Accounting 6120. Corporate Taxation Examination No. 2 Chapters 4 7. Name Spring, 2016. The University of North Carolina at Charlotte. March 16, 2016 Instructions: You may also use notes and other materials. The instructor will consider whether he can answer a question about the test, without defeating the purpose of a question. Avoid all appearances of impropriety. If you see any sign of impropriety, please prepare an anonymous note and slide it under the instructor's office door. Please turn in both the test and the computer answer sheet. Be sure to complete the name line above. On your Opscan Sheet, your Student ID Number is entered as your "Identification Number." Your test number is entered in the "special codes" area, right justified. Your test number is written in red at the top of this test. The grade for multiple choice questions will be determined as follows: 85 points, less 3 points per incorrect answer. The problem counts 15 points. Also, there is a 3 point bonus for completing the form below in good form (readable, etc.). 1. When will you graduate? CHECK ONE May 2016 Sum 2016 Dec 2016 Later 2. After grad., will you continue in a job you had before starting this program? If Yes, what company? Position or Duties? Yes No 3. While in our program, have you accepted full time employment? (or an internship) If Yes, what company? Position or Duties? Start date? Yes No 4. Are you currently seeking a Full time job? Type of company? Specialty? Yes No 5. Are you currently seeking a Part time job? Type of company? Specialty? Yes No 6. Email Address? Other than UNCC address C16-Chap-00-Tst-2-Exm-Prb-2016-3-09-2016-Post-Feb-2017. Page 1
1. Aaron would like to organize an organization as either an S corporation or as a C corporation. The corporation will earn an annual net income before tax of $500,000. Assume the corporate tax rates are 34%. The individual capital gains rate is 20% and individual ordinary income tax rate of 39.6%. The company will pay out its after tax earnings every year as a dividend if it is operated as a C corporation. Assume Aaron is the sole owner of the entity and ignore FICA taxes. Finally, assume Aaron is actively involved in the business. What is the amount of total income tax paid (by corporation and owner) if the corporation is a C corporation? a. $254,000 b. $291,000 c. $236,000 d. $255,000 e. Other 2. In its first year of existence (year 1), Charlotte Corporation (a C corporation) reported a loss for tax purposes of $30,000. In year 2 Charlotte reported a $20,000 loss. For year 3, Charlotte reports taxable income from operations of $100,000 before any loss carryovers. How much tax will Charlotte Corporation pay for year 3? a. $2,500 b. $7,500 c. $5,000 d. $0 e. Other 3. Atlanta Corporation (a construction corporation) is accumulating a significant amount of earnings and profits. Although the corporation is closely held, it is not a personal holding company. The following facts relate to the tax year: Dividend income from a qualified domestic corporation (less than 20% owned) $30,000 Taxable income $450,000 Federal income tax $153,000 Dividends paid in current year $120,000 Accumulated earnings credit $13,000 What is the amount of accumulated earnings tax on which the accumulated earnings tax is based? a. $37,000 b. $47,000 c. $0 d. $24,000 e. Other 4. The personal holding company tax a. Can be imposed on S corporations that do not regularly distribute their earnings b. Applies only to corporations that have only one owner. c. Should be self assessed by filing a separate schedule along with the regular tax return d. Cannot be imposed on a corporation that has undistributed earnings and profits of less than $150,000. 