Chapter 02 Homework Answers

7/29/2019 Chapter 02 Homework Answers

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Chapter 02

Answer Section

TRUE/FALSE

1. ANS: FOlga must report the net profit of $95,000 on her Form 1040. A sole proprietorship is not a taxable entityseparate from the individual who owns the proprietorship. The owner of a proprietorship reports transactionsof the business on a Schedule C of his or her individual tax return. It does not matter how much of the profit iswithdrawn from the proprietorship.

PTS: 1 DIF: 1 REF: Example 1 OBJ: 1NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min

2. ANS: FThe partnership must file Form 1065, an information return on which the partnership net profit or loss isreported. Wrens net income of $100,000 is allocated to Rose according to her partnership interest and Rosereports the resulting $50,000 of income on her Federal income tax return, regardless of how much of theincome was withdrawn from the partnership.


3. ANS: TSimilar to partnerships, the net profit or loss of an S corporation flows through to the shareholders to bereported on their individual tax returns. Robins net income of $350,000 is allocated entirely to Rajib, as thesole shareholder, and Rajib reports the $350,000 of income on his Federal income tax return, regardless ofhow much of the income was withdrawn from the S corporation.

PTS: 1 DIF: 1 REF: p. 2-3 OBJ: 1NAT: AICPA FN-Reporting | AACSB Analytic MSC: 2 min

4. ANS: TOn his individual income tax return for the year, Donald must report his $138,000 ($230,000 60%) share ofthe partnership income plus the $50,000 of dividends he received from the C corporation, or $188,000 of totalincome. The partnership income is taxed to a partner in the year earned, and distributions do not affect apartners share of income. A C corporations income is taxed to a shareholder only when distributed asdividends and to the extent thereof.

PTS: 1 DIF: 1 REF: p. 2-3 | p. 2-4OBJ: 1 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 2 min

5. ANS: T

Quail Corporation must pay tax on the $300,000 of corporate net income. Dividends paid are not deductibleby the corporation. Shareholders must pay tax on the $50,000 of dividends received from the corporation.This is commonly referred to as double taxation.



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6. ANS: TCapital losses of a partnership pass through from the partnership to the partners and are reported on suchpartners tax returns.


7. ANS: FTo the extent a salary paid to a shareholder/employee is considered reasonable, the corporation is allowed asalary deduction, which reduces corporate taxable income. To the extent a salary payment is not consideredreasonable, the payment is treated as a dividend, which does not reduce corporate taxable income. Therefore,Purples taxable income increases by $150,000, the amount of the unreasonable compensation (constructivedividend) paid to Katherine.

PTS: 1 DIF: 1 REF: p. 2-4 OBJ: 1NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min

8. ANS: T PTS: 1 DIF: 1 REF: p. 2-4OBJ: 1 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 2 min

9. ANS: FJake must include in gross income both salary and dividends, but he would prefer dividend income due to thepreferential tax rate accorded such income.


10. ANS: TThe tax is equal to $26,150 [($50,000 15%) + ($25,000 25%) + ($25,000 34%) + ($10,000 39%)].

PTS: 1 DIF: 1 REF: Exhibit 2.1 OBJ: 1 | 4NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min

11. ANS: T PTS: 1 DIF: 1 REF: p. 2-5 | Exhibit 2.1OBJ: 1 | 4 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

12. ANS: FSome states assess corporate income or franchise taxes on entities formed as S corporations, partnerships,and/or LLCs. Since state income taxation of entities may vary from state to state, it must be considered in theselection of an entity form.


13. ANS: TSole proprietorship is the default classification for a single-member LLC that does not elect to be treated as a

corporation under the check-the-box Regulations.



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14. ANS: TSuch entities generally must use the calendar year as their reporting period, but several exceptions to this ruleapply (e.g., business purpose for fiscal year).


15. ANS: FAs a general rule, a C corporation must use the accrual method of accounting. However, a C corporation withaverage annual gross receipts of $5 million or less may use the cash method of accounting.


16. ANS: TBecause Barry is a related party (more than 50% shareholder), Lavenders deduction for the bonus occurs in2012, the year in which the $90,000 is included in Barrys gross income.


17. ANS: TWhile the maximum rate on long-term capital gains of individuals is limited to 15%, there is no maximumrate applicable to long-term capital gains of C corporations.


18. ANS: FA corporation cannot deduct a net capital loss in the year incurred; thus, Albatross has taxable income of$125,000. For corporations, a net capital loss must be carried back three years or forward five years and beoffset against capital gains in the carryback/forward years.


19. ANS: TUnder 291, Owl will have ordinary income equal to 20% of the excess of the amount of depreciationrecapture that would arise if the property was 1245 property over the amount of depreciation recapturecomputed under 1250 (without regard to 291). The remainder of Owls gain will be 1231 gain.


20. ANS: TThe passive loss rules apply to personal service corporations and to closely held C corporations. (Closely heldcorporations 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.



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21. ANS: FIf Peach is a closely held corporation, the passive loss is deductible to the extent of the corporations activeincome, or $210,000.


22. ANS: TIn order to be deductible in the year authorized by the board of directors, a charitable contribution must bepaid within 2 1/2 months of the end of the year of authorization (March 15, 2012, in this case) and mustinvolve an accrual basis corporation. Because payment was made on March 15, 2012, the contribution isdeductible in 2011.


23. ANS: FThe 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 $75,000.

PTS: 1 DIF: 1 REF: Example 19 OBJ: 2NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min

24. ANS: TThe scientific property is ordinary income property but it qualifies for the increased deduction amountavailable for certain corporate contributions of inventory. As such, the amount of the deduction is equal tothe lesser of (1) the sum of the inventorys basis plus 50% of the appreciation on the property [$220,000 =$140,000 + 50%($300,000 $140,000)] or (2) twice the basis [$280,000 = $140,000 2]. In this case, theceiling does not apply, and the deduction amount is $220,000.


25. ANS: TThe current (2011) contribution must be applied first against the taxable income limitation and the carryover(2010) used last.


26. ANS: FFor a corporation in 2011, the domestic production activities deduction is equal to 9% of the lowerof (1)qualified production activities income or (2) taxable income. The deduction cannot exceed 50% of the W-2wages related to qualified production activities income.

PTS: 1 DIF: 1 REF: Example 24 OBJ: 2

NAT: AICPA FN-Measurement | AACSB Analytic MSC: 2 min27. ANS: FA corporate net operating loss can be carried back 2 years and forward 20 years to offset taxable income forthose years. The 3 year carryback, 5 year carryforward rule applies to corporate capital losses.



