable income of $140,000. For corporations, a
net capital loss must be carried back three years and forward five years and be
offset against capital gains in the carryback/forward years.
19. If a C corporation
uses straightline depreciation on real estate (§ 1250 property), no portion of
a gain on the sale of the property will be recaptured as ordinary income.
a. True
b. False
ANSWER: False
RATIONALE: Section 291 requires
the recapture of some depreciation for corporate taxpayers on the sale of §
1250 property
for a gain, even if straight-line depreciation had been claimed on the
property.
20. The passive loss
rules apply to closely held C corporations and to personal service corporations
but not to S corporations.
a. True
b. False
ANSWER: True
RATIONALE: The
passive loss rules apply to personal service corporations and to closely held C
corporations. (Closely held corporations may deduct passive losses to the
extent of their active income.) For S corporations (and partnerships), the
passive loss rules apply at the shareholder (partner) level.
21. Peach Corporation had
$210,000 of active income, $45,000 of portfolio income, and a $230,000 passive
loss during the current year. If Peach is a closely held C corporation that is
not a PSC, it can deduct $210,000 of the passive loss in the year.
a. True
b. False
ANSWER: True
RATIONALE: If Peach is a closely
held corporation, the passive loss is deductible to the extent of the
corporation’s active income,
or $210,000.
22. On December 19, 2014,
the directors of Quail Corporation (an accrual basis, calendar year taxpayer)
authorized a cash donation of $5,000 to the American Cancer Society, a
qualified charity. The payment, which is made on April 10, 2015, may be claimed
as a deduction for tax year 2014.
a. True
b. False
ANSWER: False
RATIONALE: In order to be deductible in the year authorized by the
board of directors, a charitable contribution must be paid within 2 1/2 months
of the end of the year of authorization (March 15, 2015, in this case) and must
involve an accrual basis corporation. Because payment was made on April 10,
2015, the contribution is deductible in 2015.
23. In the current year,
Oriole Corporation donated a painting worth $30,000 to the Texas Art Museum, a
qualified public charity. The museum included the painting in its permanent
collection. Oriole Corporation purchased the painting 5 years ago for $10,000.
Oriole’s charitable contribution deduction is $30,000 (ignoring the taxable
income limitation).
a. True
b. False
ANSWER: True
RATIONALE: The
painting is capital gain property which the museum puts to a use that is
related to its exempt function. Thus, the amount of the deduction is equal to
the fair market value of the painting, or $30,000.
24. Crow Corporation, a C
corporation, donated scientific property (basis of $30,000, fair market value
of $50,000) to State University, a qualified charitable organization, to be
used in research. Crow had held the property for four months as inventory. Crow
Corporation may deduct $50,000 for the charitable contribution (ignoring the
taxable income limitation).
a. True
b. False
ANSWER: False
RATIONALE: The scientific
property is ordinary income property but it qualifies for the increased
deduction amount available for certain corporate contributions of inventory. As
such, the amount of the deduction is equal to the lesser of (1) the sum of the
inventory’s basis plus 50% of the appreciation on the property [$40,000 = $30,000
+ 50%($50,000 – $30,000)] or (2) twice the basis [$60,000 = $30,000 ×
2]. In this case, the ceiling does not apply,
and the deduction amount is $40,000.
25. Heron Corporation, a
calendar year C corporation, had an excess charitable contribution for 2013 of
$5,000. In 2014, Heron made a further charitable contribution of $20,000.
Heron’s 2014 deduction is limited to $15,000 (10% of taxable income). The 2014
contribution must be applied first against the $15,000 limitation.
a. True
b. False
ANSWER: True
RATIONALE: The current year's (2014) contribution must be applied first
against the taxable income limitation and the carryover (2013) used last.
26. For a corporation,
the domestic production activities deduction is equal to 9% of the lesser of
(1) qualified production activities income or (2) taxable income. However, the
deduction cannot exceed 50% of the W-2 wages related to qualified production
activities income.
a. True
b. False
ANSWER: True
RATIONALE: For
a corporation, the domestic production activities deduction is equal to 9% of
the lower of (1) qualified production
activities income or (2) taxable income. The deduction cannot exceed 50% of the
W-2 wages related to qualified production activities income.
