Reg Corporate Income Taxes - From Cpafree

Front 1

The Englander Company bought land two years ago for $20,000. The property is now worth $24,000 although the corporation still owes $15,000 on its purchase. The company makes a nonliquidating distribution of this property to one of its stockholders who also accepted the obligation for the debt. What is the tax effect to Englander of making this distribution?

Back 1

For the nonliquidating distribution of property by a corporation, the corporation must report the transfer as if the property had been sold and the money conveyed as a dividend. The form of the dividend should not change the tax implications. Although the property had originally cost $20,000, it could have been sold for $24,000 and a gain of $4,000 incurred. The company could have then taken $15,000 of that amount to pay off the liability with the remaining $9,000 paid to the owner as a dividend. Given the property directly to the owner should not change that tax effect; the gain is $4,000 as if the property had been sold

Front 2

The Spainola Company bought land two years ago for $20,000. The property is now worth $24,000 although the corporation still owes $15,000 on its purchase. The company makes a nonliquidating distribution of this property to Ms. Moore, one of its stockholders who also accepted the obligation for the debt. What is the tax effect to Ms. Moore of receiving this distribution?

Back 2

Ms. Moore receives land with a value of $24,000 and a debt of $15,000. Ms. Moore is $9,000 better off than before the distribution was received and that income must be recognized for tax purposes.

Front 3

Martha transferred equipment to a corporation in exchange for 100 shares of common stock. The equipment had a basis of $120,000 and a fair value of $160,000 which is equal to the value of the shares received. There are three other shareholders who each own 100 shares of stock. What is Martha's basis in the stock?

Back 3

In most cases, the basis of property transferred to a corporation is the fair value of the shares received (or $160,000 for this problem). A more formal way of making the determination is that the basis is Martha's previous basis plus any gain recognized on the transfer. In this case, she does not own enough stock for the transfer to qualify for tax-free treatment, so she has a gain of $40,000. The basis was $120,000 and the fair value is $160,000 for a gain of $40,000. Her basis in the stock will be the old basis of $120,000 plus this gain of $40,000 or $160,000.

Front 4

In the current year, Dr. Spencer Patel decides to form a corporation. Cash of $120,000 is transferred to the business along with equipment having a tax basis of $100,000 but a fair value of $150,000. Dr. Patel received all of the stock of this new corporation. What is his tax basis in this new business and what tax basis does the new business use for this equipment?

Back 4

When an owner transfers property to a corporation and winds up with 80 percent or more of the outstanding stock, the transfer is handling like a partnership rather than a corporation. That is the tax basis is retained by both parties and no income effect results. Dr. Patel gave up two assets with a tax basis of $220,000 ($100,000 plus $120,000). He keeps that amount as his tax basis for his investment. The business picks up the equipment at its tax basis of $100,000.

Front 5

The Sherman Corporation is in the process of liquidating and going out of business. Sherman owns shares of a major American company that it bought several years ago for $20,000. These shares are given to Mr. Jones (one of the owners) as part of the liquidation when they are valued at $32,000. What is the tax effect of this distribution for Sherman Corporation?

Back 5

When property is conveyed from a corporation to an owner, whether as a nonliquidating distribution or as a liquidating distribution, it is recorded as if it had been sold for its fair value. This investment was worth $32,000 but had only cost Sherman $20,000 so there is a $12,000 gain. The investment is a capital asset so the gain is a capital gain. Section 1231 gains only relate to business property such as machinery and equipment.

Front 6

In order to qualify for a tax free exchange the transferor(s) must own at least

Back 6

80% of the corporation's stock immediately after the exchange. Also, there can be no boot received by the shareholder(s) in the transaction. In the tax laws, ownership of 80 percent of a corporation is often the necessary level required for tax-free treatment.

Front 7

On January 1, Year One, the Martha Corporation acquires all of the outstanding stock of Hugh Corporation and appropriately allocates $240,000 to an identifiable intangible asset. This asset does qualify according to the tax rules as Section 179 property. For financial reporting purposes, the company has decided to amortize this cost over the expected 40-year life of the asset and reports its net income for Year One as $600,000. What should the company report as its taxable income for Year One if the only tax difference relates to this property?

Back 7

In determining net income, the cost of this asset is amortized at a rate of $6,000 per year ($240,000 over 40 years). However, for tax purposes, Section 179 property is amortized over 15 years. For this company, that is $16,000 per year ($240,000 over 15 years). Moving the expense from $6,000 to $16,000 reduces the income from $600,000 (for financial reporting) to $590,000 (for income taxes).

Front 8

The Hamerstein Corporation is created in Year One and organization costs to get started amount to $46,000. For income tax purposes, which of the following statements is true with respect to the handling of these costs?

Back 8

Organizational costs can be immediately deducted up to $5000 with the remainder amortized to expense over 180 months.
Incorporation fees, fees paid to temporary directors, and legal and accounting costs are examples of organization costs. The first $5,000 of these costs can be expensed immediately for tax purposes although that deduction is eliminated gradually if the total costs exceed $50,000. Any amount that is not deducted as incurred can be amortized over a period of 180 months (15 years).

Front 9

For financial reporting purposes, the Scaneli Corporation started Year One with an Allowance for Doubtful Accounts of $30,000. During that year, the company wrote off $63,000 in accounts because they were judged to be totally worthless. The company used the percentage of sales method and recognized bad debt expense for the year of $68,000 so that the ending allowance was $35,000. On its tax return for the year, what amount of deduction is allowed for these accounts?