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28. ANS: TThe deduction percentage for a less than 20% ownership is 70%. Thus, the dividends received deductionwould be $35,000 ($50,000 70%).


29. ANS: T PTS: 1 DIF: 1 REF: p. 2-18OBJ: 3 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min

30. ANS: TThe corporation must hold the stock for more than 45 days in order to qualify for the dividends receiveddeduction.


31. ANS: TExpenditures incurred in connection with issuing and selling shares of stock or other securities do not qualify

as organizational expenditures. Thus, Blacks organizational expenditures total $11,000 ($2,000incorporation fee + $9,000 accounting and legal fees).


32. ANS: FSimilar to organizational expenditures, the first $5,000 (subject to a phaseout) of startup expenditures isdeductible currently, and the balance is amortized over the 180-month period beginning with the month inwhich the corporation begins business. (For tax years beinning in 2010, the first year expense amount is$10,000.)


33. ANS: FA personal service corporation is subject to the 35% rate on all taxable income; thus, the tax liability is$35,000 ($100,000 35%).


34. ANS: FSince the corporations would be members of a controlled group, their taxable income would be combined inapplying the corporate income tax rates. The tax on $100,000 would be $22,250, or $11,125 tax for eachcorporation.

PTS: 1 DIF: 1 REF: p. 2-22 | p. 2-23OBJ: 5 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 2 min


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35. ANS: TA corporation is relieved of filing income tax returns only when it ceases to do business and retains no assets.


36. ANS: F

The due date for filing a Form 1120 is the fifteenth day of the third month following the end of thecorporations tax year. Thus, a 2010 Form 1120 for a calendar year C corporation would be due March 15,2011.


37. ANS: FA corporation is a large corporation if it had taxable income of $1 million or more in any of the threepreceding years.


38. ANS: FIncome that is included in net income per books but not included in taxable income is a subtraction item.



40. ANS: FThe bonus is entered as an addition item on Schedule M-1. Since Flamingo is accruing an expenditure withrespect 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 presidents gross income (2012). An item that is an expense in computingnet income per books but not deductible in computing taxable income is an addition item on Schedule M-1.


41. ANS: TThe loss is an expense for book purposes but not deductible for tax purposes. Therefore, the $5,000 net capitalloss must be added in reconciling from book income to taxable income.


42. ANS: T PTS: 1 DIF: 1 REF: p. 2-25

OBJ: 6 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 2 min



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MULTIPLE CHOICE

1. ANS: CCarlos must report his share of the partnership income without regard to distributions, or $54,000 ($120,000 45% partnership interest).

PTS: 1 DIF: 1 REF: Example 2 | Example 3OBJ: 1 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 5 min

2. ANS: BBjorn must report his $90,000 share ($150,000 60%) of the S corporations income on his individual taxreturn. He will report $30,000 of dividend income from the C corporation.


3. ANS: CA C corporation is a separate tax paying entity and income of a C corporation is not taxed to shareholdersuntil distributed as dividends. A C corporation does not receive preferential tax rate treatment on LTCG(option b.). Income of a sole proprietorship is taxed currently on the tax return of the proprietor, and theLTCG of the entity is reported as such by the proprietor (option a.), with the preferential tax rate applicable(option d.).

PTS: 1 DIF: 1 REF: p. 2-2 | p. 2-3 | p. 2-12OBJ: 1 | 2 NAT: AICPA FN-Reporting | AACSB Analytic

MSC: 5 min4. ANS: D

A proprietorship is not a separate taxable entity. As a proprietor, Norma reports profit or loss from Hyacinthon her individual return. Normas taxable income for 2011 will be increased by $157,000 ($400,000 $240,000 = $160,000 net ordinary business income $3,000 capital loss deduction). The $75,000 shewithdrew from Hyacinth has no effect on her taxable income.

PTS: 1 DIF: 2 REF: p. 2-2 | p. 2-3 | p. 2-12OBJ: 1 | 2 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 5 min


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5. ANS: ESole proprietorships and S corporations are not separate tax paying entities. Instead, the income of suchentities passes through to the owners and is reported on their returns. Thus, if Rose Company is a soleproprietorship or S corporation, Francisco must report the $25,000 long-term capital gain on his personalincome tax return (option a.), and the preferential tax rate for such income is applicable (option c.). Ccorporations are separate tax paying entities. Thus, if Rose Company is a C corporation, Francisco will report

none of the $25,000 long-term capital gain on his personal income tax return (option b.). C corporations donot receive preferential tax rate treatment on LTCG (option d.).

PTS: 1 DIF: 1 REF: p. 2-2 | p. 2-3 | p. 2-12OBJ: 1 | 2 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min

6. ANS: DTrout, a partnership, is not a taxpaying entity. Its profit (loss) and separate items flow through to the partners.The partnerships Form 1065 reports ordinary business income of $180,000 ($400,000 income $220,000expenses). The partnership also reports the $100,000 long-term capital gain as a separately stated item onForm 1065. Glen and Michael both receive a Schedule K-1 reporting ordinary business income of $90,000and separately stated long-term capital gain of $50,000. Each partner reports ordinary business income of

$90,000 and long-term capital gain of $50,000 on his own return. The withdrawals do not affect taxableincome for the partners but decrease their basis in the partnership.


7. ANS: B$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 capitalloss ($7,000) can be carried back three years and offset against capital gain in the carryback years. If thecapital loss is not used in the carryback, it can be carried forward five years. Capital gains of corporations areincluded in taxable income and are not subject to the favorable rates applicable to individuals.

PTS: 1 DIF: 1 REF: p. 2-12 OBJ: 2NAT: AICPA FN-Measurement | AICPA-FN-Reporting | AACSB AnalyticMSC: 5 min

8. ANS: ADividend distributions are not deductible by a corporation; thus, Flycatcher still incurs corporate tax on$200,000 even if all profits were distributed to shareholders. A preferential tax rate of 15% applies to thedividends for both shareholders, resulting in additional tax of $6,000 ($40,000 15%) for each.


9. ANS: EIf a limited liability company with more than one owner does not make an election, the entity is taxed as apartnership. The other statements are correct.



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10. ANS: BThe salary for the deferral period (October 1 through December 31) must be at least proportionate to theemployees salary received for the fiscal year. The amount that Gander Corporation must pay Patrick duringthe period October 1 through December 31, 2011, to permit the continued use of its fiscal year withoutnegative tax effects, is $73,500 ($294,000 3/12).


