Prentice Hall’s Federal Taxation 2013: Corporations – Exam and Quizzes

Prentice Hall’s Federal Taxation 2013: Corporations – Exam and Quizzes

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C1 Tax Research

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1) Tax planning is not an integral part of open-fact situations.
Answer:
Page Ref.: C:1-2

2) The Internal Revenue Code of 1986 contains the current version of the tax law.
Answer:
Page Ref.: C:1-8

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.
Answer:
Page Ref.: C:1-9

4) Final regulations have almost the same legislative weight as the IRC.
Answer:
Page Ref.: C:1-10

5) A revenue ruling is issued by the Internal Revenue Service only in response to a verbal inquiry by a taxpayer.
Answer:
Page Ref.: C:1-12

6) Taxpayers must pay the disputed tax prior to filing a case with the Tax Court.
Answer:
Page Ref.: C:1-14

7) Appeals from the U.S. Tax Court are to the Court of Appeals for the Federal Circuit.
Answer:
Page Ref.: C:10-14

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.
Answer:
Page Ref.: C:1-14

9) A citator enables tax researchers to locate authorities (e.g., cases and IRS pronouncements) that have cited a particular case.
Answer:
Page Ref.: C:1-26

10) According to the Statements on Standards for Tax Services , CPAs must verify all tax return information submitted by reviewing client documentation.
Answer:
Page Ref.: C:1-27
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.
Answer:
Page Ref.: C:1-2

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

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

14) The term “tax law” includes
A) legislation.
B) treasury regulations.
C) judicial decisions.
D) all of the above
Answer:
Page Ref.: C:1-7

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.
Answer:
Page Ref.: C:1-7
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.
Answer:
Page Ref.: C:1-7

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.
Answer:
Page Ref.: C:1-7

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.
Answer:
Page Ref.: C:1-7

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
Answer:
Page Ref.: C:1-7

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.
Answer:
Page Ref.: C:1-7

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.
Answer:
Page Ref.: C:1-8
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.
Answer:
Page Ref.: C:1-8

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
Answer:
Page Ref.: C:1-8

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.
Answer:
Page Ref.: C:1-9

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.
Answer:
Page Ref.: C:1-10

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.
Answer:
Page Ref.: C:1-10
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.
Answer:
Page Ref.: C:1-10

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.
Answer:
Page Ref.: C:1-9

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.
Answer:
Page Ref.: C:1-11

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.
Answer:
Page Ref.: C:1-11

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.
Answer:
Page Ref.: C:1-11
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
Answer:
Page Ref.: C:1-11

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
Answer:
Page Ref.: C:1-11

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.
Answer:
Page Ref.: C:1-12

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.
Answer:
Page Ref.: C:1-12

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
Answer:
Page Ref.: C:1-12

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.
Answer:
Page Ref.: C:1-11 through C:1-13
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.
Answer:
Page Ref.: C:1-13

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.
Answer:
Page Ref.: C:1-13

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
Answer:
Page Ref.: C:1-14

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.
Answer:
Page Ref.: C:1-14

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.
Answer:
Page Ref.: C:1-14

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.
Answer:
Page Ref.: C:1-15 and C:1-17
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.
Answer:
Page Ref.: C:1-17

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

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

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

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

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

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
Answer:
Page Ref.: C:1-17

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

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.
Answer:
Page Ref.: C:1-18
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.
Answer:
Page Ref.: C:1-18

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
Answer:
Page Ref.: C:1-19

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.
Answer:
Page Ref.: C:1-19

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.
Answer:
Page Ref.: C:1-18

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.
Answer:
Page Ref.: C:1-20

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.
Answer:
Page Ref.: C:1-20
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.
Answer:
Page Ref.: C:1-21

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

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

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.
Answer:
Page Ref.: C:1-23

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.
Answer:
Page Ref.: C:1-23
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 BNA Daily Tax Reporter is a source of primary tax authority.
D) Tax services are sources of primary tax authority.
Answer:
Page Ref.: C:1-24

66) Which of the following is secondary authority?
A) Internal Revenue Code
B) Treasury Regulations
C) RIA and CCH tax services
D) Revenue Ruling
Answer:
Page Ref.: C:1-24

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.
Answer:
Page Ref.: C:1-25

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.
Answer:
Page Ref.: C:1-26

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.
Answer:
Page Ref.: C:1-25

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.
Answer:
Page Ref.: C:1-30

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
Answer:
Page Ref.: C:1-30

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.
Answer:
Page Ref.: C:1-30

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.
Answer:
Page Ref.: C:1-33 through C:1-35

74) Statements on Standards for Tax Services are issued by
A) the SEC.
B) the IRS.
C) the AICPA.
D) the FASB.
Answer:
Page Ref.: C:1-27

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.
Answer:
Page Ref.: C:1-27

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.
Answer:
Page Ref.: C:1-33

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.
Answer:
Page Ref.: C:1-33

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.
Answer:
Page Ref.: C:1-33

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

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

81) Describe the format of a client memo.
Answer:
82) Explain how committee reports can be used in tax research. What do they indicate?
Answer:

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?”
Answer:

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

85) What is the purpose of Treasury Regulations?
Answer:

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

87) Discuss the purposes and scope of temporary regulations.
Answer:

88) What are the purposes of citations in tax research?
Answer
89) Are letter rulings of precedential value to third parties?
Answer:

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

91) What is an information release?
Answer:

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

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

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

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

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

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).
Answer:

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?
Answe

100) What is “forum-shopping”?
Answer

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

102) Distinguish between an annotated tax service and a topical tax service.
Answer:
103) What is the purpose of a citator?
Answer:
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?
Answer:

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

106) Outline and discuss the tax research process.
Answer:

107) Compare and contrast proposed, temporary, and final regulations.
Answer:
108) Compare and contrast “interpretative” and “statutory” regulations.
Answer:

109) Explain the legislative reenactment doctrine.
Answer

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

111) Describe the appeals process in tax litigation.
Answer:

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

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

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?
Answer:

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

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C2 Corporate Formations and Capital Structure

1) A sole proprietor is required to use the same reporting period for both business and individual tax information.
Answer:
Page Ref.: C:2-3
2) S corporations are flow-through entities in which S income is allocated to shareholders.
Answer:
Page Ref.: C:2-6

3) S corporations must allocate income to shareholders based on their proportionate stock.
Answer:
Page Ref.: C:2-6

4) The check-the-box regulations permit an LLC to be taxed as a C corporation.
Answer:
Page Ref.: C:2-8

5) There are no tax consequences of a partnership converting to a C corporation.
Answer:
Page Ref.: C:2-8

6) Section 351 applies to an exchange if the contributing shareholders own more than 50% of a corporation’s stock after the transfer.
Answer:
Page Ref.: C:2-12 and C:2-13

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.
Answer:
Page Ref.: C:2-18

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.
Answer:
Page Ref.: C:2-21

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.
Answer:
Page Ref.: C:2-21 and C:2-22

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.
Answer:
Page Ref.: C:2-27

11) Any losses on the sale of Section 1244 stock are ordinary.
Answer:
Page Ref.: C:2-32 and C:2-33

12) Upon formation of a corporation, its assets have the same bases for book and tax purposes.
Answer:
Page Ref.: C:2-36
13) Business assets of a sole proprietorship are owned by
A) a member.
B) an individual.
C) a partner.
D) a stockholder.
Answer:
Page Ref.: C:2-2

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.
Answer:
Page Ref.: C:2-3

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
Answer:
Page Ref.: C:2-3

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

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
Answer:
Page Ref.: C:2-4; Example C:2-3

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

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.
Answer:
Page Ref.: C:2-6 and C:2-7

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.
Answer:
Page Ref.: C:2-6

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
Answer:

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.
Answer:
Page Ref.: C:2-6
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 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.
Answer:
Page Ref.: C:2-6

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

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

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

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.
Answer:
Page Ref.: C:2-12
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.
Answer:
Page Ref.: C:2-12

30) For Sec. 351 purposes, the term “property” does not include
A) cash.
B) accounts receivable.
C) inventory.
D) services rendered.
Answer:
Page Ref.: C:2-12 and C:2-13

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.
Answer:
Page Ref.: C:2-13; Example C:2-12

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.
Answer:
Page Ref.: C:2-14

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.
Answer:
Page Ref.: C:2-15; Example C:2-19
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.
Answer:
Page Ref.: C:2-15

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.
Answer:
Page Ref.: C:2-16; Example C:2-22

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.
Answer:
Page Ref.: C:2-16

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.
Answer:
Page Ref.: C:2-16
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.
Answer:
Page Ref.: C:2-16

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.
Answer:

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
Answer:
Page Ref.: C:2-17

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.
Answer:

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.
Answer:
Page Ref.: C:2-16 and C:2-17

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.
Answer:
Page Ref.: C:2-17 and C:2-18

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.
Answer:
Page Ref.: C:2-18 and C:2-19
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.
Answer:

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.
Answer:
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.
Answer:

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.
Answer:
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.
Answer:

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.
Answer:
Page Ref.: C:2-18

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
Answer:
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.
Answer:
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.
Answer:

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.
Answer:
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
Answer:
Page Ref.: C:2-19

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.
Answer:
Page Ref.: C:2-19

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.
Answer:
Page Ref.: C:2-20; Example C:2-30

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
Answer:
Page Ref.: C:2-21 and C:2-22

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
Answer:
Page Ref.: C:2-21 and C:2-22
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.
Answer:
Page Ref.: C:2-21

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.
Answer:
Page Ref.: C:2-21

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.
Answer:

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.
Answer:
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.
Answer:
Page Ref.: C:2-23 and C:2-24
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
Answer:
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
Answer:
Page Ref.: C:2-25

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.
Answer:

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.
Answer:
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.
Answer:
Page Ref.: C:2-26

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.
Answer:
Page Ref.: C:2-27

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.
Answer:
Page Ref.: C:2-27; Example C:2-42
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
Answer:
Page Ref.: C:2-31; Example C:2-45

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.
Answer:
Page Ref.: C:2-31; Example C:2-45

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.
Answer:
Page Ref.: C:2-31 and C:2-32

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.
Answer:
Page Ref.: C:2-32 and C:2-33; Example C:2-46
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-

Answer:

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?
Answer:

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?
Answer:

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?
Answer:
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?
Answer:

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?
Answer:

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?
Answer:

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.
Answer:

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?
Answer:

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?
Answer:

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?
Answer:

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?
Answer:

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?
Answer:

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?
Answer
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?
Answer:
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?
Answer:

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?
Answer:

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?
Answer:

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?
Answer:
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?
Answer:

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?
Answer:

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?
Answer

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?
Answer:

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?
Answer:

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?
Answer:

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?
Answer:
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?
Answer:

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?
Answer:

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

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?
Answer:

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?
Answer:

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?
Answer:
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:

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?
Answer:

111) What is the impact on a transferor if a Sec. 351 exchange involves the assumption of the shareholder’s liabilities by the corporation?
Answer:
Page Ref.: C:2-22 and C:2-24
112) What is the tax treatment for a contribution of capital to a corporation by a nonshareholder?
Answer:
Page Ref.: C:2-31

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?
Answer:
Page Ref.: C:2-35

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.
Answer:
Page Ref.: C:2-34 and C:2-35

115) Discuss the IRS reporting requirements under Sec. 351.
Answer:
Page Ref.: C:2-36

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?
Answer:
Page Ref.: C:2-6 and C:2-7

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?
Answer:
Page Ref.: C:2-11 through C:2-22

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?
Answer:
Page Ref.: C:2-11 through C:2-22

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?
Answer:
Page Ref.: C:2-12 through C:2-27

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?
Answer:
Page Ref.: C:2-32 and C:2-33

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?
Answer:
Page Ref.: C:2-33 and C:2-34
123) Sarah has advanced money to her corporation. What tax issues should she consider with respect to this money?
Answer:
Page Ref.: C:2-28 and C:2-29

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C3 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.
Answer:
Page Ref.: C:3-2

2) Corporations are permitted to deduct $3,000 in net capital losses annually.
Answer:
Page Ref.: C:3-7

3) Organizational expenses incurred after 2004 are amortized over five years.
Answer:
Page Ref.: C:3-8

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.
Answer:
Page Ref.: C:3-12

5) Corporations may carry charitable contributions in excess of the income limitation forward for five years.
Answer:
Page Ref.: C:3-13

6) The dividends-received deduction is designed to reduce double taxation of corporate dividends payable to individual shareholders.
Answer:
Page Ref.: C:3-15
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.
Answer:
Page Ref.: C:3-15

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.
Answer:
Page Ref.: C:3-19

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.
Answer:
Page Ref.: C:3-21

10) All of the taxable income of a personal service corporation is taxed at a flat 35% rate.
Answer:
Page Ref.: C:3-24

11) Corporate estimated tax payments are due April 15, June 15, September 15, and January 15.
Answer:
Page Ref.: C:3-35

12) A deferred tax asset indicates that a firm will realize the tax benefit of an event sometime in the future.
Answer:
Page Ref.: C:3-44

13) Deferred tax liabilities occur when expenses are deductible for book purposes before tax purposes.
Answer:
Page Ref.: C:3-44

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.
Answer:
Page Ref.: C:3-2

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.
Answer:
Page Ref.: C:3-2
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.
Answer:
Page Ref.: C:3-2 and C:3-3

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.
Answer:
Page Ref.: C:3-44

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.
Answer:
Page Ref.: C:3-44

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
Answer:
Page Ref.: C:3-44

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
Answer:
Page Ref.: C:3-44

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
Answer:
Page Ref.: C:3-44

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.
Answer:
Page Ref.: C:3-4

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.
Answer:
Page Ref.: C:3-4 and C:3-5

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.
Answer:
Page Ref.: C:3-5 and C:3-6

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.
Answer:
Page Ref.: C:3-6 and C:3-7

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

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.
Answer:
Page Ref.: C:3-7

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.
Answer:
Page Ref.: C:3-7

29) Evans Corporation has a $15,000 net capital loss in 2010. 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
2007
2008
2009 $10,000
11,000
5,000

A) The loss is used to offset the gains from 2009 and then carried back to offset $10,000 of the gains in 2007.
B) The loss is used to offset the $11,000 of the 2008 gains and then carried back to offset $4,000 of the year 2007 net gain.
C) The loss is used to offset $3,000 of the current year ordinary income, all of the year 2007 capital gains, and $7,000 of the year 2008 net gain.
D) The loss is used to offset the year 2007 net gains, then $5,000 of the year 2008 net gains.
Answer:
Explanation: D) The net capital loss is carried back to the year 2004 and then used to offset capital gains in subsequent tax years.
Page Ref.: C:3-7; Example C:3-3

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.
Answer:
Explanation: C)
Sales price $200,000
Minus: adjusted basis (170,000)
Realized gain $ 30,000
Minus: ordinary income under
Sec. 291
(4,000)

(Lesser of: (1) $20,000 depreciation recapture under Sec. 1245 × 0.20 or (2) $30,000 realized gain × 0.20)

Sec. 1231 gain $ 26,000

Page Ref.: C:3-7; Example C:3-4

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.
Answer:
Page Ref.: C:3-44

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.
Answer:
Page Ref.: C:3-45 and C:3-46

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.
Answer:
Page Ref.: C:3-9

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
Answer:
Explanation: B) Amortization of organizational expenses does not include the stock commission, which reduces paid-in capital, and the charter modification, which is incurred after the initial year-end.

$2,000 + $2,000 + $2,000 = $6,000 – $5,000 = $1,000/180 mo. × 5 mo. = $28
$5,000 + 28 = $5,028
Page Ref.: C:3-8 and C:3-9; Example C:3-5

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
Answer:
Explanation: C) The underwriter fees and asset transfer cost are not organizational costs. The legal fee to modify charter is incurred after the November 30 initial year end.

$10,000 + $2,000 = $12,000 – $5,000 = $7,000
($7,000/180) × 4 = $156; $5,000 + 156 = $5,156
Page Ref.: C:3-8 and C:3-9; Example C:3-5
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.
Answer:
Page Ref.: C:3-9

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.
Answer:
Page Ref.: C:3-11

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.
Answer:
Explanation: D) The $20,000 basis for the painting is used to compute the deduction since it is held less than one year and the appreciation would be a short-term capital gain if sold. As long as the pledge is paid in the first 2 1/2 months of the next tax year, the corporation may deduct the entire $12,000 in the current year. The total deduction is $32,000 ($12,000 + $20,000).
Page Ref.: C:3-11 and C:3-12

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.
Answer:
Page Ref.: C:3-11
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
Answer:
Explanation: B) [$20,000 + .50 ($40,000 – $20,000)] = $30,000.
Page Ref.: C:3-12

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.
Answer:
Page Ref.: C:3-12; Example C:3-9

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.
Answer:
Explanation: C)
FMV $70,000
Minus: basis ( 30,000)
Appreciation $40,000 × 0.50 = $20,000 = 1/2 profit
Plus: donated property’s basis 30,000
Tentative charitable contribution deduction $50,000
Limited to twice the basis ($30,000 × 2) = $60,000

Page Ref.: C:3-12; Example C:3-9
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.
Answer:
Page Ref.: C:3-11 and C:3-12

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.
Answer:
Page Ref.: C:3-13

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
Answer:
Page Ref.: C:3-13

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) $30,000
D) $50,000
Answer:
Explanation: C) $500,000 × 6% = $30,000
Page Ref.: C:3-13 and C:3-14

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
Answer:
Page Ref.: C:3-13 and C:3-14
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
Answer:
Page Ref.: C:3-14

49) In 2007, 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) $72,000
C) $60,000
D) $36,000
Answer:
Page Ref.: C:3-15; Example C:3-12

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.
Answer:
Explanation: D)
Sales $ 60,000
Plus: dividends 40,000
Gross income $100,000
Minus: expenses ( 30,000)
Taxable income before DRD $ 70,000
Minus: 70% DRD (0.70 × $40,000) ( 28,000)
Taxable income $ 42,000

Page Ref.: C:3-15; Example C:3-15

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.
Answer:
Explanation: A) The dividends-received deduction is limited to $42,000 unless using the full $49,000 dividends-received deduction will produce a NOL (i.e., taxable income would be $11,000 ($60,000 – $49,000). As shown below, the full dividends-received deduction does not produce a NOL.

Gross income from operations $ 90,000
Plus: dividends 70,000 × 0.70 = $49,000 (Tentative DRD)
Gross income $160,000
Minus: expenses ( 100,000)
Taxable income before DRD $ 60,000 × 0.70 = $42,000 (DRD Limit)

Page Ref.: C:3-15

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.
Answer:
Page Ref.: C:3-16

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.
Answer:
Page Ref.: C:3-17

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
Answer:
Explanation: A)
Gross income from operations $200,000
Plus: dividends 20,000
Gross income $220,000
Minus: expenses ( 700,000)
Taxable income before DRD ($480,000)
Minus: DRD ($20,000 x 0.70) ( 14,000)
NOL ($494,000)

Page Ref.: C:3-16

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).
Answer:
Explanation: D) The dividends-received deduction of 70% of dividends received is not limited, since using the entire $28,000 amount will produce a NOL.

Other income $ 60,000
Plus: dividends 40,000
Gross income $100,000
Minus: expenses ( 80,000)
Taxable income before DRD $ 20,000
Minus: DRD (0.70 × $40,000 ( 28,000)
Taxable income ($ 8,000)

Page Ref.: C:3-16

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.
Answer:
Explanation: B) The forty-six-day minimum stock ownership requirement prevents taking a dividends-received deduction.
Page Ref.: C:3-17

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.
Answer:
Explanation: D) The forty-six-day minimum stock ownership requirement prevents taking a dividends-received deduction.
Page Ref.: C:3-17

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.
Answer:
Page Ref.: C:3-18

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.
Answer:
Page Ref.: C:3-19

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.
Answer:
Explanation: B) Webster and Bear Corporation are related parties under Sec. 267(b). The $2,000 loss on Bear Corporation’s sale to Webster is disallowed. However, no disallowance of the $2,000 loss occurs on the sale by the purchaser to an unrelated party. The disallowed loss on the first sale cannot be used by Webster when he sells the truck unless he has a gain to offset it against. In this problem, he has a $2,000 loss ($6,000 sales price – $8,000 basis).
Page Ref.: C:3-21

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.
Answer:
Explanation: B) Ajax recognized no loss on the sale because of the Sec. 267(a) related party sale transaction rules (i.e., Ajax Corporation and Walter are related parties). When Walter sells the truck for a $5,000 ($13,000 – $8,000) gain, he is allowed to use the $2,000 disallowed loss as an offset.
Page Ref.: C:3-21

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.
Answer:
Explanation: B)
$50,000× 0.15 = $ 7,500
25,000 × 0.25 = 6,250
25,000 × 0.34 = 8,500
50,000 × 0.39 = 19,500
Regular tax $41,750

Page Ref.: C:3-23

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.
Answer:
Explanation: C)
$ 50,000× 0.15 = $ 7,500
25,000 × 0.25 = 6,250
25,000 × 0.34 = 8,500
235,000 × 0.39 = 91,650
165,000 × 0.34 = 56,100
$170,000

Page Ref.: C:3-23

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.
Answer:
Explanation: B) [(16,000,000 – 15,000,000) × 0.38] + 5,150,000 = 5,530,000
Page Ref.: C:3-23

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
Answer:
Explanation: B) When taxable income equals or exceeds $18,333,333, the tax is calculated by using a flat 35% rate. Therefore, the tax is $7,000,000 (0.35 × $20,000,000).
Page Ref.: C:3-24

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.
Answer:
Explanation: C) Personal service corporations pay an income tax liability equal to 35% of taxable income.
Page Ref.: C:3-24
67) Which of the following is not subject to classification as a personal service corporation?
A) construction
B) law
C) accounting
D) performing arts
Answer:
Page Ref.: C:3-24

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

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
Answer:
Page Ref.: C:3-25 and C:3-26.

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.
Answer:
Page Ref.: C:3-25 through C:3-28

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.
Answer:
Page Ref.: C:3-26 and C:3-27
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.
Answer:
Page Ref.: C:3-26 through C:3-28

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.
Answer:
Explanation: A) The estimated tax liability for a small corporation is the lesser of 100% of the current year’s tax liability (regular tax and alternative minimum tax), or 100% of last year’s tax liability, or $240,000.
Page Ref.: C:3-35 and C:3-36

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.
Answer:
Page Ref.: C:3-38 and C:3-39
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.
Answer:
Page Ref.: C:3-38 and C:3-39

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.
Answer:
Page Ref.: C:3-39 through C:3-43

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
Answer:
Explanation: B)
Taxable income $700,000
Plus: excess of tax depreciation over book depreciation 60,000
Plus: nontaxable life insurance proceeds 100,000
Minus: federal income taxes (240,000)
Net income $620,000

Page Ref.: C:3-40 and C:3-41

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.
Answer:
Explanation: B)
Beginning balance $ 800,000
Plus: net income 700,000
Plus: tax refund 50,000
Minus: dividends paid ( 500,000)
Ending balance $1,050,000

Page Ref.: C:3-42; Example C:3-52

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
Answer:
Explanation: A)
Taxable income 500,000
Plus: difference between book and tax depreciation 0,000
Minus: net capital loss ( 2,000)
Minus: interest on loan to acquire tax-exempt securities ( 7,000)
Financial accounting income $511,000

Page Ref.: C:3-40 and C:3-41

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.
Answer: The capital loss offsets all $11,000 of capital gain reported in the third previous year, and $14,000 can be carried over to the year before last. $10,000 of the carryover is used in the year before last, leaving $4,000 to be carried over to next year.
Page Ref.: C:3-7

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.
Answer: The loss cannot be deducted this year since Jackson did not report any capital gains. The loss must be carried back to the three preceding tax years and used as a short-term capital loss. If part or all of the loss is unused as a carryback, it can be carried forward as a short-term capital loss for five years.
Page Ref.: C:3-7

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?
Answer:right recognizes $50,000 ($100,000 – $50,000) of Sec. 1231 gain on the sale of the land. Bright also recognizes $105,000 [$450,000 – ($400,000 – $55,000)] on the sale of the building, of which $11,000 (20% of the lesser of (1) $55,000 depreciation claimed, or (2) $105,000 gain recognized) is ordinary income recaptured under Sec. 291. The remaining $94,000 ($105,000 – $11,000) gain on the sale of the building is a Sec. 1231 gain.
Page Ref.: C:3-7

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?
Answer:
Realized gain: $145,000 – ($75,000 – $60,000) = $130,000.
Sec 291 gain: $15,000 × 20% = $3,000
Sec. 1231 gain = $127,000, Sec. 291 gain – $3,000

Since the building is Sec. 1250 property, straight-line depreciation is recaptured to the extent of 20% under Sec. 291. The remaining $127,000 gain is a Sec. 1231 gain.
Page Ref.: C:3-7
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?
Answer:
$20,000 + $5,000) = $25,000 total organizational costs. Deduction is $5,000 + [ 6 × (20,000/180)] = $5,667.
Page Ref.: C:3-8 and C:3-9; Example C:3-5

85) On December 10, 2008, 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, 2009. What is Dell’s deduction for 2008? What is Dell’s deduction for 2009?
Answer:ell is allowed $0 deduction for 2008 as the bonus is not paid by March 15, 2009. Dell will take the $100,000 deduction in 2009.
Page Ref.: C:3-11; Example C:3-7

86) Chambers Corporation is a calendar year taxpayer using the accrual method of accounting. In 2009, its board of directors authorizes a $20,000 contribution to the Boy Scouts. Chambers pays the contribution on March 12, 2010. What is the maximum contribution allowed in 2009? What is the maximum contribution allowed in 2010?
Answer: The maximum allowable in 2009 is $20,000. Chambers may elect to treat all or part of the contribution as having been made in the year in which it was accrued. If Chambers makes this election, it may take the remaining amount in 2010. In this case, $0 would be remaining. If Chambers does not make the election, the $20,000 contribution is deductible when paid in 2010.
Page Ref.: C:3-11

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?
Answer: Prince may deduct the adjusted basis plus 50% of the excess of the property’s FMV over the adjusted basis (not to exceed twice the property’s adjusted basis) for a total of $33,000 [$26,000 + (.50 × $14,000)] provided the property is related to the donee’s exempt function, and it is used solely for the care of the ill..
Page Ref.: C:3-12

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?
Answer: $25,000 + 0.50 ($85,000 – $25,000) = $55,000 tentative deduction. This amount is limited to twice the property’s adjusted basis, or $50,000 (2 × $25,000). Soup Corporation can claim a $50,000 deduction.
Page Ref.: C:3-12
89) Bermuda Corporation reports the following results in 2009 and 2010:

2009 2010
Adjusted taxable income $400,000 $600,000
Charitable contributions 70,000 50,000

What is Bermuda’s contribution deduction in 2009 and 2010? What is the disposition of any remaining amount?
Answer:ermuda’s 2009 contribution deduction is limited to $40,000 (0.10 × $400,000). Bermuda has a $30,000 ($70,000 – $40,000) contribution carryover to 2010. The 2009 contribution deduction is limited to $60,000 (0.10 × $600,000). Bermuda’s deduction for 2010 is composed of the $50,000 donated in 2010, and $10,000 of the 2009 carryover. A $20,000 carryover from 2009 carries over to 2011, 2012, and 2013.
Page Ref.: C:3-13; Example C:3-11

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?
Answer:
a) None of the equipment qualifies for a special deduction.
b) There is no charitable deduction.
Page Ref.: C:3-11

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?
Answer:
Page Ref.: C:3-15
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?
Answer:
Page Ref.: C:3-15 through C:3-18

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?
Answer:
Page Ref.: C:3-15; Example C:3-15
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?
Answer:
Page Ref.: C:3-15 through C:3-18

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?
Answer:

Page Ref.: C:3-19 and C:3-20
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?
Answer:
Page Ref.: C:3-16; Example C:3-18

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?
Answer:
Page Ref.: C:3-16; Example C:3-18
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:

2005 $100,000
2006 $120,000
2007 $ 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.
Answer:
Page Ref.: C:3-19
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?
Answer:
Page Ref.: C:3-21

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, 2010 and makes the payment on March 10, 2011. What are the tax consequences of the transactions to both taxpayers in 2010 and 2011?
Answer:
Page Ref.: C:3-22; Example C:3-27
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?
Answer
Page Ref.: C:3-23

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?
Answer:
Page Ref.: C:3-26 and C:3-27
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?
Answer:
a) If they elect no special apportionment plan, Ben and Jerry are limited to $25,000 each taxed at a 15% rate and to $12,500 each taxed at a 25% rate. Since Ben has an NOL, it has no tax liability. Jerry’s tax liability is as follows:

15% tax bracket: 0.15 x $25,000 $ 3,750
25% tax bracket: 0.25 x $12,500 3,125
34% tax bracket: 0.34 x $62,500 21,250
Subtotal for Jerry Corporation $28,125

Total for Ben-Jerry controlled group $28,125

b) If the corporations elect a special apportionment plan, the group may apportion the full $50,000 and $25,000 amounts for each of the reduced tax rate brackets to Jerry Corporation. Since Ben has an NOL, it has no tax liability. Jerry’s tax liability is as follows:

15% tax bracket: 0.15 x $50,000 $ 7,500
25% tax bracket: 0.25 x $25,000 6,250
34% tax bracket: 0.34 x $25,000 8,500
Subtotal for Jerry Corporation $22,250

Total for Ben-Jerry controlled group $22,250
Page Ref.: C:3-32 and C:3-33; Example C:3-42

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
Answer: $800,000 – $272,000 + ($140,000 – $80,000) + $48,000 + $90,000 = $726,000

The reconciling number on the Schedule M-1 is taxable income before special deductions. Thus, the dividends-received deduction amount would not regularly be included in the Schedule M-1 reconciliation but must be included here since the starting point for the calculation is taxable income.
Page Ref.: C:3-39 and C:3-40
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?
Answer:
Page Ref.: C:3-44

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

107) James Corporation purchased residential real estate in 2005 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 2010, 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?
Answer:

108) What are start-up expenditures?
Answer:

109) For corporations, what happens to excess charitable contributions?
Answer:
110) Describe the domestic production activities deduction.
Answer:

Page Ref.: C:3-13 through C:3-15

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?
Answer:

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

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

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

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

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

Disadvantages include:
Answer:
117) Discuss the estimated tax filing requirements for a C corporation.
Answer:

118) What are the four principles underlying ASC 740?
Answer:

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?
Answer:

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?
Answer:

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?
Answer:

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?
Answer:
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?
Answer:

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?
Answer:
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?
Answer:

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?
Answer:

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

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C4 Corporate Nonliquidating Distributions

1) Corporate distributions that exceed earnings and profits are always capital gains.
Answer:
Page Ref.: C:4-2

2) Corporations may always use retained earnings as a substitute for earnings and profits.
Answer:
Page Ref.: C:4-5

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.
Answer:
Page Ref.: C:4-5

4) A shareholder’s basis in property distributed as a dividend is its fair market value.
Answer:
Page Ref.: C:4-9

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.
Answer:
Page Ref.: C:4-10

6) Corporations recognize gains and losses on the distribution of property to shareholders if the property’s fair market value differs from its basis.
Answer:
Page Ref.: C:4-10

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

8) In a taxable distribution of stock, the recipient shareholder takes a basis equal to the FMV of the stock received.
Answer:
Page Ref.: C:4-15

9) A stock redemption is always treated as if the shareholder sold his stock to the corporation.
Answer:
Page Ref.: C:4-17

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.
Answer:
Page Ref.: C:4-22
11) A partial liquidation of a corporation is treated as a dividend in the case of a corporate shareholder.
Answer:
Page Ref.: C:4-24 and C:4-25

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.
Answer:
Page Ref.: C:4-30

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.
Answer:
Page Ref.: C:4-3 and C:4-4

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.
Answer:
Page Ref.: C:4-4

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.
Answer:
Page Ref.: C:4-4

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.
Answer:
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.
Answer:
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.
Answer:
Page Ref.: C:4-5

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.
Answer:
Page Ref.: C:4-5 and C:4-6

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.
Answer:
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.
Answer:

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.
Answer:

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
Answer:
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.
Answer:

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.
Answer:

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.
Answer:
Page Ref.: C:4-8 through C:4-9

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.
Answer:
Page Ref.: C:4-9

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.
Answer:

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.
Answer:
Page Ref.: C:4-9

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.
Answer:

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.
Answer:

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.
Answer:
Page Ref.: C:4-10; Example C:4-15

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.
Answer:

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.
Answer:
Page Ref.: C:4-10

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.
Answer:
Page Ref.: C:4-11 through C:4-13

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.
Answer:
Page Ref.: C:4-12 through C:4-14

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.
Answer:

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.
Answer:
Explanation: B) [$60,000 (FMV)/$240,000 (total FMV)] × $80,000 (basis) = $20,000. Basis is allocated based on relative FMVs.
Page Ref.: C:4-14; Example C:4-20

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

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

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

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.
Answer:
Page Ref.: C:4-16

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.
Answer:
Page Ref.: C:4-16

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.
Answer:

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.
Answer:

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.
Answer:
Page Ref.: C:4-17

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.
Answer:
Page Ref.: C:4-17 through C:4-20

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.
Answer:
Page Ref.: C:4-18

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.
Answer:
Page Ref.: C:4-19

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.
Answer:
Page Ref.: C:4-20

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.
Answer:
Page Ref.: C:4-20 and C:4-21

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.
Answer:
Page Ref.: C:4-22

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.
Answer:
Page Ref.: C:4-22

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
Answer:
Page Ref.: C:4-23; Example C:4-35

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.
Answer:
Page Ref.: C:4-23

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.
Answer:
Page Ref.: C:4-23

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

Answer:

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.
Answer:

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.
Answer:
Page Ref.: C:4-25

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.
Answer:
Page Ref.: C:4-25

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.
Answer:
Page Ref.: C:4-26; Example C:4-41

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.
Answer:
Page Ref.: C:4-27

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.
Answer:

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.
Answer:
Page Ref.: C:4-30

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.
Answer:
Page Ref.: C:4-30 and C:4-31

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
Answer:

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.
Answer:
Page Ref.: C:4-32

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.
Answer:
Page Ref.: C:4-33

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.
Answer:
Page Ref.: C:4-34; Example C:4-49

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.
Answer:
Page Ref.: C:4-34; Example C:4-50

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
Answer:
Page Ref.: C:4-34

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
Answer:
Page Ref.: C:4-35; Example C:4-52

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.
Answer:

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?
Answer:

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?
Answer:

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?
Answer:

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

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?
Answer:

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.
Answer:

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?
Answer:

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?
Answer:
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?
Answer:
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 nonleap 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)
Answer:

84) When is E&P measured for purposes of determining whether a distribution is a dividend?
Answer: Usually at year-end. However, if a current deficit exists, the E&P available for measuring dividend income is determined at the distribution date.
Page Ref.: C:4-8
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?
Answer:

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?
Answer:

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?
Answer:
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?
Answer:

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?
Answer:

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?
Answer:

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?
Answer:

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?
Answer:

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?
Answer:

Page Ref.: C:4-18 through C:4-20

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.
Answer:
Page Ref.: C:4-21 through C:4-23

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?
Answer:
Page Ref.: C:4-28 through C:4-30

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?
Answer:

Page Ref.: C:4-30 through C:4-33

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?
Answer:

Page Ref.: C:4-31 through C:4-33

98) How does a shareholder classify a distribution for tax purposes?
Answer
Page Ref.: C:4-2
99) Outline the computation of current E&P, including two examples for each adjustment.
Answer:
Page Ref.: C:4-4

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?
Answer:
Page Ref.: C:4-8 and C:4-9

101) What is a constructive dividend? Under what circumstances are constructive dividends most likely to arise?
Answer:
Page Ref.: C:4-11 through C:4-13
102) Why are stock dividends generally nontaxable? Under what circumstances are stock dividends taxable?
Answer:
Page Ref.: C:4-13 and C:4-14

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?
Answer:
Page Ref.: C:4-16

104) Define Sec. 306 stock.
Answer:
Page Ref.: C:4-28

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?
Answer:
Page Ref.: C:4-31 and C:4-32; Examples C:4-45 and C:4-46
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?
Answer:
Page Ref.: C:4-31

107) What must be reported to the IRS by corporations when nondividend distributions are made to its shareholders?
Answer:
Page Ref.: C:4-36
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?
Answer:

Page Ref.: C:4-3 through C:4-8

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?
Answer:
Page Ref.: C:4-3 through C:4-8, and C:4-33

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?
Answer:

Page Ref.: C:4-8 through C:4-13

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?
Answer:
Page Ref.: C:4-12 and C:4-13
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?
Answer:
Page Ref.: C:4-17

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?
Answer:
Page Ref.: C:4-16 through C:4-23

Prentice Hall’s Federal Taxation 2013: Corporations,(Pope/Anderson/Kramer)
Chapter C5 Other Corporate Tax Levies

1) The alternative minimum tax is the excess of the tentative minimum tax amount over the regular tax amount.
Answer:
Page Ref.: C:5-2

2) Corporations cannot use the installment method in calculating alternative minimum taxable income (AMTI) for noninventory items.
Answer:
Page Ref.: C:5-9

3) The NOL deduction is calculated the same for regular and alternative minimum tax purposes.
Answer:
Page Ref.: C:5-9

4) The ACE adjustment always increases alternative minimum taxable income (AMTI).
Answer:
Page Ref.: C:5-10

5) Life insurance proceeds are a positive adjustment for adjusted current earnings (ACE), but not alternative minimum taxable income (AMTI).
Answer:
Page Ref.: C:5-10

6) All corporations, except S corporations and small C corporations, must calculate the ACE adjustment.
Answer:
Page Ref.: C:5-10

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.
Answer:
Page Ref.: C:5-14

8) The general business credit can be used to offset the alternative minimum tax.
Answer:
Page Ref.: C:5-15

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.
Answer:
Page Ref.: C:5-22

10) A corporation can be subject to both the accumulated earnings tax and the personal holding company tax in the same year.
Answer:
Page Ref.: C:5-25
11) To avoid the accumulated earnings tax, a corporation needs to have a definite plan for expending the accumulated earnings.
Answer:
Page Ref.: C:5-28

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.
Answer:
Page Ref.: C:5-2

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.
Answer:
Page Ref.: C:5-2

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.
Answer:
Page Ref.: C:5-2

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.
Answer:
Page Ref.: C:5-3

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.
Answer:
Page Ref.: C:5-3 through C:5-4
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.
Answer:
Page Ref.: C:5-3

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
Answer:
Page Ref.: C:5-6

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
Answer:
Page Ref.: C:5-6

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.
Answer:
Page Ref.: C:5-6 and C:5-7

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.
Answer:
Page Ref.: C:5-7
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
Answer:
Page Ref.: C:5-7

23) Becky places five-year property in service during June 2009 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
Answer:
Page Ref.: C:5-7

24) Becky places five-year property in service during June 2009 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
Answer:
Page Ref.: C:5-7

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.
Answer:
Page Ref.: C:5-7
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.
Answer:
Page Ref.: C:5-10

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
Answer:
Page Ref.: C:5-9

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.
Answer:
Page Ref.: C:5-9

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.
Answer:
Page Ref.: C:5-10
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).
Answer:
Page Ref.: C:5-10

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
Answer:
Page Ref.: C:5-11

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.
Answer:
Page Ref.: C:5-11

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
Answer:
Page Ref.: C:5-15
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
Answer:
Page Ref.: C:5-15

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.
Answer:
Page Ref.: C:5-15

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.
Answer:
Page Ref.: C:5-14
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

Answer:
Page Ref.: C:5-38

38) SFAS 109 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.
Answer:
Page Ref.: C:5-16

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.
Answer:
Page Ref.: C:5-17

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.
Answer:
Page Ref.: C:5-17
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.
Answer:
Page Ref.: C:5-17

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.
Answer:
Page Ref.: C:5-17 through C:5-18

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.
Answer:
Page Ref.: C:5-17 through C:5-21

44) The personal holding company penalty tax rate is
A) 15%.
B) 10%.
C) 20%.
D) 35%.
Answer:
Page Ref.: C:5-21
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.
Answer:
Page Ref.: C:5-22; Figure C:5-2

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%.
Answer:
Page Ref.: C:5-22

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.
Answer:
Page Ref.: C:5-23

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.
Answer:
Page Ref.: C:5-23
49) A personal holding company cannot take a dividends-paid deduction for
A) throwback dividends.
B) consent dividends.
C) deficiency dividends.
D) preferential dividends.
Answer:
Page Ref.: C:5-23

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.
Answer:
Page Ref.: C:5-23

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.
Answer:
Page Ref.: C:5-23

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.
Answer:
Page Ref.: C:5-23

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.
Answer:
Page Ref.: C:5-25
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.
Answer:
Page Ref.: C:5-25

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
Answer:
Page Ref.: C:5-25

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.
Answer:
Page Ref.: C:5-25 through C:5-27

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
Answer:
Page Ref.: C:5-26

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.
Answer:
Page Ref.: C:5-27
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
Answer:
Page Ref.: C:5-29 and C:5-30; Example 20

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.
Answer:
Page Ref.: C:5-29 and C:5-30; Example 20

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
Answer:
Page Ref.: C:5-29

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.
Answer:
Page Ref.: C:5-32

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.
Answer:
Page Ref.: C:5-32
64) The accumulated earnings tax is imposed at what rate?
A) 10%
B) 15%
C) 20%
D) 35%
Answer:
Page Ref.: C:5-32

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
Answer:
Page Ref.: C:5-33

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.
Answer:
Page Ref.: C:5-31 through C:5-33

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.
Answer:
Page Ref.: C:5-33

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
Answer:
Page Ref.: C:5-33
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.
Answer:
Page Ref.: C:5-33 and C:5-34

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.
Answer:
Page Ref.: C:5-33

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.
Answer:
Page Ref.: C:5-38

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?
Answer:
Page Ref.: C:5-2 through C:5-13; Comprehensive Example

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?
Answer:
Page Ref.: C:5-3

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?
Answer
Page Ref.: C:5-5
75) Door Corporation’s alternative minimum taxable income before the statutory exemption is $200,000. What is Door’s tentative minimum tax before credits?
Answer:

Page Ref.: C:5-5

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?
Answer:
Page Ref.: C:5-5

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?
Answer:
Page Ref.: C:5-10; Example C:5-11

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?
Answer:
Page Ref.: C:5-10; Example C:5-12

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.
Answer:
Page Ref.: C:5-14

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?
Answer:
Page Ref.: C:5-15; Example C:5-14

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?
Answer:
Page Ref.: C:5-17

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).
Answer:
Page Ref.: C:5-18; Example C:5-15

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.
Answer:
Page Ref.: C:5-20; Example C:5-16