Back 9

For tax purposes, estimated expenses (such as bad debts and warranties) must be incurred before a deduction is allowed. The taxpayer cannot anticipate or estimate the expense. It must actually be incurred. Here, $63,000 in accounts were judged worthless during the year and that is the amount that can be deducted.

Front 10

In Year One, the Pitsoni Corporation had revenues of $700,000 this year and operating expenses of $500,000. On the last day of the tax year, the Board of Directors pledged to contribute $28,000 to a local charity. The conveyance is made two weeks later. What is taxable income?

Back 10

For a corporation, charitable contributions are deductible but only up to 10 percent of the income earned prior to dividends received deduction and the donation itself. That amount is $200,000 (revenues of $700,000 minus expenses of $500,000). So, the maximum deduction this year is $20,000 ($200,000 times 10 percent). Any amount over that figure can be carried forward for up to five years. As long as a formal pledge was made in the tax year, the deduction is still allowed as long as the actual gift is made in the first 2 1/2 months of the subsequent year. The $20,000 deduction in Year One reduces taxable income to $180,000. The extra $8,000 can be forwarded for up to five years.

Front 11

For Year One, the Livingston Company had sales revenue of $700,000 and dividend revenue of $80,000 (from another domestic company in which it held a 25 percent interest). The company also had operating expenses of $600,000 and charitable contributions of $29,000. What is this company's taxable income?

Back 11

For Livingston, total revenue is $780,000 (sales of $700,000 and dividends of $80,000). Operating expenses are $600,000 which reduces the income to $180,000. Although the company made charitable contributions of $29,000, the maximum deduction in any one year is 10 percent of this income figure or $18,000. Because the company owned 20 percent or more of the other company, the dividend received deduction is 80 percent of $80,000 or $64,000. Taxable income is $98,000 ($180,000 less $18,000 and less $64,000).

Front 12

The Winstonli Company had sales revenues this year of $870,000 and operating expenses of $730,000. In addition, the company made charitable contributions of $19,000. How much of Charitable contr. can be deducted this year?

Back 12

This company had revenues of $870,000 and operating expenses of $730,000 for an income figure of $140,000. The maximum charitable contribution is 10 percent of that figure or $14,000. The remainder ($5,000) can be carried over for up to five years to reduce future taxable income.

Front 13

Hannah runs a small consulting firm. The firm's payroll per month is $2,000. Employees are paid once per month on the 15th of the month following the pay month. Hanna records payroll expense and a liability on December 31 of each year which is then paid in January of the following year. If Hannah is a cash basis taxpayer, what is her payroll expense for the year?

Back 13

Since Hannah operates as a cash basis taxpayer, she would deduct the amounts paid on the 15th day of each month which would be 12 cash payments of $2,000 or $24,000 in total. The accruals do not impact the amount to be recognized.

Front 14

Julia owns a small consulting firm. The company operates as a cash basis taxpayer. In January of the current year, the firm did work for a client and accepted a note for $40,000 plus interest at a 10 percent annual rate in lieu of immediate payment. After exactly six months, the client went bankrupt and the note was judged to be worthless. What is the amount of the bad debt expense deduction that this business is entitled to report?

Back 14

Because this business operates as a cash basis taxpayer, she has not included any revenue for tax purposes, either for the original work that was done or the interest on the note. A bad debt can only be deducted to the extent that it was included in income. Bad debt expense is actually the removal of a previously recognized income that was never received. No income was recognized here so no expense can be reported.

Front 15

Medford owns a small consulting firm. The company is incorporated and operates as an accrual basis taxpayer. In January of the current year, the firm did work for a client and accepted a note for $60,000 plus interest at a 10 percent annual rate in lieu of immediate payment. After exactly six months, the client went bankrupt and the note was judged to be worthless. That was the only account judged to be worthless during the year. At the end of the year, for financial reporting purposes, the company estimated its bad debt expenses as $69,000 which increased the allowance for doubtful accounts to a balance of $71,000. What is the amount of the bad debt expense deduction that this business is entitled to report for tax purposes?

Back 15

$60,000
For an accrual basis taxpayer, the amount of bad debt expense that is deductible is the amount actually written off. Anticipated or estimated amounts cannot be deducted.

Front 16

For tax purposes, depreciaiton is determined using the Modified Accelerated Cost Recovery System (MACRS). Which of the following statements is not true concerning MACRS?


A Equipment which put in a classificaiton having a life of ten years or less is depreciated using the double-declining balance method.
B All depreciable assets are automatically assumed to have a residual value equal to ten percent of cost.
C Residential rental property is depreciated over a life of 27 1/2 years.
D Used equipment follows the same rules as new equipment.

Back 16

The correct answer was B.

MACRS is based on a number of rigid rules so that all businesses follow the same method of depreciation. All depreciable assets are placed into one of eight classifications. Each classification has a specified life and a specified method of deprecaition. to avoid arguments with the taxpayers and to maximize the amount of the deduction (to encourage the growth of companies), residual values are ignored.

Front 17

Businesses have the ability to elect to take the cost of certain qualifying property as a Section 179 expense. Under this rule, the cost is expensed immediately rather than being capitalized. Which of the following statements is not true in connection with Section 179 acquisitions?


