Mitchell Boehm Income Tax II Chapter Questions 9/16/14. CHAPTER 17: 20, 24, 29, 38, 41, and 44

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1 CHAPTER 17: 20, 24, 29, 38, 41, and 44 20) Schedule M-1 of Form 1120 is used to reconcile financial accounting net income with taxable income reported on the corporation s income tax return as follows: net income per books + additions subtractions = taxable income. Classify the following items as additions or subtractions in the Schedule M-1 reconciliation. a. Life insurance proceeds received upon death of covered executive. Subtraction. b. Tax depreciation in excess of book depreciation. Subtraction. c. Federal income tax per books. Addition. d. Capital loss in excess of capital gain. Addition. e. Charitable contributions in excess of taxable income limitation. Addition. f. Premiums paid on life insurance policies covering executives. Addition. g. Domestic production activities deduction. Subtraction. 24) In the current year, Riflebird Company had operating income of $220,000, operating expenses of $175,000, and a long-term capital loss of $10,000. How do Riflebird Company and Roger, the sole owner of Riflebird, report this information on their respective Federal income tax returns for the current year under the following assumptions? a. Riflebird Company is a proprietorship (Roger did not make any withdrawals from the business). If it is a proprietorship, the net income and long-term capital loss of $10,000 are reported on a Schedule C on Roger s The long-term capital loss is deductible up to $3,000 against other income, and the remaining losses are carried forward to future years until absorbed by capital gains or by the $3,000 deduction. b. Riflebird Company is a C Corporation (no dividends were paid during the year). The net income of $45,000 will be first taxed at the corporate level, and following this it is distributed to the sole owner, Roger, through dividend income which is reported on his The longterm capital loss cannot be deducted against ordinary income. They can only be used as an offset against capital gains. They can be carried back to three preceding years and carried forward for a period of five years. This is treated as a short-term capital loss. 29) In the current year, Tanager Corporation (a C corporation) had operating income of $480,000 and operating expenses of $390,000. In addition, Tanager had a long-term capital gain of $55,000 and a short-term capital loss of $40,000. a. Compute Tanager s taxable income and tax for the year. Taxable income is $105,000 [($480, ,000) + (55,000 40,000)]. The tax for the year is computed as follows: Tax on $100,000 is $22,250. Tax on $5,000 is 1,950 (5,000 x 39%). Therefore the total tax is $24,200. b. Assume, instead, that Tanager s long-term capital gain was $15,000 (not $55,000). Compute Tanager s taxable income and tax for the year. Taxable income is just $90,000. The excess capital loss of $25,000 can be carried back 3 years or carried forward 5 years. The tax for the year is computed as follows: Tax on $75,000 is 13,750. Tax on 15,000 is 5,100 (15,000 x 34%). Therefore the total tax is $18,850.

2 38) During the current year, Swallow Corporation, a calendar year C corporation, has the following transactions: Income from operations $660,000 Expenses from operations 720,000 Dividends received from Brown Corporation 240,000 a. Swallow Corporation owns 12% of Brown Corporation s stock. How much is Swallow s taxable income or NOL for the year? Taxable income is $180,000 [(660, ,000) + 240,000]. Because Swallow Corp. owns less than 20% of Brown s stock, the deduction percentage is 70%. Therefore, Swallow Corporation has a dividends received deduction for the year of $126,000 (180,000*.7 is less than 240,000*.7). The taxable income is then $54,000. b. Assume instead that Swallow Corporation owns 26% of Brown Corporations stock. How much is Swallow s taxable income or NOL for the year? The dividends received deduction would be 144,000 (180,000*.8), and the taxable income would be $36,000. If Swallow Corporation owns 26% of Brown Corporation s stock, the percentage for calculating the dividends received deduction would be 80%. Under these circumstances, taking the full dividends received deduction would create an NOL. Gross income From operations $660,000 Dividends 240,000 $900,000 Less: Expenses from operations (720,000) Income before the dividends received deduction $180,000 Dividends received deduction (80% $240,000) (192,000) Net operating loss ($ 12,000) The dividends received deduction is not limited to 80% of taxable income (before the dividends received deduction) because taking 80% of $240,000 ($192,000) creates a net operating loss. Example 24 41) Egret Corporation, a calendar year C corporation, was formed on March 7, 2013, and opened for business on July 1, After its formation but prior to opening for business, Egret incurred the following expenditures: Accounting $7,000 Advertising 14,500 Employee payroll 11,000 Rent 8,000 Utilities 1,000 What is the maximum amount of these expenditures that Egret can deduct in 2013? $10,000 can be deducted. $5,000 of organizational expenditures are deducted (Accounting) and $5,000 of start-up expenditures are deducted. The total amount for each expenditure is less than $50,000, so there is no dollar-for-dollar reduction. All $41,500 of the expenditures are startup expenditures. Egret can elect under 195 to currently write off the first $5,000 and to amortize the remaining amount of such expenditures over a 180- month period beginning with the month in which it begins business (i.e., July 1, 2013). Thus, Egret s deduction in 2013 for startup expenditures is $6,217 {$5,000 +