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.
Answer:
Page Ref.: C:5-24; Example C:5-19
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?
Answer:
Page Ref.: C:5-21 and C:5-22

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.
Answer:
Page Ref.: C:5-24; Example C:5-19

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?
Answer:
Page Ref.: C:5-29 and C:5-30; Example 20

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
Answer:
Page Ref.: C:5-29 and C:5-30; Example 20

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?
Answer:
Page Ref.: C:5-33 and C:5-34; Example C:5-22

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.
Answer:
Page Ref.: C:5-33 and C:5-34; Example C:5-22

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?
Answer:

Page Ref.: C:5-33 and C:5-34; Example C:5-22

92) How is alternative minimum taxable income computed?
Answer:
Page Ref.: C:5-4
93) What are the four general rules that provide a framework for the ACE calculation?
Answer:

Page Ref.: C:5-10

94) Explain the carryover provisions of the minimum tax credit.
Answer: Page Ref.: C:5-14

95) What is a personal holding company?
Answer:
Page Ref.: C:5-16

96) Define personal holding company income.
Answer:
Page Ref.: C:5-18

97) What is the effect of the two-pronged test that allows the exclusion from PHCI of certain AIR (adjusted income from rents)?
Answer:
Page Ref.: C:5-19
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?
Answer:
Page Ref.: C:5-28

99) How is the accumulated earnings tax liability computed?
Answer:
Page Ref.: C:5-32

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?
Answer:
Page Ref.: C:5-36

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?
Answer:
.
Page Ref.: C:5-4 through C:5-11

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?
Answer:
Page Ref.: C:5-8 and C:5-9

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?
Answer:

Page Ref.: C:5-16 through C:5-19

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?
Answer:
Page Ref.: C:5-25 through C:5-29

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C6 Corporate Liquidating Distributions

1) Liquidation and dissolution have the same legal meaning.
Answer:
Page Ref.: C:6-4

2) In a complete liquidation, a liability assumed by a shareholder reduces the shareholder’s amount realized.
Answer:
Page Ref.: C:6-5

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.
Answer:
Page Ref.: C:6-6

4) The adjusted basis of property received in a complete liquidation is its fair market value on the distribution date.
Answer:
Page Ref.: C:6-6

5) Generally, a corporation recognizes gain, but not loss, on a liquidating distribution.
Answer:
Page Ref.: C:6-6
6) Section 336 prevents recognition of a loss when making a pro rata distribution of property to a related person.
Answer:
Page Ref.: C:6-8

7) The liquidation of a subsidiary corporation must be completed within one tax year to receive nonrecognition treatment.
Answer:
Page Ref.: C:6-11

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.
Answer:
Page Ref.: C:6-13

9) A subsidiary must recognize depreciation recapture income when the subsidiary is liquidated into the parent.
Answer:
Page Ref.: C:6-14

10) Liquidating expenses are generally deducted as ordinary and necessary business expenses.
Answer:
Page Ref.: C:6-16

11) A corporation is required to file Form 966 within 30 days after the adoption of a plan of liquidation.
Answer:
Page Ref.: C:6-20

12) A plan of liquidation must be reduced to writing in order to be accepted by the Internal Revenue Service.
Answer:
Page Ref.: C:6-21

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.
Answer:
Page Ref.: C:6-3 and C:6-4
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.
Answer:
Page Ref.: C:6-3 through C:6-10

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
Answer:
Page Ref.: C:6-4

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.
Answer:
Page Ref.: C:6-4

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).
Answer:
Page Ref.: C:6-5

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.
Answer:
Page Ref.: C:6-5; Example C:6-3
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.
Answer:
Page Ref.: C:6-5; Example C:6-4

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) No gain or loss is recognized.
D) $25,000 loss
Answer:

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
Answer:
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.
Answer:
Page Ref.: C:6-6

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.
Answer:
Page Ref.: C:6-6

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.
Answer:
Page Ref.: C:6-6

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.
Answer:
Page Ref.: C:6-6
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.
Answer:
Page Ref.: C:6-6

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.
Answer:
Page Ref.: C:6-6

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-

Answer:
Page Ref.: C:6-5 through C:6-7

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
Answer:

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.
Answer:
Page Ref.: C:6-8

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.
Answer:
Page Ref.: C:6-8

32) The stock of Cooper Corporation is 70% owned by Carole and 30% owned by Carole’s brother, Chris. During 2005, Chris transferred property (basis of $100,000 and FMV of $120,000) as a contribution to the capital of Cooper. During February 2006, 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
Answer:

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.
Answer:
Page Ref.: C:6-9; Example C:6-11

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
Answer:
Page Ref.: C:6-9; Example C:6-11

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
Answer:
Page Ref.: C:6-10

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

Answer:

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
Answer:

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.
Answer:
Page Ref.: C:6-10

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.
Answer:

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.
Answer:
Page Ref.: C:6-11
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.
Answer:
Page Ref.: C:6-12
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

Answer:
Page Ref.: C:6-12; Example C:6-15

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

Answer:
Page Ref.: C:6-13; Example C:6-16
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
Answer:

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

Answer:
Page Ref.: C:6-13

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.
Answer:
Page Ref.: C:6-14
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.
Answer:
Page Ref.: C:6-14

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.
Answer:
Page Ref.: C:6-12; Example C:6-15

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) cannot be determined from the facts presented
B) 0.
C) $200,000.
D) $500,000.
Answer:
Page Ref.: C:6-13; Example C:6-16

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.
Answer:
Page Ref.: C:6-14
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.
Answer:
Page Ref.: C:6-15

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

Answer:
Page Ref.: C:6-14; Example C:6-18
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
Answer:

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.
Answer:

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
Answer:
Page Ref.: C:6-15; Example C:6-21
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.
Answer:

57) During 2007, 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 2008. 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 2008.
B) $0 gain in 2007.
C) $3,000 gain in 2007, which is reported on an amended current-year tax return that is filed in 2008.
D) none of the above.
Answer:

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.
Answer:
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.
Answer:

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 Liquidating Expenses
$45,000 $3,000

B)
Gain Liquidating Expenses
$50,000 $2,000

C)
Gain Liquidating Expenses
$55,000 $3,000

D)
Gain Liquidating Expenses
$50,000 $1,000

Answer:
Page Ref.: C:6-16; Example C:6-22

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.
Answer:
Page Ref.: C:6-17 and C:6-18
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.
Answer:
Page Ref.: C:6-17 and C:6-18

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
Answer:

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.
Answer:
Page Ref.: C:6-18; Example C:6-24
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.
Answer:
Page Ref.: C:6-19; Example C:6-25

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.
Answer:
Page Ref.: C:6-20

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
Answer:
Page Ref.: C:6-20

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 to 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.
Answer:
Page Ref.: C:6-21

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.
Answer:
Page Ref.: C:6-21
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.
Answer:
Page Ref.: C:6-21

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?
Answer:
Page Ref.: C:6-5

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?
Answer: .
Page Ref.: C:6-5; Example C:6-3

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?
Answer:
Page Ref.: C:6-5; Example C:6-4

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?
Answer:
Page Ref.: C:6-5

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?
Answer:
Page Ref.: C:6-5; Example C:6-4

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?
Answer:
Page Ref.: C:6-5 and C:6-6

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?
Answer:
Page Ref.: C:6-5 and C:6-6

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?
Answer:

Page Ref.: C:6-5 through C:6-9

79) How is the gain/loss calculated if a shareholder has acquired stock at different times and at varying prices?
Answer:
Page Ref.: C:6-6

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?
Answer:
Page Ref.: C:6-6; Example C:6-5

81) What event determines when a cash or accrual method of accounting taxpayer reports a liquidating distribution?
Answer:
Page Ref.: C:6-6

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?
Answer:
Page Ref.: C:6-6; Example C:6-5

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?
Answer:
Page Ref.: C:6-10 through C:6-14

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?
Answer: Page Ref.: C:6-11 and C:6-12

85) What basis do both the parent and minority shareholders take in the assets received in a Sec. 332 liquidation?
Answer:
Page Ref.: C:6-12

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?
Answer:
Page Ref.: C:6-13

87) What attributes of a controlled subsidiary corporation are carried over to the parent when the subsidiary is liquidated?
Answer:
Page Ref.: C:6-14

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?
Answer:
Page Ref.: C:6-15

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 2007. Midwest subsequently lost a lawsuit and Penny paid an additional $3,000 in 2009 as her part of the settlement. What are the tax consequences to Penny in 2009 of the $3,000 additional payment she made?
Answer:
Page Ref.: C:6-15

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?
Answer: .
Page Ref.: C:6-16; Example C:6-22

91) Are liquidation and dissolution the same? Explain your answer.
Answer: Page Ref.: C:6-3 and C:6-4

92) Explain the difference in tax treatment between a partial liquidation and a complete liquidation.
Answer:

Page Ref.: C:6-3 through C:6-9

93) Under what circumstances does a liquidating corporation not recognize a gain or loss when making a distribution?
Answer:
Page Ref.: C:6-6 through C:6-9 and C:6-12 and C:6-13

94) In a Sec. 332 liquidation, can a subsidiary corporation recognize losses on distributions to either the parent corporation or minority shareholders?
Answer:
Page Ref.: C:6-10

95) In a Sec. 332 liquidation, what bases do both the parent and minority shareholders take in the assets received?
Answer:
Page Ref.: C:6-10

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?
Answer:
Page Ref.: C:6-11 through C:6-13

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?
Answer:
Page Ref.: C:6-15

98) What is the IRS’s position regarding whether a liquidating transaction will be considered open or closed?
Answer: Page Ref.: C:6-16

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.
Answer:
Page Ref.: C:6-19

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.
Answer:
Page Ref.: C:6-19

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?
Answer:
Page Ref.: C:6-2 through C:6-9, C:6-16, C:6-17

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?
Answer:
Page Ref.: C:6-5 through C:6-9
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?
Answer

Page Ref.: C:6-10 through C:6-14 and C:6-16

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C7 Corporate Acquisitions and Reorganizations

1) Taxable acquisition transactions can either be a purchase of assets or a purchase of stock.
Answer:
Page Ref.: C:7-2

2) In a taxable asset acquisition, the purchaser does not acquire unknown and contingent liabilities.
Answer:
Page Ref.: C:7-3

3) The Sec. 338 deemed sale rules require that 70% of the target corporation’s stock be owned.
Answer:
Page Ref.: C:7-5
4) Tax attributes of the target corporation are lost when a Sec. 338 deemed liquidation election is made.
Answer:
Page Ref.: C:7-9 and C:7-10

5) In a nontaxable reorganization, shareholders of the target corporation recognize gain or loss.
Answer:
Page Ref.: C:7-13

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.
Answer:
Page Ref.: C:7-12; Topic Review C:7-2

7) In a nontaxable reorganization, the holding period for the stock received by the target shareholders includes the holding period of the stock surrendered.
Answer:
Page Ref.: C:7-13; Topic Review C:7-3

8) The acquiring corporation does not recognize gain or loss in a reorganization where it receives boot.
Answer:
Page Ref.: C:7-14 and C:7-15

9) Type A reorganizations include mergers and consolidations.
Answer:
Page Ref.: C:7-23; Example C:7-18

10) In a triangular Type A merger, the acquiring subsidiary corporation must obtain substantially all of the target corporation’s assets.
Answer:
Page Ref.: C:7-24

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.
Answer:
Page Ref.: C:7-29 and C:7-30

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.
Answer:
Page Ref.: C:7-29 and C:7-30

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.
Answer:
Page Ref.: C:7-40
14) Advance rulings are required for all reorganizations.
Answer:
Page Ref.: C:7-48

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.
Answer:
Page Ref.: C:7-2

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.
Answer:
Page Ref.: C:7-2

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.
Answer:
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.
Answer:
Page Ref.: C:7-4

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.
Answer:
Page Ref.: C:7-5 and C:7-6

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
Answer:
Page Ref.: C:7-5 through C:7-7

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.
Answer:
Page Ref.: C:7-6
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.
Answer:
Page Ref.: C:7-6; Example C:7-4

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.
Answer:

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.
Answer:
Page Ref.: C:7-5

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.
Answer:
Page Ref.: C:7-8 and C:7-9
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
Answer:
Page Ref.: C:7-8 and C:7-9

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.
Answer:
Page Ref.: C:7-11

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.
Answer:
Page Ref.: C:7-12

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.
Answer:
Page Ref.: C:7-14 and C:7-15

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.
Answer:
Page Ref.: C:7-14
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

Answer:
Page Ref.: C:7-14 and C:7-15

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.
Answer:
Page Ref.: C:7-17

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
Answer:
Page Ref.: C:7-16
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
$200,000 $1,000,000

Answer:
Page Ref.: C:7-18

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.
Answer:
Page Ref.: C:7-16

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.
Answer:
Page Ref.: C:7-17
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.
Answer:

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.
Answer:
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.
Answer:

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.
Answer:

41) Identify which of the following statements is true.
A) To qualify as a Type A reorganization, generally at least 50% 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.
Answer:
Page Ref.: C:7-22
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.
Answer:

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.
Answer:
Page Ref.: C:7-26

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.
Answer:
Page Ref.: C:7-26

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.
Answer:
Page Ref.: C:7-29 and C:7-30
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.
Answer:
Page Ref.: C:7-29 and C:7-30

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?
Answer:

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.
Answer:
Page Ref.: C:7-30

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.
Answer:
Page Ref.: C:7-31
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.
Answer:
Page Ref.: C:7-35

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.
Answer:
Page Ref.: C:7-38

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
Answer:
Page Ref.: C:7-35

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
Answer:
Page Ref.: C:7-35
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.
Answer:
Page Ref.: C:7-36

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.
Answer:

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.
Answer:
Page Ref.: C:7-39
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.
Answer:

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.
Answer:
Page Ref.: C:7-39

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.
Answer:
Page Ref.: C:7-40; Example C:7-29

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.
Answer:
Page Ref.: C:7-40
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 all of the above are false.
Answer:
Page Ref.: C:7-41 through C:7-46

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.
Answer:
Page Ref.: C:7-42; Example C:7-33

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.
Answer:
Page Ref.: C:7-42; Example C:7-34

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.
Answer:
Page Ref.: C:7-32 and 7-43
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.
Answer:

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.
Answer:
Page Ref.: C:7-45

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
Answer:
Page Ref.: C:7-46 and C:7-47

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.
Answer:
Page Ref.: C:7-46 and C:7-47
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?
Answer:
Page Ref.: C:7-3

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?
Answer:
Page Ref.: C:7-5

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?
Answer:
Page Ref.: C:7-5 through C:7-8

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?
Answer:

Page Ref.: C:7-6 through C:7-7
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?
Answer:

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.
Answer:
Page Ref.: C:7-8 and C:7-9
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?
Answer:
Page Ref.: C:7-11 through C:7-14 and C:7-24

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?
Answer:
Page Ref.: C:7-14

77) Brad exchanges 1,000 shares of Goodyear Corporation stock having a $15,000 basis for Atlas Corporation stock having a $25,000 FMV as part of a Type A tax-free reorganization. Brad also receives $6,000 cash as part of the reorganization. How much gain must Brad recognize?
Answer:
Page Ref.: C:7-23; Example C:7-18

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?
Answer:
Page Ref.: C:7-17; Example C:7-16
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?
Answer:
Page Ref.: C:7-18

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?
Answer:
Page Ref.: C:7-18

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?
Answer:
Page Ref.: C:7-23; Example C:7-18

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?
Answer:
Page Ref.: C:7-26
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?
Answer:
Page Ref.: C:7-27; Example C:7-21

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?
Answer:
Page Ref.: C:7-27; Example C:7-21

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?
Answer:
Page Ref.: C:7-34

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?
Answer:
Page Ref.: C:7-34
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?
Answer:
Page Ref.: C:7-37

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?
Answer:
Page Ref.: C:7-39; Example C:7-28

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?
Answer:
Page Ref.: C:7-44
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.)
Answer:
Page Ref.: C:7-44

91) What are the two steps of a Sec. 338 deemed liquidation election?
Answer: Page Ref.: C:7-5

92) Define the seven classes of assets used in allocating basis when using the residual method.
Answer:
Page Ref.: C:7-8

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?
Answer:
Page Ref.: C:7-12

94) Briefly describe A, B, C, D, and G reorganization types.
Answer:

Page Ref.: C:7-14

95) What are the advantages and disadvantages of a merger transaction?
Answer:
Page Ref.: C:7-23

96) What are the advantages of a triangular merger?
Answer::
Page Ref.: C:7-24

97) What are the advantages and disadvantages of a Type C reorganization?
Answer::
Page Ref.: C:7-27; Example C:7-21

98) What are the advantages and disadvantages of a Type B reorganization?
Answer::
Page Ref.: C:7-31 and C:7-32

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?
Answer:
Page Ref.: C:7-41 through C:7-42

100) Discuss the advantages and disadvantages of a tax-free reorganization as compared with a taxable transaction.
Answer:

Page Ref.: C:7-46 and C:7-47

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?
Answer:
Page Ref.: C:7-2 through C:7-13

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?

Answer:
Page Ref.: C:7-14 through C:7-33 and C:7-43 through C:7-46

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?
Answer:
Page Ref.: C:7-33 through C:7-38

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?
Answer:
Page Ref.: C:7-33 through C:7-38

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C8 Consolidated Tax Returns

1) To be an affiliated group, the parent corporation must directly own at least 80% of another group member.
Answer:
Page Ref.: C:8-2

2) A Canadian subsidiary cannot file as part of the consolidated group with its U.S. parent.
Answer:
Page Ref.: C:8-3
3) Brother-sister controlled groups can elect to file a consolidated tax return.
Answer:
Page Ref.: C:8-4

4) An advantage of filing a consolidated return is that losses of one affiliated group member may be offset against the taxable income of other group members in the same tax year.
Answer:
Page Ref.: C:8-36

5) The election to file a consolidated return is made annually.
Answer:
Page Ref.: C:8-5

6) A separate return year is a corporation’s tax year for which it files a separate tax return or files a consolidated tax return with another affiliated group.
Answer:
Page Ref.: C:8-5

7) P and S are members of an affiliated group that has filed consolidated tax returns for a number of years. The sale of inventory by P that was acquired from S in an intercompany transaction outside the affiliated group triggers the recognition of gain by S.
Answer:
Page Ref.: C:8-18

8) Intercompany dividends and undistributed subsidiary earnings do not create temporary differences for affiliated companies filing a consolidated return.
Answer:
Page Ref.: C:8-19

9) A member’s portion of a consolidated NOL may be carried back against that member’s taxable income from the preceding two separate return years.
Answer:
Page Ref.: C:8-28

10) The treatment of capital loss carrybacks and carryovers is similar to NOLs.
Answer:
Page Ref.: C:8-24

11) The IRS can attempt to collect taxes owed on a consolidated return from any of the members of the consolidated group.
Answer:
Page Ref.: C:8-39

12) Intercompany sales between members of an affiliated group filing separate returns cause deferred tax assets to be recognized by both buyer and seller.
Answer:
Page Ref.: C:8-10
13) Identify which of the following statements is true.
A) To be part of an affiliated group, a corporation must be at least 80% directly owned by another group member.
B) Only common stock is considered when determining if the 80% ownership test is met for affiliated group eligibility.
C) An affiliated group electing to file a consolidated return may be composed of as few as two corporations.
D) All of the above are false.
Answer:
Page Ref.: C:8-2 and C:8-3

14) Which of the following corporations is an includible corporation for purposes of filing a consolidated tax return?
A) insurance companies
B) S corporations
C) car manufacturing corporation
D) foreign corporations
Answer:
Page Ref.: C:8-3

15) Diana Corporation owns stock of Tomika Corporation. For Diana and Tomika to qualify for the filing of consolidated returns, at least what percentage of Tomika’s total voting power and total value of stock must be directly owned by Diana?
A)
Total voting power Total Value of stock
51% 51%

B)
Total voting power Total Value of stock
51% 80%

C)
Total voting power Total Value of stock
80% 51%

D)
Total voting power Total Value of stock
80% 80%

Answer:
Page Ref.: C:8-3

16) Ajak Corporation owns 85% of the single class of Utech Corporation stock. Utech Corporation owns 35% of Tech Corporation. Ajak Corporation also owns 50% of Tech Corporation, and Tech Corporation owns 75% of Baxter Corporation.
A) Ajak, Tech, Utech, and Baxter Corporations are an affiliated group.
B) Ajak, Tech, and Baxter Corporations are an affiliated group.
C) Ajak, Tech, and Utech Corporations are an affiliated group.
D) None of the above are correct.
Answer:
Page Ref.: C:8-3
17) Which of the following corporations is entitled to join in a consolidated tax return without making a special election?
A) corporations exempt from tax under Sec. 501
B) real estate investment trusts
C) closely held corporations
D) foreign corporations
Answer:
Page Ref.: C:8-3

18) Identify which of the following statements is true.
A) If 100% of the stock of two corporations is owned by the same individual, the two corporations are eligible to file a consolidated return.
B) The check-the-box regulations permit partnership and LLCs to elect C corporation tax treatment.
C) A group of corporations that meets the parent-subsidiary controlled group requirements is always eligible to file a consolidated return.
D) All of the above are false.
Answer:
Page Ref.: C:8-3 and C:8-4

19) Identify which of the following statements is true.
A) When a new corporation joins an affiliated group, all of its income and expense items for the tax year, including the acquisition date, must be allocated between the separate tax return and consolidated tax return that are to be filed based on the number of days included in each of the two tax years.
B) A consolidated return election may be revoked after 5 years.
C) All members of a consolidated group must use the same tax year.
D) All of the above are false.
Answer:
Page Ref.: C:8-5 through C:8-7

20) Identify which of the following statements is true.
A) Corporations that join in a consolidated return must adopt the same tax year as the parent corporation.
B) Permission to discontinue the filing of consolidated tax returns is sometimes granted by the IRS.
C) Additional administrative costs may be incurred when filing a consolidated tax return.
D) All of the above are true.
Answer:
Page Ref.: C:8-4 and C:8-5

21) Identify which of the following statements is true.
A) A corporation may be required to file a separate return and file with an affiliated group in the same calendar year.
B) When a corporation joins in filing a consolidated return, taxable income of the member is combined with other members’ taxable income prior to any adjustments.
C) If a corporation becomes a member of an affiliated group within the first thirty days of the corporation’s tax year, the corporation can elect not to file a short-period tax return.
D) All of the above are false.
Answer:
Page Ref.: C:8-6 and C:8-7

22) Cardinal and Bluebird Corporations both use a calendar year as their tax year. At the close of business on June 30, Cardinal Corporation buys all of Bluebird Corporation’s stock. If the two corporations file a consolidated return and both corporations earn their income evenly throughout the year, what portion of Cardinal’s income will be included in the consolidated return ? (Assume all months have 30 days.)
A) 100%
B) 50%
C) 0%
D) none of the above
Answer:
Page Ref.: C:8-5; Example C:8-6

23) Cardinal and Bluebird Corporations both use a calendar year as their tax year. At the close of business on June 30, Cardinal Corporation buys all of Bluebird Corporation’s stock. If the two corporations file a consolidated return and both corporations earn their income evenly throughout the year, what portion of Bluebird’s income will be included in the consolidated return? (Assume all months have 30 days.)
A) 100%
B) 50%
C) 0%
D) none of the above
Answer:
Page Ref.: C:8-5; Example C:8-6

24) Parent Corporation owns all of the stock of Richards and Smith Corporations on January 1. The three corporations have filed consolidated tax returns for a number of calendar years. Parent sells all of the stock of Richards Corporation on June 1. Parent purchases all of the stock of Taylor Corporation on September 1. Parent sells all of the stock of Smith Corporation on November 1. When does the affiliated group terminate?
A) June 1
B) September 1
C) November 1
D) The original affiliated group does not terminate.
Answer:
Page Ref.: C:8-5

25) Alto and Bass Corporations have filed consolidated tax returns for several calendar years. At the close of business on September 30, Alto Corporation sells all of the Bass Corporation stock. What portion of Alto’s and Bass’s income for the current year will be included in the consolidated return, assuming its income is earned evenly throughout the year and all months have 30 days?
A)
Alto Bass
100% 100%

B)
Alto Bass
100% 75%

C)
Alto Bass
75% 75%

D) none of the above
Answer:
Page Ref.: C:8-5

26) Which of the following statements is incorrect with respect to the consolidated alternative minimum tax?
A) The starting point for the consolidated alternative minimum taxable income computation is consolidated taxable income before the NOL deduction.
B) The difference between the consolidated ACE amount and the consolidated preadjustment AMTI is an adjustment to consolidated taxable income in arriving at AMTI.
C) Each corporation is permitted its own $40,000 statutory exemption.
D) If the consolidated tentative minimum tax is smaller than the consolidated regular tax, there is no alternative minimum tax liability.
Answer:
Page Ref.: C:8-26

27) Identify which of the following statements is true.
A) The corporate AMT is determined on a separate return basis and then consolidated.
B) All corporations filing consolidated tax returns are subject to the AMT.
C) Alternative minimum tax payments from prior consolidated return years that are attributable to timing or permanent differences can be carried over by the affiliated group and claimed as a credit on current or future consolidated returns.
D) All of the above are false.
Answer:
Page Ref.: C:8-26

28) Which of the following statements is incorrect with respect to the consolidated alternative minimum tax?
A) A separate alternative minimum taxable income computation is made for each individual group member. These amounts are then totaled to arrive at consolidated alternative minimum taxable income.
B) Positive adjustments that are made with respect to one group member can be offset by negative adjustments that are made with respect to another group member in computing consolidated alternative minimum taxable income.
C) The affiliated group’s alternative minimum tax payment is available as a credit against its regular tax amount in future tax years.
D) The estimated tax payment rules apply to the alternative minimum tax.
Answer:
Page Ref.: C:8-26

29) Which of the following statements is true?
A) A consolidated group determines its general business credit on a consolidated basis.
B) The general business credit can be carried back 3 years and forward 15 years.
C) The general business credit can be carried forward indefinitely.
D) The general business credit can not be carried forward or backward.
Answer:
Page Ref.: C:8-25

30) The Alpha-Beta affiliated group has a consolidated regular tax amount of $52,000 and a tentative minimum tax amount of $50,000 in the current year. The maximum general business credit that can be used on the consolidated return is
A) $2,000.
B) $6,750.
C) $50,000.
D) none of the above
Answer:
Explanation: A) The general business credit that can be used equals the group’s net income tax ($52,000) minus the larger of (1) tentative minimum tax ($50,000), or (2) 25% of net income tax in excess of $25,000 ($6,750) or $2,000 ($52,000 – $50,000).
Page Ref.: C:8-25; Example C:8-33

31) Identify which of the following statements is false.
A) A corresponding item includes the income, gain, deduction, or loss amount reported by the buyer from an intercompany transaction, or from property acquired in an intercompany transaction.
B) Affiliated groups of corporations filing a consolidated tax return are not eligible for the small corporation exemption from the corporate alternative minimum tax.
C) An intercompany transaction generally results in the selling member and buying member in a property transaction being treated as divisions of a single corporation.
D) Intercompany dividends and undistributed subsidiary earnings do not create temporary differences for affiliated companies filing a consolidated return.
Answer:
Page Ref.: C:8-26

32) Identify which of the following statements is false.
A) Unused general business credit carryforwards, which originate in a consolidated return year, are absorbed in a FIFO manner, beginning with the earliest ending tax year.
B) An intercompany transaction is a transaction that takes place between two corporations that are members of the same affiliated group immediately after the transaction.
C) An intercompany item includes income reported by the seller on the providing of services by one group member to another group member and the gain/loss reported by the seller on the sale of property to another group member.
D) All of the above are false.
Answer:
Page Ref.: C:8-18 and C:8-25

33) Ajax and Brindel Corporations have filed consolidated returns for several calendar years. Ajax acquires land for $60,000 on January 1 of last year. On September 1 of this year, Ajax sells the land to Brindel for $90,000. The basis and holding period for the land acquired by Brindel are:
A)
Basis Holding Period Begins On
$60,000 January 2 of last year

B)
Basis Holding Period Begins On
$90,000 January 2 of last year

C)
Basis Holding Period Begins On
$90,000 September 2 of this year

D) none of the above
Answer:
Page Ref.: C:8-13

34) Which of the following events is an intercompany transaction?
A) a capital contribution
B) accrual of interest on a loan made by one group member to another group member; both group members use the accrual method of accounting
C) dividend payment received from a subsidiary corporation to its parent corporation; the subsidiary corporation is not an includible corporation
D) a parent corporation’s sale of stock of a subsidiary corporation to a nonmember of the group
Answer:
Page Ref.: C:8-10

35) Subsidiary Corporation purchases a used machine from Parent Corporation in an intercompany transaction. Which of the following events is a corresponding event for the intercompany transaction?
A) the purchasing group member depreciating the machine
B) the purchasing group member selling the machine for cash to a nonmember of the group
C) the departure of the purchasing group member from the affiliated group when its stock is sold to a nonmember of the group
D) All of the above are recognition events.
Answer:
Page Ref.: C:8-12 and C:8-13
36) Which of the following events is an intercompany transaction that requires the deferral and later recognition of income?
A) accrual of rentals on a lease of real property owned by one group member that is used by another group member; both group members use the accrual method of accounting
B) cash dividend payment from a subsidiary corporation to its parent corporation
C) sale of inventory from a subsidiary corporation to its parent corporation
D) None of the above transactions require the deferral and later recognition of income.
Answer:
Page Ref.: C:8-12

37) Identify which of the following statements is false.
A) Inventory sales between group members are an example of an intercompany transaction.
B) The basis to the purchasing member of property acquired in an intercompany transaction is the amount of cash paid to the selling member.
C) The holding period for property acquired in an intercompany transaction begins when the corresponding item is reported.
D) In general, buyers and sellers engaging in an intercompany transaction are treated as separate entities.
Answer:
Page Ref.: C:8-10 and C:8-11

38) Identify which of the following statements is true.
A) The basic accounting method elections that are used by the seller in intercompany transactions do not override the intercompany transaction rules.
B) P and S are members of an affiliated group that has filed consolidated tax returns for a number of years. The sale of inventory by P, which was acquired from S in an intercompany transaction, outside the affiliated group triggers the restoration of gain by S.
C) Last year, P, S, and T Corporations have filed consolidated tax returns for a number of years. Last year P Corporation sold land (a Sec. 1231 asset) to T at a $75,000 profit. The gain was deferred by P in last year’s consolidated tax return. P sold the T stock to Mike on June 1 of this year. The stock sale will require P to report in its income the gain that was deferred on the land sale.
D) All of the above are true.
Answer:
Page Ref.: C:8-10 and C:8-11

39) Parent Corporation sells land (a capital asset) to Subsidiary Corporation in an intercompany transaction, realizing a $25,000 gain. Subsidiary uses the land for five years in its trade or business before selling the land to a nonmember of the group in a cash sale in which a $50,000 gain is realized. Which statement is correct?
A) A $25,000 capital gain is included in consolidated taxable income when Parent sells the land to Subsidiary Corporation. A $50,000 Sec. 1231 gain is included in consolidated taxable income when Subsidiary sells the land.
B) A $25,000 capital gain and a $50,000 Sec. 1231 gain are included in consolidated taxable income when Subsidiary sells the land.
C) A $75,000 Sec. 1231 gain ($25,000 from Parent and $50,000 from Subsidiary) is included in consolidated taxable income in the year Subsidiary sells the land (assuming no recapture of previously deducted Sec. 1231 losses must occur).
D) None of the above are correct.
Answer:

40) Apple Corporation and Banana Corporation file consolidated returns. In January 2007, Apple sold Banana property with a basis of $120,000 for its fair value of $150,000. Banana sold the property to an unrelated party in April 2008 for $200,000. What amount of gain should be reported for these transactions in the consolidated returns for 2007 and 2008?
A)
2007 2008
$30,000 $50,000

B)
2007 2008
$0 $50,000

C)
2007 2008
$30,000 $80,000

D)
2007 2008
$0 $80,000

Answer:
Page Ref.: C:8-12

41) Parent Corporation sells land (a capital asset) to Subsidiary Corporation in an intercompany transaction, recognizing a $25,000 gain. Subsidiary holds the land as an investment for five years before selling the land to a nonmember of the group on an installment basis in a sale in which a $50,000 gain is realized. The sales proceeds are collectible in four equal installments with an appropriate interest amount being charged to the purchaser. Which statement is correct?
A) A $25,000 capital gain is included in consolidated taxable income when Parent sells the land to Subsidiary Corporation. A $50,000 capital gain is included in consolidated taxable income when Subsidiary sells the land.
B) A $25,000 capital gain from Parent and a $50,000 capital gain from Subsidiary are included in consolidated taxable income when Subsidiary sells the land.
C) The $25,000 capital gain from Parent and $50,000 capital gain from Subsidiary are included ratably in consolidated taxable income, commencing in the year the first installment is received.
D) None of the above are correct
Answer:

42) Parent and Subsidiary Corporations have filed calendar-year consolidated tax returns for several years. Parent Corporation uses the cash method of accounting while Subsidiary Corporation uses the accrual method of accounting. If Parent lends Subsidiary money,
A) the interest expense is deductible when accrued.
B) the interest expense and interest income may be reported in different consolidated return years.
C) the interest income is reported when the interest expense is accrued by Subsidiary.
D) the interest expense deduction is taken when Parent reports the interest income.
Answer:
Page Ref.: C:8-16; Example C:8-24

43) Identify which of the following statements is true.
A) P Corporation receives a dividend from its 100%-owned subsidiary corporation S. P and S have filed consolidated tax returns for a number of years. The dividend payment is out of S’s earnings and profits and reduces P’s investment in S. The dividend is an intercompany transaction and excluded from P’s gross income.
B) The consolidated dividends-received deduction percentage for dividends received by one affiliated group member from another affiliated group member is always 100%.
C) The dividends-received deduction claimed when a $50,000 dividend is received from a 100%-owned nonconsolidated life insurance company is $35,000 (ignoring any dividends-received deduction limitations).
D) All of the above are false.
Answer:
Page Ref.: C:8-24

44) Identify which of the following statements is true.
A) A shareholder corporation that receives a nondividend distribution from an affiliated group member is not required to recognize a gain when the distribution amount exceeds the shareholder’s basis in the distributing corporation’s stock.
B) The dividends-received deduction limitation for dividends received by members of an affiliated group from nonmembers is applied to the separate taxable income of each group member.
C) The dividends-received deduction cannot be taken in full on a consolidated return if the deduction amount creates or increases a consolidated NOL.
D) All of the above are false.
Answer:
Page Ref.: C:8-24

45) Identify which of the following statements is true.
A) The charitable contribution deduction is calculated on a separate return basis for each group member, and the separate company deductions of the individual group members are totaled to arrive at the consolidated deduction.
B) An affiliated group member cannot carry over any unused charitable contribution deduction from a consolidated return year to a separate return year if the member leaves the group prior to the end of the current consolidated return year.
C) Charitable contributions, which cannot be deducted in a consolidated return due to the 10% deduction limitation, can be carried forward indefinitely by the affiliated group.
D) All of the above are false.
Answer:
Page Ref.: C:8-20

46) Identify which of the following statements is true.
A) The basic dividends-received deduction rules generally do not apply to the calculation of the consolidated dividends-received deduction.
B) A member of an affiliated group can elect to carry back its own separate return losses from a consolidated return year to one of its earlier profitable separate return years.
C) A consolidated NOL is computed in part by including the consolidated capital gain in taxable income.
D) All of the above are false.
Answer:
Page Ref.: C:8-22 and C:8

47) Which of the following intercompany transactions creates temporary book/tax differences when a parent corporation owns 100% of a subsidiary’s stock and the companies file a consolidated return?
A) intercompany dividends
B) undistributed subsidiary earnings
C) intercompany sale
D) None of the above items create temporary differences.
Answer:
Page Ref.: C:8-39

48) Which of the following statements is true?
A) The definition of an affiliated group is the same for purposes of calculating the U.S. production activities deduction as it is for filing a consolidated return.
B) The consolidated charitable contributions deduction is limited to 10% of adjusted consolidated taxable income, without regard to the consolidated DRD, consolidated NOL carrybacks, consolidated capital loss carrybacks, and consolidated charitable contributions deduction.
C) The definition of an affiliated group for purposes of the U.S. production activities deduction uses a 60% ownership threshold.
D) All of the above are true statements.
Answer:
Page Ref.: C:8-20 and C:8-23

49) Parent and Subsidiary Corporations form an affiliated group. Last year, the initial year of operation, Parent and Subsidiary filed separate returns. This year, the group files a consolidated tax return. The results for last year and the current year are:

Taxable Income
Last Current
Parent ($10,000) $50,000
Subsidiary 30,000 (25,000)

How much of Subsidiary’s loss can be carried back to last year?
A) $0
B) $20,000
C) $25,000
D) none of the above
Answer:
Page Ref.: C:8-29; Example C:8-38

50) Parent and Subsidiary Corporations form an affiliated group. Last year, the initial year of operation, Parent and Subsidiary filed separate returns. This year. the group files a consolidated return.

Taxable Income
Last Current
Parent ($16,000) $20,000
Subsidiary 10,000 (21,000)

How much of the Subsidiary loss can be carried back to last year?
A) $0
B) $1,000
C) $10,000
D) none of the above
Answer:
Page Ref.: C:8-29; Example C:8-38

51) Identify which of the following statements is true.
A) The parent corporation may elect that the affiliated group use its NOL as a carryforward only.
B) A portion of a consolidated NOL can be carried back or forward to a separate return year of an individual group member.
C) The entire consolidated NOL may be available as a carryback or a carryover to a separate return year of one of the members of an affiliated group.
D) All of the above are true.
Answer:
Page Ref.: C:8-28 through C:8-30

52) Mako and Snufco Corporations are affiliated and have filed consolidated returns for the past three years. Mako acquired 100% of Zebco stock on January 1 of last year, the date of Zebco’s formation. Mako, Snufco, and Zebco, who have filed consolidated returns for last year and the current year, report the following taxable incomes.

Corporation Taxable Income
Last year Taxable Income
Current year
Mako
Snufco
Zebco
CTI $18,000
9,000
(25,000)
$ 2,000 $ 12,000
8,000
(35,000)
($15,000)

The $15,000 consolidated NOL reported in the current year
A) cannot be carried back.
B) can be carried back three years ago only.
C) can be carried back to last year and the remainder, if any, carried forward to subsequent years.
D) can only be used in future years.
Answer:

53) Pants and Skirt Corporations are affiliated and have filed consolidated tax returns for the past three years. Pants acquires 100% of Zipper stock on January 1 of this year. Zipper Corporation filed separate returns previously. Pants, Skirt, and Zipper filed a consolidated return for the current year and reported the following taxable incomes:

Corporation Taxable Income
Last year Taxable Income
Current year
Pants
Skirt
Zipper
CTI $18,000
9,000
7,000
$34,000 $ 12,000
8,000
(29,000)
($ 9,000)

The $9,000 consolidated NOL reported in the current year
A) can offset taxable income of Pants and Skirt Corporations from last year.
B) can offset Zipper Corporation separate return taxable income only from last year.
C) can be used only as a carryover to the future.
D) can offset Zipper Corporation separate return taxable income from last year and then be carried forward to offset the affiliated group’s subsequent taxable income.
Answer:
Page Ref.: C:8-29; Example C:8-38

54) Identify which of the following statements is true.
A) An affiliated group member’s allocated share of an NOL from a consolidated return year may not be available as a carryback to a separate return year of the common parent corporation.
B) If a corporation ceases to be a member of an affiliated group, the corporation is entitled to carry forward its share of the consolidated NOL even if the NOL could be used in full on the consolidated return for the year of cessation.
C) The SRLY (separate return limitation year) rules are designed to prevent the affiliated group from offsetting its current year taxable income by purchasing corporations having NOL carryovers in order to use their NOLs.
D) All of the above are false.
Answer:
Page Ref.: C:8-28 through C:8-30

55) Identify which of the following statements is true.
A) An affiliated group member incurring an NOL in a separate return year that is available as a carryback or carryforward to a consolidated return year is subject to a limit on the use of the NOL when the loss year is designated a separate return limitation year (SRLY).
B) A consolidated NOL may be carried back one year and carried forward twenty years.
C) An NOL incurred in a separate return limitation year by the corporation that is the common parent corporation for the group in the carryover year is subject to the SRLY (separate return limitation year) limitation.
D) All of the above are false.
Answer:
Page Ref.: C:8-30

56) Key and Glass Corporations were organized last year. They became an affiliated group and filed separate tax returns. This year, the corporations begin filing a consolidated tax return. Key and Glass report the following results:

Consolidated Income (loss)
Last year Income (loss)
Current year
Key
Glass ($10,000)
30,000 $40,000
(15,000)

Which of the following statements is not correct?
A) Key’s last year NOL cannot offset Glass’s last year profits.
B) Key’s last year NOL cannot offset this year’s consolidated taxable income.
C) Key’s current year income must first be offset by Glass’s current year loss.
D) Glass cannot carry its current year loss back against last year’s income.
Answer:

57) Jackson and Tanker Corporations are members of an affiliated group. The two corporations have been affiliated since they were formed last year. Both corporations have always used a calendar year as their tax year. Tanker, the subsidiary, has a separate return year NOL of $14,000 from last year. Jackson Corporation has a separate return year NOL of $16,000 from last year. Commencing this year, the two corporations filed a consolidated tax return. The NOLs can be carried over
A) to a consolidated return year and both are SRLY (separate return limitation year) losses.
B) to a consolidated return year and Tanker’s loss is a SRLY loss.
C) to a consolidated return year without limit.
D) to a consolidated return year and Jackson’s loss is a SRLY loss.
Answer:
58) Identify which of the following statements is true.
A) A built-in deduction accrues in a separate return year, but is not recognized in a consolidated return year.
B) Section 382 adopts a single-entity approach in determining ownership changes.
C) The 50-percentage-point minimum stock ownership change that triggers the Sec. 382 loss limitation rules will not occur in acquisitive transactions involving a group of corporations filing consolidated returns.
D) All of the above are false.
Answer:
Page Ref.: C:8-33

59) Blue and Gold Corporations are members of the Blue-Gold affiliated group, which filed a consolidated tax return for last year, reporting a $200,000 consolidated NOL. Small taxable income amounts were reported by Blue and Gold in separate tax returns filed in years prior to last year. Early in the current year, 100% of Blue’s stock is purchased by Robert Martin who contributes additional funds to Blue Corporation sufficient to acquire all of Green Corporation’s stock. For the current year, the affiliated group reports the following results (excluding the consolidated NOL deduction):

Corporation Taxable Income
Blue $150,000
Gold ( 25,000)
Green (since acquisition) 100,000

Which of the following statements is correct?
A) Last year’s NOL cannot be carried back.
B) The portion of last year’s NOL that is not used as a carryback can be carried over the current year but is only used against Blue’s taxable income.
C) The portion of last year’s NOL that is not used as a carryback can be carried over against the current consolidated taxable income, but is subject to the Sec. 382 limitation.
D) The portion of last year’s NOL that is not used as a carryback can be carried over, but is used only against the Blue’s and Gold’s taxable income.
Answer:
Page Ref.: C:8-34 and C:8-35

60) Mariano owns all of Alpha Corporation, which owns 100% of Beta Corporation’s single class of stock. On January 1, Alpha and Beta Corporations report a consolidated NOL carryover from prior years. What is the maximum percentage of Alpha Corporation’s single class of stock that Mariano can sell to a single shareholder without triggering the Sec. 382 loss limitation?
A) 0%
B) 50%
C) 75%
D) 80%
Answer:
Page Ref.: C:8-33

61) Last year, Trix Corporation acquired 100% of Track Corporation. The acquisition occurred on July 1, which was five months after Track’s creation. The corporations filed separate returns that year and have filed consolidated returns since then. The group results for the years, excluding the NOL deduction, are shown below.