A The cost spent for off-the-shelf computer software qualifies as long as it has a useful life of more than one year.
B There is a maximum amount that can be taken as a Section 179 expense.
C If the company buys a large quantity of qualifying property, the immediate expense is reduced, eventually to zero.
D Buildings are qualifying property for Section 179 expense but land is not.

Back 17

The correct answer was D.

To encourage the growth of smaller companies, the tax laws provide for the immediate expensing of the cost of tangible personal property used in a business as well as off-the-shelf computer software (as long as it has a life of over one year). Real property (such as land and buildings) does not qualify. Because this deduction is for smaller companies, the amount of the expense is limited. That number has changed numerous times over the years. However, if the company buys a significant amount of such assets, the immediate expense deduction begins to be lost dollar for dollar after a limit is reached.

Front 18

A corporation has paid several amounts this year and is now trying to determine which costs can be deducted for income tax purposes. Which of the following is necessary for an expense to be deducible?


A The expense must be ordinary and necessary.
B The expense must be necessary and reasonable.
C The expense must be ordinary as well as reasonable in amount.
D The expense must be ordinary, necessary and reasonable in amount.

Back 18

The correct answer was D.

Business expenses must be ordinary and necessary to be deductible. In addition, the expense must be reasonable in amount.

Front 19

Which of the following statements is true with respect to organization costs incurred by a corporation?


A Organizational expenses can be immediately deducted up to $5,000.
B Organizational expenses are expensed when incurred like all other ordinary and necessary business expenses.
C Organizational expenses are not deductible to the corporation since their useful life is unknown.
D All organization costs must be amortized to expense over 180 months.

Back 19

The correct answer was A.

For tax purposes, organization costs of up to $5,000 can be expensed by a business immediately. All remaining organization costs are amortized to expense over 180 months.

Front 20

ABC Corporation incorporated on May 1 of Year One. They incurred $7,500 in organizational expenses. How much can be expensed in their first year of operations?

Back 20

Organizational costs of up to $5,000 can be expensed immediately. Then, the remaining organizational expenses are amortized over 180 months. The first $5,000 of the $7,500 is expensed in Year One. The remainder of these costs are $2,500, am amount which is amortized over the subsequent 180 months at the rate of $13.89 per month. For the 8 months of Year One, that is $111 (rounded). Thus, the total is $5,111.

Front 21

Debbie is the sole shareholder of Debbie's Dolls, Inc., a C corporation. The corporation pays Debbie $300,000 in salary and dividends totaling $100,000. What would be the tax impact (to Debbie) if the IRS decides that $50,000 of Debbie's salary is unreasonable compensation? Assume that Debbie is in the 35% marginal bracket and that the dividends are qualified dividends which are taxed at 15%.

Back 21

Debbie must recharacterize her salary as a dividend. The $50,000 will be taxed at the 15% bracket instead of the 35% marginal rate on the shareholder's personal return. The shareholder will benefit by $10,000. The 20% difference in the tax rates (35% less 15%) times the income that is recharacterized. However, the corporation's taxable income will increase by $50,000 because it will not be able to deduct the amount deemed to be dividend.

Front 22

The IRS has just informed T&E Corporation that the compensation paid to its sole shareholder for services rendered last year is unreasonable. What is the impact of this determination?

Back 22

The corporation may not deduct the amount deemed unreasonable. This change raises taxable income for the corporation and, therefore, its income tax expense.
When the IRS determines that there is unreasonable compensation, the amount deemed unreasonable is taxed as a dividend. For the owner receiving the payment, the tax rate is likely to be lower for qualified dividends than the marginal tax rate for ordinary income. Thus, the owner benefits from having compensation deemed unreasonable and pays less tax. In contrast, the corporation will have a corresponding increase in taxable net income because the dividend is not deductible whereas the compensation would have been. Thus, the company must pay additional taxes.

Front 23

Argonti Corporation paid its sole shareholder $400,000 in compensation for work performed during the current year. The IRS has now determined that $120,000 of this amount was unreasonable compensation. What is the impact of this decision on the shareholder?

Back 23

The shareholder must reclassify the amount deemed as unreasonable compensation to dividend income.
The amount of unreasonable compensation is reclassified as dividend income. Gross income is the same as before for the taxpayer. However, the two different types of income will likely be taxed at different rates. Because the payment was deemed a dividend, the corporation now has a lower amount of deductible expenses and a higher taxable income.

Front 24

Hamrick Corporation donated stock that it held in Rosco Corporation with a fair value of $18,000 which was acquired by Hamrick for $7,000 four years ago. Hamrick also donated some of its inventory which cost $2,000 and retails for $6,000. Both donations were made to a qualified charity. What would be Hamrick's charitable donations before applying any income limitations?

Back 24

Hamrick can deduct $20,000 for its charitable contributions. The fair value of the donated stock may be deducted since sale of this stock would have yielded a long-term capital gain. The inventory would create regular ordinary income if sold. The lower of cost or fair value is used for the inventory.

Front 25

The Andrews Company makes sales on credit of $400,000 in Year One and $500,000 in Year Two and recognizes those amounts for income tax purposes. The company believes that 2 percent of all credit sales will prove to be worthless. In Year One, $3,000 in accounts are judged to be completely worthless along with another $12,000 in Year Two. What is reported by the company as its bad debt expense for income tax purposes?