27. A corporate net
operating loss can be carried back 2 years and forward 20 years to offset
taxable income for those years.
a. True
b. False
ANSWER: True
28. Azul Corporation, a
calendar year C corporation, received a dividend of $30,000 from Naranja Corporation.
Azul owns 25% of the Naranja Corporation stock. Assuming it is not subject to
the taxable income limitation, Azul’s dividends received deduction is $21,000.
a. True
b. False
ANSWER: False
RATIONALE: The
deduction percentage for a 25% ownership is 80%. Thus, the dividends received
deduction would be $24,000 ($30,000 ×
80%).
29. Because of the
taxable income limitation, no dividends received deduction is allowed if a
corporation has an NOL for the current taxable year.
a. True
b. False
ANSWER: False
RATIONALE: The
taxable income limitation for the dividends received deduction does not apply
if a corporation has an NOL for the current taxable year.
30. No dividends received
deduction is allowed unless the corporation has held the stock for more than 90
days.
a. True
b. False
ANSWER: False
RATIONALE: The
corporation must hold the stock for more than 45 days in order to qualify for the dividends received deduction.
31. Hornbill Corporation,
a cash basis and calendar year C corporation, was formed and began operations
on May 1, 2014. Hornbill incurred the following expenses during its first year
of operations (May 1 – December 31, 2014): temporary directors meeting expenses
of $10,500, state of incorporation fee of $5,000, stock certificate printing
expenses of $1,200, and legal fees for drafting corporate charter and bylaws of
$7,500. Hornbill Corporation’s current year deduction for organizational
expenditures is $5,800.
a. True
b. False
ANSWER: True
RATIONALE: All of the expenses
qualify as organizational expenditures except for the stock certificate
printing costs ($1,200). Thus, organizational expenditures total $23,000
($10,500 + $5,000 + $7,500). The current year deduction for organizational
expenditures is $5,800 {$5,000 immediate expensing + $800 amortization
[($23,000 – $5,000) ÷ 180 ×
8 months]}.
32. Lilac Corporation
incurred $4,700 of legal and accounting fees associated with its incorporation.
The $4,700 is deductible as startup expenditures on Lilac’s tax return for the
year in which it begins business.
a. True
b. False
ANSWER: False
RATIONALE: The $4,700 is
deductible as organizational expenditures
on Lilac’s tax return for the year in which it begins business.
33. A personal service
corporation with taxable income of $100,000 will have a tax liability of
$22,250.
a. True
b. False
ANSWER: False
RATIONALE: A
personal service corporation is subject to the 35% rate on all taxable income;
thus, the tax liability is $35,000 ($100,000 ×
35%).
34. Ed, an individual, incorporates
two separate businesses that he owns by establishing two new C corporations.
Each corporation generates taxable income of $50,000. As a general rule, each
corporation will have a tax liability of
$11,125.
a. True
b. False
ANSWER: True
RATIONALE: Since the corporations would be members of a controlled
group, their taxable income would be combined in applying the corporate income
tax rates. The tax on $100,000 would be $22,250, or $11,125 tax for each
corporation. If all members of a controlled group consent, an apportionment
plan can provide for an unequal allocation of the marginal tax rates.
35. A calendar year C
corporation can receive an automatic 9-month extension to file its corporate
return (Form 1120) by timely filing a Form 7004 for the tax year.
a. True
b. False
ANSWER: False
RATIONALE: Corporations
can receive an automatic extension of six
months for filing the corporate return by filing Form 7004 by the due date
of the return.
36. A corporation must
file a Federal income tax return even if it has no taxable income for the year.
a. True
b. False
ANSWER: True
RATIONALE: A corporation must file a return regardless of
whether or not it has taxable income.