5. A corporation reports the following information for the year: Sales $500,000 Cost of sales and normal operating expenses (440,000) Net income from operations (before tax) 60,000 Dividend income on Apple common stock 20,000 Net income before tax $80,000 What it the amount of the corporation s taxable income for the year? a. $40,000 b. $56,000 c. $43,000 d. $66,000 e. Other 6. In 2015, Hickory Corporation, a domestic corporation, had income, expenses and deductions: Gross receipts (Operating Revenues) $195,000 Operating Expenses, (not including cash contributions) 135,000 Net operating income before income tax and before considering items below 60,000 Gross dividend income from IBM stock 10,000 Cash contributions to qualified charities 20,000 What is the amount of Hickory Corporation s allowable charitable contribution deduction for 2015? a. $1,000 b. $20,000 c. $4,000 d. $7,000 e. Other C16-Chap-00-Tst-2-Exm-Prb-2016-3-09-2016-Post-Feb-2017. Page 2
7. Niner Corporation owns stock in Bit Corp. Niner owns 40% of the Bit Corp. stock. Bit Corp's income for the year was $500,000. Niner received a $50,000 dividend from Bit Corp. What temporary book tax difference associated with the dividend will Niner report? (Consider only the income difference ignore the dividends received deduction)? a. $50,000 b. $150,000 c. $200,000 d. $250,000 e. Other 8. Assume that on January 1, year 1, ABC Inc. issued 5,000 nonqualified stock options with an estimated value of $10 per option. Each option entitles the owner to purchase one share of ABC stock for $25 a share (the per share price of ABC stock on January 1, year 1, when the options were granted). The options vest 50 percent at the end of the day on December 31, year 1, and 50 percent at the end of the day on December 31, year 2. All 5,000 stock options were exercised in year 3 when the ABC stock was valued at $31 per share. Identify ABC s year 1 book tax differences associated with the stock options. a. $0 b. $25,000 c. $50,000 d. $10,000 e. Other 9. In year 1, Chicago Corp. recognized a loss of $15,000 on land that it had held for investment. In year 1, Chicago recognized a $50,000 gain on equipment it had purchased a few years ago. The equipment sold for $70,000 and Chicago had paid $60,000 for the equipment and had deducted $40,000 of depreciation on the equipment. What book tax differences in year 1 associated with its capital gains and losses would CHICAGO Inc. report in the above scenario? a. $5,000 b. $10,000 c. $15,000 d. $20,000 e. Other 10. ATLANTA Corp. is currently in the sixth year of its existence (2015). In 2010 2014, it reported the following income (losses) before net operating loss carryovers or carrybacks: 2010: 2011: 2012: 2013: 2014: 2015: (70,000) (30,000) 60,000 40,000 (25,000) 300,000 What was ATLANTA s 2015 taxable income? a. $255,000 b. $275,000 c. $300,000 d. $325,000 e. Other 11. ABC s taxable income for the year is $25,000 and CBA s taxable income for the year is $100,000. John Smith owns 60% of ABC and 40% of CBA while Susan Williams (not related to John) owns 40% of ABC and 60% of CBA Compute the combined tax liability of the two corporations. a. $32,000 b. $35,000 c. $21,250 d. $25,000 e. Other 12. In year 1, GSL Corp. s alternative minimum tax base is $250,000 and its regular tax liability is $10,000. What is GSL s total tax liability (regular tax and AMT) for year 1? a. $10,000 b. $30,000 c. $40,000 d. $50,000 e. Other 13. Niner Corp.'s alternative minimum taxable income is $100,000 for the current year. Niner's alternative minimum tax exemption is: a. $0 b. $2,500 c. $27,500 d. $40,000 e. Other 14. Cass Corporation reported pre tax book income of $10,000,000. During the current year, the reserve for bad debts increased by $100,000. In addition, tax depreciation exceeded book depreciation by $200,000. Finally, the company received $250,000 of tax exempt life insurance proceeds from the death of one of its officers. Assuming a tax rate of 34%, compute the company s current income tax expense or benefit. a. $3,281,000 b. $4,281,000 c. $2,281,000 d. $281,000 e. Other C16-Chap-00-Tst-2-Exm-Prb-2016-3-09-2016-Post-Feb-2017. Page 3