Back 25

For income tax purposes, bad debts cannot be anticipated. They can only be deducted when they prove to be worthless and only if they were recognized as income at the time of sale.

Front 26

The Weasley Company had sales in Year One of $500,000 plus dividend income from other domestic corporations of $100,000. The company had ordinary and necessary business expenses of $400,000. All dividends came from companies in which Weasley held 8 percent ownership. The company also made charitable contributions of $40,000 during the year. What is its taxable income?

Back 26

The company’s operating income is $200,000 ($500,000 plus $100,000 less $400,000). However, the company also gets a deduction for charitable contributions even though it is not an ordinary and necessary business expense. The amount of that deduction in any one year is limited to 10 percent of this operating income figure or $20,000 in this problem (10 percent of $200,000). In addition, because Weasley holds ownership of less than 20 percent of the domestic companies paying dividends, a 70 percent dividends received deduction can be taken or $70,000. Thus, taxable income is $500,000 plus $100,000 less $400,000 less $20,000 less $70,000 or $110,000.

Front 27

Andrew and Gandy both run businesses hauling furniture. The two companies work together to help each other fill orders and refer overflow work to each other. Andrew exchanged a large delivery truck with Gandy for a small truck and a medium size delivery truck. The fair value of the assets exchanged is equal: both sides are surrendering assets worth $37,000. Andrew’s basis in the large truck is $42,000 and Gandy’s basis in the small truck and medium truck are $8,000 and $24,000. What is the tax effect of this transactions?


A Andrew’s basis in the two new trucks is $32,000
B Gandy’s basis in the new large truck is $42,000
C Andrew records a loss of $10,000
D Andrew’s basis in the two trucks is $42,000

Back 27

The correct answer was D.

Trucks are being traded for a truck. This is a like-kind exchange. Because this is a like-kind exchange, each party to the exchange will retain the basis of the item(s) given up to be used as the basis for the item(s) received and no gain or loss will be recognized.

Front 28

AC Corporation exchanged like-kind equipment with DB Corporation. AC received equipment with a fair value of $55,000 and cash of $25,000 in exchange for equipment which cost $150,000 but now had a current tax basis of $75,000. What is the tax impact for AC Corporation of this exchange?


A AC Corporation reports a taxable gain of $25,000
B AC Corporation reports a taxable gain of $1,000
C AC Corporation carries over its own tax basis (less the cash received) but records no gain or loss
D AC Corporation reportss a gain of $5,000

Back 28

The correct answer was D.

AC received $80.000 (equipment with a fair value of $55,000 plus cash of $25,000) and gave up equipment with a tax basis of only $75,000. This results in a gain of $5,000. Since AC received the cash (not a like-kind property) as boot, the company must recognize the lesser of the gain ($5,000) or the boot received ($25,000). AC will report the $5,000 as a gain. When there is a like-kind exchange and boot (usually cash) is received, there is potentially a taxable gain. The amount taxed is the lesser of the boot received or the gain.

Front 29

Walker Ambrose owns three acres of land in Tennessee with a cost of $70,000 and a fair value of $110,000. The state of Tennessee condemns the land and takes ownership so that a road can be built through the property. The state pays Ambrose $114,000 for the land it took. Ambrose takes this money and buys similar land four miles away for $111,000. What is the tax effect of these events?

Back 29

Ambrose has a taxable gain of $3,000.

This is an involuntary conversion since the property was sold without the owner’s consent. More money was received then the tax basis of this property so there was a gain of $44,000 ($114,000 less $70,000). Part of the money was then used to buy similar replacement property. In an involuntary conversion, the taxable gain is the lower of the actual gain on the transaction ($44,000) or the money left over after the replacement ($3,000 or $114,000 less $111,000). Thus, if all of the money is used in buying a replacement, there is no taxable gain. Here, $3,000 was left and that was less than the $44,000 gain.

Front 30

AC Corporation exchanged like-kind equipment with DB Corporation. DB received equipment with a fair value of $80,000. In exchange, DB gave equipment with a fair value of $80,000 which originally cost $150,000 and had a current tax basis of $73,000. What is the tax impact for DB Corporation?

Back 30

This is a like-kind exchange. DB received equipment with fair value of $80,000 and gave up equipment with a basis of $73,000. This results in an unrealized taxable gain of $7,000. Since DB received no boot, none of the gain in taxable and DB will substitute the basis of the asset given up for the asset received. In like-kind exchanges, the taxable gain is the lesser of the boot received and the gain on the exchange. Here, there is a gain of $7,000 but no boot is received so no taxable gain is recognized.

Front 31

Which of the following would not be shown as an adjustment on a corporation's Schedule M-1?


A Life insurance proceeds on the death of a vice-president.
B Bond interest earned on State of Vermont bonds.
C Fines and penalties paid to the governemnt because of illegal acts.
D Interest paid by a corporation on its bonds that were issued at face value.

Back 31

Schedule M-1 is a schedule found on the corporate income tax return (form 1120) in which the tax return preparer is required to reconcile financial statement income (referred to as "book income") to the taxable income reported to the government. Life insurance proceeds, state and municipal bond interest, and penalties and fines are all reported for tax purposes but not for financail reporting. Thus, they should all appear on the Schedule M-1. Interest paid on bonds, though, shows up in the financial statements as well as the tax return so that there is no need for inclusion in this reconciliation.