3 $1,217 [($41,500 $5,000) 180 months 6 months]}. Egret makes the 195 election simply by claiming the deduction on its 2013 tax return. (If Egret decides to forgo the 195 election, the $41,500 must be capitalized and is deductible only when the corporation ceases to do business and liquidates.) p ) Apply the controlled and affiliated group rules to determine whether a parent-subsidiary controlled group or an affiliated group exists in each of the following independent situations. a. Throughout the year, Parent owns 65% of the stock of SubCo. Not parent-subsidiary controlled group. Yes it is Affiliated. b. Parent owns 70% of SubCo. The other 30% of SubCo stock is owned by Senior, a wholly owned subsidiary of Parent. Yes it is parent-subsidiary and yes it is affiliated. c. For 11 months, Parent owns 75% of the stock of SubCo. For the last month of the tax year, Parent owns 100% of the SubCo stock. No it is not parent-subsidiary controlled but yes it is affiliated. The 80% test is failed in a. In b., stock attribution rules apply in identifying a controlled group, but not an affiliated group. In c., the affiliated group test must be met on every day of the tax year, while the controlled group test must be met only on the last day of the year. pp to CHAPTER 18: 10, 25, 29, 32 10) Should a transferor who receives stock for both property and services be included in the control group in determining whether an exchange meets the requirement of section 351? Explain. Yes they can be included in the control group. However, they are taxed on the value of the stock issued for services but not on the stock issued for property. The value of the property generally must be at least 10% of the value of the services rendered, however, otherwise the IRS will not approve the exchange under ) Tom and Gail form Owl Corporation with the following consideration: Consideration Transferred Basis to Fair Market Number of Transferor Value Shares Issued From Tom - Cash $50,000 $50,000 Installment obligation 240, , From Gail - Inventory 60,000 50,000 Equipment 125, ,000 Patentable invention 15, , The installment obligation has a face amount of $350,000 and was acquired last year from the sale of land held for investment purposes (adjusted basis of $240,000). As to these transactions, provide the following information: a. Tom s recognized gain or loss. $0 b. Tom s basis in the Owl Corporation stock. $290,000

4 c. Owl Corporation s basis in the installment obligation. $240,000 d. Gail s recognized gain or loss. $0 e. Gail s basis in the Owl Corporation stock. $200,000 f. Owl Corporation s basis in the inventory, equipment, and patentable invention. Inventory - $60,000; Equipment 125,000; Patentable invention 15,000 g. How would your answers to the preceding questions change if Tom received common stock and Gail received preferred stock? They would not change. Both types of stock qualify as stock. Only nonqualified preferred stock would make a difference. If either of them had nonqualified preferred stock, it would be treated as boot and would therefore be a gain. h. How would your answers change if Gail was a partnership? There is no requirement for the transferors to be individuals, so the answers would not change. 29) Ann and Bob form Robin Corporation. Ann transfers property worth $420,000 (basis of $150,000) for 70 shares in Robin Corporation. Bob receives 30 shares for property worth $165,000 (basis of $30,000) and for legal services (worth $15,000) in organizing the corporation. a. What gain or income, if any, will the parties recognize on the transfer? Bob will recognize $15,000 of ordinary income for the legal services rendered to Robin Corporation. b. What basis do Ann and Bob have in the stock in Robin Corporation? Ann has a basis of $150,000 and Bob has a basis of $45,000. c. What is Robin Corporation s basis in the property and services it received from Ann and Bob? Robin Corporation has a $150,000 basis in the property received from Ann, a $30,000 basis in the property received from Bob, and it capitalizes $15,000 of organizational expenditures for the legal services performed by Bob. 32) Allie forms Broadbill Corporation by transferring land (basis of $125,000, FMV of $775,000), which is subject to a mortgage of $375,000. One month prior to incorporating Broadbill, Allie borrows $100,000 for personal reasons and gives the lender a second mortgage on the land. Broadbill Corporation issues stock worth $300,000 to Allie and assumes the mortgages on the land. a. What are the tax consequences to Allie and to Broadbill Corporation? Both 357(b) and 357(c) are applicable. The land is subject to two mortgages that are in excess of basis, causing 357(c) to be applicable. Allie has a gain of $350,000 [($375,000 + $100,000) $125,000] on the transfer pursuant to 357(c). Section 357(b) also is applicable because Allie borrowed the $100,000 shortly before incorporating and used the funds for personal purposes. Section 357(b) causes all liabilities to be tainted; thus, Allie has boot of $475,000. This generates taxable gain of $475,000, the amount of the boot. Her realized gain is $650,000 [$300,000 (value of stock received) + $475,000 (release of liabilities) $125,000 (basis of land)]. The realized gain is taxed to the extent of the boot received, or $475,000. When both 357(b) and 357(c) apply to the same transaction, 357(b) predominates. b. How would the tax consequences to Allie differ if she had not borrowed the $100,000? Section 357(b) would no longer be applicable if Allie does not take out the second mortgage. However, 357(c) will apply. Allie will have a taxable gain under 357(c) of $250,000, computed as follows: $375,000 (liabilities assumed by Broadbill Corporation) $125,000 (basis in the property transferred to Broadbill). Allie s basis in her stock will be zero, computed as follows: $125,000 (basis in the land transferred to Broadbill) + $250,000 (gain recognized by Allie) $375,000 (liabilities assumed by Broadbill). Broadbill Corporation will have a basis of $375,000 in the assets, computed as follows: $125,000 (carryover basis from Allie) + $250,000 (gain recognized to Allie).

