ACC 565 Week 5 Midterm Exam – Strayer University NEW

ACC/565 Week 5 Midterm Exam – Strayer NEW

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Chapters 1 Through 7

Chapter 1 Tax Research

1) Tax planning is not an integral part of open-fact situations.

Page Ref.: C:1-2
Objective: 1

2) The Internal Revenue Code of 1986 contains the current version of the tax law.

Page Ref.: C:1-8
Objective: 4

3) Regulations issued prior to the latest tax legislation dealing with a specific Code section are still effective to the extent they do not conflict with the provisions in the new legislation.

Page Ref.: C:1-9
Objective: 4

4) Final regulations have almost the same legislative weight as the IRC.

Page Ref.: C:1-10
Objective: 4

5) A revenue ruling is issued by the Internal Revenue Service only in response to a verbal inquiry by a taxpayer.

Page Ref.: C:1-12
Objective: 4

6) Taxpayers must pay the disputed tax prior to filing a case with the Tax Court.

Page Ref.: C:1-14
Objective: 4

7) Appeals from the U.S. Tax Court are to the Court of Appeals for the Federal Circuit.

Page Ref.: C:1-14
Objective: 4

8) Appeals from the Court of Appeals go to the Supreme Court under a writ of certiorari. The Supreme Court decides whether or not they will hear the case.

Page Ref.: C:1-14
Objective: 4

9) A citator enables tax researchers to locate authorities (e.g., cases and IRS pronouncements) that have cited a particular case.

Page Ref.: C:1-30
Objective: 7
10) According to the Statements on Standards for Tax Services, CPAs must verify all tax return information submitted by reviewing client documentation.

Page Ref.: C:1-33
Objective: 8

11) When a taxpayer contacts a tax advisor requesting advice as to the most advantageous way to dispose of a stock, the tax advisor is faced with
A) a restricted-fact situation.
B) a closed-fact situation.
C) an open-fact situation.
D) a recognized-fact situation.

Page Ref.: C:1-2
Objective: 1

12) Investigation of a tax problem that involves a closed-fact situation means that
A) the client’s transactions have already occurred and the tax questions must now be resolved.
B) the client’s tax return has yet to be filed.
C) future events may be planned and controlled.
D) research is primarily concerned with applying the law to the facts as they exist.

Page Ref.: C:1-2
Objective: 1

13) Identify which of the following statements is true.
A) Tax planning is an integral part of both closed-fact situations and open-fact situations.
B) The first step in conducting tax research is to clearly understand the issues involved.
C) The Statements on Standards for Tax Services recommend that only written tax advice be provided to the client in all situations.
D) All of the above are false.

Page Ref.: C:1-5
Objective: 2

14) The term “tax law” includes
A) legislation.
B) treasury regulations.
C) judicial decisions.
D) all of the above

Page Ref.: C:1-7
Objective: 4
15) Identify which of the following statements is false.
A) When tax advisors speak of the “tax law,” they usually have in mind just the Internal Revenue Code.
B) Members from both the House and the Senate are on the Conference Committee.
C) Records of committee hearings are helpful in determining Congressional intent.
D) All of the above are false.

Page Ref.: C:1-7
Objective: 4

16) The committee that is responsible for holding hearings on tax legislation for the House of Representatives is the
A) Finance Committee.
B) Joint Committee on Taxation.
C) Conference Committee.
D) Ways and Means Committee.

Page Ref.: C:1-7
Objective: 4

17) A tax bill introduced in the House of Representatives is then
A) referred to the House Ways and Means Committee for hearings and approval.
B) referred to the entire House for hearings.
C) voted upon by the entire House.
D) forwarded to the Senate Finance Committee for consideration.

Page Ref.: C:1-7
Objective: 4

18) The Senate equivalent of the House Ways and Means Committee is the Senate
A) Finance Committee.
B) Ways and Means Committee.
C) Tax Committee.
D) Joint Conference Committee.

Page Ref.: C:1-7
Objective: 4

19) Which of the following steps, related to a tax bill, occurs first?
A) signature or veto by the President of the United States
B) consideration by the Senate Finance Committee
C) consideration by the entire Senate
D) consideration by the House Ways and Means Committee

Page Ref.: C:1-7
Objective: 4

20) When the House and Senate versions of a tax bill are not in agreement, the disagreements are resolved by the
A) Ways and Means Committee.
B) Mediation Committee.
C) Revenue Committee.
D) Conference Committee.

Page Ref.: C:1-7
Objective: 4

21) Identify which of the following statements is true.
A) Paragraph references are most commonly used when citing or referring to the tax statutes.
B) Title 26 of the United States Code and the Internal Revenue Code of 1986 are synonymous.
C) Before 1939, tax statutes were codified or compiled into one document.
D) The Internal Revenue Code contains chapters, which are further subdivided into titles.

Page Ref.: C:1-8
Objective: 4

22) Title 26 of the U.S. Code includes
A) income tax legislation only.
B) gift tax and estate tax legislation only.
C) alcohol and tobacco tax legislation only.
D) all of the tax legislation mentioned above.

Page Ref.: C:1-8
Objective: 4

23) The tax statutes with the popular name “The Internal Revenue Code of 1986” are contained in which Title of the Code?
A) 20
B) 25
C) 26
D) 301

Page Ref.: C:1-8
Objective: 4

24) Which of the following statements regarding proposed regulations is not correct?
A) Proposed regulations expire after three years.
B) Practitioners and other interested parties may comment on proposed regulations.
C) Proposed and temporary regulations are generally issued simultaneously.
D) Proposed regulations do not provide any insight into the IRS’s interpretation of the tax law.

Page Ref.: C:1-9
Objective: 4

25) Final regulations can take effect on any of the following dates except
A) the effective date of the statutory language they interpret, provided they are issued within 18 months of the date of the change to the statute.
B) the date on which final regulations were proposed.
C) the date on which related temporary regulations were first published in the Federal Register.
D) the date on which they were issued in final form.

Page Ref.: C:1-10
Objective: 4

26) When Congress passes a statute with language such as, “The Secretary shall prescribe such regulations as he may deem necessary,” the regulations ultimately issued for that statute are
A) congressional regulations.
B) statutory regulations.
C) interpretative regulations.
D) legislative regulations.

Page Ref.: C:1-10
Objective: 4

27) Regulations are
A) equal in authority to legislation.
B) equal in authority to legislation if statutory.
C) presumed to be valid and to have almost the same weight as the IRC.
D) equal in authority to legislation if interpretative.

Page Ref.: C:1-10
Objective: 4

28) Identify which of the following statements is true.
A) If regulations are issued prior to the latest tax legislation dealing with a specific Code section, the regulations are no longer effective to the extent they conflict with the provisions in the new legislation.
B) Legislative regulations are more likely to be invalidated by the courts than are interpretative regulations.
C) Regulations have more authoritative weight than tax statues.
D) All of the above are false.

Page Ref.: C:1-9
Objective: 4

29) Identify which of the following statements is false.
A) The number “5” in the citation Reg. Sec. 1.166-5 refers to the paragraph number.
B) The Cumulative Bulletin is issued semiannually while the Internal Revenue Bulletin is issued weekly.
C) The citation Rev. Rul. 2006-5, I.R.B. 2006-1, 33, indicates that the revenue ruling can be found on page 33 of the 1st I.R.B. for 2006.
D) All of the above are false.

Page Ref.: C:1-11
Objective: 4
30) The number appearing immediately following the decimal place in a regulation citation refers to the
A) general subject matter of the regulation.
B) code section being interpreted.
C) sequential number of the regulation.
D) subsection of the Code section being interpreted.

Page Ref.: C:1-11
Objective: 4

31) The citation “Reg. Sec. 1.199-2” refers to
A) the first regulation issued in 1999.
B) the second regulation issued in 1999.
C) a regulation that interprets Code Section 199.
D) a regulation that can be found on page 199.

Page Ref.: C:1-11
Objective: 4

32) Which regulation deals with Code Section 165?
A) Reg. Sec. 1.165-5
B) Reg. Sec. 165.183-5
C) Reg. Sec. 1.5-165
D) Reg. Sec. 165-5

Page Ref.: C:1-11
Objective: 4

33) Which regulation deals with the gift tax?
A) Reg. Sec. 1.165-5
B) Reg. Sec. 20.2014-5
C) Reg. Sec. 25.2518-5
D) Reg. Sec. 301.7002-5

Page Ref.: C:1-11
Objective: 4

34) Which of the following best describes the weight of a revenue ruling?
A) Revenue rulings carry more weight than regulations.
B) Revenue rulings carry more weight than federal court decisions.
C) Regulations carry more weight than revenue rulings.
D) Revenue rulings should never be used as authority since they only apply to the taxpayer requesting the ruling.

Page Ref.: C:1-12
Objective: 4

35) The citation “Rev. Rul. 2006-8, 2006-1 C.B. 541” refers to
A) the eighth ruling of 2006 found on page 541 in Vol. 1 of the 2006 Cumulative Bulletin.
B) the eighth ruling of 2006 found on page 541 in the 2006 volume of the Cumulative Bulletin.
C) the 541st ruling of 2006 found on page eight in Vol. 1 of the 2006 Cumulative Bulletin.
D) the 1st ruling of 2006 found on page 541 in the 2006 volume of the Cumulative Bulletin.

Page Ref.: C:1-12
Objective: 4

36) Which of the following documents is issued by the IRS to a specific taxpayer?
A) regulation
B) revenue procedure
C) letter ruling
D) information release

Page Ref.: C:1-12
Objective: 4

37) Identify which of the following statements is false.
A) A revenue ruling is issued by the Internal Revenue Service only in response to a written inquiry by a taxpayer.
B) Rev. Proc. 2006-19 is a revenue procedure that was published in 2006.
C) The citation Ltr. Rul. 200611075 usually indicates the ruling was made public in the 11th week of 2006.
D) A technical advice memorandum is made available as a letter ruling.

Page Ref.: C:1-11 through C:1-13
Objective: 4

38) Identify which of the following statements is false.
A) Letter rulings are not published by the U.S. Government Printing Office.
B) Technical advice memoranda are issued by the Internal Revenue Service’s National Office to provide an answer to a technical question that arises in an audit.
C) The citation Ann. 2006-12, I.R.B. 2006-51, 22 refers to an annotation of an Internal Revenue Service release.
D) Announcements are more technical than information releases.

Page Ref.: C:1-13
Objective: 4

39) A Technical Advice Memorandum is usually
A) an internal IRS document describing alternative legislative proposals.
B) part of a Tax Court decision.
C) requested by the taxpayer before entering into a taxable transaction.
D) issued by the national office in response to an audit request.

Page Ref.: C:1-13
Objective: 4

40) Which of the following courts is not a trial court for tax cases?
A) U.S. Bankruptcy Court
B) U.S. District Court
C) U.S. Tax Court
D) U.S. Court of Federal Claims

Page Ref.: C:1-14
Objective: 4

41) The taxpayer need not pay the disputed tax in advance when the suit is initiated in
A) U.S. Court of Federal Claims.
B) U.S. Tax Court.
C) U.S. District Court.
D) both A and B.

Page Ref.: C:1-14
Objective: 4

42) If the U.S. Supreme Court decides to hear an appeal a tax case, it will grant a
A) writ of appeal.
B) writ of certiorari.
C) writ of detainer.
D) writ of habeas corpus.

Page Ref.: C:1-14
Objective: 4

43) Tax Court memorandum decisions
A) cannot be appealed.
B) are not published.
C) have less precedential value than regular decisions.
D) usually deal with factual variations of issues litigated previously.

Page Ref.: C:1-15 and C:1-17
Objective: 4

44) George’s case was handled under the “small tax case procedure.” He does not agree with the findings of the Tax Court. He would like to appeal the decision. Which one of the following is true?
A) There is no appeal.
B) He can appeal the case, but only if the amount of tax involved is greater than $5,000.
C) He would appeal first to the U.S. Court of Appeals for the Federal Circuit.
D) He would appeal first to the U.S. Court of Federal Claims.

Page Ref.: C:1-17
Objective: 4

45) Identify which of the following statements is false.
A) The acquiescence policy was adopted by the U.S. Tax Court to permit litigating parties to agree on the exact amount of the tax due.
B) Letter rulings are binding only with respect to the taxpayer requesting the ruling.
C) The small cases procedure of the U.S. Tax Court allows a less formal hearing but provides for no appeal.
D) The IRS may retroactively revoke an acquiescence.

Page Ref.: C:1-17
Objective: 4

46) The phrase “Entered under Rule 155” indicates that
A) the computation of the exact amount of the tax deficiency has been left to the litigating parties.
B) the court has not reached a decision concerning the appropriate tax treatment of an issue.
C) the parties have agreed not to appeal the decision.
D) only one Tax Court judge reviewed the case.

Page Ref.: C:1-17
Objective: 4

47) Small case procedures of the U.S. Tax Court requires that the amount in dispute not exceed
A) $5,000.
B) $10,000.
C) $50,000.
D) $100,000.

Page Ref.: C:1-17
Objective: 4

48) The acquiescence policy of the IRS extends to the
A) U.S. Supreme Court decisions.
B) U.S. Tax Court regular decisions.
C) U.S. District Court decisions.
D) both B and C

Page Ref.: C:1-17
Objective: 4

49) A tax case cannot be appealed when initiated in the
A) U.S. Court of Federal Claims.
B) U.S. Tax Court.
C) U.S. Tax Court using the small case procedures.
D) none of the above

Page Ref.: C:1-17
Objective: 4

50) Identify which of the following statements is false.
A) Regular and memorandum decisions of the Tax Court are published by the government in the Tax Court of the United States Reports.
B) The citation Cristofani, 97 T.C. 74 (1991) indicates that the decision is a regular decision of the Tax Court.
C) The citation Estate of Newhouse, 94 T.C. 193 (1990), nonacq. 1991-1 C.B. 1 indicates that the IRS did not formally disagree with this 1990 Tax Court decision until 1991.
D) The Board of Tax Appeals preceded the Tax Court.

Page Ref.: C:1-17
Objective: 4

51) Which of the following citations denotes a regular decision of the Tax Court?
A) 41 TCM 1272
B) 35 T.C. 1083 (2003)
C) 39 AFTR 2d 77-640
D) all of the above

Page Ref.: C:1-17
Objective: 7

52) You have the following citation: Joel Munro, 92 T.C. 71 (1989). Which of the following statements is true?
A) The taxpayer, Joel Munro, won the case because there is no reference to the IRS.
B) The case appears on page 71 in Volume 92 of the official Tax Court of the United States Reports and the case was decided in 1989.
C) This citation refers to a taxpayer conference between the IRS and the taxpayer.
D) The case was tried in 1989 and was appealed in 1992.

Page Ref.: C:1-17
Objective: 1

53) You need to locate a recent tax case that was tried in a Federal district court. The decision is an “unreported” decision. This means the decision was
A) not published in the Federal Supplement.
B) not published in American Federal Tax Reports.
C) not published in United States Tax Cases.
D) settled out of court.

Page Ref.: C:1-18
Objective: 4

54) A jury trial is permitted in the
A) U.S. District Court.
B) U.S. Tax Court.
C) U.S. Court of Federal Claims.
D) U.S. Tax Court when the small case procedures are used.

Page Ref.: C:1-18
Objective: 4
55) Which of the following citations is the primary citation for a U.S. District Court case?
A) 43 AFTR 2d 79-1023
B) 79-1 USTC &9323
C) 55 F.2d 930
D) 40 F.Supp. 453

Page Ref.: C:1-19
Objective: 4

56) Identify which of the following statements is true.
A) The citation, 41 TCM 1272, refers to a Tax Court regular decision published by Commerce Clearing House.
B) The Federal Supplement contains only tax cases.
C) The American Federal Tax Reports contain only tax cases.
D) All of the above are false.

Page Ref.: C:1-19
Objective: 4

57) Identify which of the following statements is true.
A) The U.S. Court of Federal Claims hears cases only in Washington, D.C.
B) Each state has at least one U.S. District Court.
C) Federal district court decisions and federal courts of appeals decisions are not printed by the U.S. Government Printing Office.
D) All of the above are false.

Page Ref.: C:1-18
Objective: 4

58) The primary citation for a federal circuit court of appeals case would be
A) 40 AFTR 2d 78-1234.
B) 44 F.Supp. 403.
C) 3 F.3d 134.
D) 79-2 USTC & 9693.

Page Ref.: C:1-20
Objective: 7

59) Identify which of the following statements is false.
A) Citations to the AFTR and the USTC are referred to as secondary citations.
B) A circuit court of appeals must follow the opinion of another circuit court of appeals if the latter appeals court has previously ruled on the tax issue.
C) A U.S. Supreme Court opinion in a tax matter has the same status as Congressional tax legislation.
D) Circuit Court decisions are reported in the Federal Reporter.

Page Ref.: C:1-20
Objective: 4
60) Identify which of the following statements is false.
A) The U.S. Tax Court must follow the previous decisions of the U.S. District Court for the district in which the taxpayer lives.
B) The U.S. Tax Court follows the previous decisions of the U.S. Court of Appeals to which the tax matter is appealable.
C) The opportunity for “forum shopping” occurs when different precedents on the same point exist.
D) The U. S. Tax Court may intentionally issue conflicting decisions.

Page Ref.: C:1-21
Objective: 4

61) When the Tax Court follows the opinion of the circuit court of appeals to which the case is appealable, the court is following the
A) Golsen rule.
B) Acquiescence rule.
C) Forum shopping rule.
D) Conformity rule.

Page Ref.: C:1-21
Objective: 1

62) The Tax Court departs from its general policy of ruling uniformly for all taxpayers where
A) a U.S. District Court has ruled differently on the issue in the taxpayer’s jurisdiction.
B) the U.S. Court of Federal Claims has ruled differently on the issue in the taxpayer’s jurisdiction.
C) the Court of Appeals in the circuit to which the Tax Court decision would be appealed has ruled differently on the issue.
D) the IRS has indicated that it will acquiesce.

Page Ref.: C:1-21
Objective: 4

63) Identify which of the following statements is false.
A) When a court opinion discusses facts and issues on which the court does not rule, the comments are called dicta.
B) Dicta in a court opinion has no influence on other tax proceedings.
C) Published articles and tax services are examples of secondary sources of authority.
D) Dicta are not authoritative.

Page Ref.: C:1-23
Objective: 4

64) When a court discusses issues not raised by the facts, the comments
A) are excluded from the formal court opinion.
B) may be referenced by the parties in other cases having the same facts.
C) are not dicta.
D) will cause the court’s decision to be declared invalid.

Page Ref.: C:1-23
Objective: 4
65) Which of the following is a true statement regarding primary authority of tax law?
A) Articles in The Journal of Taxation are viewed as primary authority.
B) Primary authority includes the Code, as well as administrative and judicial interpretations.
C) The Bloomberg BNA Daily Tax Reporter is a source of primary tax authority.
D) Tax services are sources of primary tax authority.

Page Ref.: C:1-24
Objective: 4

66) Which of the following is secondary authority?
A) Internal Revenue Code
B) Treasury Regulations
C) RIA and CCH tax services
D) Revenue Ruling

Page Ref.: C:1-24
Objective: 4

67) Identify which of the following statements is true.
A) RIA United States Tax Reporter and CCH Standard Federal Tax Reporter are topical tax services.
B) An annotated tax service is organized by broad subject areas.
C) Annotations are summaries of IRS pronouncements and court opinions.
D) All of the above are false.

Page Ref.: C:1-25
Objective: 5

68) Internet versions of topical tax services include
A) Code and Regulations.
B) Revenue rulings, letter rulings, and revenue procedures.
C) Court cases involving tax issues.
D) All of the above.

Page Ref.: C:1-26
Objective: 6

69) Which tax service is usually deemed to be the most authoritative?
A) United States Tax Reporter
B) Standard Federal Tax Reporter
C) Federal Tax Coordinator 2d
D) All are equally authoritative.

Page Ref.: C:1-25
Objective: 5
70) Assume that you want to read a description of a particular area of the law, along with one or more illustrations of how that law is applied. You will not find that type of material in
A) a citator.
B) the Treasury Regulations.
C) the Cumulative Bulletin.
D) the Committee Reports.

Page Ref.: C:1-30
Objective: 7

71) Why does a researcher use a citator?
A) to check on authorities issued subsequent to a court decision
B) to determine whether a private letter ruling exists on the subject
C) for examples of the application of a tax provision
D) none of the above

Page Ref.: C:1-30
Objective: 7

72) A citator is used to find
A) the judicial history of a case.
B) the cases that have cited a case subsequent to the issuance of the opinion.
C) whether a case has been overturned.
D) all of the above.

Page Ref.: C:1-30
Objective: 7

73) Which of the following statements about the Statements on Standards for Tax Services is true?
A) A CPA is never allowed to use a taxpayer’s estimates when preparing a tax return.
B) The CPA must tell the IRS upon becoming aware that an error has been made on a past tax return.
C) The CPA may in good faith rely on information provided by the taxpayer, without verifying the reliability of that information if reasonable inquiries are made where the information furnished appears to be incorrect.
D) The CPA should not recommend that a taxpayer take a certain position if there is any doubt as to whether the position would be approved by the IRS upon audit.

Page Ref.: C:1-33 through C:1-35
Objective: 8

74) Statements on Standards for Tax Services are issued by
A) the SEC.
B) the IRS.
C) the AICPA.
D) the FASB.

Page Ref.: C:1-32
Objective: 8
75) A client wants to take a tax return position with less than a 10% probability of being upheld in court. The CPA should
A) take the client’s desired position, but not sign the tax return.
B) inform the client that the position does not have a realistic possibility of success.
C) ask the client to sign a waiver of his right to sue the CPA in the event the IRS disallows the position.
D) take the client’s desired position and sign the return as usual.

Page Ref.: C:1-33
Objective: 8

76) According to the Statements on Standards for Tax Services, if a CPA believes that a client’s prior-year tax return contains false information, the CPA should report this to the
A) IRS.
B) SEC.
C) AICPA.
D) None of the above. The CPA does not report the false information to any external agencies, unless required by law.

Page Ref.: C:1-33
Objective: 8

77) Ralph’s business records were lost as a result of Hurricane Katrina. CPA Jane prepares Ralph’s return using estimates. What do the Statements on Standards for Tax Services state about the use of estimates?
A) Estimates may not be used.
B) Estimates may be used without disclosing their use to the IRS.
C) Estimates may be used, but Jane should disclose their use to the IRS.
D) The Statements on Standards for Tax Services do not address the use of estimates.

Page Ref.: C:1-33
Objective: 8

78) During the course of an audit, a CPA discovers an error in a prior return. According to the Statements on Standards for Tax Services, the CPA should
A) ask the client for permission to disclose the error to the IRS.
B) withdraw from the engagement.
C) inform the IRS of the error, regardless of whether the client grants permission.
D) correct the error in the current year’s tax return.

Page Ref.: C:1-33
Objective: 8

79) Explain the difference between a closed-fact and open-fact situation.

80) In all situations, tax considerations are of primary importance. Do you agree or disagree? Support your answer.

81) Describe the format of a client memo.

82) Explain how committee reports can be used in tax research. What do they indicate?

83) In 1998, Congress passed legislation concerning shifting the burden of proof to the IRS. The taxpayer must introduce “credible evidence” to shift the burden of proof to the IRS. What constitutes “credible evidence?”

84) Does Title 26 contain statutory provisions dealing only with income taxation? Explain.

85) What is the purpose of Treasury Regulations?

86) Why should tax researchers take note of the date on which a Treasury Regulation was adopted?

87) Discuss the purposes and scope of temporary regulations.

88) What are the purposes of citations in tax research?

89) Are letter rulings of precedential value to third parties?

90) What is the difference between a taxpayer-requested letter ruling and a technical advice memorandum issued as a letter ruling?

91) What is an information release?

92) What are some of the factors to consider when deciding in which court to file a tax-related claim?

93) What are some of the consequences of the small cases procedure of the Tax Court?

94) Where must a tax researcher look to access all Tax Court cases?

95) What is the minimum information that should be contained in a citation?

96) Is it possible for the Tax Court to intentionally issue conflicting decisions?

97) The Tax Court decides an expenditure is deductible in the year the issue was first litigated. The government appealed and won a reversal in the Ninth Circuit Court of Appeals. It is the only appellate decision regarding the issue. If and when the Tax Court encounters this issue again, how will it hold?

98) Indicate which courts decided the case cited below. Also indicate on which pages and in which publications the authority is reported.

U.S. v. Maclin P. Davis, 397 U.S. 301, 25AFTR 2d 70-827, 70-1 USTC &9289 (1970).

99) If the U. S. District Court for Rhode Island, the Tax Court, and the Eleventh Circuit have all ruled on a particular issue, then what precedents have been set for which courts in the future?

100) What is “forum-shopping”?

101) Under what circumstances might a tax advisor find the provisions of a tax treaty useful?

102) Distinguish between an annotated tax service and a topical tax service.

103) What is the purpose of a citator?

104) According to the Statements on Standards for Tax Services, what belief should a CPA have before taking a pro-taxpayer position on a tax return?

105) According to the AICPA’s Statements on Standards for Tax Services, what duties does the tax practitioner owe the client?

106) Outline and discuss the tax research process.

107) Compare and contrast proposed, temporary, and final regulations.

108) Compare and contrast “interpretative” and “statutory” regulations.

109) Explain the legislative reenactment doctrine.

110) In which courts may litigation dealing with tax matters begin? Discuss the factors that might be considered in deciding where to begin litigation.

111) Describe the appeals process in tax litigation.

112) Discuss the differences and similarities between regular and memorandum decisions issued by the U.S. Tax Court.

113) Assume that the Tax Court decided an expenditure in question was deductible. The government appealed to the Fifth Circuit, which reversed the decision and held it was not deductible. No other circuits have ruled on the issue.

A new case has just been filed in the Tax Court. How will the Tax Court rule if this new case is appealable to the Tenth Circuit? Would your answer be different if the case was appealable to the Fifth Circuit?

114) In list form, outline the steps to follow when using a tax service.

115) Your client wants to deduct commuting expenses on his tax return. You explain to the client that there is no legal authority allowing this deduction. The client, however, continues to insist on this action. What guidance do the Statements on Standards for Tax Services provide in this dilemma?

116) Discuss the conflict between advocacy for a client and responsibility to the IRS.

Chapter 2 Corporate Formations and Capital Structure

1) A sole proprietor is required to use the same reporting period for both business and individual tax information.

Page Ref.: C:2-3
Objective: 1

2) S corporations are flow-through entities in which S income is allocated to shareholders.

Page Ref.: C:2-6
Objective: 1

3) S corporations must allocate income to shareholders based on their proportionate stock ownership.

Page Ref.: C:2-6
Objective: 1

4) The check-the-box regulations permit an LLC to be taxed as a C corporation.

Page Ref.: C:2-8
Objective: 2

5) There are no tax consequences of a partnership converting to a C corporation.

Page Ref.: C:2-9
Objective: 3

6) Section 351 applies to an exchange if the contributing shareholders own more than 50% of a corporation’s stock after the transfer.

Page Ref.: C:2-12 and C:2-13
Objective: 4

7) The transferor’s basis for any noncash boot property received in a Sec. 351 transaction is the boot’s FMV reduced by any unrecognized gain.

Page Ref.: C:16-18
Objective: 4

8) A corporation must recognize a loss when transferring noncash boot property that has declined in value and its stock to a transferor as part of a Sec. 351 exchange.

Page Ref.: C:2-21
Objective: 4

9) If a corporation’s total adjusted bases for all properties transferred exceed the total FMV of the properties, the corporation’s bases in the property is limited to FMV if no election is made.

Page Ref.: C:2-21 and C:2-22
Objective: 4

10) The assignment of income doctrine does not apply if the transferor in a Sec. 351 exchange in which no gain is otherwise recognized transfers substantially all the assets and liabilities of the transferor’s trade or business to the controlled corporation.

Page Ref.: C:2-27
Objective: 4

11) Any losses on the sale of Section 1244 stock are ordinary.

Page Ref.: C:2-32 and C:2-33
Objective: 6

12) Upon formation of a corporation, its assets have the same bases for book and tax purposes.

Page Ref.: C:2-36
Objective: 4

13) Business assets of a sole proprietorship are owned by
A) a member.
B) an individual.
C) a partner.
D) a stockholder.

Page Ref.: C:2-2
Objective: 1

14) Identify which of the following statements is false.
A) A solely owned corporation is a sole proprietorship.
B) A sole proprietorship is a separate taxable entity.
C) A sole proprietor is considered to be an employee of the business.
D) All of the above are false.

Page Ref.: C:2-3
Objective: 1

15) Which of the following is an advantage of a sole proprietorship over other business forms?
A) tax-exempt treatment of fringe benefits
B) the deduction for compensation paid to the owner
C) low tax rates on dividends
D) ease of formation

Page Ref.: C:2-3
Objective: 1
16) Which of the following statements about a partnership is true?
A) A partnership is a taxpaying entity.
B) Partners are taxed on distributions from a partnership.
C) Partners are taxed on their allocable share of income whether it is distributed or not.
D) Partners are considered employees of the partnership.

Page Ref.: C:2-4
Objective: 1

17) Demarcus is a 50% partner in the DJ partnership. DJ has taxable income for the year of $200,000. Demarcus received a $75,000 distribution from the partnership. What amount of income related to DJ must Demarcus recognize?
A) $200,000
B) $75,000
C) $100,000
D) $37,500

Page Ref.: C:2-4; Example C:2-3
Objective: 1

18) Which of the following statements is incorrect?
A) Limited partners’ liability for partnership debt is limited to their amount of investment.
B) In a general partnership, all partners have unlimited liability for partnership debts.
C) In a limited partnership, all partners participate in managerial decision making.
D) All of the above are correct.

Page Ref.: C:2-4
Objective: 1

19) Identify which of the following statements is true.
A) Regular corporation and C corporation are synonymous terms.
B) Regular corporation and S corporation are synonymous terms.
C) A partner is generally considered to be an employee of the partnership.
D) All of the above are false.

Page Ref.: C:2-5
Objective: 1

20) Which of the following statements is correct?
A) An owner of a C corporation is taxed on his or her proportionate share of earnings.
B) S shareholders are only taxed on distributions.
C) S shareholders are taxed on their proportionate share of earnings that are distributed.
D) S shareholders are taxed on their proportionate share of earnings whether or not
distributed.

Page Ref.: C:2-6 and C:2-7
Objective: 1

21) Identify which of the following statements is true.
A) C corporation operating losses are deductible by the individual shareholders.
B) If a C corporation does not distribute its income to its shareholders annually, double taxation cannot occur.
C) Capital losses incurred by a C corporation can be used to offset the corporation’s ordinary income.
D) All of the above are false.

Page Ref.: C:2-6
Objective: 1

22) Bread Corporation is a C corporation with earnings of $100,000. It paid $20,000 in dividends to its sole shareholder, Gerald. Gerald also owns 100% of Butter Corporation, an S corporation. Butter had net taxable income of $80,000 and made a $15,000 distribution to Gerald. What income will Gerald report from Bread and Butter’s activities?
A) $35,000
B) $95,000
C) $100,000
D) $180,000

23) Which of the following statements is incorrect?
A) S corporations must allocate income and expenses to their shareholders based on their proportionate ownership interest.
B) The number of S corporation shareholders is unlimited.
C) S corporation income is taxed to shareholders when earned.
D) S corporation losses can offset shareholder income from other sources.

24) Which of the following statements is true?
A) Shareholders in a C corporation can use C corporation losses to offset shareholder income from other sources.
B) C corporation losses remain in the C corporation and can offset capital gain income from other years.
C) C corporation shareholders are taxed based on their proportionate share of income.
D) Distributions of C corporation income are not taxable.

Page Ref.: C:2-5; Example C:2-6
Objective: 1

25) Identify which of the following statements is false.
A) The check-the-box regulations permit an LLC to be taxed as a C corporation.
B) Under the check-the-box regulations, an LLC that has only two members (owners) must be taxed as a partnership.
C) A business need not be incorporated under state or federal law to be taxed as a corporation.
D) Once an election is made to change its classification, an entity cannot change again for 60 months.

Page Ref.: C:2-8
Objective: 2

26) Identify which of the following statements is true.
A) Under the check-the-box regulations, an LLC that has one member (owner) may be disregarded as an entity separate from its owner.
B) An unincorporated business may not be taxed as a corporation.
C) A new LLC that is owned by four members elects to be taxed under its default classification (as a partnership) in its first year of operations. The entity is prohibited from changing its tax classification at any time in the future.
D) All of the above are false.

Page Ref.: C:2-8
Objective: 2

27) Three members form an LLC in the current year. Which of the following statements is incorrect?
A) The LLC’s default classification under the check-the-box rules is as a partnership.
B) The LLC can elect to have its default classification ignored.
C) The LLC can elect to be taxed as a C corporation with no special tax consequences.
D) If the LLC elects to use its default classification, it can elect to change its status to being taxed as a C corporation beginning with the third tax year after the initial classification.

Page Ref.: C:2-8 and C:2-9
Objective: 2

28) Identify which of the following statements is true.
A) The exchange of stock for services rendered is not a taxable transaction.
B) The repeal of Sec. 351 would result in more existing businesses being incorporated.
C) Section 351 was enacted to allow taxpayers to incorporate without incurring adverse tax consequences.
D) All of the above are false.

Page Ref.: C:2-12
Objective: 4
29) Identify which of the following statements is true.
A) Section 351 applies exclusively to the formation of a new corporation.
B) Section 351 applies to property transfers in exchange for stock.
C) Section 351 only applies to individual transferors.
D) All of the above are false.

Page Ref.: C:2-12
Objective: 4

30) For Sec. 351 purposes, the term “property” does not include
A) cash.
B) accounts receivable.
C) inventory.
D) services rendered.

Page Ref.: C:2-12
Objective: 4

31) Rose and Wayne form a new corporation. Rose contributes cash for 85% of the stock and Wayne contributes services for 15% of the stock. The tax effect is
A) Rose and Wayne must recognize their realized gains, if any.
B) Wayne must report the FMV of the stock received as capital gain.
C) Rose and Wayne are not required to recognize their realized gains.
D) Wayne must report the FMV of the stock received as ordinary income.