Front 32

The ABC Corporation paid $39,000 this year for equipment. For tax purposes, how is this equipment classified?


A Capital asset.
B Ordinary income producing asset
C Section 1245 property
D Section 1250 property.

Back 32

The correct answer was C.

Section 1231 property refers to assets used in a trade or business. That classified is further refined. Section 1245 property is depreciable personal property used in a business. Equipment and machinery fall into this category. Section 1250 property includes business land and most real property that is subject to depreciation. This classification system makes it easier to report the property in designated ways for tax purposes.

Front 33

The Roberta Corporation reported net income on its financial statements for Year One of $670,000. That included $50,000 in interest earned on State of California bonds and $20,000 in interest earned on Acme Corporation bonds. It also included federal income tax expense of $150,000. In completing its Schedule M-1 reconciliation, what amount should Roberta report as its taxable income?

Back 33

The $50,000 in interest on the state bond interest is not taxable and should be removed. That causes taxable income to fall by $50,000. In addition, the $150,000 federal income tax expense is not deductible and should also be removed. As an expense, its removal causes income to go up by that amount. The net effect is an $100,000 increase in income ($50,000 removal of income netted against $150,000 removal of expense) so that taxable income should go from $670,000 to $770,000.

Front 34

The Applewhite Corporation reported net income on its financial statements for Year One of $450,000. That included a $30,000 loss on the sale of securities held for investment purposes. The company also recognized federal income tax expense of $100,000 and interest earned on State of Arizona bonds of $24,000. In addition, the company had a gain of $70,000 on the sale of its own treasury stock shares. In completing its Schedule M-1 reconciliation, what amount should Applewhite as its taxable income?

Back 34

Federal income taxes are an expense for financial reporting but cannot be deducted in arriving at taxable income. For a corporation, capital losses reduce reported net income of a corporation but cannot be deducted for tax purposes. Reducing these two negatives causes taxable income to go up by $130,000 ($100,000 federal taxes and $30,000 capital loss). In contrast, the state of Arizona bond interest is income for reporting purposes but is not taxable. Removing that amount causes the taxable income amount to be lower. Taxable income is the original $450,000 plus $130,000 less $24,000 or $556,000. Treasury stock gains and losses impact contributed capital but neither net income nor taxable income. It is not a reconciling item because it is neither total.

Front 35

The White Apple Corporation reported taxable income on its federal tax return for Year One of $540,000. That included a $40,000 loss on the sale of securities held for investment purposes. The company also recognized federal income tax expense of $150,000 this year and interest earned on State of Georgia bonds of $33,000. In addition, the company had a loss of $50,000 on the sale of its own treasury stock shares. Assuming no other differences exist, what amoutn will this company report as its net income for financial reporting purposes?

Back 35

In determining taxable income, the company would not have included the $150,000 income tax expense or the $40,000 loss on the securities (because capital losses cannot be deducted). In addition, the state bond interest would have been omitted because it is tax free. All three of those numbers would have been included to arrive at net income for financial reporting purposes. Taking the $540,000 income and subtracting $150,000 and $40,000 and then adding in the $33,000 in interest revenue leads to a net $157,000 reduction which brings the reported income down from $540,000 to $383,000. The loss on the treasury stock transaction does not impact net income or taxable income and, thus, does not impact this computation.

Front 36

The Bobcatt Corporation started the year with 100,000 shares of stock outstanding with an average issuance price of $16 per share although the par value was $10 per share. In January, 1,000 of these shares was reacquired for $20 per share. In August, 600 of these shares were resold to the public for $22 per share. Then, in December, the remaining 400 shares were resold to the public for $9 per share. What is the taxable gain or loss to be recognzied by this company?

Back 36

A company's transactions in its own stock (either buying or selling) is nontaxable and does not have an impact on taxable income.

Front 37

Bob Churchill owns 62 percent of Canterbury Corporation. Canterbury has a piece of equipment that it bought several years ago for $120,000 but currently has a tax basis of $37,000 and a fair value of $41,000. Churchill buys the equipment from the company for its fair value. What tax effect should Canterbury Corporation on this sale?

Back 37

Because Churchill owns over 50 percent of the stock of Canterbury, no deduction would have been allowed if the equipment had been sold for a loss. However, a $4,000 gain occurred ($41,000 minus $37,000) and that gain must be recognized unless the owner held 80 percent or more of the outstanding stock of Canterbury. Equipment is classifed as Section 1245 property for tax purposes and is not a capital asset.

Front 38

The Midlothian Corporation bought several assets this year: a building to serve as a warehouse for $500,000, an equipment to produce widgets for $110,000, and inventory for $80,000. What amount of capital assets has this company acquired?

Back 38

Zero
For a corporation, capital assets are normally limited to investments in stocks, bonds, and land (held in hopes of appreciation in value). Buildings, equipment, and inventory are bought to produce revenues and do not qualify as capital assets.

Front 39

Father Company owns 95 percent of Son Company and they file a consolidated return each year. In Year One, Father sold land with a tax basis of $325,000 to Son for its fair value of $400,000. In Year Four, Son sold the land to an outside party for its fair value of $420,000. Which of the following statements is true for the reporting on their consolidated return?