37. For purposes of the
estimated tax payment rules, a “large corporation” is defined as a corporation
that had taxable income of $1 million or more in any of the three preceding
years.
a. True
b. False
ANSWER: True
38. Schedule M-1 is used
to reconcile net income as computed for financial accounting purposes with
taxable income reported on the corporation’s income tax return.
a. True
b. False
ANSWER: True
39. An expense that is
deducted in computing net income per books but not deductible in computing
taxable income is a subtraction item on Schedule M-1.
a. True
b. False
ANSWER: False
RATIONALE: An
expense that is deducted in computing net income per books but not deductible
in computing taxable income is an addition
item on Schedule M-1.
40. On December 31, 2014,
Flamingo, Inc., a calendar year, accrual method C corporation, accrues a bonus
of $50,000 to its president (a cash basis taxpayer), who owns 75% of the
corporation’s outstanding stock. The $50,000 bonus is paid to the president on
February 2, 2015. For Flamingo’s 2014 Form 1120, the $50,000 bonus will be a
subtraction item on Schedule M-1.
a. True
b. False
ANSWER: False
RATIONALE: The bonus is entered as an addition item on Schedule M-1. Since Flamingo is accruing an
expenditure with respect to a cash basis related party (i.e., more than 50%
shareholder), the $50,000 bonus is not deductible until such time it is
included in the president’s gross income (2015). An item that is an expense in
computing net income per books but not deductible in computing taxable income
is an addition item on Schedule M-1.
41. Income that is
included in net income per books but not included in taxable income is a
subtraction item on Schedule M-1.
a. True
b. False
ANSWER: True
42. Schedule M-2 is used
to reconcile unappropriated retained earnings at the beginning of the year with
unappropriated retained earnings at the end of the year.
a. True
b. False
ANSWER: True
43. A corporation with $5
million or more in assets must file Schedule M-3 (instead of Schedule M-1).
a. True
b. False
ANSWER: False
RATIONALE: A
corporation with $10 million or more
in assets must file Schedule M-3 (instead of Schedule M-1).
44. Schedule M-3 is
similar to Schedule M-1 in that the form is designed to reconcile net income
per books with taxable income. However, an objective of Schedule M-3 is more
transparency between financial statements and tax returns than that provided by
Schedule M-1.
a. True
b. False
ANSWER: True
45. Juanita owns 60% of
the stock in a C corporation that had a profit of $200,000 in 2013. Carlos owns
a 60% interest in a partnership that had a profit of $200,000 during the year.
The corporation distributed $45,000 to Juanita, and the partnership distributed
$45,000 to Carlos. Which of the following statements relating to 2013 is incorrect?
a.
Juanita must report $120,000 of income from the corporation.
b.
The corporation must pay corporate tax on $200,000 of
income.
c.
Carlos must report $120,000 of income from the partnership.
d.
The partnership is not subject to a Federal entity-level
income tax.
e.
None of the above.
ANSWER: a
RATIONALE: Shareholders
of C corporations report the dividends received from the corporation during the
year. Thus, Juanita must report $45,000 of income from the corporation. The
other statements are correct.
46. Bjorn owns a 60%
interest in an S corporation that earned $150,000 in 2013. He also owns 60% of
the stock in a C corporation that earned $150,000 during the year. The S
corporation distributed $30,000 to Bjorn and the C corporation paid dividends
of $30,000 to Bjorn. How much income must Bjorn report from these businesses?
a.
$0 income from the S corporation and $30,000 income from the
C corporation.
b.
$30,000 income from the S corporation and $30,000 of
dividend income from the C corporation.
c.
$90,000 income from the S corporation and $0 income from the
C corporation.
d.
$90,000 income from the S corporation and $30,000 income
from the C corporation.
e.
None of the above.
ANSWER: d
RATIONALE: Bjorn must report his
$90,000 share ($150,000 × 60%)
of the S corporation’s income on his individual tax return. He will report $30,000 of
dividend income from the C corporation.
47. Rachel is the sole
member of an LLC, and Jordan is the sole shareholder of a C corporation. Both
businesses were started in the current year, and each business has a long-term
capital gain of $10,000 for the year. Neither business made any distributions
during the year. With respect to this information, which of the following statements
is correct?
a.
The C corporation receives a preferential tax rate on the
LTCG of $10,000.
b.