5 CHAPTER 19: 3, 14, 30, 40, 47 3) In determining Blue Corporation s current E&P for 2013, how should taxable income be adjusted as a result of the following transactions? a. A capital loss carryover from 2013, fully used in Addition to taxable income. b. Nondeductible meal expenses in Subtraction to taxable income. c. Interest on municipal bonds received in Addition to taxable income. d. Nondeductible lobbying expenses in Subtraction to taxable income. e. Loss on a sale between related parties in Subtraction to taxable income. f. Federal income tax refund received in Addition to taxable income. 14) Whether compensation paid to a corporate employee is reasonable is a question of fact to be determined from the surrounding circumstances. How would the resolution of this problem be affected by each of the following factors? a. The employee owns no stock but is the mother-in-law of the sole shareholder. A relative of the sole shareholder should be treated the same way as an employee-shareholder. The reasonableness of what they are paid should be compared to what an employee-shareholder would be paid in the same situation. b. The shareholder-employee does not have a college degree. Whether or not the shareholder has a college degree should only way in to the scope of the work and what they have to do. Does this employee have the qualifications for the job they have. c. The shareholder-employee works 40 hours per week for another unrelated employer. The fact that the employee has another full-time job may indicate that the salary they receive is excessive. d. The shareholder-employee was underpaid for services during the formative period of the corporation. If the employee was previously underpaid, then their current salary could reflect the missing amount from previous years. e. The corporation has never paid a dividend. If the corporation has good E&P and has never paid a dividend in the past, then it is likely that a constructive dividend may be found. f. Year-end bonuses are paid to all employees, but officer-shareholders receive disproportionately larger bonuses. These disproportionately larger bonuses to shareholders could be subject to constructive dividend treatment. 30) At the start of the current year, Blue Corporation (a calendar year taxpayer) has accumulated E&P of $100,000. Blue s current E&P is $60,000, and at the end of the year, it distributes $200,000 ($100,000 each) to its equal shareholders, Pam and Jon. Pam s stock basis is $11,000; Jon s stock basis is $26,000. How is the distribution treated for tax purposes? First the current E&P is distributed equally to Pam and Jon, $30,000 each. The accumulated E&P is then distributed fully as well, $50,000 to each of them. These dividends are taxed at the reduced tax rate available to all individuals. This leaves a return of capital of $40,000 to the company, $20,000 to each shareholder. Because Pam has a stock basis of $11,000, she recognizes a taxable gain of $9,000, and her stock basis is reduced to zero. Jon does not recognize a gain, however, his stock basis is reduced to $6, ) Lime Corporation, with E&P of $500,000, distributes land (worth $300,000, adjusted basis of $350,000) to Harry, its sole shareholder. The land is subject to a liability of $120,000, which Harry assumes. What are the tax consequences to Lime and to Harry? Harry has dividend income of $180,000 (300, ,000), and the basis of the property is $300,000, the FMV. Lime s E&P is reduced by $230,000 ($350,000 adjusted basis 120,000 liability). There is no capital gain because the FMV of the property distributed does not exceed Lime s E&P.

6 47) Silver Corporation has 2,000 shares of common stock outstanding. Howard owns 600 shares, Howard s grandfather owns 300 shares, Howard s mother owns 300 shares, and Howard s son owns 100 shares. In addition, Maroon Corporation owns 500 shares. Howard owns 70% of the stock in Maroon Corporation. a. Applying the 318 stock attribution rules, how many shares does Howard own in Silver Corporation? Howard collectively owns 1,350 shares of stock in Silver Corporation. He owns 600 shares directly, and he owns 750 shares indirectly: 300 from his mother, 100 from his son, and 70% of the 500 shares (350). b. Assume that Howard only owns 40% of the stock in Maroon Corporation. How many shares does Howard own, directly and indirectly, in Silver Corporation? The stock attribution rules do not apply in this situation because Howard owns less than 50% of the stock in Maroon Corporation. He therefore only owns 1,000 shares in Silver Corporation: His 600, his mother s 300, and his son s 100. c. Assume the same facts as in (a) above, but in addition, Howard owns a 25% interest in Yellow Partnership. Yellow owns 200 shares in Silver Corporation. How many shares does Howard own, directly and indirectly, in Silver Corporation? Howard would directly and indirectly own 1,400 shares in Silver Corporation (1,350 same as question a + 50 shares from Yellow. You do not need to own more than 50% of the shares in a partnership for the stock attribution rules to apply). CHAPTER 20: 18, 25, 28, 35 18) Dove Corporation (E&P of $800,000) has 1,000 shares of stock outstanding. The shares are owned as follows: Julia, 600 shares; Maxine (Julia s sister), 300 shares; and Janine (Julia s daughter), 100 shares. Dove Corporation owns land (basis of $300,000, FMV of $260,000) that it purchased as an investment seven years ago. Dove distributes the land to Julia in exchange for all of her shares in the corporation. Julia had a basis of $275,000 in the shares. What are the tax consequences for both Dove Corporation and Julia if the distribution is: a. A qualifying stock redemption? Dove Corporation will not be able to take a taxable loss on the land of $40,000 (300, ,000) because you cannot realize a loss on a nonliquidating distribution. Julia would not be able to take the 15,000 taxable loss (260, ,000) because Dove and Julia are related parties since Julia directly and indirectly owns more than 80% of the stock. Julia s basis in the land would be $260,000, the FMV at the time of the exchange. b. A liquidating distribution? The $40,000 loss realized by Dove Corporation on the distribution of the land is again disallowed. In this case, the loss is disallowed under the related-party loss limitation. Since Julia is deemed to own 100% of the stock of Dove, this is a distribution of loss property to a related party and such distribution is not pro rata. As to Julia, her $15,000 loss is recognized. Section 267 does not apply in the case of liquidating distributions. Her basis in the land is its fair market value, or $260,000.