Corporation Taxable Income
Last year Taxable Income
Current year
Trix
Track
Consolidated Taxable Income ($12,000)
( 10,000)
($22,000) $34,000
( 2,000)
$32,000

Which of the following statements is incorrect?
A) Last year is an SRLY (separate return limitation year) with respect to Track Corporation.
B) Track’s last year loss is offset against the consolidated current taxable income.
C) Track’s last year loss can be used to offset the current year’s consolidated taxable income.
D) None of Track’s last year’s loss can be used to offset the current year’s consolidated taxable income.
Answer:
Page Ref.: C:8-33

62) Which of the following is not reported by an affiliated group on a consolidated basis?
A) capital gain
B) section 1231 gain
C) casualty & theft gain
D) All of the above are included.
Answer:
Page Ref.: C:8-36

63) Identify which of the following statements is true.
A) Rules for carryforward and carryback of a consolidated net capital loss and a consolidated NOL are the same with the exception of the carryforward period.
B) Capital loss carrybacks and carryforwards are all treated as short-term capital losses.
C) A member leaving an affiliated group cannot use capital loss carryovers that originated in one of its previous separate return years.
D) All of the above are false.
Answer:
Page Ref.: C:8-28

64) Blair and Cannon Corporations are the two members of an affiliated group. No prior net Sec. 1231 losses have been reported by any group member. The two corporations report consolidated ordinary income of $100,000 and gains and losses from property transactions as follows:

Corporation STCG/STCL LTCG/LTCL Sec. 1231
Gains and Losses
Blair
Cannon ($5,000)
6,000 $6,000
(7,000) $3,000
(3,000)

Included in the above totals is $6,000 of long-term capital losses recognized by Cannon on an intercompany transaction. Excluded from the above is a $4,000 Sec. 1231 gain originally deferred by Cannon that must be reported by the group in the current year.

Which one of the following statements is incorrect?
A) The consolidated group must report a net long-term capital gain of $9,000 and a net short-term capital gain of $1,000.
B) Cannon Corporation’s separate return reports a $6,000 net long-term capital gain.
C) The affiliated group reports a $4,000 net Sec. 1231 gain.
D) None of the above statements are incorrect.
Answer:

65) Roland, Shedrick, and Tyrone Corporations formed an affiliated group a number of years ago, which has since filed consolidated tax returns. No prior Sec 1231 losses have been reported by any group member. The group had a consolidated capital loss carryover last year. For the current year, the group reports the following results:

Corporation Ordinary Income STCG/STCL LTCG/LTCL Sec. 1231
Gains and Losses
Roland
Shedrick
Tyrone $25,000
30,000
20,000 $4,000
(2,000)
(3,000) ($ 2,000)
14,000
8,000 ($5,000)
( 2,000)
( 3,000)

Which of following statements is incorrect?
A) No Sec. 1231 recapture can occur this year.
B) The net capital gain is taxed at the regular corporate tax rates.
C) The Sec. 1231 loss is treated as an ordinary loss.
D) The net capital gain is $20,000.
Answer:
66) Blair and Cannon Corporations are members of an affiliated group. No prior net Sec. 1231 losses have been reported by any group member. The two corporations report consolidated ordinary income of $100,000 and gains and losses from property transactions as follows.

Corporation STCG/STCL LTCG/LTCL Sec. 1231
Gains and Losses
Blair
Cannon ($5,000)
6,000 $6,000
(7,000) $3,000
(3,000)

Which of the following statements is correct?
A) The consolidated group reports a net short-term capital gain of $1,000.
B) Blair Corporation’s separate return reports a $4,000 net long-term capital gain.
C) Cannon Corporation’s separate return reports a $1,000 net long-term capital loss.
D) All three of the above are correct.
Answer:
Page Ref.: C:8-21; Example C:8-30

67) Boxcar Corporation and Sidecar Corporation, an affiliated group, reports the following results for the current year:

Corporation Ordinary Income STCG/STCL LTCG/LTCL
Boxcar
Sidecar $10,000
30,000 $10,000
(12,000) ($ 5,000)
16,000

The affiliated group’s consolidated taxable income is
A) $40,000.
B) $49,000.
C) $51,000.
D) $52,000.
Answer:
68) Boxcar Corporation and Sidecar Corporation, an affiliated group, reports the following results for the current year:

Corporation Ordinary Income STCG/STCL LTCG/LTCL
Boxcar
Sidecar $10,000
30,000 $10,000
(12,000) ($ 5,000)
16,000

What is the affiliated group’s consolidated regular tax liability?
A) $7,700
B) $7,350
C) $6,650
D) $7,950
Answer:

69) Identify which of the following statements is true.
A) When applying the large corporation rules for purposes of determining underpayments, each member of an affiliated group is considered separately.
B) The entire consolidated tax liability cannot be collected from one group member.
C) Once consolidated tax returns have been filed for two consecutive years, the affiliated group must pay estimated taxes on a consolidated basis.
D) All of the above are false.
Answer:
Page Ref.: C:8-39
70) The Alto-Baxter affiliated group filed a consolidated return for the first time last year. The group does not come under the “large” corporation rules. For last year, the group reports a tax liability of $60,000. Cooper Corporation has a $30,000 tax liability last year. This year, the Alto-Baxter affiliated group purchased all of the Cooper stock. This year, the Alto-Baxter-Cooper group reports an $110,000 consolidated tax liability. To avoid penalties for the current year, the group must make timely estimated tax payments of how much during the year?
A) $60,000
B) $90,000
C) $110,000
D) No estimated tax payments are required.
Answer:
Page Ref.: C:8-26

71) An affiliated group elects the use of the consolidated method for filing its tax return by
A) filing Form 1120.
B) filing a consent to the election from each member of the affiliated group in the initial year.
C) filing an affiliations schedule.
D) All of the above are necessary for the election.
Answer:
Page Ref.: C:8-37 and C:8-38

72) A consolidated return’s tax liability is owed by
A) all group members in equal portions.
B) the group member responsible for that portion of the tax liability.
C) all group members who are severely liable.
D) the parent corporation.
Answer:
Page Ref.: C:8-39

73) Jeffrey Corporation owns 85% of Placer Corporation and 25% of Mercer Corporation. Placer Corporation owns 60% of Mercer Corporation and 45% of Tyson Corporation. Jeffrey Corporation also owns 85% of Apple Corporation and Apple Corporation owns 30% of Tyson Corporation. Which of these corporations are members of an affiliated group if all percentages represent voting power and value held by the respective corporations?
Answer:.
Page Ref.: C:8-3
74) Toby Corporation owns 85% of James Corporation’s single class of stock and 35% of Mony Corporation’s single class of stock. James Corporation owns 45% of Mony’s stock. The remainder of James and Mony’s stock is owned by 80 individual shareholders. Are the corporations part of an affiliated group, and can they elect to file a consolidated tax return?
Answer:
Page Ref.: C:8-3; Example C:8-1
75) Toby owns all of the single class of stock of James and Mony Corporations. James Corporation owns all of Volt Corporation’s stock. Mony owns all of Wegnin Corporation. Mony and Wegnin Corporations are foreign corporations. Toby, James, and Volt are domestic corporations. Are the corporations part of an affiliated group?
Answer:
Page Ref.: C:8-2 and C:8-3; Example C:8-3

76) Penish and Sagen Corporations have filed consolidated tax returns for several calendar years. At the close of business on September 30, 2008, Penish Corporation sells its all of its Sagen stock to June. What are the tax consequences to each corporation?
Answer:
Page Ref.: C:8-7

77) P-S is an affiliated group that files a consolidated tax return. For the current year, P has separate taxable income of $350,000 and S’s separate taxable loss is $150,000. The group can take a tentative $50,000 consolidated general business credit. If the group’s regular tax liability is $61,250 and their tentative minimum tax liability is $34,500, what is their general business credit limitation? The only difference between their taxable income and AMTI is the statutory exemption.
Answer:
Page Ref.: C:8-25; Example C:8-33

78) Gee Corporation purchased land from an unrelated corporation several years ago for $105,000. The land was used by Gee as a storage lot for company trucks. Gee sold the land to Wilkers, its 85%-owned subsidiary corporation, last year (July 3) for $115,000. The land was also used in Wilkers’ trade or business. Wilkers Corporation sold the land for cash this year (August 22) for $130,000 to a corporation that was not a member of the affiliated group. What gains and losses are recognized, deferred, or restored by Gee and Wilkers Corporations?
Answer:
Page Ref.: C:8-12
79) Gee Corporation purchased land from an unrelated corporation several years ago for $105,000. The land was used by Gee as a storage lot for company trucks. Gee sold the land to Wilkers, its 85%-owned subsidiary corporation, last year (July 3) for $115,000. The land was also used in Wilkers’ trade or business. Wilkers Corporation sold the land this year (August 22) for $130,000 to a corporation that was not a member of the affiliated group. The $130,000 purchase price is to be collected in five equal, annual installments, commencing with the current year’s sale date. What gains and losses are recognized, deferred, or restored by Gee and Wilkers Corporations?
Answer:
Page Ref.: C:8-13

80) Parent Corporation purchases a machine (a five-year property) for $20,000. It claims $4,000 of depreciation under the MACRS rules in the first year it owns the property. At the close of business on the last day of the first year, Parent sells the machine to a 100%-owned corporation (Subsidiary) for $18,000. Subsidiary immediately commences depreciating the machine as a five-year property using the regular MACRS rules. What depreciation can be claimed by Subsidiary Corporation in the first year it uses the machine?
Answer:
Page Ref.: C:8-15; Example C:8-21
81) Parent Corporation purchases a machine (a five-year property) for $20,000. It claims $4,000 of depreciation under the MACRS rules in the first year it owns the property. At the close of business on the last day of the first year, Parent sells the machine to a 100%-owned corporation (Subsidiary) for $18,000. Subsidiary immediately commences depreciating the machine as a five-year property using the regular MACRS rules.

What gain is reported by Parent Corporation in the first year that Subsidiary Corporation depreciates the machine?
Answer: Page Ref.: C:8-15; Example C:8-21

82) Jason and Jon Corporations are members of an affiliated group whose taxable incomes (before dividends) are $90,000 and $100,000, respectively. Jason Corporation owns all of the Jon stock. Jon Corporation received a dividend from a less-than-20%-owned corporation of $9,900 and $25,000 from a 100%-owned nonconsolidated insurance company. Jon Corporation distributed a $40,000 dividend to Jason Corporation. Jason Corporation also received dividends from a 25%-owned corporation of $9,500. The consolidated dividends-received deduction for federal income tax purposes is what?
Answer: Page Ref.: C:8-24

83) Parent and Subsidiary Corporations are members of an affiliated group. Their separate taxable incomes (before taking into account any dividends) are $75,000 and $85,000, respectively. Subsidiary Corporation receives a dividend from a less-than-20%-owned corporation of $7,500 and from an affiliated 100%-owned nonconsolidated insurance subsidiary of $40,000. Subsidiary distributes a dividend of $35,000 to Parent Corporation who also receives dividends of $5,500 from a less-than-20%-owned corporation. The consolidated dividends-received deduction is what?
Answer:
Page Ref.: C:8-23; Example C:8-32

84) A consolidated NOL carryover is $52,000 at the beginning the year. Twenty-five percent of the loss is allocable to Duke Corporation. Duke Corporation leaves the group in the middle of the affiliated group’s tax year. Before Duke’s departure, it had earnings of $15,000 for the year, and the remainder of the affiliated group earned a total of $25,000, or $40,000 of taxable income for the group, excluding any NOL carryover. Following its departure from the affiliated group, Duke earned $8,000 in its first separate return. How much of the $52,000 NOL can Duke use on its first separate return?
Answer:

Page Ref.: C:8-29; Example C:8-37

85) On January 1, Alpha Corporation purchases 100% of the stock of Omega Corporation for $2 million. During the year, Omega Corporation earns $350,000 of taxable income, $30,000 of tax-exempt income, and distributes $150,000 in dividends. Each company paid its own tax liability. Assume a 34% tax rate. What basis adjustment must Alpha Corporation make at year-end?
Answer:
Page Ref.: C:8-34 and C:8-35

86) Explain the requirements a group of corporations must meet in order to elect to file a consolidated return.
Answer:
Page Ref.: C:8-2 and C:8-3

87) What types of corporations are not includible corporations for purposes of determining whether or not an affiliated group exists?
Answer:
Page Ref.: C:8-3

88) What are the differences between a controlled group and an affiliated group?
Answer:
89) What are the five steps in calculating consolidated taxable income?
Answer:
90) Why are other intercompany transactions not given any special treatment?
Answer:
Page Ref.: C:8-9 and C:8-10
91) Define intercompany transactions and explain the two types of transactions.
Answer:
Page Ref.: C:8-9 and C:8-10

92) Alpha, Beta, Gamma, and Delta Corporations form a controlled group. Delta is a nonincludible regulated investment company. Only Alpha, Beta, and Gamma are able to file their income tax returns on a consolidated basis. What options are available for allocating the 15%, 25%, and 34% tax rates to the members of the controlled group?
Answer:
Page Ref.: C:8-24

93) What is the carryback and carryforward rule for consolidated NOLs?
Answer:
Page Ref.: C:8-28

94) What is the consequence of having losses subject to the SRLY limitations?
Answer: Page Ref.: C:8-31

95) How do intercompany transactions affect the calculation of capital gains/losses?
Answer:
Page Ref.: C:8-21
96) What issues determine whether an affiliated group exists?
Answer
Page Ref.: C:8-3

97) All of the stock of Hartz and Ryder Corporations is owned by Morgen. Hartz Corporation has been reporting $150,000 of taxable income for each of the past five years. Ryder Corporation has been reporting $30,000 in NOLs for the same period, which totals $150,000. Approximately one-third of Hartz’s profits come from sales to Ryder. Intercompany sales between Hartz and Ryder have increased during each of the last five years. What tax issues should Morgen consider with respect to his investments in Hartz and Ryder Corporations?
Answer:
Page Ref.: C:8-36 through C:8-37
98) Marietta and Alpharetta Corporation, two accrual method of accounting corporations that use the calendar year as their tax year, have filed consolidated tax returns for a number of years. Alpharetta Corporation, a 100% owned subsidiary of Marietta, is transferring a patent, equipment, and working capital to newly created Georgia Corporation in exchange for 100% of its stock. In 2011, the corporation will begin to produce parts for the computer industry. Georgia Corporation expects to incur organizational expenditures of $10,000 and start-up expenditures of $60,000. What tax issues should Georgia Corporation consider with respect to the selection of its overall accounting method, inventory method, and tax year, and the proper reporting of its organizational and start-up expenditures?
Answer:
Page Ref.: C:8-6 through C:8-8

99) Blitzer Corporation is the parent corporation of a 10-member group that has filed consolidated tax returns for a number of years. Last year, the group sold all the stock of Wolf Corporation to Jerry Jensen. This year, Wolf Corporation reported a $300,000 NOL. Wolf’s taxable income while a group member averaged $200,000 annually for the past five years but is expected to be only $50,000 next year due to start-up costs that will be incurred with the introduction of a new product line. Profits are expected to increase in each succeeding year. What issues should Blitzer have considered when trying to value Wolf’s NOL prior to its sale? What tax issues should Wolf now consider when deciding how to use its NOL?
Answer:
Page Ref.: C:8-27 through C:8-33

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C9 Partnership Formation and Operation

1) Formation of a partnership requires legal documentation filed with the Secretary of State.
Answer:
Page Ref.: C:9-2

2) A partner’s basis for his partnership interest can be negative.
Answer:
Page Ref.: C:9-4

3) The holding period of a partnership interest acquired in exchange for a contributed capital asset begins on the date the partner transfers the asset to the partnership.
Answer:
Page Ref.: C:9-8

4) A partnership cannot make charitable contributions.
Answer:
Page Ref.: C:9-16

5) ABC Partnership distributes $12,000 to partner Al. Al’s distributive share of partnership income is $20,000. Al is taxed on $20,000.
Answer:
Page Ref.: C:9-17

6) A partner’s “distributive share” is the partner’s share of any assets distributed by the partnership.
Answer:
Page Ref.: C:9-17
7) A partner’s share of nonrecourse debt increases that partner’s share of basis.
Answer:
Page Ref.: C:9-22

8) A partner’s basis for his or her partnership interest is increased by his share of the partnership’s tax-exempt income.
Answer:
Page Ref.: C:9-24

9) Limited partners must consider the at-risk, basis, and passive loss limitations when determining the amount of their deductible loss.
Answer:
Page Ref.: C:9-26 and C:9-27

10) No gain is recognized on the sale of property between a partnership and a more-than-50% partner.
Answer:
Page Ref.: C:9-28

11) Guaranteed payments are always ordinary income to the recipient.
Answer:
Page Ref.: C:9-28

12) A partnership must file Form 1065 only if its income exceeds $1,000.
Answer:
Page Ref.: C:9-32

13) Identify which of the following statements is true.
A) Formation of a partnership requires legal documentation.
B) An individual engaged in the active conduct of a business must elect not to be taxed as a partnership.
C) A partnership exists as long as there are at least two individuals or entities engaged in the active conduct of a trade or business or a financial operation, and the business is not a trust or a corporation.
D) All of the above are false.
Answer:
Page Ref.: C:9-2

14) The definition of a partnership does not include
A) a syndicate.
B) a group.
C) a pool.
D) All of the above are included.
Answer:
Page Ref.: C:9-2
15) Identify which of the following statements is true.
A) All of the partners in a limited partnership have limited liability.
B) A limited partnership must have at least two general partners.
C) A limited partnership cannot have a corporate general partner.
D) All of the above are false.
Answer:
Page Ref.: C:9-3

16) Which of the following is false?
A) A large partnership must not be a service partnership.
B) A large partnership must have fewer than 100 partners.
C) A large partnership must not be engaged in commodity trading.
D) A large partnership is subject to a different system of audits.
Answer:
Page Ref.: C:9-4

17) Electing large partnership rules differ from other partnership rules in all of the following areas except
A) partnership income reporting.
B) partnership termination.
C) partnership audits.
D) All of the above are large partnership rule differences.
Answer:
Page Ref.: C:9-4
18) On the first day of the partnership’s tax year, Karen purchases a 50% interest in a general partnership for $30,000 cash and she materially participates in the operation of the partnership for the entire year. The partnership has $40,000 in recourse liabilities when Karen enters the partnership. Partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. There is no minimum gain related to the nonrecourse liability. During the year, the partnership incurs a $120,000 loss and a $20,000 increase in liabilities. How much of the loss can Karen report on her tax return for the current year?
A) $30,000
B) $40,000
C) $50,000
D) $60,000
Answer:
19) Identify which of the following statements is true.
A) Distribution of partnership income in the form of cash to partners is generally tax-free to the partners and the partnership.
B) When partners receive cash distributions from the partnership, they pay taxes on those distributions.
C) If money distributions exceed the partner’s basis in the partnership interest, the partner would have to recognize gain on the distribution from the partnership. Such gain is usually an ordinary gain.
D) All of the above are true.
Answer:
Page Ref.: C:9-5

20) George pays $10,000 for a 20% interest in a general partnership, which has recourse liabilities of $20,000. The partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. George’s basis in his partnership interest is
A) $10,000.
B) $12,000.
C) $14,000.
D) $30,000.
Answer:
21) On January 1, Helmut pays $2,000 for a 10% capital, profits, and loss interest in a partnership, which has recourse liabilities of $20,000. The partners share economic risk of loss from recourse liabilities in the same way they share partnership losses. In the same year, the partnership incurs losses of $6,000 and the recourse liabilities increase by $5,000. Helmut and the partnership use a calendar tax year-end. Helmut’s basis at year-end is
A) $1,500.
B) $2,000.
C) $3,500.
D) $3,900.
Answer:
22) Identify which of the following statements is true.
A) A contribution of services for a partnership interest is a tax-free transaction.
B) For federal income tax purposes, formation of a partnership is governed by Sec. 721.
C) When a partnership assumes a liability on property contributed by a partner, the only effect on the contributing partner’s basis in his or her partnership interest is that his or her basis will be increased by the amount of the liability assumed by the other partners.
D) All of the above are false.
Answer:
Page Ref.: C:9-6 and C:9-7

23) Yong contributes a machine having an adjusted basis of $20,000 and an FMV of $25,000 for a 10% partnership interest. Yong had taken $10,000 of depreciation prior to the contribution. The partnership has no liabilities. As a result of the contribution, Yong must recognize
A) no gain or loss.
B) a $5,000 Sec. 1245 gain.
C) a $5,000 capital gain.
D) $10,000 ordinary income.
Answer:
24) Identify which of the following statements is true.
A) A partner’s relief of debt is treated as if the partner receives a cash distribution.
B) When a partnership assumes any liabilities of the transferor, the transferor has an increase in the basis of his or her partnership interest.
C) Gain recognized by a contributing partner because of the assumption of liabilities by the partnership increases the partnership’s basis in the contributed property.
D) All of the above are false.
Answer:
Page Ref.: C:9-6 and C:9-7

25) For a 20% interest in partnership capital, profits, and losses, Kasi contributes a machine having a basis of $30,000 and an FMV of $40,000. The partnership also assumes a $24,000 recourse liability secured by the machine. The partnership has $6,000 in recourse liabilities immediately preceding Kasi’s contributions. Partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. Kasi’s basis in the partnership interest is
A) $10,800.
B) $12,000.
C) $13,200.
D) $30,000.
Answer:

Page Ref.: C:9-7; Example C:9-6

26) For a 30% interest in partnership capital, profits, and losses, Carol contributes a machine with a basis of $40,000 and an FMV of $80,000. The partnership assumes a $70,000 recourse liability on the machine. At the time of the contribution, the partnership had recourse liabilities of $10,000. Partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. Following the contribution, Carol has
A) a capital loss due to the contribution of $6,000 and a zero basis in the partnership interest.
B) a capital gain due to the contribution of $6,000 and a zero basis in the partnership interest.
C) a $34,000 basis in the partnership interest and no gain or loss.
D) a $43,000 basis in the partnership interest and no gain or loss.
Answer:

Page Ref.: C:9-7; Example C:9-7

27) Stella acquired a 25% interest in the STUV Partnership by contributing land having an adjusted basis of $32,000 and a fair market value of $100,000. The land was subject to a $48,000 mortgage, which was assumed by STUV. No other liabilities existed at the time of contribution. What is Stella’s basis in her partnership interest?
A) $0
B) $32,000
C) $52,000
D) $64,000
Answer:
Page Ref.: C:9-7; Example C:9-7

28) David contributes investment land with a basis of $24,000 and an FMV of $40,000 to a partnership for a 10% interest in partnership capital, profits, and losses. The land is subject to a $30,000 recourse liability, which is assumed by the partnership. The partnership has other recourse liabilities of $18,000. Partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. David must recognize a
A) $3,000 capital gain.
B) $3,000 capital loss.
C) $1,200 capital gain.
D) $1,200 capital loss.
Answer:

Page Ref.: C:9-7; Example C:9-7

29) Rashad contributes a machine having a basis of $30,000 and an FMV of $25,000 to a partnership in exchange for a 20% interest in partnership capital, profits, and losses. Prior to the contribution, the partnership had recourse liabilities of $20,000. The partnership assumes a $20,000 recourse liability that is owed by Rashad on the machine. Partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. Rashad’s basis in his partnership interest is
A) $11,000.
B) $18,000.
C) $22,000.
D) $34,000.
Answer:

Page Ref.: C:9-7

30) Albert contributes a Sec. 1231 asset to a partnership on June 1 of this year in exchange for a 10% partnership interest. He had purchased the asset on March 1, 2002. His holding period for the partnership interest begins
A) March 1, 2002.
B) March 2, 2002.
C) June 1 of the current year.
D) June 2 of the current year.
Answer:
Page Ref.: C:9-8
31) Mario contributes inventory to a partnership on August 1 of this year in exchange for a 20% partnership interest. Mario had purchased the inventory on July 2 of last year. His holding period for the partnership interest begins
A) July 2 of last year.
B) July 3 of last year.
C) August 1 of the current year.
D) August 2 of the current year.
Answer:
Page Ref.: C:9-8

32) Allen contributed land, which was being held for sale to Allen’s customers, to a partnership in exchange for a 20% interest. The partnership uses the land in its business for three years and then sells the property. When the property was contributed, it had a basis in Allen’s hands of $500,000 and an FMV of $600,000. The partnership sells the land for $700,000. The gain reported by the partnership is
A) $100,000 of ordinary income and $100,000 of Sec. 1231 gain.
B) $100,000 of Sec. 1231 gain and $100,000 of capital gain.
C) $200,000 of ordinary income.
D) $200,000 of Sec. 1231 gain.
Answer:
Page Ref.: C:9-8 and C:9-9

33) Bao had investment land that he purchased in 1990 for $80,000. Two years ago, when the land was contributed to a partnership, the FMV was $50,000. The land is inventory in the hands of the partnership. The partnership then sells the land in the current year for $46,000. The partnership’s recognized loss is
A) a $34,000 capital loss.
B) a $34,000 ordinary loss.
C) a $30,000 capital loss and a $4,000 ordinary loss.
D) a $4,000 capital loss and a $30,000 ordinary loss.
Answer:
Page Ref.: C:9-9

34) Karl arranges financing for a limited partnership to purchase real estate in exchange for a 50% interest in partnership profits. Two weeks later, Karl sells the profits interest for $30,000. In this tax year, Karl must recognize
A) no gain or loss.
B) a $30,000 short-term capital gain.
C) a $30,000 ordinary income.
D) a $30,000 Sec. 1231 gain.
Answer:
Page Ref.: C:9-10; Example C:9-12
35) Identify which of the following statements is true.
A) The contribution of Sec. 1245 property to a partnership triggers recognition of ordinary income by the contributor at the time of the transfer.
B) A partner may not recognize ordinary income when receiving a capital and profits interest in a partnership in exchange for services.
C) When a partnership interest is given to a partner in exchange for services, the partnership can deduct or capitalize the FMV of the services, depending on the nature of the services.
D) All of the above are false.
Answer:
Page Ref.: C:9-11

36) Ali, a contractor, builds an office building for a construction partnership in exchange for a capital and profits interest in the partnership worth $500,000. Which of the following statements is correct?
A) Ali recognizes $500,000 of ordinary income and the partnership can deduct $500,000 in the current year.
B) Ali recognizes no income and the partnership can deduct nothing in the current year.
C) Ali recognizes $500,000 ordinary income and the partnership deducts the $500,000 over the building’s MACRS recovery period as a depreciation expense.
D) Ali recognizes ordinary income in the current year in an amount equal to the depreciation deduction the partnership claims this year for the $500,000 capitalized amount.
Answer:
Page Ref.: C:9-11; Example C:9-14

37) Bob, Kara, and Mark are partners in the BKM Partnership. Bob is a 40% partner and has a June 30 tax year-end. Kara owns a 40% interest in the partnership and has a September 30 tax year-end, and Mark owns the remaining 20% interest and has an October 31 tax year-end. The partnership does not have a natural business year. What is the required tax year-end for the partnership (if no Sec. 444 election is made)?
A) June 30
B) September 30
C) October 31
D) December 31
Answer:
Page Ref.: C:9-12 through C:9-14; Example C:9-17
38) Identify which of the following statements is true.
A) The Fisher Partnership is owned equally by four individual partners. Two of the partners have fiscal years ending March 31 and two partners have fiscal years ending June 30. The partnership has a natural business year. The partnership must adopt a calendar year for tax reporting purposes unless a Sec. 444 election is made.
B) Partnerships make most of the tax elections for the partnership rather than the partners.
C) A partner can elect the depreciation method to be applied to the partner’s share of the partnership’s depreciable assets.
D) All of the above are false.
Answer:
Page Ref.: C:9-15

39) Identify which of the following statements is true.
A) A partnership cannot have an NOL carryback or carryforward.
B) A partnership cannot make charitable contributions.
C) Dividends received by a partnership from a domestic corporation are included in the partnership’s ordinary income.
D) All of the above are false.
Answer:
Page Ref.: C:9-16

40) Identify which of the following statements is true.
A) Tax-exempt interest received by a partnership is taxable to the partners if distributed.
B) Partnership gains and losses from two different casualty and theft occurrences in one year are passed through to the partners as two separate items.
C) The amount and character of any gains/losses is determined at the partnership level.
D) All of the above are false.
Answer:
Page Ref.: C:9-16

41) Matt and Joel are equal partners in the MJ Partnership. For the current year ended December 31, the partnership has book income of $80,000, which includes the following deductions: (1) guaranteed payments (salaries) to partners: Matt, $35,000; and Joel, $25,000; and (2) charitable contributions, $6,000. The book income amount does not include any sales of capital assets or Sec. 1231 assets or any tax-exempt income. Based on the above information, what amount should be reported as ordinary income on the partnership return?
A) $60,000
B) $80,000
C) $86,000
D) $140,000
Answer:

Page Ref.: C:9-17
42) Identify which of the following statements is true.
A) A partner’s distributive share includes the full amount of partnership ordinary income, which she must report on her tax return plus her share of separately stated taxable and tax-exempt items.
B) Sam has a 20% interest in partnership capital and profits but a 40% interest in partnership losses. The partnership has no special allocations or precontribution gains or losses. In a year in which the partnership reports ordinary income of $100,000 and a capital loss of $30,000, Sam’s distributive share is $20,000 ordinary income and $12,000 capital loss.
C) The partner’s distributive share is the partner’s share of any assets distributed by the partnership.
D) All of the above are false.
Answer:
Page Ref.: C:9-17

43) In computing the ordinary income of a partnership, a deduction is allowed for
A) net Sec. 1231 losses.
B) bad debts.
C) foreign income taxes paid.
D) charitable contributions.
Answer:
Page Ref.: C:9-17

44) Identify which of the following statements is true.
A) The Hunter Partnership has a net long-term capital gain of $4,000 and a net short-term capital loss of $1,000 for the current tax year. The gain and loss will be netted and the partners will include their proportionate share of the $3,000 net long-term capital gain on their return.
B) The Right Partnership sells a delivery truck and recognizes a gain of $2,000, which represents depreciation recaptured under Sec. 1245. The $2,000 gain will retain its identity as a separately stated item.
C) For tax purposes, the partnership takes a carryover basis in the contributed property that references the contributing partner’s basis.
D) All of the above are false.
Answer:
Page Ref.: C:9-18 and C:9-19

45) On January 2 of the current year, Calloway and Taylor contribute cash equally to form the CT Partnership. Calloway and Taylor share profits and losses in a ratio of 75% and 25%, respectively. The partnership’s ordinary income for the year was $40,000. Calloway received a distribution of $5,000 during the year. What is Calloway’s share of taxable income for the year?
A) $5,000
B) $10,000
C) $20,000
D) $30,000
Answer:
Page Ref.: C:9-18
46) The XYZ Partnership reports the following operating results for the current year:

Net long-term capital loss ($40,000)
Net Sec. 1231 loss ( 16,000)
Ordinary income 50,000

Tai has a 20% profits interest and a 25% loss interest in the XYZ Partnership. His distributive share of ordinary income is
A) $6,800.
B) $8,500.
C) $10,000.
D) $12,500.
Answer:
Page Ref.: C:9-18; Example C:9-20

47) Latoya owns a 10% interest in the ABC Partnership from January 1 through June 30 (the 181st day of the tax year) of the current year (a nonleap year). On July 1, Latoya buys an additional 10% interest in the partnership. The XYZ Partnership’s ordinary income is $109,500 and it is earned evenly throughout the year. Latoya’s distributive share of the ordinary income is
A) $16,380.
B) $16,425.
C) $16,470.
D) $21,900.
Answer:

Page Ref.: C:9-18; Example C:9-21

48) On December 1, Antonio, a member of a three-person partnership, purchases investment securities from the partnership for their $37,000 FMV. All partners share profits and losses equally. The securities were acquired by the partnership for $25,000 cash in March of the current year. What amount and character of gain will Antonio recognize because of this transaction?
A) $0 gain
B) $4,000 ordinary income
C) $4,000 short-term capital gain
D) $12,000 ordinary income
Answer:

Page Ref.: C:9-18
49) Meg and Abby are equal partners in the AM Partnership, which earns $40,000 ordinary income, $6,000 long-term capital gain (LTCG), and $2,000 Sec. 1231 loss during the current year. What is the amount and character of income that must be reported on Abby’s tax return for this year’s partnership operations?
A) $20,000 ordinary income, $3,000 LTCG, $1,000 Sec. 1231 loss
B) $19,000 ordinary income, $3,000 LTCG
C) $23,000 ordinary income, $1,000 Sec. 1231 loss
D) $22,000 ordinary income
Answer:
Page Ref.: C:9-18

50) On December 31 of last year, Alex and Jackson become equal partners in the AJ Partnership with assets having a tax basis and FMV of $120,000. The partnership, which deals in securities, had no liabilities at the end of last year. In January of this year, Franklin contributes his investment securities with an FMV of $60,000 (purchased two years ago at a cost of $45,000) to become an equal partner in the new AJF Partnership. The securities, which are inventory to the partnership, are sold on December 15 of the current year for $90,000. What amount and character of gain from the sale of these securities should be allocated to Franklin?
A) $10,000 ordinary income
B) $15,000 capital gain and $10,000 ordinary income
C) $25,000 capital gain
D) $25,000 ordinary income
Answer:
Page Ref.: C:9-18 and C:9-19

51) At the formation of the BD Partnership, Betty contributes land with a basis of $10,000 and an FMV of $30,000 and Dick contributes cash of $30,000. Betty and Dick share profits and losses equally. When the land is sold two years later for $50,000, Betty must recognize a gain of
A) $10,000.
B) $20,000.
C) $30,000.
D) $40,000.
Answer:

Page Ref.: C:9-19
52) Identify which of the following statements is false.
A) Jean and Blossom form an equal partnership. Jean contributes $10,000 cash and Blossom contributes property with a $10,000 FMV and a $5,000 basis. When the partnership sells the property contributed by Blossom for $10,000 shortly after the formation, Blossom must include the $5,000 gain in her income.
B) In order to shift income/loss between partners, there must be substantial economic effect.
C) The BB Partnership wants to make a special allocation of $10,000 of long-term capital gain to Bob and a special allocation of $10,000 of ordinary income to Briana. This allocation will have a substantial economic effect.
D) Partners must make up negative balances in their capital accounts upon liquidation of the partnership.
Answer:
Page Ref.: C:9-19
53) William and Irene each contribute $20,000 cash to the WI Partnership on January 1 of last year. William and Irene share profits and losses equally. Last year, the partnership reported tax-exempt interest income of $4,000. This year, each partner receives $1,000 of the tax-exempt interest income in a cash distribution. There are no partnership liabilities and no other income, loss, contributions, or distributions during both years. William’s basis in the partnership interest following these transactions is
A) $19,000.
B) $20,000.
C) $21,000.
D) $22,000.
Answer:

Page Ref.: C:9-21 through C:9-23
54) Miguel has a 50% interest in partnership capital, profits, and losses. The basis for his partnership interest is $50,000. The partners share the economic risk of loss from recourse liabilities in the same way they share partnership losses. Miguel receives a distribution of land that has an FMV of $40,000 and an adjusted basis of $30,000. The land is subject to a $15,000 liability, which Miguel assumes. His basis in the partnership interest following the land distribution is
A) $12,500.
B) $20,000.
C) $27,500.
D) $35,000.
Answer:

Page Ref.: C:9-22; Example C:9-26

55) Identify which of the following statements is true.
A) A general partner’s share of recourse debt is based on his or her economic risk of loss, and his or her share of nonrecourse debt is predominantly based on his or her share of partnership profits.
B) A partner’s basis for his or her partnership interest is increased by his or her share of the partnership’s tax-exempt income.
C) If all tax-exempt interest income is distributed when received by a partnership, the partners’ bases are the same after the distribution as they were before the tax-exempt interest was received by the partnership.
D) All of the above are true.
Answer:
Page Ref.: C:9-22 and C:9-23

56) Identify which of the following statements is true.
A) Although a partner’s basis in the partnership cannot go below zero, a partner’s book capital account (equity) may be negative.
B) Tom purchased for cash a 40% capital, profits, and loss interest in the TP General Partnership. His $140,000 basis in his partnership interest includes his $45,000 share of recourse debt and his $30,000 of nonrecourse debt (that is not qualified nonrecourse real estate financing). His at-risk basis cannot be more than $65,000.
C) Terri is a limited partner in the STU Partnership, which manufactures children’s toys. Because the partnership is actively involved in a trade or business, Terri’s income from the partnership is classified as active income for the passive activity loss rules.
D) All of the above are false.
Answer:
Page Ref.: C:9-25
57) Identify which of the following statements is true.
A) When adjusting a partner’s basis in a partnership interest, the negative basis adjustments are made prior to the positive basis adjustments.
B) Martin and Carlos formed an equal partnership to which Martin contributed $10,000 cash and Carlos contributed a building worth $10,000 with a basis of $2,000. In the first year of operation, the partnership suffered a $10,000 ordinary loss. Martin and Carlos can each deduct a $5,000 loss on their personal tax returns.
C) Any distributive share of a loss that cannot be deducted by a partner because of the Sec. 704(d) basis loss limitation is permanently lost.
D) All of the above are false.
Answer:
Page Ref.: C:9-24 and C:9-25

58) Stan had a basis in his partnership interest at the beginning of last year of $30,000. There was no change in partnership liabilities during the year. His share of the partnership’s ordinary loss last year was $40,000 and the partnership had no separately stated items. This year, Stan has a distributive share of ordinary income of $30,000. The taxable income from the partnership reported on Stan’s personal income tax return this year (ignoring the at-risk and passive activity loss limitations) is
A) $10,000 ordinary loss.
B) $20,000 ordinary income.
C) $30,000 ordinary income.
D) $40,000 ordinary income.
Answer:

Page Ref.: C:9-25

59) A partnership has one general partner, Allen, who materially participates in the business. Allen had a $30,000 distributive share of ordinary losses for this year and the partnership had no separately stated gains or losses. There are no changes in liabilities during this year and there are no additional contributions or distributions. At the beginning of this year, the Sec. 705 basis was $40,000 and the at-risk basis was $15,000. The basis on December 31 of this year based on the above information is
A) $10,000.
B) $15,000.
C) $25,000.
D) $40,000.
Answer:
Page Ref.: C:9-25

60) Martin is a limited partner in a card shop. At the end of the partnership’s tax year, Martin’s basis in the partnership interest is $25,000 ($5,000 cash investment plus a $20,000 share of nonqualified nonrecourse financing). Martin’s distributive share of partnership losses for the tax year is $33,000. Martin has $30,000 of passive income this year from other activities. How much of the $33,000 partnership loss can be used by Martin in the year of the loss?
A) $5,000
B) $25,000
C) $30,000
D) $33,000
Answer:
Explanation:
Page Ref.: C:9-26; Example C:9-32

61) David purchased a 10% capital and profits interest in a partnership this year. He does not participate in the partnership’s business. David has no passive income in the current year. His distributive share of the partnership’s loss is $40,000 for this year. David’s Sec. 705 basis in the partnership is $32,000 and his at-risk basis is $16,000 at the end of the current year. How much of the loss can David deduct on his tax return?
A) $0
B) $16,000
C) $32,000
D) $40,000
Answer:
Page Ref.: C:9-27; Example C:9-33

62) Jangyoun sells investment land having a $30,000 basis to a partnership in which he has a 60% partnership interest. The partnership pays $26,000 (FMV) for the land. Later, the partnership sells the investment land to a nonpartner for $31,000. On the sale of the land, the partnership must recognize a
A) $0 gain or loss.
B) $1,000 capital gain.
C) $4,000 capital gain and $1,000 Sec. 1231 gain.
D) $5,000 capital gain.
Answer:
Page Ref.: C:9-28; Example C:9-36
63) Identify which of the following statements is true.
A) A partner who performs services for a partnership is usually not considered an employee of the partnership.
B) It may be necessary for the partnership to capitalize a partner’s guaranteed payment.
C) Guaranteed payments are ordinary income to the recipient.
D) All of the above are true.
Answer:
Page Ref.: C:9-28 and C:9-20

64) When computing the partnership’s ordinary income, a deduction is allowed for
A) contributions to charitable organizations.
B) net operating losses.
C) net short-term capital losses.
D) guaranteed payments to partners.
Answer:
Page Ref.: C:9-28

65) When determining the guaranteed payment, which of the following statements is correct?
A) If the distributive share is less than the guaranteed minimum amount, the guaranteed payment is equal to the difference between the distributive share and the guaranteed minimum amount.
B) If the distributive share is greater than the guaranteed minimum amount, the guaranteed payment is equal to the difference between the distributive share and the guaranteed minimum amount.
C) Guaranteed payments are payments determined with regard to the partnership income.
D) The distinction between guaranteed payments and distributive shares is clear in practice.
Answer:
Page Ref.: C:9-28

66) Yee manages Huang real estate, a partnership in which she is also a partner. She receives 40% of all partnership income before guaranteed payments, but no less than $80,000 per year. In the current year, the partnership reports $400,000 in ordinary income. What is Yee’s distributive share and her guaranteed payment?
A)
Distributive Share Guaranteed Payment
$80,000 $80,000

B)
Distributive Share Guaranteed Payment
$160,000 0

C)
Distributive Share Guaranteed Payment
$160,000 $80,000

D)
Distributive Share Guaranteed Payment
$160,000 $160,000

Answer:
Page Ref.: C:9-29; Example C:9-38
67) Yee manages Huang real estate, a partnership in which she is also a partner. She receives 40% of all partnership income before guaranteed payments, but no less than $80,000 per year. In the current year, the partnership reports $100,000 in ordinary income. What is Yee’s distributive share and her guaranteed payment?
A)
Distributive Share Guaranteed Payment
$40,000 0