The LLC must pay corporate tax on taxable income of $10,000.
c.
Jordan must report $10,000 of LTCG on his tax return.
d.
Rachel must report $10,000 of LTCG on her tax return.
e.
None of the above.
ANSWER: d
RATIONALE: Under
the default rules of the check-the-box Regulations, a single-member LLC is
treated as a proprietorship for Federal tax purposes. As such, Rachel reports
the $10,000 LTCG on her tax return (Form 1040). A C corporation does not
receive preferential tax rate treatment on LTCG (option a.). The LLC is ignored
for Federal income tax purposes and its income, gains, deductions, and losses
are reported as a proprietorship, not as a corporation (option b.). A C corporation
is a separate taxpaying entity (Form 1120) and income of a C corporation is not
taxed to its shareholders until distributed as dividends (option c.).
48. Norma formed Hyacinth
Enterprises, a proprietorship, in 2014. In its first year, Hyacinth had operating
income of $400,000 and operating expenses of $240,000. In addition, Hyacinth
had a long-term capital loss of $10,000. Norma, the proprietor of Hyacinth
Enterprises, withdrew $75,000 from Hyacinth during the year. Assuming Norma has
no other capital gains or losses, how does this information affect her taxable
income for 2014?
a.
Increases Norma’s taxable income by $157,000 ($160,000
ordinary business income – $3,000 longterm capital loss).
b.
Increases Norma’s taxable income by $150,000 ($160,000 ordinary
business income – $10,000 longterm capital loss).
c.
Increases Norma’s taxable income by $75,000.
d.
Increases Norma’s taxable income by $160,000.
e.
None of the above.
ANSWER: a
RATIONALE: A proprietorship is not a separate taxable entity. As a
proprietor, Norma reports profit or loss from Hyacinth on her individual
return. Norma’s taxable income for 2014 will be increased by $157,000 ($400,000
– $240,000 = $160,000 net ordinary business income – $3,000 capital loss
deduction). The $75,000 she withdrew from Hyacinth has no effect on her taxable
income.
49. Pablo, a sole
proprietor, sold stock held as an investment for a $40,000 long-term capital
gain. Pablo’s marginal tax rate is 33%. Loon Corporation, a C corporation, sold
stock held as an investment for a $40,000 long-term capital gain. Loon’s
marginal tax rate is 35%. What tax rates are applicable to these capital gains?
a.
15% rate applies to Pablo and 35% rate applies to Loon.
b.
15% rate applies to Loon and 33% rate applies to Pablo.
c.
35% rate applies to Loon and 33% rate applies to Pablo.
d.
15% rate applies to both Pablo and Loon.
e.
None of the above.
ANSWER: a
RATIONALE: Pablo
reports the LTCG on his individual tax return (Form 1040, Schedule D), and it
is subject to a maximum tax rate of 15%. Loon reports the LTCG on its corporate
return (Form 1120) but the gain does not receive preferential tax rate
treatment. Therefore, the LTCG will be taxed at 35%.
50. Lucinda is a 60%
shareholder in Rhea Corporation, a calendar year S corporation. During the
year, Rhea Corporation had gross income of $550,000 and operating expenses of
$380,000. In addition, the corporation sold land that had been held for
investment purposes for a short-term capital gain of $30,000. During the year,
Rhea Corporation distributed $50,000 to Lucinda. With respect to this
information, which of the following statements is correct?
a.
Rhea Corporation will pay tax on taxable income of $200,000.
b.
Lucinda reports ordinary income of $50,000.
c.
Lucinda reports ordinary income of $120,000.
d.
Lucinda reports ordinary income of $102,000 and a short-term
capital gain of $18,000.
e.
None of the above.
ANSWER: d
RATIONALE: Rhea
Corporation, an S corporation, is not a taxpaying entity (option a.). Its
profit (loss) and separate items flow through to the
shareholders. The corporation’s Form 1120S reports ordinary business income of $170,000
($550,000 income – $380,000 expenses). The corporation also reports the $30,000
shortterm capital gain as a separately stated item. Lucinda receives a
Schedule K-1 reporting ordinary business income of $102,000 (60% × $170,000) and separately stated short-term
capital gain of $18,000 (60% × $30,000), and she will report
such income on her own return. The distributions are not taxable for Lucinda
but decrease the basis in her Rhea Corporation stock.