11. ANS: BThe salary for the deferral period (November 1 through December 31) must be at least proportionate to theemployees salary received for the fiscal year. The amount that Purple Corporation must pay Jason during theperiod November 1 through December 31, 2011, to permit the continued use of its fiscal year withoutnegative tax effects, is $37,500 ($225,000 2/12).


12. ANS: DFalcon Corporation cannot use the cash receipts method because it had average annual gross receipts of morethan $5 million ($16 million 3 = $5.33 million) during the three preceding years. Hawk Corporation, a PSC,may use the cash method without regard to its gross receipts.


13. ANS: DA corporation that uses the accrual method cannot claim a deduction for an accrual with respect to a relatedparty until the recipient reports that amount as income. Thus, Ivory cannot deduct the $50,000 bonusattributable to Craig, a related party (i.e., more than 50% shareholder), until 2012. Ivory can deduct in 2011the salary payments made to each shareholder plus the accrued bonus to Oscar, or $450,000 ($200,000 salary+ $200,000 salary + $50,000 bonus).


14. ANS: BBecause Charles is a related party (i.e., more than 50% shareholder). Peregrines deduction for the bonus mustwait until Charles includes the bonus in gross income. Charles, who is a cash basis, calendar year taxpayerwill include the payment in gross income in the year he receives it from Peregrine. Therefore, if Peregrinepays Charles the bonus anytime in 2012, the corporation can deduct the bonus in 2012.



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15. ANS: BNet short-term capital gain for 2011 $ 35,000Net long-term capital loss for 2011 (200,000)Net capital loss ($165,000)

The net capital loss of $165,000 is not deductible on the 2011 return, but must be carried back to the three

preceding years, applying it to 2008, 2009, and 2010, in that order. The net capital loss is carried back orforward as short-term capital loss.

2011 net capital loss ($165,000)

Offset against2008 (net long-term capital gain) $ 20,0002009 (net short-term capital gain) 55,0002010 (net long-term capital gain) 30,000Total carrybacks $105,000

Bears capital loss carryover is $60,000 ($165,000 $105,000), which may be carried over to 2012, 2013

2014, 2015, and 2016, in that order.


16. ANS: DThe capital loss will offset the $10,000 capital gain. The remaining $20,000 capital loss can be carried backto the three preceding years to reduce any capital gains in those years. Any remaining loss not offset againstcapital gains in the three preceding tax years can be carried forward for five years to offset capital gains inthose years. The long-term capital loss will be treated as short-term capital loss when carried back orforward.


NAT: AICPA FN-Reporting | AACSB Analytic MSC: 5 min17. ANS: C

$100,000 operating income $40,000 operating expenses + $2,000 LTCG $2,000 STCL = $60,000 taxableincome. The net capital loss of $8,000 ($2,000 LTCG $10,000 STCL = $8,000 net capital loss) cannot bededucted in the year incurred, but can be carried back three years and forward five years.



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18. ANS: DFirst, determine the recognized gain:

Sales price $600,000Less adjusted basis:

Cost of property $500,000

Less cost recovery (104,701) (395,299)Recognized gain $204,701

Second, determine the 1245 recapture potential. This is the lesser of $204,701 (recognizedgain) or $104,701 (cost recovery claimed).

Third, determine the normal 1250 recapture amount:

Cost recovery taken $104,701Less straight-line cost recovery (104,701) 1250 ordinary income $ 0

Fourth, because the taxpayer is a corporation, determine the additional 291 amount:

1245 recapture potential $104,701Less 1250 recapture amount (0)

Excess 1245 recapture potential $104,701

Apply 291 percentage 20%

Additional ordinary income under 291 $ 20,940

Beige Corporations recognized gain of $204,701 is accounted for as follows:

Ordinary income under 1250 $ 0

Ordinary income under 291 20,940 1231 gain 183,761Total recognized gain $204,701

PTS: 1 DIF: 3 REF: Example 15 OBJ: 2NAT: AICPA FN-Measurement | AICPA-FN-Reporting | AACSB AnalyticMSC: 10 min

19. ANS: APersonal service corporations cannot offset passive losses against either active or portfolio income.


20. ANS: DA personal service corporation may not offset passive loss against active income or portfolio income. Thus,Azuls taxable income is $340,000 ($300,000 + $40,000).



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21. ANS: CAs a closely held corporation, Sage may offset $90,000 of the $110,000 passive loss against the $90,000 ofactive income, but may not offset the remaining $20,000 against portfolio income.


22. ANS: BA closely held corporation that is not a PSC can deduct passive losses against active income but not portfolioincome. Thus, Violets taxable income is $70,000 [$90,000 (active income) + $70,000 (portfolio income) $90,000 (passive loss limited to active income)].


23. ANS: BSince Grocer Services is a corporation and the inventory exception is met, one-half of the appreciation on thefood may be claimed, or $2,250 [50% of ($8,000 $3,500)]. Therefore, $5,750 ($3,500 basis + $2,250appreciation) is allowed as a deduction. Because the Acme stock was not held more than 12 months, it isordinary income property, and the deduction is limited to basis ($4,000). The deduction for the delivery van,which is nota capital asset, is limited to the lesserof adjusted basis ($7,500) or fair market value ($7,100).Thus, $5,750 + $4,000 + $7,100 = $16,850.

PTS: 1 DIF: 3 REF: p. 2-15 | p. 2-16 | Example 21OBJ: 2 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 10 min

24. ANS: CThe contribution of computers qualifies for the increased contribution amount available with respect to certaininventory. The contribution amount is equal to the lesser of (1) the sum of the propertys basis plus 50% ofthe appreciation on the property [$85,000 = $50,000 basis + .5($120,000 fair market value $50,000 basis)]or (2) twice the propertys basis ($100,000 = 2 $50,000 basis). Thus, Plums deduction for the charitablecontribution of the inventory is $85,000.


25. ANS: CIncome from operations $135,000Dividends received 9,000Subtotal $144,000Less: Expenses from operations 99,000Limitation base for contributions $ 45,000Allowable contribution percentage 10%Charitable contribution allowed $ 4,500

The charitable contribution deduction is based on taxable income determined without regard to the charitablecontribution deduction, any net operating loss carryback or capital loss carryback, dividends receiveddeduction, and domestic production activities deduction.



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26. ANS: BHippos tentative domestic production activities deduction for 2011 is 9% of the lesser of:

taxable income (before DPAD) $800,000

qualified production activities income $950,000

Although the tentative deduction is $72,000 ($800,000 9%), the wage limitation applies ($130,000 50% =$65,000). Therefore, Hippos domestic production activities deduction is $65,000.