B)
Distributive Share Guaranteed Payment
$40,000 $80,000

C)
Distributive Share Guaranteed Payment
$40,000 $40,000

D)
Distributive Share Guaranteed Payment
0 $80,000

Answer:
Page Ref.: C:9-29; Example C:9-39

68) Identify which of the following statements is true.
A) Bob gives his 16-year-old daughter Michelle a 20% capital and profits interest in his accounting practice. She does no work for the partnership and is not involved at all with the operations of the partnership. In fact, she does not know that her dad transferred the interest in the partnership to her. If the partnership allocates an $8,000 distributive share of ordinary income to her, it is properly reported on Michelle’s individual tax return.
B) Valid family partnership partners may be subject to the “kiddie tax.”
C) Joan gives her daughter, Sarah, a 25% interest in a partnership that operates a steel mill. Sarah, age 19, was allocated $20,000 from the partnership as her share of the partnership ordinary income. The IRS will require the income to be included on Sarah’s return.
D) All of the above are false.
Answer:
Page Ref.: C:9-30

69) In January of this year, Arkeva, a calendar-year taxpayer, receives a $50,000 guaranteed payment from NFR Partnership. NFR deducted the payment during its tax year ending November 30 of last year. What tax year must Arkeva report her guaranteed payment in?
A) She may elect either year.
B) last year
C) current year
D) She does not need to report guaranteed payments on her return.
Answer:
Page Ref.: C:9-29; Example C:9-40
70) Henry has a 30% interest in the HMS Partnership’s capital, profits, and losses computed after taking into account his guaranteed payment of $40,000. In the current year, HMS reports ordinary income of $30,000 and capital gains of $60,000 before taking into account Henry’s guaranteed payment. What is the amount and character of all income or loss that Henry must report as a result of partnership activities?
A) $40,000 guaranteed payment (ordinary income), $3,000 ordinary loss, $18,000 capital gain
B) $40,000 guaranteed payment (ordinary income), $15,000 capital gain
C) $40,000 guaranteed payment (ordinary income), $9,000 ordinary income, $6,000 capital gain
D) $13,000 guaranteed payment (ordinary income), $6,001 ordinary income, $38,820 capital gain
Answer:
71) Nicholas, a 40% partner in Nedeau Partnership, gives one-half of his interest to his sister, Michelle. During the current year, Nicholas performs services for the partnership for which reasonable compensation is $80,000, but for which he accepts no pay. Nicholas and Michelle are each credited with a $100,000 distributive share, all of which is ordinary income. What are Nicholas’ and Michelle’s distributive share?
A)
Nicholas Michelle
$100,000 $100,000

B)
Nicholas Michelle
$ 60,000 $ 60,000

C)
Nicholas Michelle
$180,000 $100,000

D)
Nicholas Michelle
$140,000 $ 60,000

Answer:
Page Ref.: C:9-31; Example C:9-42
72) Brent is a general partner in BC Partnership. His distributive share of partnership income and his guaranteed payment for the year are as follows:

Ordinary income $30,000
Short-term capital gain $18,000
Guaranteed payment $36,000

What is his self-employment income?
A) $84,000
B) $66,000
C) $48,000
D) $36,000
Answer:
Page Ref.: C:9-33; Example C:9-44

73) Brent is a limited partner in BC Partnership. His distributive share of partnership income and his guaranteed payment for the year are as follows:

Ordinary income $30,000
Short-term capital gain $18,000
Guaranteed payment $36,000

What is his self-employment income?
A) $84,000
B) $66,000
C) $48,000
D) $36,000
Answer:
Page Ref.: C:9-33; Example C:9-45

74) Doug purchases a 20% interest in the Quix Partnership for $10,000 on January 1, 2019, and begins to materially participate in the partnership’s business. The Quix Partnership uses the calendar year as its tax year. At the time of the purchase, the Quix Partnership has $4,000 in liabilities, and Doug’s share is 20%. What is Doug’s basis in his partnership interest on January 1, 2010?
Answer:
Page Ref.: C:9-5; Example C:9-1
75) Dan purchases a 25% interest in the Haymarket Partnership for $20,000 on January 1, 2010, and begins to materially participate in the partnership’s business. The Haymarket Partnership uses the calendar year as its tax year. At the time of the purchase, the Haymarket Partnership has $2,000 in liabilities, and Dan’s share is 25%. During the year, the Haymarket Partnership incurs $8,000 in losses and its liabilities increase by $4000. What is Dan’s basis in his partnership interest on December 31, 2010?
Answer:
Page Ref.: C:9-5; Example C:9-2

76) Dan purchases a 25% interest in the Haymarket Partnership for $20,000 on January 1, 2010, and begins to materially participate in the partnership’s business. The Haymarket Partnership uses the calendar year as its tax year. At the time of the purchase, the Haymarket Partnership has $2,000 in liabilities, and Dan’s share is 25%. During the year, the Haymarket Partnership incurs $100,000 in losses and its liabilities increase by $4000. What is Dan’s basis in his partnership interest on December 31, 2010?
Answer:
Page Ref.: C:9-5; Example C:9-3

77) Jane contributes land with an FMV of $100,000 and a basis of $80,000 to the Green Partnership in exchange for a 25% partnership interest. The partnership assumes the $40,000 mortgage on the land. Mary has a 25% share of partnership liabilities. The Green Partnership has $8,000 in liabilities immediately before Jane’s contribution. What is Jane’s basis in her partnership interest?
Answer:
Page Ref.: C:9-7; Example C:9-6
78) Jane contributes land with an FMV of $100,000 and a basis of $40,000 to the Green Partnership in exchange for a 25% partnership interest. The partnership assumes the $80,000 mortgage on the land. Mary has a 25% share of partnership liabilities. The Green Partnership has $8,000 in liabilities immediately before Jane’s contribution. What is Jane’s basis in her partnership interest?
Answer:
Page Ref.: C:9-7

79) Bob contributes cash of $40,000 and Carol contributes land with a basis of $25,000 and an FMV of $40,000 to become equal partners in the BC Partnership. The partnership immediately obtains a $30,000 mortgage on the land and the partners will share the economic risk of loss equally. What are the two partners’ bases in the partnership after these transactions are completed?
Answer:
Page Ref.: C:9-7

80) Kay and Larry each contribute property to become equal partners in the KL General Partnership. Kay contributes office furniture with an adjusted basis of $40,000 and an FMV of $50,000, which she has depreciated using MACRS. Larry contributes land with a basis of $60,000 and an FMV of $50,000, which he had been holding as an investment. The partnership will use the land as a parking lot for their business.
a) What is the partnership’s basis in each of the two pieces of property?
b) If the land that Larry contributed is sold four years after the contribution for $45,000, what is the amount and character of the gain or loss which Larry should report?
Answer:

Page Ref.: C:9-8 and C:9-9
81) Sarah purchased land for investment in 2008 for $80,000. In 2009 when the FMV of the land was only $70,000, she contributed it to the SL Partnership, which is in the business of developing and selling lots. SL Partnership developed the contributed land and sold it in 2010 for $50,000. What is the amount and character of the gain or loss?
Answer: Page Ref.: C:9-9; Example C:9-11

82) George receives a 10% limited partnership interest (capital and profits interest) in the HIJ Partnership in return for managing the partnership’s rental property. The partnership interest has an FMV of $35,000. What is the amount and character of the income (if any) that George must report as a result of becoming a partner?
Answer:

What is the maximum amount that the partnership can deduct as an organization and syndication expense for the first year in which the partnership begins business, assuming the business began on October 1?
Answer
Page Ref.: C:9-12

84) Charles Jordan files his income tax return on a calendar-year basis. He is a principal partner in a partnership using a tax year ending June 30. Jordan’s share of the partnership’s ordinary income was $24,000 for the fiscal year ending June 30 of last year and $72,000 for the fiscal year ending June 30 of the current year. Assume the partnership earned its income evenly throughout the year. How much should Jordan report on his Form 1040 for last year as his share of the partnership’s ordinary income?
Answer:
Page Ref.: C:9-12

85) The XYZ Partnership is held by ten partners who have the following capital and profits ownership of the partnership. The tax year-end used by each of the ten partners is also indicated. Assume each partner has used this year-end for at least five years.

Partner Ownership Partner’s Tax Year-End
A
B
C
D
E
F
G
H
I
K 8%
8%
8%
10%
10%
10%
10%
12%
12%
12% 12/31
6/30
9/30
6/30
6/30
10/31
9/30
12/31
6/30
6/30

What is the required year-end for the XYZ Partnership, assuming that the business has no natural business year and has not filed a Sec. 444 election?
Answer
Page Ref.: C:9-12 and C:9-13

86) AT Pet Spa is a partnership owned equally by Travis and Ashley. The partnership had the following revenues and expenses this year. Which of the following items are separately stated? Nonseparately stated? What is each partner’s distributive share of ordinary income?

Revenues $500,000
Salary expense (nonpartners) 250,000
Supplies 40,000
Insurance 50,000
Depreciation (no Sec. 179 amounts) 10,000
Dividend income 2,000
Long-term capital gain 30,000
Answer:
Page Ref.: C:9-17

87) The WE Partnership reports the following items for its current tax year:

Item Amount
Income
Operating income $90,000
Rental income 15,000
Interest income:
Tax-exempt municipal bonds 2,000
Corporate bonds 4,000
Sec. 1231 gain 20,000
Sec. 1245 gain 18,000
Long-term capital gain 7,000

Expenses
Rental expenses 12,000
Salaries paid to employees (not partners) 30,000
Charitable contributions 5,000
Interest paid related to borrowings used to finance municipal bonds 3,000

What is the WE Partnership’s ordinary income for the current year?
Answer: Page Ref.: C:9-17

88) Elijah contributes securities with a $90,000 FMV (purchased in 2005 at a cost of $50,000) to become a one-third partner in the EJK Partnership on January 1 of the current year. The securities are sold on December 15 of the current year for $105,000. How much of the partnership’s capital gain from the sale of these securities should be allocated to Elijah?
Answer:
Page Ref.: C:9-19

89) Clark and Lewis are partners who share the profits and losses of the C&L Partnership 60% and 40%, respectively. The tax basis of each partner’s interest in the partnership as of December 31 of last year was as follows: Clark, $14,000; Lewis, $12,000. During the current year, the partnership had ordinary income of $20,000 and a long-term capital loss of $10,000 from the sale of securities. The partnership made cash distributions proportionately to the two partners during this year totaling $20,000. What is the amount of Lewis’s tax basis of his partnership interest on December 31 of the current year?
Answer:
Page Ref.: C:9-24

90) The partners of the MCL Partnership, Martin, Clark, and Lewis, share profits and losses in a ratio of 4:3:3, respectively. The tax basis of each partner, as of December 31 of the current year, is as follows: Martin, $7,200; Clark, $6,000; and Lewis, $2,500. During the current year, the partnership incurred an ordinary loss of $15,000. The loss is not reflected in the tax basis figures presented above. Nothing else occurs during the year that would affect the partners’ bases. As a result of this loss, what amount should Martin, Clark, and Lewis report on their individual tax returns for the current year? What limitations (other than the Sec. 704(d) loss limitations) may prevent them from deducting their losses in the current year?
Answer:
Page Ref.: C:9-23 through C:9-26

91) The Troika Partnership has an ordinary loss of $48,000 for the year. Before allocation of the loss at the end of the year, Shaad’s one-third limited partnership interest has an adjusted basis of $5,000. Shaad’s only other income or loss is his $30,000 salary from a factory job. What amount can Shaad deduct on his tax return as his share of the partnership’s loss?
Answer: Page Ref.: C:9-23 through C:9-26

92) Edward owns a 70% interest in the capital, profits, and losses of the Edward and Moore Partnership. During the year, Edward purchases surplus inventory from the partnership for $5,000. On the date of the sale, the inventory has an adjusted basis to the partnership of $8,000. For the year, the partnership’s ordinary income is $50,000 after including the loss on the sale of the inventory to Edward. Assuming that there are no other partnership items to be separately stated, what is Edward’s distributive share of the partnership’s ordinary income for the year?
Answer:
Page Ref.: C:9-27

93) In January, Daryl and Louis form a partnership with each contributing $75,000 in cash. The partnership agreement provides that Daryl would receive a guaranteed payment for salary of $20,000 and that partnership profits and losses (computed after deducting Daryl’s salary) would be shared equally. For the year, the partnership’s operations result in an $18,000 ordinary loss after payment of Daryl’s guaranteed payment. The partnership has no outstanding liabilities at year-end. What is the basis amount of Daryl’s partnership interest at year-end?
Answer:
Page Ref.: C:9-29

94) Jeremey is a partner in the Jimimey partnership. Why does he need to know his basis in his partnership interest?
Answer: Page Ref.: C:9-4

95) Explain the difference between partnership distributions and distributive shares.
Answer:
Page Ref.: C:9-5 and C:9-17

96) Does the contribution of services to a partnership in exchange for an unrestricted partnership interest qualify for Sec. 721 nontaxable treatment?
Answer:o.
Page Ref.: C:9-10
97) Explain the tax consequences for both the service partner and the partnership when a contribution of services is made to the partnership.
Answer:
Page Ref.: C:9-10

98) What are the three rules and their order when determining a partnership tax year?
Answer:
Page Ref.: C:9-12 and C:9-13

99) Briefly explain the aggregate and entity theories as they relate to partnerships.
Answer:
Page Ref.: C:9-17

100) What is included in partnership taxable income?
Answer:
Page Ref.: C:9-17
101) Under what conditions will a special allocation of partnership depreciation be recognized? Assume the partnership has no nonrecourse liabilities.
Answer:
Page Ref.: C:9-18 through C:9-20

102) Explain the three different limitation provisions that a partner must satisfy before a loss can be deducted.
Answer:
Page Ref.: C:9-24

103) What is the tax impact of guaranteed payments on the partner and the partnership?
Answer: Page Ref.: C:9-28

104) Victor and Kristina decide to form VK Partnership. They will be equal partners. Victor contributes a building with a $150,000 FMV and a $105,000 adjusted basis to the partnership. The building has a $60,000 mortgage, which the partnership assumes. Kristina contributes land with a $70,000 FMV and a $95,000 adjusted basis. Kristina will manage the day-to-day activities of the partnership. She will begin to receive a guaranteed payment for her work, starting in the second year of operations, and continuing on as long as she manages the operations of the partnership. Victor and Kristina have agreed that the guaranteed payment will be $10,000 per year. What tax issues should Victor, Kristina, and the partnership consider with respect to the formation and operation of the partnership?
Answer:
Page Ref.: C:9-5 through C:9-12
105) When the PDQ Partnership formed, it knew it had a good product, but it was a bit short on cash. After seeing the product, Jim, a CPA, said that he would set up an accounting system for the partnership in exchange for a 15% profits interest in the partnership. The partners agreed to this, as Jim was receiving only a profits interest and not a capital interest in the partnership. Jim’s usual fee for this type of service would be approximately $5,000. What tax issues should Jim and the PDQ Partnership consider with respect to the payment made for the services?
Answer:

Page Ref.: C:9-10 through C:9-12

106) Jason, a lawyer, provided legal services for the employees of the ABC Partnership during the first six months of the current year. In exchange, he received a 2% capital and profits interest in the partnership. The value of the interest is $5,000. What are the tax consequences to Jason, the ABC Partnership, and the employees of ABC?
Answer:
Page Ref.: C:9-11; Example C:9-13

107) Dinia has agreed to provide services valued at $30,000 to the L-M Partnership. On January 1 of the current year, she is given a 20% capital and profits interest in the partnership in exchange for her services. The partnership has no liabilities at the time but has assets with a basis of $50,000 and an FMV of $70,000. What are the tax consequences to Dinia and the partnership?
Answer:
Page Ref.: C:9-11
108) Mary and Martha, who had been friends for years, decided to open a retail store to sell kitchen and bath items. In June, they spent $500 looking for a suitable location. They paid an attorney $1,500 to have their partnership agreement drawn up, and they paid an accountant $400 to set up their accounting system. During July, they searched for vendors for the merchandise they planned to carry and stocked their shelves. The store opened in August and was immediately successful. They paid the accountant $300 to prepare an income statement for August. What tax issues should the partnership consider with regard to beginning this business?
Answer:

Page Ref.: C:9-12

109) Tracy has a 25% profit interest and a 20% loss interest in the Dupont Partnership. The Dupont Partnership reports the following income and loss items for the current year:

Net long-term capital loss $50,000
Net Sec. 1231 gain 45,000
Ordinary income 110,000

What is Tracy’s distributive share?
Answer:

Page Ref.: C:9-18; Example C:9-20
110) Mike and Jennifer form an equal partnership. Mike contributes cash of $15,000 and Jennifer contributes land having a $15,000 FMV and a basis of $5,000. If the partnership sells the land three years later for $18,000, what are the tax consequences to Mike and Jennifer?
Answer:
Page Ref.: C:9-19; Example C:9-23

111) Jerry has a 10% interest in the EKG Partnership capital, profits, and losses. He is a limited partner. At the beginning of the current year, his basis in his partnership interest is $10,000. The partnership earned $20,000 of ordinary income this year and repaid a $150,000 nonrecourse liability. What tax issues should Jerry consider with respect to reporting the results of this year’s activities for the EKG Partnership on his personal return?
Answer:
Page Ref.: C:9-21 through C:9-24
112) Samantha works 40 hours a week as a clerk in the mall and earns $28,000. In addition, she works five hours each week in the XYZ Partnership’s office. Samantha, a 15% limited partner in the XYZ Partnership, has been allocated a $4,000 loss from the partnership for the current year. The basis for her interest in XYZ before accounting for current operations is $7,000. What tax issues should Samantha consider with respect to her interest in, and employment by, the XYZ Partnership?
Answer:

Page Ref.: C:9-23 through C:9-26

113) At the beginning of the current year, Terry has a $40,000 basis for his general partnership interest in the TKE Partnership. He materially participates in the business activities of the partnership. On November 1, he receives a $4,000 distribution. His distributive share of TKE’s current items is a $5,000 net long-term capital gain and a $50,000 ordinary loss. What amount will he include in his current year’s tax return?
Answer: Page Ref.: C:9-24; Example C:9-29

114) Janice has a 30% interest in the Jansen Partnership. She is to receive a guaranteed payment for deductible services of $50,000. The partnership reports $30,000 of ordinary income and a $100,000 long-term capital gain before deducting the guaranteed payment. What is her income from the partnership?
Answer:
Page Ref.: C:9-28; Example C:9-40
115) Bud has devoted his life to his business, the BK Partnership, in which he owns an 85% capital and profits interest. Because he has worked so hard all his life, he never married and has no children. He has decided to give a 25% capital and profits interest to Berry, a close friend, if Berry will work in the business for five years. Berry will receive guaranteed payments for his work. Bud devotes all his time to the partnership, but he takes no salary. What tax issues should Bud and Berry consider with respect to the gift of the partnership interest and Bud’s employment arrangement with the partnership?
Answer:
Page Ref.: C:9-29 and C:9-30

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C10 Special Partnership Issues

1) A partnership cannot recognize a gain or loss on a current distribution.
Answer:
Page Ref.: C:10-2

2) If a partnership asset with a deferred precontribution gain is distributed within seven years of acquisition in a nonliquidating distribution to a partner who did not contribute the asset, the precontribution gain must be recognized by the contributing partner.
Answer:
Page Ref.: C:10-2

3) In a current distribution, the partner’s basis in the partnership interest is reduced by the amount of money received and by the partnership’s bases in the distributed property.
Answer:
Page Ref.: C:10-4

4) A partner’s holding period for property distributed as a current distribution begins on the date of distribution.
Answer:
Page Ref.: C:10-7

5) Under Sec. 751, unrealized receivables include potential Section 1245 or 1250 recapture on the partnership’s depreciable property.
Answer:
Page Ref.: C:10-8
6) For Sec. 751 purposes, “substantially appreciated inventory” means property held for sale to customers whose market value exceeds its adjusted basis.
Answer:
Page Ref.: C:10-8

7) A partner can recognize gain, but not loss, on a liquidating distribution.
Answer:
Page Ref.: C:10-12

8) A partner’s holding period for a partnership interest is never considered when determining the holding period for property distributed in a liquidating distribution.
Answer:
Page Ref.: C:10-14

9) The sale of a partnership interest always results in capital gain or loss rather than ordinary income.
Answer:
Page Ref.: C:10-16 and C:10-17

10) When a retiring partner receives payments that exceed the value of that partner’s partnership property, the excess payment is a guaranteed payment.
Answer:
Page Ref.: C:10-19

11) Under the check-the-box rules, an LLC with more than one member is taxed as a partnership unless it elects to be taxed as a corporation.
Answer:
Page Ref.: C:10-21

12) A limited liability company is a form of business entity that combines the legal benefits of the corporate form with the tax benefits of the partnership form.
Answer:
Page Ref.: C:10-30
13) A new partner, Gary, contributes cash and assumes a share of partnership liabilities. Diane’s capital, profits, and loss interest in the partnership is reduced by 5% due to the admission of Gary. The Sec. 751 rules do not apply. Partnership liabilities at the time Gary is admitted are $200,000, and all of the liabilities are recourse debts for which the partners share the economic risk of loss in the same way they share partnership profits. Diane’s basis in the partnership interest prior to Gary’s admission is $5,000. Due to the admission of Gary, partner Diane has
A) no recognized gain or loss and a partnership interest basis of $10,000.
B) no recognized gain or loss.
C) a recognized gain of $5,000 and a partnership interest basis of zero.
D) a recognized gain of $5,000 and a partnership interest basis of $5,000.
Answer:

14) If a distribution occurs within ________ years of the contribution date, in a nonliquidating distribution that does not qualify for Sec. 751 treatment, the distribution event may trigger a precontribution gain or loss.
A) three
B) five
C) seven
D) unlimited
Answer:
Page Ref.: C:10-2

15) Mirabelle contributed land with a $5,000 basis and a $9,000 FMV to MS Partnership four years ago. This year the land is distributed to Sergio, another partner in the partnership. At the time of distribution, the land had a $12,000 FMV. How much gain should Mirabelle and Sergio recognize?
A)
Mirabelle Sergio
0 0

B)
Mirabelle Sergio
$4,000 0

C)
Mirabelle Sergio
$4,000 $3,000

D)
Mirabelle Sergio
$5,500 $1,500

Answer:
Page Ref.: C:10-3; Example C:10-2

16) Mirabelle contributed land with a $5,000 basis and a $9,000 FMV to MS Partnership four years ago. This year the land is distributed to Sergio, another partner in the partnership. At the time of distribution, the land had a $12,000 FMV. What is the impact of the distribution on Mirabelle’s partnership basis?
A) 0
B) $4,000 increase
C) $4,000 decrease
D) $7,000 increase
Answer:
Page Ref.: C:10-3; Example C:10-2

17) Susan contributed land with a basis of $6,000 and an FMV of $10,000 to the SH Partnership two years ago to acquire her partnership interest. This year, the land is distributed to Harry when its FMV is $11,000. No other distributions have been made since Susan became a partner. When the land is distributed, the partnership’s basis in the land immediately before distribution is increased by
A) $0.
B) $1,000.
C) $4,000.
D) $5,000.
Answer:
Page Ref.: C:10-3; Example C:10-2

18) Helmut contributed land with a basis of $5,000 and an FMV of $10,000 to the HG Partnership five years ago to acquire a 50% partnership interest. This year the land is distributed to another partner, Gail, when its FMV is $11,000. No other distributions have been made since Helmut became a partner. When the land is distributed to Gail, Helmut recognizes a gain of
A) $0.
B) $2,500.
C) $3,000.
D) $5,000.
Answer:
Page Ref.: C:10-3; Example C:10-2

19) Becky has a $24,000 basis in her partnership interest. She receives a current distribution of $4,000 cash, unrealized receivables with a basis of $12,000 and an FMV of $16,000, and land held as an investment with a basis of $3,000 and an FMV of $8,000. The partners’ relative interests in the Sec. 751 assets do not change as a result of the current distribution. The basis of her partnership interest following the distribution is
A) $5,000.
B) $1,000.
C) $0.
D) ($4,000).
Answer:

20) John has a basis in his partnership interest of $30,000. He receives a current distribution of $6,000 cash, unrealized receivables (FMV $11,000, basis $10,000), inventory (FMV $8,000, basis $4,000), and investment land (FMV $7,000, basis $6,000). The partners’ relative interest in the Sec. 751 assets do not change as a result of the current distribution. His basis in the land is
A) $5,000.
B) $6,000.
C) $7,000.
D) $10,000.
Answer:
21) Danielle has a basis in her partnership interest of $12,000. She receives a current distribution of $8,000 cash and equipment with a basis of $7,000. There is no potential gain under Sec. 737. What is her basis in the equipment?
A) $0
B) $4,000
C) $7,000
D) none of the above
Answer:
Page Ref.: C:10-4

22) Identify which of the following statements is true.
A) If a partnership asset with a deferred precontribution gain is distributed in a nonliquidating distribution to the partner who contributed the asset, the precontribution gain must be recognized by the partner.
B) The partner’s basis in the partnership interest is normally reduced by the FMV of property distributed in a nonliquidating distribution.
C) When a current distribution from a partnership reduces the basis of the partnership interest to zero, the partner’s interest in the partnership is terminated.
D) All of the above are false.
Answer:
Page Ref.: C:10-4 through C:10-7

23) Tenika has a $10,000 basis in her interest in the TF Partnership and no remaining precontribution gain immediately before receiving a current distribution that consisted of $4,000 in money, plastic tubes held in inventory with a $3,000 basis to the partnership and an FMV of $3,375, and drip irrigation pipe held as inventory with a $6,000 basis to the partnership and an FMV of $5,000. What is the basis in Tenika’s hands of the distributed property?
A) $10,000
B) $6,000
C) $9,000
D) $10,125
Answer:

24) Tenika has a $10,000 basis in her interest in the TF Partnership and no remaining precontribution gain immediately before receiving a current distribution that consisted of $4,000 in money, plastic tubes held in inventory with a $3,000 basis to the partnership and an FMV of $3,375, and drip irrigation pipe held as inventory with a $6,000 basis to the partnership and an FMV of $5,000. What is Tenika’s basis for the plastic tubes and drip irrigation pipe?
A)
Plastic Tubes Drip Pipe
3,375 $5,000

B)
Plastic Tubes Drip Pipe
$3,000 $6,000

C)
Plastic Tubes Drip Pipe
$3,000 $5,000

D)
Plastic Tubes Drip Pipe
$2,250 $3,750

Answer:

25) The total bases of all distributed property in the partner’s hands following a nonliquidating distribution is limited to
A) the partner’s predistribution basis in his partnership interest.
B) the FMV of the property distributed.
C) the partnership’s bases in the distributed property.
D) the predistribution FMV of the partner’s partnership interest.
Answer:
Page Ref.: C:10-6
26) Carlos has a basis in his partnership interest of $30,000. He receives a current distribution of $6,000 cash, unrealized receivables (FMV $11,000, basis $10,000), inventory (FMV $8,000, basis $4,000), land held as an investment (FMV $7,000, basis, $6,000), and building (FMV $21,000, basis $9,000). The partners’ relative interests in the Sec. 751 assets do not change as a result of the current distribution. Carlos’s basis in the building is
A) $2,500.
B) $6,000.
C) $7,500.
D) $9,000.
Answer:

27) Bart has a partnership interest with a $32,000 basis. He receives a current distribution of $6,000 cash, unrealized receivables (FMV $9,000, basis $10,000), inventory (FMV $8,000, basis $4,000), investment land (FMV $7,000, basis $4,000), and building (FMV $20,000, basis $8,000). No depreciation recapture applies with respect to the building. The partners’ relative interests in the Sec. 751 assets do not change as a result of the current distribution. Bart’s basis in the building is
A) $3,000.
B) $4,000.
C) $6,000.
D) $8,000.
Answer:
28) Identify which of the following statements is true.
A) The basis for property distributed by a partnership cannot be increased above the carryover basis amount when it is received by a partner in a nonliquidating distribution.
B) A partner’s partnership capital account balance cannot be less than zero.
C) The length of time a partner owns a partnership interest is relevant when determining the holding period for distributed property.
D) All of the above are false.
Answer:
Page Ref.: C:10-7

29) Identify which of the following statements is true.
A) If a partner sells property received in a partnership distribution for a gain and the property was inventory in the hands of the distributing partnership, the partner will always recognize ordinary income.
B) The primary purpose of Sec. 751 is to prevent partnerships from converting capital gains into ordinary income.
C) Unrealized receivables include rights to payments on the sale of a capital asset.
D) All of the above are false.
Answer:
Page Ref.: C:10-7 and C:10-8

30) Identify which of the following statements is true.
A) The depreciation recapture potential for a Sec. 1245 property is not included in the definition of a Sec. 751 asset.
B) For Sec. 751 purposes, “substantially appreciated inventory” means property held for sale to customers whose market value exceeds its adjusted basis.
C) Inventory for Sec. 751 purposes includes all property except cash, capital assets, and Sec. 1231 assets assets.
D) All of the above are false.
Answer:
Page Ref.: C:10-8

31) For purposes of Sec. 751, inventory includes all of the following except
A) capital assets or 1231 property.
B) items held for sale in the ordinary course of business.
C) accounts receivable.
D) All of the above are inventory per Sec. 751.
Answer:
Page Ref.: C:10-8

32) The AB Partnership has a machine with an FMV of $25,000 and a basis of $20,000. The partnership has taken an $8,000 depreciation on the machine. The unrealized receivable related to the machine is
A) $0.
B) $5,000.
C) $8,000.
D) $20,000.
Answer:
Page Ref.: C:10-8; Example C:10-10
33) The Internal Revenue Code includes which of the following assets in the definition of Sec. 751 properties?
A) inventory, which is substantially appreciated
B) cash
C) capital assets
D) Sec. 1231 assets
Answer:
Page Ref.: C:10-8

34) The definition of “inventory” for purposes of Sec. 751 includes
A) cash.
B) land held for investment.
C) marketable securities not held by dealers.
D) depreciation recapture potential on Sec. 1231 assets.
Answer:
Page Ref.: C:10-8

35) The definition of “unrealized receivable” does not include the
A) right to payment for services performed by a cash-basis taxpayer.
B) recapture potential on Sec. 1245 property.
C) recapture potential on Sec. 1250 property.
D) right to payment for services performed by an accrual-basis taxpayer.
Answer:
Page Ref.: C:10-8

36) What is the definition of “substantially appreciated inventory”?
A) inventory with a FMV greater than its basis
B) inventory and unrealized receivables with a FMV greater than their basis
C) inventory with a FMV greater than 120% of its basis
D) inventory and unrealized receivables with a FMV greater than 120% of their basis
Answer:
Page Ref.: C:10-8

37) The ABC Partnership owns the following assets on December 31.

Basis FMV
Cash $20,000 $20,000
Unrealized receivables -0- 40,000
Inventory $20,000 30,000
Land (Sec. 1231 asset) 50,000 90,000

The indication that ABC owns substantially appreciated inventory is
A) the total FMV of all assets except cash is greater than their total basis.
B) the FMV of all assets except land is $90,000 while their bases is $40,000.
C) the FMV of the inventory is $30,000 while its adjusted basis is $20,000.
D) the FMV of the inventory and unrealized receivables is $70,000 while their adjusted bases is $20,000.
Answer:
Page Ref.: C:10-8; Example C:10-11

38) The XYZ Partnership owns the following assets on December 31:

Basis FMV
Cash $20,000 $20,000
Unrealized receivables -0- 15,000
Inventory $30,000 35,000
Land (Sec. 1231 asset) 40,000 70,000

By how much must XYZ reduce its unrealized receivables to avoid meeting the substantially appreciated inventory test?
A) $10,000
B) $14,000
C) $15,000
D) No amount of reduction of unrealized receivables will affect meeting the substantially appreciated inventory test.
Answer:
39) The XYZ Partnership owns the following assets on December 31:

Basis FMV
Cash $10,000 $10,000
Unrealized receivables -0- 10,000
Inventory $25,000 30,000

A partner has a 20% interest with a basis of $6,000 in XYZ before receiving a liquidating distribution of $10,000 cash. XYZ Partnership has no liabilities. His recognized gain is
A) $4,000 capital gain.
B) $3,000 capital gain and $1,000 ordinary income.
C) $3,000 ordinary income.
D) $3,000 ordinary income and $1,000 capital gain.
Answer:

40) Identify which of the following statements is true.
A) A liquidating distribution that terminates a partnership interest cannot include more than one distribution.
B) A partnership with a large amount of unrealized receivables and substantially appreciated inventory items liquidated and distributed all of its assets in kind to each partner in proportion to their partnership interests. Each partner will report ordinary income at the time these assets are received equal to their FMV.
C) The rule for recognizing gain on a liquidating distribution is the same rule that is used for a current distribution.
D) All of the above are false.
Answer:
Page Ref.: C:10-12

41) Identify which of the following statements is true.
A) When unrealized receivables are distributed in a liquidating distribution, the basis of the receivables will be increased.
B) The bases of unrealized receivables and inventory distributed by a partnership in liquidation of a partnership interest are never increased above their bases in the hands of the partnership.
C) The basis of the partnership interest is apportioned between all of the assets received in a liquidating distribution based on the relative FMVs of the assets.
D) All of the above are false.
Answer:
Page Ref.: C:10-12

42) Ted King’s basis for his interest in the Troy Partnership is $24,000. In complete liquidation of his interest, King receives cash of $4,000 and real property (not a Sec. 751 asset) having an FMV of $40,000. Troy’s adjusted basis for this realty is $15,000. Section 736 does not apply. King’s basis for this realty is
A) $15,000.
B) $20,000.
C) $36,000.
D) $40,000.
Answer:

43) Derrick’s interest in the DEF Partnership is liquidated when his basis in the interest is $30,000. He receives a liquidating distribution of $20,000 cash and inventory with a basis of $8,000 and an FMV of $30,000. Derrick will recognize
A) no gain or loss.
B) $2,000 capital loss.
C) $2,000 ordinary loss.
D) $10,000 capital loss and $20,000 ordinary loss.
Answer:
Page Ref.: C:10-12; Example C:10-15

44) Before receiving a liquidating distribution, Kathy’s basis in her interest in the KLM Partnership is $30,000. The distribution consists of $5,000 in money, inventory having a $1,000 basis to the partnership and a $2,000 FMV, and two parcels of undeveloped land (not held as inventory) having basis of $3,000 and $9,000 to the partnership with FMVs of $5,000 and $12,000, respectively. What is Kathy’s basis in each parcel of land?
A)
Parcel One Parcel Two
$5,000 $12,000

B)
Parcel One Parcel Two
$3,000 $9,000

C)
Parcel One Parcel Two
$7,059 $16,941

D)
Parcel One Parcel Two
$6,000 $18,000

Answer:

45) Ten years ago, Latesha acquired a one-third interest in Dana Associates, a partnership, for $26,000 cash. This year, Latesha’s entire interest in the partnership is liquidated when her basis is $24,000. Dana’s assets consist of the following: cash, $20,000; inventory with a basis of $46,000 and an FMV of $40,000. Dana has no liabilities. Latesha receives the cash of $20,000 in liquidation of her entire interest. What is Latesha’s recognized loss on the liquidation of her interest in Dana?
A) $0
B) $4,000 long-term capital loss
C) $4,000 short-term capital loss and $2,000 ordinary loss
D) $4,000 long-term capital loss and $2,000 ordinary loss
Answer:
46) Identify which of the following statements is true.
A) On December 31 of the current year, Max Curcio’s adjusted basis for his interest in the Maduro & Motta Partnership is $36,000. Maduro & Motta distributes cash of $6,000 and a parcel of land held as an investment to Curcio in liquidation of his entire interest in the partnership. The land has an adjusted basis of $18,000 to the partnership and an FMV of $42,000. Curcio’s basis in the land is $18,000.
B) Jake has a basis in his partnership interest of $40,000 before receiving a liquidating distribution of $5,000 cash, inventory with a basis of $4,000 and an FMV of $5,000, and land with a basis of $3,000 and an FMV of $6,000. Jake will receive no further distributions. He can recognize a loss of $28,000 at the time the liquidating distribution is received.
C) A partner’s holding period for a partnership interest is never considered when determining the holding period for property distributed in a liquidating distribution.
D) All of the above are false.
Answer:
Page Ref.: C:10-14

47) Identify which of the following statements is false.
A) On June 30 of the current year, James Roe sells his interest in the Roe & Doe Partnership for $30,000. Roe’s adjusted basis in Roe & Doe at June 30 is $7,500 before apportionment of any partnership income for the current year. The Roe & Doe Partnership uses the calendar year as its tax year and has no liabilities on June 30. Roe’s distributive share of partnership income up to June 30 is $22,500. Roe acquired his interest in the partnership five years ago. Roe will have a long-term capital gain on the sale of his interest of $22,500.
B) Section 751 assets include all inventory and all unrealized receivables in a sale or exchange situation.
C) When a partnership interest is sold, the buyer and seller can allocate the sale price among the Sec. 751 assets and non-Sec. 751 assets in any reasonable manner.
D) Statements B and C are true.
Answer:
Page Ref.: C:10-16 and C:10-17

48) Kenya sells her 20% partnership interest having a $28,000 basis to Ebony for $40,000 cash. At the time of the sale, the partnership has no liabilities and its assets are as follows:

Basis FMV
Cash $20,000 $20,000
Unrealized receivables -0- 40,000
Inventory 10,000 40,000
Land (Sec. 1231) 110,000 100,000

Kenya and Ebony have no agreement concerning the allocation of the sales price. Ordinary income recognized by Kenya as a result of the sale is
A) $6,000.
B) $12,000.
C) $14,000.
D) $16,000.
Answer:

49) Steve sells his 20% partnership interest having a $28,000 basis to Nancy for $40,000 cash. At the time of the sale, the partnership has no liabilities and its assets are as follows:

Basis FMV
Cash $20,000 $20,000
Unrealized receivables -0- 40,000
Inventory 10,000 40,000
Land (Sec. 1231) 110,000 100,000

The receivables and inventory are Sec. 751 assets. There is no agreement concerning the allocation of the sales price. Steve must recognize
A) no gain or loss.
B) $12,000 ordinary income.
C) $12,000 capital gain.
D) $14,000 ordinary income and $2,000 capital loss.
Answer:
50) Identify which of the following statements is true.
A) John Albin is a retired partner of Brill & Crum, a personal service partnership. Albin has not rendered any services to Brill & Crum since his retirement six years ago. Under the provisions of Albin’s retirement agreement, Brill & Crum is obligated to pay Albin 10% of the partnership’s net income each year through the end of the current year. In compliance with the agreement, Brill & Crum pay Albin $25,000 in the current year. Albin should treat this $25,000 as a long-term capital gain.
B) An exchange of partnership interests in different partnerships qualifies under the like-kind exchange rules.
C) The payment for partnership property to a retiring partner is not deductible by the partnership and often not income to the retiring partner.
D) All of the above are false.
Answer:
Page Ref.: C:10-19

51) For tax purposes, a partner who receives retirement payments ceases to be regarded as a partner
A) on the last day of the taxable year in which the partner retires.
B) on the last day of the month in which the partner retires.
C) on the day on which the partner retires.
D) only after the partner’s last payment is received.
Answer:
Page Ref.: C:10-20

52) If a partnership chooses to form an LLC, under the check-the-box rules, and assuming no elections are made, the entity will be taxed as
A) a partnership if it has more than one member.
B) an S corporation.
C) a C corporation.
D) Unable to determine from the facts presented.
Answer:
Page Ref.: C:10-21

53) Identify which of the following statements is true.
A) Under the check-the-box rules, an LLC with more than one member is taxed as a corporation unless it elects to be taxed as a partnership.
B) The partnership’s tax year closes with respect to a partner whose interest is transferred by gift.
C) An LLC has been taxed as a partnership for five years. Under the check-the-box rules, the LLC makes a timely election in 2009 to be taxed as a C corporation. The election of C corporation status is permitted and results in the LLC’s assets being transferred from a partnership to a C corporation under the federal income tax rules.
D) All of the above are false.
Answer:
Page Ref.: C:10-21
54) If a partner dies, his or her tax year closes
A) on the date of death.
B) on the day after death.
C) on the day before death.
D) on some other date.
Answer:
Page Ref.: C:10-22

55) A partnership terminates for tax purposes
A) only when it terminates under local partnership law.
B) when at least 50% of the total interest in partnership capital and profits changes hands by sale or exchange within twelve consecutive months.
C) when the sale of partnership assets is made only to an outsider(s) and not to an existing partner(s).
D) when a partnership tax return (Form 1065) ceases to be filed by the partnership.
Answer:
Page Ref.: C:10-22

56) Marc is a calendar-year taxpayer who owns a 30% capital and profits interest in the MN Partnership. Nancy sells the remaining 70% capital and profits interest to Henry on October 31. The partnership year-end is March 31 as permitted by the IRS for business purpose reasons. The MN Partnership
A) terminates on March 31.
B) terminates on October 31.
C) terminates on December 31.
D) does not terminate.
Answer:
Page Ref.: C:10-22

57) A partnership terminates for federal income tax purposes if
A) a general partner who owns a majority interest dies.
B) state partnership law terminates the partnership.
C) a partnership interest of more than 50% is gifted.
D) within a 12-month period there is a sale or exchange of at least 50% of the total interest in partnership capital and profits.
Answer:
Page Ref.: C:10-22 and C:10-23

58) Identify which of the following statements is true.
A) The partnership tax year closes when a partner transfers his interest by gift.
B) If a partner dies in a two-member partnership, the partnership terminates on the date of death, even though the successor-in-interest continues to share in the profits and losses of the partnership business.
C) When the interest of a partner who owns 60% of a partnership is completely liquidated by a partnership distribution, the partnership is considered terminated, even though three other partners remain.
D) All of the above are false.
Answer:
Page Ref.: C:10-22 and C:10-23
59) Identify which of the following statements is false.
A) A sale or exchange of at least 50% of the capital and profits interest in a partnership within a 12- consecutive-month period will terminate the partnership and end all of the partnership’s elections.
B) When using the 50% rule to terminate a partnership, if an interest is sold more than once during the 12-month period, each sale is counted separately.
C) A partner’s individual income tax return, under some circumstances, may include the results of partnership operations for a period exceeding 12-months.
D) When several different transfers are made during a 12-month period, the partnership termination occurs on the date of the transfer that first crosses the 50% threshold.
Answer:
Page Ref.: C:10-22 and C:10-23