51. Elk, a C corporation,
has $370,000 operating income and $290,000 operating expenses during the year.
In addition, Elk has a $10,000 longterm capital gain and a $17,000 shortterm
capital loss. Elk’s taxable income is:
a.
$63,000.
b.
$73,000.
c.
$80,000.
d.
$90,000.
e.
None of the above.
ANSWER: c
RATIONALE: $370,000 (operating
income) – $290,000 (operating
expenses) + $10,000 (LTCG) – $10,000 (STCL) = $80,000
taxable income. A corporation cannot deduct a net capital loss in the year
incurred. The net capital loss ($7,000) can be carried back three years and offset
against capital gain in the carryback years. If the capital loss is not used in
the carryback, it can be carried forward five years. Capital gains of
corporations are included in taxable income and are not subject to the
favorable rates applicable to individuals.
52. Flycatcher
Corporation, a C corporation, has two equal individual shareholders, Nancy and
Pasqual. In the current year, Flycatcher earned $100,000 net profit and paid a
dividend of $10,000 to each shareholder. Regardless of any tax consequences
resulting from their interests in Flycatcher, Nancy is in the 33% marginal tax
bracket and Pasqual is in the 15% marginal tax bracket. With respect to the
current year, which of the following statements is incorrect?
a.
Flycatcher cannot avoid the corporate tax altogether by
distributing all $100,000 of net profit as dividends to the shareholders.
b.
Nancy incurs income tax of $1,500 on her dividend income.
c.
Pasqual incurs income tax of $1,500 on his dividend income.
d.
Flycatcher pays corporate tax of $22,250.
e.
None of the above.
ANSWER: c
RATIONALE: A
preferential tax rate of 0% applies to dividend income of individual taxpayers
in the lowest two marginal tax brackets (10% or 15%); thus, Pasqual pays income
tax of $0 on his dividend income. A preferential tax rate of 15% or 20% applies
to dividend income of individual taxpayers in higher tax rate brackets (i.e.,
greater than 15%); thus, Nancy pays income tax of $1,500 on her dividend income
(option b.). Dividend distributions are not deductible by a corporation, and
Flycatcher still incurs corporate tax on $100,000 even if all profits were
distributed to shareholders (option a.). Corporate tax on $100,000 of taxable
income is $22,250 (option d.).
53. Which of the
following statements is incorrect about
LLCs and the check-the-box Regulations?
a.
If a limited liability company with more than one owner does
not make an election, the entity is taxed as a corporation.
b.
All 50 states have passed laws that allow LLCs.
c.
An entity with more than one owner and formed as a corporation
cannot elect to be taxed as a partnership.
d.
If a limited liability company with one owner does not make
an election, the entity is taxed as a sole proprietorship.
e.
A limited liability company with one owner can elect to be
taxed as a corporation.
ANSWER: a
RATIONALE: If
a limited liability company with more than one owner does not make an election,
the entity is taxed as a partnership. The other statements are correct.
54. Patrick, an attorney,
is the sole shareholder of Gander Corporation, a C corporation. Gander is a
personal service corporation with a fiscal year ending November 30 (pursuant to
a § 444 election). The corporation paid Patrick a salary of $180,000 during its
fiscal year ending November 30, 2014. How much salary must Gander pay Patrick
during the period December 1 through December 31, 2014, to permit the
corporation to continue to use its fiscal year without negative tax effects?
a.
$0
b.
$30,000
c.
$165,000
d.
$180,000
e.
None of the above
ANSWER: e
RATIONALE: The salary for the deferral period (December 1 through
December 31) must be at least proportionate to the employee’s salary received
for the fiscal year. The amount that Gander Corporation must pay Patrick during
the period December 1 through December 31, 2014, to permit the continued use of
its fiscal year without negative tax effects, is $15,000 ($180,000 × 1/12).