Page Ref.: C:2-13; Example C:2-12
Objective: 4

32) Identify which of the following statements is true.
A) A transferor’s gain or loss that goes unrecognized when Sec. 351 applies is permanently exempt from taxation.
B) If a taxpayer transfers property and services as part of a transaction meeting the Sec. 351 requirements, all of the stock received is counted in determining whether the property transferors have acquired control.
C) If a taxpayer transfers property and services as part of a transaction meeting the Sec. 351 requirements, the nonrecognition of gain or loss will apply to the services.
D) All of the above are false.

Page Ref.: C:2-14
Objective: 4

33) Jermaine owns all 200 shares of Peach Corporation stock valued at $50,000. Kenya, a new shareholder, receives 200 newly issued shares from Peach Corporation in exchange for inventory with an adjusted basis of $40,000 and an FMV of $50,000. Which of the following statements is correct?
A) No gain will be recognized by Kenya.
B) The transaction results in $10,000 of ordinary income for Kenya.
C) The transaction results in $10,000 of capital gain for Kenya.
D) Kenya may defer the recognition of any tax until the stock is sold.

Page Ref.: C:2-15; Example C:2-19
Objective: 4

34) Identify which of the following statements is true.
A) To qualify for Sec. 351 treatment, control is defined as more than 50% ownership of the voting stock, and more than 50% of all other classes of stock.
B) If a shareholder receives stock with an FMV greater than the FMV of the property exchanged in a Sec. 351 transaction, the excess FMV may be considered a gift from one shareholder to another shareholder.
C) Only transfers to newly created corporations qualify for Sec. 351 treatment.
D) All of the above are false.

Page Ref.: C:2-15
Objective: 4

35) Barry, Dan, and Edith together form a new corporation; Barry and Dan each contribute property in exchange for stock. Within two weeks after the formation, the corporation issues additional stock to Edith in exchange for property. Barry and Dan each hold 10,000 shares and Edith will receive 9,000 shares. Which transactions will qualify for nonrecognition?
A) Only the first transaction will qualify for nonrecognition.
B) Only the second transaction will qualify for nonrecognition.
C) Because of the step transaction doctrine, neither transaction will qualify.
D) Both transactions will qualify under Sec. 351 if they are part of the same plan of incorporation.

Page Ref.: C:2-16; Example C:2-22
Objective: 4

36) In accordance with the rules that apply to corporate formation, which one of the following features does not make an issue of preferred stock “nonqualified”?
A) The shareholder can require the corporation to redeem the stock.
B) The dividend rate on the stock may not vary with interest rates, commodity prices, or other similar indices.
C) The corporation is either required to redeem the stock or is likely to exercise a right to redeem the stock.
D) The stock is limited and preferred as to dividends.

Page Ref.: C:2-16
Objective: 4

37) Under Sec. 351, corporate stock may include all of the following except
A) voting stock.
B) nonvoting stock.
C) stock warrants.
D) qualified preferred stock.

Page Ref.: C:2-16
Objective: 4

38) Matt and Sheila form Krupp Corporation. Matt contributes property with an FMV of $55,000 and a basis of $35,000. Sheila contributes property with an FMV of $75,000 and a basis of $40,000. Matt sells his stock to Paul shortly after the exchange. The transaction will
A) not qualify under Sec. 351.
B) qualify under Sec. 351 if Matt can show that the sale to Paul was not part of a prearranged plan.
C) qualify with respect to Sheila under Sec. 351 whether Matt qualifies or not.
D) qualify under Sec. 351 only if an advance ruling has been obtained.

Page Ref.: C:2-16
Objective: 4

39) Brad forms Vott Corporation by contributing equipment, which has a basis of $50,000 and an FMV of $40,000 in exchange for Vott stock. Brad also contributes $5,000 in cash. If the transaction meets the Sec. 351 control and ownership tests, what are the tax consequences to Brad?
A) He recognizes a $5,000 loss.
B) He recognizes a $5,000 gain and a $10,000 loss.
C) He recognizes neither a gain nor a loss.
D) He recognizes a $10,000 loss.

40) If an individual transfers an ongoing business to a corporation in a Sec. 351 exchange, the individual must recognize any realized gain
A) only if the adjusted basis of the property transferred is less than the FMV of the stock received.
B) if the transferor receives property other than stock.
C) if the FMV of the property exchanged exceeds the FMV of the stock received.
D) both A and B above

Page Ref.: C:2-17
Objective: 4
41) Carmen and Marc form Apple Corporation. Carmen transfers land that is Sec. 1231 property, with an adjusted basis of $18,000 and an FMV of $20,000 in exchange for one-half of the Apple Corporation stock. Marc transfers equipment that originally cost $28,000 on which he has taken $5,000 in depreciation deductions. The equipment has an FMV of $25,000 and he receives one-half of the stock and a $5,000 short-term note. The transaction meets the requirements of Sec. 351. Which statement below is correct?
A) There is no recognized gain or loss.
B) Carmen recognizes a $2,000 Sec. 1231 gain and Marc recognizes $5,000 as ordinary income.
C) Carmen recognizes a $2,000 Sec. 1231 gain and Marc recognizes a $5,000 Sec. 1231 gain.
D) Carmen recognizes no gain and Marc recognizes $2,000 as ordinary income.

42) Identify which of the following statements is true.
A) The definition of stock under Sec. 351 includes stock rights and warrants.
B) The receipt of property other than stock by the transferor will trigger the recognition of gain or loss under Sec. 351.
C) The character of the gain recognized by the transferor when boot is received in a Sec. 351 transaction depends on the type of boot received.
D) All of the above are false.

Page Ref.: C:2-16 and C:2-17
Objective: 4

43) Identify which of the following statements is true.
A) To determine a shareholder’s basis in a single class of stock received in a Sec. 351 exchange, the FMV of the stock received must be known.
B) If more than one asset is transferred by the transferor in a Sec. 351 nonrecognition transaction, the transferor is assumed to have received a proportionate share of the stock, cash, and other boot property for each property transferred based upon the assets’ relative FMVs.
C) The transferor’s basis for any noncash boot property received in a Sec. 351 transaction is the boot’s FMV reduced by any unrecognized gain.
D) All of the above are false.

Page Ref.: C:2-17 and C:2-18
Objective: 4
44) Identify which of the following statements is true.
A) If stock and boot property are both received in a Sec. 351 exchange, the transferor must allocate the total basis in the contributed property between the stock and boot property based on the relative FMVs of the stock and the boot property.
B) The adjusted basis of stock received in a Sec. 351 transaction is computed by deducting the deferred loss from the FMV of the stock received.
C) The holding period for stock received in a Sec. 351 transaction in exchange for a capital asset begins on the day after the date of the exchange.
D) All of the above are false.

Page Ref.: C:2-18 and C:2-19
Objective: 4

45) Jerry transfers two assets to a corporation as part of a Sec. 351 exchange. The first asset has an adjusted basis of $70,000 and an FMV of $50,000. The second asset has an adjusted basis of $70,000 and an FMV of $150,000. The FMV of the stock received is $180,000, and he also receives $20,000 cash. The realized and recognized gain on the second asset is
A) $80,000 realized; $20,000 recognized.
B) $80,000 realized; $15,000 recognized.
C) $20,000 realized; $10,000 recognized.
D) $10,000 realized; $10,000 recognized.

46) Max transfers the following properties to a newly created corporation for $90,000 of stock and $10,000 cash in a transaction that qualifies under Sec. 351.

Asset One Asset Two Asset Three
FMV
Basis $30,000
35,000 $45,000
40,000 $25,000
20,000

Max’s recognized gain is
A) $3,000.
B) $5,000.
C) $7,000.
D) $10,000.

47) Cherie transfers two assets to a newly-created corporation. The first asset has an adjusted basis of $40,000 and a FMV of $50,000. The second asset has an adjusted basis of $35,000 and a FMV of $25,000. Cherie receives stock with FMV of $66,000 and $9,000 cash. Cherie must recognize a gain of
A) $10,000.
B) $6,000.
C) $5,000.
D) $4,000.

48) Henry transfers property with an adjusted basis of $90,000 and an FMV of $100,000 to a newly-formed corporation in a Sec. 351 exchange. Henry receives stock with an FMV of $80,000 and a short-term note with a $20,000 FMV. Henry’s recognized gain is
A) $0.
B) $5,000.
C) $10,000.
D) $20,000.

49) Henry transfers property with an adjusted basis of $95,000 and an FMV of $100,000 to a newly formed corporation in a Sec. 351 exchange. Henry receives stock with an FMV of $85,000 and a short-term note with a $15,000 FMV. Henry’s basis in the stock is
A) $100,000.
B) $95,000.
C) $90,000.
D) $85,000.

50) A shareholder’s basis in stock received in a Sec. 351 transaction is
A) increased by the gain recognized by the corporation.
B) decreased by the gain recognized by the transferor.
C) decreased by liabilities assumed by the corporation.
D) increased by the FMV of boot received from the corporation.

Page Ref.: C:2-18
Objective: 4

51) Jeremy transfers Sec. 351 property acquired three years earlier having a $100,000 basis and a $160,000 FMV to Jeneva Corporation. Jeremy receives all 200 shares of Jeneva stock having a $140,000 FMV, and a $20,000 90-day Jeneva note. What is Jeremy’s recognized gain?
A) $0
B) $60,000
C) $20,000
D) $160,000

52) Carolyn transfers property with an adjusted basis of $50,000 and an FMV of $60,000 in exchange for Prime Corporation stock in a Sec. 351 transaction. Carolyn’s basis in the stock is
A) $60,000.
B) $50,000.
C) $10,000.
D) $0.

53) Ralph transfers property with an adjusted basis of $65,000 and an FMV of $70,000 to Lake Corporation in a Sec. 351 transaction. Ralph receives stock worth $60,000 and a short-term note having a $10,000 FMV. Ralph’s basis in the stock is
A) $75,000.
B) $70,000.
C) $65,000.
D) $60,000.

54) Sarah transfers property with an $80,000 adjusted basis and a $100,000 FMV to Super Corporation in a Sec. 351 transaction. Sarah receives stock with an $85,000 FMV and a short-term note with a $15,000 FMV. Sarah’s basis in the stock is
A) $100,000.
B) $95,000.
C) $85,000.
D) $80,000.

55) The transferor’s holding period for any stock received in exchange for a capital asset
A) includes the holding period for the property transferred.
B) begins on the day after the exchange.
C) begins on the day of the exchange.
D) none of the above

Page Ref.: C:2-19
Objective: 4

56) The transferor’s holding period for any boot property received in a Sec. 351 stock exchange
A) includes the holding period for the boot transferred.
B) begins on the day after the exchange.
C) begins on the day of the exchange.
D) is the same as the holding period of the stock received in the exchange.

Page Ref.: C:2-19
Objective: 4

57) Beth transfers an asset having an FMV of $200,000 and an adjusted basis of $150,000 to ABC Corporation in a Sec. 351 transaction. Beth receives in exchange ABC common stock having an FMV of $175,000 and Zeus Corporation common stock (a capital asset) having an FMV of $25,000 and a basis of $10,000 to ABC Corporation. ABC Corporation must recognize
A) no gain.
B) a $15,000 capital gain.
C) a $25,000 capital gain.
D) a $50,000 capital gain.

Page Ref.: C:2-20; Example C:2-30
Objective: 4

58) Chris transfers land with a basis of $40,000 to Webb Corporation in exchange for 100% of Webb’s stock. At the date of the transfer, the land had a $30,000 fair market value. Absent an election by Chris, Webb’s basis in the land is
A) $30,000.
B) $35,000.
C) $40,000.
D) none of the above

Page Ref.: C:2-21 and C:2-22
Objective: 4

59) Chris transfers land with a basis of $40,000 to Webb Corporation in exchange for 100% of Webb’s stock. At the date of the transfer, the land had a $30,000 fair market value. Chris makes an election to reduce his basis in Webb’s stock to $30,000, so Webb’s basis in the land is
A) $30,000.
B) $35,000.
C) $40,000.
D) none of the above

Page Ref.: C:2-21 and C:2-22
Objective: 4

60) The transferee corporation’s basis in property received in a Sec. 351 exchange is
A) the FMV of the property received.
B) the transferee corporation’s basis in the stock exchanged.
C) the transferor’s basis for the property plus gain recognized by the transferor.
D) the transferor’s basis for the property plus gain recognized by the transferee corporation.

Page Ref.: C:2-21
Objective: 4

61) Identify which of the following statements is true.
A) Section 351 provides for nonrecognition of gain for the transferee corporation when it distributes appreciated land that is boot property to a shareholder.
B) A corporation must recognize a loss when transferring noncash boot property that has declined in value and its stock to a transferor as part of a Sec. 351 exchange.
C) The transferee corporation’s holding period for assets acquired in an exchange meeting the Sec. 351 requirements includes the transferor’s holding period for the property.
D) All of the above are false.

Page Ref.: C:2-21
Objective: 4

62) Mario and Lupita form a corporation in a transaction coming under Sec. 351. Lupita transfers property with an adjusted basis of $150,000 and an FMV of $200,000 in exchange for one-half of the stock. The property has an $80,000 mortgage, which the corporation assumes. Lupita has a recognized gain of
A) $0.
B) $50,000.
C) $100,000.
D) $80,000.

63) Mario and Lupita form a corporation in a transaction coming under Sec. 351. Lupita transfers property with an adjusted basis of $150,000 and an FMV of $200,000 in exchange for one-half of the stock. The property has an $80,000 mortgage, which the corporation assumes. The corporation’s basis in the property is
A) $200,000.
B) $150,000.
C) $80,000.
D) $130,000.

64) Lynn transfers land having a $50,000 adjusted basis, an $80,000 FMV, and $10,000 cash to Allied Corporation in exchange for 100% of Allied’s stock. The corporation assumes the $70,000 mortgage on the land. Which of the following statements is correct?
A) Lynn recognizes no gain and the stock basis is $60,000.
B) Lynn recognizes a $10,000 gain and the stock basis is $60,000.
C) Lynn recognizes no gain and the stock basis is $50,000.
D) Lynn recognizes a $10,000 gain and the stock basis is zero.

65) Identify which of the following statements is true.
A) The transferee corporation’s acquisition or assumption of liabilities in excess of the total adjusted bases of the properties transferred by a transferor results in a gain recognition by the transferor.
B) When a transferor exchanges a mortgaged property under Sec. 351 and the amount of the mortgage is greater than the transferor’s basis in the property, the transferor’s basis in the stock received will be equal to the basis the transferor had in the mortgaged property.
C) When forming a corporation, the accounts payable of a transferor’s business are not liabilities for gain computation purposes if the transferor’s business uses the accrual method of accounting.
D) All of the above are false.

Page Ref.: C:2-23
Objective: 4

66) Martin operates a law practice as a sole proprietorship using the cash method of accounting. Martin incorporates the law practice and transfers the following items to a new, solely owned corporation.

Adjusted Basis FMV
Cash
Equipment
Accounts receivable
Accounts payable (deductible expenses)
Note payable (on equipment) $10,000
80,000
0
0
50,000 $ 10,000
100,000
120,000
60,000
50,000

Martin must recognize a gain of ________ and has a stock basis of ________:
A) $0; $30,000
B) $0; $40,000
C) $20,000; $30,000
D) $20,000; $40,000

67) Silvia transfers to Leaf Corporation a machine she had purchased a year ago for $50,000. The machine has a $40,000 adjusted basis and an $55,000 FMV on the transfer date. $10,000 in depreciation was claimed by Silvia prior to the transfer. Silvia receives all 1,000 shares of Leaf Corporation stock worth $50,000 and a two-year note with a $5,000 FMV. What is the amount and character of the recognized gain or loss?
A) $15,000 ordinary income
B) $15,000 capital gain
C) $5,000 ordinary income
D) $5,000 capital gain

Page Ref.: C:2-25
Objective: 4

68) Jeremy operates a business as a sole proprietorship. The proprietorship uses the cash method of accounting. He decides to incorporate and transfers the assets and liabilities of the sole proprietorship to the newly formed corporation in exchange for its stock. The assets, which include $10,000 of accounts receivable with a zero basis, have a basis of $20,000 and an FMV of $40,000. The liabilities include accounts payable of $12,000, which will be deductible when paid, and a note payable on medical equipment of $7,000. Jeremy’s basis for his stock is
A) $40,000.
B) $20,000.
C) $13,000.
D) $8,000.

69) Colleen operates a business as a sole proprietorship. She purchased a computer for $10,000 last year. The computer is five-year recovery property for MACRS purposes and is depreciated under the regular MACRS rules. This year, Colleen incorporates the business and transfers the computer to the new corporation on July 20. The depreciation on the computer for this year allocable to the sole proprietorship is
A) $1,868.
B) $1,600.
C) $1,333.
D) $500.

70) Identify which of the following statements is true.
A) The transferor must recapture depreciation when exchanging Sec. 1245 property in all transactions coming under Sec. 351.
B) A corporation receiving property in a Sec. 351 exchange can select any MACRS depreciation method for the asset.
C) When depreciable property is transferred to a corporation in a Sec. 351 exchange in which no gain is recognized, the corporation must continue to use the transferor’s depreciation method and recovery period for the property.
D) All of the above are false.

Page Ref.: C:2-26
Objective: 4

71) Identify which of the following statements is true.
A) The assignment of income doctrine requires a cash method of accounting for a transferor/shareholder to recognize income when accounts receivable are transferred by the shareholder to the corporation in a Sec. 351 exchange in which no gain is otherwise recognized.
B) The assignment of income doctrine is a legislative requirement that income be taxed to the person who earns it.
C) The assignment of income doctrine does not apply if the transferor in a Sec. 351 exchange in which no gain is otherwise recognized transfers when a sole proprietor transfers substantially all the assets and liabilities of the transferor’s trade or business to a controlled corporation.
D) All of the above are false.

Page Ref.: C:2-27
Objective: 4

72) A medical doctor incorporates her medical practice, which is operated as a sole proprietorship. The proprietorship uses the cash method of accounting. Among the assets contributed to the new corporation are unrealized receivables worth $40,000. The receivables are collected by the corporation. Which of the following statements is correct?
A) The $40,000 of receivables is included as ordinary income on the doctor’s personal income tax return when collected by the corporation.
B) The doctor must include the $40,000 as ordinary income in her personal income tax return at the time of incorporation.
C) The $40,000 of receivables is included as ordinary income in the corporation’s income tax return at the time of incorporation.
D) The $40,000 of receivables is included as ordinary income in the corporation’s income tax return when collected.

Page Ref.: C:2-27; Example C:2-42
Objective: 5

73) The City of Springfield donates land worth $250,000 to Deuce Corporation to induce it to locate in Springfield and provide 1,000 jobs for its citizens. How much gross income must Deuce Corporation recognize because of the land contribution, and what is the land’s basis to Deuce Corporation?
A) $250,000 income; $250,000 basis
B) $250,000 income; $0 basis
C) $0 income; $250,000 basis
D) $0 income; $0 basis

Page Ref.: C:2-31; Example C:2-45
Objective: 5

74) The City of Portland gives Data Corporation $60,000 cash and land worth $100,000 to induce it to move. The cash was not spent during the 12 months following contribution. The contribution results in
A) income recognition in the amount of $160,000 to the corporation at the time of contribution.
B) income recognition in the amount of $60,000 to the corporation 12 months after the time of contribution.
C) a zero basis in the land and $60,000 ordinary income to the corporation 24 months after the time of contribution if the cash is not used to purchase an asset.
D) a zero basis in the land and a $60,000 basis reduction in other assets.

Page Ref.: C:2-31; Example C:2-45
Objective: 5

75) Identify which of the following statements is true.
A) Property contributions to a corporation by nonshareholders will result in income recognition by the corporation if the contributed property is subsequently sold.
B) Section 1244 ordinary loss treatment is available to any shareholder.
C) A taxpayer must make a special election to take advantage of Sec. 1244.
D) All of the above are false.

Page Ref.: C:2-31 and C:2-32
Objective: 5

76) Ralph and Yolanda purchased 20% of the initial offering of Major Corporation common stock for $150,000. Major Corporation is a qualifying small business corporation and the stock qualifies as Sec. 1244 stock. Ten months later, Major Corporation files for bankruptcy and the shareholders are notified that the stock is worthless. Ralph and Yolanda, who are married and file a joint return, have a
A) $150,000 ordinary loss.
B) $150,000 capital loss.
C) $100,000 ordinary loss; $50,000 capital loss.
D) $100,000 ordinary loss; $50,000 ordinary loss carryforward.

Page Ref.: C:2-32; Example C:2-46
Objective: 6

77) Yenhung, who is single, forms a corporation using a tax-free asset transfer, which qualifies under Sec. 351. She contributes property having an adjusted basis of $50,000 and an FMV of $40,000. The stock received from the corporation is Sec. 1244 stock. When Yenhung sells the stock for $30,000, her loss is

A)
Ordinary loss Capital loss
$ 0 $20,000

B)
Ordinary loss Capital loss
$10,000 $10,000

C)
Ordinary loss Capital loss
$20,000 $ 0

D)
Ordinary loss Capital loss
$10,000 $ 0

78) Nathan is single and owns a 54% interest in the new NT Partnership, a calendar-year entity. The NT Partnership reports $100,000 of profits for its first year. Assuming Nathan is taxed at a 35% marginal tax rate on the additional income, how much tax does Nathan owe if the NT Partnership does not distribute any of its profits to him?

79) On January of the current year, Rae purchases 100% of Sun Corporation stock for $30,000. Sun Corporation reports taxable income of $25,000 in the current year, on which it pays tax of $3,750. None of the remaining $21,250 is distributed to Rae. However, on January 1 of the next year, Rae sells her stock to Lee for $51,250. What are the tax consequences to Rae of the sale?

80) What are the tax consequences to Whitney who owns 50% of Museum Corporation, a qualifying S Corporation that is a calendar-year entity, if Museum Corporation reports $60,000 of taxable income? How would your answer change if Museum Corporation reported a $40,000 loss?

81) On January 20 of the current year, a group of ten individuals organize an LLC to conduct an ink-making business in Florida. This year, the LLC is an eligible entity under the check-the-box regulations. How will the LLC be taxed?

82) Maria has been operating a business as a sole proprietorship for several years. She needs additional capital and wants to incorporate her business. The assets of her business (building, land, inventory, and so on) have a $400,000 adjusted basis and a $1.5 million FMV. Maria is willing to exchange the assets for 1,500 shares of Metro Corporation stock, each having a $1,000 FMV. Bill and John are each willing to invest $500,000 in Maria’s business and will each receive 500 shares of stock. Why is Sec. 351 important to Maria? Does it matter to Bill and John?

83) Phil and Nick form Philnick Corporation. Phil exchanges cash and other property for 900 shares (90% of the outstanding shares) of Philnick stock. Nick performs accounting services in exchange for 100 shares of Philnick stock worth $10,000. What are the tax consequences from forming the Philnick Corporation to Phil and Nick?

84) In which of the following independent situations is the Sec. 351 control requirement met?
a) Jane transfers property to Jet Corporation for 75% of Jet Corporation’s stock, and Susan provides services to Jet Corporation for the remaining 25% of Jet Corporation stock.
b) Paul transfers property to Pride Corporation for 60% of Pride’s stock, and Bob transfers property worth $15,000 and performs services worth $25,000 for the remaining 40% of Pride’s stock.
c) Herb and his wife Carolyn each have owned 50% of the 100 outstanding shares of Wykert Corporation stock since it was formed three years ago. In the current year, their daughter, Cindy, transfers property to Wykert Corporation for 50 newly issued shares of Wykert stock.
d) John and Pam develop a plan to form PJ Corporation on May 2 of this year. John transfers property worth $50,000 for 50 shares of PJ Corporation stock. As part of the single plan to incorporate, Pam transfers $50,000 cash for 50 shares of PJ Corporation stock on July 1.
e) Assume the same facts as in Part (d), except that John has a prearranged plan to sell 30 of his shares to Steven on September 1.

85) Frans and Arie own 75 shares and 25 shares of Vogel Corporation stock, respectively. There are no other owners. Frans transfers property with a $30,000 adjusted basis and a $50,000 FMV to Vogel Corporation in exchange for an additional 25 shares of Vogel stock. Does this property-for-stock exchange qualify for Sec. 351 treatment?

86) For the last four years, Bob and Ellen have each owned 100 of the 200 outstanding shares of Racer Corporation’s stock. Bob transfers land having a $10,000 basis and a $30,000 FMV to Racer for an additional 30 shares of stock, and Ellen transfers $2,000 for an additional two shares of stock. What is the amount of gain or loss that Bob must recognize on the exchange? If the transaction does not comply with the Sec. 351 requirements, how can it be made to comply?

87) Dan transfers property with an adjusted basis of $50,000 and an FMV of $100,000 to a newly formed Sun Corporation in exchange for 500 shares of Sun stock, which is one-half of the outstanding Sun stock. His daughter, Sylvia, transfers property with an adjusted basis of $25,000 and an FMV of $50,000 for the other 500 shares at the same time. What are the tax consequences of the two transfers, assuming all the requirements of Sec. 351 are met?

88) Tanicia owns all 100 shares of Midwest Corporation’s stock, valued at $100,000. Gwen owns property that has a $15,000 adjusted basis and a $100,000 FMV. Gwen contributes the property to Midwest Corporation in exchange for 100 shares of newly issued Midwest stock. Does Section 351 apply to Gwen’s exchange? What is the amount of her realized gain or loss? How much is recognized?

89) Abby owns all 100 shares of Rent Corporation’s stock, valued at $10,000. Bart owns property that has a $1,500 adjusted basis and a $10,000 FMV. Bart contributes the property to Rent Corporation in exchange for 100 shares of newly issued Rent stock. Abby transfers additional property worth $10,000 for an additional 10 shares of newly issued Rent stock too. Does Sec. 351 apply?

90) Anton, Bettina, and Caleb form Cage Corporation. Each contributes appreciated property worth $10,000 for one-third of the Cage stock. Before the exchange, Anton arranges to sell his stock to Darma as soon as he receives it. Does Sec. 351 apply?

91) South Corporation acquires 100 shares of treasury stock for $10,000. The next year, South reissues the 100 shares for land having a $15,000 FMV. What is the amount of gain or loss realized by South Corporation, and how much is recognized?

92) Azar, who owns 100% of Hat Corporation, transfers land having a $50,000 FMV and a $30,000 adjusted basis to Hat. In return, Azar receives additional shares of Hat common stock having a $40,000 FMV and Cap Corporation common stock having a $10,000 FMV. The Cap Corporation common stock, a capital asset, has a $2,500 basis on Hat’s books. What is Azar’s realized and recognized gain? Does Hat Corporation recognize a gain on the stock transfer to Azar?

93) Yolanda transfers land, a capital asset, having a $70,000 adjusted basis and an $125,000 FMV plus $10,000 cash to Jazz Corporation in exchange for all its stock. Jazz Corporation assumes the $100,000 mortgage on the land. The mortgage assumption has no tax avoidance purpose and has the requisite business purpose. What is the amount of Yolanda’s realized gain or loss? How much is recognized and what is its character? What is Yolanda’s basis in the Jazz stock?

94) Zoe Ann transfers machinery having a $36,000 adjusted basis and a $70,000 FMV for all 100 shares of Zeema Corporation’s stock. Before the transfer, Zoe Ann used the machinery in her business. She originally paid $50,000 for the machinery and claimed $14,000 of depreciation before transferring the machinery. Zoe Ann recaptures no depreciation on the transfer and the recapture potential is transferred to Zeema Corporation. Zeema sells the machine for $66,000 after it had depreciated the machine an additional $4,000. What is Zeema’s gain on the machine and what is its character?

95) On July 9, 2008, Tom purchased a computer (five-year property for MACRS purposes) for $6,000, which he used in his sole proprietorship. He claimed $1,200 (0.20 × $6,000) of depreciation for 2008. On February 9, 2009, he transfers the computer and other assets of his sole proprietorship to Brewer Corporation in exchange for Brewer stock in a transfer qualifying under Sec. 351. What is the amount of depreciation for 2008 claimed by Tom? What is the amount of depreciation for 2009 claimed by Brewer Corporation? What is Brewer’s basis in the computer on the date of transfer?

96) Reba, a cash basis accountant, transfers all of the assets and liabilities of her practice to Able Corporation in exchange for all of Able Corporation’s stock. The assets include $20,000 of accounts receivable. What is the Corporation’s basis in the receivables? Will the corporation be taxed on the receivables, as they are collected?

97) Ra Corporation issues a twenty-year obligation at its $1,000 face amount. Rames purchases the obligation for $1,000 on the issue date. Due to a decline in interest rates, Ra calls the obligation by paying $1,010 to each of the holders of the twenty-year obligations. What is the tax treatment of the $1,010 by Ra and Rames?

98) The City of Seattle gives Dotcom Corporation $120,000 cash and land worth $200,000 to induce it to relocate to Seattle. Dotcom Corporation did not spend the cash during the 12 months following the contribution. What are the tax consequences to Dotcom Corporation with respect to the contribution?

99) The City of Providence donates land worth $125,000 to Triple A Corporation to induce it to locate in Providence and provide jobs for its citizens. How much gross income must Triple A Corporation recognize because of the land contribution, and what is the land’s basis to Triple A Corporation?

100) Nikki exchanges property having a $20,000 adjusted basis and a $16,000 FMV for 100 shares of Niftik stock in a transaction qualifying under Sec. 351. The stock qualifies as Sec. 1244 stock. Nikki’s basis in her Niftik stock is $20,000. If Nikki sells her stock for $5,000, what is the amount and character of her loss?

101) Darnell, who is single, exchanges property having a $60,000 adjusted basis and a $50,000 FMV for 1,000 shares of Fox Corporation stock in a transaction qualifying under Sec. 351. The stock qualifies as Sec. 1244 stock. If Darnell sells his stock for $30,000, what is the amount and character of his recognized gain or loss?

102) Gene purchased land five years ago as an investment. The land cost him $200,000 and is now worth $530,000. Gene plans to transfer the land to Dee Corporation, which will subdivide the land and sell individual parcels. Dee Corporation’s profits on the land will be ordinary income. What are the tax consequences of the asset transfer and land sales if Gene contributes the land to Dee Corporation in exchange for all of its stock? What alternative methods can be used to structure the transaction to achieve better tax consequences?

103) Severs Corporation employs Susan as its legal counsel. Her annual compensation from Severs Corporation is $100,000. Severs Corporation is experiencing financial problems, and Susan lends the corporation $50,000 in 2008 in an attempt to help it through its financial difficulties. Severs Corporation subsequently declares bankruptcy, and in 2010 Susan and the other creditors receive 10 cents on each dollar they are owed. What is the amount and character of Susan’s loss?

104) The tax disadvantages of the C corporation form of doing business include “double taxation.” What is meant by the term “double taxation” as used in this context?

105) Discuss the impact of the contribution of cash as part of a Sec. 351 exchange.

106) This year, John, Meg, and Karen form Frost Corporation. John contributes land purchased as an investment four years ago for $15,000 that has a $30,000 FMV in exchange for 30 shares of Frost stock. Meg contributes machinery (Sec. 1231 property) purchased four years ago and used in her business having a $35,000 adjusted basis and a $30,000 FMV in exchange for 30 shares of Frost stock. Karen contributes services worth $20,000 in exchange for 20 shares of Frost stock.
a) What is the amount of John’s recognized gain or loss?
b) What is John’s basis in his Frost shares? When does his holding period begin?
c) What is the amount of Meg’s recognized gain or loss?
d) What is Meg’s basis in her Frost shares? When does her holding period begin?
e) How much income, if any, must Karen recognize?
f) What is Karen’s basis in her Frost shares? When does her holding period begin?
g) What is Frost Corporation’s basis in the land and the machinery? When does its holding period begin? How does Frost Corporation treat the amount paid to Karen for her services?

107) This year, John, Meg, and Karen form Frost Corporation. John contributes land purchased as an investment four years ago for $25,000 that has a $30,000 FMV in exchange for 30 shares of Frost stock. Meg contributes machinery (Sec. 1251 property) purchased four years ago and used in her business having a $50,000 adjusted basis and a $30,000 FMV in exchange for 30 shares of Frost stock. Karen contributes services worth $15,000 and $5,000 cash in exchange for 20 shares of Frost stock.
a) What is the amount of John’s recognized gain or loss?
b) What is John’s basis in his Frost shares? When does his holding period begin?
c) What is the amount of Meg’s recognized gain or loss?
d) What is Meg’s basis in her Frost shares? When does her holding period begin?
e) How much income, if any, must Karen recognize?
f) What is Karen’s basis in her Frost shares? When does her holding period begin?
g) What is Frost Corporation’s basis in the land and the machinery? When does its holding period begin? How does Frost Corporation treat the amount paid to Karen for services?

108) On May 1 of the current year, Kiara, Victor, Pam, and Joe form Newco Corporation with the following investments:
Property Transferred
Number of
Transferor Asset Basis to Transferor FMV common
shares issued
Kiara Land $12,000 $30,000
Building 38,000 70,000 400
Mortgage and the
land & building 60,000 60,000
Victor Equipment 25,000 40,000 300
Pam Van 15,000 10,000 50
Joe Accounting Services 0 10,000 100

Kiara purchased the land and building several years ago for $12,000 and $50,000, respectively. Kiara has claimed straight-line depreciation on the building. Victor also received a Newco Corporation note for $10,000 due in three years. The note bears interest at a rate acceptable to the IRS. Victor purchased the equipment three years ago for $50,000. Pam also receives $5,000 cash. Pam purchased the van two years ago for $20,000.

a) Does the transaction satisfy the requirements of Sec. 351?
b) What are the amounts and character of the reorganized gains or losses to Kiara, Victor, Pam, Joe, and Newco Corporation?
c) What is each shareholder’s basis for his or her Newco stock? When does the holding period for the stock begin?
d) What is Newco Corporation’s basis for its property and services? When does its holding period begin for each property?