15. Davison Company determined that the book basis of its office building exceeded the tax basis by $800,000. This basis difference is properly characterized as: a. Permanent difference b. Taxable temporary difference c. Deductible temporary difference d. Favorable book tax difference e. Both b and d above are correct 16. As of the beginning of the year, Gratiot Company recorded a valuation allowance of $200,000 against its deferred tax assets of $1,000,000. The valuation allowance relates to a net operating loss carryover from the prior year. During the year, management concludes that the valuation allowance should be increased. What is the impact of management s increase in the balance of the valuation allowance on the company s effective tax rate (ETR)? a. Increases the ETR b. Decreases the ETR c. No impact on the ETR 17. Charlotte Corporation. earned book net income before tax of $500,000 in 2014. In computing its book income, Charlotte deducted $50,000 more in warranty expense for book purposes than allowed for tax purposes. Charlotte had no other temporary or permanent differences. Assume the U.S. tax rate is 35%. No valuation allowance is required. How much current income tax expense is reported on its financial statements for 2014? a. $175,000 b. $192,500 c. $157,500 d. $17,500 e. Other 18. Charlotte Corp.'s books showed pretax income of $800,000 for the year ended December 31, 2015. In the computation of federal income taxes, the following data were considered: Interest revenue on municipal bonds $350,000 Depreciation deducted for tax purposes in excess of book depreciation $50,000 Enacted federal tax rates, 2015 30% What amount of the company s book equivalent of taxable income? a. $ 450,000 b. $ 800,000 c. $400,000 d. $435,000 e. Other 19. Abbot Corporation reported the following information for 2015 Pretax book income $500,000 Increase in the reserve for bad debts $5,000 Tax depreciation exceeded GAAP depreciation by $40,000 Received life insurance proceeds on death of an officer $3,000 Income tax rate 34%, Abbot's current income tax expense or benefit would be a. $186,320 b. $170,000 c. $157,080 d. $153,680 e. Other 20. York Company reports current E&P of $300,000 and accumulated negative E&P of $200,000. York distributed $400,000 to its sole shareholder on the last day of the year. The shareholder s tax basis in her York stock is $75,000. How much of the $400,000 distribution is treated as a dividend by the shareholder? a. $300,000 b. $200,000 c. $100,000 d. $0 e. Other 21. This year, Silver Company reports current E&P of negative $300,000. Its accumulated E&P at the beginning of the year was $200,000. Silver distributed $400,000 to its sole shareholder on March 31 of this year. The shareholder s tax basis in his Silver stock is $75,000. How much of the $400,000 distribution is a dividend? a. $125,000 b. $75,000 c. $150,000 d. $50,000 e. Other C16-Chap-00-Tst-2-Exm-Prb-2016-3-09-2016-Post-Feb-2017. Page 4
22. Gold Corporation declared a stock dividend to all shareholders of record on March 25 of this year. Shareholders will receive one share of Gold stock for each ten shares of stock they already own. Brenda owns 1,000 shares of Gold stock with a tax basis of $100 per share. The fair market value of the Gold Corporation stock was $110 per share on March 25 of this year. Brenda had the choice of receiving 1 share of stock in Gold Corporation for each 10 shares she owned or $100 cash for each 10 shares she owned in the company. She chose to receive the stock. How much dividend income does she report? a. $0 b. $10,000 c. $11,000 d. $$100,000 e. Other 23. Bronze Corp., which had current and accumulated earnings and profits of $500,000. Bronze made a non liquidating distribution of appreciated land to its shareholders in the year. This property had an adjusted basis of $40,000 and a fair market value of $50,000 at the date of distribution. How much gain did Bronze recognize on this distribution? a. $0 b. $10,000 c. $50,000 d. $50,000 24. A majority stockholder of Gastonia Corporation wishes to get access to some of the excess cash in the corporation. Gastonia Corporations is owned 90% by Arnold and 10% by Betty. Arnold owns 90 shares with a cost of $100 per share. Betty owns 10 shares with a cost of $100 per share. The company redeems 50 shares from Arnold at a redemption price of $300 per share. No stock is redeemed from Betty. This is not a redemption to pay death taxes, and it is not a partial liquidation. What is tax impact on Arnold? a. Dividend income of $15,000 c. Dividend income of $10,000 b. Capital gain of $15,000 d. Capital gain of $10,000 e. Other 25. Time for a rest. Would your rather have a. a headache b. a good grade on this test C16-Chap-00-Tst-2-Exm-Prb-2016-3-09-2016-Post-Feb-2017. Page 5