Back 39

A gain of $95,000 is recognized in Year Four.
When one company holds 80 percent or more of the stock of another company, gains on transfers are not reported for tax purposes until eventually realized by a sale to an outside party. Thus, the $75,000 gain is not taxable in Year One. However, in Year Four, when the land is sold to an unrelated outside party, the original $75,000 gain as well as the current $20,000 gain are both taxable.

Front 40

In Year One, the Grant Corporation had taxable income of $30,000. In Year Two, Grant had taxable income of $40,000. In Year Three, Grant had taxable income of $50,000. However, in Year Four, Grant had a net operating loss of $300,000. Grant needed cash and sought any available carryback refund immediately. How much of the net operating loss will Grant carry forward to Year Five?

Back 40

Net operating losses can be carried back for two years so that a refund of previous tax payments can be received. Any remaining portion of the net operating loss can then be carried forward for up to 20 years. Grant can carry the $300,000 loss back and wipe out the $40,000 taxable income for Year Two and the $50,000 taxable income for Year Three. That leaves $210,000 of the Year Four net operating loss to be carried forward to Year Five and beyond.

Front 41

A furniture store (The Granite Corporation) has been very profitable. The installment sales method is used solely for tax purposes in order to defer payment of income taxes until later periods. Company officials are now determining the alternative minimum tax for the present year. Which of the following statements is true about that computation?


A The benefit derived from using the installment sales method in connection with the sale of this inventory must be added to taxable income as an adjustment.
B The benefit derived from using the installment sales method in connection with the sale of this inventory must be eliminated as a preference item.
C The benefit derived from using the installment sales method in connection with the sale of this inventory must be added to taxable income as part of the adjusted current earnings (ACE) adjustment.
D The benefit derived from using the installment sales method in connection with the sale of inventory is assumed to be one of the components of the annual exemption amount in determining the alternative minimum tax.

Back 41

The correct answer was A.

In determining the alternative minimum taxable income, certain tax benefits and preferences are removed as adjustments, preference items, or part of the ACE adjustment. The benefit of the installment sales method (being able to defer income into future years) is removed by being added to taxable income as an adjustment.

Front 42

A United States corporation has already computed its taxable income for the current year. Officials are now determining whether an additional alternative minimum tax amount needs to be paid. During the year, the corporation received $22,000 in interest revenue from the ownership of City of Atlanta bonds. In computing the alternative minimum tax, which of the following statements is true?


A Municipal bond interest is not taken into consideration when turning a corporation’s taxable income into its alternative minimum taxable income.
B This municipal bond interest should be added to its taxable income as an adjustment.
C This municipal bond interest should be added to its taxable income as a preference item.
D A portion of this municipal bond interest should be added to taxable income as a component of the adjusted current earnings (ACE) adjustment.

Back 42

The correct answer was D.

To calculate the alternative minimum taxable income, certain tax benefits and preferences are removed as adjustments, preference items, or part of the ACE adjustment. Municipal bond interest is included as a component of the ACE adjustment which means that it is not moved into taxable income completely but only partially.

Front 43

If a corporation qualifies as a personal holding company, a personal holding company tax is assessed and must be paid along with the regular income tax. Which of the following statements is not true about personal holding companies and this tax?


A A company must omit the benefit of its charitable contributions in determining whether a tax is due.
B To qualify as a personal holding company, more than half of the value of the outstanding stock must be owned by five or fewer individuals at some point during the last half of the year.
C To qualify as a personal holding company, at least 60 percent of its ordinary income must be generated by dividends, interest, rents, royalties, and other passive income.
D This tax can be reduced or eliminated through the payment of dividends to the owners.

Back 43

The correct answer was A.

The personal holding company tax is designed to encourage adequate dividend payments to be made by companies, with only a few owners, that generate a significant amount of passive income (such as dividends and interest). The authoritative guidelines set the boundaries at five or fewer individuals owning 50 percent or more of the stock during the last half of the year and passive income (dividends, interest, and the like) making up at least 60 percent of total ordinary income. Without this tax, such companies would likely choose to hold onto their income and avoid double taxation by not paying dividends to the owners. Therefore, the tax can be avoided through the distribution of an adequate amount of dividends. The rules on charitable contributions are actually looser in computing the personal holding company tax rather than more restrictive.

Front 44

Andrew and Andy both run businesses hauling furniture. Andrew exchanged a large delivery truck with Andy for a small truck and medium size delivery truck. The fair market value of the assets exchanged is equal: $37,000. Andrew’s basis in the large truck is $42,000 and Andy’s basis in the small truck and medium truck are $8,000 and $24,000, respectively. What is the tax effect of this transactions?


A Andrew’s total basis in the two new trucks is $32,000.
B Andy’s basis in the new large truck is $42,000.
C Andrew records a loss of $10,000.
D Andrew’s total basis in the two trucks is $42,000.

Back 44

The correct answer was D.

Because this is a like-kind exchange, each party to the exchange will substitute the basis of the item(s) given up for the item(s) received. Since no boot was exchanged, both parties retain their tax basis and no income effect is recognized.

Front 45

Which of the following would not be an adjustment on Schedule M-1 of a corporation's federal income tax return?


A Life insurance proceeds
B Municipal bond interest income
C Fines and penalties
D Interest paid on corporate bonds issued at par.