55. Saleh, an accountant,
is the sole shareholder of Turquoise Corporation, a C corporation. Turquoise is
a personal service corporation with a fiscal year ending September 30 (pursuant
to a § 444 election). The corporation paid Saleh a salary of $330,000 during
its fiscal year ending September 30, 2014. How much salary must Turquoise pay
Saleh during the period October 1 through December 31, 2014, if the corporation
is to continue to use its fiscal year without negative tax effects?
a.
$0
b.
$27,500
c.
$82,500
d.
$247,500
e.
None of the above
ANSWER: c
RATIONALE: The salary for the deferral period (October through
December) must be at least proportionate to the employee’s salary received for the
fiscal year. The amount that Turquoise Corporation must pay Saleh during the
period October 1 through December 31, 2014, to permit Turquoise to continue to
use its fiscal year without negative tax effects is $82,500 ($330,000 × 3/12).
56. Copper Corporation, a
C corporation, had gross receipts of $5 million in 2011, $6 million in 2012,
and $3 million in 2013. Gold Corporation, a personal service corporation (PSC),
had gross receipts of $4 million in 2011, $7 million in 2012, and $5 million in
2013. Which of the corporations will be allowed to use the cash method of
accounting in 2014?
a.
Copper Corporation only.
b.
Gold Corporation only.
c.
Both Copper Corporation and Gold Corporation.
d.
Neither Copper Corporation nor Gold Corporation.
e.
None of the above.
ANSWER: c
RATIONALE: Copper Corporation can
use the cash receipts method because it had average annual gross receipts of $5
million or less ($14 million ÷ 3 = $4.67 million) during the three preceding
years. Gold Corporation, a PSC, may use the cash method without regard to its
gross receipts.
57. Ivory Corporation, a
calendar year, accrual method C corporation, has two cash method, calendar year
shareholders who are unrelated to each other. Craig owns 35% of the stock, and
Oscar owns the remaining 65%. During 2014, Ivory paid a salary of $100,000 to
each shareholder. On December 31, 2014, Ivory accrued a bonus of $25,000 to
each shareholder. Assuming that the bonuses are paid to the shareholders on
February 3, 2015, compute Ivory Corporation’s 2014 deduction for the above
amounts.
a.
$250,000
b.
$225,000
c.
$200,000
d.
$125,000
e.
None of the above
ANSWER: b
RATIONALE: A corporation that uses the accrual method cannot claim a
deduction for an accrual with respect to a related party until the recipient
reports that amount as income. Thus, Ivory cannot deduct the $25,000 bonus
attributable to Oscar, a related party (i.e., more than 50% shareholder), until
2015. Ivory can deduct in 2014 the salary payments made to each shareholder
plus the accrued bonus to Craig, or $225,000 ($100,000 salary + $100,000 salary + $25,000 bonus).
58. On December 31, 2014,
Peregrine Corporation, an accrual method, calendar year taxpayer, accrued a
performance bonus of $100,000 to Charles, a cash basis, calendar year taxpayer.
Charles is president and sole shareholder of the corporation. When can
Peregrine deduct the bonus?
a.
In 2014, if the bonus was authorized by the Board of
Directors and payment was made on or before March 15, 2015.
b.
In 2015, if payment was made at any time during that year.
c.
In 2014, if payment was made on or before March 15, 2015.
d.
In 2015, but only if payment was made on or before March 15,
2015.
e.
None of the above.
ANSWER: b
RATIONALE: Because Charles is a related party (i.e., more than 50%
shareholder). Peregrine’s deduction for the bonus must wait until Charles
includes the bonus in gross income. Charles, who is a cash basis, calendar year
taxpayer, will include the payment in gross income in the year he receives it
from Peregrine. Therefore, if Peregrine pays Charles the bonus anytime in 2015,
the corporation can deduct the bonus in 2015.