27. ANS: AAn 80% dividends received deduction is allowed (choice c.) and results in an NOL of $19,000 [$200,000(operating income) + $30,000 (dividends) $225,000 (operating deductions) $24,000 (DRD of $30,000 80%)] (choice b.). Generally an NOL is carried back 2 years and forward 20 years, but a corporation canelect to forgo the carryback period and just carry the NOL forward (choice d.).

PTS: 1 DIF: 2 REF: p. 2-17 | Example 25OBJ: 2 | 3 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min

28. ANS: EAll of the statements are correct with respect to a corporate NOL.

PTS: 1 DIF: 2 REF: p. 2-17 | Example 40OBJ: 2 | 7 NAT: AICPA FN-Reporting | AACSB Reflective ThinkingMSC: 5 min

29. ANS: CReds dividends received deduction is 70% of the dividend received ($28,000 $40,000). The 70% dividends

received deduction applies if ownership is less than 20%.



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30. ANS: DThe dividends received deduction depends upon the percentage of ownership by the corporate shareholder.Because Eagle Corporation owns 25% of Hawk Corporation, Eagle would qualify for a 80% deduction,calculated as shown below.

1. Multiply the dividends received by the deduction percentage ($130,000 80% = $104,000).

2. Multiply the taxable income before the dividends received deduction by the deductionpercentage ($100,000 80% = $80,000).

3. Limit the deduction to the lesser of step 1 or step 2, unless subtracting the amount derived instep 1 ($104,000) from taxable income before the dividends received deduction ($100,000)generates an NOL ($100,000 $104,000 = $4,000 NOL). If so, use the amount derived in step1 ($104,000). In this case, the NOL exception to the taxable income limitation applies, and thededuction equals $104,000.


31. ANS: CThe dividends received deduction depends upon the percentage of ownership by the corporate shareholder. IfCopper Corporation owns 65% of Bronze Corporation, Copper would qualify for a 80% deduction, or$120,000 in this case.


32. ANS: BThe dividends received deduction depends upon the percentage of ownership by the corporate shareholder. IfOrange Corporation owns 15% of White Corporation, Orange would qualify for an 70% deduction, or$42,000 in this case.


33. ANS: AA corporation must hold stock for more than 45 days in order to qualify for a deduction with respect todividends on such stock. All of the other statements are correct.

PTS: 1 DIF: 2 REF: p. 2-18 to 2-20 | Footnote 19OBJ: 3 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min


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34. ANS: CQualifying organizational expenditures include these items:

Expenses of temporary directors and of organizational meetings $ 9,000Fee paid to the state of incorporation 1,000Accounting services incident to organization 2,500

Legal services for drafting the corporate charter and bylaws 3,500Total $16,000

Emerald Corporations deduction under 248 for 2011 is determined as follows:

Immediate expensing $5,000Amortization [($16,000 $5,000) 180] 6 (months in tax year) = 367Total $5,367


35. ANS: BSparrows taxable income is $195,000 [$510,000 operating income $370,000 operating expenses + $55,000net capital gain ($80,000 long-term capital gain $25,000 short-term capital loss)]. Corporate income tax ontaxable income of $195,000 is $59,300:

Tax on $100,000 = $22,250Tax on $95,000 39% = 37,050Total tax liability $59,300

Corporations do not receive a preferential tax rate on long-term capital gains.

PTS: 1 DIF: 2 REF: p. 2-12 | Example 30 | Exhibit 2.1OBJ: 2 | 4 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min

36. ANS: BSince Black Corporation is a personal service corporation, a 35% flat tax rate applies to its taxable income of$30,000 [$420,000 (gross receipts) $190,000 (salary expense) $200,000 (other operating expenses)]; thus,corporate income tax is $10,500. Blacks after-tax income distributed to George therefore equals $19,500($30,000 $10,500). George incurs income tax of $66,500 ($190,000 35%) on the salary income and$2,925 ($19,500 15%) on the dividend income, for a total tax of $69,425. Thus, the total combined incometax is $79,925 ($10,500 tax to Black Corporation + $69,425 tax to George).

PTS: 1 DIF: 3 REF: p. 2-22 | Example 8OBJ: 1 | 4 NAT: AICPA FN-Measurement | AACSB Analytic

MSC: 10 min37. ANS: DThe marginal tax rate brackets for corporations are not adjusted for inflation.

PTS: 1 DIF: 1 REF: Exhibit 2.1 | p. 2-22 | p. 2-23OBJ: 1 | 4 | 6 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 5 min


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38. ANS: AA corporation is relieved from filing a tax return only when it ceases to do business and retains no assets(option b.). Corporations are subject to the alternative minimum tax (option c.). In general, the requiredannual payment for corporate estimated taxes is 100% of the corporations final tax for the current year(option d.).

PTS: 1 DIF: 1 REF: p. 2-22 to 2-24OBJ: 4 | 6 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 5 min

39. ANS: CPayment Amount

April 15, 2011 $ 110,500*June 15, 2011 399,500**September 15, 2011 255,000December 15, 2011 255,000

Total $1,020,000

*Based on preceding years tax, for first installment only: [$1.3 million taxable income

34% (see Exhibit2.1)] = $442,000 4 = $110,500.

**Based on current years tax, for remaining installments: [$3 million taxable income 34% (see Exhibit2.1)] = $1,020,000 4 = $255,000. Second installment must include shortfall from first installment:[$255,000 + ($255,000 $110,500)] = $399,500.


40. ANS: AThe other items are subtractions on Schedule M-1.


41. ANS: AThe life insurance proceeds would be included in book income but not in taxable income. Therefore, asubtraction is required to reconcile book income to taxable income. The other items are additions onSchedule M-1.



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PROBLEM

1. ANS:a. Revenues, expenses, gains, and losses of a proprietorship flow through to the proprietor.

Consequently, Lucinda reports the $110,000 operating profit and $30,000 long-term capitalgain on her individual return. The preferential tax rate on LTCG applies with respect to the

$30,000 gain.

b. A single-member LLC is taxed as a proprietorship. Consequently, Lucinda reports the$110,000 operating profit and $30,000 long-term capital gain on her individual return. Thepreferential tax rate on LTCG applies with respect to the $30,000 gain.

c. Revenues, expenses, gains, and losses of an S corporation flow through to the shareholders.Separately stated items (e.g., capital gains and losses), retain their character at theshareholder level. Consequently, Lucinda reports the $110,000 operating profit and $30,000long-term capital gain on her individual return. The preferential tax rate on LTCG applieswith respect to the $30,000 gain.

d. Shareholders of a regular (C) corporation report income from the corporation to the extent ofdividends received. Therefore, Lucinda does not report any of Waterthrushs operating profitor capital gain on her individual return. [Waterthrush Company would report taxable incomeof $140,000 ($110,000 operating profit + $30,000 long-term capital gain) on its corporatereturn (Form 1120). C corporations do not receive preferential tax rate treatment withrespect to LTCGs.]