109) Lynn transfers property with a $56,000 adjusted basis and a $100,000 FMV to Florida Corporation for 75 shares of Florida stock. Fred, Lynn’s father, transfers property with a $64,000 adjusted basis and a $100,000 FMV to Florida Corporation for the remaining 25 shares of Florida stock.
a) What is the amount of each transferor’s gain or loss?
b) What is Lynn’s basis for her Florida stock?
c) What is Fred’s basis for his Florida stock?
Answer:
a) Neither Lynn nor Fred recognizes any gain or loss on the exchange since Sec. 351 applies.
b) Since the exchange is disproportionate, it is likely that Fred has made a gift of 25 shares of Florida stock to Lynn. Lynn’s basis in her 75 shares is $88,000 ($56,000 basis in property transferred by Lynn + $32,000 basis in the 25 shares received from Fred). (This answer assumes no gift taxes were paid by Fred on the transfer.)
c) Fred’s basis in his 25 shares is $32,000 [$64,000 – (0.50 × $64,000)].
Page Ref.: C:2-15
Objective: 4

110) Norman transfers machinery that has a $45,000 basis and a $105,000 FMV and $30,000 in money to Elnor Corporation in exchange for 50 shares of Elnor stock. The machinery, used in Norman’s business, originally cost him $150,000 and is subject to a $84,000 liability which Elnor Corporation assumes. Kate exchanges $51,000 cash for the remaining 50 shares of Elnor stock.
a) What is the amount and character of Norman’s recognized gain or loss?
b) What is his basis in the Elnor stock?
c) What is Elnor’s basis in the machinery?
d) What is the amount and character of Kate’s recognized gain or loss?
e) What is Kate’s basis in the Elnor stock?
f) When do Norman and Kate’s holding periods for their stock begin?

111) What is the impact on a transferor if a Sec. 351 exchange involves the assumption of the shareholder’s liabilities by the corporation?

112) What is the tax treatment for a contribution of capital to a corporation by a nonshareholder?

113) Why would a transferor want to avoid the nonrecognition of gain under Sec. 351? How can the nonrecognition provision of Sec. 351 be avoided?

114) Discuss the tax planning opportunities that are available in forming a corporation when one of the parties owns property that has a high basis and a low FMV.

115) Discuss the IRS reporting requirements under Sec. 351.

116) Jane and Joe plan to go into business together. They plan to incorporate the business. What tax issues should they consider when deciding whether or not to elect S corporation status?

• Are their individual marginal tax rates lower or higher than a C Corporation’s marginal tax rates?
• Do they anticipate profits or losses in the first few years of business?
• Will the corporation generate any capital gains or losses?
• Do they plan to withdraw money from the corporation?
• Will they want or need fringe benefits?
• Do they plan to use a calendar year end or a fiscal year end?

117) Michael contributes equipment with a $25,000 adjusted basis and a $40,000 FMV to Miller Corporation for 25 of its 50 shares of stock. His son, Michael Jr., contributes $10,000 cash for the remaining 25 Miller shares. What tax issues should Michael and his son consider with respect to the stock acquisitions?

118) Stu Walker has owned all 200 shares of Lance Corporation’s stock for the past six years. This year, Megan Jones contributes property with a $100,000 basis and a $160,000 FMV for 160 newly issued Lance shares. At the same time, Stu contributes $30,000 in cash for 30 newly issued Lance shares. What tax issues should Megan and Stu consider with respect to the stock acquisitions?

119) On April 2 of the current year, Jana transfers land with a basis of $140,000 and a fair market value of $120,000 to Amish Corporation in exchange for all of its stock. She had originally acquired the land on December 1, 2002. What tax issues arise from the exchange?

120) Joan transfers land (a capital asset) having a $20,000 adjusted basis to Jet Corporation in a transaction qualifying under Sec. 351. In exchange, she received 50 shares of Jet Corporation common stock valued at $50,000, a $15,000 Jet Corporation bond due in 10 years, and a $10,000 Jet Corporation note due in 3 years. What tax issues should Joan consider with respect to the transfer?
a) What is the amount of Joan’s realized gain or loss? What is the amount of Joan’s recognized gain or loss? What is the character of Joan’s recognized gain or loss?
b) What is Joan’s basis in her stock? What is Joan’s basis in the bond? What is Joan’s basis in the note?
c) What is Jet Corporation’s basis in the land?

121) Several years ago, John acquired 200 shares of Jersey Corporation stock directly from the corporation for $150,000 in cash. This year, he sold the stock to Bill for $85,000. What tax issues should John consider with respect to the stock sale?

122) Will, a shareholder in Wiley Corporation, lent money to the corporation. The corporation is unable to repay him. What tax issues should Will consider with respect to the loan?

123) Sarah has advanced money to her corporation. What tax issues should she consider with respect to this money?

Chapter 3 The Corporate Income Tax

1) A C corporation must use a calendar year as its tax year unless it has a substantial business purpose to use a fiscal year.

Page Ref.: C:3-2
Objective: 1

2) Corporations are permitted to deduct $3,000 in net capital losses annually.

Page Ref.: C:3-7
Objective: 2

3) Organizational expenses incurred after 2004 are amortized over five years.

Page Ref.: C:3-8
Objective: 2

4) Corporations may deduct the adjusted basis of inventory plus one-half of the excess of the property’s FMV over its adjusted basis if the inventory is used for the care of the ill, needy, or infants.

Page Ref.: C:3-11
Objective: 2

5) Corporations may carry charitable contributions in excess of the income limitation forward for five years.

Page Ref.: C:3-13
Objective: 2

6) The dividends-received deduction is designed to reduce double taxation of corporate dividends payable to individual shareholders.

Page Ref.: C:3-15
Objective: 2

7) Sparks Corporation receives a dividend of $100,000 from Jill Corporation, a C Corporation. Sparks owns 70% of Jill Corporation stock. Sparks’ dividends-received deduction is $80,000.

Page Ref.: C:3-15
Objective: 2

8) An election to forgo an NOL carryback must be made on or before the return due date (including extensions) for the year in which the NOL is incurred.

Page Ref.: C:3-19
Objective: 2

9) If a controlling shareholder sells depreciable property to a controlled corporation and the property is depreciable by the purchaser, any gain on the sale is a 1231 gain.

Page Ref.: C:3-21
Objective: 2

10) All of the taxable income of a personal service corporation is taxed at a flat 35% rate.

Page Ref.: C:3-24
Objective: 3

11) Corporate estimated tax payments are due April 15, June 15, September 15, and January 15.

Page Ref.: C:3-35
Objective: 5

12) A deferred tax asset indicates that a firm will realize the tax benefit of an event sometime in the future.

Page Ref.: C:3-44
Objective: 7

13) Deferred tax liabilities occur when expenses are deductible for book purposes before tax purposes.

Page Ref.: C:3-44
Objective: 7

14) Identify which of the following statements is true.
A) A corporation is a separate taxpaying entity that must file a tax return annually.
B) A newly formed corporation must select its basic accounting method.
C) The terms “regular corporation” and “C corporation” are synonymous.
D) All of the above are true.

Page Ref.: C:3-2
Objective: 1

15) Identify which of the following statements is false.
A) A corporation’s fiscal year generally must end on the last day of the month.
B) A fiscal year may not end on December 31.
C) A new corporation can elect a fiscal year that runs from February 16 to February 15 of the following year.
D) A corporation’s first tax year may not cover a full 12-month period.

Page Ref.: C:4-2
Objective: 1

16) Identify which of the following statements is true.
A) A corporation that is a member of an affiliated group filing a consolidated tax return may be allowed a tax year which is different from the group’s parent.
B) An S corporation must generally use a calendar year.
C) A corporation’s first year must cover a twelve-month period.
D) All of the above are false.

Page Ref.: C:3-2 and C:3-3
Objective: 1

17) Which of the following results in a deferred tax asset?
A) Revenue or gains are recognized earlier for book purposes than for tax purposes.
B) Operating loss or tax credit carryforwards exist.
C) Tax basis of an asset is less than its book.
D) Expenses are deductible earlier for tax purposes than for book purposes.

Page Ref.: C:3-44
Objective: 7

18) Which of the following items will not create a deferred tax liability?
A) Revenues or gains are recognized earlier for book purposes than for tax purposes.
B) Expenses or losses are deductible earlier for tax purposes than for book purposes.
C) Tax basis of an asset is less than its book basis.
D) Operating loss or tax credit carryforwards exist.

Page Ref.: C:3-44
Objective: 7

19) Which of the following types of evidence indicate that a valuation allowance is needed to reduce the deferred tax asset?
A) history of profits
B) excess of appreciated asset values over basis
C) existing contracts or sales backlogs, which will generate significant future income
D) short carryback or carryover periods

Page Ref.: C:3-44
Objective: 7

20) Which of the following items is a permanent difference between taxable and financial accounting income?
A) depreciation
B) dividends-received deduction
C) bad debts
D) net capital loss

Page Ref.: C:3-44
Objective: 7

21) Which of the following items is a temporary difference between tax income and financial accounting income?
A) production activities deduction
B) proceeds on life insurance on a key executive
C) dividends-received deduction
D) depreciation

Page Ref.: C:3-44
Objective: 7

22) Once a corporation has elected a taxable year, it can change the taxable year without IRS permission if
A) the resulting short period does not have a net operating loss.
B) the corporation has not changed its accounting period within the last ten years.
C) the annualized income for the short period is at least 80% of the corporation’s income for the preceding taxable year.
D) All of the above conditions must be met.

Page Ref.: C:3-4
Objective: 1

23) A new corporation may generally select one of the following accounting methods with the exception of
A) cash method.
B) accrual method.
C) retail method.
D) hybrid method.

Page Ref.: C:3-4 and C:3-5
Objective: 1

24) Identify which of the following statements is false.
A) A corporation with annual gross receipts of $5,000,000 or less can use the accrual method to account for sales, cost of goods sold, inventories, accounts receivable and payable, and the cash method for other income and expenses.
B) Casualty losses incurred by a corporation are deductible subject to a nondeductible floor similar to those applicable to individuals.
C) The passive loss rules do not apply to widely held C corporations.
D) Corporations may receive a deduction for dividends received from other corporations.

Page Ref.: C:3-5 and C:3-6
Objective: 2

25) Identify which of the following statements is true.
A) A corporate capital loss can be carried back three years, and then can be carried forward five years.
B) Corporate capital loss carrybacks can offset corporate ordinary income earned in previous years.
C) At the election of a corporation, a net capital loss carryback can be forgone and carried forward only.
D) All of the above are false.

Page Ref.: C:3-6 and C:3-7
Objective: 2

26) Trail Corporation has gross profits on sales of $140,000 and deductible expenses of $180,000. In addition, Trail has a net capital gain of $60,000. Trail’s taxable income is
A) a $20,000 loss.
B) a $40,000 loss.
C) $60,000.
D) $20,000.

Page Ref.: C:3-7; Example C:3-2
Objective: 2

27) Identify which of the following is false.
A) Corporations that sell real property at a gain must report an additional 20% of the entire gain as ordinary income.
B) Corporations selling real property that previously had been depreciated using an accelerated method are subject to Sec. 291.
C) Section 291 reduces the amount of net Sec. 1231 gains that can be offset by corporate capital losses.
D) Section 291 recapture applies to Sec. 1250 property.

Page Ref.: C:3-7
Objective: 2

28) Dallas Corporation, not a dealer in securities, realizes taxable income of $60,000 from the operation of its business. Additionally, in the same year, Dallas realizes a long-term capital loss of $10,000 from the sale of marketable securities. If the corporation realizes no other capital gains or losses, what is the proper treatment for the $10,000 long-term capital loss on the tax return?
A) Use $3,000 of the loss to reduce taxable income and carry $7,000 of the long-term capital loss forward for five years.
B) Use $6,000 of the loss to reduce taxable income and carry $4,000 of the long-term capital loss forward for five years.
C) Use $10,000 of the long-term capital loss to reduce taxable income.
D) Carry the $10,000 long-term capital loss back three years as a short-term capital loss, then forward five years.

Page Ref.: C:3-7
Objective: 2

29) Evans Corporation has a $15,000 net capital loss in 2011. The corporation reported the following capital gain net income during the past three years. Identify which of the following statements is true.

Year Capital Gain
Net Income
2008
2009
2010 $10,000
11,000
5,000

A) The loss is used to offset the gains from 2010 and then carried back to offset $10,000 of the gains in 2008.
B) The loss is used to offset the $11,000 of the 2009 gains and then carried back to offset $4,000 of the year 2008 net gain.
C) The loss is used to offset $3,000 of the current year ordinary income, all of the year 2008 capital gains, and $7,000 of the year 2009 net gain.
D) The loss is used to offset the year 2008 net gains, then $5,000 of the year 2009 net gains.

30) Booth Corporation sells a building classified as a residential rental property for $200,000. The MACRS straight-line depreciation taken is $20,000 and the adjusted basis of the building is $170,000. Booth Corporation must recognize ordinary income of
A) $30,000.
B) $20,000.
C) $4,000.
D) $0.

31) Which of the following items indicate that a company does not need a valuation allowance?
A) existing sales contracts that will produce sufficient income to realize the deferred tax asset
B) excess of appreciated asset value over tax basis sufficient to realize the deferred tax asset
C) a strong history of earnings without considering the deferred tax asset
D) All of the above are correct.

Page Ref.: C:3-44
Objective: 7
32) Which of the following statements is correct?
A) Deferred tax assets/liabilities are always classified as current on the balance sheet.
B) The classification of deferred tax assets/liabilities depends on whether the related asset is current or noncurrent.
C) Deferred tax assets are classified based on their expected reversal dates.
D) Deferred tax assets/liabilities are classified as noncurrent on the balance sheet.

Page Ref.: C:3-45 and C:3-46
Objective: 7

33) Organizational expenditures include all of the following except for
A) costs incurred when issuing stock.
B) legal costs incident to the creation of the corporation.
C) expenses of organizational meetings.
D) fees paid to the state of incorporation.

Page Ref.: C:3-9
Objective: 2

34) Green Corporation is incorporated on March 1 and begins business on June 1. Green’s first tax year ends on October 31, i.e., a short year. Green incurs the following expenses during the year:

Month Type Amount
February
March
March
April
December Draft charter
Stock commission
Accounting fees to set up books
Temporary director fees
Charter modification fee $ 2,000
30,000
2,000
2,000
1,000

What is the deduction for organizational expenses if Green chooses to deduct its costs as soon as possible?
A) $36,000
B) $5,028
C) $667
D) $500

35) Edison Corporation is organized on July 31. The corporation starts business on August 10. The corporation adopts a November 30 fiscal year end. The following expenses are incurred during the year:

Date Type Amount
6-30
7-10
7-15
6-30
12-6 Attorney’s fees associated with obtaining charter
Underwriter fees for stock sale
Transfer cost for property contributed to the corporation for stock
Costs of organizational meetings
Legal fees to modify charter $ 10,000
25,000
3,000
2,000
4,000

What is the maximum amount of organizational expenditures that can be deducted by the corporation for its first tax year ending November 30?
A) $16,000
B) $12,000
C) $5,156
D) $800

36) Identify which of the following statements is true.
A) Organizational expenditures incurred by a corporation do not include the cost of accounting services necessary to create the corporation.
B) Organizational expenditures incurred by a corporation do not include the cost of printing stock.
C) Unamortized organizational expenses cannot be deducted when the corporation is liquidated.
D) All of the above are false.

Page Ref.: C:3-9
Objective: 2

37) Identify which of the following statements is true.
A) A corporation that accrues compensation payable to an employee must pay the amount within two and one-half months after the close of the taxable year to deduct the amount in the year of the accrual.
B) Accrued compensation that is deductible in the year of accrual is considered to be part of an IRS deferred compensation plan.
C) Accrued compensation not paid within three and one-half months after the close of the corporation tax year is deducted in the year following the accrual.
D) All of the above are false.

Page Ref.: C:3-10
Objective: 2

38) Super Corporation gives a painting to a museum for public display on August 6. The painting was purchased on April 3 of the same year for $20,000 and is worth $30,000 at the date of gift. Also, Super accrues a charitable contribution on December 30 and pays the $12,000 contribution on February 1 of the next year. Super Corporation is a calendar-year corporation that uses the accrual method of accounting. Before considering the 10% limitation rule, the maximum deduction for the current year is
A) $12,000.
B) $20,000.
C) $30,000.
D) $32,000.

39) Identify which of the following statements is true.
A) “Ordinary income property” with regard to the charitable contribution deduction does not include property whose sale would have produced a short-term capital gain.
B) The Twilight Corporation purchases inventory for $5,000. Its FMV on the date it is donated to the Blue-Gray Hospital for the care of the needy is $14,000. The maximum charitable contribution deduction available for the donation is $9,000.
C) Corporations’ charitable deductions are limited to 20% of their adjusted taxable income.
D) All of the above are false.

Page Ref.: C:3-12
Objective: 2

40) In February of the current year, Brent Corporation donates computer equipment that it purchased six months ago to Eastside High School for use in its educational program. The donated property had a $20,000 adjusted basis to Brent and a $40,000 FMV. What is the amount of the gift?
A) $20,000
B) $30,000
C) $35,000
D) $50,000

41) Garth Corporation donates inventory having an adjusted basis of $40,000 and an FMV of $150,000 to a qualified public charity. The inventory will be used by the charity to care for the ill. The maximum charitable contribution deduction before consideration of the 10% limitation is
A) $40,000.
B) $55,000.
C) $80,000.
D) $95,000.

42) Blueboy Inc. contributes inventory to a qualified charity for use in feeding the needy. The inventory has a $70,000 FMV and a $30,000 adjusted basis. Blueboy Inc. can take a charitable contribution deduction of
A) $20,000.
B) $30,000.
C) $50,000.
D) $60,000.

43) Identify which of the following statements is true.
A) When a corporation donates appreciated capital gain property to a charity, the amount of the contribution deduction generally equals the property’s FMV.
B) When a corporation donates appreciated capital gain property to a private nonoperating foundation, the corporation’s contribution is limited to the property’s FMV minus the ordinary gain that would have resulted from the property’s sale.
C) When a corporation contributes appreciated property to a charity, the charitable contribution deduction is the property’s FMV or adjusted basis, depending on the election made by the taxpayer.
D) All of the above are false.

Page Ref.: C:3-11 and C:3-12
Objective: 2
44) If a corporation’s charitable contributions exceed the deduction limitation in a particular year, the excess
A) is not deductible in any future year.
B) becomes a carryover to a maximum of five succeeding years.
C) may be carried back to the third preceding year.
D) is carried over indefinitely.

Page Ref.: C:3-13
Objective: 2

45) Richards Corporation has taxable income of $280,000 calculated before the charitable contribution deduction and before its dividends-received deduction of $34,000. Richards makes cash contributions of $35,000 to charitable organizations. What is Richards Corporation’s charitable contribution deduction for the current year?
A) $24,600
B) $28,000
C) $31,400
D) $35,000

Page Ref.: C:3-13
Objective: 2

46) JLA is a U.S. shoe manufacturer. Its domestic production income is $1,000,000 and U.S. W-2 wages are $600,000. Taxable income before the domestic production deduction is $500,000. What is the amount of the production activities deduction?
A) $15,000
B) $20,000
C) $45,000
D) $50,000

47) The U.S. production activities deduction is based on a percentage of which of the following?
A) taxable income before the production activities deduction
B) 50% of W-2 wages.
C) qualified production activities income
D) both A and C above

Page Ref.: C:3-14
Objective: 2

48) For purposes of the production activities deduction, domestic production gross receipts do not include which of the following?
A) construction performed in the United States
B) engineering or architectural services performed in the United States for construction projects in the United States
C) lease, rental, license, sale, or other disposition of qualified production property manufactured, produced, grown, or extracted in whole or in significant part within the United States
D) sale of food and beverages prepared at a retail establishment

Page Ref.: C:3-14
Objective: 2

49) In 2011, Summer Corporation earns domestic gross receipts of $2 million and incurs allocable expenses of $800,000. It has $400,000 of income from other sources, resulting in taxable income of $1.6 million before the U.S. production activities deduction. What is its U.S. production activities deduction?
A) $120,000
B) $108,000
C) $60,000
D) $36,000

Page Ref.: C:3-14; Example C:3-12
Objective: 2

50) Island Corporation has the following income and expense items for the year:

Gross receipts from sales $60,000
Dividends received from 15%-owned domestic corporation 40,000
Expenses connected with sales 30,000

The taxable income of Island Corporation is
A) $100,000.
B) $70,000.
C) $47,000.
D) $42,000.

51) Maxwell Corporation reports the following results:

Gross income from operations $90,000
Dividends received from 18%-owned domestic corporation 70,000
Expenses 100,000

Maxwell’s dividends-received deduction is
A) $42,000.
B) $49,000.
C) $56,000.
D) $70,000.

52) Identify which of the following statements is true.
A) The dividends-received deduction is designed to reduce double taxation of corporate dividends.
B) The full 80% dividends-received deduction is available without restriction.
C) If a corporation receives dividends eligible for the 80% dividends-received deduction and the 70% dividends-received deduction, the 70% dividends-received deduction reduces taxable income prior to the 80% deduction.
D) All of the above are false.

Page Ref.: C:3-15
Objective: 2
53) Identify which of the following statements is false.
A) The 70% dividends-received deduction is limited to 70% of the taxable income of the corporation without regard to any NOL deduction, any capital loss carryback, and the dividends-received deduction itself unless the dividends-received deduction produces an NOL.
B) Members of an affiliated group can claim a 90% dividends-received deduction for dividends received from other group members that is not subject to a taxable income limitation.
C) A corporate dividends-received deduction is not allowed for dividends received on stock held for 40 days.
D) All of the above are false.

Page Ref.: C:3-16
Objective: 2

54) Money Corporation has the following income and expenses for the tax year:

Gross profit on sales: $200,000
Expenses: 700,000
Dividends received from less-than-20%-owned domestic corporations: 20,000

What is Money’s net operating loss?
A) $494,000
B) $480,000
C) $520,000
D) $220,000

55) Miller Corporation has gross income of $100,000, which includes $40,000 of dividends from a 10%-owned corporation. In addition, Miller has $80,000 of expenses. Miller’s taxable income or loss is
A) $20,000.
B) $6,000.
C) $0.
D) ($8,000).

56) Two days before the ex-dividend date, Drexel Corporation buys 100 shares of Zebra Corporation stock (less than 1%) for $200,000. Drexel Corporation receives $10,000 of dividends from Zebra Corporation. Two weeks after the ex-dividend date, Drexel Corporation sells the Zebra Corporation stock for $190,000. Which of the following statements is correct?
A) Drexel Corporation cannot recognize a capital loss.
B) Drexel Corporation cannot take a dividends-received deduction on the Zebra Corporation dividend.
C) Drexel Corporation will be allowed a 70% dividends-received deduction when reporting the Zebra Corporation dividend.
D) Drexel Corporation will receive no dividends-received deduction because the stock was purchased ex-dividend.

57) West Corporation purchases 50 shares (less than 1%) of Perch Corporation common stock on April 3. The ex-dividend date is April 4. West Corporation pays $50,000 for the stock and receives a dividend of $5,000 on the Perch stock. On May 1, West Corporation sells the Perch stock for $45,000. West’s taxable income before the dividends-received deduction is $4,000. West’s dividends-received deduction is
A) $3,500.
B) $3,200.
C) $2,800.
D) $0.

58) Identify which of the following statements is true.
A) A corporate NOL can be carried back two years and forward 15 years.
B) An election to forgo an NOL carryback must be made on or before the return due date (including extensions) for the year in which the NOL is incurred.
C) In computing an NOL for the current year, a deduction is allowed for NOLs from previous years.
D) All of the above are false.

Page Ref.: C:3-19
Objective: 2

59) Identify which of the following statements is true.
A) The charitable contribution deduction is computed after the deduction for an NOL.
B) The charitable contribution deduction is computed after the dividends-received deduction.
C) The NOL deduction claimed by a corporation must be taken after the dividends-received deduction.
D) All of the above are false.

Page Ref.: C:3-19
Objective: 2
60) Webster, who owns all the Bear Corporation stock, purchases a dump truck from Bear Corporation in January. The truck cost $12,000 and has a $10,000 adjusted basis at the time of the sale. Webster pays Bear the truck’s $8,000 FMV. Later in the same year, Webster sells the dump truck to an unrelated party for $6,000. Webster can recognize a loss of
A) $4,000.
B) $2,000.
C) $3,000.
D) $5,000.

61) Walter, who owns all of the Ajax Corporation stock, purchases a truck from Ajax Corporation in January. The truck cost $12,000 and has a $10,000 adjusted basis. Walter pays the truck’s $8,000 FMV. Later in the same year, Walter sells the truck to an unrelated party for $13,000. With respect to these transactions,
A) Ajax Corporation reports a loss of $2,000 and Walter reports a gain of $5,000.
B) Ajax Corporation reports no loss and Walter reports a gain of $3,000.
C) Ajax Corporation reports a loss of $4,000 and Walter reports a gain of $5,000.
D) Ajax Corporation reports no loss and Walter reports a gain of $5,000.

62) Davis Corporation, a manufacturer, has taxable income of $150,000. Davis’s regular tax liability is
A) $15,000.
B) $41,750.
C) $34,000.
D) $35,000.

63) Delux Corporation, a retail sales corporation, has a taxable income of $500,000. Delux Corporation’s regular tax liability is
A) $158,250.
B) $162,200.
C) $170,000.
D) $175,000.

64) Access Corporation, a large manufacturer, has a taxable income of $16,000,000. Access Corporation’s tax is
A) $5,440,000.
B) $5,530,000.
C) $5,600,000.
D) $5,680,000.

65) Glacier Corporation, a large retail sales company, has a taxable income of $20,000,000. What is Glacier Corporation’s tax?
A) $6,800,000
B) $7,000,000
C) $7,800,000
D) $7,200,000

66) Baxter Corporation is a personal service corporation. Baxter Corporation has taxable income of $10,000. Baxter Corporation’s tax is
A) $1,500.
B) $3,400.
C) $3,500.
D) $3,900.

67) Which of the following is not subject to classification as a personal service corporation?
A) construction
B) law
C) accounting
D) performing arts

Page Ref.: C:3-23
Objective: 3

68) Identify which of the following statements is true.
A) Personal service corporations may be subject to the passive activity limitations.
B) All C corporations may be subject to the passive activity limitations.
C) Personal service corporations may use passive losses and credits to offset net active income but not portfolio income.
D) Both A and B are true.

Page Ref.: C:3-24
Objective: 3

69) Joker Corporation owns 80% of Klue Corporation. Joker Corporation also owns 45% of Lion Corporation and 45% of Mark Corporation. Klue Corporation owns 40% of Lion Corporation and 10% of Mark Corporation. Which corporations are members of a controlled group?
A) Klue, Lion, and Mark Corporations
B) Joker, Klue, Lion, and Mark Corporations
C) Joker, Klue, and Lion Corporations
D) Joker and Klue Corporations

Page Ref.: C:3-25 and C:3-26
Objective: 4

70) Identify which of the following statements is false.
A) Brown Corporation owns 60% of Clark Corporation and 65% of Davis Corporation. Davis Corporation owns 10% of Clark Corporation, and Clark Corporation owns 10% of Davis Corporation. The remaining stock is owned by an individual shareholder. Brown, Davis, and Clark Corporations are a parent-subsidiary controlled group.
B) There are three categories of control groups: parent-subsidiary, brother-sister, and combined.
C) The controlled group test is applied on December 31.
D) A controlled group must apportion certain tax benefits among its members.

Page Ref.: C:3-25 through C:3-28
Objective: 4
71) Andy owns 20% of North Corporation and 60% of Tent Corporation. North and Tent have only one class of stock outstanding. Barbara owns 50% of North Corporation and 20% of Tent Corporation. North and Tent Corporations will be brother-sister corporations if
A) no stock ownership change occurs.
B) Barbara acquires an additional 10% of North stock.
C) Andy acquires an additional 10% of North stock and Barbara acquires an additional 10% of Tent stock.
D) Barbara acquires an additional 10% of North stock and an additional 10% of Tent stock.

Page Ref.: C:3-26 and C:3-27
Objective: 4

72) Sun and Moon Corporations each have only one class of stock outstanding. Their stock ownership is shown below.

Shareholder Sun Corporation Moon Corporation
Arthur
Brenda
Charles 50%
20%
30% 60%
40%

Which of the four stock ownership changes that are illustrated is the minimum change that is needed if Sun and Moon Corporations are to be brother-sister corporations? (Assume the two corporations are equally valued.)
A) No stock ownership change is required.
B) Charles must acquire an additional 10% of Sun Corporation.
C) Charles must acquire an additional 5% of Moon Corporation.
D) Arthur must acquire an additional 30% of Moon Corporation.

Page Ref.: C:3-26 through C:3-28
Objective: 4

73) Grant Corporation is not a large corporation for estimated tax purposes and reports on a calendar-year basis. Grant expects the following results:

Regular tax $248,000
Alternative minimum tax 40,000
Total tax due $288,000

Grant’s tax liability for last year was $240,000. Grant’s minimum total estimated tax payment for this year to avoid a penalty is
A) $240,000.
B) $248,000.
C) $288,000.
D) $280,000.

74) Identify which of the following statements is true.
A) A corporate tax return must be filed by the fifteenth day of the fourth month following the close of the corporation’s tax year.
B) A corporation is required to file a tax return even if it has no taxable income.
C) A corporation with gross receipts, total income, and total assets of $1,000,000 or less is permitted to file Form 1120-A.
D) All of the above are false.

Page Ref.: C:3-38 and C:3-39
Objective: 6

75) Identify which of the following statements is false.
A) A corporation must file a tax return annually.
B) A corporation can obtain an automatic six-month extension of time to file its tax return.
C) The IRS will permit an extension of time to file a corporate return beyond the original due date only when the corporation’s delay is reasonable.
D) The IRS can rescind the extension period.

Page Ref.: C:3-38 and C:3-39
Objective: 6

76) Identify which of the following statements is true.
A) Form 1120 Schedule L contains the corporation’s income statement.
B) Schedule M-1 (Form 1120) is an analysis of the corporation’s retained earnings.
C) Organizational expense amortized over fifteen years for purposes of determining taxable income results in an upper adjustment in the initial years to book income on the Schedule M-1 when the expense is being amortized over ten years for book income purposes.
D) All of the above are false.

Page Ref.: C:3-35 and C:3-36
Objective: 6
77) Bishop Corporation reports taxable income of $700,000 on its tax return. Given the following information from the corporation’s records, determine Bishop’s net income per its financial accounting records.

Deduction for federal income taxes per books $240,000
Depreciation claimed on the tax return 135,000
Depreciation reported on the financial accounting books 75,000
Life insurance proceeds on death of a corporate officer 100,000

A) $520,000
B) $620,000
C) $660,000
D) $560,000

78) Dreyfuss Corporation reports the following items:

Unappropriated retained earnings, beginning of year: $800,000
Net income: 700,000
Federal income tax refund for last year taken directly to retained earnings: 50,000
Cash dividends paid this year: 500,000

The unappropriated retained earnings at year-end are
A) $1,000,000.
B) $1,050,000.
C) $1,500,000.
D) $2,050,030.

79) Winter Corporation’s taxable income is $500,000. In addition, Winter has the following items:

Depreciation for tax purposes $60,000
Depreciation for financial accounting purposes 40,000
Net capital loss (2,000)
Interest on loan to acquire tax-exempt securities 7,000

What is Winter’s financial accounting income?
A) $511,000
B) $513,000
C) $518,000
D) $520,000

80) Lass Corporation reports a $25,000 net capital loss this year. The corporation reports the following net capital gains during the past three years.

Year Net Long-Term
Capital Gain Net Short-Term
Capital Gain
Third previous year
Year before last
Last year $5,000
7,000
0 $6,000
3,000
0

Determine the amount of net capital loss carried back to each preceding tax year and the amount of capital loss, if any, available as a carryforward.

81) Jackson Corporation, not a dealer in securities, realizes taxable income of $80,000 from the operation of its business. Additionally, Jackson Corporation realizes a $10,000 long-term capital loss from the sale of marketable securities. Explain the treatment of the loss on the corporate return for this and any other years.

82) Bright Corporation purchased residential real estate five years ago for $450,000, of which $50,000 was allocated to the land and $400,000 was allocated to the building. Bright booked straight-line MACRS deductions of $55,000 during the past five years. This year, Bright sells the property for $550,000, of which $100,000 is allocated to the land and $450,000 is allocated to the building. What is the amount and character of Bright’s recognized gain or loss on the sale?

83) Ryan Corporation sells a commercial building and land. The sales proceeds attributable to the building is $145,000. When purchased, the building is allocated $75,000 of the purchase price. The firm has depreciated the building using the MACRS rules. The MACRS deductions taken total $60,000. What is the amount and character of Ryan’s recognized gain?

84) The following expenses are incurred by Salter Corporation when it is organized on July 1:

Attorney fees to draft charter $20,000
Underwriter fees for stock sale 10,000
Transfer cost for property contributed to the corporation for stock 4,000
Costs of organizational meetings before beginning business 5,000
Costs of directors’ meetings after beginning business 8,000

Salter commenced business on September 8. What is the maximum amount of organizational expenditures that can be deducted by the corporation for its first tax year ending December 31?

85) On December 10, 2011, Dell Corporation (a calendar-year taxpayer) accrues an obligation for a $100,000 bonus to Muriel, a sales representative who had had an outstanding year. Muriel owns no Dell Corporation stock. The bonus is paid on May 5, 2012. What is Dell’s deduction for 2011? What is Dell’s deduction for 2012?

86) Chambers Corporation is a calendar year taxpayer using the accrual method of accounting. In 2011, its board of directors authorizes a $20,000 contribution to the Boy Scouts. Chambers pays the contribution on March 12, 2012. What is the maximum contribution allowed in 2011? What is the maximum contribution allowed in 2012?

87) Prince Corporation donates inventory having an adjusted basis of $26,000 and an FMV of $40,000 to County Hospital, which is a qualified public charity. What is the amount of Prince’s deduction?