Back 45

Schedule M-1 is used to reconcile book to tax differences on the federal income tax return. Interest paid on corporate bonds issued at par and is deductible for both book and tax purposes. Therefore, there is no adjustment to reconcile the books and the tax return. Life insurance proceeds and municipal bond interest income are not taxable and would be subtractions on Schedule M-1. Fines and penalties are both additions on Schedule M-1 because they are not deductible on the tax return.

Front 46

The Topeka Corporation reported taxable income of $2 million in Year One and $3 million in Year Two. The tax liability $700,000 (Year One) and $1,020,000 (Year Two). Retained earnings at the end of Year One was $80,000. In order for the company to escape the estimated tax underpayment penalty for Year Two, what is the total amount of estimated tax payments that must be made?

Back 46

Because the company made more than $1 million, the company cannot base its estimated tax payments on 100 percent of the prior year's tax liability. The estimated tax should be 100 percent of the current year's tax liability or $1,020,000.

Front 47

Which of the following costs should not be included in the cost of inventory under the uniform capitalization rules?


A Labeling
B Storage
C Handling
D Shipping to customers.

Back 47

All costs incurred in acquiring inventory for resale must be included in the cost of the inventory. The costs to purchase, label, handle, process, and store the inventory are all part of the costs to get the inventory ready to sell. Shipping to customers actually takes place after the sale has been made.

Front 48

The Hazelton Corporation reports $270,000 in its earnings and profits account prior to recording any dividend distributions. The company paid preferred and common dividends of $200,000 and $100,000. How are the shareholders to report their distributions?.


A The preferred shareholders have a dividend of $200,000 and the common shareholders have a dividend of $100,000.
B The preferred shareholders have a dividend of $200,000 and the common shareholders have a dividend of $70,000 as well as a nontaxable distribution of $30,000.
C The preferred shareholders have a dividend of $200,000 and the common shareholders have a dividend of $70,000 as well as a capital gain of $30,000.
D The preferred shareholders have a dividend of $180,000 and a nontaxable distribution of $20,000 and the common shareholders have a dividend of $90,000 and a nontaxable distribution of $10,000.

Back 48

The correct answer was B.

When corporate distributions exceed earnings and profits, the earnings and profits are first allocated to the distribution made to the preferred shareholders with any remainder to the common shareholders. In this case, the $200,000 distribution to the preferred shareholders leaves $70,000 of earnings and profits for the common shareholders. Preferred shareholder collect dividends of $200,000 and the common shareholders have a dividend of $70,000 along with a nontaxable return of basis of $30,000.

Front 49

The Woods Corporation sold depreciable property to a shareholder who owns 75% of the company for $33,000 in cash. This property had cost the company $100,000 several years ago but now had an adjusted tax basis of $45,000. What is the income tax effect to be reported by Woods?

Back 49

none
When one party owns over 50 percent of a corporation, they are viewed as related parties and losses on sales between them cannot be deducted until the property is eventually sold to an outside party. In contrast, gains continue to be taxable until the ownership level hits 80 percent.

Front 50

Crowell Company operates a manufacturing facility in Ireland through a wholly-owned subsidiary. Crowell earned $300,000 in taxable income and the subsidiary earned $80,000. Assuming that the tax rate in the US and Ireland are 35 percent and 30 percent respectively, what is Crowell's US tax liability assuming there are no book-tax differences?

Back 50

Crowell will be taxed in the US on the full $380,000 that it earned. This income will be taxed at the 35 percent US rate for a total of $133,000. Crowell will receive a tax credit equal to the amount paid to Ireland of $24,000 ($80,000 times 30 percent).

Front 51

The Walrus Corporation, a domestic corporation, had sales this year of $900,000 and operating expenses of $840,000. In addition, the company received dividends of $40,000 from another domestic corporation in which it held 22 percent of the outstanding stock. What taxable income should Walrus report for this year?

Back 51

The company's income is $100,000. That is sales revenues of $900,000 plus dividends of $40,000 less operating expenses of $840,000. Because dividends were collected by one domestic corporation from another, a dividends received deduction is allowed. For ownership of 20 percent or more up to 80 percent, this deduction is 80 percent (or $32,000 of the $40,000 dividend). This dividends received deduction reduces taxable income from $100,000 to $68,000. Under 20 percent ownership, the dividends received deduction is only 70 percent. For ownership of 80 percent or more, the dividends received deduction is 100 percent.

Front 52

The Albatross Corporation, a domestic corporation, had sales this year of $700,000 and operating expenses of $580,000. In addition, the company received dividends of $30,000 from Neck Corporation, another domestic corporation, in which it held 19 percent of the outstanding stock. What taxable income should Albatross report for this year?

Back 52

The company's income is $150,000. This amount is the sales revenues of $700,000 plus dividends of $30,000 less operating expenses of $580,000. Because dividends were collected by one domestic corporation from another, a dividends received deduction is allowed. For ownership of under 20 percent, this deduction is 70 percent (or $21,000 of the $30,000 dividend). This dividends received deduction reduces taxable income from $150,000 to $129,000. For ownership of 20 percent up to 80 percent ownership, the dividends received deduction is 80 percent. For ownership of 80 percent or more, the dividends received deduction is 100 percent.