PTS: 1 DIF: 2 REF: p. 2-2 to 2-4 | p. 2-12OBJ: 1 | 2 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 10 min

2. ANS:a. Janets tax on $250,000 at 35% $87,500

b. Janets tax on $150,000 at 35% $52,500Beiges tax on $100,000 at corporate rates 22,250Total tax $74,750

c. Beiges tax on $100,000 at corporate rates $22,250Janets tax on $77,750 dividend distributed at 15% 11,663Janets tax on $150,000 salary at 35% 52,500Total tax $86,413

d. Janets tax on $250,000 at 35% $87,500

PTS: 1 DIF: 3 REF: p. 2-2 to 2-5 OBJ: 1 | 4NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min


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3. ANS:a. If Shrike Company is a C corporation, the $220,000 is taxable at the corporate level, resulting

in corporate tax of $69,050. The after-tax dividend distribution of $150,950 ($220,000 $69,050) to Carlos will result in tax of $22,642.50 ($150,950 15%). Total taxes amount to$91,692.5 ($69,050 + $22,642.50).

b. If Shrike Company is a proprietorship, there is no entity level Federal income tax. Instead, theincome of the proprietorship is reported on Carloss personal tax return, resulting in tax of$77,000 ($220,000 35%). Carloss withdrawal of the after-tax income has no income taxconsequences.

PTS: 1 DIF: 2 REF: p. 2-2 to 2-5 | Example 5 | Example 6OBJ: 1 | 4 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 10 min

4. ANS:Under 267(a)(2), an accrual method taxpayer must defer a deduction for an expenditure attributable to acash method related party until such time the related party reports the amount as income. For purposes of thislimitation, a more-than-50% shareholder of the corporation is a related party.

a. Since Leticia, a cash method related party, does not include the bonus in her incomeuntil its receipt in 2012, Canarys deduction for the bonus occurs in 2012. The fact thatthe payment to Leticia occurs prior to the filing date for Canarys 2011 tax return is ofno consequence.

b. Again, Leticia is a cash method related party who does not include the bonus in herincome until its receipt in 2012; thus, Canarys deduction for the bonus is deferred until2012.

c. Since Leticia is not a related party for purposes of the 267(a)(2) limitation, Canarydeducts the bonus, under the accrual method, in 2011.



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5. ANS:a. Net short-term capital gain $ 40,000

Net long-term capital loss (180,000)Net capital loss ($140,000)

The net capital loss of $140,000 is not deductible in 2011 but must be carried back to

the three preceding years, applying it to 2008, 2009, and 2010, in that order. Such netcapital loss is carried back or forward as a short-term capital loss.

b. 2011 net capital loss ($140,000)

Offset against2008 net long-term capital gains $35,0002009 net short-term capital gains 15,0002010 net long-term capital gains 40,000

Total carrybacks $90,000

c. $50,000 ($140,000 $90,000) STCL carryover to 2012, 2013, 2014, 2015, and 2016, in

that order.

d. Ellen would net these transactions with all other capital transactions for 2011. Assumingthese were her only capital transactions in 2011, she would offset $40,000 of capitallosses against the capital gains and deduct an additional $3,000 in capital losses on herreturn. The remaining $137,000 ($180,000 $40,000 $3,000) would be carriedforward indefinitely as a LTCL.

PTS: 1 DIF: 2 REF: p. 2-12 | Example 13 | Example 14OBJ: 2 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 10 min

6. ANS:a. The salary for the deferral period (November 1 through December 31) must be at least

proportionate to the employees salary received for the fiscal year. The amount that ShawCorporation must pay Shaw during the period November 1 through December 31, 2011,to permit the continued use of its fiscal year without negative tax effects, is $42,500($255,000 2/12).

b. As a PSC is subject to a tax rate of 35%, Shaws tax is $33,250 ($95,000 35%). Toillustrate the negative tax impact of classification as a PSC, compare this amount to the$20,550 that a regular (non-PSC) corporation would pay.

PTS: 1 DIF: 2 REF: p. 2-22 | Example 11

OBJ: 2 | 4 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min


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7. ANS:a. Lavenders total amount of charitable contributions is $375,000 [$90,000 (inventory) +

$65,000 (stock) + $220,000 (land)], computed as follows:

Inventory: this qualifies for the enhanced contribution amount available with respect tocertain inventory, since it consists of tangible research property contributed to a

qualified educational organization that uses the property for research training. Thecontribution amount is equal to the lesser of (1) the sum of the propertys basis plus 50%of the appreciation on the property [$90,000 = $70,000 basis + 50%($110,000 fairmarket value $70,000 basis)] or (2) twice the propertys basis ($140,000 = 2 $70,000basis). Thus, the amount of the contribution is $90,000.

Stock: this is capital gain property, since a sale of the stock would result in long-termcapital gain for Lavender. Thus, the amount of the contribution is the stocks fairmarket value, or $65,000.

Land: this is capital gain property, since a sale of the land would result in a long-termcapital gain for Lavender. Thus, the amount of the contribution is the lands fair market

value, or $220,000.

b. Lavenders current year charitable deduction is limited to $250,000 [10% $2.5 million(taxable income before charitable deduction)], and the excess charitable contribution of$125,000 ($375,000 $250,000) is carried forward to the five succeeding tax years.


8. ANS:In general, charitable contributions are deductible in the year made. However, in the case of an accrualmethod corporation, a deduction can be claimed in the current year for a charitable contribution made in thesubsequent year if (1) the contribution is approved by the board of directors of the corporation in the currentyear, and (2) the contribution is made on or before the fifteenth day of the third month of the subsequent year.

a. The requirements for an accrual of the charitable deduction are satisfied; thus, the$50,000 contribution is deductible by Gull in 2011, subject to the taxable incomelimitation. For 2011, the taxable income limitation for charitable deductions is $42,000(10% $420,000). The excess contribution amount of $8,000 carries forward to 2012(five-year carryover limit).

b. The requirements for an accrual of the charitable deduction are not satisfied; thus, the$50,000 contribution is deductible by Gull in 2012 (the year the contribution is made),subject to the taxable income limitation. For 2012, the taxable income limitation forcharitable deductions is $37,000 (10% $370,000). The excess contribution amount of$13,000 carries forward to 2013 (five-year carryover limit).