7 25) Pursuant to a complete liquidation in the current year, Scarlet Corporation distributes to Jake land (basis of $425,000, FMV of $390,000) that was purchased three years ago and held as an investment. The land is subject to a liability of $250,000. Jake, who owned 35% of the Scarlet shares outstanding, had a basis of $60,000 in the stock. What are the tax consequences of the liquidating distribution to Scarlet Corporation and to Jake? Scarlet Corporation will recognize a long-term capital loss of $35,000 [$390,000 (fair market value) $425,000 (basis)] on the liquidating distribution of land. Neither the related-party loss limitation nor the built-in loss limitation would apply to the loss realized on the distribution. Jake will recognize a long-term capital gain of $80,000 [$140,000 (fair market value of land less liability) $60,000 (basis of stock)]. Jake will have a basis of $390,000 in the land. pp and ) The stock in Ivory Corporation is owned by Gold Corporation (80%) and Imelda (20%). Gold Corporation purchased its shares in Ivory nine years ago at a cost of $650,000, and Imelda purchased her shares in Ivory four years ago at a cost of $175,000. Ivory Corporation has the following assets that are distributed in complete liquidation: Adjusted Basis Fair Market Value Cash $600,000 $600,000 Inventory 80, ,000 Equipment 350, ,000 a. Assume that Ivory Corporation distributes the cash and inventory to Gold Corporation and the equipment to Imelda. What are the tax consequences of the distributions to Ivory Corporation, to Gold Corporation, and to Imelda? Due to Gold Corporation owning 80% of the stock, Ivory Corporation does not recognize a gain or loss in this situation. In a section 332 parentsubsidiary liquidation, up to 20 percent of the susidiary s stock can be owned by minority shareholders, in this case it being Imelda. In such liquidations, a distribution of property to a minority shareholder is treated in the same manner as a nonliquidating distribution. Therefore, Ivory can recognize a gain but not a loss, meaning it cannot recognize the 150,000 (350, ,000) loss to Imelda. Gold Corporation has no gain or loss on the inventory and has a $80,000 basis in it. Its stock basis is eliminated. Imelda has a recognized gain of $25,000 (200, ,000) and has a 200,000 basis in the equipment. b. Assume that Ivory Corporation distributes the cash and equipment to Gold Corporation and the inventory to Imelda. What are the tax consequences of the distributions to Ivory Corporation, to Gold Corporation, and to Imelda? Again, Section 332 applies and Ivory recognizes no gain or loss on the distribution of the cash and equipment to Gold Corporation. However, Ivory Corporation does recognize the gain of $120,000 ($200,000 fair market value $80,000 basis) on the distribution of the inventory to Imelda. Gold Corporation recognizes no gain or loss on the liquidation and takes a basis of $350,000 in the equipment. Gold s basis in its Ivory Corporation stock is eliminated. Imelda recognizes a gain of $25,000 ($200,000 amount realized $175,000 basis in stock), and she has a basis of $200,000 in the inventory.

8 35) Target Corporation holds assets with a FMV of $4 million (adjusted basis of $2.2 million) and liabilities of $1.5 million. It transfers assets worth $3.7 million to Acquiring Corporation in a Type C reorganization, in exchange for Acquiring voting stock and the assumption of $1.4 million of Target s liabilities. Target retained a building worth $300,000 (adjusted basis of $225,000). Target distributes the Acquiring voting stock and the building with an associated $100,000 mortgage to Wei, its sole shareholder, for all of her stock in Target. Wei s basis in her stock is $2.1 million. a. What is the value of the stock transferred from Acquiring to Target? The value of the stock transferred from Acquiring to Target is $2.3 million ($3.7 million - $1.4 million of liabilities assumed). b. What is the amount of gain (loss) recognized by Wei, Target, and Acquiring on the reorganization? Wei receives $2.3 million in stock and a building valued at $300,000 with a $100,000 mortgage for her Target stock. Thus, Wei receives $2.5 million for her Target stock ($2.3 million + $300,000 $100,000). Since her basis is $2.1 million, Wei recognizes gain to the extent of the boot received, which is $200,000 ($300,000 building $100,000 mortgage). Target has a $75,000 ($300,000 $225,000) recognized gain on the reorganization due to the building distributed to Wei. Acquiring has no gain or loss on the reorganization. c. What is Wei s basis in the stock and building she received? Wei s basis in the building is $300,000 and has a $100,000 liability she acquired. Her basis in the stock is computed as follows: Realized Gain Recognized Gain Postponed Gain Stock Basis $2,500,000 $200,000 $400,000 $2,300,000 2,100, , ,000 $ 400,000 $200,000 $2,100,000 CHAPTER 21: 32, 40, 45, Liz and John formed the equal LJ Partnership on January 1 of the current year. Liz contributed $80,000 of cash and land with a fair market value of $90,000 and an adjusted basis of $75,000. John contributed equipment with a fair market value of $170,000 and an adjusted basis of $20,000. John had previously used the equipment in his sole proprietorship. a. How much gain or loss will Liz, John, and the partnership realize? Liz would realize a $15,000 gain on the contribution of the land. John would realize a $150,000 gain on the contribution of the land. The partnership realizes a gain equal to the value of the property it receives, or $260,000. b. How much gain or loss will Liz, John, and the partnership recognize? There is no gain or loss recognized by anyone because of section 721. c. What bases will Liz and John take in their partnership interests? Liz would have a $155,000 substituted basis (80,000+75,000) and John would have a $20,000 substituted basis. d. What bases will LJ take in the assets it receives? LJ would have a $155,000 carryover basis in the property and cash received from Liz and a $20,000 carryover basis in the land received from John. e. Are there any differences between inside and outside basis? Explain. The partnership, the inside basis, has the same basis as Liz and John, the outside basis. They are both $175,000. f. How will the partnership depreciate any assets it receives from the partners? LJ would step into the shoes of John and continue the same cost recovery method and life used by John.