1 C 2 B 3 A 4 C 5 D 6 D 7 B 8 B 9 A 10 B 11 A 12 D 13 D 14 A 15 E 16 A 17 B 18 A 19 C 20 A 21 A 22 C 23 B 24 A 25 B C16-Chap-00-Tst-2-Exm-Prb-2016-3-09-2016-Post-Feb-2017. Page 6
Information for Ann Corporation's first year of operations. Company was organized on 1-1-2015. Balance Sheet 12-31-2015 Income Statement-2015 Cash $200,000 Revenue from repair services $400,000 Savings account 180,000 Interest earned on Municipal Bonds 40,000 Prepaid expense 80,000 Salary expense- 100% to Owner $100,000 Total current assets 460,000 Depreciation expense 50,000 Property & equipment $350,000 Loss on sale of capital asset 50,000 Accum. depreciation (50,000) Interest expense 15,000 Book value of property 300,000 Other expense 175,000 Other assets including DTA 100,000 Total Expense 390,000 Total non-current assets 400,000 Net Income before Tax 50,000 Total assets $860,000 Current income tax expense $24,000 Income tax payable $24,000 Deferred income tax expense (benefit) (20,000) 4,000 Notes payable (10%) 150,000 Net Income after Tax $46,000 Other liabilities 40,000 Retained Earnings Statement - 2015 Total liabilities $214,000 Retained earnings - beginning balance $0 Common stock ($100 par) $600,000 Net income 46,000 Retained earnings 46,000 Total 46,000 Total owner equity 646,000 Dividends paid Total liabilities & equity $860,000 Retained earnings - ending balance $46,000 There has been no change in ownership since Ann started Ann Corp. with a cash investment on 1-1-2015. S Status is not elected. All sales are on credit. Income tax rate is 40%. There are only two book-tax adjustments needed to arrive at taxable income. Part 1. Enter net income before tax. Enter the adjustments needed to compute taxable income. Enter the amount of taxable income for the year. Net income before tax (shown above) 50,000 Part 2. Explain the tax rules that make it necessary for you to make those adjustments Part 3. Using information for the company above, please complete Schedules M-1 and M-2 on the next page. C16-Chap-00-Tst-2-Exm-Prb-2016-3-09-2016-Post-Feb-2017. Page 7
Schedule M 1 1 Net income (loss) per books 7 Income recorded on books this year 2 Federal income tax per books not included on this return (itemize): 3 Excess of capital losses over capital gains Tax exempt interest 4 Income subject to tax not recorded on books this year 8 Deductions on this return not charged against book income this year (itemize): 5 Expenses recorded on books this year a Depreciation not deducted on this return (itemize): b Contributions carryover a Depreciation b Charitable contributions c Travel and entertainment d Bad Debts 9 Add lines 7 and 8 6 Add lines 1 throuqh 5 10 Income (Ln 28, page 1) ln 6 less ln 9 Schedule M 2 Analysis of Unappropriated Retained Earnings per Books (Line 25, Schedule L) 1 Balance at beginning of year 5 Distributions: a Cash 2 Net income (loss) per books b Stock 3 Other increases (itemize): c Property 6 Other decreases (itemize): 7 Add lines 5 and 6 4 Add lines 1. 2. and 3 8 Balance at end of year (line 4 less line 7) C16-Chap-00-Tst-2-Exm-Prb-2016-3-09-2016-Post-Feb-2017. Page 8