PTS: 1 DIF: 2 REF: Example 17 | Example 22OBJ: 2 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 10 min


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9. ANS:Quartz has an NOL, computed as shown below:

Gross income:From operations $450,000Dividends 100,000 $550,000

Less:Expenses from operations $500,000Dividends received deduction ($100,000 70%) 70,000 (570,000)

Net operating loss ($ 20,000)

The dividends received deduction is not limited to the taxable income limitation because it creates a netoperating loss.

PTS: 1 DIF: 2 REF: Example 25 | Example 26OBJ: 2 | 3 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min

10. ANS:a. The key to this question is the relationship between the dividends received deduction and the

NOL deduction. The dividends received deduction is limited to a percentage of taxableincome of the corporation (unless taking the full dividends received deduction would causeor increase an NOL). In this case, the dividends received deduction is limited to 70% oftaxable income.


Less: Expenses from operations (285,000)Taxable income before the dividends received deduction $ 90,000Dividends received deduction (70% $90,000) (63,000)

Taxable income $ 27,000

The dividends received deduction is limited to 70% of taxable income because taking 70% of$115,000 ($80,500) would not create an NOL.

b. If Coyote Corporation owns 25% of Roadrunner Corporations stock, the percentage forcalculating the dividends received deduction is 80%. Under these circumstances, taking thefull dividends received deduction would create an NOL.


Less: Expenses from operations (285,000)Taxable income before the dividends received deduction $ 90,000Dividends received deduction (80% $115,000) (92,000)Net operating loss ($ 2,000)

PTS: 1 DIF: 2 REF: Example 25 | Example 26OBJ: 2 | 3 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 10 min


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11. ANS:a. Warbler has qualifying organizational expenditures of $39,000 [$25,000 (expenses of

temporary directors and organizational meetings) + $2,000 (incorporation fee) + $12,000(accounting fees)]. Expenses related to the printing or selling of stock or other securities donot qualify as organizational expenditures. Warblers 2011 deduction for the organizationalexpenditures is $6,889 {$5,000 + [($39,000 $5,000)/180 10 months]}.

b. Warbler now has qualifying organizational expenditures of $54,000 [$39,000 (as computed ina., above) + $15,000 (legal fees)]. Warblers 2011 deduction for the organizationalexpenditures is $3,944 {$1,000 + [($54,000 $1,000)/180 10 months]}. The $5,000immediate expensing amount is reduced to the extent qualifying organizational expendituresexceed $50,000; thus, only $1,000 of the expenditures are immediately deductible, and theremainder of the expenditures are amortized over 180 months.

PTS: 1 DIF: 2 REF: p. 2-20 | p. 2-21 | Example 28OBJ: 3 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 10 min

12. ANS:Violet Corporation:

Tax on $22,000 15% $3,300

Indigo Corporation:Tax on $90,000

$50,000 $ 7,500

$25,000 25% 6,250

$15,000 5,100Total tax $18,850

Orange Corporation:

Tax on $220,000$100,000 $22,250$120,000 39% 46,800Total tax $69,050

Blue Corporation:Tax on $5,100,000

$335,000 $ 113,900$4,765,000 34% 1,620,100Total tax $1,734,000

Green Corporation:

Tax on $19,800,000 35% $6,930,000

PTS: 1 DIF: 2 REF: Example 29 | Example 30 | Exhibit 2.1OBJ: 4 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 10 min


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13. ANS:A corporation that had taxable income of $1 million or more in any of the three preceding years is a largecorporation for purposes of utilizing the prior years tax exception for estimated tax payments. As such,Almond Corporation can use the prior years tax exception for computing its first 2011 estimated tax paymentonly, and any shortfall as a result of such use must be paid with the second installment.

Payment AmountApril 15, 2011 $ 67,150*June 15, 2011 187,850**September 15, 2011 127,500December 15, 2011 127,500

Total $510,000

*Based on preceding years tax, for first installment only: [$790,000 taxable income 34% (see Exhibit 2.1)]= $268,600 4 = $67,150.

**Based on current years tax, for remaining installments: [$1.5 million taxable income 34% (see Exhibit2.1)] = $510,000 4 = $127,500. Second installment must include shortfall from first installment: [$127,500+ ($127,500 $67,150)] = $187,850.


14. ANS:Net income per books is reconciled to taxable income as follows:

Net income per books (after tax) $257,950Plus: Items that decreased net income per books but did not affect

taxable income+ Federal income tax liability 41,750

+ Excess of capital losses over capital gains 6,000+ Interest paid on loan incurred to purchase tax-exempt bonds 1,500+ Premiums paid on policy on life of president of the corporation 7,800

Subtotal $315,000Minus: Items that increased net income per books but did not

affect taxable income Interest income from tax-exempt bonds (15,000) Life insurance proceeds received as a result of the death of

the corporate president (150,000)Taxable income $150,000


NAT: AICPA FN-Measurement | AACSB Analytic MSC: 10 min


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ESSAY

1. ANS:The correct answers are shaded.

Tax Questions

Column A

Partnership

Column B

S Corporation

Column C

C Corporation

Who pays tax on the entitysincome?

PartnersPartnership

ShareholdersS corporation

ShareholdersC Corporation

Are operating losses passed throughto owners?

YesNo

YesNo

YesNo

Are capital gains (losses) reportedon owners tax returns as such?

YesNo

YesNo

YesNo

Are distributions of profits taxable

to owners?

Yes

No

Yes

No

Yes

No

Nontax Factors Partnership S Corporation C Corporation

Is the liability of owners limited? YesNo

YesNo

YesNo

Is there free transferability ofownership interests?

YesNo

YesNo

YesNo

PTS: 1 DIF: 2 REF: p. 2-3 to 2-7 OBJ: 1NAT: AICPA FN-Reporting | AACSB Analytic MSC: 10 min

2. ANS:If Osprey were a proprietorship, LLC, or S corporation, the companys net loss of $200,000 would passthrough to Mary. In such cases, Mary would deduct the $200,000 loss on her individual income tax return for2011, thus saving $70,000 of tax ($200,000 35%). If Osprey were a regular (C) corporation, the net losswould not pass through to Mary and instead, would have to be carried forward to succeeding tax years of thecorporation.

PTS: 1 DIF: 2 REF: p. 2-2 to 2-8 | p. 2-37 | p. 2-38OBJ: 1 | 7 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 5 min


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3. ANS:Other transactions frequently used to reduce corporate taxes include interest payments to ashareholder-creditor and rent payments to a shareholder-lessor. To the extent payments to shareholders resultin corporate deductions, the double taxation effect associated with dividend distributions is avoided.Corporate income that is offset by trade or business deductions effectively avoids the corporate income tax.As a result, such income is taxed only at the shareholder level (e.g., as compensation, interest, or rent

income). Since dividends are not deductible, corporate income that is distributed in such form is subject toboth the corporate income tax and the shareholder level income tax (e.g., individual income tax).