9 40. On July 1 of the current year, the R&R Partnership (an LLLP) was formed to operate a bed-andbreakfast. The partnership paid $3,000 in legal fees for drafting the partnership agreement and $5,000 for accounting fees related to organizing the entity. It also paid $10,000 in syndication costs to locate and secure investments from limited partners. In addition, before opening the inn for business, the entity paid $15,500 for advertising and $36,000 in costs related to an open house just before the grand opening of the property. The partnership opened the inn for business on October 1. a. How are these expenses classified? Organization costs: $3,000 of legal fees, $5,000 of accounting fees. Startup costs: $15,500 for advertising, $36,000 for open house. Syndication costs: $10,000 to locate and secure investments from limited partners b. How much may the partnership deduct in its initial year of operations? Organization costs: $5,050 [5,000 + (3,000 x 3/180)]. Startup costs: $4,300 [5,000 reduced by 1,500 (51,500-50,000). $800 (48,000 x 3/180) of the remaining 48,000 (51,500 3,500). c. How are costs treated that are not deducted currently? The remaining organizational and startup costs are amortized and deducted over a 180 month period, beginning with the day the inn opened for business on October 1. The syndication costs are nondeductible. 45. Amy and Mitchell are equal partners in the accrual basis AM Partnership. At the beginning of the current year, Amy s capital account has a balance of $300,000, and the partnership has recourse debts of $200,000 payable to unrelated parties. Assume that all partnership recourse debt is shared equally between the partners. The following information about AM s operations for the current year is obtained from the partnership s records. Ordinary income $400,000 Interest Income 4,000 Long-term capital loss 6,000 Short-term capital gain 12,000 Charitable contribution 4,000 Cash distribution to Amy 20,000 Assume that year-end partnership debt payable to unrelated parties is $140,000. If all transactions are reflected in her beginning capital and basis in the same manner, what is Amy s basis in the partnership interest: a. At the beginning of the year? Her beginning of the year basis is $400,000 (300,000 capital account + 100,000 (200,000/2) share of AM s debt) b. At the end of the year? Her end of the year basis is determined as follows: Capital account 300,000 Add: Taxable income 200,000 Interest income 2,000 Net ST Capital gain 3, , ,000 Less: Charitable Contribution 2,000 Cash distribution 20,000 (22,000) 483,000 Plus: Share of AM s debt (140,000/2) 70,000 Amy s basis, end of year 553,000

10 62. Gil s outside basis in his interest in the GO Partnership is $100,000. In a proportionate nonliquidating distribution, the partnership distributes to him cash of $30,000, inventory (FMV of $40,000, basis to the partnership of $20,000), and land (FMV of $90,000, basis to the partnership of $50,000). The partnership continues in existence. a. Does the partnership recognize any gain or loss as a result of this distribution? Explain. In general, neither the partner nor the partnership recognizes gain or loss when a nonliquidating distribution occurs (Chapter 21, pg. 39). b. Does Gil recognize any gain or loss as a result of this distribution? Explain. A proportionate nonliquidating distribution of cash is taxable to the partner if the distributed cash exceeds the outside basis of his or her interest in the partnership. Losses are not recognized by the partner. c. Calculate Gil s basis in the land, in the inventory, and in his partnership interest immediately following the distribution. His basis in the land is the same as that of the partnership, or $50,000. This reduces his partnership interest by $50,000. His basis in the inventory is the same as that of the partnership, or $20,000. This reduces his partnership interest by another $20,000. Finally, the cash distribution reduces his partnership interest by another $30,000, making his partnership interest $0 ($100,000 50,000 20,000 30,000). CHAPTER 22: 5, 11, 19, 25, 25, 34A&B ONLY 5. Which of the following are requirements to be an S corporation? a. Limited to a maximum of 100 shareholders. This is not true because family members can jointly own stock and only be counted as one shareholder. Also two small business corporations, can theoretically form a partnership and have 100 shareholders each and still have S corp status b. Has no resident alien shareholders. It cannot have nonresident alien shareholders. c. Has only once class of stock. This is the only TRUE one. d. May have no straight debt. Nah. e. Cannot be a member of an affiliated group. Think again. 11. Which of the following can be a shareholder of an S corporation? a. Resident alien. Sure. b. Partnership. No way. c. Charitable remainder trust. Yeah. No. d. IRA. No e. Estate. Yeah. f. One-person LLC (disregarded entity). Yeah. 19. For each of the following independent statements, indicate whether the transaction will increase (+), decrease (-), or have no effect (NE) on the basis of a shareholder s stock in an S corporation. a. Expenses related to tax-exempt income. Decrease. b. Short-term capital gain. Increase. c. Nonseparately computed loss. Decrease. d. Section 1231 gain. Increase. e. Depletion not in excess of basis. Decrease. f. Separately computed income. Increase. g. Nontaxable return-of-capital distribution by the corporation. Decrease.

11 h. Advertising expenses. Decrease. i. Business gifts in excess of $25. Decrease. j. Depreciation recapture income. Increase. k. Dividends received by the S corporation. Increase. l. LIFO recapture tax paid. Decrease. m. Recovery of a bad debt previously deducted. Increase. n. Long-term capital loss. Decrease. o. Corporate distributions out of AAA. Decrease. 25. Maul, Inc., a calendar year S corporation, incurred the following items. Tax-exempt bond interest income 3,000 Sales 140,000 Depreciation recapture income 12,000 Long-term capital gain 20, gain 7,000 Cost of goods sold (42,000) Administrative expenses (15,000) Depreciation expense (MACRS) (17,000) Charitable contributions (7,000) a. Compute Maul s nonseparately computed income or loss. Sales $140,000 Less: COGS (42,000) Administrative expenses (15,000) Depreciation (MACRS) (17,000) Net Income 66,000 Add: Deprecation recapture 12,000 Nonseparately stated income $78,000 b. If Carl is a 40% owner of Maul, Inc., what is his share of the long-term capital gain? Carl s share is of the LTCG is $8,000 (20,000 x 40%). 34. Cougar, Inc., is a calendar year S corporation. Cougar s Form 1120S shows nonseparately stated ordinary income of $80,000 for the year. Johnny owns 40% of the Cougar stock throughout the year. The following information is obtained from the corporate records. (See page in text). a. Compute Cougar s book income or loss. Nonseparately stated ordinary income 80,000 Add: Separately stated items: Tax exempt interest income 3,000 Long-term capital gain 14,000 Dividends received 5,000 Refund of state taxes 5,000 Less separately stated items: Charitable contributions (6,000)