60) Sally is a calendar-year taxpayer who owns a 30% capital and profits interest in the SEM
Partnership. Eric sells the remaining 70% capital and profits interest to Michelle on October 3. The partnership year-end is March 31 as permitted by the IRS for business purposes. Which of the following statements is correct?
A) Sally must conform her tax year with the partnership tax year.
B) The new partnership is a continuation of the old partnership.
C) Sally’s tax return will include a partnership distributive share only for the period ending March 31.
D) Sally’s tax return will include partnership distributive shares for periods ending March 31 and October 3.
Answer:
Page Ref.: C:10-23 and C:10-24

61) The LM Partnership terminates for tax purposes on July 15 when Latasha sells her 60% capital and profits interest to Zoe for $100,000. The partnership has no liabilities, and its assets at the time of termination are as follows:

Assets Basis FMV
Cash $ 20,000 $ 20,000
Receivables 10,000 12,000
Inventory 22,000 28,000
Building 80,000 85,000
Land 30,000 21,667
Total $162,000 $166,667

Marika, a 40% partner in the LM Partnership, has a $64,800 basis in her partnership interest (outside basis) at the time of the termination. She has held her LM Partnership interest for three years at the time of the termination. The bases of Marika and Zoe in the new LM Partnership is:
Marika Zoe
A)
Marika Zoe
$64,800 $ 97,200

B)
Marika Zoe
$66,667 $100,000

C)
Marika Zoe
$64,800 $100,000

D)
Marika Zoe
$66,667 $ 97,200

Answer:
Page Ref.: C:10-24; Example 10-28

62) The AB, BC, and CD Partnerships merge into the ABCD Partnership. AB (owned by Austin and Ben) contributes assets worth $100,000. BC (owned by Ben and Charlie) contributes assets worth $200,000. CD (owned by Charlie and Dennis) contributes assets worth $300,000. The capital and profits interest in ABCD is owned by: Austin, 10%; Ben, 30%; Charlie, 25%; and Dennis, 35%. ABCD Partnership is a continuation of
A) none of the partnerships.
B) AB.
C) BC.
D) CD.
Answer:
Page Ref.: C:10-25; Example C:10-30
63) Han purchases a 25% interest in the CHOP Partnership from Huang for $600,000. The partnership has assets with a basis of $1,600,000. What is the amount of the basis adjustment, if the partnership has a 754 election in place?
A) $0
B) $150,000 increase in Han’s basis in his partnership interest
C) $200,000 increase in Han’s share of the basis in partnership assets
D) $1,000,000 increase in partnership assets
Answer:
Page Ref.: C:10-26

64) Patrick purchases a one-third interest in the PPP partnership for $600,000. The partnership has assets with a value of $1,500,000. PPP has a 754 election in effect. What is the amount of the basis adjustment?
A) $0
B) $300,000 increase in the basis of partnership assets
C) $100,000 increase in Patrick’s basis in the partnership assets
D) $100,000 increase in Patrick’s share of the basis in the partnership assets
Answer:
Page Ref.: C:10-26

65) Which of the following statements is correct?
A) A partnership may make an annual election to adjust the basis of its assets upon the sale of a partnership interest.
B) The Sec. 754 election applies to both sales and distributions.
C) The Sec. 754 election applies to only current and nonliquidating distributions.
D) A partnership can revoke a Sec. 754 election every 5 years.
Answer:
Page Ref.: C:10-26 and C:10-27

66) Which of the following is valid reason for making a 754 election?
A) An incoming partner pays more for a partnership interest that his or her proportionate share of partnership assets.
B) Partners are able to increase their basis in the partnership interest upon the sale of a partnership interest.
C) Partnerships can increase, but not decrease, their basis in partnership assets.
D) A partnership can reduce its basis in assets upon cash distributions to partners.
Answer:
Page Ref.: C:10-27

67) Patrick purchased a one-third interest in the PPP partnership for $600,000. At the time of the purchase, the partnership had a 754 election in effect and its only asset was land with a basis of $1,500,000. This year, PPP sells the land for $1,800,000. What is Patrick’s recognized share of the gain on the sale of the land?
A) $0
B) $100,000
C) $300,000
D) none of the above
Answer:
68) When must a partnership make mandatory basis adjustments?
A) on any sale of a 20% or greater partnership interest
B) on any sale of a partnership interest for $250,000 or more
C) on any distribution of assets with a value of $250,000 or more
D) on any sale of a partnership interest where the partnership’s adjusted basis in its assets exceeds their fair market value by $250,000 or more
Answer:
Page Ref.: C:10-27

69) Identify which of the following statements is true.
A) When a partnership is divided into two or more new partnerships, all of the resulting partnerships must be considered new partnerships.
B) A partnership is “publicly traded” only if its interests are traded on an established securities exchange.
C) A limited liability company is a form of business entity that combines the legal benefits of the corporate form with the tax benefits of the partnership form.
D) All of the above are false.
Answer:
Page Ref.: C:10-29 through C:10-32

70) The STU Partnership, an electing Large Partnership, has no passive activities and reports the following transactions for the year: net long-term capital losses $50,000, Sec. 1231 gain $60,000, ordinary income $20,000, charitable contributions $15,000, and tax-exempt income $2,000. How much will be reported as ordinary income to its partners?
A) $5,000
B) $17,000
C) $20,000
D) $22,000
Answer:

71) The STU Partnership, an electing Large Partnership, has no passive activities and reports the following transactions for the year: net long-term capital losses $50,000, Sec. 1231 gain $60,000, ordinary income $20,000, charitable contributions $15,000, and tax-exempt income $2,000. How much will be reported as long-term capital gains to its partners?
A) $0
B) $10,000
C) $50,000
D) $60,000
Answer:
Page Ref.: C:10-32

72) Two years ago, Tom contributed investment land with a basis of $50,000 and FMV of $62,000 to the RST Partnership. This year, Tom has a basis in his partnership interest of $53,000 when he receives a current distribution of $14,000 cash and inventory with a basis of $35,000 and FMV of $52,000. (There is no Sec. 751 exchange in connection with the inventory distribution.) The partnership continues to hold the land Tom contributed. How much gain (if any) must Tom recognize as a result of this distribution?
Answer:
Page Ref.: C:10-3; Example C:10-3

73) On November 30, Teri received a current distribution of cash of $4,000, marketable securities with a basis of $24,000 and an FMV of $30,000, and inventory with a basis of $2,000 and an FMV of $6,000. Prior to the distribution, Teri’s basis in her interest in the partnership was $30,000. (There is no Sec. 751 exchange as a result of the distribution.) How much gain (if any) must Teri recognize as a result of the distribution?
Answer:
$ 4,000
Page Ref.: C:10-3

74) Jerry has a $50,000 basis for his interest in JJ Partnership before receiving a current distribution consisting of $8,000 in money, accounts receivable having a zero basis to the partnership, and land having a $28,000 basis to the partnership. What will Jerry’s basis be in these assets?
Answer:
Page Ref.: C:10-4; Example C:10-6
75) Jerry has a $50,000 basis for his interest in JJ Partnership before receiving a current distribution consisting of $8,000 in money, accounts receivable having a zero basis to the partnership, and land having a $28,000 basis to the partnership. What is Jerry’s basis in his partnership interest after the distribution?
Answer:
Page Ref.: C:10-4; Example C:10-6

76) Last year, Cara contributed investment land with an FMV of $24,000 and basis of $18,000 to the CDE Partnership. CDE made no distributions during last year, and Cara’s basis in her partnership interest on December 31 of last year was $28,000. On January 1 of this year, the partnership distributed cash of $30,000 to Cara and distributed the land contributed by Cara to another partner, David. On the distribution date, the land had a $27,000 FMV. Assume the CDE Partnership reported no profit or loss this year. How much gain (if any) must Cara recognize as a result of the distributions? What is her basis in the partnership after the distributions?
Answer:
Page Ref.: C:10-5 and C:10-11

77) The TK Partnership has two assets: $20,000 cash and a machine having a $28,000 basis and a $40,000 FMV. The partnership has claimed $16,000 in depreciation on the machine since its purchase. If the machine is sold for its FMV, would TK Partnership have an unrealized receivable item?
Answer:
Page Ref.: C:10-8; Example C:10-10

78) The Tandy Partnership owns the following assets on December 31:

Assets Basis Fair Market Value
Cash
Unrealized receivables
Inventory
Land, Sec. 1231 property
Total $20,000
-0-
20,000
35,000
$75,000 $ 20,000
30,000
25,000
70,000
$145,000

Is the partnership’s inventory considered to be substantially appreciated for purposes of Sec. 751? Show your work.
Answer:
Page Ref.: C:10-8 and C:10-9; Example C:10-11

79) The CHS Partnership’s balance sheet presented below is prepared on a cash basis at September 30 of the current year.

Assets Basis Fair Market Value
Cash
Accounts receivable
Land (capital asset)
Total $12,000
-0-
63,000
$75,000 $ 12,000
48,000
90,000
$150,000

Equities Basis Fair Market Value
Notes payable
Cindy, Capital
Helen, Capital
Sally, Capital
Total $30,000
15,000
15,000
15,000
$75,000 $ 30,000
40,000
40,000
40,000
$150,000

Cindy withdraws from the partnership under an agreement whereby she takes one-third of each of the three assets and assumes $10,000 of the notes payable. Her basis for the partnership interest before any distribution is $25,000. What gain/loss should she report for tax purposes?
Answer:
Page Ref.: C:10-8 through C:10-12

80) Adnan had an adjusted basis of $11,000 for his interest in the Adnan and Donnell Partnership on December 31. On this date, Adnan received from the partnership, in complete liquidation of his interest, $10,000 cash and land with a $2,000 basis to the partnership and a $3,000 FMV. What is Adnan’s basis for the land distributed to him?
Answer:
page Ref.: C:10-12
81) Eicho’s interest in the DPQ Partnership is terminated when her basis in the partnership is $70,000. She receives a liquidating distribution of $20,000 cash and inventory with a $24,000 basis and a $40,000 FMV. What is her gain or loss, and what is her basis in the inventory received?
Answer:

82) Eicho’s interest in the DPQ Partnership is terminated when her basis in the partnership is $70,000. She receives a liquidating distribution of $20,000 cash and inventory with a $24,000 basis and a $40,000 FMV. She also receives, as part of the distribution, a desk that has a $100 basis and a $200 FMV to the partnership. What is her gain or loss, and what is her basis in the items received?
Answer:
Page Ref.: C:10-12 and C:10-13; Example C:10-16

83) On December 31, Kate receives a $28,000 liquidating distribution from the KLM Partnership. On that date, Kate’s basis in her limited partnership interest is $18,000 (which, of course, includes her share of partnership liabilities). The other partners assume her $6,000 share of liabilities. Just prior to the distribution, the partnership has the following balance sheet. Kate is leaving the partnership but the partnership is continuing.

Assets Basis Fair Market Value
Cash
Accounts receivable
Inventory
Land
Total $30,000
-0-
15,000
45,000
$90,000 $ 30,000
20,000
25,000
90,000
$165,000

Equities Basis Fair Market Value
Notes payable
Kate, capital
Lynn, capital
Mark, capital
Total $30,000
12,000
24,000
24,000
$90,000 $ 30,000
27,000
54,000
54,000
$165,000

What is the amount and character of the gain that Kate must recognize on the liquidating distribution?
Answer
Page Ref.: C:10-12 through C:10-16
84) The HMS Partnership, a cash method of accounting entity, has the following balance sheet at December 31 of last year;

Assets Basis Fair Market Value
Cash
Accounts receivable
Total $51,000
-0-
$51,000 $ 51,000
210,000
$261,000

Equities Basis Fair Market Value
Notes payable
Henry, capital
Mark, capital
Sam, capital
Total $30,000
7,000
7,000
7,000
$51,000 $ 30,000
77,000
77,000
77,000
$261,000

Sam, who has a one-third interest in profits, losses, and liabilities, sells his partnership interest to Beverly, for $77,000 cash on January 1 of this year. Sam’s basis in his partnership interest (which, of course, includes a share of partnership liabilities) at the time of the sale was $17,000. In addition, Beverly assumes Sam’s share of the partnership liabilities. What is the amount and character of the gain that Sam will recognize from this sale?
Answer:
Page Ref.: C:10-16 through C:10-18

85) On December 31, Kate sells her 20% interest (with a basis of $18,000 which, of course, includes a share of partnership liabilities) in the KLM Partnership to Karl for $27,000 cash plus assumption of her $6,000 share of liabilities. On that date, the partnership has the following balance sheet:

Assets Basis Fair Market Value
Cash
Accounts receivable
Inventory
Land
Total $30,000
-0-
15,000
45,000
$90,000 $ 30,000
20,000
25,000
90,000
$165,000

Equities Basis Fair Market Value
Notes payable
Kate, capital
Lynn, capital
Mark, capital
Total $30,000
12,000
24,000
24,000
$90,000 $ 30,000
27,000
54,000
54,000
$165,000

What are the amount and character of the gain that Kate must recognize on the sale?
Answer :
Page Ref.: C:10-16 through C:10-18

86) Tony sells his one-fourth interest in the WindyCity Partnership to Bill for $100,000 cash when the partnership’s assets are as follows:

Assets Basis Fair Market Value
Cash
Unrealized receivables
Inventory
Land
Total $80,000
-0-
80,000
80,000
$240,000 $ 80,000
72,000
184,000
64,000
$400,000

The partnership has no liabilities on the sale date. Tony’s basis in his partnership interest on the date of the sale is $60,000. What is the amount of gain realized by Tony on the sale of his partnership interest?
Answer:
Page Ref.: C:10-17; Example C:10-20

87) Tony sells his one-fourth interest in the WindyCity Partnership to Bill for $100,000 cash when the partnership’s assets are as follows:

Assets Basis Fair Market Value
Cash
Unrealized receivables
Inventory
Land
Total $80,000
-0-
80,000
80,000
$240,000 $ 80,000
72,000
184,000
64,000
$400,000

The partnership has no liabilities on the sale date. Tony’s basis in his partnership interest on the date of the sale is $60,000. What is the allocation of Tony’s gain to the assets received?
Answer:
Page Ref.: C:10-17; Example C:10-20

88) Tony sells his one-fourth interest in the WindyCity Partnership to Bill for $100,000 cash when the partnership’s assets are as follows:

Assets Basis Fair Market Value
Cash
Unrealized receivables
Inventory
Land
Total $80,000
-0-
80,000
80,000
$240,000 $ 80,000
72,000
184,000
64,000
$400,000

The partnership has no liabilities on the sale date. Tony’s basis in his partnership interest on the date of the sale is $60,000. What are the amount and character of Tony’s gain?
Answer:
Page Ref.: C:10-17; Example C:10-20

89) Joshua is a 40% partner in the XY Partnership when he sells his entire interest to Stanley for $60,000 cash. At the time of the sale, Joshua’s basis is $36,000, which includes his $10,000 share of partnership liabilities. The partnership has no Sec. 751 assets. Calculate Joshua’s gain or loss on the sale.
Answer:
Page Ref.: C:10-18; Example C:10-21

90) Sean, Penelope, and Juan formed the SPJ partnership by each contributing assets with a basis and fair market value of $200,000. In the following year, Penelope sold her one-third interest to Pedro for $225,000. At the time of the sale, the SPJ partnership had the following balance sheet:

Basis FMV
Cash $200,000 $200,000
Land $400,000 $475,000
$600,000 $675,000

Shortly after Pedro became a partner, SPJ sold the land for $475,000. What are the tax consequences of the sale to Pedro and the partnership (1) assuming there is no Section 754 election in place, and (2) assuming the partnership has a valid Section 754 election?
Answer:
Page Ref.: C:10-27

91) What is included in the definition of unrealized receivables?
Answer:
Page Ref.: C:10-8

92) Do most distributions made by a partnership require a Sec. 751 calculation?
Answer:
Page Ref.: C:10-11

93) What conditions are required for a partner to recognize a loss upon receipt of a distribution from a partnership?
Answer:
Page Ref.: C:10-12 and C:10-13

94) What is the character of the gain/loss on the sale of a partnership interest?
Answer:
Page Ref.: C:10-16

95) Can a partner recognize both a gain and a loss on the sale of a partnership interest? If so, under what conditions?
Answer:
Page Ref.: C:10-16 through C:10-19

96) What are some advantages and disadvantages of making a Section 754 election?
Answer:

Page Ref.: C:10-26 through C:10-28

97) What are the advantages of a firm being formed as a limited liability company (LLC) instead of as a limited partnership?
Answer:
Page Ref.: C:10-30

98) The limited liability company (LLC) has become a popular business form because of its limited liability protection for its owner. The S corporation also provides limited liability protection for its owner. What advantages does an LLC provide that are not available with an S corporation?
Answer:
Page Ref.: C:10-30

99) What is an electing large partnership? What are the advantages to the partnership of electing to be taxed under the electing large partnership rules?
Answer:
Page Ref.: C:10-32 through C:10-34

100) All states have adopted laws providing for limited liability companies. Describe a limited liability company (LLC).
Answer:
Page Ref.: C:10-30

101) When Rachel’s basis in her interest in the RST Partnership is $40,000, she receives a current distribution of office equipment. The equipment has an FMV of $60,000 and a basis of $50,000. Rachel will not use the office equipment in a business activity. What tax issues should Rachel consider with respect to the distribution?
Answer:
Page Ref.: C:10-2 through C:10-8

102) Ed receives a $20,000 cash distribution from the EV Partnership, which reduces his partnership interest from one-third to one-fourth. The EV Partnership is a general partnership that uses the cash method of accounting and has substantial liabilities. EV’s inventory has appreciated substantially since it was purchased. What issues should Ed consider with regard to the distribution?
Answer:
Page Ref.: C:10-7 through C:10-11

103) David sells his one-third partnership interest to Diana for $60,000 when his basis in the partnership interest is $48,000. On the date of sale, the partnership has no liabilities and the following assets:

Assets Basis FMV
Cash $40,000 $40,000
Inventory 18,000 27,000
Building 75,000 102,000
Land 11,000 11,000

The building is depreciated on a straight-line basis. What tax issues should David and Diana consider with respect to the sale transaction?
Answer:

Page Ref.: C:10-16 through C:10-19

104) Rod owns a 65% interest in the RRR Partnership, a general partnership, which he sells to the two remaining partners  Roger and Regis. The three partners have agreed that Rod will receive $160,000 in cash from the sale. Rod’s basis in the partnership interest before the sale is $125,000, which includes his $35,000 share of partnership recourse liabilities. The partnership has assets with a $310,000 FMV and a $210,000 adjusted basis. What issues should Rod, Roger, and Regis consider before this sale takes place?
Answer
Page Ref.: C:10-16 through C:10-19, C:10-22 through C:10-24

105) Quinn and Pamela are equal partners in the QP Partnership. On December 30 of the current year, the QP Partnership agrees to liquidate Quinn’s partnership interest for a cash payment on December 30 of each of the next five years. What tax issues should Quinn and Pamela consider with respect to the liquidation of Quinn’s partnership interest?
Answer:
Page Ref.: C:10-22 through C:10-25

106) Brown Company recently has been formed as a limited liability company (LLC). Brown Company is owned equally by three individualsGene, Susan, and Sandraall of whom have substantial income from other sources. Brown is a manufacturing firm and expects to earn approximately $130,000 of ordinary income and $30,000 of long-term capital gain each year for the next several years. Gene will be a full-time manager and will receive a salary of $60,000 each year. What tax issues should the owners consider regarding the LLC’s initial year of operations?
Answer:
Page Ref.: C:10-30
107) The Principle Limited Partnership has more than 300 partners and is publicly traded. The Principle was grandfathered under the 1987 Tax Act and has consistently been taxed as a partnership. In the current year, The Principle Limited Partnership will continue to be very profitable and will continue to pay out about 30% of its income to its owners each year. The managing partners of The Principle want to consider the firm’s options for taxation in the current and later years.
Answer:

Page Ref.: C:10-29

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C11 S Corporations

1) The S corporation rules were enacted to allow small corporations to enjoy the nontax advantages of the corporate form of business without being subject to the tax disadvantage of double taxation.
Answer:
Page Ref.: C:11-2

2) Up to six generations of a family are considered as one shareholder for purposes of the 100-shareholder limit.
Answer:
Page Ref.: C:11-4

3) Corporations and partnerships can be S corporation shareholders.
Answer:
Page Ref.: C:11-4,

4) A testamentary trust can be an S shareholder for two years, beginning on the date the stock transfers to the trust.
Answer:
Page Ref.: C:11-5
5) The election of Subchapter S status by a corporation is valid only if all shareholders consent to the election.
Answer:
Page Ref.: C:11-8

6) A corporation must make an S election for the current year after March 15 in the case of a calendar-year corporation.
Answer:
Page Ref.: C:11-8

7) All shareholders must consent to the revocation of S status.
Answer:
Page Ref.: C:11-10

8) Even if the termination of an S election is considered to be inadvertent, the election to terminate is irrevocable.
Answer:
Page Ref.: C:11-11

9) Tax-exempt interest earned by an S corporation is not reported to its shareholders because it is excluded from the shareholders’ gross income.
Answer:
Page Ref.: C:11-15

10) S shareholders are allocated shares of income, gain, loss, deduction, and credit based on their number of shares of stock and period of time for which the stock is held.
Answer:
Page Ref.: C:11-19

11) S shareholders cannot increase the basis of their stock by a ratable share of the general S corporation liabilities.
Answer:
Page Ref.: C:11-21

12) The accumulated adjustments account is the cumulative total of ordinary income or loss and separately stated items (excluding tax-exempt income and expenses) for the most recent continuous period during which the corporation has been an S corporation.
Answer:
Page Ref.: C:11-29
13) Identify which of the following statements is true.
A) The S corporation rules were enacted to allow small corporations to enjoy the nontax advantages of the corporate form of business without being subject to the tax disadvantage of double taxation.
B) A partnership can elect to be taxed as a corporation under the check-the-box regulations. As a corporation, an S election can be made.
C) For C corporations that desire to be taxed like a partnership, the S corporation rules provide a practical alternative for an existing C corporation to obtain many of the tax benefits of being taxed as a partnership.
D) All of the above are true.
Answer:
Page Ref.: C:11-2

14) Which of the following corporate tax levies are imposed on an S corporation?
A) corporate income tax
B) corporate alternative minimum tax
C) accumulated earnings tax
D) None of these taxes are imposed on an S corporation.
Answer:
Page Ref.: C:11-3

15) Identify which of the following statements is true.
A) A partnership can be an S corporation shareholder.
B) A nonresident alien can be an S corporation shareholder.
C) An S corporation can have more than 100 shareholders, since families are treated as a single shareholder.
D) All of the above are false.
Answer:
Page Ref.: C:11-4

16) Which one of the following individuals or entities is ineligible to be an S corporation shareholder?
A) an estate
B) resident alien of the United States
C) a voting trust where all of the beneficiaries are U.S. citizens
D) a partnership where all of the partners are U.S. citizens
Answer:
Page Ref.: C:11-4

17) Which of the following statements about stock ownership is not correct?
A) A C corporation can own stock of an S corporation.
B) An S corporation can own stock of a C corporation.
C) A tax-exempt charity can own stock of an S corporation.
D) An S corporation can own stock of a Qualified Subchapter S Subsidiary.
Answer:
Page Ref.: C:11-4
18) Trusts that can own S corporation stock include all of the following except
A) charitable remainder unitrusts.
B) QSSTs.
C) grantor trusts.
D) testamentary trusts.
Answer:
Page Ref.: C:11-5

19) Which of the following would terminate a Subchapter S election?
A) Estate becomes a shareholder.
B) Grantor trust becomes a shareholder.
C) Voting trust becomes a shareholder.
D) Partnership becomes a shareholder.
Answer:
Page Ref.: C:11-4 and C:11-5

20) Which one of the following is not one of the corporation-related requirements for S corporation status?
A) The corporation must be a domestic corporation.
B) The corporation must not have any foreign-sourced income.
C) The corporation must not be an “ineligible” corporation.
D) The corporation must have only one class of stock.
Answer:
Page Ref.: C:11-6

21) Identify which of the following statements is true.
A) A trust can own S corporation stock and have a C corporation as a beneficiary as long as the corporation is the sole beneficiary.
B) A QSST is an arrangement whereby the stock owned by a number of shareholders is placed under trust control for purposes of exercising the stock voting rights.
C) A testamentary trust can be converted into a QSST trust.
D) All of the above are false.
Answer:
Page Ref.: C:11-5

22) Mary, a U.S. citizen, owned 25% of the stock of Floran Corporation, an electing S corporation. At the time of her death, the Floran stock may go to all the following without affecting the S election except
A) her estate.
B) a testamentary trust.
C) a small business trust.
D) a charitable remainder unitrust.
Answer:
Page Ref.: C:11-5
23) Alligood Corporation has two classes of common stock outstanding. The Class A and Class B common stock give the shareholders identical rights and interests in the profits and assets of the corporation. Class A stock has one vote per share. Class B stock is nonvoting. Alligood Corporation may
A) not make the S election due to different voting rights.
B) make the S election once the Class B is retired.
C) make the S election at any time.
D) not make the S election due to two classes of stock.
Answer:
Page Ref.: C:11-6; Example C:11-2

24) Identify which of the following statements is true.
A) An S corporation cannot own any stock of another corporation.
B) An S corporation cannot own 100% of the stock of another S corporation.
C) An S corporation that owns all of the stock of a Qualified Subchapter S Subsidiary (QSub) must report all the income, deductions, and losses of the subsidiary on its own tax return.
D) All of the above are true.
Answer:
Page Ref.: C:11-6

25) Identify which of the following statements is true.
A) Convertible debt issues might be considered “stock” for purposes of the S corporation single class of stock requirement.
B) The S election must be made no later than the fifteenth day of the fourth month of the tax year for which the election is to be effective.
C) A majority of shareholders must consent to the S corporation election.
D) All of the above are false.
Answer:
Page Ref.: C:11-7

26) Identify which of the following statements is true.
A) Shareholders who acquire stock in an S corporation after the election date and prior to the election’s effective date must consent to the election.
B) S corporation consent by shareholders is binding on the current tax year and all future tax years.
C) Only shareholders who own stock on the date an S election takes effect must consent to the election.
D) All of the above are false.
Answer:
Page Ref.: C:11-8

27) A C corporation was formed five years ago and is a fiscal-year taxpayer with a June 30 year-end. The C corporation wants to make an S election for its tax year beginning in the current year. The election must be made by ________ (assuming permission can be obtained to continue using the fiscal year from the IRS).
A) June 30 of the current year
B) September 15 of the current year
C) June 30 of the next year
D) September 15 of the next year
Answer:
Page Ref.: C:11-8; Example C:11-3
28) Helmut and Sergei own all the stock of Zappo Corporation, a calendar-year domestic corporation. On January 30 of the current year, Sergei sells his entire interest in the Zappo stock to Nils. All three individuals are U.S. citizens. Can an S election be made for the current year?
A) not for the current year but for the next year
B) Yes, if Helmut and Nils agree to report all of the corporation’s income for the entire year
C) Yes, if Sergei will also join in the election with Helmut and Nils
D) Yes, if Helmut and Nils agree to file a short-period return and Sergei also agrees to the return
Answer:
Page Ref.: C:11-8

29) Davies Corporation is a calendar-year taxpayer that is owned equally by Vivian, Rob, Danny, and Doug Davies. At the close of business on May 31, Rob Davies sells his 25% stock interest to Paula Bryan. Which of the following statements about the S election is correct?
A) Paula must consent to the S election, otherwise the election terminates at the close of business on May 31.
B) A new S election form must be filed by June 30 of the same year, with all shareholders consenting to the election. If a new S election is not filed, the election terminates on June 30 of that year.
C) Paula has 30 days to terminate the S election, otherwise the election remains in place for the entire year and all subsequent years.
D) None of the above statements are correct.
Answer:
Page Ref.: C:11-8

30) The passive income test relating to an S corporation election is applied
A) daily.
B) monthly.
C) quarterly.
D) annually.
Answer:
Page Ref.: C:11-10

31) Identify which of the following statements is true.
A) All of the shareholders of an S corporation must consent to a revocation of the S election.
B) A revocation of an S corporation election can be retrospective to any date.
C) An S election will not be terminated due to excess passive income if the corporation does not have Subchapter C E&P.
D) All of the above are true.
Answer:
Page Ref.: C:11-10

32) Which of the following conditions will not cause an S election to be terminated?
A) exceeding the 100-shareholder limit
B) creating a second class of stock having a dividend preference
C) selecting an improper tax year
D) failing to file a timely tax return
Answer:
Page Ref.: C:11-10
33) On June 30 of the current year, the S election of Great Corporation is terminated, thus creating a six-month S short year and a six-month C short year. Great Corporation is a calendar-year taxpayer. The S short-year return is due
A) September 15.
B) December 15.
C) March 15 of the next year.
D) June 30 of the next year.
Answer:
Page Ref.: C:11-11

34) Krause Corporation makes an S election, believing that it has no current or accumulated E&P. However, after an IRS audit, Krause is found to have failed the passive investment income test for three consecutive years and also to have a Subchapter C E&P balance from its three pre-election tax years. The IRS will
A) automatically terminate the election and Krause cannot reelect for a 5-year time period.
B) retroactively revoke the election to the first day on which it was effective and Krause will not be able to reelect.
C) treat the error as such and allow the election to continue unbroken.
D) likely treat the termination as inadvertent and will probably approve a continued S election if the corporation distributes the Subchapter C E&P.
Answer:
Page Ref.: C:11-11; Example C:11-8

35) If an S corporation inadvertently terminates its election, the IRS
A) may permit the corporation to report as an S corporation even for the period that includes the termination date.
B) will not permit the corporation to restore its S election until the completion of a five-year waiting period.
C) will permit restoration of the S election only if the event causing the termination was not within the control of the corporation.
D) will permit restoration of the S election if a majority of the shareholders consent to the reinstatement.
Answer:
Page Ref.: C:11-11

36) Identify which of the following statements is false.
A) A C corporation short-year income tax liability must be determined on an annualized basis.
B) If the termination of an S election is considered to be inadvertent, then the election is permitted to continue in place as if the termination had never occurred.
C) If an S election is terminated and the termination is not considered to be inadvertent, a ten-tax-year waiting period is required before making a new election.
D) A corporation can obtain relief for a late S election if the IRS consents.
Answer:
Page Ref.: C:11-12
37) April Corporation’s Subchapter S election was voluntarily terminated for 2010. The first year that April would be eligible to reelect S corporation status is
A) 2012.
B) 2013.
C) 2014.
D) 2015.
Answer:
Page Ref.: C:11-12

38) Identify which of the following statements is true.
A) An S corporation should have a buy-sell agreement to guard itself against an ill-advised sale of its stock.
B) The terms “small business corporation” and “S corporation” are synonymous.
C) A regular corporation has common and preferred stock outstanding on January 1. On January 2, the preferred stock is canceled in a recapitalization, leaving only common stock outstanding. The corporation can make an S election for this tax year.
D) All of the above are false.
Answer:
Page Ref.: C:11-12

39) Identify which of the following statements is true.
A) The natural business year for fiscal-year election purposes is any tax year that ends within six months after the peak period of business.
B) Section 444 permits an S corporation to elect to use a fiscal year other than a permitted year.
C) A new corporation that is 100% owned by Johnny Blake, a cash method of accounting taxpayer, makes an S election for its initial tax year. The S corporation must also elect to use the cash method of accounting as its overall accounting method.
D) All of the above are false.
Answer:
Page Ref.: C:11-13

40) For an S corporation to elect to use a fiscal year other than a permitted year, the fiscal year elected must have a maximum deferral period of
A) one month.
B) two months.
C) three months.
D) six months.
Answer:
Page Ref.: C:11-13
41) When a Sec. 444 fiscal-year election is made, the S corporation makes required payments to the IRS in order to continue to use the fiscal year as its tax year. Which of the following statements about the tax year is correct?
A) The Sec. 444 payment is deductible by the S corporation as an income tax.
B) The Sec. 444 payment is allocated ratably to each shareholder and claimed as a tax payment on their own tax return(s).
C) The Sec. 444 payments are refundable if the S election is terminated.
D) The Sec. 444 payments must be made quarterly on the same dates that the S corporation’s estimated tax payments are otherwise due.
Answer:
Page Ref.: C:11-14

42) An S corporation is permitted to claim
A) the dividends-received deduction.
B) a personal exemption.
C) a deduction based on the amortization of organizational expenditures.
D) a net operating loss.
Answer:
Page Ref.: C:11-15

43) Which of the following items is not separately stated for an S corporation?
A) short-term capital gain
B) dividend income
C) Section 1245 income
D) charitable contribution
Answer:
Page Ref.: C:11-15

44) Identify which of the following statements is true.
A) An election for an S corporation to use the Sec. 179 expensing election is made by the corporation and not by its shareholders.
B) The S corporation’s separately stated items are in general the same ones that apply in partnership taxation.
C) An S corporation cannot claim a dividends-received deduction.
D) All of the above are true.
Answer:
Page Ref.: C:11-15

45) Identify which of the following statements is true.
A) Perry Corporation, an S corporation, receives $10,000 of dividends from a 25%-owned domestic corporation. Perry is allowed an 80% dividends-received deduction with respect to the distribution.
B) An NOL is incurred by a C corporation in the current tax year. The C corporation makes an S election for the following tax year. The entire C corporation NOL carryover can be passed through to the S corporation’s shareholders at the end of the following tax year.
C) Tax-exempt interest earned by an S corporation is not reported to its shareholders because it is excluded from the shareholders’ gross income.
D) All of the above are false.
Answer:
Page Ref.: C:11-15
46) Identify which of the following statements is true.
A) Beach Corporation, an S corporation, has gross receipts of $240,000; taxable income of $120,000; passive investment income of $100,000; and expenses directly attributable to the passive investment income of $20,000. The corporation’s excess net passive income is $32,000.
B) The built-in gains tax applicable to S corporations can be avoided if the property is held for ten years.
C) An S corporation generally will not owe the built-in gains tax if the corporation has never been a C corporation.
D) All of the above are true.
Answer:
Page Ref.: C:11-16 and C:11-17

47) Shanghai Corporation was organized and elected S status in the current year. How much passive investment income can Shanghai earn and retain its S status?
A) none
B) 80% of gross receipts
C) 50% of gross receipts
D) no limit
Answer:
Page Ref.: C:11-16

48) The recognition period for the built-in gains tax extends for how many years after the S election takes effect?
A) one year
B) three years
C) five years
D) ten years
Answer:
Page Ref.: C:11-17

49) King Corporation, a cash method taxpayer that uses the calendar year as its tax year, was incorporated on June 1, 1984. The corporation made its initial S election on December 1 of last year, effective for the current tax year. Earnings and profits of $60,000 have been retained from C corporation tax years. Which one of the following events results in the recognition of a built-in gain?
A) collection of accounts receivable in the current year that resulted from services performed last year
B) collection of interest income earned in the current year on bonds purchased on January 1 of last year
C) collection of dividends declared on April 5 of the current year on stock purchased on February 14 of the current year
D) None of the above are built-in gains.
Answer:
Page Ref.: C:11-16 and C:11-17
50) Identify which of the following statements is true.
A) Long-term capital gains may be subject to double taxation if the gains are subject to both the excess net passive income tax rules and the built-in gains tax rules.
B) Special allocations of ordinary income or loss and separately stated items that are available for partnerships are also permitted with S corporations.
C) When an S corporation’s shares are sold by a shareholder during a tax year, the transferee’s share of the earnings is reported from the day after the transfer date through the end of the tax year.
D) All of the above are false.
Answer:
Page Ref.: C:11-19

51) Train Corporation is an S corporation that is owned equally by Carlos and Diane at the beginning of the year. On April 21 (the 111th day of Train’s tax year) of the current year, Carlos sells all of his Train Corporation stock to Andre. How many days will be used when computing Carlos’s share of S corporation income for this year (a nonleap year), assuming that a special income allocation election is not made?
A) 110
B) 111
C) 254
D) 255
Answer:
Page Ref.: C:11-19

52) Cactus Corporation, an S Corporation, had accumulated earnings and profits of $100,000 at the beginning of 2008. Tex and Shirley each own 50% of the stock. Cactus does not make any distributions during 2008, but had $200,000 of ordinary income. In 2009, ordinary income was $100,000 and distributions were $100,000. What is Tex’s ordinary income for 2008?
A) $0
B) $50,000
C) $100,000
D) $200,000
Answer:
Page Ref.: C:11-19 and C:11-20

53) Cactus Corporation, an S Corporation, had accumulated earnings and profits of $100,000 at the beginning of 2009. Tex and Shirley each own 50% of the stock. Cactus does not make any distributions during 2009, but had $200,000 of ordinary income. In 2010, ordinary income was $100,000 and distributions were $100,000. What is Tex’s ordinary income for 2010?
A) $0
B) $50,000
C) $100,000
D) $200,000
Answer:
Page Ref.: C:11-19 and C:11-20
54) Cactus Corporation, an S Corporation, had accumulated earnings and profits of $100,000 at the beginning of 2009. Tex and Shirley each own 50% of the stock and have a basis in their stock of $50,000 on January 1, 2009. Cactus does not make any distributions during 2009, but had $200,000 of ordinary income. In 2010, ordinary income was $100,000 and distributions were $100,000. What is Tex’s basis at January 1, 2011?
A) $100,000
B) $150,000
C) $200,000
D) $250,000
Answer:
Page Ref.: C:11-19 and C:11-20

55) Identify which of the following statements is true.
A) The overall S corporation loss limitation equals the shareholder’s adjusted basis for his/her S corporation stock plus his/her ratable share of all S corporation liabilities.
B) The loss pass-throughs from an S corporation may produce a net operating loss for the shareholder.
C) An S corporation shareholder can increase the adjusted basis of his/her stock by any indebtedness owed the shareholder by the S corporation.
D) All of the above are false.
Answer:
Page Ref.: C:11-20

56) An electing S corporation has a $30,000 ordinary loss for the nonleap year. On January 1, Beverly and Sonya own equally all of the S corporation stock. On the 146th day of the year, Beverly gives her one-half of the S corporation stock to her daughter Becky. How much of the $30,000 ordinary loss is allocated to Beverly?
A) $25,000
B) $15,000
C) $6,000
D) $5,959
Answer:
Page Ref.: C:11-20; Example C:11-17

57) An electing S corporation has a $30,000 ordinary loss for the nonleap year. On January 1, Beverly and Sonya own equally all of the S corporation stock. On the 146th day of the year, Beverly gives her one-half of the S corporation stock to her daughter Becky. How much of the $30,000 ordinary loss is allocated to Sonya?
A) $25,000
B) $15,000
C) $10,000
D) $6,000
Answer:
Page Ref.: C:11-21
58) Which one of the following special loss limitations apply to an S corporation?
A) at-risk rules
B) passive activity limitation rules
C) hobby loss rules
D) All of the above apply.
Answer:
Page Ref.: C:11-22

59) Dilley Corporation is an electing S corporation that uses a calendar year as its tax year. On October 31, Dilley’s S election is terminated because of the acquisition of stock by an ineligible stockholder. Dilley Corporation shareholder Alan is allocated an S corporation loss for the year, which cannot be used because of the basis limitation. Alan will lose the unused loss if not used by
A) December 31 of this year.
B) March 15 of next year.
C) October 31 of next year.
D) December 31 of next year.
Answer:
Page Ref.: C:11-23; Example C:11-20

60) Identify which of the following statements is false.
A) Randy is a shareholder in an S corporation. His stock basis is $10,000 and his basis in a loan he made to the corporation is $3,000. Randy’s share of the corporation’s ordinary loss for the current year is $11,000. Ignoring the at-risk and passive activity limitations, Randy can deduct the loss in full.
B) A shareholder’s S corporation stock basis will increase when the shareholder acts as guarantor on a corporate indebtedness.
C) A shareholder’s ratable share of the S corporation’s ordinary loss reduces the adjusted basis of his/her S corporation stock. Once the basis of the stock is reduced to zero, any loss-passthrough that remains reduces the basis of S corporation debts that are owed to the shareholder.
D) Debt basis is restored before stock basis.
Answer:
Page Ref.: C:11-25 and C:11-26

61) An S corporation reports ordinary income of $120,000 after deducting $20,000 for Fred’s salary. Fred and his three children own the S corporation equally. The IRS determines Fred’s stock transfer to his three children is not bona fide. Reasonable compensation for Fred is $40,000. How much of the S corporation’s $140,000 pre-salary income must be reported by Fred?
A) $140,000
B) $100,000
C) $50,000
D) $40,000
Answer:
Page Ref.: C:11-23; Example C:11-21
62) Identify which of the following statements is false.
A) The AAA balance can be negative, but the shareholder’s basis in the S corporation stock cannot be less than zero.
B) The AAA represents the cumulative income/loss recognized in post-1982 S corporation years.
C) Nonmoney property distributions made by an S corporation having accumulated E&P are treated differently when determining the corporate-level gain recognized under Sec. 311 than are property distributions made by an S corporation without accumulated E&P.
D) Tax-exempt income does not increase the AAA but increases the basis of the S corporation stock.
Answer:
Page Ref.: C:11-27 through C:11-29

63) Pressley Corporation was incorporated on January 1, 2004. The corporation made its S election on March 1, 2008. The corporation retains an E&P balance from its C corporation days. During the current year, it made a cash distribution to its sole shareholder Robert Pressley. What is the proper sequence in reducing the corporate earnings accounts for the distribution?
A) AAA; E&P
B) AAA; OAA; E&P
C) E&P; AAA
D) AAA; PTI; E&P
Answer:
Explanation: A) The OAA is not a separate accumulated earnings account even though it is reported on page 4 of the Form 1120S. The tax-exempt income otherwise included in OAA becomes part of the S corporation’s stock basis for distribution purposes.
Page Ref.: C:11-28
64) Dixon Corporation was incorporated on January 1, 2005. The corporation made its S election on April 1, 2008. The corporation retains an E&P balance from its C corporation days. Which one of the following current-year income and expense items is not included in Dixon Corporation’s Accumulated Adjustments Account?
A) ordinary income or loss
B) tax-exempt bond interest income
C) long-term capital gains and losses
D) amortization of organizational expenditures
Answer:
Explanation: B) The tax-exempt bond interest income is included in the Other Adjustments Account.
Page Ref.: C:11-29