The IRS is aware of the preference for deductible payments to shareholders over nondeductible dividenddistributions. As a result, corporate payments to shareholders of purported trade or business expendituresgenerally will attract increased IRS scrutiny. In particular, the IRS will examine whether such paymentssatisfy the reasonableness requirement for a 162 trade or business deduction. When shareholdercompensation (or other payment) is unreasonable, the IRS may recharacterize the excessive amount as aconstructive dividend and disallow the associated corporate deduction. To satisfy the reasonablenessrequirement of 162, corporate payments to shareholders should be comparable to amounts that would bepaid to unrelated parties in similar transactions (i.e., an arms-length price).

PTS: 1 DIF: 2 REF: p. 2-4 | p. 2-37OBJ: 1 | 7 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 10 min

4. ANS:Robin Corporation prefers treating the payment as salary, as a $250,000 deduction for such would provide thecorporation with a tax savings of $87,500 [$250,000 (salary deduction) 35% (marginal tax rate)]. Ifinstead, the payment were treated as a dividend, none of the $250,000 would deductible by Robin.

Nancy prefers treating the payment as a dividend, as a preferential tax rate of 15% would apply to the$250,000 and result in only $37,500 of tax. If, instead, the payment were treated as salary, Nancy wouldincur tax of $87,500 [$250,000 (salary) 35% (marginal tax rate)]. Thus, Nancy would save $50,000 of taxif the payment were treated as a dividend instead of salary.

PTS: 1 DIF: 1 REF: p. 2-4 | p. 2-37OBJ: 1 | 7 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 5 min

5. ANS:A C corporation is a separate taxable entity, so its taxable income has no effect on the shareholders until suchtime a dividend is paid. When dividends are paid, shareholders must report dividend income on their taxreturns. Thus, Red Corporation will be taxed on $450,000 and the shareholders have no tax consequences.On the other hand, the income of a partnership is passed through to and reported by the partners on their taxreturns. Thus, each partner will receive a passthrough of $225,000 of income from Orange Company($450,000 2 partners).

PTS: 1 DIF: 2 REF: p. 2-3 | p. 2-4 | Concept Summary 2.1OBJ: 1 NAT: AICPA FN-Reporting | AACSB AnalyticMSC: 5 min


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6. ANS:When the IRS issued the check-the-box Regulations in 1996, the Federal tax treatment of limited liabilitycompanies (LLCs) was simplified. Currently, an entity formed as an LLC has great flexibility in determiningthe manner in which it will be taxed for Federal purposes. Under the check-the-box Regulations, an LLCwith more than one owner can elect to be taxed as a partnership or as a corporation. If no election is madethe LLC will be taxed as a partnership. An LLC with only one owner can elect under the Regulations to be

taxed as a sole proprietorship or as a corporation. If no election is made for a single-owner LLC, the entitywill be taxed as a sole proprietorship.

An election as to entity classification is made by filing Form 8832 (Entity Classification Election). Entitiesthat are incorporated under state law and entities that are required to be taxed as corporations under Federallaw (e.g., certain publicly traded partnerships) are not eligible to make an election under the check-the-boxRegulations.



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7. ANS:Similarities:

Gross income is defined the same for both types of taxpayers.

Some exclusions are available to both types of taxpayers (e.g., life insurance proceeds,

municipal bond interest).

Capital asset is defined the same for both types of taxpayers.

Nontaxable exchange provisions (e.g., like-kind exchanges, involuntary conversions) areapplicable to both types of taxpayers.

Depreciation recapture under 1245 is the same for both types of taxpayers.

Some loss disallowance provisions apply to both types of taxpayers (e.g., wash sales, relatedparty losses).

Treatment of business expenditures is similar for both types of taxpayers.

Some credits are available to both types of taxpayers (e.g., foreign tax credit).

Differences:

Tax rates are different.

Certain exclusions apply only to individuals (e.g., employer provided benefits), while othersapply only to corporations (e.g., contributions to capital).

Depreciation recapture under 1250 differs between the two types of taxpayers.

Corporations do not have nonbusiness deductions, itemized deductions, standard deductions,personal or dependency exemptions, or adjusted gross income.

Computation of casualty losses differs between the two types of taxpayers.

Some credits available to individual taxpayers are not available to corporations (e.g., child taxcredit, earned income credit).



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8. ANS:In general, a corporate taxpayer may select a calendar year or a fiscal year for tax return reporting purposes.A newly formed corporation generally can select its initial reporting period without having to obtain IRSconsent. However, certain types of corporate taxpayers are subject to restrictions on their reporting period. Ingeneral, personal service corporations (PSCs) and S corporations are required to use the calendar year for taxreporting. Exceptions to this rule apply, and a fiscal year can be elected by a PSC (or S corporation), under

any of the following conditions:

A business purpose for the year can be demonstrated.

The PSC tax year results in a deferral of not more than three months income. An electionunder 444 is required, and the PSC will be subject to the deduction limitations of 280H.The corporation must pay the shareholder-employees salary during the portion of the calendaryear after the close of the fiscal year. In addition, the salary for that period must be at leastproportionate to the employees salary for the fiscal year. (For an S corporation electing a 444 deferral, the required payments provision of 7519 must be satisfied. See Chapter 12.)

The PSC (or S corporation) retained the same year that was used for its fiscal year ending

1987, provided an election was made under 444 and subject to the deduction limitations of 280H (or 7519, in the case of an S corporation).


9. ANS:Crow Corporation and Jessica are related parties under 267 (corporation and a more-than-50% shareholder).As a result, the interest expense on the loan is deductible by Crow in the year it is actually paid to Jessica, or2012. Thus, Crow has no deduction for interest expense on the loan for 2011. If Jessica was a 25%shareholder, the related party provisions of 267 would not apply to the interest expense accrual, and Crowwould have a $18,000 deduction for such in 2011.



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10. ANS:In general, a C corporation must adopt the accrual method of accounting. However, there are severalexceptions to this rule, and the following C corporations can use the cash method of accounting:

Corporations engaged in the trade or business of farming or timber.

Qualified personal service corporations.

Corporations with average annual gross receipts of $5 million or less for the previous 3-yearperiod.