12 STCL (6,000) LTCL (7,000) Book Income $88,000 b. Compute Johnny s ending stock basis. Johnny s beginning stock basis $32,000 Ordinary income (80,000x40%) 32,000 Tax-exempt income (3,000) 1,200 Dividends received (5,000) 2,000 Refund of state taxes (5,000) 2,000 LTCG (14,000) 5,600 Additional purchases (9,000) 9,000 51,800 Charitable contributions (6,000) (2,400) STCL (6,000) (2,400) LTCL (7,000) (2,800) (7,600) $76,200 CHAPTER 24: 2, 7, 26, 29, Complete the following chart by indicating whether each item is true or false. Explain your answers by referencing the overlap of rules appearing in Federal and most state income tax laws. a. Most of the states start with Federal taxable income in computing state taxable income (i.e., taxable income is piggybacked with the Federal amount). TRUE. b. The states use a wide variety of rules to compute corporate taxable income; thus, there is no typical state income tax computation. TRUE. c. State rules as to which entities can join in a consolidated return match those of Federal law. FALSE. States often apply different rules in identifying the members of a group filing a consolidated return and the income of each group member that is subject to tax. d. The corporate income tax systems of most states can be described as having progressive rate structures. FALSE. As only a few states apply more than one or two tax rates to taxable income, there is little progressivity to these tax systems. e. A typical state income tax credit would equal 10% of the costs incurred to purchase and install solar energy panels for an existing factory. TRUE. 7. Indicate whether each of the following items should be allocated or apportioned by the taxpayer in computing state corporate taxable income. Assume that the state follows the general rules of UDITPA. a. Profits from sales activities. Apportion; business income b. Profits from consulting and other service activities. Apportion; business income c. Losses from sales activities. Apportion; business loss d. Profits from managing the stock portfolio of a client. Apportion; business income e. Profits from managing one s own stock portfolio. Neither; Not a trade or business f. Gain on the sale of a plot of land held by a real estate developer. Apportion; business income. g. Gain on the sale of a plot of land held by a manufacturer, on which it may expand its factory. Allocate; nonbusiness income

13 h. Rent income received by a manufacturer from the leasing of space to a supplier. Apportion; Business income 26. Use figure 24.1 to compute Balboa Corporation s State F taxable income for the year. Addition modification $29,000 Allocated income (total) 25,000 Allocated income (State F) 3,000 Allocated income (State G) 22,000 Tax credits 800 Federal taxable income 90,000 Subtraction modifications 15,000 Apportionment percentage 40% Tax rate 5% 90, ,000-15, ,000-25,000 79,000 X 40% 31,600 +3,000 34,600 X 5% 1, Perk Corporation is subject to tax only in State A. Perk generated the following income and deductions. Federal taxable income $300,000 State A income tax expense 15,000 Refund of State A income tax 3,000 Depreciation allowed for Federal tax purposes 200,000 Depreciation allowed for state tax purposes 120,000 Federal taxable income is the starting point in computing A taxable income. State income taxes are not deductible for A tax purposes. Determine Perk s A taxable income. $300, ,000-3,000 (+200, ,000) 392,000

14 36. Roger Corporation operates in two states, as indicated below. This year s operations generated $400,000 of apportionable income. State A State B Total Sales $800,000 $200,000 $1,000,000 Property 300, , ,000 Payroll 200,000 50, ,000 Compute Roger s State A taxable income assuming that State A apportions income based on a: a. Three-factor formula, equally weighted. Sales (800,000/1,000,000) = 80% Property (300,000/600,000) = 50% Payroll (200,000/250,000) = 80% Sum of apportionment factors 210% Average 3 Apportionment factor for State A 70% Taxable Income x $400,000 Income apportioned to State A $280,000 b. Double-weighted sales factor. Sales (800,000/1,000,000) 80%x2 = 160% Property (300,000/600,000) = 50% Payroll (200,000/250,000) = 80% Sum of apportionment factors 290% Average 4 Apportionment factor for State A 72.5% Taxable Income x $400,000 Income apportioned to State A $290,000 c. Sales factor only. Sales (800,000/1,000,000) = 80% Apportionment factor for State A = 80% Taxable Income x $400,000 Income apportioned to State A = $320,000 CHAPTER 26: 16, 22, 36, Indicate whether each of the following statements is true or false. a. The government never has a taxpayer pay interest on an overpayment of tax. FALSE. The government is required to pay interest at the applicable Federal rate to any taxpayer who has made an overpayment of tax. Interest on the overpayment begins to accrue from the later of 45 days after the unextended due date of the return or 45 days after the return actually is filed. However, if the refund is not made within this 45-day period, interest begins to accrue from the due date of the return. p b. The IRS can compromise on the amount of tax liability if there is doubt as to the taxpayer s ability to pay. TRUE. Prior to the time that the case is referred to the Justice Department for prosecution or defense, the IRS can compromise on any civil or criminal case that does not involve illegal drugs. However, the IRS will not enter into a compromise with a taxpayer if the