88) During the year, Soup Corporation contributes some of its inventory to a qualified charity for use in feeding the needy. The inventory has an FMV of $85,000 and an adjusted basis of $25,000. What is the amount of Soup Corporation’s charitable contribution deduction for the donation of the inventory as determined without regard to the overall charitable contribution limitation?

89) Bermuda Corporation reports the following results in 2009 and 2010:

2011 2012
Adjusted taxable income $400,000 $600,000
Charitable contributions 70,000 50,000

What is Bermuda’s contribution deduction in 2011 and 2012? What is the disposition of any remaining amount?

90) Zerotech Corporation donates the following property to an elementary school:
• Computer printer purchased three years ago for $1,000. The printer has a $500 FMV and $0 adjusted basis on contribution date.
• Computer equipment acquired one year ago at a cost of $5,000. The equipment has an $8,000 FMV and $0 adjusted basis on contribution date.
• Computer software acquired two months ago at a cost of $10,000. The software will be used in a prekindergarten program. Its FMV on the contribution date is $10,000 and it has an adjusted basis of $0.

a) Identify any donation qualifying for special treatment.
b) What is Zerotech’s charitable contribution deduction?

91) Francine Corporation reports the following income and expense items for the tax year ending December 31:

Gross receipts from sales $55,000
Dividends received from 15%-owned domestic corporation 28,000
Expenses connected with sales 20,000

What is Francine Corporation’s taxable income?

92) Carter Corporation reports the following results for the current year:

Gross profits on sales $660,000
Dividends from less than 20%-owned corporations 300,000
Operating expenses 650,000

a) What is Carter Corporation’s taxable income for the current year?
b) How would your answer to Part (a) change if Carter’s operating expenses are instead $700,000?
c) How would your answer to Part (a) change if Carter’s operating expenses are instead $760,000?

93) Bebop Corporation reports the following results in the current year:
Gross income from operations $150,000
Dividends from 15% owned domestic corporation 50,000
Expenses 140,000

What is Bebop’s taxable income?

94) Jackel, Inc. has the following information for the current tax year:

Gross sales $350,000
Cost of goods sold 50,000
Dividends received (10%) 40,000
Operating expenses 30,000
Charitable contributions 45,000

What is Jackel’s charitable contribution deduction? What is Jackel’s taxable income?

95) Dexter Corporation reports the following results for the current year:

Gross income from operations $90,000
Dividends from less than 20%-owned corporations 50,000
Operating expenses 75,000
Charitable contributions 10,000

In addition, Dexter has a $25,000 NOL carryover from the preceding tax year. What is Dexter’s taxable income for the current year?

96) Chase Corporation reports the following results in the current year:

Gross income from operations $150,000
Dividends from 15%-owned domestic corporation 50,000
Expenses 155,000

What is Chase’s taxable income?

97) Dumont Corporation reports the following results in the current year:

Gross income from operations $150,000
Dividends from 15%-owned domestic corporation 50,000
Expenses 165,500

What is Dumont’s taxable income?

98) Courtney Corporation had the following income and expenses for the tax year:

Gross profit on sales $300,000
Expenses $600,000
Dividends received from less-than-20%-
owned domestic corporations $ 20,000

Courtney had taxable income for the past three years of:

2009 $100,000
2010 $120,000
2011 $ 80,000

a) Determine the corporation’s NOL for the current year.
b) Determine the amount of NOL carried back to each preceding tax year and the amount of NOL, if any, available as a carryforward.

99) Paul, who owns all the stock in Rodgers Corporation, purchases a truck from the corporation in January. The truck cost $11,000 and has an adjusted basis of $9,000. Paul pays Rodgers the truck’s $7,000 FMV. Paul sells the truck later in the tax year to an unrelated party for $12,000. What is the amount and character of the income that Paul will report on this year’s tax return?

100) Little Corporation uses the accrual method of accounting. Little’s sole shareholder, Renee, uses the cash method of accounting. Both taxpayers use the calendar year as their tax year. The corporation accrues a $25,000 interest payment to Renee on December 25, 2011 and makes the payment on March 10, 2012. What are the tax consequences of the transactions to both taxpayers in 2011 and 2012?

101) Westwind Corporation reports the following results for the current year:

Gross profit on sales $250,000
Long-term capital gain 25,000
Long-term capital loss 10,000
Short-term capital gain 7,500
Short-term capital loss 12,500
Operating expenses 80,000

What are Westwind’s taxable income and regular tax liability before credits for the current year?

102) Woods and Tiger Corporations have only one class of stock outstanding, owned by the following individuals:
Stock Ownership Percentages
Shareholder Woods Corp. Tiger Corp.
John 80% 25%
Sarah 20% 75%

Are Woods and Tiger members of a brother-sister controlled group? Why or why not?

103) Ben and Jerry Corporations are members of the Ben-Jerry controlled group. The corporations file separate tax returns for the current year and report the following results:

Corporation Taxable Income (NOL)
Ben $(25,000)
Jerry 100,000

a) If they elect no special apportionment plan, what is their combined tax liability?
b) If they DO elect a special apportionment plan, what is their lowest combined tax liability?

104) Exam Corporation reports taxable income of $800,000 on its federal income tax return. Given the following information from the corporation’s records, determine its book income.

Deduction for federal income taxes per
financial accounting records $272,000
Depreciation claimed on the tax return 140,000
Depreciation recorded on the financial accounting records 80,000
Dividends-received deduction 48,000
Life insurance proceeds on death of corporate officer 90,000

105) Continental Corporation anticipates a 34% tax rate for the next several years and has a $500,000 NOL carryover.
a) What is the journal entry to record the NOL carryover’s tax benefits, assuming that no valuation is needed?
b) What is the journal entry if Continental Corporation estimates that one-half of the NOL will not be realized?

106) How does the use of a net capital loss differ for individual and corporate taxpayers?

107) James Corporation purchased residential real estate in 2007 for $225,000, of which $25,000 was allocated to land and $200,000 was allocated to the building. James Corporation took straight-line MACRS deductions of $30,000 during the years 2005-2009. In 2012, James corporation sold the property for $285,000, of which $60,000 is allocated to the land and $225,000 is allocated to the building. What are the amounts and character of James Corporation’s recognized gain or loss on the sale?

108) What are start-up expenditures?

109) For corporations, what happens to excess charitable contributions?

110) Describe the domestic production activities deduction.

111) What are the various levels of stock ownership by corporate shareholders for the dividends-received deduction (DRD)? What is the DRD% for each level of ownership?

112) How does the use of an NOL differ for individual and corporate taxpayers?

113) When computing corporate taxable income. what is the proper sequencing of deductions?

114) What impact does an NOL carryforward have on the proper sequencing of deductions to compute corporate taxable income?

115) What is probably the most common reason for making a consolidated return election?

116) What are some of the advantages and disadvantages of filing a consolidated return?

117) Discuss the estimated tax filing requirements for a C corporation.

118) What are the four principles underlying ASC 740?

119) Newco Corporation has asked you to help determine whether it should use the accrual method or the cash method of accounting. What are the tax issues involved in making this determination?

120) Zeta Corporation received a $150,000 dividend from Omega Corporation this year. Zeta owns 10% of Omega’s single class of stock. What tax issues should Zeta consider with respect to its dividend income?

121) Vanda Corporation sold a truck with an adjusted basis of $50,000 to Barbara for $30,000. Vanessa owns 25% of the Vanda stock. What tax issues should Vanda and Vanessa consider with respect to the sale/purchase?

122) You are the CPA who prepares the tax returns for Dudley, his wife Margo, and their two corporations. Dave owns 100% of Duright Corporation’s stock. Duright’s current-year taxable income is $100,000. Margo owns 100% of Northwest Corporation’s stock. Northwest’s current-year taxable income is $150,000. Dudley and Margo file a joint federal income tax return. What issues should be considered with respect to the calculation of the three tax return liabilities?

123) Cricket Corporation has a $50,000 NOL in the current year. Cricket’s taxable income in each of the previous two years was $25,000. Cricket expects its taxable income for next year to exceed $400,000. What issues should be considered with respect to the use of the NOL?

124) Quality Corporation, a regular corporation, has an opportunity to realize $50,000 of additional income in either the current year or next year. What tax issues need to be considered in determining when to realize the income?

125) Beta Corporation recently purchased 100% of XYZ Corporation stock. You are their CPA. What tax issues need to be addressed before determining whether or not to file a consolidated tax return?

126) Jeffrey Corporation has asked you to prepare its corporate federal income tax return. What issue do you need to address in considering whether Schedule M-3 is required?

127) Junod Corporation’s book income is $500,000. What tax issues must be addressed in determining taxable income?

Chapter 4 Corporate Nonliquidating Distributions

1) Corporate distributions that exceed earnings and profits are always capital gains.

Page Ref.: C:4-2
Objective: 1

2) Corporations may always use retained earnings as a substitute for earnings and profits.

Page Ref.: C:4-5
Objective: 2

3) When computing E & P, Section 179 property must be expensed ratably over a five-year period, starting with the month in which it is expensed for Sec. 179 purposes.

Page Ref.: C:4-5
Objective: 2

4) A shareholder’s basis in property distributed as a dividend is its fair market value.

Page Ref.: C:4-9
Objective: 3

5) When appreciated property is distributed in a nonliquidating distribution, the net effect on the distributing corporation’s E&P is that it is reduced by the FMV of the property distributed and increased by the gain (net of federal income taxes) recognized due to the property distribution.

Page Ref.: C:4-10
Objective: 3

6) Corporations recognize gains and losses on the distribution of property to shareholders if the property’s fair market value differs from its basis.

Page Ref.: C:4-10
Objective: 3

7) In a nontaxable distribution of stock rights, when the value of the rights is less than 15% of the value of the stock with respect to which the rights were distributed, the basis of the rights is zero unless the shareholder elects to allocate stock basis to the rights.

Page Ref.: C:4-14 and C:4-15
Objective: 4

8) In a taxable distribution of stock, the recipient shareholder takes a basis equal to the FMV of the stock received.

Page Ref.: C:4-15
Objective: 4
9) A stock redemption is always treated as if the shareholder sold his stock to the corporation.

Page Ref.: C:4-17
Objective: 5

10) The Sec. 318 family attribution rules can be waived for purposes of the Sec. 302(b)(3) complete termination rules even though the redeeming shareholder is a creditor of the corporation.

Page Ref.: C:4-22
Objective: 5

11) A partial liquidation of a corporation is treated as a dividend in the case of a corporate shareholder.

Page Ref.: C:4-24 and C:4-25
Objective: 5

12) Two corporations are considered to be brother-sister corporations for purposes of the Sec. 304 redemption rules if one shareholder owns more than 50% of each corporation.

Page Ref.: C:4-30
Objective: 7

13) Identify which of the following statements is false.
A) For E&P dividend distribution purposes, property as defined in Sec. 317(a) includes money.
B) The function of E&P is to provide a measure of a corporation’s economic ability to pay dividends.
C) At formation, a corporation’s E&P depends on the amount of capital contributed by the shareholders.
D) Adjustments to taxable income when computing E&P do not include tax-exempt interest.

Page Ref.: C:4-3 and C:4-4
Objective: 2

14) Identify which of the following increases Earnings & Profits.
A) a capital contribution
B) life insurance proceeds payable to the spouse
C) tax-exempt interest income
D) All of the above increase E&P of a corporation.

Page Ref.: C:4-4
Objective: 2

15) Current E&P does not include
A) tax-exempt interest income.
B) life insurance proceeds where the corporation is the beneficiary.
C) federal income tax refunds from prior years.
D) All of the above are included.

Page Ref.: C:4-4
Objective: 2

16) Grant Corporation sells land (a noninventory item) with a basis of $57,000 for $100,000. Nichole will be paid on an installment basis in five equal annual payments, starting in the current year. The E&P for the year of sale will be increased as a result of the sale (excluding federal income taxes) by
A) $0.
B) $8,600.
C) $43,000.
D) $100,000.

17) Boxer Corporation buys equipment in January of the current year with a seven-year class life for $15,000. The corporation expensed the $15,000 under Sec. 179. The deduction in the year of purchase for E&P purposes due to the acquisition and expensing of the equipment is
A) $1,500.
B) $3,000.
C) $14,000.
D) $15,000.

18) For purposes of determining current E&P, which of the following items cannot be deducted in the year incurred?
A) charitable contribution in excess of the 10% limitation
B) capital losses in excess of capital gains
C) life insurance premiums (in excess of the increase in cash surrender value for the policy) paid on the lives of key employees
D) dividends-received deduction

Page Ref.: C:4-5
Objective: 2

19) Identify which of the following statements is true.
A) Section 179 property must be expensed ratably over a five-year period when computing E&P.
B) Losses on property sales to related parties are not deductible when computing E&P.
C) Distributions made out of accumulated E&P are allocated ratably between multiple distributions made during the tax year.
D) All of the above are false.

Page Ref.: C:4-5 and C:4-6
Objective: 2
20) Poppy Corporation was formed three years ago. Poppy’s E&P history is as follows:

Year Current E&P Distributions
2005
2006
2007 $6,000
5,000
1,000 $4,000
1,000
0

Poppy Corporation’s accumulated E&P on January 1 will be
A) $0.
B) $7,000.
C) $5,000.
D) $12,000.

21) Dixie Corporation distributes $31,000 to its sole shareholder, Sally. At the time of the distribution, Dixie’s E&P is $25,000 and Sally’s basis in her Dixie stock is $10,000. Sally’s basis in her Dixie stock after the distribution is
A) $4,000.
B) $10,000.
C) $25,000.
D) $31,000.

22) Crossroads Corporation distributes $60,000 to its sole shareholder Harley. Crossroads has earnings and profits of $55,000 and Harley’s basis in her stock is $20,000. After the distribution, Harley’s basis is
A) $5,000.
B) $15,000.
C) $20,000.
D) $60,000.

23) Tomika Corporation has current and accumulated earnings and profits of $0. Tomika distributes $10,000 to its sole shareholder, Alana. What are Tomika’s earnings and profits after the distribution?
A) $0
B) ($10,000)
C) $10,000
D) none of the above

24) Exit Corporation has accumulated E&P of $24,000 at the beginning of the current tax year. Current E&P is $20,000. During the year, the corporation makes the following distributions to its sole shareholder who has a $22,000 basis for her stock.

Date Amount Distributed
April 1 $20,000
June 1 20,000
August 1 15,000
November 1 5,000

The treatment of the $15,000 August 1 distribution would be
A) $15,000 is taxable as a dividend; $5,000 from current E&P and the balance from accumulated E&P.
B) $15,000 is taxable as a dividend from accumulated E&P.
C) $4,000 is taxable as a dividend from accumulated E&P, and $11,000 is tax-free as a return of capital.
D) $5,000 is taxable as a dividend from current E&P, and $10,000 is tax-free as a return of capital.

25) Oreo Corporation has accumulated E&P of $8,000 at the beginning of the current year. During the year (a nonleap year), the corporation incurs a current E&P deficit of $18,250. The corporation distributes $11,000 on March 20th to Morris, its sole shareholder, who has a $9,000 basis for his stock. If the exact loss cannot be determined as of the date of distribution, the treatment of the distribution will be
A) $4,100 dividend and a $6,900 capital gain.
B) $11,000 return of capital.
C) $4,100 dividend and a $6,900 tax free return of capital.
D) $8,000 dividend and a $3,000 return of capital.

26) Identify which of the following statements is true.
A) If both the current and accumulated E&P have deficit balances, a corporate distribution cannot be characterized as a dividend.
B) The shareholder’s basis in property received in a nonliquidating distribution is the property’s FMV reduced by liabilities assumed by the shareholder.
C) A corporation recognizes gain when distributing money as a dividend to its shareholders.
D) All of the above are false.

Page Ref.: C:4-8 and C:4-9
Objective: 3

27) Identify which of the following statements is true.
A) The holding period for property received by a shareholder in a nonliquidating distribution begins on the day after the distribution.
B) When making a nonliquidating distribution, a corporation recognizes gains and losses.
C) When making a nonliquidating distribution, the corporation’s E&P is reduced by the property’s FMV even though the property’s basis is greater than its FMV.
D) All of the above are false.

Page Ref.: C:4-9
Objective: 3

28) Hogg Corporation distributes $30,000 to its sole shareholder, Ima. At the time of the distribution, Hogg’s E&P is $14,000 and Ima’s basis in her stock is $10,000. Ima’s gain from this transaction is a
A) $6,000 capital gain.
B) $14,000 capital gain.
C) $20,000 capital gain.
D) $30,000 capital gain.

29) One consequence of a property distribution by a corporation to a shareholder is that
A) the amount of the distribution is increased by any liability assumed by the shareholder.
B) the holding period of the distributed property includes the holding period of the distributing corporation.
C) the shareholder’s basis in the distributed property is the same as the distributing corporation’s basis.
D) any liabilities assumed by the shareholder do not reduce the shareholder’s basis.

Page Ref.: C:4-9
Objective: 3

30) Wills Corporation, which has accumulated a current E&P totaling $65,000, distributes land to its sole shareholder, an individual. The land has an FMV of $75,000 and an adjusted basis of $55,000. The shareholder assumes a $15,000 liability associated with the land. The shareholder will recognize
A) $60,000 of dividend income and have a $60,000 basis in the land.
B) $65,000 of dividend income and have a $75,000 basis in the land.
C) $60,000 of dividend income and have a $75,000 basis in the land.
D) $65,000 of dividend income and have a $65,000 basis in the land.

31) Wills Corporation, which has accumulated a current E&P totaling $70,000, distributes land to its sole shareholder, an individual. The land has an FMV of $75,000 and an adjusted basis of $60,000. The shareholder assumes a $15,000 liability associated with the land. The transaction will have the following tax consequences.
A) The corporation will recognize a $15,000 gain; the shareholder will recognize dividend income of $75,000.
B) The corporation will recognize no gain; the shareholder will recognize dividend income of $75,000.
C) The corporation will recognize a $15,000 gain; the shareholder will recognize dividend income of $60,000.
D) The corporation will recognize no gain; the shareholder will recognize dividend income of $60,000.

32) A corporation distributes land and the related liability to Meg, its sole shareholder. The land has an FMV of $60,000 and is subject to a liability of $70,000. The corporation has current and accumulated E&P of $80,000. The corporation’s adjusted basis for the property is $70,000. What effect does the transaction have on the corporation?
A) A recognized loss of $10,000; its E&P is reduced by $70,000.
B) A recognized loss of $10,000; its E&P is unchanged.
C) No recognized gain or loss; its E&P is reduced by $60,000.
D) No recognized gain or loss; its E&P is unchanged by the distribution.

Page Ref.: C:4-10; Example C:4-15
Objective: 3

33) A corporation distributes land and the related liability in a nonliquidating distribution to a shareholder. The land (a capital asset) has an adjusted basis of $70,000, an FMV of $100,000 and is subject to a mortgage of $120,000. The corporation must recognize
A) a $20,000 capital loss.
B) a $50,000 capital gain.
C) a $70,000 capital gain.
D) no gain or loss.

34) Identify which of the following statements is true.
A) The FMV of an obligation is used to determine the E&P reduction when a corporation distributes the obligation to its shareholders.
B) When appreciated property is distributed to shareholders, E&P must be increased by any gain (net of taxes) recognized due to the property distribution.
C) When appreciated property is distributed in a nonliquidating distribution, the net effect on the distributing corporation’s E&P is that it is reduced by the net of the FMV of the property distributed minus the gain (net of federal income taxes) recognized due to the property distribution.
D) Only B and C above are true.

Page Ref.: C:4-10
Objective: 3

35) Which of the following transactions does not have the potential of creating a constructive dividend?
A) compensation paid by a corporation to a shareholder-employee
B) purchase of corporate property by the shareholder
C) shareholder’s rental of corporate property
D) All of the above can result in a constructive dividend.

Page Ref.: C:4-11 through C:4-13
Objective: 3

36) Identify which of the following statements is true.
A) Loans made to shareholders in proportion to their stock ownership in the corporation is evidence that the loans are disguised dividends.
B) Corporate payments for the shareholder’s benefit may be a taxable dividend.
C) If the shareholder can elect to receive distributing corporation stock or money, the receipt of distributing corporation stock will be a taxable dividend.
D) All of the above are true.

Page Ref.: C:4-12 through C:4-14
Objective: 3

37) An individual shareholder owns 3,000 shares of Baxter Corporation common stock with a basis of $10 per share. She receives a nontaxable 5% stock dividend. The basis per share of the common stock after the stock dividend is
A) $9.00.
B) $9.50.
C) $9.52.
D) $10.00.

38) Tia owns 2,000 shares of Bass Corporation common stock with an $80,000 basis. Bass distributes a nontaxable preferred stock dividend. When the preferred stock is distributed, it has an FMV of $60,000 and the FMV of the 2,000 common stock shares is $180,000. The basis of the preferred stock is
A) $0.
B) $20,000.
C) $60,000.
D) $80,000.

39) Bat Corporation distributes stock rights with a $20,000 FMV to its common stock shareholders. The $20,000 value of the stock rights at the time of distribution is less than 15% of the value of the underlying stock. Which of the following statements is true?
A) A shareholder must allocate basis to the rights based on the relative FMVs of the stock and the rights.
B) A shareholder cannot allocate any basis to the rights.
C) The basis in the rights is zero unless a shareholder makes a valid election to allocate basis to the rights.
D) The holding period for the rights begins on the day the rights are distributed in all cases.

Page Ref.: C:4-15; Example C:4-21
Objective: 4

40) Identify which of the following statements is false.
A) The distribution of stock rights will be taxable if the value of the stock rights is more than 15% of the value of the underlying stock.
B) The distribution of stock rights is generally tax free under Sec. 305.
C) If the value of stock rights is less than 15% of the value of the underlying stock, the basis of the rights is zero unless the shareholder elects to allocate basis to the rights.
D) The holding period for stock rights includes the holding period for the underlying stock.

Page Ref.: C:4-15
Objective: 4

41) Bruce receives 20 stock rights in a nontaxable distribution. The stock rights have an FMV of $5,000. The common stock with respect to which the rights are issued has a basis of $4,000 and an FMV of $120,000. Bruce allows the stock rights to lapse. He can deduct a loss of
A) $0.
B) $1,000.
C) $5,000.
D) none of the above

Page Ref.: C:4-15; Example C:4-23
Objective: 4

42) Identify which of the following statements is true.
A) The distributing corporation’s E&P must be reduced by the FMV of nontaxable stock rights distributed to shareholders.
B) A stock redemption can be used to withdraw some assets from a corporation prior to a sale of the business.
C) A shareholder can redeem part of his stock and recognize a capital gain if the corporation has only one shareholder.
D) All of the above are false.

Page Ref.: C:4-16
Objective: 5

43) Which of the following is not a reason for a stock redemption?
A) desire by remaining shareholders to retain control
B) desire by shareholders to reduce the corporate tax liability
C) Redemption of shares is a good corporate investment.
D) No outside market exists for the stock.

Page Ref.: C:4-16
Objective: 5

44) Elijah owns 20% of Park Corporation’s single class of stock. Elijah’s basis in the stock is $8,000. Park’s E&P is $28,000. If Park redeems all of Elijah’s stock for $48,000, Elijah must report dividend income of
A) $0.
B) $28,000.
C) $40,000.
D) $48,000.

45) Joshua owns 100% of Steeler Corporation’s stock. Joshua’s basis in the stock is $8,000. Steeler Corporation has E&P of $40,000. If Steeler Corporation redeems 60% of Joshua’s stock for $50,000, Joshua must report dividend income of
A) $0.
B) $8,000.
C) $40,000.
D) $50,000.

46) Which of the following is not a condition that permits a stock redemption to be treated as a sale?
A) It provides funds for payment of income taxes.
B) It is not essentially equivalent to a dividend.
C) The redemption is substantially disproportionate.
D) The redemption completely terminates the shareholder’s interest.

Page Ref.: C:4-17 through C:4-20
Objective: 5

47) Identify which of the following statements is false.
A) A stock redemption is treated as a sale or exchange only if the shareholder’s ownership of one particular class of stock is terminated.
B) An individual is not considered to own stock owned by a brother under the family attribution rules of Sec. 318.
C) An individual is considered to own the stock owned by his parents, children, spouse, and grandchildren under the family attribution rules of Sec. 318.
D) A person who has an option to purchase stock is considered to own the stock.

Page Ref.: C:4-18
Objective: 5

48) What are the consequences of a stock redemption to the distributing corporation?
A) The corporation recognizes a gain or loss as if it had sold the distributed property for its FMV immediately before the redemption.
B) If the redemption is treated as a dividend, E&P is reduced in the same manner as for a regular dividend.
C) If the redemption is treated as a sale, only accumulated earnings and profits is reduced.
D) All of the above are correct.

Page Ref.: C:4-19
Objective: 5

49) Identify which of the following statements is true.
A) Generally in a stock redemption, if the shareholder’s ownership percentage is substantially reduced, the redemption is treated as a sale.
B) The family attribution rules of Sec. 318 are as inclusive as the family attribution rules of Sec. 267.
C) A 10% shareholder of a corporation is considered to own 10% of any stock that is owned by the corporation under the Sec. 318 attribution rules.
D) All of the above are false.

Page Ref.: C:4-18
Objective: 5

50) Which of the following requirements must be met for a redemption to be treated as substantially disproportionate?
A) The shareholder must own less than 50% of the outstanding stock (in terms of voting power) after the redemption.
B) After the redemption, the shareholder must own less than 80% of his percentage ownership of voting stock prior to the redemption.
C) After the redemption, the shareholder must own less than 80% of his percentage ownership of common stock (voting and nonvoting) prior to the redemption.
D) All of the above must be met.

Page Ref.: C:4-20
Objective: 5

51) Identify which of the following statements is true.
A) Stock ownership attributed to a corporation from one of its shareholders cannot be attributed to another of the corporation’s shareholders under the Sec. 318 attribution rules.
B) Under the attribution rules relating to stock redemptions, a person who has an option to purchase stock is considered to own the stock.
C) A stock redemption that qualifies as substantially disproportionate is a safe harbor for capital gain treatment.
D) All of the above are true.

Page Ref.: C:4-20 and C:4-21
Objective: 5

52) Identify which of the following statements is true.
A) The Sec. 318 family attribution rules can be waived for purposes of the Sec. 302(b)(3) complete termination rules even though the redeeming shareholder is a creditor of the corporation.
B) Waiver of the Sec. 318 family attribution rules is permitted for all related party stock transactions.
C) For a redemption to be essentially equivalent to a dividend, the shareholder must not have control of the corporation immediately following the redemption.
D) All of the above are false.

Page Ref.: C:4-22
Objective: 5

53) Family Corporation, a corporation controlled by Buddy’s family, redeems all of Buddy’s stock. For the redemption to be treated as a sale, which one of the following conditions must be met?
A) Buddy cannot be a creditor of the corporation after the redemption.
B) Buddy cannot be an officer of the corporation after the redemption.
C) Buddy cannot acquire an interest, even by inheritance, for 10 years unless the bequest was made prior to the redemption.
D) Buddy must have purchased the redeemed stock from a person whose stock ownership would be attributed to Buddy.

Page Ref.: C:4-22
Objective: 5

54) All of Sphere Corporation’s single class of stock is owned by four unrelated individuals in the following manner: Zack 27%, Xu 24.33%, Yvonne 24.33%, and Win 24.33%. Some of Zack’s stock holdings are redeemed by Sphere Corporation, resulting in Zack’s interest being reduced to 22.27%. Xu, Yvonne, and Win owned equally the remaining 77.73% of the Sphere stock. How should the redemption of Zack’s stock be treated by Zack?
A) dividend income
B) sale transaction
C) return of capital
D) some other treatment

Page Ref.: C:4-23; Example C:4-35
Objective: 5

55) Identify which of the following statements is true.
A) To have a bona fide partial liquidation, a firm must continue to conduct a qualified trade or business, which it had conducted for a period of more than three years prior to the redemption.
B) To qualify as a partial liquidation, a distribution must result in a bona fide contraction of the corporate business at the corporate level.
C) A partial liquidation of a corporation must be pro rata.
D) All of the above are false.

Page Ref.: C:4-24
Objective: 5

56) Blast Corporation manufactures purses and make-up kits. The corporation decides to quit manufacturing purses and distributes the assets associated with this division to its shareholders. The distribution of the these assets will be treated as a partial liquidation if
A) the corporation so elects.
B) the corporation discontinues the line of business and the transaction is “essentially equivalent to a dividend.”
C) the distribution is made within 24 months of the adoption of a plan of liquidation and the transaction is “not essentially equivalent to a dividend.”
D) the distribution is “not essentially equivalent to a dividend” and is made within the year a plan of liquidation is adopted or within the succeeding year.

Page Ref.: C:4-24
Objective: 5

57) Perch Corporation has made paint and paint brushes for the past ten years. Perch Corporation is owned equally by Arnold, an individual, and Acorn Corporation. Perch Corporation has $100,000 of accumulated and current E&P. Both Arnold and Acorn Corporation have a basis in their stock of $10,000. Perch Corporation discontinues the paint brush operation and distributes assets worth $10,000 each to Arnold and Acorn Corporation in redemption of 20% of their stock. Due to the distribution, Arnold and Acorn Corporation must report:

A)
Arnold Acorn Corporation
$8,000 capital gain $8,000 capital gain

B)
Arnold Acorn Corporation
$8,000 capital gain $10,000 dividend

C)
Arnold Acorn Corporation
$10,000 dividend $8,000 capital gain

D)
Arnold Acorn Corporation
$10,000 dividend $10,000 dividend

58) The gross estate of a decedent contains $2,000,000 cash and 100% of Davis Corporation stock worth $600,000. Funeral and administrative expenses and state death taxes allowable as estate tax deductions amount to $400,000. The estate owes no other liabilities. The decedent’s Davis stock can be
A) redeemed to the extent of the death taxes and the estate’s funeral and administrative costs with sale or exchange treatment.
B) redeemed with dividend treatment.
C) redeemed in full with sale or exchange treatment only if the proceeds are used to pay the death taxes and funeral and administrative costs.
D) redeemed to the extent of the death taxes and the funeral and administrative costs with sale or exchange treatment only if the proceeds are used to pay the death taxes and funeral and administrative costs.

59) Identify which of the following statements is true.
A) If a stock redemption is made by an estate following the decedent’s death, the redemption may receive capital gains treatment only if the money is actually used to pay the death taxes.
B) Attribution rules do not apply to qualified Sec. 303 stock redemptions.
C) The value of decedent’s stock satisfies the Sec. 303 minimum if it is less than 35% of the decedent’s gross estate.
D) All of the above are false.

Page Ref.: C:4-25
Objective: 5

60) Identify which of the following statements is true.
A) Only stock included in the decedent’s gross estate can be redeemed under the Sec. 303 provisions.
B) If the stock redemption proceeds are used to pay either the estate’s funeral and administrative expenses or death taxes, the redemption can qualify for capital gains treatment under Sec. 303.
C) Usually, a stock redemption qualifying under Sec. 303 as a redemption to pay death taxes will result in little or no gain to the redeeming shareholder.
D) All of the above are true.

Page Ref.: C:4-25
Objective: 5

61) Jack Corporation redeems 200 shares of its stock for $100,000 from Junior, who inherited the stock from his father, Ken. The stock’s FMV on Ken’s date of death was $90,000. Ken’s basis in the stock was $40,000. Jack Corporation had an E&P balance of $300,000. If the redemption qualifies under Sec. 303, Junior will
A) recognize a capital gain of $10,000.
B) recognize a capital gain of $60,000.
C) recognize $100,000 in dividend income.
D) recognize dividend income of $50,000 and a capital gain of $10,000.

Page Ref.: C:4-26; Example C:4-41
Objective: 5

62) Identify which of the following statements is false.
A) The rules for the recognition of a gain or loss by a corporation that distributes property in redemption of its stock are the same as the rules for property distributions that are not in redemption of stock.
B) Generally, little or no gain is recognized by the redeeming shareholder in a qualified Sec. 303 redemption.
C) When a stock redemption is considered a sale of stock by the shareholder, the E&P of the redeeming corporation is reduced by the FMV of the property used to redeem the stock.
D) Under Sec. 311, a corporation does not recognize a loss when it distributes property that has declined in value.

Page Ref.: C:4-27
Objective: 5

63) Circle Corporation has 1,000 shares of common stock outstanding. Circle redeems 450 shares owned by Dennis for $75,000 in complete redemption of Dennis’s interest. The redemption qualifies as a sale. When the redemption is made, Circle Corporation has $150,000 of current and accumulated E&P and paid-in capital of $50,000. The distribution reduces paid-in capital by
A) $67,500.
B) $22,500.
C) $17,500.
D) $0.

64) Identify which of the following statements is true.
A) The distribution of preferred stock as a stock dividend will result in income or a taxable gain being recognized by the shareholder on the date of the distribution if the stock is Sec. 306 stock.
B) Corporations without E&P can distribute preferred stock as a stock dividend that is Sec. 306 stock.
C) Two corporations are considered to be brother-sister corporations for purposes of the Sec. 304 redemption rules if one shareholder owns more than 50% of each corporation.
D) All of the above are false.

Page Ref.: C:4-30
Objective: 6

65) John owns 70% of the May Corporation stock and 60% of the June Corporation stock. John sells one-half of his interest in May Corporation to June Corporation for $45,000. The E&P accounts of May and June are $25,000 and $35,000, respectively. The result would be that
A) John has sold his stock and reports a capital gain or loss.
B) John has sold his stock and reports a capital gain but no loss.
C) the transaction is treated as a contribution to May’s capital and a redemption of June stock.
D) the sale is recast as a dividend paid to John, first by June and then by May.