59. Carrot Corporation, a
C corporation, has a net short-term capital gain of $65,000 and a net long-term
capital loss of $250,000 during 2014. Carrot Corporation had taxable income
from other sources of $720,000. Prior years’ transactions included the
following:
|
2010
|
Net long-term capital gain
|
$150,000
|
|
2011
|
Net
short-term capital gain
|
60,000
|
|
2012
|
Net
short-term capital gain
|
45,000
|
|
2013
|
Net
long-term capital gain
|
35,000
|
Compute
the amount of Carrot’s capital loss carryover to 2015.
a.
$0
b.
$32,000
c.
$45,000
d.
$185,000
e.
None of the above
|
ANSWER:
RATIONALE:
The net capital loss
of $185,000 is not deductible in 2014, but must be carried back to the three
preceding years, applying it to 2011, 2012, and 2013, in that order. The net
capital loss is carried back or forward as short-term capital loss.
|
2014 net capital loss
|
($185,000)
|
|
Offset against
|
|
|
2011 (net short-term capital
gain)
|
$ 60,000
|
|
2012 (net short-term capital
gain)
|
45,000
|
|
2013 (net long-term capital
gain)
|
35,000
|
|
Total carrybacks
|
$140,000
|
Carrot’s capital loss carryover
is $45,000 ($185,000 – $140,000),
which may be carried over to 2015, 2016, 2017, 2018, and 2019, in that order.
60. In 2014, Bluebird
Corporation had net income from operations of $100,000. Further, Bluebird
recognized a long- term capital gain of $30,000, and a short-term capital loss
of $45,000. Which of the following statements is correct?
a.
Bluebird Corporation will have taxable income in 2014 of
$100,000 and will have a net capital loss of $15,000 that can be carried back 3
years and forward 5 years.
b.
Bluebird Corporation may use the capital loss to offset the
capital gain and must carry the net capital loss of $15,000 forward five years
as a short-term capital loss.
c.
Bluebird Corporation may deduct $33,000 of the capital loss
in 2014 and may carry forward the remainder of the capital loss indefinitely to
offset capital gains.
d.
Bluebird Corporation will have taxable income in 2014 of
$85,000.
e.
None of the above.
ANSWER: a
RATIONALE: The
capital loss will offset the $30,000 capital gain. The remaining $15,000
capital loss can be carried back to the three preceding years to reduce any
capital gains in those years. Any remaining loss not offset against capital
gains in the three preceding tax years can be carried forward for five years to
offset capital gains in those years. The loss will be treated as short-term
capital loss when carried back or forward.
61. In the current year,
Sunset Corporation (a C corporation) had operating income of $200,000 and
operating expenses of $175,000. In addition, Sunset had a $30,000 long-term
capital gain, a $52,000 short-term capital loss, and $5,000 taxexempt interest
income. What is Sunset Corporation’s taxable income for the year?
a.
$0
b.
$3,000
c.
$22,000
d.
$30,000
e.
None of the above
ANSWER: e
RATIONALE: $25,000 ($200,000
operating income – $175,000
operating expenses + $30,000 LTCG – $30,000 STCL). The $22,000 net
capital loss is not deductible in the year incurred; rather, the loss is
carried back three years and forward five years. The tax-exempt interest income
is excluded from gross income.
62. Beige Corporation, a
C corporation, purchases a warehouse on August 1, 1998, for $1 million.
Straight-line depreciation is taken in the amount of $411,750 before the
property is sold on June 11, 2014, for $1.2 million. What is the amount and
character of the gain recognized by Beige on the sale of the realty?
a.
Ordinary income of $0 and § 1231 gain of $611,750.
b.
Ordinary income of $411,750 and § 1231 gain of $200,000.
c.
Ordinary income of $82,350 and § 1231 gain of $529,400.
d.
Ordinary income of $117,650 and § 1231 gain of $494,100.
e.
None of the above.
| |||||||||||||
ANSWER:
RATIONALE:
Second, determine the § 1245
recapture potential. This is the lesser of $611,750
(recognized gain) or $411,750
(cost recovery claimed).