15 liability has been established by a valid judgment, and there is no doubt as to the IRS s ability to collect the amounts that are due. p c. The IRS is required to accept Colin s application for an installment plan that delays the payment of her $6,000 outstanding tax liability. TRUE. A taxpayer usually is guaranteed the right to use an installment agreement when the amount in dispute does not exceed $10,000. pp d. The offer in compromise program attempts to allow upper-income taxpayers additional time in which to pay delinquent tax amounts. FALSE. An offer in compromise is most appropriate when the taxpayer exhibits financial hardships. p Indicate whether each of the following parties could be subject to the tax preparer penalties. a. Tom prepared Sally s return for $250. Yes, if Tom is not a CPA, attorney, or EA he could be subject to penalties. b. Theresa prepared her grandmother s return for no charge. This is correct. Theresa is not allowed to charge immediate family for doing their return. c. Georgia prepared her church s return for $500 (she would have charged an unrelated party $3,000 for the same work). Georgia would be subject to penalties because she did not charge a fair amount for her services. d. Geoff prepared returns for low-income taxpayers under his college s VITA program. This is correct. e. Hildy prepared the return of her corporate employer. This is correct. f. Heejeo, an administrative assistant for an accounting firm, processed a client s return through TurboTax. This is correct. 36. Trudy s AGI last year was $200,000. Her Federal income tax came to $65,000, which she paid through a combination of withholding and estimated payments. This year, her AGI will be $300,000, with a projected tax liability of $45,000, all to be paid through estimates. a. Ignore the annualized income method. Compute Trudy s quarterly estimated tax payment schedule for this year. Current year method: First quarter payment (45,000/4 *90%) $10,125 Second quarter payment 10,125 Third quarter payment 10,125 Fourth quarter payment 10,125 Year Total $40,500 Prior year method: First quarter payment (65,000/4 *110%) $17,875 Second quarter payment 17,875 Third quarter payment 17,875 Fourth quarter payment 17,875 Year Total $71,500 Thus, Trudy will use the current-year method for her estimates this year, as it produces the lower payment amount. The remaining tax [$45,000 $40,500 = $4,500] is due with the return, but no underpayment penalty is assessed.

16 b. Assume instead that Trudy s AGI last year was $100,000 and resulted in a Federal income tax of $20,000. Determine her quarterly estimated tax payment schedule for this year. Because Trudy s prior-year AGI did not exceed $150,000, the underpayment penalty is avoided if she remits only 100% of the prior-year tax. Current-Year Method First quarter payment [$45,000 tax 4 payments 90% required] $10,125 Second quarter payment 10,125 Third quarter payment 10,125 Fourth quarter payment 10,125 $40,500 Prior-Year Method First quarter payment [($20,000 4) 100% required] $ 5,000 Second quarter payment 5,000 Third quarter payment 5,000 Fourth quarter payment 5,000 $20,000 Thus, Trudy now uses the prior-year method for her estimates this year, as it produces the lower payment amount. The remaining tax ($45,000 $20,000 = $25,000) is due with the return but no underpayment penalty is assessed. 39. Keely filed her 2013 Form 1040 on April 4, What is the applicable statute of limitations in each of the following independent situations? a. The taxpayer incurred a bad debt loss that she failed to claim. April 15, For bad debts and worthless securities, a seven-year period of limitations applies. The extended period is provided in recognition of the inherent difficulty of identifying the exact year in which a bad debt or security becomes worthless. b. A taxpayer inadvertently omitted a large amount of gross income. April 15, If a taxpayer omits an amount of gross income in excess of 25 percent of the gross income stated on the return, the statute of limitations is increased to six years. c. Same as (b), except that the omission was deliberate. This would be a fraudulent return, and assessments can therefore be made at any time. There is no statute of limitations. d. A taxpayer innocently overstated her deductions by a large amount. April 15, e. What if no return was filed by the taxpayer? If no return is filed or a fraudulent return is filed, assessments can be made at any time. There is, in effect, no statute of limitations in these cases.

17 CHAPTER 27: 23, 34, 36, In each of the following independent situations, indicate whether the transfer is subject to the Federal gift tax. a. Asa contributes to his mayor s reelection campaign fund. The mayor has promised to try to get some of Asa s property rezoned from residential to commercial use. Transfers to political organizations are exempt from the application of the Federal gift tax. b. Mary Ann inherits her father s collection of guns and mounted animals. Five months later, she disclaims any interest in the mounted animals. There is no gift tax because the disclaimer was made in a timely manner (less than 9 months) c. Same as (b). Ten months later, Mary Ann disclaims any interest in the guns. This is not done in a timely manner and would therefore be subject to the Federal gift tax. d. Haydon pays an orthodontist for the dental work performed on Michele, his dependent cousin. This does not apply to the gift tax. The payments must be made directly to the provider. Also, there is no requirement that the beneficiary of the service qualifies as a dependent of the payee. e. Same as (d), except that Michele is not Hayden s dependent. There is still no gift tax, because there is no requirement that the beneficiary of the service qualifies as a dependent of the payee. f. Floyd creates a revocable trust with his children as the beneficiaries. Because it is a revocable trust, Floyd has not ceased to have dominion and control over the property and there is therefore no gift tax applied. g. Florence purchases a U.S. savings bond listing herself and Taylor (her daughter) as joint owners. No gift occurs on the creation of joint ownership in a bank account and U.S. savings bonds. h. Same as (g). One year later, Taylor predeceases Florence. No gift occurs since Taylor had no vested interest in the bond she possessed a mere expectancy of ownership. i. Same as (g). One year later, Florence predeceases Taylor. The transfer is testamentary (by death) and not by gift. 34. Natalie s estate includes the following assets: Fair Market Value Date of Death Six Months Later Apartment building $4,400,000 $4,380,000 Stock in Blue Corporation 1,200,000 1,300,000 Stock in Green Corporation 900, ,000 Accrued rents on the apartment building are as follows: $60,000 (date of death) and $70,000 (six months later). To pay expenses, the executor of Natalie s estate sells the Green stock for $650,000 five months after her death. a. If the section 2032 election is made, how much is included in Natalie s gross estate? $6,390,000 ($4,380,000+1,300, ,000+60,000). The accrued rents are always the date of death. b. As to part (a), assume that the Green stock is sold for $650,000 seven months (rather than five months) after Natalie s death. How does this change your answer, if at all? You would therefore use the FMV of the Green Corporation stock when it is 6 months later. The amount would then be $6,440,000. c. How much is included in the gross estate if the section 2032 election is not made? $6,560,000 ($4,400,000+1,200, ,000+60,000). 36. Carl made the following transfers during the current year: Transferred $900,000 in cash and securities to a revocable trust, life estate to himself and remainder interest to his three adult children by a former wife. No gift takes place on the creation of the trust. Carl has not ceased to have dominion and control over the property. In consideration of their upcoming marriage, gave Lindsey (age 21) a $90,000 convertible. This is a taxable gift of $90,000.