Chapter 4 C16-Chap-00-Tst-2-Exm-Sol-2016-3-09-2016-Post-Feb-27-2017 Page 1 of 5 1 C Connect problem S Corp. C. Corp. Pretax earnings 500,000 500,000 Entity Tax Rate 34% Entity level tax 0 170,000 Entity after tax income 500,000 330,000 Owner tax rate 39.6% 20% Owner tax 198,000 66,000 Entity income tax 0 170,000 Total income tax 198,000 236,000 Owner after tax income 302,000 264,000 40% 47% 2 B Connect problem Description (1) Year 3 taxable income $100,000 (2) Year 1 NOL carryforward ($30,000) (3) Year 2 NOL carryforward ($20,000) (4) Taxable income reported $50,000 (5) Tax rate 15% Taxes paid in year 3 $7,500 3 A Unreasonable Accumulation of Earnings Taxable income $450,000 Adjustments: Plus: Dividend received deduction 21,000 Minus: Federal income tax liability (153,000) Dividends paid (120,000) (120,000) Accumulated Earnings Credit (13,000) Accumulated taxable income $185,000 Answer Times: Accumulated earnings tax rate 20.0% Accumulated earnings tax $37,000 37200 A corporation must pay its profits out as a dividend, or have good reasons for not paying dividends (business needs). Otherwise pay the penalty tax. 4 C 5 D A corporation reports the following for the year: Sales Cost of sales and normal operating expenses Net income from operations (before tax) Dividend income on Apple Corporation stock Net income before tax $500,000 (440,000) 60,000 20,000 $80,000 Dividend Income $20,000 Dividend Received deduction 70% ($14,000) Taxable income $66,000
Chapter 5 C16-Chap-00-Tst-2-Exm-Sol-2016-3-09-2016-Post-Feb-27-2017 Page 2 of 5 6 D Hickory Corp, a domestic corp, had income, expenses and deductions: Gross receipts (Operating Revenues) $195,000 Operating Expenses, (not including cash contributions) 135,000 Net operating income before income tax & items below 60,000 Gross dividend income from IBM stock 10,000 Net income before Charity and Dividend Received deduction 70,000 Cash contributions to qualified charities 20,000 Charitable contribution deduction for 2015? $7,000 Charitable contribution deduction limit is 10% of taxable income before DRD, etc. 7 B Bit Corp. After tax income $500,000 40% Income using Equity Method 200,000 Dividend income Tax Return 50,000 Difference $150,000 8 B GAAP Value of options at grant GAAP Expense for options vesting year 1 TAX expense for year 1 Difference $50,000 25,000 0 $25,000 Expense recognized on tax return when exercised (in this case). 9 A Loss on sale of land held as an investment 15,000 Capital loss Equipment cost 60,000 Acc. Deprec. 40,000 Book Value 20,000 Selling Price 70,000 Gain 50,000 Ordinary income 40,000 40,000 GAAP and Tax income Capital gain 10,000 10,000 Capital gain 10 B 2010 (70,000) 2011 (30,000) 2012 60,000 2013 40,000 2015 (25,000) (25,000) 2016 300,000 300,000 $275,000 If Atlanta does not elect to forgo any NOL carrybacks, what is its 2015 taxable income after the NOL deduction? $275,000 taxable income.
Chapter 5 C16-Chap-00-Tst-2-Exm-Sol-2016-3-09-2016-Post-Feb-27-2017 Page 3 of 5 11 A $50,000 15% 7,500 $25,000 25% 6,250 $25,000 34% 8,500 $25,000 39% 9,750 $125,000 32,000 $100,000 15% 15,000 $25,000 25% 6,250 21,250 12 D AMT Corporation Alternative Minimum Tax Taxable income Tax preference items & Adjustments Alternative minimum taxable income Minus: Exemption Tax base for AMT 250,000 Tax (AMT base X 20%) 50,000 Minus: Regular tax liability 10,000 Alternative Minimum Tax $40,000 Total Tax $50,000 13 D AMT Corporation Alternative Minimum Tax AMT Exemption AMTI $100,000 Floor 150,000 Excess over Floor Phase out Rate 25% Reduction in exemption Unadjusted Exemption Amount 40,000 Exemption allowed $40,000
Chapter 6 C16-Chap-00-Tst-2-Exm-Sol-2016-3-09-2016-Post-Feb-27-2017 Page 4 of 5 Cass 14 A Pre tax book income 10,000,000 Increase in bad debt reserve 100,000 Excess tax depreciation (200,000) Tax exempt life insurance proceeds (250,000) Taxable income 9,650,000 34% Current income tax expense 3,281,000 15 E Taxable temporary difference and favorable book tax difference. Future taxable income will increase by $800,000 compared to future book income as the excess book basis is recovered, resulting in a future tax payable. 16 A Decreases the ETR. Increasing the allowance account increases tax expense. 