65) Identify which of the following statements is true.
A) An S corporation may be subject to the corporate alternative minimum tax.
B) Allocation of tax preference items for AMT generally occurs on a daily basis.
C) An S corporation may be subject to the corporate alternative minimum tax when the corporation has accumulated E&P from prior C corporation tax years.
D) All of the above are false.
Answer:
Page Ref.: C:11-33
66) Identify which of the following statements is true.
A) Fringe benefits limited by the more-than-2%-shareholder rule include stock options, group term life insurance premiums, and medical insurance premiums.
B) A shareholder owning 2% or more of an S corporation’s stock, who is also an employee of the corporation, must include all statutory fringe benefits in gross income on his/her individual return.
C) Section 318 stock attribution rules are used to define 2% or more shareholders of S corporation’s stock.
D) All of the above are false.
Answer:
Page Ref.: C:11-33 and C:11-34

67) An S corporation is not treated as a corporate taxpayer with respect to which one of the following fringe benefits?
A) stock options
B) qualified retirement plans
C) group term life insurance premiums
D) nonqualified deferred compensation
Answer:
Page Ref.: C:11-34

68) Identify which of the following statements is false.
A) The election form can be signed by a person authorized to sign the S corporation tax return.
B) An S election is filed by the corporation by using Form 2553 on or before the due date (without regard to any extensions) for the corporate tax return for the tax year in question.
C) An S corporation must file a tax return for any year in which the S corporation is in existence.
D) The IRS can grant extensions of time of filing shareholder consents to the S election.
Answer:
Page Ref.: C:11-37
69) Identify which of the following statements is false.
A) An S corporation files a Form 1120S corporate income tax return on or before the 15th day of the fourth month following the close of its tax year.
B) An S corporation’s ordinary income or loss is reported by an individual shareholder on Schedule E of Form 1040.
C) An S corporation that owes the built-in gains tax or the excess net passive income tax must make quarterly estimated tax payments.
D) An S corporation cannot use the prior-year tax liability exception when determining the required payment to be made with respect to the built-in gains tax.
Answer:
Page Ref.: C:11-37 and C:11-38
70) Mashburn Corporation is an S corporation that uses a fiscal year ending June 30 as its tax year. When is Mashburn Corporation’s income tax return due?
A) July 15
B) September 15
C) October 15
D) March 15 of the next year
Answer:
Page Ref.: C:11-37

71) An S corporation is permitted an automatic extension of time for filing its tax return. The automatic extension period is
A) one month.
B) two months.
C) three months.
D) six months.
Answer:
Page Ref.: C:11-37

72) Which of the following tax levies imposed on an S corporation are required to be paid by using estimated tax payments?
A) built-in gains tax
B) excess net passive income tax
C) both A and B
D) none of the above
Answer:
Page Ref.: C:11-38

73) Connie’s Restaurant has been an S corporation since it was formed in 2006. Its results for the previous year are as follows:

Sales $200,000
Supplies 90,000
Salaries 50,000
Depreciation 5,000
Interest on business loan 1,000
Charitable contributions 3,000
Advertising 4,000
Utilities expense 6,000
Property taxes 1,000
Gain on the sale of
investment land (long-term) 8,000

What are Connie’s separately stated items? What is the S corporation’s ordinary income?
Answer:
Page Ref.: C:11-14 and 11-15

74) Power Corporation reports the following results:

Service income (not passive income) $40,000
Dividend income 30,000
Interest income 60,000
Passive income-related expenses 20,000
Other expenses 50,000

At the end of the year, Power’s Subchapter C E&P is $50,000. What is Power Corporation’s excess net passive income and its excess net passive income tax for the year?
Answer:
Page Ref.: C:11-16

75) Chuck Corporation reports the following results for this year:

Service (nonpassive) income $17,500
Dividend income 18,500
Interest income 14,000
Passive income-related expenses 5,000
Other expenses 12,500

At the end of this year, Chuck’s E&P for its C corporation tax years amount to $30,000. Compute Chuck Corporation’s excess net passive income.
Answer:

Page Ref.: C:11-16

76) Potter Corporation reports the following results for the current year:

Operating income $40,000
Dividend income 35,000
Interest income 25,000
Other expenses 25,000
Passive income-related expenses 20,000

At the end of the year, Potter’s Subchapter C E&P is $50,000. What is the amount of Potter’s excess net passive income?
Answer:
Page Ref.: C:11-16

77) Boxer Corporation, a C corporation, elects on June 30 of last year to make an S election for the current year. The net unrealized built-in gains at the beginning of the current year are $300,000. The net recognized built-in gains in the current year are $110,000. What is Boxer’s built-in gains tax for the current year?
Answer:
Page Ref.: C:11-17

78) Gofer Corporation, an S corporation, is owned equally by Mahmoud and Kwame. The corporation had long-term capital gains of $100,000 and ordinary income of $90,000 for the current year and made no distributions. What is the amount of ordinary income from S corporation activities that Mahmoud must report?
Answer:
Page Ref.: C:11-19

79) For the calendar year, Elk Corporation, an S corporation, has book income of $55,000, which includes $45,000 from operations and a $10,000 net long-term capital gain. During the year, $22,500 is distributed to Elk’s three equal shareholders, all of whom are calendar-year taxpayers. What are Elk’s total ordinary income and capital gain pass-throughs for the year?
Answer:
Page Ref.: C:11-19

80) The Vanity Corporation organized and began operations in January. The corporation’s ten equal shareholders elect to have Vanity taxed as an S corporation, and the election and necessary consents are filed in a timely manner. For its first tax year ended December 31, Vanity has ordinary income of $64,000 and short-term capital gains of $16,000. During the year, it distributes $30,000 in cash equally to its ten shareholders. For the year, how much income should each shareholder report and how should it be characterized?
Answer:
Page Ref.: C:11-19 through C:11-24

81) Arnie is a 50% shareholder in Energy Corporation, an S corporation. The S corporation had an $80,000 ordinary loss last year and $10,000 of ordinary income this year. Before accounting for last year’s losses, Arnie’s basis in his Energy stock is $32,000 and Energy owed Arnie $4,000 (an unsecured note having a basis of $4,000) at the end of last year. In addition, Energy had $100,000 of other liabilities owed to creditors other than Arnie at the end of last year. What income and loss must Arnie report on his current return as a result of owning the Energy stock (ignoring the at-risk and passive activity limitations)?
Answer:
Page Ref.: C:11-21

82) Eagle Corporation has always been an S corporation. Eagle is 100% owned by Katy. Katy’s adjusted basis in the Eagle stock is $100,000 on January 1 of the current year. During the current year, Eagle distributes XYZ stock (a capital asset) to Katy. The XYZ stock has a $50,000 FMV and a $40,000 adjusted basis on Eagle’s books. The XYZ stock has been held as an investment for four years by Eagle. Eagle Corporation reports $40,000 of ordinary income in the current year. What is Katy’s basis in the Eagle stock at the beginning of the next year?
Answer:
Page Ref.: C:11-24 and C:11-25

83) Robert Elk paid $100,000 for all of the single class of stock of Elkom Corporation, an electing S corporation, when incorporated in January, 2007. Elkom’s operating results and dividend distribution are as follows:

Tax Year Ending Ordinary Income Distribution
2007
2008
2009 ($40,000)
60,000
30,000
$20,000 (9/30)

What is Elk’s basis for his Elkom stock on December 31 of 2007?
Answer

84) King Corporation, an electing S corporation, is 100% owned by Crystal. On January 1 of the current year, her adjusted basis in the King stock is $30,000. During the year, King reports an ordinary loss of $30,000, tax-exempt municipal bond income of $15,000, dividend income from domestic corporations of $5,000, a long-term capital loss of $20,000, and a short-term capital loss of $30,000. What is Crystal’s basis for the King stock at the end of the year?
Answer:
Page Ref.: C:11-24 and C:11-25
85) David owns 25% of an S corporation’s stock (a capital asset) for the first three months of the S corporation’s tax year. During the year, the S corporation has $16,000 of ordinary income and $32,000 of long-term capital gain. David starts the year with a basis of $50,000 in his S corporation stock and sells the stock for $56,000 on April 1 of the year. Assuming all months have 30 days, how much gain/loss does David report on the sale of the stock and what is its character?
Answer:
Page Ref.: C:11-25; Example C:11-23

86) Jeff owns 50% of an S corporation’s stock with a basis in his stock of $50,000 on January 1. In addition, the S corporation owes Jeff $30,000 on January 1. The debt has a basis of $30,000 and is evidenced by a note. The S corporation reports an ordinary loss of $150,000 for the current year. The next year, it reports ordinary income of $20,000. On January 1 of the third year, the note is repaid. Due to the repayment of the note, Jeff must report what?
Answer:
Page Ref.: C:11-25 and C:11-26

87) Rocky Corporation, an S corporation, reports the following results for the current year:

Ordinary income $70,000
Long-term capital gain 20,000
Municipal bond interest income 10,000
Domestic corporate dividends 6,000
Charitable contributions 16,000

Rocky’s AAA and accumulated E&P balances at the beginning of the year are $80,000 and $50,000, respectively. Rocky makes a $100,000 cash distribution to its sole shareholder on June 1 and a second $100,000 cash distribution on December 1. The shareholder’s basis for Rocky stock on January 1 was $120,000. Discuss the tax consequences of these transactions.
Answer:

Page Ref.: C:11-25 and C:11-28

88) Zebra Corporation has always been an S corporation and is 100% owned by Paul. Paul has a basis of $40,000 in his Zebra stock at the beginning of the year. During the year, Zebra has an ordinary loss of $20,000 and a long-term capital gain of $10,000. In addition, Zebra Corporation distributed $55,000 in cash to Paul on December 1. Will the distribution cause Paul to recognize a gain? If so, what are its amount and character?
Answer:

Page Ref.: C:11-27
89) Caravan Corporation has always been an S corporation. Caravan Corporation is 100%owned by Alan Merten. On January 1, Alan has an adjusted basis of $50,000 in his Caravan stock. During the year, Caravan reports ordinary income of $60,000, a long-term capital gain of $10,000, and a charitable contribution of $5,000. Alan receives a $20,000 cash distribution from Caravan on December 1. What income does Alan recognize from the distribution, and what is his basis in the Caravan stock at year-end?
Answer:
Page Ref.: C:11-27

90) List and discuss five advantages and five disadvantages of electing to be taxed as an S corporation over a C corporation or a partnership.
Answer:
Page Ref.: C:11-5; Example C:11-1

92) Shamrock Corporation has two classes of common stock outstanding. The Class A and Class B common stock give the shareholders identical rights and interests in the profits and assets of the corporation. Class A has one vote per share. Class B is nonvoting. Can Shamrock Corporation make an S corporation election?
Answer:
Page Ref.: C:11-6; Example C:11-2

93) Garret and Hans own all the stock of GH Corporation. Garret sells all his GH stock to Olga on February 12. The next day, GH makes an S election. For the election to apply to the current year, who must consent to the election?
Answer:
Page Ref.: C:11-8; Example C:11-4

94) Swamp Corporation, a calendar-year taxpayer, has been an S corporation for several years. However, the corporation has become quite profitable, and management feels that it would be advantageous to make a public stock offering. What are Swamp Corporation’s options concerning the date of revocation of the S election?
Answer:
Page Ref.: C:11-10; Example C:11-5

95) Zinc Corporation is created in the current year and promptly makes an S election. How much passive income can it earn this year without fear of losing its S corporation status or being subject to the Sec. 1375 tax on excess net passive income?
Answer:
Page Ref.: C:11-10; Example C:11-6
96) Bellows Corporation, a calendar-year taxpayer, has been an S corporation for ten years. Last year, John sold all the Bellows stock to Micky. Payments for the stock are to be made over a five-year period. In March of next year, Micky fails to make the necessary payments and John repossesses the stock. During the time Micky holds the stock, Bellows Corporation revokes its S election. Can Bellows Corporation reelect S status?
Answer: Page Ref.: C:11-12; Example C:11-9

97) What is a permitted year?
Answer:
Page Ref.: C:11-13

98) Can loss or credit carryforwards from a previous C corporation tax year help reduce the built-in gains tax?
Answer: Page Ref.: C:11-17

99) If losses are suspended due to the lack of basis in S corporation stock, do the losses expire when the S election terminates?
Answer:
Page Ref.: C:11-22

100) VJ Corporation is to be owned equally by Vic and Joe. The corporation will be formed by exchanging the assets and liabilities of the V & J Manufacturing Partnership for all the corporation’s stock on September 1 of the current year. Both shareholders use the calendar year as their tax year and desire to make an S election. What tax issues should Vic and Joe consider with respect to the incorporation?
Answer:
Page Ref.: C:11-2 through C:11-8, C:11-12, C:11-13, C:11-23, C:11-24, C:11-35, and C:11-36

101) Woods Corporation has operated as a C corporation for the last seven years. The corporation has assets with a $500,000 adjusted basis and a $700,000 FMV. Liabilities are $200,000. Wolf Woods, a calendar-year taxpayer, owns all of the Woods Corporation stock. The corporation has a June 30 year-end and uses the accrual method of accounting. In order to reduce his total combined corporate and personal federal income tax liability, Wolf’s CPA has told him to convert the corporation to S corporation status. Wolf would like to complete the conversion on the last day of the corporation’s tax year. What tax issues should Wolf and his CPA consider with respect to the S election?
Answer:
Page Ref.: C:11-7, C:11-8, C:11-12 through C:11-18, C:11-35, and C:11-36

102) Troy owns 50% of Dot.Com, an e-commerce company. His S corporation stock basis at the beginning of the year is $300,000. Dot.Com has not done well this year and will report an ordinary loss of $875,000. Troy’s marginal tax rate for the current year is 35%. What tax issues should Troy consider with respect to the loss?
Answer:
Page Ref.: C:11-18 through C:11-23, C:11-33, and C:11-34
103) Cook’s Outlet has been an S corporation since its inception six years ago. On January 1 of the current year, the corporation’s two equal shareholders, Davis and Dane, had adjusted bases of $150,000 and $175,000, respectively, for their S corporation’s stock. The shareholders plan to have the corporation distribute land with a $50,000 adjusted basis and a $200,000 FMV in the current year. Ordinary income is expected to be $180,000 in the current year. What tax issues should Davis and Dane consider with respect to the distribution?
Answer:
Page Ref.: C:11-15 through C:11-17 and C:11-26 through C:11-30

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C12 The Gift Tax

1) The gift tax is a wealth transfer tax that applies to transfers during a person’s lifetime and transfers at death.
Answer:
Page Ref.: C:12-2

2) The annual exclusion permits donors to make gifts of $13,000 each to multiple donees.
Answer:
Page Ref.: C:12-4

3) Molly sells her car, valued at $30,000, to her nephew Todd for $18,000. Molly has made a taxable gift.
Answer:
Page Ref.: C:12-7

4) A qualified disclaimer must be made within nine months after (a) the day the property is transferred, or (b) the day the person receiving the property becomes age 21, whichever is later.
Answer:
Page Ref.: C:12-9

5) Phil transfers $50,000 to a revocable trust benefiting his son, Josh. The transfer is a taxable gift.
Answer:
Page Ref.: C:12-10
6) Mia makes a taxable gift when she makes her mother a joint owner on Mia’s bank account. Mia has $25,000 in the account.
Answer:
Page Ref.: C:12-14

7) The changing of a life insurance policy beneficiary from a spouse to an adult daughter constitutes a gift for transfer tax purposes.
Answer:
Page Ref.: C:12-14

8) A net gift occurs when a donor makes a gift subject to the agreement that the recipient agrees to pay the gift tax.
Answer:
Page Ref.: C:12-15

9) Mike transfers securities to an irrevocable trust and gives Rachel the power to determine who will receive the trust’s income and assets. Rachel, her estate, and her creditors cannot be beneficiaries or receive the trust assets. Rachel has a general power of appointment.
Answer:
Page Ref.: C:12-15

10) A “Crummey demand power” in a trust document allows the donor to demand a distribution from the trust in years in which earnings exist within the trust.
Answer:
Page Ref.: C:12-17 and C:12-18

11) Gift tax returns are filed on a calendar-year basis.
Answer:
Page Ref.: C:12-30 and C:12-31

12) The purchase of a $15,000 engagement ring generates a taxable gift necessitating the filing of a gift tax return.
Answer:
Page Ref.: C:12-30 and C:12-31

13) Identify which of the following statements is true.
A) The gift tax is a wealth transfer tax that applies to transfers during a person’s lifetime and transfers at death.
B) The gift tax is not a part of the unified transfer tax system.
C) Under the unified transfer tax system, taxable gifts made after 1976 are included in the donor’s death tax base.
D) All of the above are false.
Answer:
Page Ref.: C:12-3
14) In 1998, Delores made taxable gifts to her son of property with an FMV of $200,000. In the current year when Delores dies, the property is worth $800,000. The amount included in Delores’s estate tax base because of the 1998 gift is
A) $0.
B) $189,000.
C) $200,000.
D) $800,000.
Answer:
Page Ref.: C:12-4; Example C:12-1

15) In the current year, Cesar, who is single, gives $26,000 to each of his 20 nieces and nephews for a total property transfer of $520,000. Cesar’s taxable gifts total
A) $520,000.
B) $240,000.
C) $300,000.
D) $280,000.
Answer:
Page Ref.: C:12-4
16) Identify which of the following statements is true.
A) If the annual exclusion for gifts is not used in the current year, the unused portion can be carried forward to subsequent years.
B) Individuals may not give more than $13,000 per person in gifts each year before being taxed on the transfer.
C) For transfer tax purposes, both the charitable contribution deduction and the marital deduction are unlimited.
D) All of the above are false.
Answer:
Page Ref.: C:12-5

17) In November 1976, Grant uses $30,000 of the specific exemption available at that time. The unified credit available to Grant for post-1976 transfers is reduced by
A) $0.
B) $6,000.
C) $15,000.
D) $30,000.
Answer:
Explanation: B) $30,000 × 0.20 = $6,000
Page Ref.: C:12-6
18) Barbara sells a house with an FMV of $170,000 to her daughter for $120,000. From this transaction, Barbara is deemed to have made a gift (before the annual exclusion) of
A) $50,000.
B) $170,000.
C) $120,000.
D) $0.
Answer:
Explanation: A) $170,000 – $120,000 = $50,000
Page Ref.: C:12-7

19) In the current year, Bonnie, who is single, sells stock valued at $60,000 to Linda for $15,000. Later that year, Bonnie gives Linda $25,000 in cash. Bonnie’s taxable gifts from these transfers total
A) $70,000.
B) $59,000.
C) $57,000.
D) $25,000.
Answer:

20) Identify which of the following statements is true.
A) A taxable gift may occur when property is sold in an arm’s length transaction for less than its FMV.
B) An individual can inadvertently make a gift by underestimating a property’s fair market value and selling it to a relative for a price below its fair market value.
C) The statutory exemption from the gift tax for payments for medical care requires that the payment be made for a relative.
D) All of the above are false.
Answer:
Page Ref.: C:12-7

21) Vincent makes the following property transfers in the current year:

• $5,000 tuition for a grandson paid directly to the school
• $1,000 medical expense for a child paid directly to a hospital
• $500 donation to the Democratic party
• $10,000 property settlement in conjunction with a divorce
• $3,000 room and board at college for a grandson paid directly to the school

Vincent’s gifts for the year before considering the annual gift tax exclusion total
A) $19,500.
B) $19,000.
C) $3,000.
D) $0.
Answer:
Page Ref.: C:12-8 and C:12-9
22) Identify which of the following statements is true.
A) Cash paid directly to a medical school for room and board is a “qualified transfer” and not subject to the gift tax.
B) Transfers by an individual to a political party constitute a gift subject to the gift tax rules.
C) A statutory exemption from the gift tax is available for property transfers between divorced individuals when the divorce occurs during a three-year period beginning one year before the transfer agreement is made.
D) All of the above are false.
Answer:
Page Ref.: C:12-8 and C:12-9

23) Greg transfers property on August 8 of the current year with an adjusted basis of $40,000 and an FMV of $90,000 to his ex-wife as a property settlement that is part of their divorce agreement. The property settlement agreement and the divorce were both finalized on June 3 of the current year. Greg has made a gift of
A) $0.
B) $40,000.
C) $80,000.
D) $90,000.
Answer:
Page Ref.: C:12-8 and C:12-9

24) Which of the following transactions constitutes a completed gift made by Ellen, a widow, in the current year?
A) Ellen deposits $100,000 cash and Matt deposits $5,000 cash into a joint savings account. Matt does not withdraw anything during the current year.
B) Ellen names Larry the beneficiary of a $100,000 life insurance policy on Ellen’s life. The beneficiary designation is revocable.
C) Ellen transfers property to a revocable trust, naming the bank as trustee. The trustee must pay out all the income to Ed over Ed’s lifetime, beginning next year.
D) Ellen reimburses her granddaughter $15,000 for her tuition at medical school.
Answer:
Page Ref.: C:12-7 through C:12-14

25) Identify which of the following statements is true.
A) An individual making a qualified disclaimer can determine to whom the disclaimed property will pass.
B) A qualified disclaimer must be made within six months after (a) the day the property is transferred, or (b) the day the person receiving the property becomes age 21, whichever is later.
C) One of the tests that a qualified disclaimer must meet is that it must be an irrevocable, unqualified, written refusal to accept property.
D) All of the above are false.
Answer:
Page Ref.: C:12-9
26) Identify which of the following statements is false.
A) A gift occurs when a revocable trust is funded.
B) A gift does not occur until the transfer is complete.
C) A transfer is incomplete (and not subject to the gift tax) if the donor retains the power to name new beneficiaries or to change the interests of the beneficiaries.
D) Transfers to an irrevocable trust can be deemed incomplete.
Answer:
Page Ref.: C:12-10

27) Which of the following transfers is subject to the gift tax?
A) Matilda contributes $5,000 to a Senate candidate’s political organization.
B) Frank gives $30,000 to a lobbying group promoting stricter environmental regulations.
C) Julia establishes a trust benefiting her nieces and nephews. Julia will determine the amount of any distributions made.
D) Lance purchases land, titling it in the names of Lance and Sheryl, joint owners.
Answer:
Page Ref.: C:12-8 and C:12-9

28) Gordon died on January 1 and by his will left land with an adjusted basis of $60,000 and an FMV of $100,000 to Becky. Becky disclaims the property on December 31 of the year of death, when the land was still worth $100,000. Becky has made a gift (before the annual gift tax exclusion) of
A) $100,000.
B) $60,000.
C) $50,000.
D) $0.
Answer:
Page Ref.: C:12-10; Example C:12-13

29) Jack transfers property worth $250,000 to a revocable trust on January 1. Two-and-a-half years later, when the property is worth $300,000, the trust becomes irrevocable. Which of the following statements is correct?
A) A $300,000 gift occurs when the trust became irrevocable.
B) A $250,000 gift occurs when the original transfer was made.
C) A $250,000 gift occurs when the trust became irrevocable.
D) Jack may elect which amount to report as a gift.
Answer:
Page Ref.: C:12-10; Example C:12-15

30) Which of the following statements is true?
A) Transfers to an irrevocable trust can be deemed incomplete due to powers retained by the grantor.
B) If the donor retains the power to change the trust beneficiary, the gift is complete.
C) Transfers to a revocable trust are completed gifts.
D) All of the above are false.
Answer:
Page Ref.: C:12-10 and C:12-11
31) Calvin transfers land to a trust. Calvin retains the right to the income from the land for the rest of his life. Upon his death, the land is to be transferred to his daughter, Melissa. Calvin’s interest is
A) a remainder interest.
B) a life estate.
C) a reversionary interest.
D) a term certain.
Answer:
Page Ref.: C:12-11 and C:12-12

32) Calvin transfers land to a trust. Calvin retains the right to the income from the land for the rest of his life. Upon his death, the land is to be transferred to his daughter, Melissa. Melissa’s interest is
A) a remainder interest.
B) a life estate.
C) a reversionary interest.
D) a term certain.
Answer:
Page Ref.: C:12-11 and C:12-12

33) Calvin transfers land to a trust. His daughter Melissa will receive the income from the land for ten years. After ten years, the land is returned to Calvin. Calvin’s interest is
A) a term certain.
B) a life estate.
C) a reversionary interest.
D) none of the above.
Answer:
Page Ref.: C:12-11 and C:12-12

34) Identify which of the following statements is false.
A) If an individual transfers property in trust and reserves the right to the trust’s income for life, the individual retains a life estate.
B) An individual who receives a remainder interest will receive property after the death of the holder of a life estate.
C) If a grantor transfers property in trust and names a beneficiary to receive only a term-certain interest and then the property is to return to the grantor, the transaction is not subject to gift tax.
D) Life estates are valued using actuarial tables.
Answer:
Page Ref.: C:12-11 and C:12-12

35) Identify which of the following statements is true.
A) The creation of a joint bank account constitutes a taxable gift.
B) The creation of a joint tenancy by one person will result in a gift equal to the other joint tenant’s pro rata interest in the property.
C) The naming of a life insurance policy beneficiary constitutes a gift for transfer tax purposes.
D) Since municipal bond interest is exempt from federal income taxation, gifting the bonds escapes the gift tax.
Answer:
Page Ref.: C:12-14
36) Identify which of the following statements is false.
A) The interpolated terminal reserve is similar to a life insurance policy’s cash surrender value.
B) A gift occurs when the owner of an insurance policy irrevocably assigns all ownership rights in the policy to another.
C) The payment of premiums on an insurance policy that is owned by another does not constitute a gift.
D) The value of the gift of a life insurance policy is the amount it would cost to purchase a comparable policy on the date of the gift.
Answer:
Page Ref.: C:12-14

37) On April 1, Martha opens a joint bank account with Ned and deposits $1,000. Ned deposits $500 into the account on April 2. On May 2, Martha withdraws $750. Two days later, Ned withdraws $600.
A) Martha has made a gift to Ned of $100.
B) Ned has made a gift to Martha of $500.
C) Martha has made a gift to Ned of $600.
D) Martha has made a gift to Ned of $1,000.
Answer:
Page Ref.: C:12-14; Example C:12-23
38) Damitria transfers her rights in a $100,000 insurance policy on June 1 to Tremayne. The policy has a cash value of $9,000 and an interpolated terminal reserve of $8,500. The annual policy premium of $12,000 had been paid on January 1. Damitria’s gift (before the annual gift tax exclusion) to Tremayne is
A) $8,500.
B) $9,000.
C) $15,500.
D) $20,500.
Answer:

39) Which of the following is a completed gift?
A) Greta transfers $50,000 to a revocable trust benefiting her children Hans and Julio.
B) Juan purchases a ski chalet using his own funds, but listing Penelope as a joint owner.
C) Horatio transfers $60,000 to a bank account with Hazel. Hazel does not contribute any money to the account.
D) Mike changes the beneficiary of his policy to Meredith.
Answer:
Page Ref.: C:12-14
40) Identify which of the following statements is false.
A) A power of appointment exists when a person transfers property and grants someone else the power to specify who eventually will receive the property.
B) A person possesses a general power of appointment if the person has the power to appoint property to himself, his creditors, his estate, or the creditors of his estate.
C) The donee’s payment of the gift tax does not reduce the amount of the gift because it is treated as consideration paid to the donor.
D) The donor must recognize as a gain the excess of the gift tax payable over the adjusted basis of the property.
Answer:
Page Ref.: C:12-15

41) Tia funds an irrevocable trust with $100,000, naming Vonda to receive income for life. Tia also grants Vonda a general power of appointment during her life. During the next year, Vonda directs the trustee to give $100,000 to Rick. Which of the following statements is not correct?
A) Tia made a $100,000 gift to Rick.
B) Vonda makes a $100,000 gift to Rick.
C) Tia has made a gift of $100,000 to Vonda.
D) Exercising a general power of appointment constitutes a gift.
Answer:
Page Ref.: C:12-15

42) Identify which of the following statements is true.
A) A purpose of the annual exclusion is to eliminate the necessity of accounting for and reporting small gifts such as those made for weddings and Christmas.
B) The gift tax exclusion is available only for a gift of a present interest.
C) A present interest is an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property.
D) All of the above are true.
Answer:
Page Ref.: C:12-16 and C:12-17

43) Identify which of the following statements is false.
A) A future interest includes reversions, remainders, and other interests, which are limited to commence in use, possession, or enjoyment at some future date or time.
B) The gift tax exclusion is available only for a gift of a present interest.
C) A trust for a minor (Sec. 2503(c) trust) must distribute all of its income currently in order to qualify for the annual exclusion.
D) For a transfer made in trust, each beneficiary is deemed to be a separate donee.
Answer:
Page Ref.: C:12-17

44) Identify which of the following statements is true.
A) The trustee of a Sec. 2503(c) trust must distribute all of the corpus and accumulated income when the beneficiary reaches the age of 25.
B) The gift tax exclusion is available for a gift of a present or future interest.
C) A “Crummey demand power” in a trust document allows the donor to demand a distribution from the trust in years in which assets are transferred to the trust.
D) All of the above are true.
Answer:
Page Ref.: C:12-16 and C:12-17
45) George transfers property to an irrevocable trust for the benefit of his adult children and names himself as trustee. The trust document requires the trustee to distribute trust property to the beneficiaries at the trustee’s discretion with the possibility of no distribution to certain beneficiaries as the trustee deems appropriate. The trust will terminate at the end of nine years, and the property will pass to George’s children. Which of the following statements is correct?
A) The beneficiaries receive a present interest in the trust property when George transfers the assets to the trust.
B) The transfer by George is eligible for the annual gift tax exclusion.
C) George’s transfer of property to the trust is not taxed under gift tax rules at the date of transfer.
D) George’s transfer of property to the trust is a gift of a future interest.
Answer:
Page Ref.: C:12-16 and C:12-17

46) A Sec. “2503(c) trust”
A) is a discretionary trust for a beneficiary of any age.
B) is intended for beneficiaries over the age of 20.
C) requires distribution of trust assets to the beneficiary at age 21.
D) can be formed only by the parent(s) of the beneficiaries.
Answer:
Page Ref.: C:12-17

47) Marilyn and Earl establish a trust benefiting their grandchild, Courtney, age 4. Courtney is to receive the accumulated income and corpus when she reaches age 30. In the year of the transfer, Courtney has a two-week period in which to request distributions. This trust is a
A) 2503(c) trust.
B) Clifford trust.
C) Crummey trust.
D) none of the above
Answer:
Page Ref.: C:12-17 and C:12-18

48) A Crummey trust
A) provides the donor with the ability to retrieve the property.
B) prohibits the beneficiary from withdrawing assets.
C) allows the donor an annual exclusion for transfers.
D) receives property that is not eligible for the annual exclusion.
Answer:
Page Ref.: C:12-17 and C:12-18

49) Why are Crummey trusts popular for minors?
A) They are considered gifts of a future interest and allow the donor to take an exclusion.
B) They are considered gifts of a present interest, permitting an annual gift tax exclusion.
C) Crummey trusts require annual distributions to minors.
D) Donors are only subject to the gift tax when funds are distributed from Crummey trusts.
Answer:
Page Ref.: C:12-17 and C:12-18
50) Identify which of the following statements is false.
A) The marital deduction for gift tax purposes is limited to one-half the value of the property transferred.
B) The marital deduction is generally allowed since the transfer remains within the economic (husband/wife) unit.
C) The marital deduction for gift tax purposes is limited to the amount of the includible gift (e.g., the amount of the gift that is in excess of the annual exclusion).
D) Transfers of community property are eligible for the marital exclusion.
Answer:
Page Ref.: C:12-19

51) Identify which of the following statements is true.
A) When making a QTIP transfer, the donor does not control who will receive the property on the death of the donee-spouse.
B) The marital deduction is limited to the amount of the gift that exceeds the annual exclusion.
C) Claiming the marital deduction on a QTIP transfer is mandatory.
D) Terminal interests cannot be eligible for the marital deduction.
Answer:
Page Ref.: C:12-19 and C:12-20

52) A husband transfers $90,000 by gift directly to his wife. The marital deduction for the transfer is
A) $0 unless he elects to claim one.
B) $90,000.
C) $78,000.
D) none of the above
Answer:
Page Ref.: C:12-19; Example C:12-33

53) In the current year, Melanie makes two transfers to Peter, her husband. In June, she gives him land valued at $50,000. In December, she transfers $500,000 to a trust with a bank named as trustee. All income must be paid to Peter monthly for life. At Peter’s death, the property passes to their children. Compute the maximum marital deduction assuming Melanie makes the appropriate elections.
A) $550,000
B) $537,000
C) $500,000
D) $50,000
Answer:

Page Ref.: C:12-19 and C:12-20
54) A split-interest gift transfer
A) involves two public (charitable) organizations.
B) involves two present interests.
C) qualifies for a charitable contribution deduction if the recipient charity receives a guaranteed annuity, which is a present interest.
D) cannot qualify for a deduction if a future interest is given to a charitable organization.
Answer:
Page Ref.: C:12-22

55) Hu makes a gift of his home to a local homeless shelter (a 501(c)(3) charity). Hu will retain his home for 10 years, after which the homeless shelter will take possession. The value of Hu’s 10-year interest is $30,000 and the remainder interest is valued at $120,000. Which of the following statements is correct?
A) Hu is allowed a charitable deduction on his gift tax return for $150,000 in the current year.
B) Hu is allowed an exclusion of $12,000 on his gift of $120,000 to the charity.
C) Hu is not allowed to deduct the contribution until the charity takes possession in 10 years.
D) Hu has a charitable contribution deduction of $120,000 on his current gift tax return.
Answer:
Page Ref.: C:12-22; Example C:12-39

56) Identify which of the following statements is false.
A) The gift-splitting election will apply to all transfers made during the portion of any year that the spouses electing gift splitting are married to each other.
B) The gift-splitting election is made separately on each gift either spouse makes.
C) Making gifts during one’s lifetime helps to reduce the amount of estate taxes owed at death.
D) In order to use gift splitting, both spouses must be U.S. citizens or residents at the time of the transfer.
Answer:
Page Ref.: C:12-22 and C:12-23

57) A gift-splitting election
A) requires each spouse to give property.
B) may result in lower marginal gift tax rates.
C) results in a $6,500 per donee annual exclusion for each spouse.
D) is binding on future years.
Answer:
Page Ref.: C:12-22 and C:12-23
58) Sandra, who is married, creates an irrevocable trust in the amount of $200,000 for her 18-year-old daughter, Kelly. She names the bank as trustee. Before Kelly reaches age 21, the trustee may pay the income to Kelly. Kelly will receive any undistributed assets when she reaches age 21. If Kelly dies before age 21, the assets will be paid to her estate. In addition, Sandra creates an irrevocable trust for her son, Kevin, age 21. He is entitled to withdraw up to $26,000 per year. Sandra contributes $13,000 in the current year. Sandra elects gift splitting with her husband. Her husband makes no gifts in the current year. Sandra’s annual exclusions to be claimed on her gift tax return total
A) $26,000.
B) $15,500.
C) $12,000.
D) $0.
Answer:

Page Ref.: C:12-22 and C:12-23

59) In the current year, Donna gives $50,000 cash and $30,000 of stock to Mike. She also gives $40,000 of tax-exempt bonds to Angela. Her husband, Andy, gives $200,000 of land to Angela. Assume the couple elects gift splitting for the current year. Donna’s taxable gifts total
A) $134,000.
B) $148,000.
C) $110,000.
D) $60,000.
Answer:

Page Ref.: C:12-22 and C:12-23

60) The computation of the gift tax liability for a current year
A) is made without reference to previous years.
B) requires the use of current-year tax rates only.
C) requires the use of different rates, depending on when the gifts were made.
D) requires knowledge of the total gift taxes paid in previous years.
Answer:
Page Ref.: C:12-23
61) Gloria makes the following gifts during the year:

$15,000 cash to her son, Andy
Stock with a basis of $10,000 and a $30,000 fair market value to her sister, Helen
$100,000 to a revocable trust benefiting her nephew, George
Land with a basis of $60,000 and a fair market value of $50,000 to the American Cancer Society

Before considering the unified credit, what are Gloria’s taxable gifts?
A) $19,000
B) $45,000
C) $95,000
D) $121,000
Answer:

Page Ref.: C:12-25 and C:12-26

62) Steve gave stock with an adjusted basis of $7,000 and an FMV of $10,000 to Alice. No gift tax was paid. Later, Alice sold the stock for $12,000. The gain Alice will recognize on the sale is
A) $5,000.
B) $2,000.
C) $0.
D) none of the above
Answer:

Page Ref.: C:12-26

63) Virginia gave stock with an adjusted basis of $8,000 and an FMV of $10,000 to Carmen. No gift tax was paid on the transfer. Carmen then sold the stock for $9,000. The gain or loss Carmen will recognize on the sale is
A) $2,000 gain.
B) $1,000 gain.
C) $1,000 loss.
D) none of the above
Answer:
Page Ref.: C:12-26

64) Tracy gave stock with an adjusted basis of $18,000 and an FMV of $15,000 to her nephew Phil. No gift tax was paid. Phil sold the stock for $16,000. The gain or loss Phil will recognize on the sale is
A) $1,000 gain.
B) $0.
C) $1,500 loss.
D) none of the above
Answer:

Page Ref.: C:12-27
65) Miguel gives Roberta land with an adjusted basis of $50,000 and an FMV of $40,000. No gift tax is paid. Roberta sells the land for $36,000. Roberta recognizes
A) no loss.
B) a $4,000 loss.
C) a $14,000 loss.
D) none of the above
Answer:
Page Ref.: C:12-27

66) Ed gives Steve land with an adjusted basis of $40,000 and an FMV of $90,000. Ed paid no gift tax. Ed then inherits the same land back from Steve at Steve’s death eight months later. At Steve’s death, the land is worth $120,000. Ed’s basis in the land becomes
A) $120,000.
B) $90,000.
C) $40,000.
D) cannot be determined from the facts given
Answer:
Page Ref.: C:12-27

67) In 2009, Letty makes taxable gifts totaling $4 million. Her only other taxable gifts amount to $1 million, all of which were made in 1986. What is Letty’s 2008 gift tax liability before the unified credit?
A) $2,220,800
B) $1,875,000
C) $1,840,800
D) $1,785,000
Answer:
Page Ref.: C:12-26

68) Identify which of the following statements is true.
A) If the gifted property’s FMV on the date of the gift exceeds its adjusted basis and the donor pays no gift tax, the donee’s basis is the same as the donor’s basis if the property is sold for a loss.
B) Prospective donors should not dispose of property that has declined in value by selling it rather than gifting it.
C) A $13,000 annual exclusion per donee is available for both gift tax and estate tax purposes.
D) All of the above are false.
Answer:
Page Ref.: C:12-27
69) Interest-free or below-market loans
A) must always have interest imputed on them.
B) may result in treating the borrower as paying interest.
C) result in treating the entire loan proceeds as a gift.
D) will always result in at least $1,000 of interest income being imputed.
Answer:
Page Ref.: C:12-28

70) On July 1, Frank loans his brother Matt $200,000. The loan is evidenced by an interest-free demand note. The loan is still outstanding on December 31. The applicable interest rate is 12%. Frank is treated as having made a gift of
A) $200,000.
B) $24,000.
C) $12,000.
D) $0.
Answer:
Page Ref.: C:12-28; Example C:12-44

71) Elaine loaned her brother, Mike, $175,000 to purchase a new home. Elaine does not charge Mike any interest on the loan. What are the tax consequences to Elaine and Mike?
A) Elaine is treated as having made a gift of the forgone interest on the $175,000 loan to Mike.
B) Elaine only has to impute interest on $75,000 of the loan to Mike.
C) If Mike has no net investment income, Elaine does not have to treat the forgone interest as a gift.
D) Mike can deduct the interest that he is deemed to have paid Elaine.
Answer:
Page Ref.: C:12-28; Example C:12-44

72) On January 1, Jeff loans his friend Patrick $7,000 to buy a used car. Patrick signs a nointerest-bearing demand note. The applicable interest rate is 5%. Which of the following statements is correct?
A) Jeff has made a taxable gift to Patrick of $3,500.
B) Jeff must report interest income of $3,500 from Patrick.
C) Jeff has made a gift to Patrick that is not taxable since it is less than $11,000.
D) Interest does not have to be imputed on the gift since the loan amount is less than $10,000 and does not have a tax avoidance motive.
Answer:
Page Ref.: C:12-28

73) Roger makes a $1,000,000 cash gift on January 1 of the current year, and dies on February 1 of the current year. Roger’s gift tax return is due
A) April 15 of the current year.
B) December 31 of the current year.
C) April 15 of the next year.
D) nine months after his date of death.
Answer:
Page Ref.: C:12-31
74) Identify which of the following statements is false.
A) Gift tax returns are due annually by April 15 following the year of the gift. No extensions are allowed.
B) The donor pays the gift tax generally.
C) Gift tax returns are filed on a calendar-year basis.
D) Receipt of an extension of time for filing a gift tax return does not extend the due date for payment of the gift tax.
Answer:
Page Ref.: C:12-31

75) Which of the following situations requires that a gift tax return be filed?
A) George gives wife, Laura, a new car for her birthday.
B) Yanisha makes gifts of $3,000 of present interest property to each of her nieces and nephews.
C) Archie pays the hospital medical bills for his friend Paige.
D) Ida purchases a beach home, listing Mark as a joint tenant. Mark provides no consideration for the home.
Answer:
Page Ref.: C:12-30 and C:12-31

76) Which of the following statements is true?
A) If the donor does not pay the gift tax, the donee is personally liable for the tax.
B) When a married couple elects gift splitting, each spouse is potentially liable for 50% of the gift tax.
C) Gift tax returns are due March 15 in the year following the gift.
D) Donors can request an automatic extension of time to pay their gift tax even when they don’t request to have an income tax extension.
Answer:
Page Ref.: C:12-31

77) Discuss the ways in which the estate and gift tax system is a unified system.
Answer:
Page Ref.: C:12-3 and C:12-4

78) Jennifer and Terry, a married couple, live in Illinois; which is a common law state. In the current year, Terry gives his sister $200,000 cash. Jennifer and Terry agree to gift splitting. Neither Jennifer nor Terry has made any taxable gifts in prior years. What are Jennifer and Terry’s taxable gifts?
Answer:
Page Ref.: C:12-5
79) Connie has some acreage that is valued at $1,500,000. Her daughter would like to build a home on it, but can only afford $500,000. Connie agrees to sell it to her daughter for $500,000. Is there any gift tax consequence as a result of this transaction?
Answer:
Page Ref.: C:12-5

80) In October 1976, Marian made a large taxable gift. It was her first gift. Marian used her $30,000 specific exemption to reduce her taxable gift amount. What impact does this gift have on her unified credit and death tax base?
Answer:
Page Ref.: C:12-7; Example C:12-5