Page Ref.: C:4-30 and C:4-31
Objective: 7

66) Boris owns 60 of the 100 shares outstanding of Bread Corporation stock and 80 of the 100 shares of Butter Corporation stock. His basis in the Bread shares is $10,000 and his basis in his Butter shares is $5,000. Boris sells 30 of his Bread Corporation shares to Butter Corporation for $25,000. Bread Corporation has E&P of $20,000 and Butter Corporation has E&P of $40,000. In applying the substantially disproportionate test to determine if this is a sale or a dividend, Boris is treated as owning how many shares of Bread after the sale?
A) 30 shares
B) 54 shares
C) 60 shares
D) 80 shares

67) Rose has a $20,000 basis in the 60% of the Parent Corporation stock that she owns. Parent Corporation owns a 70% interest in Child Corporation. Parent and Child have current and accumulated E&P balances of $25,000 and $40,000, respectively. In return for $15,000, Rose sells 10% of the Parent Corporation stock to Child Corporation. What is the impact of the transaction on Rose?
A) Rose will recognize a $5,000 capital gain.
B) Rose will be treated as having received a $15,000 dividend distribution from Child Corporation.
C) Rose will be treated as having sold stock to Parent Corporation and recognize a $15,000 capital gain.
D) Rose will be treated as having received a $15,000 dividend from Parent Corporation.

Page Ref.: C:4-32
Objective: 7

68) Which of the following statements is not true about redemptions?
A) Redemptions of Sec. 306 stock are generally treated as dividends to the shareholder.
B) A sale of stock from one controlled corporation to another controlled corporation is treated as a redemption.
C) Redemptions to pay death taxes are treated as dividends to the shareholder.
D) A distribution in redemption of stock is generally a dividend.

Page Ref.: C:4-33
Objective: 7

69) Marie owns one-half of the stock of Starke Corporation and serves as its President. The remaining stock is owned by 10 investors, none of whom owns more than 10% of the outstanding shares. Marie entered a hedge agreement with the corporation three years ago about salary payments that are declared unreasonable compensation by the IRS. Two years ago, the Corporation paid Marie a salary and bonus of $500,000. The IRS subsequently held that $200,000 of the salary is unreasonable compensation. Last year, Starke Corporation and the IRS agreed that $150,000 of the compensation is, in fact, unreasonable. This year, the $150,000 is repaid by Marie to the corporation.
A) The entire $500,000 is taxable to Marie in the year of receipt and $150,000 of the compensation is deductible by Marie last year.
B) Marie must amend the return of two years ago to adjust her taxable compensation to the agreed- upon reasonable amount.
C) The entire $500,000 is taxable to Marie in the year of receipt and $150,000 of the compensation is deductible by Marie this year.
D) Marie must not include the agreed-upon amount in her return since it is not deductible.

Page Ref.: C:4-34; Example C:4-49
Objective: 8

70) Van owns all 1,000 shares of Valley Metal Corporation stock. The stock has a $100,000 FMV. Karen wants to purchase the stock from Van but has only $70,000. Valley Metal has ample cash, which is not needed for operations. Which of the following best qualifies for bootstrap redemption treatment and no constructive dividends to the purchaser?
A) Karen contracts to acquire all the stock of the corporation on an installment plan and then uses corporate funds to pay the installment obligations.
B) Karen buys 70 shares from Van for $70,000 and Van causes Valley Metal Corporation to redeem his remaining shares for $30,000.
C) Karen buys 70 shares from Van for $70,000 and then contracts to buy the remaining 30 shares from Van. She then causes Valley Metal Corporation to redeem Van’s 30 shares.
D) Karen buys 70 shares from Van for $70,000 and obtains an option to purchase Van’s remaining stock for $50,000. Karen then assigns the option to Valley Metal Corporation. The corporation subsequently exercises the option.

Page Ref.: C:4-34; Example C:4-50
Objective: 8

71) Which of the following statements best describes a bootstrap acquisition?
A) The shareholder sells part of his or her stock to a purchaser and then the corporation redeems the original shareholder’s remaining stock.
B) The shareholder sells his stock in exchange for cash and debt.
C) The shareholder exchanges his stock for stock of a different corporation.
D) none of the above

Page Ref.: C:4-34
Objective: 8

72) Good Times Corporation has a $60,000 accumulated E&P balance at the beginning of the year and incurs a $100,000 deficit during the year. Because of its poor operating performance, Good Times pays only three of its usual $10,000 quarterly dividend payments to its sole shareholder: those ordinarily paid March 31, June 30, and September 30. How are the March 31, June 30, and September 30 payments of $10,000 treated?
A) dividend; dividend; return of capital
B) dividend; return of capital; return of capital
C) return of capital; dividend; dividend
D) return of capital; return of capital; dividend

Page Ref.: C:4-35 and C:4-36; Example C:4-52
Objective: 8

73) On April 1, Delta Corporation distributes $120,000 in cash to each of its two equal shareholders, Sarah and Matt. At the time of the distribution, Delta’s E&P is $160,000. Sarah’s basis in her stock is $50,000 and Matt’s basis in his stock is $20,000. How are the distributions characterized to Sarah and Matt? Be specific.

74) Omega Corporation is formed in 2006. Its current E&P and distributions for each year through 2010 are as follows:

Year Current E&P (deficit) Distributions
2007 $(20,000) 0
2008 30,000 0
2009 36,000 $18,000
2010 16,000 0

Is the distribution made from current or accumulated E&P? At the beginning of 2011, what is accumulated E&P?

75) In 2010, Tru Corporation deducted $5,000 of bad debts. It received no tax benefit from the deduction because it had an NOL in 2010 that it was unable to carry back or forward. In 2011, Tru recovered $4,000 of the amount due.
a) What amount must Tru include in income in 2011?
b) What effect does the $4,000 have on E&P in 2011, if any?

76) In the current year, Ho Corporation sells land that has a $6,000 basis and a $10,000 FMV to Henry, an unrelated individual. Henry makes a $25,000 down payment this year and will pay Ho $25,000 per year for the next three years, plus interest on the unpaid balance at a rate acceptable to the IRS. Ho’s realized gain is $4,000. Since Ho is not in the business of selling land, it will use the installment method of accounting. How does this transaction affect Ho’s E&P in the current year and the three subsequent years?

77) When computing E&P and taxable income, different depreciation methods are often used. What happens when the taxpayer sells such assets?

78) River Corporation’s taxable income is $25,000, after deducting a $5,000 NOL carryover from last year and after claiming a $10,000 dividends-received deduction. What is the current E&P?

79) White Corporation is a calendar-year taxpayer. Wilhelmina owns all of its stock. Her basis for the stock is $25,000. On March 1 of the current year (not a leap year), White Corporation distributes $60,000 to Wilhelmina. Determine the tax consequences of the cash distribution to Wilhelmina in each of the following independent situations:
a) Current E&P $15,000, accumulated E&P $50,000.
b) Current E&P $25,000, accumulated E&P $(25,000).
c) Current E&P ($36,500), accumulated E&P $65,000.
d) Current E&P ($10,000), accumulated E&P $(25,000.

80) Splash Corporation has $50,000 of taxable income before any charitable contribution deduction. Splash contributed $20,000 to a qualified charitable organization. Due to the 10% of taxable income limitation on charitable contribution deductions, Splash’s contribution deduction is limited to $5,000. What effect does the charitable contribution have on current and future E&P?

81) Peach Corporation was formed four years ago. Its current E&P (or E&P deficit) and distributions for the most recent four years are as follows:

Year Current E&P (Deficit) Distributions
2005
2006
2007
2008 ($20,000)
8,000
( 5,000)
25,000 $ 2,000
4,000
0
4,000

What is Peach’s accumulated E&P at the beginning of 2006, 2007, 2008, and 2009?

82) Payment Corporation has accumulated E&P of $19,000 and current E&P of $28,000. During the year, the corporation makes the following distributions to its sole shareholder:

Date Amount Distributed
April 1
June 1
August 1
November 1 $20,000
20,000
15,000
5,000

The sole shareholder’s basis in her stock is $45,000. What are the tax consequences of the June 1 distribution?

83) Green Corporation is a calendar-year taxpayer. All of the stock is owned by Evan. His basis for the stock is $35,000. On March 1 (of a non-leap year), Green Corporation distributes $120,000 to Evan. Determine the tax consequences of the cash distribution to Evan in each of the following independent situations:

Current E&P Accumulated E&P
a) $30,000 $100,000
b) 50,000 ( 50,000)
c) (73,000) 40,000
d) (20,000) ( 50,000)

84) When is E&P measured for purposes of determining whether a distribution is a dividend?

85) In the current year, Pearl Corporation has $300,000 of current and accumulated E&P. On June 3, Pearl Corporation distributes a parcel of land (a capital asset) worth $120,000 to Betty, a shareholder. The land has a $60,000 adjusted basis to Pearl Corporation and is subject to a $16,000 mortgage, which Betty assumes. Assume a 34% marginal corporate tax rate.
a) What is the amount and character of the income recognized by Betty as a result of the distribution?
b) What is Betty’s basis for the land?
c) What is the amount and character of Pearl’s gain or loss as a result of the distribution?
d) What effect does the distribution have on Pearl’s E&P?

86) In the current year, Red Corporation has $100,000 of current and accumulated E&P. On March 2, Red Corporation distributes to Randy, a shareholder, a parcel of land (a capital asset) having a $60,000 FMV. The land has a $30,000 adjusted basis (for both tax and E&P purposes) to Red Corporation and is subject to an $8,000 mortgage, which Randy assumes. Assume a 34% marginal corporate tax rate.
a) What is the amount and character of the income Randy recognizes as a result of the distribution?
b) What is Randy’s basis for the land?
c) What is the amount and character of Red Corporation’s gain or loss as a result of the distribution?
d) What effect does the distribution have on Red Corporation’s E&P?

87) Digger Corporation has $50,000 of current and accumulated E&P. On March 1, Digger distributes land with a $30,000 FMV and a $17,500 adjusted basis to Dave, its sole shareholder. The land is subject to a $5,000 liability which Dave assumes.
a) What are the amount and character of the distribution?
b) What is Dave’s basis in the property?
c) When does his holding period for the property begin?

88) Gould Corporation distributes land (a capital asset) worth $90,000 to Gerry, a shareholder. The land has a $30,000 basis to Gould. What is the amount and character of the gain or loss recognized by Gould?

89) Strong Corporation is owned by a group of 20 shareholders. During the current year, Strong Corporation pays $225,000 in salary and bonuses to Stedman, its president and controlling shareholder. The IRS audits Strong’s tax return and determines that reasonable compensation for Stedman would be $125,000. Strong Corporation agrees to the adjustment.
a) What effect does the disallowance of part of the deduction for Stedman’s salary and bonuses have on Strong Corporation and Stedman?
b) What tax savings could have been obtained by Strong Corporation and Stedman if an agreement had been in effect that required Stedman to repay Strong Corporation any amounts determined by the IRS to be unreasonable?

90) Checkers Corporation has a single class of common stock outstanding. Bert owns 100 shares, which he purchased five years ago for $200,000. In the current year, when the stock is worth $2,500 per share, Checkers Corporation declares a 10% stock dividend payable in common stock. Bert receives ten additional shares on December 10 of the current year. On January 25 of next year he sells all ten shares for $30,000.
a) How much income must Bert recognize when he receives the stock dividend?
b) How much gain or loss must Bert recognize when he sells the ten shares he received as a stock dividend?

91) Ace Corporation has a single class of stock outstanding. Alan owns 200 shares of the common stock, which he purchased for $50 per share two years ago. On April 10, of the current year, Ace Corporation distributes to its shareholders one right to purchase a share of common stock at $60 per share for each share of common stock held. At the time of the distribution, the common stock is worth $75 per share, and the rights are worth $15 per right. On September 10, Alan sells 100 rights for $2,000 and exercises the remaining 100 rights. He sells 60 of the shares acquired with the rights for $80 each on November 10.

a) What is the amount and character of income Alan recognizes when he receives the rights?
b) What is the amount and character of gain or loss Alan recognizes when he sells the rights?
c) What is the amount and character of gain or loss Alan recognizes when he exercises the rights?
d) What is the amount and character of gain or loss Alan recognizes when he sells the new common stock?
e) What basis does Alan have in his remaining shares?

92) Peter owns all 100 shares of Parker Corporation’s stock. His basis in the stock is $30,000. Parker Corporation has $300,000 of E&P. Parker Corporation redeems 25 of Peter’s shares for $90,000. What are the consequences to Peter and to Parker Corporation?

93) Maury Corporation has 200 shares of stock outstanding as follows:

Name Shares
Amy (an individual) 30
APB Partnership (Amy is a 20% partner) 25
ABC Partnership (Amy is a 70% partner) 50
Silver Corporation (Amy is a 30% shareholder) 50
Gold Corporation (Amy is a 60% shareholder) 45
Total 200

How many shares is Amy deemed to own under the Sec. 318 attribution rules?

94) Dave, Erica, and Faye are all unrelated. Each has owned 100 shares of News Corporation stock for five years and each has a $180,000 basis in those 100 shares. News Corporation’s E&P is $720,000. News redeems all 100 of Dave’s shares for $300,000, their FMV.
a) What is the amount and character of Dave’s recognized gain or loss? What basis do Erica and Faye have in their remaining shares? What effect does the redemption have on News’s E&P?
b) Assuming instead that Dave is Erica’s son, answer the questions in part (a) again.

95) Bart, a 50% owner of Atlas Corporation’s common stock, receives a distribution of a new class of Atlas preferred stock having a $40,000 FMV. Bart’s basis in the Atlas common stock is $30,000. Its FMV is $80,000 on the distribution date. One year later, the corporation redeems the preferred stock for $75,000. At the time the stock was issued, the corporation’s current and accumulated E&P was $80,000. At the end of the year of redemption, the current and accumulated E&P is $25,000. No other distributions out of E&P were made in the year of redemption. What are the tax consequences of the transaction?

96) Susan owns 150 of the 200 outstanding shares of Parent Corporation’s stock. Parent owns 160 of the 200 outstanding shares of Subsidiary Corporation’s stock. Susan sells 50 shares of her Parent stock to Subsidiary for $40,000. Susan’s basis in her Parent shares is $15,000 ($100 per share). Subsidiary Corporation and Parent Corporation have E&P of $60,000 and $25,000, respectively, at the end of the year in which the redemption occurs.
a) What is the amount and character of Susan’s gain or loss on the sale?
b) What is Susan’s basis in her remaining shares of Parent stock?
c) How does the sale affect the E&P of Parent and Subsidiary Corporations?
d) What basis does Subsidiary Corporation take in the Parent shares it purchases?
e) How would your answer to Part (a) change if Susan instead sells 100 of her Parent shares to Subsidiary Corporation for $80,000?

97) Rich owns 60 of the 100 outstanding shares of Rainbow Corporation’s stock and 80 of the 100 outstanding shares of Oz Corporation’s stock. Rich’s basis in his Rainbow shares is $12,000, and his basis in his Oz shares is $8,000. Rich sells 30 of his Rainbow shares to Oz Corporation for $50,000. At the end of the year of the sale, Rainbow and Oz Corporations have E&Ps of $25,000 and $40,000, respectively.
a) What is the amount and character of Rich’s gain or loss?
b) What is Rich’s basis in his remaining shares of the Rainbow and Oz stock?
c) How does the sale affect the E&Ps of Rainbow and Oz Corporations?
d) What basis does Oz Corporation take in the Rainbow shares it purchases?
e) How would your answer to part (a) change if Rich owns only 50 shares of the 100 outstanding shares of Oz Stock?

98) How does a shareholder classify a distribution for tax purposes?

99) Outline the computation of current E&P, including two examples for each adjustment.

100) Maple Corporation distributes land to a noncorporate shareholder. Explain how the following items are computed:
a) The amount of the distribution.
b) The amount of the dividend.
c) The basis of the land to the shareholder.
d) The start of the holding period for the land.
How would your answers change if the distribution was made to a corporate shareholder?

101) What is a constructive dividend? Under what circumstances are constructive dividends most likely to arise?

102) Why are stock dividends generally nontaxable? Under what circumstances are stock dividends taxable?

103) What is a stock redemption? What are some of the reasons for making a stock redemption? Why are some redemptions treated as sales and others as dividends?

104) Define Sec. 306 stock.

105) Alice owns 56% of Daisy Corporation’s stock and 50% of May Corporation’s stock. Alice sells one-half of her interest in May Corporation to Daisy Corporation for $30,000. The E&P balances of Daisy and May are $25,000 and $35,000, respectively. Alice’s basis in her Daisy stock is $40,000 and her basis in the May stock is $38,000. What are the tax consequences of the transaction?

106) Ameriparent Corporation owns a 70% interest in Flag Corporation. The corporations have current and accumulated E&Ps of $25,000 and $40,000, respectively. Taxpayer, who has a $20,000 basis in her 40% ownership interest of Ameriparent Corporation, sells sufficient stock to Flag to reduce her interest in Ameriparent from 40% to 20%. Taxpayer receives $20,000 for the stock she surrenders. What are the tax consequences of the transaction for Taxpayer?

107) What must be reported to the IRS by corporations when nondividend distributions are made to its shareholders?

108) Tia receives a $15,000 cash distribution from Main Corporation in March of the current year. Main has $6,000 of accumulated E&P at the beginning of the year and $12,000 of current E&P. Main also distributed $15,000 in cash to Betty, who purchased all 300 shares of Main stock from Tia in June of the current year. What tax issues should be considered with respect to the distributions paid to Tia and Betty?

109) Kiara owns 100% of the shares of Lion Corporation. Kiara’s basis is $70,000 and the FMV of the shares is $200,000. Kiara is willing to sell all of the stock to Tia, but Tia is unwilling to pay more than $150,000 for the stock because the Corporation has excess cash balances. They have agreed that Kiara can withdraw $50,000 in cash from Lion before the stock sale. What tax issues should be considered with respect to Kiara and Tia’s agreement?
Page Ref.: C:4-3 through C:4-8, and C:4-33
Objective: 2

110) Jerry purchased land from Winter Harbor Corporation, his 100%-owned corporation, for $275,000. The corporation purchased the land three years ago for $300,000. Similar tracts of land located nearby have sold for $400,000 in recent months. What tax issues should be considered with respect to the corporation’s sale of the land?

111) John, the sole shareholder of Photo Specialty Corporation has had an exceptional year. He is considering issuing himself a large bonus in lieu of a dividend. You are concerned about unreasonable compensation. What issues must be considered?

112) Stone Corporation redeems 1,000 share of its stock from Steve for $100,000. Steve’s basis in those shares is $80,000. What tax issues should Steve consider with respect to the transaction?

113) Nichol Corporation has 100 shares of common stock outstanding. Nichol repurchased all of Ned’s 30 shares for $35,000 cash during the current year. Ned received the shares as a gift from his mother three years ago. They have a basis to him of $16,000. Nichol Corporation has $100,000 in current and accumulated E&P. Ned’s mother owns 40 of the remaining shares; unrelated individuals own the other 30 shares. What tax issues should be considered with respect to the corporation’s purchase of Ned’s shares?

Chapter 5 Other Corporate Tax Levies

1) The alternative minimum tax is the excess of the tentative minimum tax amount over the regular tax amount.

Page Ref.: C:5-2
Objective: 1

2) Corporations cannot use the installment method in calculating alternative minimum taxable income (AMTI) for noninventory items.

Page Ref.: C:5-10
Objective: 1

3) The NOL deduction is calculated the same for regular and alternative minimum tax purposes.

Page Ref.: C:5-8
Objective: 1

4) The ACE adjustment always increases alternative minimum taxable income (AMTI).

Page Ref.: C:5-9
Objective: 1

5) Life insurance proceeds are a positive adjustment for adjusted current earnings (ACE), but not alternative minimum taxable income (AMTI).

Page Ref.: C:5-9
Objective: 1

6) All corporations, except S corporations and small C corporations, must calculate the ACE adjustment.

Page Ref.: C:5-9
Objective: 2

7) The minimum tax credit available for a corporation’s alternative minimum tax liability can be carried forward indefinitely and offsets regular tax liabilities in future years.

Page Ref.: C:5-12
Objective: 1

8) The general business credit can be used to offset the alternative minimum tax.

Page Ref.: C:5-13
Objective: 1

9) Wind Corporation is a personal holding company. Its taxable income for this year is $100,000. The corporation’s charitable contributions are $5,000 greater than its income tax charitable contribution deduction limitation. Wind’s UPHCI is $95,000, assuming no other adjustments must be made.

Page Ref.: C:5-20
Objective: 2

10) A corporation can be subject to both the accumulated earnings tax and the personal holding company tax in the same year.

Page Ref.: C:5-25
Objective: 3

11) To avoid the accumulated earnings tax, a corporation needs to have a definite plan for expending the accumulated earnings.

Page Ref.: C:5-26
Objective: 3

12) Identify which of the following statements is false.
A) The alternative minimum tax is the excess of the tentative minimum tax amount over the regular tax amount.
B) All corporations with gross receipts of less than $10 million are exempt from the AMT.
C) If the firm does not qualify for Small C corporation status, the C corporation statutory exemption amount for alternative minimum tax purposes is phased out when alternative minimum taxable income reaches $310,000.
D) The purpose of the AMT is to ensure that every taxpayer with substantial economic income pays a minimum tax.

Page Ref.: C:5-2
Objective: 1

13) Identify which of the following statements is false.
A) The corporate AMT produces relatively little tax revenue.
B) The small corporation AMT exemption exempts 95% of all corporations from the AMT.
C) The corporate AMT is similar to the AMT for individuals.
D) The starting point for computing a corporation’s AMT is book income.

Page Ref.: C:5-2
Objective: 1

14) The Small C corporation exemption from AMT continues as long as average gross receipts for the three preceding tax years are
A) $6.5 million or less.
B) $7.0 million or less.
C) $7.5 million or less.
D) $8.0 million or less.

Page Ref.: C:5-3
Objective: 1
15) When computing a corporation’s alternative minimum taxable income, its taxable income is
A) only increased (never decreased) by tax preference items.
B) only increased (never decreased) by adjustments.
C) increased by the statutory exemption of $40,000.
D) increased by 75% of the excess of adjusted current earnings over taxable income.

Page Ref.: C:5-5
Objective: 1

16) In the last three years, Wolf Corporation had gross receipts of $3,000,000, $5,000,000, and $10,000,000. Which of the following statements is correct?
A) Wolf receives a statutory exemption of $40,000 based on its receipts.
B) Wolf is exempt from the AMT.
C) Wolf is subject to the AMT in the current year.
D) There is insufficient information to determine whether Wolf is subject to the AMT.

Page Ref.: C:5-5
Objective: 1

17) Identify which of the following statements is true.
A) The corporate alternative minimum tax rate is 35%.
B) No credits are allowed when computing the tentative minimum tax.
C) Tax preference items always increase alternative minimum taxable income.
D) All of the above are false.

Page Ref.: C:5-5
Objective: 1

18) Which of the following items are tax preference items for purposes of arriving at alternative minimum taxable income?
A) excess intangible drilling costs on oil and gas properties
B) interest income earned on federal obligations
C) all depreciation claimed on pre-1987 real property acquisitions
D) excess of net long-term capital gains over short-term capital losses

Page Ref.: C:5-5
Objective: 1

19) Foggy Corporation has regular taxable income of $1,200,000. It has $250,000 of interest income on private activity bonds and $100,000 of interest on City of New Orleans bonds. How much is Foggy’s preadjustment AMTI?
A) $1,200,000
B) $1,350,000
C) $1,450,000
D) $1,550,000

Page Ref.: C:5-5
Objective: 1

20) Identify which of the following statements is true.
A) Depreciation on real property may be a tax preference item for purposes of computing AMT.
B) Depreciation on real property may be an adjustment item for purposes of computing AMT.
C) Adjustments to taxable income always increase alternative minimum taxable income.
D) Both A and B are true.

Page Ref.: C:5-6 and C:5-7
Objective: 1

21) Identify which of the following statements is false.
A) Tax-exempt interest on certain private activity bonds may be taxed under the alternative minimum tax.
B) Tax preference items and adjustments may either increase or decrease taxable income to obtain AMTI.
C) Depending on the date an asset is placed in service, depreciation may be an adjustment to taxable income or a tax preference item for alternative minimum tax purposes.
D) Different depreciation rules are used when computing taxable income and alternative minimum taxable income.

Page Ref.: C:5-5
Objective: 1

22) Which of the following items are adjustments made to arrive at alternative minimum taxable income?
A) excess percentage depletion
B) excess of deprecation claimed on personalty acquired in the current year for taxable income purposes over that claimed for alternative minimum tax purposes
C) tax-exempt interest income earned on private activity bonds
D) statutory exemption

Page Ref.: C:5-6
Objective: 1

23) Becky places five-year property in service during June 2014 using the half-year convention. Depreciation is $1,500 under the 150% declining balance method and $2,000 under 200% declining balance. Becky uses the 200% declining balance method for regular income tax purposes. What is the amount of Becky’s AMT adjustment?
A) $0
B) $1,500 positive adjustment
C) $500 positive adjustment
D) $500 negative adjustment

Page Ref.: C:5-7
Objective: 1

24) Becky places five-year property in service during June 2014 using the half-year convention. Depreciation is $1,500 under the 150% declining balance method and $2,000 under 200% declining balance. Becky uses the 150% declining balance method for regular income tax purposes. What is the amount of Becky’s AMT adjustment?
A) $0
B) $1,500 positive adjustment
C) $500 positive adjustment
D) $500 negative adjustment

Page Ref.: C:5-7
Objective: 1

25) Which of the following statements about the alternative minimum tax depreciation rules is correct?
A) The MACRS depreciation rules are used to calculate the depreciation deduction when calculating alternative minimum taxable income regardless of the date the property was placed in service.
B) The excess of the gain reported on the disposition of tangible personal property for income tax purposes over the gain reported for alternative minimum tax purposes is a positive adjustment to taxable income in arriving at alternative minimum taxable income.
C) A 31.5-year recovery period is used when calculating the commercial real property depreciation deduction for alternative minimum taxable income purposes.
D) No depreciation adjustment is made when computing AMT for real property acquired after 1998.

Page Ref.: C:5-7
Objective: 1

26) Identify which of the following statements is true.
A) A corporation’s adjusted current earnings (ACE) amount is calculated by making adjustments that are similar to those used in computing earnings and profits (E&P).
B) The adjusted current earnings (ACE) adjustment attempts to adjust the AMT tax base towards a corporation’s economic income.
C) Adjusted current earnings (ACE) is computed beginning with preadjustment alternative minimum taxable income.
D) All of the above are true.

Page Ref.: C:5-9
Objective: 1

27) Which of the following is not an adjustment in calculating AMTI?
A) gain on installment sales of noninventory property
B) the regular tax NOL deduction
C) production activities deduction
D) the difference between the gains for AMTI and regular tax purposes

Page Ref.: C:5-8
Objective: 1

28) How does the deduction for U.S. production activities affect AMTI?
A) The computation of qualified production activities is the same for taxable income and AMTI.
B) The computation of qualified production activities is based on qualified production activities income for AMTI.
C) The computation of qualified production activities is based on AMTI before the deduction for qualified production activities.
D) The computation of qualified production activities is based on the lesser of qualified production activities income or AMTI before the deduction for qualified production activities.

Page Ref.: C:5-8
Objective: 1

29) Identify which of the following statements is false.
A) Adjusted current earnings (ACE) is the same as E&P.
B) A corporation’s positive adjusted current earnings (ACE) adjustment equals 75% of the excess of its ACE over its preadjustment AMTI (AMTI before this adjustment and the alternative tax NOL deduction).
C) A corporation’s negative adjusted current earnings (ACE) adjustment equals 75% of the excess of its preadjustment AMTI (AMTI before this adjustment and the alternative tax NOL deduction) over its ACE, but may not exceed the cumulative “net” ACE adjustment amounts from all post-1989 tax years.
D) The ACE adjustment is not required of S corporations.

Page Ref.: C:5-9
Objective: 1

30) Tax-exempt interest income on state and local municipal bonds that are not a private activity is
A) a tax preference item.
B) a positive adjustment in calculating alternative minimum taxable income (AMTI).
C) a negative adjustment in calculating alternative minimum taxable income (AMTI).
D) included in calculating ACE (adjusted current earnings).

Page Ref.: C:5-9
Objective: 1

31) Certain adjustments must be made to alternative minimum taxable income (AMTI) to arrive at adjusted current earnings (ACE). Which one of the following adjustments increases AMTI to arrive at ACE?
A) federal income taxes paid
B) the 80% dividends-received deduction
C) gain realized on the installment sale of noninventory property
D) excess of capital losses over capital gains

Page Ref.: C:5-10
Objective: 1

32) Identify which of the following statements is true.
A) The ACE adjustment is required of S corporations.
B) The 70% dividends-received deduction reduces preadjustment AMTI to arrive at ACE.
C) The 80% dividends-received deduction can be claimed when computing a corporation’s adjusted current earnings (ACE).
D) All of the above are false.

Page Ref.: C:5-9
Objective: 1

33) Mountaineer, Inc. has the following results:

Regular corporate tax liability $ 400,000
Taxable income 2,000,000
Preferences 500,000
Adjustments (200,000)

What is the amount of the tentative minimum tax?
A) $500,000
B) $360,000
C) $460,000
D) none of the above

Page Ref.: C:5-10 through C:5-12
Objective: 1

34) Mountaineer, Inc. has the following results:

Regular corporate tax liability $ 400,000
Taxable income 2,000,000
Preferences 500,000
Adjustments (200,000)

What is the amount of the alternative minimum tax?
A) $0
B) $60,000
C) $100,000
D) none of the above

Page Ref.: C:5-10 through C:5-12
Objective: 1

35) Identify which of the following statements is true.
A) The minimum tax credit carries forward indefinitely and offsets regular tax liabilities in future years.
B) The minimum tax credit available for a corporation’s alternative minimum tax liability can be carried over for five years.
C) The general business credit is permitted to offset 100% of the larger of (1) a corporation’s regular tax amount, or (2) its tentative minimum tax amount.
D) All of the above are false.

Page Ref.: C:5-12
Objective: 1

36) Which of the following statements regarding the minimum tax credit is correct?
A) It can only be carried forward.
B) It must be carried back before being carried forward.
C) Taxpayers may elect to forgo the carryback period and carry the credit forward.
D) There are not carryforwards or carrybacks of the minimum tax credit.

Page Ref.: C:5-12
Objective: 1

37) Beta Corporation incurs an $80,000 regular tax liability and a $20,000 AMT liability. Assuming no restrictions on Beta’s ability to use the minimum tax credit, what journal entry would be necessary to record tax expense?

A)
Federal income tax expense 60,000
Deferred tax asset 20,000
Taxes payable 80,000

B)
Federal income tax expense 80,000
Taxes payable 80,000

C)
Federal income tax expense 60,000
Taxes payable 60,000

D)
Federal income tax expense 80,000
Deferred tax asset 20,000
Taxes payable 60,000

Page Ref.: C:5-37
Objective: 6

38) ASC 740 requires that
A) the AMT is not considered as federal income tax expense.
B) companies must establish a valuation allowance for the minimum tax credit.
C) the minimum tax credit creates a deferred tax asset.
D) the minimum tax credit increases federal income tax expense.

Page Ref.: C:5-35
Objective: 6
39) The personal holding company tax might be imposed
A) on both partnerships and corporations.
B) on companies whose gross income arises solely from rentals, if the lessors render no services to the lessees.
C) if more than 50% of the company is owned by five or fewer individuals for the entire year.
D) on small business investment companies licensed by the Small Business Administration.

Page Ref.: C:5-15
Objective: 2

40) Foster Corporation has gross income for regular tax purposes of $100,000, which includes a net Sec. 1231 gain of $10,000 and a net capital gain of $10,000. Ordinary gross income for personal holding company purposes is
A) $70,000.
B) $80,000.
C) $90,000.
D) $100,000.

Page Ref.: C:5-15
Objective: 2

41) Identify which of the following statements is false.
A) Askew Corporation has ten unrelated shareholders, each of whom owns 10% of the outstanding stock. This corporation is a personal holding company.
B) Stock owned by an individual, in addition to stock attributed from her spouse, parents, children, and siblings, are all counted towards whether or not the personal holding company stock ownership test has been met.
C) S corporations and tax-exempt organizations are excluded from the personal holding company (PHC) definition.
D) A person who holds an option to acquire stock is considered to own the stock for purposes of the PHC stock requirements.

Page Ref.: C:5-15
Objective: 2

42) Identify which of the following statements is true.
A) The personal holding company tax is levied to prevent closely held corporations from sheltering passive income.
B) Caleb Corporation is owned by a mother and her two daughters. It reports $100,000 of rental income, $30,000 of depreciation, interest, and property taxes on the rental real estate, and $10,000 of dividend income. Caleb Corporation is classified as a personal holding company.
C) Luke Corporation is owned by a father and his son. The corporation employs 10 individuals to provide public accounting services. Father and son make all of the work assignments for the professional employees. The professional fees earned by the corporation are personal holding company income.
D) All of the above are false.

Page Ref.: C:6-14
Objective: 2
43) Identify which of the following statements is true.
A) The personal holding company taxes that are paid by a corporation can be used as a credit against its regular tax amount.
B) Whether a corporation is subject to the personal holding company tax is determined by using two objective tests, while the determination of whether a corporation is subject to the accumulated earnings tax is determined subjectively.
C) Income from personal service contracts are not included in personal holding company income.
D) All of the above are false.

Page Ref.: C:5-15 and C:5-22
Objective: 2

44) The personal holding company penalty tax rate is
A) 15%.
B) 10%.
C) 20%.
D) 35%.

Page Ref.: C:5-19
Objective: 2

45) Which of the following is not an adjustment to taxable income when computing the personal holding company tax?
A) dividends-received deduction
B) dividends-paid deduction
C) NOL carryover from immediately preceding tax year
D) All of the above are adjustments.

Page Ref.: C:5-20; Figure C:5-2
Objective: 2

46) Identify which of the following statements is false.
A) The 80% dividends-received deduction can be claimed when computing a corporation’s undistributed personal holding company income (UPHCI).
B) Rental expenses in excess of rental income are added back to taxable income to arrive at personal holding company income (PHCI).
C) Wind Corporation is a personal holding company. Its taxable income for this year is $100,000. The corporation’s charitable contributions are $5,000 greater than its income tax charitable contribution deduction limitation. Wind’s UPHCI is $95,000, assuming no other adjustments must be made.
D) The PHC tax is assessed at 15%.