Third, determine the normal §
1250 recapture amount:
Cost recovery taken $411,750
Less straight-line
cost recovery (411,750)
§ 1250 ordinary
income $ –0–
Fourth, because the taxpayer is
a corporation, determine the additional § 291
amount:
|
§
1245 recapture potential
|
$411,750
|
|
Less
§ 1250 recapture amount
|
(–0–)
|
|
Excess
§ 1245 recapture potential
|
$411,750
|
|
Apply
§ 291 percentage
|
20%
|
|
Additional
ordinary income under § 291
|
$ 82,350
|
Beige Corporation’s recognized
gain of $611,750 is accounted for as follows:
|
Ordinary
income under § 1250
|
$ –0–
|
|
Ordinary
income under § 291
|
82,350
|
|
§
1231 gain
|
529,400
|
|
Total recognized gain
|
$611,750
|
63. During the current
year, Woodchuck, Inc., a closely held personal service corporation, has
$115,000 of net active income, $40,000 of portfolio income, and $135,000 of
passive activity loss. What is Woodchuck’s taxable income for the current year?
a.
$0
b.
$20,000
c.
$40,000
d.
$155,000
e.
None of the above
ANSWER: d
RATIONALE: Personal
service corporations cannot offset passive activity losses against either
active or portfolio income. Thus, Woodchuck’s taxable income is $155,000
($115,000 net active income +
$40,000 portfolio income).
64. Grackle Corporation,
a personal service corporation, had $230,000 of net active income, $40,000 of
portfolio income, and a $250,000 passive activity loss during the year. How
much is Grackle’s taxable income?
a.
$20,000
b.
$40,000
c.
$270,000
d.
$520,000
e.
None of the above
ANSWER: c
RATIONALE: A personal service corporation may not offset passive
activity loss against net active income or portfolio income. Thus, Grackle’s
taxable income is $270,000 ($230,000 + $40,000).
65. Grebe Corporation, a
closely held corporation that is not a PSC, had $75,000 of net active income,
$60,000 of portfolio income, and a $105,000 passive activity loss during the
year. How much of the passive activity loss can Grebe deduct in the current
year?
a.
$0
b.
$60,000
c.
$105,000
d.
$135,000
e.
None of the above
ANSWER: e
RATIONALE: As
a closely held corporation, Grebe may offset $75,000 of the $105,000 passive
activity loss against the $75,000 of net active income, but may not offset any
of the remaining $30,000 of passive activity loss against portfolio income.
66. During the current
year, Violet, Inc., a closely held corporation (not a PSC), has $55,000 of
passive activity loss, $80,000 of net active income, and $20,000 of portfolio
income. How much is Violet’s taxable income for the current year?
a.
$20,000
b.
$45,000
c.
$80,000
d.
$100,000
e.
None of the above
ANSWER: b
RATIONALE: A closely held corporation that is not a PSC can deduct
passive activity losses against net active income but not portfolio income.
Thus, Violet’s taxable income is $45,000 [$80,000 (net active income) + $20,000 (portfolio income) – $55,000 (passive activity loss)].
67. During the current
year, Owl Corporation (a C corporation), a retailer of children’s apparel, made
the following donations to qualified charitable organizations.
Adjusted Basis Fair Market Value
Children’s clothing
held as inventory, to Haven
for
Hope $10,000 $15,000
Stock in Exxon
Corporation acquired two years ago and 5,000 3,000
held as an investment, to City
University
Land acquired four
years ago and held as an investment, 50,000 75,000
to Humane Society
How much qualifies
for the charitable contribution deduction?
a.
$63,000
b.
$65,000
c.
$90,500
d.
$92,500
e.
None of the above
ANSWER: c
RATIONALE: Since Owl is a
corporation and the inventory exception is met, one-half of the appreciation on
the clothing may be claimed, or $2,500 [.50($15,000 – $10,000)]. Therefore, $12,500 ($10,000 basis + $2,500 appreciation) is the contribution amount for the inventory.
The Exxon stock was loss property (fair market value less than basis);
therefore, the contribution amount is the stock’s fair market value, or $3,000.
The land is capital gain property, an appreciated capital asset held more than
one year, and the contribution amount is the land’s fair market value, or
$75,000. Thus, the total amount of contributions for Owl Corporation is $90,500
($12,500 + $3,000 + $75,000).
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