There is a limitation on the use of the cash method by otherwise qualifying corporations that maintaininventories. In general, these corporations must use the accrual method in determining sales and cost ofgoods sold. However, corporations with average annual gross receipts of $1 million or less for the mostrecent 3-year period are not subject to the limitation. (Further, some corporations with average annual grossreceipts of $10 million or less for the previous 3-year period also can avoid the limitation.)

Accrual method corporations are subject to a limitation on the deductibility of an accrued expenditure

attributable to a cash method related party (e.g., a more-than-50% shareholder). In such cases, thecorporations deduction for the expenditure is deferred until the recipient includes the amount in income.

PTS: 1 DIF: 2 REF: p. 2-11 OBJ: 2NAT: AICPA FN-Reporting | AACSB Reflective Thinking MSC: 5 min


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11. ANS:Tax year of deduction: In general, a charitable contribution is deductible only in the year the gift is madeFor an accrual basis corporation, however, a charitable contribution can be deducted in the current year for acontribution that is (1) approved by the corporations board of directors by the end of such year and (2) paidon or before the fifteenth day of the third month of the next year.

Amount of contribution: In addition to cash gifts, property contributions to qualified charitable organizationsare also deductible. For property that is depreciated (fair market value less than basis), the amount of thecontribution is the propertys fair market value. For property that is appreciated (fair market value greaterthan basis), the amount of the contribution depends on whether the property is capital gain property orordinary income property. Capital gain property is property that, if sold, would result in a long-term capitalgain or 1231 gain. A contribution of capital gain property generally results in a deductible amount equal tothe propertys fair market value. If the capital gain property is tangible personal property and the charitableorganizations use of the property is unrelated to its exempt function, the amount of the contribution is equalto the propertys basis. (Contributions of capital gain property to certain private foundations are similarlylimited to the propertys basis.) Ordinary income property is property that, if sold, would not result in along-term capital gain or 1231 gain. Typically, the deduction for a contribution of ordinary incomeproperty is equal to the propertys basis. However, charitable contributions of certain inventory property by

corporations can result in an enhanced deduction amount. For such inventory property, the deductible amountis equal to the lesser of (1) the sum of the propertys basis plus 50% of the appreciation on the property or (2)twice the propertys basis.

Annual limitation on deduction: A corporate taxpayers charitable deduction is limited to 10% of taxableincome (determined without regard to the charitable contribution deduction, any net operating loss carrybackor capital loss carryback, dividends received deduction, and domestic production activities deduction). Anycontributions in excess of the 10% limitation may be carried forward for five years. In any tax year for whichthere is a charitable contribution carryover, current years gifts are applied against the 10% limitation first,with carryover amounts deducted in order of time.

PTS: 1 DIF: 2 REF: p. 2-14 to 2-16 | p. 2-38 | p. 2-39

OBJ: 2 | 7 NAT: AICPA FN-Measurement | AACSB AnalyticMSC: 10 min


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12. ANS:a. Expenditures that qualify as organizational expenditures include the following: legal

services incident to organization, such as costs of drafting the corporate charter, thebylaws, the minutes, and the terms of original stock certificates; necessary accountingservices; expenses of temporary directors and of organizational meetings of directors orstockholders; and fees paid to the state of incorporation. Expenditures that do not

qualify for amortization include those connected with the issuing or selling of shares ofstock or other securities (e.g., commissions, professional fees, and printing costs) orwith the transfer of assets to a corporation.

To qualify for amortization under 248, the expenditure must be incurred before theend of the taxable year in which the corporation begins business. In this regard, thecorporations method of accounting is of no consequence. Expenditures incurred by acash basis corporation in its first tax year but paid in a subsequent year qualify for theelection.

b. In general, the first $5,000 of qualifying organizational expenditures are deductible inthe current year plus an amortization of the remaining expenditures over the 180-month

period beginning with the month in which the corporation begins business. However,the $5,000 first-year expensing amount is reduced to the extent qualifyingorganizational expenditures exceed $50,000.

c. A corporation is deemed to have made the 248 election by claiming the allowablededuction on the tax return for its first tax year. No separate statement or specificidentification of the deducted amount as organizational expenditures is required. Acorporation can elect to forgo the deemed election by clearly electing to capitalizeorganizational expenditures on a timely filed return for its first tax year. In such cases,organizational expenditures cannot be deducted until the corporation ceases to dobusiness and liquidates. (However, if the corporate charter limits the life of thecorporation, the expenditures could be amortized over the life of the corporation.)


13. ANS:Estimated tax payments are required if the corporations tax liability is expected to be $500 or more. Therequired annual payment (which includes estimated AMT liability) is the lesser of (1) 100% of thecorporations tax for the current year or (2) 100% of the corporations tax for the preceding year. Estimatedpayments are made quarterly, due on or before the 15th day of the 4th, 6th, 9th, and 12th month of the taxableyear. Underpayment of estimated tax penalty can be avoided if the quarterly payments are filed timely andequal to the corporations tax liability for the prior year (or tax liability computed on an annualized method).A corporation with taxable income of $1 million or more in any of its three preceding years can use the prior

years tax liability for computing only the first installment payment. In such cases, the corporations secondinstallment payment must include any shortfall resulting from using the prior years liability for the firstinstallment (instead of the current years liability).



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14. ANS:Schedule M-1 is used to reconcile the differences between net income per books with taxable income (beforeany dividends received deduction and NOL deduction). Examples of items that are additions include Federalincome tax expense, excess of capital losses over capital gains, income subject to tax but not recognized forbook purposes, book depreciation in excess of tax depreciation, and nondeductible expenditures (e.g., finesand penalties, meals and entertainment disallowance). Examples of items that are subtractions include

tax-exempt income (e.g., life insurance proceeds), tax depreciation in excess of book depreciation, carryoveramounts deductible in current year but expensed in prior year for book purposes (e.g., charitable contributioncarryover deductible in current year), and domestic production activities deduction.


15. ANS:Schedule M-3 was created, in part, in response to financial reporting scandals, such as Enron and WorldCom.Schedule M-3 requires corporations to report much more information regarding the differences betweenfinancial net income (loss) and taxable income than is required of Schedule M-1. This greater transparencyshould allow the IRS to more easily identify corporations that engage in aggressive tax practices, as those

transactions generally result in book/tax differences that must be reported on Schedule M-3. Entities withtotal assets of $10 million or more must file Schedule M-3 (in lieu of Schedule M-1). The financial figures(e.g., amount of total assets, net income or loss) required of the Schedule M-3 are drawn from thecorporations Form 10-K. If Form 10-K is not filed, then another financial source, e.g., certified financialstatements, is used.


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