18 Purchased a $100,000 certificate of deposit listing title as Carl, payable on proof of death to Lindsey. This is not a taxable gift until Lindsey actually receives the CD. It is an incomplete transfer. Established a joint checking account with his wife, Catherine, in December of the current year with $30,000 of funds he inherited from his parents. In January of the following year, Catherine withdrew $15,000 of the funds and filed for divorce. $15,000 of this is a taxable gift in the following year. However, this is neutralized with the marital deduction. Purchased for $80,000 a paid-up insurance policy on his life (maturity value of $500,000). Carl designated Lindsey as the beneficiary. As the beneficiary of an unmatured insurance policy holds a mere contingent interest, no transfer has occurred. Paid $13,400 to a college for his niece s tuition and $6,000 for her room and board. The niece is not Carl s dependent. The room and board cost is subject to the gift tax. Gave his aunt $22,000 for her gallbladder operation. The aunt is not Carl s dependent. This is a taxable gift. The gift could have been avoided if the doctor/surgeon was paid directly instead of paid to his aunt. What are Carl s taxable gifts for the current year? 52. In each of the independent situations below, determine the transfer tax (i.e., estate and gift) consequences of what has occurred. (In all cases, assume that Gene and Mary are married and that Ashley is their daughter.) a. Mary purchases an insurance policy on Gene s life and designates Ashley as the beneficiary. Mary dies first, and under her will, the policy passes to Gene. No tax consequences result from the purchase of the policy. On Mary s death, the unmatured value of the policy will be included in her gross estate. A marital deduction in the same amount as the inclusion is allowed Mary s estate. b. Gene purchases an insurance policy on his life and designates Ashely as the beneficiary. Gene gives the policy to Mary and continues to pay the premiums thereon. Two years after the gift, Gene dies first, and the policy proceeds are paid to Ashley. Gene made a gift to Mary of the policy which need not be reported, due to the marital deduction. The payments of the premiums also represent nontaxable gifts. At Gene s death, the policy proceeds are included in Gene s gross estate under Because Mary owns the policy, she has made a gift of the proceeds to Ashley. It is hard to imagine a worse tax result! c. Gene purchases an insurance policy on Mary s life and designates Ashley as the beneficiary. Ashley dies first one year later. There is no taxable event that took place. d. Assume the same facts as in part (c). Two years later, Mary dies. Because Gene has not designated a new beneficiary, the insurance proceeds are paid to him. The proceeds will not be subject to any transfer tax. Neither Mary (as the insured) nor Ashley (as the former beneficiary) had any property interest in the policy. Furthermore, the policy proceeds paid to Gene will not be subject to income tax. e. Gene purchases an insurance policy on his life and designates Mary as the beneficiary. Gene dies first, and the policy proceeds are paid to Mary. The proceeds are included in Gene s gross estate under 2042 but qualify for the marital deduction under 2056.

19 CHAPTER 28: 19, 24, 28, Complete the following chart, indicating the comparative attributes of the typical simple trust and complex trust by answering yes/no or explaining the differences between the entities where appropriate. Attribute Simple Trust Complex Trust Trust could incur its own tax Yes (if capital gains are Yes liability during the year allocable to corpus). Trust generally distributes all of Yes Depends on the terms of the the DNI Trust can deduct its charitable contributions in the year of or the year after payment Trust could claim a foreign tax credit No; none of the beneficiaries can be charitable organizations No, such credit is assigned to pertinent taxpayers ratably, based on receipt of entity accounting income Yes agreement Yes Maximum tax rate on net longterm Yes capital gains = 20% AMT preferences and Yes Yes adjustments flow through to beneficiaries ratably Trust can adopt the FIFO Yes Yes method for its inventory assets; the grantor had been using lower of cost or market Trust can use a tax year other No (unless it is tax-exempt like No (unless it is tax-exempt like than the calendar year a pension plan) a pension plan) Amount of personal exemption $300 $100 or $300 depending on whether corpus payments or charitable donations are made 24. The Allwardt Trust is a simple trust that correctly uses the calendar year for tax purposes. Its income beneficiaries (Lucy and Ethel) are entitled to the trust s annual accounting income in shares of one-half each. For the current tax year, Allwardt reports the following: Ordinary Income $100,000 Long-term capital gains, allocable to corpus 30,000 Trustee commission expense, allocable to corpus 5,000 Use the format of Figure 28.3 to address the following items. a. How much income is each beneficiary entitled to receive? $50,000 b. What is the trust s DNI? $95,000 (100,000 5,000) c. What is the trust s taxable income? $29,700 [100,000+30,000-5, ,000] d. How much gross income is reported by each of the beneficiaries? $47,500 (95,000/2) Yes