Front 53

Massive Corporation, a domestic corporation, had sales this year of $800,000 and operating expenses of $815,000. In addition, the company received dividends of $100,000 from Sun Corporation, another domestic corporation, in which it held 17 percent of the outstanding stock. What taxable income should Massive report for this year?

Back 53

The company's income is $85,000. This amount is the sales revenues of $800,000 plus dividends of $100,000 less operating expenses of $815,000. Because dividends were collected by one domestic corporation from another, a dividends received deduction is allowed. For ownership of under 20 percent, this deduction is 70 percent. This percentage is taken on the lower of the dividend ($100,000) or the income ($85,000). Thus the dividends received deduction here is 70 percent of $85,000 or $59,500. This dividends received deduction reduces taxable income from $85,000 to $25,500. The dividends received deduction would have been based on the dividend if that deduction created a taxable loss or made a taxable loss larger. Because a deduction of $70,000 (70 percent of $100,000) does not turn the $85,000 into a loss, the dividends received deduction is based on the lower number.

Front 54

The Holstein Corporation made sales revenues in Year One of $870,000 and incurred operating expenses of $630,000. In addition, the company had a net short-term capital gain on the sale of some securities of $21,000 and a net long-term capital loss on the sale of other securities of $39,000. Taxable income is ______

Back 54

Corporations are not allowed any capital loss deduction. Thus, the net loss of $18,000 ($21,000 gain less $39,000 loss) can be carried back for up to three years and then forward for up to five years to reduce other capital gains. However, no reduction is allowed in taxable income. Only the $870,000 revenue and $630,000 in expenses are allowed for a net taxable income of $240,000.

Front 55

A corporation buys some investments in stocks and bonds in Year one and holds them in hopes of appreciation of value. In Year Four, the corporation sells all of these investments. It is the company’s only capital asset transaction for the current year. Which of the following statements is not true?


A There is no reduced tax rate to be used if the sales resulted in a net gain.
B There is no deduction in Year Four if the sales resulted in a net loss.
C If a net loss resulted, it can be carried back for three years and forward for up to five years to reduce other capital gains.
D If a net loss resulted, it can be carried back and then forward. Within the carry process, the loss is always viewed as long-term.

Back 55

The correct answer was D.

Corporations must net all short-term and long-term capital gains and losses. Any resulting capital gain is taxed but at the ordinary tax rate. There is no reduced rate as is applicable for individual taxpayers. Any net loss is not deductible. Instead, it can be carried back for three years to reduce or eliminate net capital gains. In addition, it can then be carried forward for up to five years. When a loss is carried back and forward in this manner, it is always handled as a short-term capital loss.

Front 56

The Boynton Corporation owns 33 percent of Company A and 17 percent of Company Z. This year, Boynton received a dividend of $60,000 from Company A and a dividend of $50,000 from Company Z. All of the companies are domestic corporations. What is the increase in the taxable income of Boynton as a result of this total of $110,000 in dividend revenue? Assume Boynton is otherwise a profitable company.

Back 56

When one domestic corporation receives a cash dividend from another, the dividend is included as revenue but a dividends received deduction is then allowed. The deduction is 70 percent if the company owned less than 20 percent of the other company. The deduction goes up to 80 percent if the company owned less than 80 percent of the other company but at least 20 percent. For Company A, 33 percent is owned so the dividends received deduction is $48,000 ($60,000 times 80 percent). For Company Z, only 17 percent is owned so the deduction is $35,000 ($50,000 times 70 percent). Dividend revenue is $110,000 while the dividends received deduction is $83,000 ($48,000 plus $35,000) leaving an increase in taxable income of $27,000.

Front 57

On July 1, Year One, the Rivera Company buys shares in two other publicly-traded companies. Each of these investments was made at a cost of $30,000. In addition, on the same day, the company repurchased some of its own outstanding shares for $40,000. The first investment was sold on April 1, Year Two for $23,000. The second investment was sold on October 1, Year Two for $35,000. The treasury stock was sold for $46,000 on November 1, Year Two. What is the impact of these transactions on the taxable income reported by Rivera for Year Two?

Back 57

There is no impact on taxable income.
There is no tax effect created by the purchase and sale of the treasury shares. In contrast, the sale of the first investment created a $7,000 short-term capital loss whereas the sale of the second investment lead to a $5,000 long-term capital gain. The company has a $2,000 net short-term capital loss. Corporations do not get any reduction in income from capital losses. However, this $2,000 can be carried back for up to three years and then forward for up to five years to reduce other capital gains that might result.

Front 58

Gonzales Corporation bought a piece of equipment for $50,000. After depreciation of $6,000 had been taken on this equipment, it had a tax basis of $44,000. In the current tax year, company officials decided to change the products that it was manufacturing and sold the equipment because it had become unnecessary in their plans. The equipment was rather unique and the company was able to negotiate a price of $51,000. What should the company report as ordinary income from the sale of this equipment?

Back 58

The depreciation expense taken on this equipment reduced the amount of ordinary income reported by the company. Therefore, any gain up to the amount of this depreciation is reported as ordinary income. The depreciation expense is being recaptured through the sale of the asset. Thus, the first $6,000 of the gain here is reported as ordinary income. The $1,000 gain in excess of the $6,000 is reported separately as a Section 1231 (based on the tax code that explains the law) gain. This Section 1231 gain may serve as a capital gain for the company depending on the impact of other income items listed in this category.