Page Ref.: C:5-20
Objective: 2
47) Identify which of the following statements is true.
A) Consent dividends are cash dividends paid following an authorizing vote of the shareholders.
B) Dividends that are paid in the two preceding tax years can be used as a dividend carryover to reduce the amount of the current year’s personal holding company (PHC) tax liability.
C) Dividends paid by a personal holding company in the first 2 1/2 months of a tax year are automatically throwback dividends.
D) All of the above are false.

Page Ref.: C:5-22 and C:5-23
Objective: 2

48) Identify which of the following statements is true.
A) A deficiency dividend is included in the shareholder’s gross income for his/her tax year that includes the last day of the tax year in which the personal holding company claims a dividends-paid deduction.
B) A shareholder who receives a deficiency dividend must report the dividend as gross income for the tax year that includes the last day of the distributing corporation’s tax year on which it was a PHC.
C) A personal holding company’s payment of a deficiency dividend eliminates its need to pay the personal holding company tax as well as any interest and underpayment penalties on the tax deficiency.
D) All of the above are false.

Page Ref.: C:5-22 and C:5-23
Objective: 2

49) A personal holding company cannot take a dividends-paid deduction for
A) throwback dividends.
B) consent dividends.
C) deficiency dividends.
D) preferential dividends.

Page Ref.: C:5-22 and C:5-23
Objective: 2

50) Dragon Corporation reports a distribution on its return from the third previous year as a stock redemption producing a capital gain. When the return is audited during the current year, the distribution of the third previous year is characterized by the IRS as a dividend. This change causes Dragon Corporation to be classified as a personal holding company for the third previous year. Which of the following statements is correct?
A) Dragon Corporation will owe no interest and/or underpayment penalty if the PHC tax is avoided by a deficiency dividend.
B) Dragon Corporation will owe interest and/or underpayment penalty even if the PHC tax is avoided by a deficiency dividend.
C) A deficiency dividend is not permitted to be paid by Dragon.
D) A dividend must be paid within 120 days of establishing the PHC tax liability and a claim for a dividends-paid deduction must be filed within 90 days of the determination date.

Page Ref.: C:5-22 and C:5-23
Objective: 4
51) Which of the following actions cannot be used to eliminate a possible personal holding company tax liability involving a corporation owned by a mother and a father?
A) Sell additional stock to other family members.
B) Make a cash distribution within 2 1/2 months of the end of the tax year.
C) Make a deficiency distribution within 90 days of the date on which the IRS determines that a personal holding company liability is owed.
D) Liquidate the corporation.

Page Ref.: C:5-22 and C:5-23
Objective: 4

52) The personal holding company tax
A) may be imposed regardless of the number of equal stockholders in a corporation.
B) may be eliminated by the payment of a deficiency dividend.
C) qualifies as a tax credit, which may be used by the shareholders to reduce their individual income taxes.
D) applies to any corporation whose shareholders satisfy the stock ownership requirement.

Page Ref.: C:5-22 and C:5-23
Objective: 4

53) The accumulated earnings tax does not apply to corporations that
A) have more than one class of stock.
B) are personal holding companies.
C) are members of a controlled group.
D) are closely held corporations.

Page Ref.: C:5-23
Objective: 3

54) Identify which of the following statements is true.
A) A corporation can be subject to both the accumulated earnings tax and the personal holding company tax in the same year.
B) The accumulated earnings tax is applied to a corporation’s earnings. If the earnings are not subsequently distributed, the earnings will be taxed again under the accumulated earnings tax the next year.
C) The accumulated earnings tax is not levied on the corporation’s total accumulated earnings balance, but only on its current-year addition to the balance.
D) All of the above are false.

Page Ref.: C:5-23
Objective: 3

55) Which of the following entities is subject to the accumulated earnings tax?
A) Sec. 501 tax-exempt corporation
B) personal holding company
C) C corporation
D) S corporation

Page Ref.: C:5-23
Objective: 3
56) Identify which of the following statements is true.
A) In practice, the accumulated earnings tax applies only to closely held corporations.
B) A corporation bears the burden of proving that its earnings are not being accumulated to avoid income taxes.
C) To avoid the accumulated earnings tax, a corporation needs to have a definite plan for expending the accumulated earnings.
D) All of the above are true.

Page Ref.: C:5-23 through C:5-25
Objective: 3

57) Which of following generally does not indicate an unreasonable earnings accumulation?
A) loans to shareholders
B) expenditure of corporate funds for the personal benefit of the shareholders
C) planned expansion of business facilities
D) investments in properties or securities unrelated to the activities of the corporation

Page Ref.: C:5-25
Objective: 3

58) All of the following are recognized as reasons for accumulating earnings except
A) working capital needs.
B) product liability loss reserves.
C) redemption of stock of deceased shareholder.
D) All of the above are recognized reasons for accumulating earnings.

Page Ref.: C:5-25
Objective: 3

59) When using the Bardahl formula, an increase in annual credit sales (while holding the average accounts receivable balance constant) has which of the following effects on the working capital requirements?
A) increase
B) decrease
C) no effect
D) increase, decrease, or no effect, depending on other factors

Page Ref.: C:5-27 and C:5-28; Example 19
Objective: 3

60) Identify which of the following statements is true.
A) The Bardahl formula is based on the firm’s inventory period, receivables period, credit period, and total cash expenditures for cost of sales and operating expenses.
B) The Bardahl formula uses the concept of working capital, cash over current liabilities.
C) The Bardahl formula provides mathematical exactness when calculating reasonable working capital needs for accumulated earnings tax purposes.
D) All of the above are false.

Page Ref.: C:5-27 and C:5-28; Example 19
Objective: 3
61) When using the Bardahl formula, an increase in accounts payable (while holding purchases and operating expenses constant) has which of the following effects on the working capital requirements?
A) increase
B) decrease
C) no effect
D) increase, decrease, or no effect, depending on other factors

Page Ref.: C:5-28
Objective: 3

62) Identify which of the following statements is true.
A) A corporation accumulates earnings to fund the redemption of a shareholder’s stock following her death so as to provide her estate with liquidity to pay death taxes. Such an accumulation of earnings is a reasonable business need.
B) A corporation accumulates earnings to fund a buy-sell agreement. Such an accumulation of earnings is a reasonable business need.
C) A corporation’s net capital gain (minus any federal income taxes paid with respect to such gain) increases the tax base for the accumulated earnings tax.
D) All of the above are false.

Page Ref.: C:5-29
Objective: 3

63) A corporation cannot reasonably accumulate earnings to
A) protect against pending litigation.
B) fund an employee retirement plan.
C) self-insure.
D) redeem stock of an elderly shareholder where such accumulation occurs prior to the shareholder’s death.

Page Ref.: C:5-29
Objective: 3

64) The accumulated earnings tax is imposed at what rate?
A) 10%
B) 15%
C) 20%
D) 35%

Page Ref.: C:5-29
Objective: 3

65) When computing the accumulated earnings tax, which of the following is not a reduction to arrive at accumulated taxable income?
A) accumulated earnings credit
B) NOL deduction claimed
C) accrued federal income taxes
D) dividends-paid deduction

Page Ref.: C:5-30
Objective: 3

66) Identify which of the following statements is true.
A) Payment of deficiency dividends will prevent the imposition of the accumulated earnings tax.
B) All corporations are exempt from the accumulated earnings tax on their first $250,000 of accumulated earnings.
C) A health service corporation can claim an accumulated earnings credit of $250,000.
D) All of the above are false.

Page Ref.: C:5-31
Objective: 3

67) When computing the accumulated earnings tax, the dividends-paid deduction is not available for
A) dividends paid during the tax year.
B) throwback dividends.
C) stock dividends.
D) All of the above are deductible.

Page Ref.: C:5-31
Objective: 3

68) In determining accumulated taxable income for the purpose of the accumulated earnings tax, which one of the following is allowed as a deduction?
A) excess charitable contributions
B) dividends-received deduction
C) net operating loss deduction
D) net capital loss for the current year

Page Ref.: C:5-30
Objective: 3

69) Which of the following is not permitted an accumulated earnings credit based on reasonable needs of the business?
A) an operating company
B) an investment company
C) an incorporated engineer
D) All of the above are permitted a credit based on reasonable business needs.

Page Ref.: C:5-31
Objective: 3

70) Which of the following actions cannot be used to eliminate a potential accumulated earnings tax liability situation involving a corporation owned by a mother and a father?
A) Create plans to invest retained earnings in a plant expansion.
B) Make a cash distribution within 2 1/2 months after the end of the tax year.
C) Make a deficiency distribution within 90 days of the date on which the IRS determines that an accumulated earnings tax liability is owed.
D) Liquidate the corporation.

Page Ref.: C:5-31
Objective: 3
71) Identify which of the following statements is false.
A) A corporation files a Schedule AE to report the amount of its accumulated earnings tax liability for the tax year.
B) A corporation that is subject to the accumulated earnings tax may also be subject to interest and underpayment penalties on the amount of the unpaid liability.
C) A corporation files a Schedule PH to report its PHC tax for the tax year.
D) The corporate AMT liability is reported on Form 4626.

Page Ref.: C:5-36
Objective: 5

72) Hydrangia Corporation reports the following results for the current year:

Taxable income $300,000
Interest on private activity bonds 20,000
Life insurance proceeds 250,000
Dividends-received deduction 50,000
Depreciation claimed for:
Taxable income purposes 175,000
AMT purposes 130,000
Adjusted current earnings 800,000

What is Hydrangia Corporation’s alternative minimum tax liability?

73) Barker Corporation, a personal service company, has $200,000 of taxable income. Barker has tax preferences and positive adjustments of $200,000 and negative adjustments of $140,000 for alternative minimum tax purposes. No credits are available. Barker’s regular tax liability is $70,000. What is the tentative minimum tax amount?

74) Arnold Corporation reports taxable income of $250,000, tax preference items of $20,000, and positive AMT adjustments of $20,000. What is its statutory exemption, when computing alternative minimum taxable income?

75) Door Corporation’s alternative minimum taxable income before the statutory exemption is $200,000. What is Door’s tentative minimum tax before credits?

76) Barker Corporation, a personal service company, has $200,000 of taxable income. Barker has tax preferences and positive adjustments of $200,000 and negative adjustments of $140,000 for alternative minimum tax purposes. No credits are available. Barker’s regular tax liability is $70,000. How much is its alternative minimum tax liability?

77) Drury Corporation, which was organized three years ago, reports the following adjusted current earnings (ACE) and preadjustment alternative minimum taxable income (AMTI) amounts.

Second previous year Last year Current year
ACE
AMTI (excluding ACE adjustment) $3,000
2,500 $2,000
2,000 $1,000
2,500

What is the ACE adjustment to increase (or decrease) taxable income to arrive at AMTI for the second previous year?

78) Drury Corporation, which was organized three years ago, reports the following adjusted current earnings (ACE) and preadjustment alternative minimum taxable income (AMTI) amounts.

Second previous year Last year Current year
ACE
AMTI (excluding adjustments) $3,000
2,500 $2,000
2,000 $1,000
2,000

What is the ACE adjustment to increase (or decrease) taxable income to arrive at AMTI for the current year?

79) Flower Corporation, a C corporation but not a personal service corporation, has taxable income of $200,000 plus $125,000 of positive adjustments plus $150,000 of tax preferences. Its regular tax liability is $68,000. Calculate Flower Corporation’s minimum tax credit.

80) In the current year, Sun Corporation’s federal income taxes before credits are $220,000. Its TMT is $100,000. Their only available credit is a research credit (part of the general business credit) of $160,000. The general business credit is limited to what amount?

81) Investors Corporation has ten unrelated individual shareholders who each own 10% of the outstanding stock. For their tax year ended December 31 of this year, Investors’ gross income includes:

Interest on federal government obligations $10,000
Dividends from savings and loan associations
on passbook savings accounts $2,000
Interest earned on notes receivable $5,000
Net rental income $3,000

No dividends are paid during the tax year or during the 2-1/2 month throwback period. Deductible administrative expenses total $4,000 for the year. Rental income has been reduced by $1,000 of depreciation and $2,000 of interest expense. What is Investors’ undistributed personal holding company income?

82) Khuns Corporation, a personal holding company, reports the following:

Rental income $50,000
Depreciation 10,000
Interest expense 5,000
Real estate taxes 2,000
Maintenance expenses 5,000
Administrative expenses 5,000

Calculate Khuns Corporation’s adjusted income from rents (AIR).

83) Lake Corporation is a personal holding company. Lake reports the following results for the current year:

Rental income $100,000
Operating profit 80,000
Dividend income 30,000
Interest income 20,000
Depreciation 30,000
Mortgage interest expense 18,000
Real estate taxes 8,000
Other expenses 20,000

No dividends are paid during the current year or the 2-and-one-half-month throwback period. The mortgage relates to the rental properties. Calculate the adjusted income from rents exclusion from personal holding company income.

84) Eagle Corporation, a personal holding company, has the following results:

Taxable income $200,000
Dividends-received deduction 30,000
Excess charitable contributions 10,000
Long-term capital gains 10,000
Federal income taxes 61,000

Calculate the PHC tax.

85) Raptor Corporation is a PHC for 2009 and reports $200,000 of taxable income on its federal income tax return.

Operating profit $100,000
Long-term capital gain 80,000
Dividends (20%-owned corporation) 90,000
Interest 100,000
Gross income 370,000
Salaries expense (50,000)
General and administrative expense (25,000)
Dividends-received deduction (72,000)
Taxable income $223,000
Regular tax liability $ 70,220

What is Raptor’s PHC tax, assuming that it does not pay any dividends?

86) Mullins Corporation is classified as a PHC for the current year, reporting $263,000 of taxable income on its federal income tax return:

Operating profit $150,000
Long-term capital gain 20,000
Short-term capital gain 20,000
Dividends (from 25%-owned domestic corporation) 200,000
Interest 150,000
Gross income $540,000
Minus: general and administrative expenses ( 40,000)
Minus: salaries ( 30,000)
“Adjusted” taxable income $470,000
Minus: charitable contributions ( 47,000)
Taxable income before special deductions $423,000
Minus: dividends-received deduction (160,000)
Taxable income $263,000

Actual charitable contributions made by Mullins Corporation were $75,000. What are the federal income tax due and the personal holding company (PHC) tax liability? Discuss the methods (if any) by which payment of the PHC tax can be avoided.

87) The following information is reported by Acme Corporation.

Cost of goods sold $350,000
Average inventory balance 35,000
Average accounts receivable balance 65,000
Sales (all on account) 325,000
Average accounts payable balance 45,000
Operating expenses (excluding depreciation) 500,000
Purchases 40,000

What is Acme Corporation’s average operating cycle as a percentage of the year?

88) Given the following information about Jones Corporation, what are Jones’s working capital needs using the Bardahl formula, assuming that federal income taxes are not an operating expense?

Average inventory $ 33,000
Cost of goods sold 300,000
Purchases 250,000
Average accounts receivable balance 80,000
Average credit sales 320,000
Average accounts payable balance 30,000
Operating expense 400,000
Depreciation claimed as operating expense 50,000
Federal income taxes 25,000
Advances to suppliers 30,000

89) A manufacturing corporation has accumulated E&P of $210,000 and current E&P of $65,000. Accumulated taxable income, before reduction for the accumulated earnings credit, is $90,000 for the current year. No dividends were paid during the year. The corporation has an increase in reasonable business needs of $35,000. If the corporation is not a service corporation and has reported no long-term capital gains, what is the amount of earnings subject to the accumulated earnings tax?

90) Green Corporation, a closely held operating corporation, reports the following:

Taxable income $200,000
Long-term capital gain 30,000
Dividends-received deduction 20,000
Federal income taxes on long-term capital gain 11,700
Accumulated earnings credit 80,000
Federal income taxes 65,150

Calculate Green’s accumulated taxable income.

91) Lawrence Corporation reports the following results during the current year:

Taxable income $500,000
Federal income taxes 170,000
Dividends paid: June 5 50,000
Accumulated E&P balance: January 1 800,000

No dividends were paid in the throwback period. A long-term capital gain of $50,000 is included in taxable income. The statutory accumulated earnings tax exemption has been used up in prior years. An additional earnings accumulation of $60,000 for the current year can be justified as meeting the reasonable needs of the business. What is Lawrence Corporation’s accumulated earnings tax liability?

92) How is alternative minimum taxable income computed?

93) What are the four general rules that provide a framework for the ACE calculation?

94) Explain the carryover provisions of the minimum tax credit.

95) What is a personal holding company?

96) Define personal holding company income.

97) What is the effect of the two-pronged test that allows the exclusion from PHCI of certain AIR (adjusted income from rents)?

98) The courts and the Treasury Regulations have mentioned a number of reasonable needs that allow a corporation to accrue earnings and avoid the accumulated earnings tax. What are these reasons?

99) How is the accumulated earnings tax liability computed?

100) Smartmoney, Inc. was formed by three wealthy dentists to pool their investment funds. They each invested $200,000 in the corporation, which was immediately used to purchase stocks to be held as investments. The first year, the corporation received dividends of $70,000 and filed a tax return paying a corporation tax in the amount of $3,150 [($70,000 dividends – $49,000 DRD) × .15 = $3,150]. The IRS audits this corporation and sends a tax bill in the amount of $10,028 ($66,850 UPHCI × 0.15 = $10,028) plus underpayment penalty and interest. What is this additional tax and what should the dentists do about it? What action(s) do you recommend the corporation take for the tax year in question and subsequent tax years?

101) Larry Corporation purchased a new precision casting machine for its manufacturing facility. The machine cost $2 million, and another $150,000 was spent on installation. The machine was placed in service in June 2009. The old machine, which was placed in service in 2003, was sold in 2009 to an unrelated party for a $250,000 financial accounting profit. What asset disposition and capital recovery issues do you need to address when removing the old machine from, and placing the new machine on, the financial accounting and tax books and in calculating the 2009 tax depreciation?

102) Rich Company sold equipment this year for $50,000. The equipment had been depreciated using 200% declining balance. Accumulated depreciation totals $60,000 for regular tax purposes and $70,000 for AMTI. The equipment originally cost $90,000. What AMT issues does this sale present?

103) Church Corporation is a closely held C corporation. All of the stock is owned by Charles and Chanda Church. The corporation, in its second month of operation in its initial tax year, anticipates earning $150,000 of gross income in the current year. Gross income is expected to be approximately 40% dividends, 30% corporate bond interest, and 30% net real estate rentals (after interest, property taxes, and depreciation). Administrative expenses are expected to be $20,000. What special problems does the large amount of passive income that Church Corporation expects to earn present to you as their CPA?

104) Eight individuals own Navy Corporation, a C corporation. Three shareholders make up the board of directors and own 51% of the stock. The corporation has a successful manufacturing business. It has accumulated $3 million of E&P and expects to accumulate another $200,000 of E&P annually. Annual dividend payments are $30,000. Demand for Navy’s goods has been strong, but the company does not anticipate any expansion or repair of the current plant for three to five years. Management has invested $200,000 annually in growth stocks. Its current investment portfolio is $1.2 million. The portfolio is held as protection against a business slowdown. Loans to shareholder-employees currently are $400,000. As Navy’s CPA, what tax issues should you have your client consider?

Chapter 6 Corporate Liquidating Distributions

1) Liquidation and dissolution have the same legal meaning.

Page Ref.: C:6-4
Objective: 1

2) In a complete liquidation, a liability assumed by a shareholder reduces the shareholder’s amount realized.

Page Ref.: C:6-5
Objective: 2

3) In general, a noncorporate shareholder that receives a distribution in complete liquidation of the liquidating corporation recognizes his or her entire realized gain as a capital gain.

Page Ref.: C:6-6
Objective: 2

4) The adjusted basis of property received in a complete liquidation is its fair market value on the distribution date.

Page Ref.: C:6-6
Objective: 2

5) Generally, a corporation recognizes a gain, but not a loss, on a liquidating distribution.

Page Ref.: C:6-6
Objective: 2

6) Section 336 prevents recognition of a loss when making a pro rata distribution of property to a related person.

Page Ref.: C:6-8
Objective: 2

7) The liquidation of a subsidiary corporation must be completed within one tax year to receive nonrecognition treatment.

Page Ref.: C:6-11
Objective: 3

8) A subsidiary recognizes no gain or loss on a distribution to a parent corporation owning more the majority of the subsidiary’s stock in a complete liquidation.

Page Ref.: C:6-13
Objective: 3

9) A subsidiary must recognize depreciation recapture income when the subsidiary is liquidated into the parent.

Page Ref.: C:6-14
Objective: 3

10) Liquidating expenses are generally deducted as ordinary and necessary business expenses.

Page Ref.: C:6-16
Objective: 4

11) A corporation is required to file Form 966 within 30 days after the adoption of a plan of liquidation.

Page Ref.: C:6-20
Objective: 7

12) A plan of liquidation must be reduced to writing in order to be accepted by the Internal Revenue Service.

Page Ref.: C:6-21
Objective: 7

13) In a complete liquidation of a corporation, which of the following is false?
A) All stock of the liquidating corporation is canceled or redeemed.
B) The corporation ceases to be a going concern.
C) The corporation divests itself of substantially all its properties.
D) The liquidation of a corporation means it has undergone dissolution.

Page Ref.: C:6-3 and C:6-4
Objective: 1

14) Identify which of the following statements is false.
A) The tax attributes of the liquidating corporation carry over to the shareholders when the liquidation is conducted under the general liquidation rules.
B) Baker Corporation was formed in a Sec. 351 exchange three years ago by Emil, Fred, and George who own equal stock interests. The corporation can be liquidated tax-free under the special liquidation rules of Secs. 332 and 337.
C) The terms “liquidation” and “dissolution” are synonymous.
D) All of the above are false.

Page Ref.: C:6-3 through C:6-10
Objective: 2

15) When a corporation liquidates, it performs three activities. What is the general order of these activities in a plan of liquidation?
A) pay debts, distribute property to shareholders, and wind up its affairs
B) wind up its affairs, distribute property to shareholders, pay debts
C) pay debts, wind up its affairs, and distribute property to shareholders
D) wind up its affairs, pay debts, and distribute property to shareholders

Page Ref.: C:6-4
Objective: 1

16) Moya Corporation adopted a plan of liquidation last year. All but a nominal amount of Moya’s assets are distributed to its shareholders within the year. Which of the following statements is not true?
A) The liquidation of Moya Corporation means the corporation has undergone dissolution.
B) Moya Corporation retains its state charter.
C) Moya Corporation’s existence is preserved.
D) Moya Corporation has been liquidated for tax purposes.

Page Ref.: C:6-4
Objective: 1

17) Liquidation rules generally are applied the same to the following organizations except for
A) subsidiary corporations (80% controlled).
B) C corporations.
C) S corporations.
D) subsidiary corporations (less than 80% controlled).

Page Ref.: C:6-5
Objective: 2

18) Riverwalk Corporation is liquidated, with Juan receiving $5,000 in money and other property having a $6,000 FMV. Juan’s basis in his Riverwalk stock is $8,000. Upon liquidation, Juan must recognize a gain of
A) 0.
B) $2,000.
C) $3,000.
D) $11,000.

Page Ref.: C:6-5; Example C:6-3
Objective: 2

19) Riverwalk Corporation is liquidated, with Juan receiving $5,000 in money, other property having a $6,000 FMV, and a $1,000 mortgage on the property. Juan’s basis in his River walk stock is $8,000. Upon liquidation, Juan must recognize a gain of
A) 0.
B) $2,000.
C) $3,000.
D) $11,000.

Page Ref.: C:6-5; Example C:6-4
Objective: 2
20) Texas Corporation is undergoing a complete liquidation and distributes land to Robert, one of its shareholders, in exchange for all of Robert’s stock. The land has a basis of $300,000 and an FMV of $400,000 on Texas Corporation’s books and is subject to a $325,000 liability. Robert assumes the liability on the property. Robert’s basis in his Texas Corporation stock is $100,000. What is the amount of gain or loss recognized by Robert on the distribution?
A) $175,000 gain
B) $25,000 gain
C) $25,000 loss
D) No gain or loss is recognized.

21) Robot Corporation is liquidated, with Marty receiving property having an adjusted basis of $60,000 and an FMV of $90,000. The property is subject to a $80,000 mortgage, which Marty assumes. Marty’s basis in the Robot stock surrendered is $50,000. Marty must recognize
A) a $40,000 loss.
B) no gain or loss.
C) a $60,000 gain.
D) none of the above

22) Identify which of the following statements is true.
A) The method of accounting used by shareholders involved in a complete liquidation is relevant when determining the year in which the shareholder’s gain or loss should be reported.
B) An accrual method of accounting taxpayer recognizes his/her realized gain on a corporate liquidation when there has been actual or constructive receipt of the liquidating distribution(s).
C) If a shareholder assumes or acquires liabilities of the liquidating corporation, the amount of these liabilities does not reduce the amount realized by the shareholder.
D) All of the above are false.

Page Ref.: C:6-6
Objective: 2
23) Property received in a corporate liquidation by a noncorporate shareholder has
A) a basis equal to its basis on the liquidating corporation’s books increased by any gain recognized by the shareholder upon receipt of the property. Its holding period includes the holding period of the shareholder’s stock.
B) a basis equal to its basis on the liquidating corporation’s books increased by any gain recognized by the shareholder upon receipt of the property. Its holding period commences on the day after the distribution date.
C) a basis equal to its FMV reduced by any liabilities assumed by the shareholder. Its holding period commences on the day after the distribution date.
D) a basis equal to its FMV. Its holding period commences on the day after the distribution date.

Page Ref.: C:6-6
Objective: 2

24) Identify which of the following statements is true.
A) In general, a noncorporate shareholder that receives a distribution in complete liquidation of the liquidating corporation recognizes his or her entire realized gain as a capital gain.
B) The basis for nonmoney property received by a noncorporate shareholder as part of a liquidating distribution is the same as its basis on the books of the liquidating corporation.
C) The liquidating corporation does not recognize gains and losses when making a distribution of nonmoney property.
D) All of the above are false.

Page Ref.: C:6-6
Objective: 2

25) Identify which of the following statements is true.
A) A loss recognized by a shareholder upon complete liquidation of a corporation may not qualify for ordinary loss treatment if the stock is Sec. 1244 stock.
B) The loss that is recognized by an individual shareholder on the liquidation of a corporation is a capital loss, up to certain limits, if the stock is Sec. 1244 stock.
C) The loss recognized by a corporate shareholder on the worthlessness of the controlled subsidiary’s stock is an ordinary loss.
D) All of the above are false.

Page Ref.: C:6-6
Objective: 2

26) Under a plan of complete liquidation, Coast Corporation distributes land with a $300,000 adjusted basis and a $400,000 FMV to William, a 25% shareholder. William has a $200,000 basis in his Coast stock. The land is inventory in the hands of Coast Corporation. Coast Corporation must recognize
A) no gain.
B) $100,000 of ordinary income.
C) $100,000 of long-term capital gain.
D) $200,000 of ordinary income.

Page Ref.: C:6-6
Objective: 2
27) Identify which of the following statements is true.
A) With limited exceptions, a loss can be recognized by a liquidating corporation when it makes a liquidating distribution of property that has declined in value.
B) When computing the corporate-level gain on a liquidating distribution, the FMV of the property cannot exceed the liability assumed or acquired by the shareholder.
C) The FMV of property distributed by a liquidating corporation can be less than the amount of the liability assumed or acquired by the shareholder.
D) All of the above are false.

Page Ref.: C:6-6
Objective: 2

28) Under a plan of complete liquidation, Key Corporation distributes land (not a disqualified property) with an adjusted basis of $410,000 and an FMV of $300,000 for all Sharon’s stock. Sharon’s basis in her 5% interest in the Key stock is $250,000. Find Sharon’s basis in the land and Key Corporation’s recognized gain or loss.

A)
Basis Recognized Gain/Loss
$300,000 $110,000 loss

B)
Basis Recognized Gain/Loss
$250,000 $110,000 loss

C)
Basis Recognized Gain/Loss
$300,000 $0

D)
Basis Recognized Gain/Loss
$250,000 $0

Page Ref.: C:6-5 through C:6-7
Objective: 2
29) Barnett Corporation owns an office building that cost $900,000. Barnett has taken $600,000 of depreciation on the building. The property is subject to a $600,000 mortgage. The office building has a current FMV of $400,000. Barnett Corporation is liquidated and the office building is distributed to a single individual shareholder who assumes the mortgage. Barnett Corporation must recognize
A) no gain or loss.
B) a $100,000 gain.
C) a $300,000 gain.
D) none of the above

30) Identify which of the following statements is true.
A) A liquidating distribution of property other than a disqualified property that is made ratably to all shareholders (based on their stockholdings) will permit the recognition of loss on the portion of the distribution that is made to a related person.
B) A subsidiary corporation can recognize losses on distributions to either the parent corporation or minority shareholders in a Sec. 332 liquidation.
C) Section 336 prevents recognition of a loss when making a pro rata distribution of property to a related person.
D) All of the above are false.

Page Ref.: C:6-8
Objective: 2

31) Identify which of the following statements is true.
A) The loss realized on the sale of a property is disallowed when such property was received by a corporation as a contribution of capital in a transaction having as its principal purpose the recognition of loss pursuant to the corporation’s subsequent liquidation later in the same taxable year.
B) Losses claimed in a tax return filed before the adoption of the plan of liquidation are not restricted by Sec. 336(d)(2).
C) Properties acquired by a liquidating corporation as a capital contribution occurring within three years of the adoption of a plan of liquidation are generally presumed to have a tax avoidance motive.
D) All of the above are false.

Page Ref.: C:6-8
Objective: 2

32) The stock of Cooper Corporation is 70% owned by Carole and 30% owned by Carole’s brother, Chris. During 2013, Chris transferred property (basis of $100,000 and FMV of $120,000) as a contribution to the capital of Cooper. During February 2014, Cooper adopted a plan of liquidation and subsequently made a pro rata distribution of the property back to Carole and Chris. At the time of the liquidation, the property had an FMV of $80,000. What amount of loss can be recognized by Cooper on the distribution of property?
A) $0
B) $6,000
C) $12,000
D) $20,000

33) Last year, Toby made a capital contribution of a pretzel maker having a $2,000 adjusted basis and a $200 FMV to Keke Corporation in exchange for additional stock. This year, Keke Corporation adopted a plan of liquidation. Prior to the adoption of the liquidation plan, Keke had not used the pretzel maker in connection with the conduct of its trade or business. Which of the following statements is true?
A) Keke Corporation may recognize a loss of $1,800.
B) Keke Corporation may recognize a loss of $200.
C) Keke Corporation’s basis for determining the loss will be $2,000.
D) Keke Corporation’s basis for determining the loss will be $200.

Page Ref.: C:6-9; Example C:6-11
Objective: 2

34) Toby made a capital contribution of a pretzel maker having a $2,000 adjusted basis and a $200 FMV to Keke Corporation in exchange for additional stock last year. Later that same year, Keke sold the pretzel maker for $300. This year, Keke adopted a plan of liquidation. Previously, Keke had never used the pretzel maker in connection with the conduct of its trade or business. The sale was reported on Keke’s current tax return. What reporting option does Keke Corporation not have because of its plan of liquidation?
A) File an amended tax return for the tax year in which the tax loss was originally claimed.
B) Recapture the loss on the tax return for the year the plan for liquidation was adopted.
C) Recognize a gain of $100 for the current year.
D) none of the above

Page Ref.: C:6-9; Example C:6-11
Objective: 2

35) Dexer Corporation is owned 70% by Amy and 30% by Brad. Dexer Corporation owns Eagle Corporation stock with a $50,000 adjusted basis and a $30,000 FMV. The stock is not disqualified property. As part of a complete liquidation, the Eagle Corporation stock is distributed to Amy. Amy’s basis in her Dexer stock is $40,000. Dexer Corporation will recognize
A) no loss.
B) a $10,000 loss.
C) a $20,000 loss.
D) none of the above

Page Ref.: C:6-10
Objective: 2

36) Cowboy Corporation owns 90% of the single class of stock in Doggie Corporation. The other 10% is owned by Miguel, an individual. Cowboy’s basis in its Doggie Corporation stock is $100,000 and Miguel’s basis is $50,000. Doggie Corporation distributes property having an adjusted basis of $150,000 and an FMV of $500,000 to Cowboy Corporation, and $60,000 of money to Miguel as a liquidating distribution. Doggie and Cowboy Corporations must recognize gain of:

A)
Doggie Cowboy
$0 $0

B)
Doggie Cowboy
$10,000 $0

C)
Doggie Cowboy
$400,00 $350,000

D)
Doggie Cowboy
$350,000 $400,000

37) Parent Corporation owns 100% of the single class of stock of Subsidiary Corporation. Parent’s basis in the Subsidiary stock is $500,000 when Parent completely liquidates Subsidiary Corporation within a single tax year. The Subsidiary Corporation assets have a $700,000 adjusted basis and an $800,000 FMV at liquidation. As a result of the liquidation, Parent must recognize a
A) $0 gain.
B) $200,000 gain.
C) $300,000 gain.
D) none of the above

38) Identify which of the following statements is true.
A) A parent corporation cannot liquidate a subsidiary corporation (having but a single class of stock) and avoid recognizing its realized gain unless the parent corporation owns at least 80% of the subsidiary’s stock.
B) The liquidation of a subsidiary corporation must be completed within one tax year to receive nonrecognition treatment.
C) The provisions permitting a tax-free liquidation of a subsidiary corporation apply to both corporate and noncorporate shareholders of the subsidiary.
D) All of the above are false.