81) Discuss the statutory exemptions from the gift tax.
Answer:
Page Ref.: C:12-7 through C:12-9
82) Ida sells some stock to Mae for $20,000 at a time when the stock is valued at $50,000. Later in the year, she gives Mae $15,000 in cash.
a) What is the amount of Ida’s taxable gifts?
b) How would your answer to Part (a) change if Ida gave the cash to Jonathan instead of to Mae?
Answer:
Page Ref.: C:12-7 and C:12-16

83) Yuli wants to help his adult grandson, Jerry, become a CPA. He pays all of Jerry’s tuition this year, which totals $20,000. He also pays $9,000 for Jerry’s room and board at school. Yuli makes the payments directly to the school. What are the gift tax consequences?
Answer:
Page Ref.: C:12-8

84) Bryce pays $10,000 for his adult grandson’s tuition at medical school and $8,000 for the grandson’s room and board in the medical school’s dormitory. All payments are made directly to the medical school. Do these payments by Bryce qualify as gifts?
Answer:
Page Ref.: C:12-8

85) Ward and June decide to divorce after 30 years of marriage. Ward transfers $500,000 to June in settlement of her property rights. What are the gift tax consequences of this transfer?
Answer:
Page Ref.: C:12-9

86) Abby transfers $10,000 to a political organization to promote her favorite candidate for president. Does Abby’s transfer qualify as a gift?
Answer:
Page Ref.: C:12-9; Example C:12-10

87) On March 1, Bruce transfers $300,000 to a revocable trust with Sprint Bank as trustee. The trustee must pay out all the income to Sam during Sam’s lifetime. At Sam’s death, the property is to be paid to Sam Jr. On December 31, the trustee distributes $40,000 of income to Sam. What date did a gift occur? What was the amount of the gift?
Answer:
Page Ref.: C:12-10; Example C:12-14
88) Karen purchased a beach house for $300,000 and immediately titled it in the names of Karen and Kenny, as joint tenants with right of survivorship. Karen and Kenny are not married. Did a gift occur? If so, for what amount?
Answer:
Page Ref.: C:12-14; Example C:12-24

89) On June 1, Sherri deposits $60,000 into a new joint bank account in the names of Sherri and John. Her friend John makes no deposits. On December 15th, John withdraws $25,000 from the joint account. What are the gift tax consequences, if any?
Answer:
Page Ref.: C:12-14

90) On September 1, George transfers his entire ownership rights in a $250,000 life insurance policy on his own life to his sister, Sally. The policy’s interpolated terminal reserve is $30,000 as of September 1. On July 1, George had paid the policy’s $6,000 annual premium. What are the gift tax consequences, if any?
Answer:
Page Ref.: C:12-14

91) On September 1, George transfers his entire ownership rights in a $250,000 life insurance policy on his own life to his sister, Sally. The policy’s interpolated terminal reserve is $30,000 as of September 1. On July 1, George had paid the policy’s $6,000 annual premium. On July 1 of the subsequent year, George again paid the premium on the policy. What are the gift tax consequences in the subsequent year, if any?
Answer:
Page Ref.: C:12-14

92) Discuss the purpose of the gift tax annual exclusion.
Answer: Page Ref.: C:12-16

93) What is a “net gift” and what is the potential income tax problem associated with making a net gift?
Answer:
Page Ref.: C:12-15
94) Donna transfers $200,000 of property to an irrevocable trust with a bank as trustee. Donna names Toby (age 60) to receive all of the trust income for the rest of his life. At Toby’s death, the property is to pass to Al or Al’s estate. What kind of interest do Toby and Al possess?
Answer: Page Ref.: C:12-17; Example C:12-30

95) Contrast the Crummey trust with the Sec. 2503(c) trust.
Answer:

Page Ref.: C:12-17 and C:12-18

96) In the current year, Martha makes the transfers below to her husband, Ryan. What is the amount, if any, of her marital deduction?
a) In August, she gives him a house valued at $250,000.
b) In December, she gives him a 15-year income interest in a trust with the bank name as trustee. She names her son as the remainderman. The trust is irrevocable and is funded with $500,000 of assets, and 8% is the applicable interest rate.
Answer:

Page Ref.: C:12-18 and C:12-19

97) What are the requirements for classifying a transaction as a transfer of a qualified terminable interest property (QTIP)?
Answer:
Page Ref.: C:12-19 and C:12-20
98) In 2009, Lilly makes taxable gifts aggregating $5 million. Her only other taxable gifts amount to $1 million, all of which were made in 1998. What is her gift tax liability?
Answer:
Page Ref.: C:12-24 and C:12-25

99) Discuss at least two reasons for making inter vivos (lifetime) gifts.
Answer:
Page Ref.: C:12-29 and C:12-30

100) Discuss the negative aspects of gifts.
Answer:
Page Ref.: C:12-30
101) What is the due date for the gift tax return? Are there any exceptions? If so, what are they?
Answer:
Page Ref.: C:12-30
102) Describe the penalties for undervaluing gifts on a gift tax return.
Answer:
Page Ref.: C:12-31

103) Kenny is thinking of making a substantial gift of stock to his fiancée, Maria. The wedding is scheduled for October 1 of the current year. Kenny already has exhausted his unified credit. He also is considering giving $26,000 cash this year to each of his three children by a previous marriage. What tax issues should Kenny consider with respect to the gifts he plans to make to Maria and his three children?
Answer:
Page Ref.: C:12-4, C:12-5 and C:12-18
104) Terry is considering transferring assets valued at $400,000 to an irrevocable trust for the benefit of her son, Cliff, age 15, with First National Bank as trustee. Her attorney has drafted a trust agreement that provides that Cliff is to receive income at the trustee’s discretion for the next 20 years and that at age 35, the trust assets will be distributed equally between Cliff and his sister Joanna. Terry anticipates that her husband will consent to gift splitting. What tax issues should Terry and her husband consider with respect to the trust she is creating?
Page Ref.: C:12-4, C:12-5, C:12-15 through C:12-18

105) Jason funds an irrevocable trust with Liberty Bank as trustee and reserves the right to receive the income for seven years. He provides that at the end of the seventh year, the trust assets will pass outright to his adult daughter, Paula, or to Paula’s estate should Paula not be alive. Jason transfers assets valued at $1.5 million to the trust; the assets at present are producing income of about 7.5% per year. Assume that the Sec. 7520 rate per the actuarial tables for the month of the transfer is 10%. What tax issues should Jason consider regarding the trust?
Answer:
Page Ref.: C:12-12 and C:12-13

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C13 The Estate Tax

1) The estate tax is a wealth transfer tax.
Answer:
Page Ref.: C:13-2

2) The tax base for the federal estate tax is the total of the decedent’s taxable estate and post-1986 taxable gifts if the decedent made gifts in 1981.
Answer:
Page Ref.: C:13-2

3) In 2009, the unified credit enables an estate valued at $3,500,000 or less to not be subject to the estate tax.
Answer:
Page Ref.: C:13-5

4) Listed stocks are valued at their closing price on the date of death.
Answer:
Page Ref.: C:13-6

5) An executor can value each asset in an estate at the lower of its FMV at death or the alternate valuation date.
Answer:
Page Ref.: C:13-7 and C:13-8

6) The probate estate includes property that passes by will or an intestacy statute and does not include property that passes due to a beneficiary designation.
Answer:
Page Ref.: C:13-9

7) Taxpayers can avoid the estate tax by making gifts at least a year prior to death.
Answer:
Page Ref.: C:13-10 and C:13-11

8) A special power of appointment exists if the holder can exercise the power in favor of himself or herself, his or her creditors, or the creditors of his or her estate.
Answer:
Page Ref.: C:13-15

9) Administrative expenses are not deductible on the estate’s income tax return.
Answer:
Page Ref.: C:13-18

10) A terminable interest is one that ceases upon the passage of time or the occurrence of some event.
Answer:
Page Ref.: C:13-21
11) An executor may elect to postpone payment of the estate tax attributable to a remainder or reversionary interest until 6 months after the interests of the other person(s) terminate.
Answer:
Page Ref.: C:13-28

12) The estate tax return is due, ignoring extensions, 3-1/2 months after the decedent’s date of death.
Answer:
Page Ref.: C:13-35

13) Identify which of the following statements is true.
A) The tax base for the federal estate tax is the total of the decedent’s taxable estate and post-1976 taxable gifts.
B) Property included in a decedent’s gross estate consists of only that property to which the decedent held title.
C) Funeral expenses are not deductible from the gross estate.
D) All of the above are false.
Answer:
Page Ref.: C:13-2

14) Martin transfers stock to an irrevocable trust and names himself to receive the trust income for life with the remainder interest gifted to his son. When Martin dies,
A) none of the stock will be included in Martin’s estate.
B) the stock’s value at the time of transfer to the trust will be included in Martin’s estate.
C) the value of the stock less the present value of the income receivable by Martin will be included in Martin’s estate.
D) the value of the stock at death will be included in Martin’s estate.
Answer:
Page Ref.: C:13-2

15) Which of the following is deductible in arriving at the amount of the taxable estate?
A) expenses incurred in administering the estate
B) casualty losses that occurred while administering the estate
C) charitable contributions
D) All of the above are deductible.
Answer:
Page Ref.: C:13-3

16) For 2009, the unified credit is equivalent to a statutory exemption of
A) $1,000,000.
B) $1,500,000.
C) $780,800.
D) $3,500,000
Answer:
Page Ref.: C:13-5

17) Identify which of the following statements is true.
A) The unified credit is the only credit common to both the gift and estate tax computation.
B) For estate tax purposes, publicly traded stocks are valued at their closing price on the date of death.
C) Stocks traded on a stock exchange are valued at the closing price for the date of death unless the alternate valuation date is elected.
D) All of the above are false.
Answer:
Page Ref.: C:13-5

18) The FMV of an asset for gift or estate tax purposes is the same except for
A) marketable securities.
B) land.
C) life insurance policies.
D) patents.
Answer:
Page Ref.: C:13-6

19) Brent, who died on January 10, owned 10 shares of Potts Corporation stock. The closest trading dates to January 10 are January 8 (two working days before the date of death) and January 11 (one working day after the date of death). On January 8, the stock traded at a high of 101 and a low of 97, while on January 11, the high was 90 and the low was 86. The date-of-death per-share value is
A) $99.00.
B) $95.33.
C) $93.50.
D) $91.67.
Answer:

20) The value of stock that is not publicly traded may be determined by considering
A) the nature and history of the business.
B) earning capacity.
C) dividend-paying capacity.
D) all of the above
Answer:
Page Ref.: C:13-7

21) Appraisal methods used to value real estate for estate tax purposes may include
A) comparable sales.
B) reproduction cost.
C) capitalization of earnings.
D) all of the above
Answer:
Page Ref.: C:13-7
22) Reversionary interests in publicly traded stocks included in a gross estate must be valued
A) by an independent actuary.
B) by an appraiser.
C) by considering the fact that the transferor has died.
D) using actuarial tables.
Answer:
Page Ref.: C:13-7

23) The alternate valuation date is generally
A) 3 months after the date of death.
B) 6 months after the date of death.
C) 9 months after the date of death.
D) 12 months after the date of death.
Answer:
Page Ref.: C:13-7

24) Denise died April 1 and owned several bonds that paid interest March 31 and September 30. Also, she owned stock that paid dividends quarterly on March 31, June 30, September 30, and December 31. Denise’s estate received the interest and dividends on the payment dates. What should be included in Denise’s gross estate?
A) all interest and dividends received in the year of death.
B) only interest and dividends received prior to the date of death
C) only interest and dividends received after the date of death
D) none of the interest and dividends received
Answer:
Page Ref.: C:13-7

25) Identify which of the following statements is false.
A) The “blockage” regulations allow the IRS to prevent the estate’s executor from electing the alternate valuation date.
B) If the alternate valuation date is elected, changes in value that occur solely because of a “mere lapse of time” usually are to be ignored.
C) The alternate valuation date can be elected for estate tax purposes only if the election decreases the value of the gross estate and estate tax liability (after reduction for credits).
D) If property is sold within 6 months of the date of death, the alternative valuation date is the date of sale.
Answer:
Page Ref.: C:13-7 and C:13-8

26) The alternate valuation date can be elected for estate tax purposes only if the election
A) increases the value of the gross estate.
B) decreases the value of the gross estate.
C) decreases the estate tax liability (after reduction for tax credits).
D) Both B and C are required.
Answer:
Page Ref.: C:13-8

27) Identify which of the following statements is true.
A) The alternate valuation date can be used for estate tax purposes only if the election increases the value of the gross estate.
B) If the alternative valuation date is elected, changes in value that occur solely because of “mere lapse of time” usually are to be ignored.
C) The gross estate, a federal law concept, is generally smaller than the probate estate, a state law concept.
D) All of the above are false.
Answer:
Page Ref.: C:13-8

28) Identify which of the following statements is true.
A) A courtesy interest is a widower’s interest in his deceased wife’s property.
B) All gifts made within three years of the date of death must be included in the gross estate.
C) Dower rights are not the same as courtesy rights.
D) All of the above are false.
Answer:
Page Ref.: C:13-10

29) On March 1, Bart transfers ownership of a $700,000 life insurance policy on his life that he purchased in 2002. How long must Bart live to avoid inclusion of the $700,000 death benefit in his estate?
A) six months
B) one year
C) three years
D) No minimum time period exists.
Answer:
Page Ref.: C:13-10

30) Four years ago, Roper transferred to his son ownership of a $100,000 life insurance policy that Roper purchased on his own life in 2000. The cash value of the policy on the transfer date was $25,000. Roper died on March 1 of this year. The amount included in Roper’s gross estate due to the life insurance policy is
A) $0.
B) $25,000.
C) $35,000.
D) $100,000.
Answer:
Page Ref.: C:13-11; Example C:13-13

31) On March 1, Sue transfers stock worth $20,000 to Frank. How long must Sue live to avoid inclusion of the $20,000 of stock in her gross estate?
A) six months
B) one year
C) three years
D) No minimum time period exists, but she must be alive at transfer of ownership.
Answer:
Page Ref.: C:13-11; Example C:13-14

32) The gross-up rule requires
A) all beneficial interests be included in the decedent’s estate.
B) post-1976 gifts by the decedent be included in the decedent’s estate.
C) certain gifts made by the decedent within three years of the date of death are included in the decedent’s gross estate.
D) gift taxes on gifts made by the decedent or the decedent’s spouse that are paid by the decedent or his estate during the three-year period ending with the decedent’s date of death must be included in the decedent’s gross estate.
Answer:
Page Ref.: C:13-11

33) In February of the current year, Tom dies. Two years and nine months before the date of death, Tom made a gift of stock valued at $2 million. Gift taxes paid on the transfer by Tom were $435,000 after reduction for a $345,800 unified credit ($780,800 – $345,800). At the time of his death, the gifted stock was valued at $2.3 million. The amount included in Tom’s gross estate from this transfer is
A) $2,000,000.
B) $2,300,000.
C) $435,000.
D) none of the above
Answer:
Page Ref.: C:13-11; Example C:13-15

34) In 2012, Paul transfers $1,000,000 to a trust benefiting his three children. As trustee, he has the power to determine the amount of distributions each year. Paul dies in the current year when the trust has a value of $1,200,000. How much of the trust’s value is included in Paul’s estate?
A) $0
B) $400,000
C) $1,000,000
D) $1,200,000
Answer:
Page Ref.: C:13-11 and C:13-12

35) Identify which of the following statements is true.
A) The gross-up rule applies to the gift tax triggered by a gift during a three-year look-forward period.
B) All gift taxes paid by the decedent on gifts made within five years of the date of death must be included in the gross estate.
C) If a transferor retains voting rights in stock of a controlled corporation for the transferor’s lifetime, the stock is included in the transferor’s gross estate.
D) All of the above are false.
Answer:
Page Ref.: C:13-12

36) Identify which of the following statements is true.
A) Reversionary interests of less than 5% are includible in the gross estate.
B) A reversionary interest means a chance exists that the property may pass back to the transferor under the terms of the transfer.
C) If a reversionary interest exceeds 3% of the property’s value, the amount that is included in the estate is not the value of the reversionary interest, but rather the date-of-death value of the gifted property less the value of intervening life estates.
D) All of the above are false.
Answer:
Page Ref.: C:13-12

37) Dan transfers an apartment building to Grace but retains the right to the rental income for 10 years. Dan dies nine years after the transfer when the building is worth $600,000. The applicable federal rate is 10% and the reversionary actuarial factor is 0.30. How much would be included in Dan’s estate?
A) $0
B) $150,000
C) $350,000
D) $600,000
Answer:
Page Ref.: C:13-12; Example C:13-18

38) In 2001, Alejandro buys an annuity for $100,000 that will pay Alejandro an annual amount for life with survivor benefits to his wife. When Alejandro dies in the current year, a comparable contract would have cost $81,000. What amount is included in Alejandro’s gross estate?
A) $0
B) $81,000
C) $100,000
D) $181,000
Answer:
Page Ref.: C:13-13

39) Identify which of the following statements is false.
A) Annuities not related to employment are valued in the gross estate at the cost of a comparable contract multiplied by a fraction that represents the portion of the purchase price that the decedent has contributed.
B) If an annuity ceases payments with the death of the decedent and nothing is to be received by any other party, the annuity is included in the gross estate.
C) When persons other than spouses own property jointly, the amount included in the joint owner’s gross estate is measured in accordance with the consideration the decedent furnished to purchase the property.
D) Statements A and C are true.
Answer:
Page Ref.: C:13-13

40) Yoyo Corporation maintains a retirement plan for its employees to which it makes 70% of the contributions and the employees make 30%. Gary dies this year and is employed at the time of his death. Gary’s spouse will receive an annuity valued at $600,000 from the retirement plan. How much of the annuity will be included in Gary’s gross estate?
A) $600,000
B) $420,000
C) $180,000
D) $0
Answer:
Page Ref.: C:13-14; Example C:13-24

41) In 2001, Polly and Fred, brother and sister, purchased a condominium at a golf resort. Polly contributed 60% of the $200,000 cost; Fred contributed 40%. Polly dies in the current year when the condominium has a $300,000 value. How much is included in Polly’s estate?
A) $120,000
B) $180,000
C) $200,000
D) $300,000
Answer:
Page Ref.: C:13-14 and C:13-15

42) Following are the fair market values of Wilma’s assets at her date of death:

Personal effects and jewelry $150,000
Land which Wilma bought and held as a joint
tenant with right of survivorship with her sister 800,000

The executor of Wilma’s estate did not elect the alternate valuation date. The amount includible in Wilma’s gross estate is
A) $150,000.
B) $550,000.
C) $800,000.
D) $950,000.
Answer:
Page Ref.: C:13-14

43) Four years ago, David gave land to Mike that he purchased for $70,000, which is presently worth $100,000. Three years ago, Mike exchanged the land (then worth $150,000) along with a $100,000 cash contribution made by David for a new piece of land worth $250,000. The new land is titled with David and Mike as joint tenants with the right of survivorship. When Mike dies this year, the land is worth $300,000. Mike’s estate will include
A) $0.
B) $150,000.
C) $180,000.
D) $300,000.
Answer:
44) In 1999, Roger gives stock valued at $100,000 to Martha. Roger and Martha are not related. In 2000, Martha uses the stock then valued at $110,000 as partial consideration to acquire realty costing $220,000. Pat (her brother) furnishes the remaining $110,000 of consideration. The realty is titled in the names of Martha and Pat as joint tenants with right of survivorship. This year, Martha dies and Pat survives. The realty is valued at $300,000 at Martha’s death. How much, if any, of the realty’s value will be included in Martha’s estate?
A) $0
B) $110,000
C) $150,000
D) $300,000
Answer:

45) Identify which of the following statements is true.
A) If spouses are the only joint owners, only one-half of the value of the jointly owned property is included in the gross estate, regardless of the relative amount of consideration provided by either spouse.
B) Special powers of appointment give the power holder less restricted powers than a general power of appointment.
C) The gross estate does not include the value of life insurance policies on the decedent if the proceeds are receivable by the executor or for the benefit of the estate.
D) All of the above are false.
Answer:
Page Ref.: C:13-15

46) Proceeds of a life insurance policy payable to the estate’s executor, as the estate’s representative, are
A) includible in the decedent’s gross estate only if the premiums had been paid by the insured.
B) includible in the decedent’s gross estate only if the policy was taken out within three years of the insured’s death.
C) never includible in the decedent’s gross estate.
D) always includible in the decedent’s gross estate.
Answer:
Page Ref.: C:13-16
47) Two years ago, Nils transfers a $200,000 life insurance policy on his life to his daughter, Gail. The policy is worth $60,000 at the time of transfer and Gail pays Nils $50,000. When Nils dies this year, the $50,000 cash is still in a savings account. The consideration offset when computing Nils’s gross estate is
A) $0.
B) $50,000.
C) $150,000.
D) $166,667.
Answer:
Page Ref.: C:13-17; Example C:13-33
48) Ernie died this year. His will creates a $2,000,000 QTIP trust for his widow. Ernie’s executor elects to claim the marital deduction for the QTIP transfer. At the time of the surviving spouse’s death, the value of the QTIP trust is $3.6 million. The amount of the QTIP trust included in the surviving spouse’s gross estate is
A) $3,600,000.
B) $2,000,000.
C) $1,800,000.
D) $0.
Answer:
Page Ref.: C:13-18; Example C:13-34

49) Ted died on May 3. At the time of his death, he owned a beach house valued at $250,000. On June 10, the beach house was completely destroyed by a hurricane and there was no insurance coverage. If the executor elects to use the alternate valuation date, the executor will
A) include the beach house in the gross estate at $250,000.
B) take a casualty loss of $250,000 on the estate tax return.
C) take a casualty loss of $250,000 on the estate’s income tax return.
D) include the beach house in the gross estate at $0.
Answer:
Page Ref.: C:13-19; Example C:13-37

50) Identify which of the following statements is true.
A) Administrative expenses are not deductible on the estate’s income tax return.
B) Casualty or theft losses incurred during the administration of the estate are not deductible on the estate tax return.
C) There is a limitation of $100,000 on the charitable contribution deduction for estate tax purposes.
D) All of the above are false.
Answer:
Page Ref.: C:13-19

51) Identify which of the following statements is true.
A) Regardless of how large the gross estate is, the estate tax liability can be completely eliminated if the estate is willed to a charitable organization.
B) There is a ceiling on the marital deduction.
C) All transfers to the surviving spouse are eligible for the marital deduction.
D) All of the above are false.
Answer:
Page Ref.: C:13-19
52) Identify which of the following statements is false.
A) To qualify for the marital deduction, property must be includible in the decedent’s gross estate.
B) Property is not eligible for the marital deduction if it passes to the spouse under the individual’s dower rights.
C) A terminable interest is one that ceases upon the passage of time or the occurrence of some event.
D) Some, but not all, terminal interests qualify for the marital deduction.
Answer:
Page Ref.: C:13-21
53) Which of the following is not a test for an interest to qualify for the marital deduction?
A) The property must be included in the decedent’s gross estate.
B) If a QTIP transfer is made, the spouse must be entitled to all of the income at least annually for life.
C) The interest conveyed must not be a nondeductible terminable interest.
D) All of the above are required.
Answer:
Page Ref.: C:13-21

54) When computing the federal estate tax liability in 2009, the maximum amount for a taxable estate (not tentative tax) that the unified credit for the current year will eliminate all of the tax is
A) $555,800.
B) $780,800.
C) $3,500,000.
D) $2,000,000.
Answer:
Page Ref.: C:13-23

55) Which of the following credits is available for estate tax purposes?
A) investment tax credit
B) credit for income taxes paid on decedent’s final return
C) credit for estate taxes paid on certain prior transfers
D) All of the above are available.
Answer:
Page Ref.: C:13-25

56) Which of the following is not a credit for purposes of computing the federal estate tax liability?
A) credit for gift tax paid on pre-1977 gifts
B) credit for estate taxes paid on certain prior transfers
C) a credit for foreign death taxes
D) All of the above are credits for the federal estate tax.
Answer:
Page Ref.: C:13-24 and C:13-25

57) Identify which of the following statements is true.
A) If a marital deduction is elected on a QTIP trust transfer, property remaining in the QTIP trust is not included in the estate of the surviving spouse.
B) The credit for state death taxes has been replaced with a deduction for state estate taxes.
C) The unified credit is the only credit allowed against the estate tax.
D) All of the above are false.
Answer:
Page Ref.: C:13-24
58) Identify which of the following statements is true.
A) The credit for taxes paid on prior transfers does not reduce the impact of property being taxed in more than one estate in quick succession.
B) The deduction for state death taxes is not limited.
C) An estate is not entitled to a credit for foreign death taxes paid on property located in a foreign country and included in the gross estate.
D) All of the above are false.
Answer:
Page Ref.: C:13-24

59) Lou dies on April 12, 2007. All of Lou’s property passed to Paula, his daughter. Paula dies on January 15, 2009. Both Lou’s and Paula’s estates pay federal estate taxes. Lou’s estate tax was $350,000. How much can Paula’s estate claim for a credit for tax on prior transfers?
A) $350,000
B) $280,000
C) $210,000
D) $140,000
Answer:
Page Ref.: C:13-25

60) Joe dies late in 2007 and his estate is subject to an estate tax of $2 million. He leaves all of his assets to his daughter, Claudia. Claudia dies in early 2009. Which of the following statements is correct?
A) Claudia’s estate receives no credit or deduction for the tax paid by Joe’s estate.
B) Claudia’s estate receives a credit for $1,000,000 of Joe’s estate tax.
C) Claudia’s estate receives a credit for $2,000,000 of Joe’s estate tax.
D) Claudia’s estate receives a deduction for $2,000,000 of Joe’s estate tax.
Answer:
Page Ref.: C:13-25

61) Betty dies on February 20, 2009. Her estate consisted of the following assets, all valued as of her date of death:

Stock with a basis of $40,000 and a fair market value of $200,000
Home valued at $1,500,000 and a basis of $490,000
Cash of $70,000
Life insurance on Betty’s life owned by her daughter with a $500,000 face value

What is Betty’s gross estate?
A) $600,000
B) $1,100,000
C) $1,770,000
D) $2,270,000
Answer:
Page Ref.: C:13-25 through C:13-27
62) Which of the following circumstances would cause the gifted property to be included in the donor’s gross estate?
I. Donor retains a life estate in the gift property.
II. Donor retains the power to revoke or amend the gift.
III. Donor gives more than $13,000 to one donee in one year.
IV. Donor dies within three years of gifting land.
A) I, II and III
B) I, II
C) II, IV
D) III, IV
Answer:
Page Ref.: C:13-25 through C:13-27

63) One of the major problems facing executors in managing the estate is
A) identifying deductions.
B) liquidity.
C) the unified credit computation.
D) determining the method to value assets.
Answer:
Page Ref.: C:13-28

64) The payment date for estate taxes may be extended by the IRS for all of the following reasons except
A) the estate includes a 40% interest in a closely held business.
B) the estate includes a relatively large remainder or reversionary interest.
C) the executor of the estate shows reasonable cause.
D) All are valid reasons.
Answer:
Page Ref.: C:13-28

65) Identify which of the following statements is true.
A) The period for payment of estate taxes may be extended if the executor shows “reasonable cause” for not being able to pay some, or all, of the estate tax liability on the regular due date.
B) The estate tax on interests in certain closely held businesses may be paid in installments over a 15-year period if elected.
C) An executor may elect to postpone payment of the estate tax attributable to a remainder or reversionary interest until eight months after the interests of the other person(s) terminate.
D) All of the above are false.
Answer:
Page Ref.: C:13-28
66) Identify which of the following statements is true.
A) The estate tax on interests in certain closely held businesses may be paid in installments over a 15-year period if elected.
B) An executor may elect to postpone payment of the estate tax attributable to a remainder or reversionary interest until six months after the interests of the other person(s) terminate.
C) A corporation with 25 owners can be classified as a closely held business if the decedent’s gross estate holds 10% of the stock.
D) All of the above are false.
Answer:
Page Ref.: C:13-28

67) A stock redemption to pay death taxes under Sec. 303 is generally treated as
A) a sale or exchange of property.
B) a dividend.
C) a return of capital.
D) ordinary income.
Answer:
Page Ref.: C:13-29

68) The maximum amount of the stock redemption proceeds under Sec. 303 is determined by summing all of the following except
A) the estate’s death taxes.
B) the estate’s funeral expenses.
C) the estate’s administrative expenses.
D) All are allowable.
Answer:
Page Ref.: C:13-29

69) Identify which of the following statements is false.
A) Special use valuation is available for farmland to help alleviate liquidity problems.
B) The transferee is liable for the generation-skipping transfer tax (GSTT) in the case of a direct skip.
C) The generation-skipping transfer tax (GSTT) is imposed to assure that some form of transfer taxation is imposed once a generation.
D) A direct skip skips one or more generations.
Answer:
Page Ref.: C:13-29 and C:13-30

70) Identify which of the following statements is true.
A) The transferee is liable for the generation-skipping transfer tax (GSTT) in the case of a direct skip.
B) Special use valuation is available for farmland to help alleviate liquidity problems.
C) Qualified disclaimers are not available for estate planning purposes.
D) All of the above are false.
Answer:
Page Ref.: C:13 -29 and C:13-30
71) The GSTT’s (generation-skipping transfer tax) purpose is
A) to impose a graduated transfer tax one time a generation.
B) to impose some form of transfer tax one time a generation.
C) to impose a graduated transfer tax every other generation.
D) to impose some form of transfer tax every other generation.
Answer:
Page Ref.: C:13-30

72) Identify which of the following statements is false.
A) Every grantor is entitled to a $5 million exemption from the GSTT in 2011.
B) If Greg transfers assets directly to his grandson, this transaction would be an example of a direct skip.
C) If Shaad transfers property in trust to his son, with the remainder to his grandson, at the death of the son a taxable termination will result.
D) The GSTT is levied at a flat rate, which is higher than the top rate under the estate tax rate schedule.
Answer:
Page Ref.: C:13-30

73) Sasha gives $1,000,000 to her granddaughter. Sasha has used all of her unified credit and is in the 45% marginal gift tax bracket; ignore the annual exclusion and exemption. What is the amount of her tax on this transfer?
A) $450,000
B) $1,102,500
C) $1,450,000
D) $652,500
Answer:
Page Ref.: C:13-31; Example C:13-52

74) A qualified disclaimer is a valuable estate planning tool because
A) it establishes the value of the disclaimed assets.
B) it qualifies the assets for the alternative valuation date.
C) it is not treated as a gift made by the person who disclaims.
D) it allows the person making the disclaimer to determine the recipient.
Answer:
Page Ref.: C:13-34

75) Identify which of the following statements is false.
A) Life insurance can help provide liquidity for paying estate taxes.
B) Life insurance has the potential for large appreciation.
C) The insured does not have to be the owner of the policy.
D) Life insurance is always part of the estate of the insured.
Answer:
Page Ref.: C:13-34
76) Identify which of the following statements is true.
A) In general, an estate tax return is not required to be filed unless the value of the gross estate and adjusted taxable gifts exceeds the exemption equivalent.
B) Estate taxes must be paid when the return is filed, including any extensions.
C) The estate tax return is due, ignoring extensions, 12 months after the decedent’s date of death.
D) All of the above are false.
Answer:
Page Ref.: C:13-35

77) Melissa transferred $650,000 in trust in 2006: income for life to herself, the remainder to her son. What part, if any, of the value of the trust’s assets will be included in Melissa’s estate?
Answer:
Page Ref.: C:13-2

78) In 2001, Clara made taxable gifts of $2 million. This year, Clara dies with a taxable estate of $4 million. At the time of her death, the FMV of the property Clara gifted in 2001 is $8 million. What is the amount of the estate tax base?
Answer:
Page Ref.: C:13-4; Example C:13-2

79) Yee made $3 million of taxable gifts in 1993 and paid gift taxes (less the unified credit) of $1,098,000. Yee died in 2008 with a taxable estate of $100,000. At current rates, the gift taxes payable on $3 million would be $1,240,800. Yee died in a year when the unified credit was $780,800. Determine her estate tax liability.
Answer:

Page Ref.: C:13-5

80) In 1992, Gert made a $5,000,000 taxable gift. The 1992 gift tax on $5,000,000 was $2,390,000. Gert was entitled to a unified credit of $192,800, resulting in a gift tax of $2,198,000. Assume Gert dies in 2009 when the credit is $780,800 and the marginal rate is 45%, the tax on $5,000,000 would equal $2,130,800 before subtracting any credit. In arriving at Gert’s estate tax liability, what is the amount subtracted for 1992 gift taxes paid?
Answer:
Page Ref.: C:13-5; Example C:13-4

81) Wally died on November 15. His gross estate includes 100 shares of ABC Corporation stock. On November 15, ABC’s stock trades at a high of $100, a low of $92, and a close of $94. What is the per-share value of the stock in Wally’s estate?
Answer:
Page Ref.: C:13-6
82) Julian died on November 1 and owned 100 shares of a New York Stock Exchange stock. The stock traded at a high of 100 and a low of 98 on November 1. It opened at 98 and closed at 100. On Julian’s estate tax return, what will the per-share and total value of the stock be?
Answer:
Page Ref.: C:13-6; Example C:13-6

83) Ray died on March 4. His estate includes some stock and a parcel of land. The stock is still owned by the estate on September 4, but the land is sold on August 30. If Ray’s executor elects the alternate valuation date, what values would be used for estate tax purposes for the stock and the land?
Answer:
Page Ref.: C:13-7; Example C:13-9

84) In 2000, Mike transfers $100,000 of leased land to a trust. The trust income is payable to Mike’s son for 13 years, after which time the land is to revert to Mike. This year, Mike dies when the land is valued at $210,000. The applicable federal rate is 10%, and the reversionary actuarial factor is 0.30. How much of the trust value must be included in Mike’s estate?
Answer:
Page Ref.: C:13-7; Example C:13-8

85) Donna died on June 1 of the current year. The executor considers the following information when preparing her estate tax return:
• In 1997, Donna transfers title to her personal residence to her son. The residence is worth $60,000 on the transfer date. Donna continued to live alone in the residence until her death. She did not pay any rent. At her death, the residence is worth $100,000.
• In 1998,Donna created an irrevocable trust and funded it with $300,000 of assets. Donna names a bank as trustee. According to the trust agreement, all the trust income is to be paid out annually for 25 years. The trustee, however, is to decide how much income to pay each year to Donna’s son and daughter. Upon termination of the trust, the assets are to be distributed equally among her two children or their estates. The trust’s assets are worth $320,000 when Donna dies.
• In 1998, Donna created a revocable trust with a bank named as trustee. She named her grandchild Joe as the beneficiary for life. Upon Joe’s death, the property is to be distributed equally among Joe’s descendants. The trust assets are worth $300,000 when Donna dies. How much would be included in Donna’s gross estate?
Answer:
Page Ref.: C:13-9, C:13-11, and C:13-12

86) Mary creates and funds a revocable trust. Mary names her son to receive the income for life and her grandson to receive the property upon the son’s death. What are Mary’s powers with respect to the trust, and how will the trust be treated in her estate?
Answer:
Page Ref.: C:13-13; Example 13-21
87) In 1997, Barry and Fred provide $20,000 and $60,000 of consideration, respectively, to purchase a beach house titled in both their names as joint tenants with right of survivorship. Barry dies in the current year and is survived by Fred. The beach house is valued at $100,000. What amount must be included in Barry’s gross estate for the beach house?
Page Ref.: C:13-15; Example C:13-25

88) Five years ago, George and Jerry (his brother) provide $40,000 and $60,000, respectively, to purchase realty titled in the names of George and Jerry as joint tenants with right of survivorship. George dies in the current year and is survived by Jerry. At the time of George’s death, the realty is valued at $300,000. What is the value of the realty in George’s gross estate?
Answer:
Page Ref.: C:13-15; Example C:13-25

89) The following items were discovered in reviewing materials for John’s estate tax return:
(1) Two years ago, John sold stock to his son, Patrick, for $30,000. At the date of sale, the stock had a value of $65,000. The value of the stocks at John’s death was $90,000.
(2) John owned a beach house, worth $500,000, with his sister, Amber, who paid for it.
(3) John’s home was held in a tenancy by the entirety with his wife, Julia. Julia paid for the house, which had a value of $300,000 on the date of his death.
(4) John’s clothing and other personal belongings are worth $3,700 on the date of his death.
What amount is included in John’s estate?
Answer:
Page Ref.: C:13-14 and C:13-15

90) Karen died on May 5 of the current year. Her executor elects date-of-death valuation. Karen’s gross estate possibly includes the following items:
• Joint checking account (with her husband), which has a balance of $10,000. Her husband did not contribute to the account.
• Joint savings account (with her daughter), which has a balance of $50,000. Her daughter did not contribute to the account.
• Life insurance policy on the life of Karen, having a face value of $400,000. The cost of a comparable policy immediately before Karen’s death is $150,000. Karen’s estate is the beneficiary.
• Life insurance policy on the life of Karen’s daughter, having a face value of $100,000 with an interpolated terminal reserve immediately before Karen’s death of $30,000.
Unexpired premiums are $5,000. Karen is the beneficiary. How much, if any, of these items are included in Karen’s estate?
Answer:
Page Ref.: C:13-14 and C:13-16
91) At Mark’s death, Mark owed a debt of $40,000 plus $2,000 of accrued interest. Mark’s funeral expenses were $5,000, and Mark’s charge card had a balance due of $400. The expected administration costs for the estate are $2,000. Assume the estate will owe no income taxes in the next few years and that the taxable estate is expected to be in excess of $1 million. What amount should the estate deduct?
Answer:
Page Ref.: C:13-19; Example C:13-35

92) On December 1, 1976, Bart made a gift and claimed a $30,000 specific exemption. When Bart died in 2008, his tax base was $2,000,000. Assuming the maximum unified credit is $780,800, what is the credit available when computing Bart’s estate tax is what?
Answer:
Page Ref.: C:13-24; Example C:13-43

93) Guy died this year. His estate includes a closely held business interest valued at $400,000 and other property valued at $675,000. Guy’s allowable Sec. 2053 and 2054 deductions total $75,000. Within three years of death, partly in hopes of qualifying his estate for the installment payment allowed under Sec. 6166 treatment, Guy made gifts of listed securities of $350,000 (at 2002 valuations) and paid no gift tax on the gift. Is Guy’s estate eligible for Sec. 6166 treatment?
Answer:
Page Ref.: C:13-35; Example C:13-55

94) Outline and briefly describe the estate tax computation, beginning with the gross estate.
Answer:
Page Ref.: C:13-3
95) Explain how shares of stock traded on a stock exchange are valued. What is the blockage rule?
Answer: Page Ref.: C:13-6

96) Discuss the transferor provisions relating to the estate tax, and provide three examples of transactions governed by the transferor provisions.
Answer:
Page Ref.: C:13-10 through C:13-13

97) Explain why living trusts are popular tax-planning vehicles.
Answer:
Page Ref.: C:13-12 and C:13-13

98) Compare the tax treatment of administration expenses with that of the decedent’s debts.
Answer:
Page Ref.: C:13-17 and C:13-18

99) List the various categories of estate tax deductions, and compare them with the categories of gift tax deductions. What differences exist?
Answer:
Page Ref.: C:13-18 through C:13-22

100) Mr. Howell died this year. He willed a copyright with a 10-year remaining life to Mrs. Howell. His will also sets up a trust for the benefit of Mrs. Howell whom he entitles to receive all of the income semiannually until the earlier of her remarriage or her death. Upon her remarriage or death, the trust property is to be distributed to their children. Do the copyright and trust transfers qualify for the marital deduction? Explain.
Answer:
Page Ref.: C:13-21 and C:13-22

101) Compare the credits available for estate tax purposes with the credits available for gift tax purposes. What differences exist?
Answer:

Page Ref.: C:13-23 through C:13-25

102) Briefly discuss how inter vivos gifts can be used to reduce the size of the estate tax base.
Answer:
Page Ref.: C:13-32

103) Discuss some of the factors to be considered in determining the amount of property that should pass under the marital deduction.
Answer:
Page Ref.: C:13-33

104) Michael Moriarty, a widower, is quite elderly and is beginning to do some estate planning. His goal is to reduce his transfer taxes. He is considering purchasing land with a high potential for appreciation and owning it with his grandson as joint tenants with rights of survivorship. Michael would provide all of the consideration, estimated to be about 11.5 million. What tax issues should Michael Moriarty consider with respect to the purchase of the land?
Answer:
Page Ref.: C:13-10, C:13-11, C:13-14, C:13-22, C:13-30 and C:13-31

105) Praneh Patel, a widower, died in March of the current year. His gross estate is $5,325,000, and at the time of his death, he owed debts of $40,000. His will made a charitable bequest of $280,000 and left the rest of his property to his children. His administrative expenses are estimated to be about $55,000. What tax issues should the estate’s CPA consider when preparing Praneh’s estate tax return and his estate’s income tax return?
Answer:
Page Ref.: C:13-17 through C:13-19 and C:13-22

106) Mary Johnson dies early in the current year. All her property passes subject to her will, which states that all of her property is to go to a QTIP trust for Dan for life with the remainder to their children. Mary’s gross estate is about $5 million, and her Sec. 2053 deductions are very small. Dan, who is in poor health, already owns about $3 million of property. What tax issues should Dan Johnson and the estate’s executor consider with respect to the property that passes to the QTIP trust?
Answer:
Page Ref.: C:13-17, C:13-21, C:13-22, C:13-32 and C:13-33
107) Lily dies early in the current year. All her property passes subject to her will, which provides that her surviving husband, Rick, is to receive all the property outright. Her will further states that any property Rick disclaims will pass instead to their children in equal shares. Lily’s gross estate is about $5 million, and her Sec. 2053 deductions are very small. Rick, who is in poor health, already owns about $3 million of property. What tax issues should Rick consider with respect to the property bequeathed to him by his wife?
Answer:
Page Ref.: C:13-33

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C14 Income Taxation of Trusts and Estates

1) For purposes of trust administration, the term “sprinkling” relates to the mandatory distribution of income among various beneficiaries.
Answer:
Page Ref.: C:14-3

2) A trust receives no standard deduction when computing taxable income.
Answer:
Page Ref.: C:14-8

3) A complex trust permits accumulation of current income, provides for charitable contributions, or distributes principal during the taxable year.
Answer:
Page Ref.: C:14-9

4) The distribution deduction for a complex trust is the lesser of the amount distributed or distributable net income, reduced by net tax-exempt income.
Answer:
Page Ref.: C:14-20

5) The personal exemption available to a trust is adjusted annually based on changes in the consumer price index.
Answer:
Page Ref.: C:14-10

6) Distributable net income (DNI) does not include capital gains allocated to principal.
Answer:
Page Ref.: C:14-11