17 B North GAAP Return Revenue? Expenses? Book net income Before Tax $500,000 $500,000 Warranty Expense GAAP? Warranty Expense on Tax Return? Excess GAAP Warranty Expense $50,000 $50,000 Book net income Before Tax $500,000 Taxable income $550,000 Income tax rate 35% 35% GAAP provision for income tax $175,000 Income tax currently payable $192,500 18 A Pretax book income $800,000 Remove permanent book tax difference ($350,000) Book equivalent of taxable income (includes temp. differences) $450,000 34% Tax to be paid this year, or in the future $153,000 Note: this is a guess of the sum of current and deferred income tax expense. See the following text taken from our textbook. Page 6 22. Under the assumption that all temporary differences will appear on a tax return in a current or future period, the total tax provision should reflect the tax that ultimately will be paid on pretax net income adjusted for permanent differences. This is a straightforward back-of-the-envelope method of verifying the ASC 740 approach to calculating total tax provision - using a company's book equivalent of taxable income. The total income tax provision should equal the company's tax rate, multiplied by its book equivalent of taxable income. [Sum of current tax expense (benefit) and deferred tax expense (benefit)] We would emphasize that this approach to computing a company's income tax provision is not in accordance with GAAP and will not provide the correct answer when there are changes in a company's income tax rate. 19 C Pretax book income $500,000 Increase in the reserve for bad debts $5,000 Tax depreciation exceeded GAAP depreciation by ($40,000) Received life insurance proceeds on death of an officer ($3,000) $462,000 34% Current income tax expense $157,080
Chapter 7 C16-Chap-00-Tst-2-Exm-Sol-2016-3-09-2016-Post-Feb-27-2017 Page 5 of 5 20 A Christine has distribution of $300,000, all of which is from the company s current E&P. So, she has dividend income of $300,000. 21 A Silver reports a dividend of $50,000. At beginning of the year, accumulated E&P is $200,000 He first computes balance in E&P as of June 30 by allocating the deficit in current E&P pro rata over the year. The deficit in current E&P on June 30 is negative $75,000, computed as [($300,000) x 3/12]. Hence, accumulated E&P as of June 30 is $125,000, computed as $200,000 $75,000. Current E&P for year ($300,000) Fraction of year 25% Loss in first quarter ($75,000) Begin. Accumulated E&P $200,000 E&P on date of dividend $125,000 22 C If Brenda chooses the Gold stock, she would have a taxable dividend equal to $11,000, computed as 1,000/10 x $110, because the distribution has the potential to be non pro rata to the shareholders. Brenda s tax basis in the stock she receives will equal its fair market value of $11,000 (100 x $110). If Brenda choose the cash, she would be taxed on the amount of cash received, $10,000. 23 B A corporation recognizes a gain on a distribution of appreciated property to a shareholder, as if the corporation sold the property at Fair Market Value. 24 A Shares % Owned Shares % Owned Before Before After redemption After redemption Arnold 90 90% 40 80% Betty 10 10% 10 20% Total 100 100% 50 100% After the stock redemption, Arnold owns 80% of the outstanding stock (90% before). To be disproportionate, his ownership must be less than 72% (80% of 90%). So he fails one test. Also fails the another test. Must be a minority shareholder after the redemption. He owns 80%. Redemptions That Are Substantially Disproportionate - textbook pg. 7-21. The IRC states in 302(b)(2) that a redemption will be treated as an exchange if the redemption is substantially disproportionate with respect to the shareholder. A shareholder meets this requirement by satisfying all three stock ownership tests: 1 Immediately after the exchange, the shareholder owns less than 50 percent of the total combined voting power of all classes of stock entitled to vote. 2 The shareholder's percentage ownership of voting stock after the redemption is less than 80 percent of his or her percentage ownership before the redemption. 3 The shareholder's percentage ownership of the aggregate fair market value of the corporation's common stock (voting and nonvoting) after the redemption is less than 80 percent of his or her percentage ownership before the redemption. 25 B