Page Ref.: C:6-10
Objective: 3

39) Carly owns 25% of Base Corporation’s single class of stock and Premier Corporation owns the remaining 75%. Carly’s basis in the Base stock is $200,000 and Premier Corporation’s basis in the Base stock is $600,000. Carly receives property with a $175,000 adjusted basis and a $250,000 FMV and Premier Corporation receives property with a $600,000 adjusted basis and a $750,000 FMV in complete liquidation of Base Corporation. All of Base’s cash is used to pay its liabilities. Which of following statements is correct concerning the tax effects of the liquidation?
A) Neither Carly nor Premier Corporation will recognize a gain.
B) Carly will recognize some gain but Premier Corporation will not recognize any gain.
C) Both Carly and Premier will recognize some gain.
D) Carly will not recognize any gain but Premier will recognize some gain.

40) When a subsidiary corporation is liquidated into its parent corporation under a formal plan of liquidation, the distributions must take place within
A) a six-month period.
B) a 12-month period.
C) the current and next tax years.
D) the current and next three tax years.

Page Ref.: C:6-11
Objective: 3

41) Parent Corporation for ten years has owned all of the stock of Subsidiary Corporation, which manufactures widgets. Parent’s basis in Subsidiary’s stock is $500,000. Subsidiary Corporation is insolvent and has no assets to redeem any of the stock that Parent Corporation owns when it liquidates. Nearly all of Subsidiary’s gross income during the past five years has come from nonpassive activities. Parent can recognize
A) a $500,000 short-term capital loss.
B) a $500,000 long-term capital loss.
C) a $500,000 ordinary loss.
D) a $500,000 bad debt deduction.

Page Ref.: C:6-12
Objective: 3

42) Ball Corporation owns 80% of Net Corporation’s stock and Jack owns the remaining 20% of Net Corporation’s stock. Ball’s basis in the Net stock is $200,000 and Jack’s basis in the Net stock is $100,000. Under a plan of complete liquidation, Ball Corporation receives property with an adjusted basis of $400,000 and an FMV of $800,000 and Jack receives property with an adjusted basis of $50,000 and an FMV of $200,000. Ball and Jack’s recognized gains on the liquidation are:

A)
Ball Jack
$0 $0

B)
Ball Jack
$0 $100,000

C)
Ball Jack
$200,000 $50,000

D)
Ball Jack
$600,000 $100,000

Page Ref.: C:6-12 and C:6-13; Example C:6-15
Objective: 3
43) Ball Corporation owns 80% of Net Corporation’s stock and Jack owns the remaining 20% of Net Corporation’s stock. Ball’s basis in the Net stock is $200,000 and Jack’s basis in the Net stock is $100,000. Under a plan of complete liquidation, Ball Corporation receives property with an adjusted basis of $400,000 and an FMV of $800,000 and Jack receives property with an adjusted basis of $50,000 and an FMV of $200,000. Ball and Jack’s bases in the property received are:

A)
Ball Jack
$800,000 $200,000

B)
Ball Jack
$400,000 $200,000

C)
Ball Jack
$400,000 $ 50,000

D)
Ball Jack
$200,000 $100,000

Page Ref.: C:6-13; Example C:6-16
Objective: 3

44) Market Corporation owns 100% of Subsidiary Corporation’s stock. Market Corporation completely liquidates Subsidiary Corporation, receiving land with a $400,000 adjusted basis and a $500,000 FMV in exchange for Subsidiary stock, which has a $300,000 adjusted basis. Market Corporation has a basis in the land of
A) $300,000.
B) $400,000.
C) $500,000.
D) none of the above

45) Dusty Corporation owns 90% of Palace Corporation’s stock and Susan owns the remaining stock. Dusty Corporation’s stock basis is $300,000 and Susan’s stock basis is $20,000. Under a plan of complete liquidation, Dusty Corporation receives property with a $400,000 adjusted basis and a $540,000 FMV and Susan receives property with a $20,000 adjusted basis and a $60,000 FMV. The bases of the properties are:

A)
Dusty Susan
$300,000 $20,000

B)
Dusty Susan
$400,000 $20,000

C)
Dusty Susan
$400,000 $60,000

D)
Dusty Susan
$540,000 $60,000

Page Ref.: C:6-13
Objective: 3

46) Identify which of the following statements is false.
A) Minority shareholders involved in a Sec. 332 subsidiary liquidation must recognize a gain or loss under the Sec. 331 general liquidation rules.
B) The parent corporation takes a basis in property received when liquidating a subsidiary corporation in a Sec. 332 liquidation equal to its basis to the subsidiary corporation.
C) Section 332 is applicable to both the parent corporation and the minority shareholders if they exist.
D) Property received by a minority shareholder takes a basis equal to its fair market value.

Page Ref.: C:6-12
Objective: 3

47) Identify which of the following statements is false.
A) Liquidating distributions made to minority shareholders in the tax-free liquidation of a controlled subsidiary corporation are treated by the liquidating corporation in the same way as nonliquidating distributions.
B) Sec. 337(a) provides that the liquidating corporation recognizes no gain or loss on the distribution of property to the 80% distributee in a complete Sec. 332 liquidation.
C) The depreciation recapture provisions in Secs. 1245 and 1250 override the Sec. 337(a) nonrecognition rule if a controlled subsidiary corporation is liquidated into its parent corporation.
D) A corporation that distributes the stock of a subsidiary may elect to treat the distribution as a sale of the subsidiary’s assets.

Page Ref.: C:6-14
Objective: 3
48) Lake City Corporation owns all the stock in Columbia Corporation. Pursuant to a plan of complete liquidation, Columbia distributes land having a $500,000 FMV and a $200,000 basis to Lake City. Columbia’s gain with respect to the distribution will be
A) no gain recognized.
B) $200,000.
C) $300,000.
D) $500,000.

Page Ref.: C:6-12 and C:6-13; Example C:6-15
Objective: 3

49) Lake City Corporation owns all of the stock in Columbia Corporation. Pursuant to a plan of complete liquidation, Columbia distributes land having a $500,000 FMV and a $200,000 basis to Lake City. Lake City’s basis in the land will be
A) 0.
B) $200,000.
C) $500,000.
D) cannot be determined from the facts presented

Page Ref.: C:6-13; Example C:6-16
Objective: 3

50) The general rule for tax attributes of liquidating corporations is
A) they disappear when the liquidation is complete.
B) they carry over for five years.
C) they disappear only for controlled subsidiary corporations.
D) they carry over for an indefinite period of time.

Page Ref.: C:6-14
Objective: 3

51) Sandy, a cash method of accounting taxpayer, has a basis of $46,000 in her 500 shares of Newt Corporation stock. She receives the following distributions as part of Newt’s plan of liquidation.

March 31, 2007 $10,000
July 15, 2007 10,000
November 15, 2007 10,000
January 15, 2008 10,000

The amount of the final distribution is not known on December 31, 2007. What are the tax consequences of the distributions?
A) Sandy will recognize a loss of $4,500 in 2007 and a $1,500 loss in 2008.
B) Sandy will recognize the entire loss in 2007.
C) Sandy will recognize the entire loss in 2008.
D) None of the above is correct.

Page Ref.: C:6-16
Objective: 4
52) Prime Corporation liquidates its 85%-owned subsidiary Bass Corporation under the provisions of Secs. 332 and 337. Bass Corporation distributes land to its minority shareholder, John, who owns a 15% interest. The property received by John has a $55,000 FMV. The land was used in the Bass Corporation’s business and has a $65,000 adjusted basis and is subject to a $10,000 liability, which is assumed by John. John’s basis in his stock is $25,000. What gain or loss will John and Bass Corporation recognize on the distribution of the land?

A)
John Bass
$20,000 gain $0

B)
John Bass
$20,000 gain $10,000 loss

C)
John Bass
$30,000 gain $0

D)
John Bass
$30,000 gain $10,000 loss

Page Ref.: C:6-14; Example C:6-18
Objective: 3

53) Greg, a cash method of accounting taxpayer, owns 100 shares of Parker Corporation stock with a basis of $20,000. Greg receives two liquidating distributions of $8,000 on March 3 of last year, and $8,000 on August 8 of this year. The amount of the second distribution is not known until June 15 of this year. Greg recognizes
A) a gain of $8,000 last year and a loss of $12,000 this year.
B) a loss of $2,000 last year and a loss of $2,000 this year.
C) no loss last year and a $4,000 loss this year.
D) none of the above

54) Barbara owns 100 shares of Bond Corporation stock with a basis of $40,000. Barbara receives two liquidating distributions, including $16,000 paid last year and $20,000 paid in the current year. An additional distribution of an undetermined amount is expected next year. On last year’s tax return, Barbara can recognize a loss of
A) $0.
B) $1,000.
C) $4,000.
D) $14,000.

55) Hope Corporation was liquidated four years ago. Teresa reported a $40,000 long-term capital gain due to the liquidation on her individual tax return. This year, Teresa pays $6,000 as part of the settlement of a lawsuit against Hope. Due to the $6,000 payment, Teresa recognizes a
A) $6,000 long-term capital loss.
B) $6,000 short-term capital loss.
C) $6,000 ordinary loss.
D) none of the above

Page Ref.: C:6-15 and C:6-16; Example C:6-21
Objective: 4

56) Key Corporation distributes a patent with an indeterminable value to Gary as part of a plan of complete liquidation. In addition, Gary receives $40,000 cash and land with a $70,000 FMV and a $30,000 adjusted basis. Gary’s basis in the Key stock (a capital asset) surrendered is $120,000. If Gary relies on the open transaction doctrine, at the liquidation date he must recognize a
A) $0 gain.
B) $10,000 capital loss.
C) $30,000 capital loss.
D) $70,000 capital gain.

57) During 2013, Track Corporation distributes property to Cindy as part of a complete liquidation. Property included in the distribution is $30,000 in cash, land with a $40,000 adjusted basis and a $60,000 FMV, and a copyright without an ascertainable FMV and having a zero basis. The first payment to Cindy of $8,000 for use of the copyrighted property occurs in 2014. Cindy has a basis in the Track stock of $95,000 immediately preceding the liquidation. The minimum amount of gain that Cindy must recognize is a
A) $3,000 gain in 2014.
B) $0 gain in 2013.
C) $3,000 gain in 2013, which is reported on an amended current-year tax return that is filed in 2014.
D) none of the above.

58) Identify which of the following statements is false.
A) An individual taxpayer, who is assessed an additional payment of money based on stock ownership in a corporation whose stock is redeemed in a complete liquidation, may recognize a capital loss to the extent of the additional assessment.
B) The open transaction doctrine defers the shareholder’s gain or loss from a liquidation until the assets can be valued by sale or collection.
C) The open transaction doctrine as applied to complete corporate liquidations refers to the numerous planning alternatives available when liquidating a corporation.
D) The IRS asserts that the open transaction doctrine should be used only in extraordinary circumstances.

Page Ref.: C:6-16
Objective: 4

59) Identify which of the following statements is true.
A) Upon liquidation, any capitalized expenditures unamortized at the time of liquidation should be deducted if they have no further value to the corporation.
B) Shareholders who receive an installment obligation as part of their liquidating distribution ordinarily report the FMV of their obligation as part of the consideration received to calculate the amount of recognized gain or loss.
C) A liquidating corporation treats expenses associated with selling its property as an offset against the sales proceeds.
D) All the above are true.

Page Ref.: C:6-16 and C:6-17
Objective: 4
60) Homewood Corporation adopts a plan of liquidation on June 15 and shortly thereafter sells a parcel of land on which it realizes a $50,000 gain (excluding the effects of a $5,000 sales commission). Homewood pays its legal counsel $2,000 to draft the plan of liquidation. The accountant fees for the liquidation are $1,000, which are also paid during the year. What is Homewood Corporation’s realized gain on the sale of land and deductible liquidation expenses?

A)
Gain Liquidation Expenses
$45,000 $3,000

B)
Gain Liquidation Expenses
$50,000 $2,000

C)
Gain Liquidation Expenses
$55,000 $3,000

D)
Gain Liquidation Expenses
$50,000 $1,000

Page Ref.: C:6-16; Example C:6-22
Objective: 4

61) When a liquidating corporation pays off an unsecured debt obligation,
A) the corporation recognizes no gain or loss if it uses appreciated property.
B) the corporation recognizes no gain or loss if it uses cash.
C) the corporation recognizes any gains but not losses realized.
D) the corporation recognizes losses but not gains realized.

Page Ref.: C:6-17 and C:6-18
Objective: 5

62) Identify which of the following statements is true.
A) The Sec. 332 nonrecognition rules apply to the parent corporation when a subsidiary corporation transfers property to the parent corporation in payment of the subsidiary’s debt obligation.
B) A subsidiary corporation is prevented from recognizing gain or loss when transferring property to its parent corporation in satisfaction of an indebtedness it owes to the parent corporation as part of its complete liquidation.
C) Nonrecognition of gain or loss rules apply to a subsidiary corporation when, pursuant to its complete liquidation, the subsidiary transfers property to a third-party creditor.
D) All of the above are false.

Page Ref.: C:6-17 and C:6-18
Objective: 5
63) Parent Corporation owns all of Subsidiary Corporation’s stock. In addition, Parent Corporation owns $100,000 (face amount and basis) of Subsidiary Corporation’s bonds. When Subsidiary Corporation is completely liquidated, it distributes property with a $70,000 adjusted basis and a $100,000 FMV to Parent Corporation in redemption of the Subsidiary Corporation bonds. Following the liquidation, Parent Corporation will have a basis in the Subsidiary Corporation property received for the bonds of
A) $0.
B) $70,000.
C) $100,000.
D) none of the above

64) Santa Fe Corporation adopts a plan of liquidation late in the current tax year in which it expects to earn $100,000 profits from its operating activities. Santa Fe’s operating activities are discontinued before the end of the year. Pursuant to the liquidation, it distributes assets, which result in the recognition of $30,000 of ordinary losses. Santa Fe also distributes assets that have appreciated in value, which results in the recognition of $30,000 of ordinary gains. Generally, Santa Fe Corporation should distribute
A) the $30,000 of ordinary loss property in the current year and the $30,000 of ordinary gain property next year.
B) both the ordinary loss and gain properties this year.
C) both the ordinary losses and gains properties next year.
D) the $30,000 of ordinary gain property in the current year and the $30,000 of ordinary loss property next year.

Page Ref.: C:6-18; Example C:6-24
Objective: 5

65) Parent Corporation owns 70% of Sam Corporation’s single class of stock. This year, Parent Corporation purchases for cash the remaining 30% of Sam Corporation’s stock from four individual investors pursuant to a tender offer. A plan of liquidation is approved by Sam Corporation’s shareholders during the last month of this year, and Sam Corporation’s assets are distributed by year-end to Parent Corporation in exchange for all of Sam’s outstanding stock. Parent Corporation should
A) not recognize any gains and losses on the redemption.
B) recognize gains and losses on the redemption.
C) recognize gains but not losses on the redemption.
D) recognize losses but not gains on the redemption.

Page Ref.: C:6-19; Example C:6-25
Objective: 6
66) A liquidation must be reported to the Internal Revenue Service on Form 966
A) within 60 days of the adoption of a plan of liquidation.
B) that is filed with the national IRS office.
C) whether the shareholders’ realized gain is recognized or not.
D) by the shareholders.

Page Ref.: C:6-20
Objective: 7

67) If a liquidating subsidiary corporation primarily has loss property to distribute, the parent corporation should
A) follow Sec. 332 rules.
B) avoid Sec. 332 rules.
C) follow Sec. 332 rules but avoid Sec. 337.
D) none of the above

Page Ref.: C:5-20
Objective: 6

68) Identify which of the following statements is false.
A) A corporation must file an information return with the Internal Revenue Service within thirty days of adopting a resolution to liquidate.
B) The adoption of a formal plan of liquidation can provide additional benefits under tax laws to the corporation and its shareholders.
C) A plan of liquidation must be produced in writing in order to be accepted by the Internal Revenue Service.
D) The adoption of a plan of liquidation permits a parent corporation a three-year time period to carry out the complete liquidation of its subsidiary.

Page Ref.: C:6-21
Objective: 7

69) A Sec. 332 liquidation requires a complete statement be filed with the distributee’s tax return
A) when a liquidating distribution is received.
B) when the liquidation plan is adopted.
C) when the liquidation is compiled.
D) No statement is required with the return.

Page Ref.: C:6-21
Objective: 7

70) A plan of liquidation
A) must be written.
B) details the steps to be undertaken in carrying out the liquidation.
C) must be a formal plan.
D) must be completed in one year.

Page Ref.: C:6-21
Objective: 7
71) Lake Corporation distributes a building used in its business to Sandy in exchange for all of her Lake stock. Sandy’s basis in her stock is $30,000 and the property she receives has a $90,000 FMV. As part of the distribution, Sandy assumes a liability associated with the property of $65,000. The property’s basis prior to the liquidating distribution was $25,000. What are the tax consequences of the distribution to Sandy? To Lake Corporation?

72) Under the general liquidation rules, Kansas Corporation is liquidated, with Sam Topeka receiving $20,000 in cash plus other property having a $24,000 FMV. Sam Topeka’s basis in his Kansas stock is $32,000. What is Sam Topeka’s amount realized and gain recognized on the liquidation?

73) Under the general liquidation rules, Missouri Corporation is liquidated, with Jefferson receiving $5,000 in cash plus other property having a $6,000 FMV and assuming a $2,000 mortgage on the property. Jefferson’s basis in his Missouri stock is $8,000. What is Jefferson’s amount realized and gain or loss recognized on the liquidation?

74) Albert receives a liquidating distribution from Glidden Corporation as part of a complete redemption of its stock. Albert receives cash of $5,000 and other property with an adjusted basis of $6,000 and an FMV of $10,000. Albert’s basis in the Glidden stock surrendered is $8,000. How much gain does he recognize?

75) Mary receives a liquidating distribution from Snell Corporation as part of a redemption of all of its stock. Mary’s basis in the Snell stock is $10,000. In exchange for her stock, Mary receives property with an $8,000 basis and a $15,000 FMV that is subject to a $3,000 mortgage. Mary also receives cash of $5,000. What is Mary’s recognized gain?

76) John and June, husband and wife, have owned Ruby Corporation for a number of years. Their basis in the Ruby stock, which they own jointly, is $200,000. The Ruby stock is Sec. 1244 stock. Ruby Corporation liquidates, and John and June receive the following from the corporation: accounts receivable, $30,000 FMV; a car, $21,000 FMV; office furniture, $11,000 FMV; and $25,000 in cash. What is the amount and character of their gain or loss?

77) Charlene and Dennis each own 50% of Brewster Corporation and have owned it for five years. The adjusted bases of their Brewster stock are $80,000 and $40,000 respectively. Brewster Corporation liquidates and distributes $60,000 to Charlene in exchange for her stock. It distributes a parcel of land with a $140,000 FMV which is subject to a $90,000 mortgage to Dennis in exchange for his stock. Dennis assumes the mortgage and also receives $10,000 in cash.
a) What is the character and amount of each shareholder’s gain or loss?
b) What is each shareholder’s basis in the property received in the liquidation?

78) Jack Corporation is owned 75% by Sherri and 25% by Mark. Sherri and Mark have $125,000 and $50,000 bases in their stock, respectively. Jack Corporation adopts a plan of liquidation on March 1. On April 12, Sherri receives the following property as a liquidating distribution: cash of $30,000; land, $125,000 FMV; and 150 shares of Green Corporation stock, $30,000 FMV. The land is subject to a $20,000 mortgage. On the same date, Mark receives $10,000 FMV of Green stock (50 shares) and cash of $45,000 as a liquidating distribution. The land has a basis of $50,000 and the stock has a basis of $70,000 in Jack Corporation’s hands. Both are capital assets to Jack Corporation and have been held for a number of years.
a) What is the amount and character of Jack Corporation’s recognized gain or loss on the liquidating distributions?
b) What are the amounts and characters of Sherri and Mark’s recognized gains or losses?
c) What are the bases of the land and stock to Sherri and Mark?

79) How is the gain/loss calculated if a shareholder has acquired stock at different times and at varying prices?

80) Specialty Corporation distributes land to one of its shareholders, Sam, as part of a plan of liquidation. The land, which was used in Specialty’s business, has an adjusted basis of $50,000 and an FMV of $130,000 on the date of distribution. Sam’s basis in Specialty Corporation stock is $100,000. What is the amount and character of the gain/loss recognized by Specialty Corporation? What is the amount and character of the gain/loss recognized by Sam?

81) What event determines when a cash or accrual method of accounting taxpayer reports a liquidating distribution?

82) Under Illinois Corporation’s plan of liquidation, the corporation distributes land to one of its shareholders, Springer. The land, which is used in Illinois trade or business, has a $20,000 adjusted basis and a $60,000 FMV on the distribution date. What are the tax consequences of this distribution to Illinois and Springer?

83) Parent Corporation owns 100% of the stock of Subsidiary Corporation. The adjusted basis of its stock investment is $100,000. A plan of liquidation is adopted. Subsidiary distributes to Parent assets with a $325,000 FMV and a $275,000 adjusted basis. Subsidiary also distributes liabilities in the amount of $40,000. Subsidiary has a $150,000 E&P balance.
a) What is the amount and character of Subsidiary Corporation’s recognized gain or loss on the distribution?
b) What is the amount and character of Parent Corporation’s recognized gain or loss on the redemption of the Subsidiary stock?
c) What basis does Parent take in the assets?
d) What happens to parent Corporation’s basis in the Subsidiary stock and to Subsidiary’s tax attributes?

84) Parent Corporation owns 80% of the stock of an insolvent subsidiary corporation. Vic owns the remaining 20% of the stock. The courts determine the subsidiary to be bankrupt, and the shareholders receive nothing for their investment. How do they report their losses?

85) What basis do both the parent and minority shareholders take in the assets received in a Sec. 332 liquidation?

86) Why should a corporation that is 100% owned by another corporation be treated differently when it liquidates than a corporation that is 100% owned by an individual?

87) What attributes of a controlled subsidiary corporation are carried over to the parent when the subsidiary is liquidated?

88) Jack has a basis of $36,000 in his 1,000 shares of Acorn Corporation stock (a capital asset). The stock was acquired three years ago. He receives the following distributions as part of a plan of liquidation of Acorn Corporation:

Date Amount
March 31 of 2009 $10,000
July 15 of 2009 10,000
November 15 of 2010 10,000
January 15 of 2010 10,000

What are the amount and character of the gain or loss that Jack will recognize during 2009? During 2010?

89) Penny, a cash-basis taxpayer, reported a $15,000 long-term capital gain on the exchange of her Midwest Corporation stock when the corporation liquidated in 2012. Midwest subsequently lost a lawsuit and Penny paid an additional $3,000 in 2014 as her part of the settlement. What are the tax consequences to Penny in 2014 of the $3,000 additional payment she made?

90) New York Corporation adopts a plan of liquidation on March 15 and shortly thereafter sells a parcel of land on which it realizes a $15,000 gain (excluding the effects of a $2,000 sales commission). New York pays its legal counsel $500 to draft the plan of liquidation. All of New York’s remaining properties are distributed to its shareholders on September 15. What are the tax consequences to New York on the land sale?

91) Are liquidation and dissolution the same? Explain your answer.

92) Explain the difference in tax treatment between a partial liquidation and a complete liquidation.

93) Under what circumstances does a liquidating corporation not recognize a gain or loss when making a distribution?

94) In a Sec. 332 liquidation, can a subsidiary corporation recognize losses on distributions to either the parent corporation or minority shareholders?

95) In a Sec. 332 liquidation, what bases do both the parent and minority shareholders take in the assets received?

96) What are the differences, if any, in the tax rules applying to distributions made to a parent corporation and a minority shareholder when a controlled corporation liquidates?

97) What are the tax consequences of a cash-method shareholder, subsequent to a liquidation, if obligated to pay a contingent liability of the liquidated corporation?

98) What is the IRS’s position regarding whether a liquidating transaction will be considered open or closed?

99) What are the tax consequences to Parent Corporation when Parent Corporation, which owns 75% of Subsidiary Corporation’s single class of stock, purchases for cash the remaining 25% of the Subsidiary stock from three individual shareholders pursuant to a tender offer? Three months later as part of an approved plan of liquidation, Subsidiary’s assets all distributed to Parent Corporation in exchange for all of Subsidiary’s outstanding stock.

100) For that following set of facts, what are the tax consequences to Parent Corporation, Subsidiary Corporation, and a Subsidiary Corporation shareholder, Melisa? Parent Corporation owns 80% of Subsidiary Corporation’s stock. Melisa owns the remaining 20% of the Subsidiary stock. Parent and Melisa’s stock have adjusted bases of $100,000 and $25,000, respectively, for their Subsidiary stock. Subsidiary distributes land having a $125,000 adjusted basis and a $200,000 FMV to Parent and $50,000 in cash to Melisa.

101) Bluebird Corporation owns and operates busses and has decided to liquidate its operations. Victor, who owns 80% of the company’s stock, will receive all of the busses, repair parts inventory, and all tools and equipment. He plans to start a bus company in another town. Penny, who owns 20% of the stock, wants nothing to do with the new bus business and will receive a cash distribution. Bluebird will incur about $20,000 of expenses in connection with the liquidation. What tax issues should Victor, Penny, and Bluebird consider with respect to the liquidation?

102) Chip and Dale are each 50% owners of Tree Corporation, a holding company. They have each held their stock since the company was formed five years ago. Tree’s money is invested almost entirely in stocks, bonds, rental real estate, and land. All of the stocks are traded on the New York Stock Exchange except for 1,000 shares of Conifer Corporation stock. Conifer is privately held by 50 individuals. Last year, Conifer reported about $2 million in net income. During a meeting with Chip and Dale, you discover that they plan to liquidate Tree Corporation as soon as possible to avoid the personal holding company tax. What tax issues should Chip and Dale consider with respect to this liquidation?

103) Parent Corporation, which operates an electric utility, created a 100%-owned corporation, Subsidiary that built and managed an office building. Assume the two corporations have filed separate tax returns for a number of years. The utility occupied two floors of the office building, and Subsidiary offered the other ten floors for lease. Only 25% of the total rental space was leased because of the high crime rate in the area surrounding the building. Rental income was insufficient to cover the mortgage payments, and Subsidiary filed for bankruptcy because of the poor prospects. Subsidiary’s assets were taken over by the mortgage lender. Parent lost its entire $500,000 investment. At the time Subsidiary was liquidated, another $100,000 of debts remained unpaid for the general creditors, which included a $35,000 account payable to Parent. What tax issues should Parent and Subsidiary consider with respect to the bankruptcy and liquidation of Subsidiary?

Chapter 7 Corporate Acquisitions and Reorganizations

1) Taxable acquisition transactions can either be a purchase of assets or a purchase of stock.

Page Ref.: C:7-2
Objective: 1

2) In a taxable asset acquisition, the purchaser does not acquire unknown and contingent liabilities.

Page Ref.: C:7-3
Objective: 1

3) The Sec. 338 deemed sale rules require that 70% of the target corporation’s stock be owned.

Page Ref.: C:7-5
Objective: 1

4) Tax attributes of the target corporation are lost when a Sec. 338 deemed liquidation election is made.

Page Ref.: C:7-9 and C:7-10
Objective: 1

5) In a nontaxable reorganization, shareholders of the target corporation recognize gain or loss.

Page Ref.: C:7-13
Objective: 2

6) In a nontaxable reorganization, the acquiring corporation has a holding period for the acquired assets that begins on the day after the transaction date.

Page Ref.: C:7-12; Topic Review C:7-2
Objective: 2

7) In a nontaxable reorganization, the holding period for the stock received by the target shareholders includes the holding period of the stock surrendered.

Page Ref.: C:7-13; Topic Review C:7-3
Objective: 2

8) The acquiring corporation does not recognize gain or loss in a reorganization where it receives boot.

Page Ref.: C:7-14 and C:7-15
Objective: 3

9) Type A reorganizations include mergers and consolidations.

Page Ref.: C:7-23 and C:7-24; Example C:7-18
Objective: 4
10) In a triangular Type A merger, the acquiring subsidiary corporation must obtain substantially all of the target corporation’s assets.

Page Ref.: C:7-24
Objective: 4

11) In a Type B reorganization, the acquiring corporation obtains substantially all of the target corporation’s assets in exchange for its voting stock and a limited amount of other consideration.

Page Ref.: C:7-29 and C:7-30
Objective: 4

12) In a Type B reorganization, the target corporation exchange their stock for the acquiring corporation’s voting stock, and the target corporation remains in existence as the acquiring corporation’s subsidiary.

Page Ref.: C:7-29 and C:7-30
Objective: 4

13) A Type C reorganization is a change in identity, legal form, or state of incorporation in which the shareholders retain the same equity interest.

Page Ref.: C:7-41
Objective: 7

14) Advance rulings are required for all reorganizations.

Page Ref.: C:7-48
Objective: 10

15) Identify which of the following statements is false.
A) Taxable acquisition transactions can either be a purchase of assets or a purchase of stock.
B) The tax-free reorganization rules are an example of the wherewithal to pay concept.
C) A taxable acquisition of a target corporation’s assets results in the nonrecognition of gain or loss on the disposition of each individual asset.
D) Sales of depreciable assets as part of a taxable acquisition result in depreciation recapture.

Page Ref.: C:7-2
Objective: 1

16) Identify which of the following statements is false.
A) A taxable acquisition of the assets of a target corporation that is subsequently liquidated, results in a loss of the target corporation’s tax attributes.
B) A taxable acquisition of the assets of a target corporation, that is subsequently liquidated, results in the target corporation’s shareholders recognizing gain or loss on the surrender of their target stock.
C) An acquiring corporation in a tax-free or a taxable acquisition transaction does not recognize gain or loss when its stock is issued in exchange for property.
D) An acquiring corporation in a taxable acquisition transaction must acquire all of the assets and liabilities of the target corporation.

Page Ref.: C:7-2
Objective: 1

17) Axle Corporation acquires 100% of Drexel Corporation’s stock from Drexel’s shareholders for $500,000 cash. Drexel Corporation has assets with a $600,000 adjusted basis and an $800,000 FMV. The assets are subject to $200,000 in liabilities. Drexel Corporation shareholders purchased their stock eight years ago for $300,000. Axle Corporation’s basis in the Drexel Corporation stock is
A) $800,000.
B) $600,000.
C) $500,000.
D) $300,000.

18) Identify which of the following statements is true.
A) Acquisition of the stock of a target corporation in a taxable acquisition transaction is reflected in an increased basis for the target corporation’s assets on its books.
B) Acquisition of 100% of the stock of a target corporation in a taxable transaction followed by a tax-free liquidation of the target corporation permits a step-up in the basis of the target corporation’s assets to their FMV.
C) Usually when 100% of the stock of a target corporation is purchased by an acquiring corporation, the basis of the assets of the target corporation reflects the purchase price of the target stock.
D) All of the above are false.

Page Ref.: C:7-4
Objective: 1

19) Identify which of the following statements is true.
A) A deemed liquidation election is available when a target corporation is liquidated into its parent corporation.
B) Corporate purchasers generally prefer Sec. 338 treatment because of the significant tax savings originating from the step-up in basis.
C) The Sec. 338 deemed liquidation rules require that 100% of the target corporation’s stock be purchased.
D) All of the above are false.

Page Ref.: C:7-5 and C:7-6
Objective: 1

20) Identify which of the following statements is false.
A) A Sec. 338 election usually triggers taxation to the target corporation.
B) A Sec. 338 election must be made not later than the fifteenth day of the ninth month following the first stock acquisition in a series of acquisitions that leads to 80% or more stock ownership.
C) When a Sec. 338 election is made, the target corporation is treated as having sold all of its assets at their FMV at the close of the acquisition date.
D) In a Sec. 338 deemed sale election, the shareholders of the target corporation sell their stock to the acquiring corporation.

Page Ref.: C:7-5 through C:7-7
Objective: 1

21) A stock acquisition that is not treated as a purchase for purposes of meeting the Sec. 338 rules is
A) stock whose adjusted basis is determined by its basis in the hands of the person from whom it was acquired.
B) stock acquired from a decedent.
C) stock acquired in a tax-free reorganization.
D) All of the above are correct.

Page Ref.: C:7-6
Objective: 1

22) Melon Corporation makes its first purchase of 30% of Hill Corporation stock on July 31 of this year. Melon Corporation uses a calendar tax year. To use the Sec. 338 election, Melon Corporation must purchase
A) an additional 50% of Hill Corporation stock by December 31 of this year.
B) an additional 50% of Hill Corporation stock by July 30 of next year.
C) an additional 51% of Hill Corporation stock by December 31 of this year.
D) an additional 51% of Hill Corporation stock by July 30 of next year.

Page Ref.: C:7-6; Example C:7-4
Objective: 1

23) Jersey Corporation purchased 50% of Target Corporation’s single class of stock on June 1 of this year. They purchased an additional 40% on November 20 of this year. The Sec. 338 election must be made on or before
A) June 30 of this year.
B) November 30 of this year.
C) August 15 of next year.
D) June 30 of next year.

24) Identify which of the following statements is true.
A) When the acquiring corporation makes the Sec. 338 election, the target corporation is treated in many respects as a new corporation.
B) A Sec. 338 election requires the adoption of the old target corporation’s tax year by the new target corporation.
C) Tax attributes of the target corporation are not lost when a Sec. 338 deemed liquidation election is made.
D) All of the above are false.

Page Ref.: C:7-5
Objective: 1

25) Identify which of the following statements is true.
A) The total basis of the target corporation’s assets following a Sec. 338 election in general equals the amount paid for the target corporation’s stock minus the target corporation’s liabilities.
B) The residual method ensures that any premium paid for the target stock is reflected in depreciable assets.
C) The allocation of the total basis of the target corporation’s assets to the individual assets following a Sec. 338 election occurs under the residual method.
D) All of the above are false.

Page Ref.: C:7-8 and C:7-9
Objective: 1

26) Which of the following definitions of Sec. 338 property classes is not correct?
A) Class I: cash, demand deposits, and similar accounts in banks, savings and loan associations, etc.
B) Class II: actively traded personal property such as publicly traded securities
C) Class III: covenants not to compete, similar restrictions on trade, etc.
D) Class IV: inventory or other property held primarily for sale to customers

Page Ref.: C:7-8 and C:7-9
Objective: 1

27) When gain is realized by a target corporation from disposing of its assets in a tax-free reorganization, the gain is
A) recognized if boot is received and immediately distributed to its shareholders.
B) recognized without exception.
C) recognized if boot is received and retained.
D) never recognized.

Page Ref.: C:7-11
Objective: 1

28) In a Sec. 338 election, the target corporation
A) will no longer file a separate return.
B) must use the preacquisition tax year.
C) will have a holding period for assets beginning on the day after the acquisition date.
D) is considered to be a continuation of the old target corporation for purposes of the tax attribute carryover rules.

Page Ref.: C:7-12
Objective: 1

29) Identify which of the following statements is true.
A) Depreciation recapture rules do not override the nonrecognition of gain or loss rules.
B) The acquisition of liabilities by an acquiring corporation will trigger a gain.
C) A target corporation will recognize a gain when it distributes stock to its shareholders.
D) The basis of property acquired in a reorganization is its FMV.

Page Ref.: C:7-14 and C:7-15
Objective: 3

30) Identify which of the following statements is true.
A) The target corporation in a tax-free reorganization generally recognizes no gain or loss when boot property is received in exchange for assets because such property is usually distributed to its shareholders and creditors when the target corporation is liquidated.
B) In tax-free reorganizations, one transaction cannot qualify for more than one type of tax-free reorganization.
C) The Sec. 1245 recapture rules override the nonrecognition of gain or loss rules for an asset-for-stock tax-free reorganization.
D) All of the above are false.

Page Ref.: C:7-14
Objective: 3

31) Broom Corporation transfers assets with an adjusted basis of $300,000 and an FMV of $400,000 to Docker Corporation in exchange for $400,000 of Docker Corporation stock as part of a tax-free reorganization. The Docker stock had been purchased from its shareholders one year earlier for $350,000. How much gain do Broom and Docker Corporations recognize on the asset transfer?

A)
Broom Docker
$0 $0

B)
Broom Docker
$0 $50,000

C)
Broom Docker
$100,000 $0

D)
Broom Docker
$100,000 $50,000

Page Ref.: C:7-14 and C:7-15
Objective: 3

32) Identify which of the following statements is false.
A) The acquiring corporation does not recognize gains or losses under Sec. 1001 when it transfers noncash boot property to the target corporation or its shareholders.
B) Gain recognized by a shareholder in a tax-free reorganization may be characterized as a dividend.
C) If no gain or loss is recognized by a stock or security holder in a tax-free reorganization, the stock or securities received take a substituted basis equal to the basis of the shares or securities surrendered.
D) Tax-free reorganizations generally do not involve actual redemptions of the stock of the target corporation’s shareholders.

Page Ref.: C:7-17
Objective: 3

33) Paper Corporation adopts a plan of reorganization and exchanges 1,000 shares of its voting stock and $50,000 in cash for Chase Corporation’s assets having a $200,000 adjusted basis and a $275,000 FMV. Chase Corporation is subsequently liquidated. What is Paper Corporation’s basis in the assets acquired in the exchange?
A) $200,000
B) $250,000
C) $275,000
D) $50,000

Page Ref.: C:7-16
Objective: 3
34) Bob exchanges 4000 shares of Beetle Corporation stock that he had purchased for $800,000 for 6000 shares of Butterfly Corporation common stock with a fair market value of $1,000,000. What is Bob’s recognized gain on the exchange and his basis in the Butterfly stock?

A)
Recognized Gain Basis
$0 $1,000,000

B)
Recognized Gain Basis
$0 $800,000

C)
Recognized Gain Basis
$200,000 $1,000,000

D)
Recognized Gain Basis
$100,000 $800,000

Page Ref.: C:7-18
Objective: 3

35) Identify which of the following statements is true.
A) In a tax-free reorganization, the acquiring corporation’s holding period for the acquired properties includes the period of time the target corporation held the properties.
B) In a tax-free reorganization, if the acquiring corporation uses nonmonetary boot property, gains or losses will be recognized by the acquiring corporation.
C) The receipt of cash by a shareholder results in the recognition of all of his or her realized gain even if the transaction qualifies as a tax-free reorganization.
D) All of the above are false.

Page Ref.: C:7-16
Objective: 2

36) Rocky is a party to a tax-free asset-for-stock reorganization. As part of the transaction, Rocky exchanges 100% of the Hope Corporation stock with a $40,000 basis and a $50,000 FMV for Moth Corporation stock worth $40,000 and $10,000 cash. Hope Corporation is subsequently liquidated as part of the reorganization, with Moth receiving the Hope assets and liabilities. Rocky is
A) not required to recognize any gain or loss.
B) required to recognize capital gain or dividend income of $10,000, depending on Hope Corporation’s current and accumulated E&P and Rocky’s postacquisition interest in Moth Corporation.
C) required to recognize dividend income of $10,000 if Hope Corporation’s current and accumulated E&P is at least $10,000.
D) able to recognize capital gain income of $10,000 without regard to his post-acquisition interest in Moth Corporation.

Page Ref.: C:7-17
Objective: 3
37) Buddy owns 100 of the outstanding shares of Binder Corporation stock. Buddy’s basis in his Binder Corporation stock is $100,000. Binder Corporation is merged with Clipper Corporation in a tax-free reorganization. Buddy receives 50 shares of Clipper stock worth $150,000 and $150,000 cash. The remaining 100 shares of Binder stock were owned by Bruce who received the same consideration for his Binder stock. Binder and Clipper have E&P balances of $250,000 and $500,000, respectively. Buddy and Bruce each own 25% of Clipper Corporation’s 200 shares of stock after the reorganization. Which of the following is correct?
A) Buddy recognizes $200,000 as dividend income.
B) Buddy recognizes $200,000 as a capital gain.
C) Buddy recognizes $150,000 as dividend income.
D) Buddy recognizes $150,000 as a capital gain.

38) Acme Corporation acquires Fisher Corporation’s assets in a Type A reorganization for $800,000 of Acme’s nonvoting preferred stock and $200,000 (face amount and FMV) of securities. The assets have an adjusted basis of $600,000 and an FMV of $1,500,000. In addition, Acme Corporation assumes $500,000 of Fisher’s liabilities. At the time of the transfer, Acme’s E&P is $400,000. Fisher distributes the stock and securities to its sole shareholder Barbara for all of her Fisher stock. After the reorganization, Barbara owns 25% of Acme’s stock. Barbara has an adjusted basis of $400,000 in her Fisher stock. Barbara must recognize a gain of
A) $0.
B) $200,000 dividend income.
C) $200,000 capital gain.
D) $650,000 capital gain.

39) Acme Corporation acquires Fisher Corporation’s assets in a Type A reorganization for $800,000 of Acme’s nonvoting preferred stock and $200,000 (face amount and FMV) of securities. The assets have an adjusted basis of $600,000 and an FMV of $1,500,000. In addition, Acme Corporation assumes $500,000 of Fisher’s liabilities. At the time of the transfer, Acme’s E&P is $400,000. Fisher distributes the stock and securities to its sole shareholder Barbara for all of her Fisher stock. After the reorganization, Barbara owns 25% of Acme’s stock. Barbara has an adjusted basis of $400,000 in her Fisher stock. Barbara’s basis for her Acme securities is
A) 0.
B) $200,000.
C) $350,000.
D) $400,000.

40) American Corporation acquires the noncash assets of Utech Corporation in exchange for $700,000 of its voting stock plus $50,000 of cash. Utech Corporation assets are worth $750,000. Utech Corporation does not distribute the stock and cash but instead holds the stock as an investment. Utech will use the American cash along with the cash it retained to start a new business. The transaction can be classified as a
A) Type A reorganization.
B) Type B reorganization.
C) Type C reorganization.
D) The transaction does not qualify as a tax-free reorganization.

41) Identify which of the following statements is true.
A) To qualify as a Type A reorganization, the IRS currently requires at least 40% of the total consideration used must be acquiring corporation stock.
B) A Type A reorganization has the advantage of avoiding the acquisition of unknown and contingent liabilities.
C) A merger usually involves the approval of all of the shareholders of both corporations.
D) All of the above are false.

Page Ref.: C:7-22
Objective: 4
42) Rock Corporation acquires all of the assets of Stone Corporation using only its voting stock. Stone Corporation distributes the Rock stock to its shareholders pursuant to its liquidation. After the acquisition, Stone Corporation’s shareholders own 20% of the Rock stock (by voting power and value). The transaction is classified as a
A) Type B reorganization.
B) Type C reorganization.
C) Type D reorganization.
D) The transaction does not qualify as a tax-free reorganization.

43) Identify which of the following statements is false.
A) In a Type C reorganization, the acquired corporation must distribute stock, securities, and other property it receives to its shareholders.
B) A Type C reorganization is less flexible than a Type A reorganization because of the solely-for-voting stock requirement of a Type C.
C) To qualify as a Type C reorganization, the target corporation must be formally dissolved.
D) In a Type C reorganization, shareholders of the acquiring corporation generally do not have to approve the acquisition.

Page Ref.: C:7-26
Objective: 4

44) Identify which of the following statements is true.
A) The acquired corporation in a Type C reorganization may retain its corporation charter.
B) Alpha Corporation acquires 100% of the assets of Beta Corporation in exchange for $75,000 of Alpha stock and $25,000 in cash. Beta is subsequently liquidated. This exchange qualifies as a Type C reorganization.
C) Alpha Corporation acquires 100% of the assets of Beta Corporation in exchange for $75,000 of Alpha stock and the assumption of $25,000 of Beta liabilities. Beta is subsequently liquidated. This exchange does not qualify as a Type C reorganization.
D) All of the above are false.

Page Ref.: C:7-26
Objective: 4

45) In a Type B reorganization, the
1. stock of the target corporation is acquired solely for the voting stock of either the acquiring corporation or its parent.
2. acquiring corporation must have control of the target corporation immediately after the acquisition.
A) Only statement 1 is correct.
B) Only statement 2 is correct.
C) Both statements are correct.
D) Neither statement is correct.

Page Ref.: C:7-29 and C:7-30
Objective: 4
46) Identify which of the following statements is true.
A) Both a Type B reorganization or a reverse triangular merger will not allow the target corporation to remain in existence.
B) Andrews Corporation gives 10% of its stock worth $200,000 and Andrews notes worth $10,000 in exchange for 80% of Baxter Corporation’s stock. The exchange qualifies as a Type B reorganization.
C) In a Type B reorganization, with minor exceptions only voting stock can be used by the acquiring corporation to acquire the target corporation’s stock.
D) All of the above are false.

Page Ref.: C:7-29 and C:7-30
Objective: 4

47) Acquiring Corporation acquires all of the stock of Target Corporation in a Type B (stock-for-stock) reorganization. Both corporations have always filed separate tax returns. Which one of the following statements regarding the acquisition is correct?
A) Acquiring and Target Corporations can elect to file a consolidated tax return.
B) Acquiring and Target Corporations must file a consolidated tax return.
C) Acquiring Corporation assumes all of the tax attributes of Target Corporation.
D) Acquiring Corporation must step up or step down the basis of the Target Corporation’s assets to their FMV on the acquisition date?

48) Identify which of the following statements is true.
A) A Type B reorganization must be accomplished in one transaction.
B) “Creeping acquisitions” are not allowed in a Type B reorganization.
C) Boxer Corporation acquires 81% of Excel Corporation’s stock in a Type B reorganization. When Boxer Corporation acquires an additional 11% of Excel Corporation’s stock two years later in exchange for Boxer stock, the second acquisition is also treated as a Type B reorganization.
D) All of the above are false.

Page Ref.: C:7-30
Objective: 4

49) Identify which of the following statements is true.
A) Ann, Dewey Corporation’s sole shareholder, exchanges her Dewey stock having a $400,000 FMV and a $175,000 adjusted basis for $350,000 of Heider Corporation stock and $50,000 cash. Ann realizes a $225,000 gain on the stock transfer, none of which is recognized.
B) A Type B reorganization can be accomplished without formal shareholder approval.
C) The target corporation’s tax attributes are lost in a Type B reorganization.
D) All of the above are false.

Page Ref.: C:7-31
Objective: 4
50) Table Corporation transfers one-half of its assets to Chair Corporation in exchange for 100% of Chair Corporation’s single class of stock. Following the exchange, Table Corporation distributes the Chair stock ratably to its shareholders. This transaction will constitute a
A) Type A reorganization.
B) Type C reorganization.
C) divisive Type D reorganization.
D) acquisitive Type D reorganization.

Page Ref.: C:7-35
Objective: 5

51) Identify which of the following statements is true.
A) A split-off Type D reorganization occurs when part of the assets of one corporation are transferred to a controlled corporation in exchange for its stock, and shares of the controlled corporation’s stock are distributed to all of the distributing corporation’s shareholders without having them surrender any of their stock in the distributing corporation.
B) In a Type D reorganization, the existence of a good corporate business purpose is necessary before the stock of a controlled subsidiary can be distributed to the shareholders of the distributing corporation.
C) A distribution of a controlled corporation’s stock can be a tax-free Type D reorganization, even if none of the distributing corporation’s assets are transferred to the controlled corporation.
D) All of the above are false.

Page Ref.: C:7-38
Objective: 5

52) In which of the following reorganizations does the distributing corporation transfer all of its assets to two controlled corporations before the distributing corporation dissolves?
A) split-off
B) spin-off
C) split-up
D) Type C reorganization

Page Ref.: C:7-35
Objective: 5

53) Midnight Corporation transferred part of its assets to Noon Corporation in exchange for all of Noon’s stock. Midnight distributed all of Noon’s stock pro rate to Midnight’s shareholders. What is this type of reorganization?
A) split-off
B) spin-off
C) split-up
D) dividend distribution

Page Ref.: C:7-37
Objective: 5
54) Identify which of the following statements is true.
A) A tax-free spin-off coming under Sec. 355 occurs when a parent corporation distributes stock in a controlled subsidiary corporation in exchange for some of its own stock.
B) Tax-free split-offs and spin-offs coming under Sec. 355 require the surrender of shareholder stock.
C) When boot is received in a Sec. 355 spin-off transaction, the FMV of the boot will be a dividend to the extent of the shareholder’s ratable share of the distributing corporation’s E&P.
D) All of the above are false.

Page Ref.: C:7-36
Objective: 5

55) Grand Corporation transfers 40% of its assets having an adjusted basis of $600,000 and an FMV of $800,000 to New Corporation in exchange for 75% of its single class of stock. Grand Corporation is owned equally by Annie and Betsy who are unrelated. Annie’s basis for her Grand stock is $300,000 and Betsy’s basis is $400,000. Annie exchanges all of her Grand stock for all of the New stock received in the exchange. Which of the following statements is correct concerning these transactions?
A) Grand Corporation does not recognize a gain on the asset transfer to New Corporation or the stock distribution to Annie.
B) Annie recognizes a $500,000 capital gain on the exchange of the Grand stock for the New stock.
C) Annie’s basis in the New stock is $300,000.
D) Grand’s basis for the New assets is $600,000.

56) Identify which of the following statements is true.
A) The control requirement for Sec. 355 differs from the control requirement under Sec. 351.
B) Aspect Corporation transfers assets to newly created Expert Corporation in exchange for all of Expert’s stock. Shortly after the transfer, Aspect exchanges one-half of the Expert stock that it receives for land. The individuals transferring the land have never been Aspect shareholders. This transaction qualifies as a divisive Type D reorganization and is tax-free to all parties.
C) Common stock can be exchanged for preferred stock in the same corporation as a Type E reorganization.
D) All of the above are false.

Page Ref.: C:7-39
Objective: 6
57) Shareholders in Boxer Corporation exchange all of their nonvoting Class B common stock for additional shares of Boxer’s Class A common stock. Which of the following statements is correct?
A) If boot is added to the exchange, the entire gain realized on the exchange is recognized in full.
B) The exchange is a Type F reorganization, assuming all requirements are met.
C) The exchange is tax-free even if no plan of reorganization has been created.
D) The basis of the Class A common stock received is equal to its FMV.

58) If the FMV of the stock received in a Type E reorganization does not equal the FMV of the stock surrendered, the difference may be
A) a contribution to capital.
B) compensation for services.
C) a dividend.
D) All of the above are correct.

Page Ref.: C:7-39
Objective: 6

59) Roby Corporation, a Tennessee corporation, decides to change its state of incorporation to Delaware to take advantage of its more favorable state corporation laws. Roby Corporation can take advantage of the Type F reorganization rules by
A) exchanging the Tennessee corporation’s assets for the Delaware corporation’s stock and liquidating the Tennessee corporation.
B) liquidating the Tennessee corporation and reincorporating in Delaware.
C) merging the Tennessee corporation stock into an existing Delaware corporation.
D) recapitalizing the Tennessee corporation.

Page Ref.: C:7-40; Example C:7-29
Objective: 6

60) Identify which of the following statements is true.
A) Able Corporation (New York) transfers its assets to Able Corporation (Delaware) in exchange for all of its stock. Able Corporation (New York) is liquidated. This exchange is a Type F reorganization.
B) Strict adherence to legislative guidelines with regard to reorganizations is sufficient for tax-free treatment.
C) A suitable business purpose for a tax-free reorganization is to permit the minimization of shareholder taxes.
D) All of the above are false.

Page Ref.: C:7-40
Objective: 6
61) Identify which of the following statements is true.
A) The step-transaction doctrine has always been used by the IRS to convert a tax-free transaction into a taxable transaction.
B) Tax attributes carry over from the target corporation to the acquiring corporation in all acquisitive reorganizations.
C) In a Type A reorganization, the net operating loss carryover can be used by the acquiring corporation without limitation in its first tax year that ends after the acquisition date.
D) All of the above are false.

Page Ref.: C:7-41 through C:7-46
Objective: 7

62) Grant Corporation transfers highly appreciated stock to Subsidiary Corporation in exchange for all of its stock. The Subsidiary Corporation stock is distributed to its sole shareholder, Peter. Three weeks after the distribution of the Subsidiary stock, Subsidiary Corporation liquidates. Peter then sells the appreciated stock that he received in the liquidation. This series of transactions
A) does not meet the statutory definition of a divisive Type D reorganization.
B) fails the business purpose requirement.
C) results in a capital gain to Peter.
D) None of the above is correct.

Page Ref.: C:7-42; Example C:7-33
Objective: 7

63) Roger transfers assets from his sole proprietorship to his 100%-owned Motor Corporation. Immediately after the incorporation, Motor Corporation transfers all of its assets to Blue Corporation for 10% of Blue’s stock. Motor Corporation is liquidated. Which of the following statements is correct?
A) The asset transfer by Motor Corporation meets the statutory Type C reorganization requirements.
B) The IRS may collapse the two transactions into a single transaction, resulting in denial of tax-free reorganization treatment.
C) The IRS may apply the step transaction doctrine.
D) All of the above statements are correct.

Page Ref.: C:7-42; Example C:7-34
Objective: 7

64) The acquiring corporation does not obtain the target corporation’s tax attributes in
A) a Type A reorganization.
B) a Type B reorganization.
C) an acquisitive Type C reorganization.
D) an acquisitive Type D reorganization.

Page Ref.: C:7-32 and 7-43
Objective: 8
65) Acquiring Corporation is 100%-owned by Peter Hart. Target Corporation is 100% owned by Dick Weber. The two individuals are not related. Target Corporation has $400,000 of NOL carryovers at the time Acquiring Corporation is considering making a cash acquisition of part or all of Target Corporation’s stock. What is the maximum amount of Target stock that can be acquired in a single transaction without the Sec. 382 loss limitation rules applying to the NOLs?
A) 49%
B) 50%
C) 80%
D) Any acquisition of Target stock will cause the Sec. 382 loss limitation to apply.

66) Identify which of the following statements is false.
A) When determining the use of an NOL carryover following a change of ownership, the old loss corporation and the new loss corporation may be the same for Sec. 382 purposes.
B) A new loss corporation that does not continue the business enterprise of the old loss corporation during the two-year period beginning on the date of the stock ownership change cannot use the net operating loss carryover.
C) One advantage of a tax-free reorganization is that losses realized as part of a tax-free reorganization are not recognized.
D) For purposes of Sec. 382, ownership changes are tested any time a 5% shareholder has a stock transaction affecting his ownership.

Page Ref.: C:7-45
Objective: 8

67) Which one of the following is not a corporate reorganization as defined in the Internal Revenue Code?
A) recapitalization
B) mere change in identity
C) merger
D) stock redemption

Page Ref.: C:7-46 and C:7-47
Objective: 9

68) Identify which of the following statements is true.
A) A plan of reorganization must be a written document.
B) Advance rulings are required for all reorganizations.
C) The IRS will issue an advance ruling on any proposed tax-free reorganization.
D) All of the above are false.

Page Ref.: C:7-46 and C:7-47
Objective: 10
69) Brown Corporation has assets with a $650,000 basis and an $800,000 FMV. The assets are subject to $250,000 in liabilities. Clark Corporation acquires all of Brown’s assets and liabilities for $600,000 in cash. Brown Corporation then liquidates. What is Clark Corporation’s basis in the acquired assets?

70) Pacific Corporation acquires 80% of the stock of Jackson Corporation for $3,000,000 in the current year. Jackson’s assets have a basis of $2,000,000 and its liabilities are $800,000. The assets are worth $3,500,000. What gain is recognized by Jackson Corporation on the deemed sale of its assets if a Sec. 338 election is made?

71) Dreyer Corporation purchased 5% of Willy Corporation’s stock five years ago for $100,000. Dreyer then decides to purchase an additional 80% of the Willy stock for $1,000,000 on April 15 of the current year. On the acquisition date, Willy Corporation’s liabilities are $150,000. A $300,000 tax liability is incurred by Willy on the Sec. 338 deemed sale. What is the total basis of Willy Corporation’s assets for Sec. 338 basis allocation purposes?

72) Parent Corporation purchases all of Target Corporation’s stock for $200,000 and makes a deemed liquidation election. Target Corporation has Class I assets with an adjusted basis of $55,000 and an FMV of $55,000; Class II assets with an adjusted basis of $40,000 and an FMV of $60,000; and Class V assets with an adjusted basis of $70,000 and an FMV of $100,000. The Class V assets are subject to a $20,000 liability. Assume a 34% corporate tax rate. What is the adjusted grossed-up basis of Target Corporation’s stock?

73) Parent Corporation purchases all of Target Corporation’s stock for $200,000 and makes a deemed liquidation election. Target Corporation has Class I assets with an adjusted basis of $55,000 and an FMV of $55,000; Class II assets with an adjusted basis of $40,000 and an FMV of $60,000; and Class V assets with an adjusted basis of $70,000 and an FMV of $100,000. The Class V assets are subject to a $20,000 liability. Assume a 34% corporate tax rate.

Assuming that the adjusted grossed-up basis is $237,000 ($200,000 + $20,000 + $17,000 federal income taxes), what is the allocation of adjusted grossed-up basis to Class VI assets?

74) The assets of Bold Corporation have a $1,000,000 basis and a $3,000,000 FMV. Its liabilities are $500,000. Tidel Corporation acquires 80% of the Bold Corporation stock for $2,000,000. What gain is recognized by Bold Corporation if a timely Sec. 338 election is made by Tidel Corporation? What is the total basis of the assets to Bold Corporation following the deemed sale? Assume a 34% corporate tax rate.

75) Acquiring Corporation acquires all of the assets of Target Corporation in exchange for $3,000,000 of Acquiring common stock and the assumption of $2,000,000 of Target’s liabilities. The assets had a $2,300,000 adjusted basis to Target. Target’s sole shareholder, Paula, had a $1,000,000 adjusted basis for her stock. Target Corporation had $600,000 of E&P on the acquisition date. Paula receives all of the Acquiring common stock in the liquidation of Target. What are the tax consequences of the acquisition to: Acquiring, Target, and Paula?

76) Zebra Corporation transfers assets with a $120,000 basis and a $250,000 FMV to Hat Corporation for common stock worth $200,000 and cash of $50,000. The exchange qualifies as a tax-free reorganization. Zebra Corporation distributes the stock and cash to its shareholders pursuant to its liquidation. How much gain must Zebra Corporation recognize?

78) Martha owns Gator Corporation stock having an adjusted basis of $21,000. As part of a tax-free reorganization involving Gator and Baker Corporations, Martha exchanges her Gator stock for $18,000 of Baker stock and $6,000 (face amount and FMV) of Baker securities. What is Martha’s basis in the Baker stock?

79) Marty is a party to a tax-free reorganization. He has a basis of $22,000 in his Van Corporation stock that has an FMV of $35,000. Marty exchanges the Van stock for Young Corporation stock worth $29,000 and Young securities with a face amount of $7,000 and an FMV of $6,000. What is Marty’s basis in the Young securities?

80) Acme Corporation acquires Fisher Corporation’s assets in a Type A reorganization for $800,000 of Acme’s nonvoting preferred stock and $200,000 (face amount and FMV) of securities. The assets have an adjusted basis of $600,000 and an FMV of $1,500,000. In addition, Acme Corporation assumes $500,000 of Fisher’s liabilities. At the time of the transfer, Acme’s E&P is $400,000. Fisher distributes the stock and securities to its sole shareholder Barbara for all of her Fisher stock. After the reorganization, Barbara owns 25% of Acme’s stock. Barbara has an adjusted basis of $400,000 in her Fisher stock. What is Barbara’s basis for her Acme stock?

81) As part of a plan of corporate reorganization, Sally exchanged 1,000 shares of Tone Corporation common stock that she had purchased for $85,000, for 3,000 shares of Fade Corporation voting common stock having an $87,000 FMV. What is the amount and character of Sally’s recognized gain and her basis in the Tone stock as a result of the exchange?

82) Gulf Corporation wants to acquire all of Beamer Corporation’s assets and liabilities in a Type C reorganization. The FMV of Beamer’s assets is $500,000. Beamer’s liabilities are $70,000. How much cash can Gulf Corporation use to pay for Beamer’s assets without violating the Type C reorganization requirements?

83) Carol owns Target Corporation stock having an adjusted basis of $41,000. As part of a Type C tax-free reorganization involving Revbo and Target Corporations, Carol exchanges her Target stock for $42,000 of Revbo stock and Revbo securities having a face amount and FMV of $8,000. What is Carol’s basis in the Revbo stock?

84) Town Corporation acquires all of the stock of Country Corporation in June in exchange for Town voting common stock. Both Town and Country use a calendar year as their tax year. In the following January, Country pays all of its liabilities and distributes its remaining assets to Town pursuant to its liquidation. These assets consist of $50,000 in cash and land having a $30,000 FMV and a $10,000 basis to Country. Upon distribution of Country’s assets to Town, all of Country’s capital stock is canceled. Town’s basis for the Country stock prior to the liquidation was $57,000. What is the amount and character of Town’s recognized gain on receipt of Country’s assets pursuant to the liquidation?

85) Baxter Corporation transfers assets with an adjusted basis of $300,000 and an FMV of $500,000 to Duke Corporation for 90% of Duke’s single class of stock worth $500,000. The Duke stock is then exchanged for Frank’s 50% interest in Baxter Corporation. Frank’s basis in the Baxter stock he surrenders is $120,000. What is Frank’s basis in the Duke stock he receives?

86) Baxter Corporation transfers assets with an adjusted basis of $300,000 and an FMV of $500,000 to Duke Corporation for 90% of Duke’s single class of stock worth $500,000. The Duke stock is then exchanged for Frank’s 50% interest in Baxter Corporation. Frank’s basis in the Baxter stock he surrenders is $120,000. What is Duke Corporation’s basis in the assets it receives?

87) Paris Corporation has E&P of $200,000. Paris owns all of Slider Corporation’s stock, which is worth $80,000. The stock has been held for five years. Paris distributes all of the Slider stock and $20,000 cash to a 50% shareholder in exchange for all of the shareholder’s 100 shares of Paris stock. The exchange qualifies as a Sec. 355 split-off transaction. The 50% shareholder’s basis in the Paris stock surrendered is $90,000. What is the amount of the gain that the 50% shareholder must recognize?

88) On July 1, in connection with a recapitalization of Yorktown Corporation, Robert Moore exchanges 1,000 shares of Yorktown preferred stock, which cost him $95,000, for 1,000 shares of Yorktown common stock worth $108,000 and bonds having a principal amount of $10,000 and an FMV of $10,500. What is the amount of Moore’s realized and recognized gain?

89) Florida Corporation is 100% owned by Lawton Chiles. Georgia Corporation is 100% owned by Zell Miller. Georgia Corporation acquires on December 31 of the previous year all of Florida Corporation’s stock for $5,000,000 in a cash purchase transaction. Both corporations use the calendar year as their tax year. At the time of the acquisition, Florida Corporation had a $500,000 NOL. During the current year, the two corporations file separate tax returns and Florida Corporation reports $700,000 of taxable income. The long-term tax-exempt rate for the period, including the acquisition date is 6%. What is Florida Corporation’s taxable income for the current year?

90) Acquiring Corporation acquires at the close of business on June 30 (of a nonleap year) all of the stock of Target Corporation as part of a merger transaction. Target Corporation is liquidated into Acquiring Corporation on the same day as part of the merger. Acquiring obtains assets having a $600,000 FMV and a $275,000 adjusted basis, along with a $100,000 net operating loss. Acquiring Corporation reports taxable income of $146,000 for the year. What amount of Target Corporation’s NOL can be used to offset Acquiring Corporation’s taxable income? (Assume all months have 30 days and ignore the Sec. 382 limitation rules.)

91) What are the two steps of a Sec. 338 deemed liquidation election?

92) Define the seven classes of assets used in allocating basis when using the residual method.

93) Why would an acquiring corporation want an acquisition to be tax-free if it gets only a substituted basis rather than a step-up basis for the acquired assets?

94) Briefly describe A, B, C, D, and G reorganization types.

95) What are the advantages and disadvantages of a merger transaction?

96) What are the advantages of a triangular merger?

97) What are the advantages and disadvantages of a Type C reorganization?

98) What are the advantages and disadvantages of a Type B reorganization?

99) The Supreme Court has held that literal compliance with the statutory requirements for a reorganization transaction is not enough for a transaction to receive tax-free treatment. The courts have placed four primary restrictions on reorganization transactions. What are they?

100) Discuss the advantages and disadvantages of a tax-free reorganization as compared with a taxable transaction.

101) John Van Kirk owns all the stock of Monmouth Restaurant Corporation in Pittsburgh. John would like to sell his business and retire to sunny Florida now that he has turned 65. Pam, a long-time bartender at Monmouth Restaurant, offers to purchase all the business’s noncash assets in exchange for a 25% down payment, with the remaining 75% being paid in five equal annual installments. Interest will be charged at a 10% rate on the unpaid installments. John plans to liquidate the corporation that has operated the restaurant and have Monmouth Restaurant distribute the installment notes and any remaining assets. What tax issues should Monmouth Restaurant, John, and Pam consider with respect to the purchase transaction?

102) WorldCom is a telecommunications company that provides national and international service to local and long-distance customers. On September 14, 1998, WorldCom acquired MCI Communications Corporation (MCI) pursuant to a merger agreement. The acquisition can be divided into three stages:

1) WorldCom created an acquisitions subsidiary (TC Investments Corporation) by transferring WorldCom stock and cash to TC Investments Corporation in exchange for newly issued TC Investments Corporation stock. TC Investments Corporation then used the WorldCom stock and cash to acquire MCI as described in the next two steps.
2) TC Investments Corporation used cash to purchase all the outstanding MCI Class A common stock from British Telecommunications (BT) for $51 per share. BT had acquired the MCI Class A common stock two years earlier in a failed merger attempt involving BT and MCI. In addition, TC Investments Corporation used WorldCom stock to acquire all outstanding shares of regular MCI common stock from other MCI shareholders. In this exchange, MCI shareholders received 1.2439 shares of WorldCom stock for each share of regular MCI common stock surrendered. TC Investments Corporation paid cash in lieu of issuing fractional WorldCom shares to MCI shareholders who were entitled to such fractional shares. More than 50% of the consideration used to acquire MCI was composed of WorldCom stock.

3) After the stock acquisition, MCI transferred its assets to TC Investments Corporation in a liquidation transaction, after which TC Investments Corporation held MCI assets instead of MCI stock. TC Investments Corporation then changed its name to MCI Communications Corporation, and WorldCom changed its name to MCI WorldCom.

After these three steps, MCI Communications Corporation, which held the acquired MCI assets, ended up as a subsidiary of MCI WorldCom. Total assets of MCI WorldCom after the merger were $86 billion, including the stock of its subsidiary, MCI Communications Corporation.

On December 31, 1997, prior to the acquisition, MCI had $576 million of U.S. NOL carryovers and $179 million of minimum tax credit carryovers. MCI WorldCom incurred expenses of $127 million in connection with the acquisition. MCI WorldCom recorded the transaction as a purchase for financial accounting purposes with the excess of cost over FMV being recorded as a combination of goodwill, in-process R&D costs, and other intangible assets. In addition, MCI WorldCom incurred $21 million in employee severance pay outlays. MCI stock options were converted into MCI WorldCom stock options. What type of reorganization did WorldCom and MCI engage in? What tax issues should the parties to the reorganization (MCI, BT, TC Investments Corporation, WorldCom, and the MCI and WorldCom shareholders) consider when evaluating the acquisition?

103) In Fall 1999, Ford Motor Company’s board of directors announced the $25.8 billion spin-off of its 80.7% interest in the Associated First Capital Corporation finance unit to the Ford shareholders. Ford said that it would distribute about $22.7 billion in Associates shares to its holders of Ford common and Class B stock, and $3.1 billion in cash to shareholders who hold Ford stock in U.S. employee savings accounts. According to market observers who track Ford operations, the spin-off is one of several moves Ford has taken to increase shareholder value by selling off nonautomotive assets, moves that included the initial public offering in April 1999 of Hertz Corporation. Ford said that it will take a one-time, noncash, nontaxable gain of about $16.5 billion in the first quarter as a result of the spin-off. What tax issues should the parties to the divisive transaction consider?

104) Johnson Co. transferred part of its assets to Alive Corporation in exchange for all of Alive’s stock. The Alive stock received for the assets was distributed to the Johnson shareholders. What tax issues should the parties to the divisive reorganization consider?