7) The $3,000 limitation on deducting net capital losses does not apply to a trust.
Answer:
Page Ref.: C:14-16
8) Distributable net income (DNI) is not reduced by the charitable contribution deduction when calculating the deductible discretionary distributions for a complex trust.
Answer:
Page Ref.: C:14-20

9) Income in respect of a decedent (IRD) is included in the decedent’s final income tax return.
Answer:
Page Ref.: C:14-27

10) Income in respect of a decedent (IRD) includes interest earned by a cash-basis taxpayer but not received by the taxpayer before death.
Answer:
Page Ref.: C:14-28

11) Grantor trusts are taxed as complex trusts.
Answer:
Page Ref.: C:14-30

12) Trusts are required to make estimated tax payments.
Answer:
Page Ref.: C:14-35

13) A tax entity, often called a fiduciary, includes all of the following except
A) estates.
B) complex trusts.
C) testamentary trusts.
D) All of the above are fiduciaries.
Answer:
Page Ref.: C:14-2

14) Which of the following statements is incorrect?
A) The income tax rules governing estates and trusts are generally identical.
B) Income generated by property owned by an estate or trust is reported on that entity’s tax return.
C) Subchapter K contains the special rules applicable to estates and trusts.
D) All of the above are correct.
Answer:
Explanation: C) Subchapter J contains the rules.
Page Ref.: C:14-2

15) An inter vivos trust may be created by all of the following except a
A) grantor.
B) trustor.
C) executor.
D) transferor.
Answer:
Page Ref.: C:14-2
16) The executor or administrator is responsible for all the following estate duties except
A) preserving the estate’s existence as a separate taxpayer.
B) collecting the assets.
C) paying the debts and taxes.
D) distributing the property.
Answer:
Page Ref.: C:14-2

17) Beneficiaries of a trust may receive
A) an income interest only.
B) a remainder interest only.
C) both an income and a remainder interest.
D) Any of the above is correct.
Answer:
Page Ref.: C:14-3

18) Revocable trusts means
A) the transferor may not demand the assets be returned.
B) income or estate tax savings for the grantor.
C) the assets in the trust avoid probate.
D) the grantor is always the beneficiary.
Answer:
Page Ref.: C:14-3

19) Identify which of the following statements is false.
A) For purposes of trust administration, the term “sprinkling” relates to the discretionary authority of the trustee to distribute income among various beneficiaries.
B) The IRS may terminate an estate as a taxpayer after the expiration of a reasonable period of time for performance of the administrative duties.
C) Assets in a revocable trust do not avoid probate.
D) Assets in a revocable trust are included in the gross estate.
Answer:
Page Ref.: C:14-3

20) Which of the following statements regarding the taxation of a trust is incorrect?
A) An irrevocable trust’s income is taxed to the grantor.
B) Trusts are generally not taxed at favorable rates for income shifting.
C) Trusts are not subject to double taxation.
D) A trust’s long-term capital gains are taxed at a top rate of 15%.
Answer:
Page Ref.: C:14-4
21) Identify which of the following statements is false.
A) A conduit approachthat is, the income has the same character in the hands of the beneficiary as it has to the trustgoverns for fiduciary income taxation.
B) Essentially, an estate or trust is taxed on any income it earns, whether retained or distributed.
C) Many of the same rules that determine the calculation of taxable income for individuals apply to trusts.
D) Trusts receive a personal exemption.
Answer:
Page Ref.: C:14-4

22) The conduit approach for fiduciary income tax means
A) the distributed income has the same character in the hands of the beneficiary as it has to the trust.
B) the distributed income goes to all beneficiaries proportionately.
C) the distributed income is determined by the trustee annually.
D) the distributed income of a remainder interest is determined by the property.
Answer:
Page Ref.: C:14-4

23) Texas Trust receives $10,000 interest on U.S. Treasury bonds and $15,000 interest on State of New York bonds. All $25,000 is distributed to the trust beneficiary, Gary. Which of the following statements is correct?
A) Gary has $25,000 of ordinary gross income.
B) Gary has $10,000 of taxable interest income and $15,000 of tax-free interest income.
C) Gary has no taxable income because the trust must pay the tax.
D) Gary has $10,000 of capital gain and $15,000 of tax-free interest income.
Answer:
Page Ref.: C:14-4; Example C:14-3

24) The term “trust income” when not preceded by an explanatory word relates most closely to
A) gross income.
B) taxable income.
C) distributable net income.
D) net accounting income.
Answer:
Page Ref.: C:14-5

25) A trust has net accounting income of $15,000. In addition, the trust has a $10,000 capital gain, which is not included in net accounting income. The trust is required to distribute the trust income to the beneficiary. The beneficiary will receive
A) $10,000.
B) $15,000.
C) $24,700.
D) $25,000.
Answer:
Page Ref.: C:14-5; Example C:14-4
26) If a state has adopted the Revised Uniform Principal and Income Act, which of the following statements is correct?
A) The state law definition of trust income will preempt any other definitions.
B) The definition of trust income in the trust document will preempt all other definitions.
C) Under state law, tax-exempt interest will not be allocated to income.
D) The definition of principal in the trust document must classify capital gains as principal.
Answer:
Page Ref.: C:14-5 and C:14-6

27) Identify which of the following statements is false.
A) State trust law preempts the trust document when defining income.
B) The Uniform Act on principal and income requires depreciation to be charged against income.
C) A statement in the trust instrument concerning the allocation of depreciation to principal or income overrides a provision of state law.
D) The Uniform Act allocates royalties to both principal and income.
Answer:
Page Ref.: C:14-5

28) Estates and trusts
A) are taxed on state and municipal bond interest.
B) are not taxed on capital gains.
C) receive a deduction for administrative expenses not otherwise deducted on the estate tax return (Form 706).
D) receive a $1,000 personal exemption.
Answer:
Page Ref.: C:14-8

29) Identify which of the following statements is false.
A) A trust receives no standard deduction when computing taxable income.
B) Trust tax preparation fees are miscellaneous itemized deductions and subject to the 2% nondeductible floor.
C) There is no limit on a fiduciary’s charitable contribution deduction if such a contribution is authorized in the trust instrument.
D) All of the above are false.
Answer:
Page Ref.: C:14-8

30) Identify which of the following statements is false.
A) The personal exemption for a trust provides a tax savings when some income is allocated to principal.
B) Distributable net income (DNI) sets the ceiling on the amount of distributions taxed to the beneficiaries.
C) A complex trust must distribute all its income annually.
D) The beneficiaries of a simple trust are taxed on their share of DNI irrespective of the amount they receive.
Answer:
Page Ref.: C:14-9
31) Charitable contributions made by a fiduciary
A) are limited to 50% of fiduciary income.
B) must be authorized in the trust instrument in order to be deductible.
C) flows through to be deducted on the beneficiary’s tax return.
D) are subject to the 2% floor.
Answer:
Page Ref.: C:14-8

32) A trust distributes 30% of its income to Mark and 20% to Nancy. The remaining 50% is accumulated. The trust’s depreciation is $1,000. The trust instrument is silent regarding the depreciation deduction. State law requires the depreciation be charged to principal. What part of the depreciation deduction will be allocated to Mark?
A) $0
B) $200
C) $300
D) $1,000
Answer:

33) A simple trust
A) may make charitable distributions.
B) may make discretionary distributions of principal.
C) may accumulate income.
D) is required to distribute all of its income currently.
Answer:
Page Ref.: C:14-9

34) A trust is required to distribute 10% of its income to Eleanor. In addition, the trustee in his discretion may distribute income to Eleanor and/or Marshall. The trust has net accounting income of $50,000, none of which is tax-exempt. The trust distributes the $5,000 mandatory payment to Eleanor and also distributes discretionary amounts of $5,000 to Eleanor and $5,000 to Marshall. How much must Eleanor include in income?
A) $5,000
B) $10,000
C) $50,000
D) none of the above
Answer:
Page Ref.: C:14-9

35) Yellow Trust must distribute 33% of its income annually to Patrick. In addition, the trustee in its discretion may distribute additional income to Minna or Patrick. In the current year, the trust has net accounting income and distributable net income of $150,000, none from tax-exempt sources. The trust makes a $50,000 mandatory distribution to Patrick and a discretionary distribution of $20,000 each to Patrick and Minna. What amounts of income do Patrick and Minna report?
A)
Patrick Minna
$ 50,000 $0

B)
Patrick Minna
$ 70,000 $20,000

C)
Patrick Minna
$170,000 $0

D)
Patrick Minna
$150,000 $20,000

Answer:
Page Ref.: C:14-9

36) The exemption amount for an estate is
A) $0.
B) $100.
C) $300.
D) $600.
Answer:
Page Ref.: C:14-10

37) A trust that is required to distribute all of its income annually receives a personal exemption for the year of
A) $0, because it retains no income.
B) $100.
C) $300.
D) $600.
Answer:
Page Ref.: C:14-10

38) A trust is required to distribute all of its income annually. It distributes all of the income and $2,000 of principal to the beneficiary. Which of the following statements is correct?
A) The trust is a complex trust and is allowed a $300 exemption.
B) The trust is a complex trust and is allowed a $100 exemption.
C) The trust is a simple trust and is allowed a $300 exemption.
D) The trust is a simple trust and is allowed a $100 exemption.
Answer:
Page Ref.: C:14-10
39) Which of the following is not an addition to trust taxable income when computing distributable net income (DNI)?
A) distribution deduction
B) capital gains allocated to principal
C) tax-exempt interest
D) personal exemption
Answer:
Page Ref.: C:14-11

40) A trust has the following results:

Net tax-exempt interest $10,000
Net accounting income 64,000
Trustee fees charged to corpus 2,000

The Uniform Act is followed. The trust document requires one-fifth of the income to be distributed annually to David and the remainder of the income to Patty. What is distributable net income?
A) $74,000
B) $72,000
C) $64,000
D) $62,000
Answer:

41) Identify which of the following statements is true.
A) The personal exemption available to a trust is adjusted annually based on changes in the consumer price index.
B) Income received by a trust beneficiary has the same character it had at the trust level.
C) Distributable net income (DNI) excludes tax-exempt income.
D) All of the above are false.
Answer:
Page Ref.: C:14-15

42) A simple trust has a distributable net income (DNI) of $50,000 and net accounting income of $60,000, all from taxable sources. The trust has a sole beneficiary, Marty. The trust reports on a calendar tax year and distributes the $60,000 of 2008’s net accounting income to Marty on January 20, 2009. No other distributions are made in the current year. Marty’s taxable income from the trust this year is
A) $0.
B) $49,700.
C) $50,000.
D) $60,000.
Answer:
Page Ref.: C:14-16
43) Identify which of the following statements is true.
A) Beneficiaries of simple trusts are taxed currently on their pro rata share of taxable distributable net income (DNI) regardless of the actual amount distributed to them during the period.
B) The income received by the beneficiaries of the trust loses its character once it is distributed.
C) Capital losses remaining in the final year of a trust do not pass through to the beneficiaries succeeding to the trust property.
D) All of the above are false.
Answer:
Page Ref.: C:14-16

44) A trust is required to distribute all of its income currently. Two years ago, it had a $10,000 capital loss. Last year, it had a $3,000 capital gain. This year, the trust is terminated. Albert has a 40% interest in the trust, and Barbara has a 60% interest. Barbara receives a capital loss pass-through of
A) $0.
B) $2,400.
C) $4,200.
D) $7,000.
Answer:

45) In the current year, a trust has distributable net income (DNI) of $30,000. During the year, the trust makes a mandatory distribution to Sarah of $5,000 and a discretionary distribution of $10,000 to Kyle. The trust has no tax-exempt income. The distribution deduction of the trust is
A) $30,000.
B) $15,000.
C) $10,000.
D) $5,000.
Answer:
Page Ref.: C:14-18

46) Panther Trust has net accounting income and distributable net income of $100,000, $75,000 from taxable sources and $25,000 from tax-exempt sources. During the year, the trust makes a mandatory distribution to Julius and Steve of $50,000 each. The distribution deduction is
A) $25,000.
B) $50,000.
C) $75,000.
D) $100,000.
Answer:
Page Ref.: C:14-18
47) Panther Trust has net accounting income and distributable net income of $100,000, $75,000 from taxable sources and $25,000 from tax-exempt sources. During the year, the trust makes a mandatory distribution to Julius and Steve of $50,000 each. How much of Steve’s distribution is taxable?
A) $12,500
B) $25,000
C) $37,500
D) $50,000
Answer:
Page Ref.: C:14-18

48) Identify which of the following statements is true.
A) In a complex trust, distributable net income (DNI) does not act as a ceiling on the amount of the distribution deduction.
B) Distributable net income (DNI) is not reduced by the charitable contribution deduction when calculating the deductible discretionary distributions for a complex trust.
C) In a complex trust, distributable net income (DNI) is not reduced by the charitable contribution deduction when comparing DNI with the mandatory distributions in order to determine the amount of the distribution deduction.
D) All of the above are false.
Answer:
Page Ref.: C:14-20

49) Identify which of the following statements is true.
A) Tax-exempt income is allocated among beneficiaries in the proportion that total tax-exempt income bears to total distributable net income (DNI).
B) Both income required to be distributed currently and discretionary income distributions are included in tier-1 distributions.
C) Under the tier system, tier-2 beneficiaries are the first to absorb income.
D) All are false.
Answer:
Page Ref.: C:14-21

50) Apple Trust reports net accounting income of $40,000, all from taxable sources. The trustee is required to distribute $15,000 annually to Megan. The trustee also makes discretionary distributions of $30,000, $7,500 to Megan and $22,500 to Caroline. The trust pays $5,000 of the discretionary distributions from corpus. What is the taxable amount of the Megan’s tier-2 distribution?
A) $7,500
B) $6,250
C) $15,000
D) $22,500
Answer:
51) Identify which of the following statements is true.
A) An individual cannot be both a tier-1 and tier-2 beneficiary in the same year.
B) Tier-2 beneficiaries potentially can receive more favorable tax treatment than tier-1 beneficiaries.
C) Bequests of specific sums of money when distributed out of an estate result in the recognition of gross income by the beneficiary receiving the bequest.
D) All of the above are false.
Answer:
Page Ref.: C:14-22

52) A trust has net accounting income of $30,000, but distributable net income (DNI) of only $25,000 because certain expenses are charged to principal. The trust is required to distribute $10,000 to Alice and it makes a discretionary distribution of $20,000 to Ben. The trust has no tax-exempt income. The amount that Ben reports as gross income is
A) $20,000.
B) $16,667.
C) $15,000.
D) none of the above
Answer:
Page Ref.: C:14-22

53) A trust has net accounting income and distributable net income (DNI) of $60,000, all from taxable sources. The trustee is required to distribute $40,000 of current income to Harry. In addition, the trustee makes a discretionary distribution to Harry of $10,000 and a discretionary distribution to Susan of $30,000. $20,000 of the $40,000 total discretionary distributions is from corpus. Gross income reportable by Harry is
A) $50,000.
B) $45,000.
C) $37,500.
D) $30,000.
Answer:
Page Ref.: C:14-22

54) Martha died and by her will, specifically bequeathed, and the executor distributed, $20,000 cash and a $70,000 house to Harold. The distributions were made in a year in which the estate had $65,000 of DNI, all from taxable sources. The maximum Harold will be required to report as gross income as a result of these distributions is
A) $0.
B) $20,000.
C) $65,000.
D) $70,000.
Answer:
Page Ref.: C:14-23
55) An estate made a distribution to its sole beneficiary of $15,000 for the year. This distribution was not the result of a specific bequest. The estate had $40,000 of taxable interest and $34,000 of expenses attributable to earning that interest. What amount of the distribution is taxable to the beneficiary?
A) $40,000
B) $15,000
C) $6,000
D) $0
Answer:
Page Ref.: C:14-23

56) Fred, a cash-basis taxpayer, died on January 15, 2007. In 2008, the estate made a $9,000 distribution from estate income to Fred’s sole heir. The estate had $20,000 of taxable interest and a $10,000 net long-term capital gain allocable to corpus. The estate incurred $5,000 in expenses attributable to the estate income. What is the estate’s distributable net income (DNI)?
A) $15,000
B) $20,000
C) $25,000
D) $30,000
Answer:
Page Ref.: C:14-23

57) Apple Trust reports net accounting income of $40,000, all from taxable sources. The trustee is required to distribute $15,000 annually to Megan. The trustee also makes discretionary distributions of $30,000, $7,500 to Megan and $22,500 to Caroline. The trust pays $5,000 of the discretionary distributions from corpus. What is the amount of the distribution deduction?
A) $40,000
B) $45,000
C) $15,000
D) $30,000
Answer:
Page Ref.: C:14-25

58) An example of income in respect to a decedent (IRD) for a cash method of accounting taxpayer is
A) interest earned but not received prior to death.
B) salary earned but not received prior to death.
C) gain from an installment sale entered into before death.
D) All of the above are examples.
Answer:
Page Ref.: C:14-27 and C:14-28
59) Joyce passed away on January 3 while on an extended holiday cruise celebrating a very successful, and most profitable previous year. Joyce was the chief executive officer of the Quillip Corporation. After the independent audit of Quillip’s last year’s financial statements was completed in February of this year, Joyce’s estate received a $1,000,000 bonus check resulting from last year’s corporate profits. Joyce’s estate also sold Quillip stock for $500,000 in February of this year. Joyce originally purchased this stock eight years ago for $10,000. The stock was valued at $495,000 on her date of death. Solely based on the above facts, how much income in respect of a decedent should Joyce’s estate report in the current year?
A) $1,485,000
B) $1,000,000
C) $485,000
D) $5,000
Answer:
Page Ref.: C:14-27 and C:14-28

60) Identify which of the following statements is true.
A) Income in respect of a decedent (IRD) is the gross income the decedent earned before death but had not collected before death.
B) An estate may deduct up to $5,000 of capital losses against the ordinary income taxable in the estate.
C) An example of income in respect of a decedent (IRD) is the gain recognized on property sold by the estate after the decedent’s death.
D) All of the above are false.
Answer:
Page Ref.: C:14-27

61) Identify which of the following statements is false.
A) Federal estate taxes related to income in respect of a decedent (IRD) is deductible by the estate in the year the IRD is includible in the estate’s gross income.
B) An example of deductions in respect of a decedent (DRD) are property taxes that accrued prior to the decedent’s death but were not paid until after death.
C) Items of IRD receive a step-up in basis as a result of the decedent’s death.
D) Interest earned but not received before death is IRD.
Answer:
Page Ref.: C:14-27 and C:14-28

62) Michael died last year with a taxable estate and estate tax base of $2,000,000. Michael’s estate owed no state death taxes. Michael’s estate includes $250,000 of income in respect of a decedent (IRD), none of which is received by his surviving spouse. His estate had no DRD. The estate collects $200,000 of the IRD during its current tax year. The Sec. 691(c) deduction for the estate in current year is
A) $153,000.
B) $122,400.
C) $112,500.
D) $90,000.
Answer:
Page Ref.: C:14-29; Example C:14-31

63) Identify which of the following statements is true.
A) Under the grantor trust rules, a grantor may be taxed on all or a portion of the trust’s income even though the income is distributed to the named beneficiary or someone else.
B) An irrevocable trust cannot be a grantor trust.
C) Large amounts of income can be shifted to children under the age of 18 through the use of trusts that make distributions, and the income will be taxed at the lower rates of the children.
D) All of the above are false.
Answer:
Page Ref.: C:14-30

64) Sally transfers property to a revocable trust. Under the terms of the trust agreement, Allison is to receive income for ten years at which time the remainder is to go to Tom. During the year, the trust earns $10,000 in corporate bond interest income and recognizes a capital gain of $20,000. The interest is distributed to Allison and the capital gain is properly allocated to principal. Allison (not Sally) will pay tax on
A) $0.
B) $10,000.
C) $20,000.
D) $30,000.
Answer:
Page Ref.: C:14-31; Example C:14-33

65) Five years ago, Jon transferred stock to an irrevocable trust with First Bank named as trustee, and provided that the trustee is to pay some or all of the trust income to the beneficiary Dan for 15 years. At the end of the 15th year, the trust property, including any undistributed income, will revert to Jon. In the current year, the trust collected $52,000 of dividend income, and distributed $30,000 of this amount to Dan. In addition, the trust sold some of the stock at a $6,000 capital gain. For the current year, the tax results occurred?
A) Dan is taxed on $30,000 of dividends and the trust on the remaining dividends, plus the capital gain, less the $100 personal exemption.
B) The trust is taxed on the $52,000 of dividends less the $100 personal exemption, and Jon is taxed on the capital gain.
C) Dan is taxed on $30,000 of dividends, and the remaining dividends plus the capital gain are taxed to Jon.
D) Jon is taxed on all of the dividends and on the capital gain.
Answer:
Page Ref.: C:14-30 and C:14-31

66) In which of the following situations will the grantor trust rules apply?
A) The trust is revocable and mandates the distribution of income to the named beneficiary.
B) The trust is irrevocable, and the trustee, who is also the grantor, has the power to distribute or accumulate income for the named beneficiary.
C) The trust is irrevocable, the income must be paid out currently, and the trust assets will revert to the grantor at the end of nine years.
D) The grantor trust rules will apply in each of the situations.
Answer:
Page Ref.: C:14-30 through C:14-33

67) Karly created a $300,000 trust that provided her mother with a lifetime income interest starting on January 1, with the remainder to go to her son. Karly expressly retained the power to revoke both the income and remainder interests at any time. Who will be taxed on the trust’s income?
A) Karly’s mother
B) Karly’s son
C) Karly
D) the trust
Answer:
Page Ref.: C:14-31

68) Which of the following is the most accurate statement concerning the use of trusts in tax planning?
A) The grantor trust rules allow grantors to shift income into trusts and reduce their own taxes.
B) Nontax reasons for the use of trusts (such as avoidance of probate) typically outweigh tax reasons for creating trusts today.
C) The large 15% tax bracket available to trusts allows complex trusts to be used as an income-shifting device.
D) None of the above statements are correct.
Answer:
Page Ref.: C:14-30

69) All of the following are advantages of a sprinkling trust, except
A) the trustee can choose the amount to distribute among multiple beneficiaries.
B) the trustee can determine the amount to retain in the trust.
C) the trustee can determine the amount to distribute to the sole trust beneficiary.
D) the trustee can consider the tax rates of the beneficiaries and trust.
Answer:
Page Ref.: C:14-34

70) Marge died on August 24 of the current year. Her estate collected taxable bond interest of $10,000 per month beginning in September. The only beneficiary of Marge’s estate is Art, a calendar-year taxpayer. Which of the following statements is correct?
A) If the estate selects November 30 as a year-end and makes no distributions prior to that date, the estate will be taxed on $30,000 less a $600 personal exemption for its first tax year.
B) If the estate selects January 31 of next year at its year-end and distributes $40,000 to Art in December of this year and nothing in January, the $40,000 will be taxed on Art’s next year’s tax return.
C) If the estate selects December 31 as its year-end and distributes nothing to Art in December and $40,000 in January of next year, $40,000 less the $600 personal exemption will be taxed on the estate’s first tax return.
D) All of the above are correct.
Answer:
Page Ref.: C:14-35

71) Mary died this year. Her will creates a trust for the benefit of her children. A portion of the estate’s assets are placed in this trust. The estate has income from assets it will transfer to other beneficiaries at a later date. Mary’s brother Joe is the trustee of the trust and executor of the estate. Which of the following statements is true?
A) Joe must choose December 31 as the tax year-end for both the estate and trust.
B) Joe is free to choose any tax year-end for both the trust and estate.
C) Joe must choose December 31 as the estate tax year-end but is free to choose any tax year-end for the trust.
D) Joe must choose December 31 as the trust tax year-end but is free to choose any tax year-end for the estate.
Answer:
Page Ref.: C:14-34

72) Administration expenses incurred by an estate
A) are deductions in respect of a decedent and may be deducted on both the estate tax return (Form 706) and the estate income tax return (Form 1041).
B) an executor must elect where to deduct administration expenses (Form 706 or Form 1041).
C) such expenses are only deductible on Form 706.
D) such expenses are only deductible on Form 1041.
Answer:
Page Ref.: C:14-35

73) Identify which of the following statements is true.
A) All trusts and estates must use a calendar year-end.
B) All estates with gross income of at least $500 must file an income tax return.
C) Trusts are required to make estimated tax payments.
D) All of the above are false.
Answer:
Page Ref.: C:14-35

74) Briefly discuss the reasons for establishing a trust.
Answer: Page Ref.: C:14-3

75) Briefly discuss some of the reasons for using a revocable trust.
Answer: The grantor may wish to have his property managed by an individual or institution with superior management skills.
The grantor may wish to avoid high probate costs. The grantor may wish to avoid the publicity of probate.
Page Ref.: C:14-3

76) This year, the Huang Trust received $20,000 of dividends and $30,000 of tax-free interest. It distributes all of its receipts to its beneficiary. How should the beneficiary treat the distribution?
Answer:
Page Ref.: C:14-4; Example C:14-3

77) The governing instrument for the Lopez Trust contains no definitions of income and principal. The Trust is located in a state that has adopted the Uniform Act. In the current year, the trust reports the following receipts and disbursements:

Dividends $10,000
Proceeds from sales of stock, including $10,000 of gain $40,000
Trustee’s fee, all charged to income $ 500
CPA’s fee for preparation of tax return $ 200

What is the trust’s net accounting income?
Answer:
Page Ref.: C:14-6; Example C:14-5

78) A trust document does not define income and principal. The state in which the trust is operated has adopted the Uniform Act. The trust reports the following:

Dividends $2,500
Capital gain 1,500
Tax return preparation fee 200
Trustee fees, all charged to income 100

What is the amount of trust’s net accounting income?
Answer:
Page Ref.: C:14-6; Example C:14-5

79) Little Trust, whose trust instrument is silent with respect to depreciation, collects rental income of $20,000 and pays property taxes of $1,000. Depreciation expense is $5,000.

Little Trust is in a state where all depreciation is charged to principal. What is the trust’s net accounting income?
Answer:
Page Ref.: C:14-6; Example C:14-6

80) A trust document does not define income or principal. The state in which the trust is operated has adopted the Uniform Act, including allocation of depreciation to income. The trust reports the following:

Net business profits $20,000
Net rental income 5,000
Proceeds from stock sale
(including $10,000 gain) 50,000
Trustee fee (charged to income) 2,000
Depreciation 3,000

What is the amount of the trust’s net accounting income?
Answer:

81) A trust document does not mention the treatment for depreciation. The state has adopted the Uniform Act. The trust results are the following:

Business net profits $2,000
Rental income 1,000
Depreciation 100
Rent expense 100

Calculate net accounting income.
Answer:
Page Ref.: C:14-6

82) Ebony Trust was established two years ago with Brent as the beneficiary. The trust instrument instructed the trustee last year to make discretionary distributions of income to Brent. Beginning in two years, the trustee is instructed to pay all of the trust income earned that year to Brent. What was the trust’s personal exemption last year? What will the personal exemption be in two years?
Answer:
Page Ref.: C:14-10; Example C:14-10

83) A trust must distribute all of its income annually. Capital gains are allocated to principal. The trust has dividend income of $12,000, capital gains of $6,000, and no expenses. Calculate the trust’s taxable income.
Answer:
Page Ref.: C:14-10; Example C:14-11

84) Melody Trust has $60,000 of DNI for the current year, $20,000 of rental income and $40,000 of corporate bond interest. The trust instrument requires the trustee to distribute 30% of the trust income to Lee and 70% to Sarah, annually. The trust instrument does not require an allocation of the different types of income to the two beneficiaries. What is the amount and composition of the income reported by Lee and Sarah, respectively?
Answer:
Page Ref.: C:14-11; Example C:14-12

85) A trust reports the following results:

Allocable to
Income Principal
Taxable bond interest $20,000
Rental income 10,000
Gain on sale of investment land 10,000
Property taxes 2,000
Trustee fees 500

The trust must distribute all of its income annually. Calculate taxable income after the distribution deduction.
Answer:

Page Ref.: C:14-12; Example C:14-13
86) A trust reports the following results:

Interest from corporate bonds $20,000
Dividends 10,000
Tax-exempt interest 20,000
Trustee fees 6,000
Capital gain 10,000

All of the items are allocated to income except the capital gains. Calculate the maximum amount of trustee fees that are deductible.
Answer:
Page Ref.: C:14-14; Example C:14-15

87) A trust reports the following results:

Dividend income $20,000
Capital gains 10,000
Tax-exempt interest 10,000
Trustee fees 3,000

All of the items above are allocated to income. Calculate the maximum amount of trustee fees that are deductible.
Answer:
Page Ref.: C:14-14; Example C:14-15

88) A trust has distributable net income (DNI) of $50,000, including $30,000 tax-exempt interest income and $20,000 taxable interest income. The trust instrument requires that all income be distributed at least annually, 30% to Jane and 70% to Joe. What is the amount and character of the income that Jane receives?
Answer:
Page Ref.: C:14-15

89) A simple trust has the following results:

DNI $60,000
Net tax-exempt interest 8,000
Net accounting income 62,000

Calculate the distribution deduction.
Answer:
Page Ref.: C:14-15
90) In the year of termination, a trust incurs a $20,000 NOL. In addition, it has a $30,000 NOL carryover from the two preceding tax years. The trust distributes 40% of its assets to Sam, 30% of its assets to Alex, and 30% of its assets to Catherine. How much of the NOL can Sam (who has $150,000 of gross income) deduct on his return in the year that the trust terminates?
Answer:
Page Ref.: C:14-16; Example C:14-18

91) Explain to a client the significance of the income and principal categorization scheme used for fiduciary accounting purposes.
Answer:
Page Ref.: C:14-4 and C:14-5

92) Outline the classification of principal and income under the Revised Uniform Principal and Income Act.
Answer:
Page Ref.: C:14-5 and C:14-6

93) A client asks about the relevance of state law in classifying items as principal or income. Explain the relevance.
Answer:
Page Ref.: C:14-5 and C:14-6

94) List some common examples of principal and income items.
Answer:
Page Ref.: C:14-5 and C:14-6; Topic Review C:14-1

95) What is the basis of inherited IRD items to the beneficiary?
Answer:
Page Ref.: C:14-9
96) Explain the three functions of distributable net income (DNI).
Answer:
Page Ref.: C:14-11

97) Explain how to determine the deductible portion of trustee’s fees.
Answer:
Page Ref.: C:14-13 and C:14-14

98) The Tucker Trust was established six years ago. The trust is required to distribute all of the trust income at least annually to Betty for life. Capital gains are credited to principal. The current year results of the trust are as follows:

Amounts Allocable To
Income Principal
Dividends $15,000
Rental income from land 2,500
Tax-exempt interest 7,500
Rental expenses 500
Trustee fees $600
Tax return preparation fee 250
Capital gain on stock sale (stock purchased five years ago) 24,250 6,000
Distribution of net accounting income 1,300
Payment of estimated taxes

Compute (a) distributable net income (DNI), (b) the distribution deduction, (c) trust taxable income, and (d) Betty’s reportable income and its classification. Charge all of the deductible expenses against rent income.
Page Ref.: C:14-18

99) Describe the tier system for trust beneficiaries.
Answer:
Page Ref.: C:14-21 and C:14-22

100) The Williams Trust was established six years ago. The trust document allows the trustee to distribute income in its discretion to beneficiaries Carol and Karen for the next 15 years. The trust will then be terminated and the trust assets will be divided equally between Carol and Karen. Capital gains are part of principal.

The current year income and expenses of the trust are reported below.

Amounts Allocable To
Income Principal
Dividends $15,000
Rental income from land 2,500
Tax-exempt interest 7,500
Rental expenses 500
Trustee’s fees $600
Tax return preparation fee 250
Capital gain on stock sale (stock purchased four years ago) 6,000
Distribution of net accounting income to:
Carol 7,000
Karen 3,500
Payment of estimated tax 2,620 1,680

Compute (a) distributable net income (DNI), (b) distribution deduction, (c) trust taxable income, and (d) Carol’s and Karen’s reportable income and its classification. Charge all of the deductible expenses against the rental income.
Answer:
Page Ref.: C:14-25 through C:14-27

101) Describe the double taxation of income in respect of a decedent and how it can be reduced.
Answer:
Page Ref.: C:14-28

102) What is the benefit of the 65-day rule?
Answer:
Page Ref.: C:14-33 and C:14-34

103) For the first five months of its existence (August through December 2008), the Estate of Christine Lowry had gross income (net of expenses) of $7,000 per month. For January through July 2009, the executor estimates that the estate will have gross income (net of expenses) totaling $5,000. The estate’s sole beneficiary is Christine’s son, Jonathan, who is a calendar-year taxpayer. Jonathan incurred a large NOL from his sole proprietorship years ago, and $34,000 of the NOL carryover remains but expires at the end of 2008. During 2008, Jonathan received only $5,000 of income from part-time employment. What tax issues should the executor of Christine’s estate consider with respect to the reporting of the estate’s income?
Answer:

Page Ref.: C:14-10 through C:14-13 and C:14-33 and C:14-34
104) Sukdev Basi funded an irrevocable simple trust in May 2008. The trust benefits Sukdev’s son for life and grandson upon the son’s death. One of the assets he transferred to the trust was Jetco stock, which had an FMV on the transfer date of $40,000. Sukdev’s basis in the stock was $44,000, and he paid no gift tax on the transfer. The stock’s value has dropped to $33,000, and the trustee thinks that now, October 2011, might be the time to sell the stock and take the loss deduction. For 2011, the trust will have $20,000 of income exclusive of any gain or loss. Sukdev’s taxable income is approximately $15,000. What tax and nontax issues should the trustee consider concerning the possible sale of the stock?
Answer:
Page Ref.: C:14-16

105) Ed Camby sold an apartment building in May 2008 for a small amount of cash and a note payable over five years. Principal and interest payments are due annually on the note in April of 2009 through 2013. Ed died in August 2008. He willed all his assets to his daughter Anna. Ed’s gross estate is about $3 million, and his estate tax deductions are very small. What tax issues should the executor of his estate consider with respect to reporting the sale of the building and the collection of the installments?
Answer:
Page Ref.: C:14-28

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C15 Administrative Procedures

1) The majority of the individual tax returns that are audited are selected under the DIF program.
Answer:
Page Ref.: C:15-5

2) The IRS will issue a 90-day letter (a Statutory Notice of Deficiency) if the taxpayer does not file a protest letter within 30 days of the date of the 30-day letter.
Answer:
Page Ref.: C:15-9

3) The 90-day letter (Statutory Notice of Deficiency) gives the taxpayer 90 days to file a petition with the Tax Court or to pay the disputed tax.
Answer:
Page Ref.: C:15-9

4) If the taxpayer has credible evidence, the IRS bears the burden of proof in a tax dispute.
Answer:
Page Ref.: C:15-10

5) A letter ruling is a written determination that interprets and applies the tax laws to the taxpayer’s specific set of facts.
Answer:
Page Ref.: C:15-11

6) The “automatic” extension period for filing an individual return is seven months.
Answer:
Page Ref.: C:15-13

7) The maximum failure to file penalty is a total of 25% of the underpayment.
Answer:
Page Ref.: C:15-18

8) A taxpayer who fails to file and fails to pay taxes is subject to a combined 5.5% monthly penalty on the underpayment.
Answer:
Page Ref.: C:15-18

9) The statute of limitations, which stipulates the time frame within which either the government or the taxpayer may request a redetermination of tax due, usually expires 6 years after the date on which the return is filed.
Answer:
Page Ref.: C:15-26

10) The statute of limitations is unlimited for a tax return that is never filed.
Answer:
Page Ref.: C:15-27
11) Treasury Department Circular 230 regulates the practice of attorneys, CPAs, enrolled agents, and enrolled actuaries before the IRS.
Answer:
Page Ref.: C:15-33

12) Anyone who prepares a tax return is subject to the provisions of Circular 230.
Answer:
Page Ref.: C:15-33

13) The Internal Revenue Service is part of the
A) Congress.
B) Treasury Department.
C) Federal Bureau of Investigation.
D) U.S. Customs Department.
Answer:
Page Ref.: C:15-2

14) The program specifically designed to identify returns with a high potential for a deficiency assessment is the
A) TCMP.
B) DIF program.
C) instant audit program.
D) 1040 program.
Answer:
Page Ref.: C:15-5

15) Identify which of the following statements is false.
A) The majority of the individual tax returns that are audited are selected under the DIF program.
B) The TCMP audit program has been temporarily suspended by the IRS and replaced in part by lifestyle audits.
C) The IRS is authorized to pay a reward to individuals who provide information resulting in increased collections.
D) All of the above are false.
Answer:
Page Ref.: C:15-4 through C:15-6

16) Identify which of the following statements is true.
A) If a taxpayer has been audited in at least one of the two previous years on the same item and the earlier audit did not result in any additional tax owed, the taxpayer may qualify for the special audit relief rule.
B) A taxpayer can request and always receive an exemption from an audit by the IRS if his return was audited in at least one of the two previous years and the previous audit did not result in any change to his tax liability.
C) The signing of Form 870 allows the taxpayer to wait for 30 interest-free days after the billing date to pay the tax.
D) All of the above are true.
Answer:
Page Ref.: C:15-7
17) Identify which of the following statements is false.
A) A Technical Advice Memorandum may be requested by an IRS auditor if the transaction in question involves an especially complex tax issue.
B) If the taxpayer being audited does not concur with the proposed assessment, the Service is required to send the taxpayer a 30-day letter detailing the proposed changes and the available appeals process.
C) During the audit process, if the taxpayer concurs with the assessment of tax by the IRS and signs Form 870 (Waiver of Statutory Notice), then the taxpayer is precluded from filing a refund suit.
D) Interest on a deficiency accrues from the due date of the return through the payment date.
Answer:
Page Ref.: C:15-8

18) Identify which of the following statements is false.
A) Appeals officers usually have the operating authority to settle disputes with taxpayers based on the “hazards of litigation.”
B) When an appeals officer is dealing with an “appeals coordinated issue,” he has the authority to settle with the taxpayer based on the “hazards of litigation.”
C) A Technical Advice Memorandum may be requested by an IRS auditor if the transaction in question involves an especially complex tax issue.
D) If the taxpayer and the appeals officer fail to reach agreement, the IRS issues a 90-day letter.
Answer:
Page Ref.: C:15-7 and C:15-8

19) The IRS provides advice concerning an issue that arises during an audit by issuing
A) a revenue ruling.
B) an audit memorandum.
C) a technical advice memorandum.
D) a private letter ruling.
Answer:
Page Ref.: C:15-8

20) In order to appeal to the Appeals Division, a taxpayer must submit a protest letter to the IRS
A) if an office audit is involved.
B) as a response to receiving a 30-day letter.
C) in a field audit involving a assessment of taxes, interest, and penalties in excess of $10,000.
D) if a TCMP audit is involved.
Answer:
Page Ref.: C:15-8

21) A taxpayer will receive a 30-day letter
A) to notify him that the return was selected for audit.
B) after a response to the 90-day letter with a protest.
C) only if the taxpayer does not sign Form 870.
D) only if the taxpayer is more than 30 days late in filing the tax return.
Answer:
Page Ref.: C:15-9
22) How long does a taxpayer have to file a petition with the U.S. Tax Court following the date of the Statutory Notice of Deficiency?
A) 90 days
B) three months
C) 180 days
D) 30 days
Answer:
Page Ref.: C:15-9

23) The court in which the taxpayer does not have to pay the tax and then litigate for a refund is the
A) U.S. Court of Federal Claims.
B) Federal district court.
C) Tax Court.
D) all of the above
Answer:
Page Ref.: C:15-9

24) Identify which of the following statements is true.
A) Form 870-AD is used if the taxpayer and IRS representative agree to a lesser tax liability than that originally proposed by the Service.
B) Signing of Form 870-AD by the taxpayer does not generally preclude the subsequent filing of a refund claim.
C) The IRS will issue a 90-day letter (a Statutory Notice of Deficiency) if the taxpayer does not file a protest letter within 10 days of the date of the 30-day letter.
D) All of the above are false.
Answer:
Page Ref.: C:15-9

25) Identify which of the following statements is true.
A) The 90-day letter offers the taxpayer the choice of paying the tax assessed or filing a petition refuting the tax assessment with the Tax Court.
B) A taxpayer can choose to initiate tax litigation in a U.S. district court, the Tax Court, or a Court of Appeals.
C) The IRS cannot raise a new tax issue after issuance of the Statutory Notice of Deficiency (90-day letter).
D) All of the above are false.
Answer:
Page Ref.: C:15-9

26) Identify which of the following statements is false.
A) In general, the taxpayer has the burden of proof in Tax Court cases. However, the IRS has the burden of proof for issues raised after the issuance of the 90-day letter.
B) A taxpayer may want to avoid using the Tax Court to litigate an issue because decisions from this court cannot be appealed.
C) The Tax Court can be used to litigate a tax issue without first paying the tax assessment.
D) In order to litigate in the Tax Court, a petition must be filed within 90 days of the issuance of a notice of deficiency.
Answer:
Page Ref.: C:15-9
27) Identify which of the following statements is false.
A) If the phrase “Entered under Rule 155” appears at the end of the Tax Court’s opinion, the litigating parties must jointly determine the additional tax due.
B) A taxpayer does not have to pay the tax assessment before filing suit in a U.S. district court or the U.S. Court of Federal Claims.
C) Either the taxpayer or the government can appeal the decision of a court of original jurisdiction to the next higher court with the potential for a final ruling from the U.S. Supreme Court if a writ of certiorari is granted.
D) All of the above are false.
Answer:
Page Ref.: C:15-9

28) Identify which of the following statements is false.
A) So-called private letter rulings are made public after confidential information is eliminated.
B) A letter ruling is a written statement issued to a taxpayer by the IRS that interprets and applies the tax laws to that taxpayer’s specific set of facts.
C) Only the taxpayer can appeal the decision of a court of original jurisdiction to the next higher court.
D) If the Supreme Court decides to hear a case, it grants certiorari.
Answer:
Page Ref.: C:15-9 and C:15-10

29) Which one of the following statements about letter rulings is false?
A) If a taxpayer requests and pays for a ruling, the IRS must respond to his request by issuing a ruling.
B) A ruling is a response to a taxpayer’s specific set of facts.
C) Rulings become public information.
D) The IRS issues revenue procedures periodically, which prescribe the information that must be supplied with a ruling request.
Answer:
Page Ref.: C:15-11 through C:15-12

30) Which of the following items can be omitted from a taxpayer’s request for a ruling?
A) names, addresses, and taxpayer identification numbers of all interested parties
B) a detailed explanation of the transaction
C) the particular conclusion desired by the taxpayer
D) the location of the IRS district office that has examination jurisdiction
Answer:
Page Ref.: C:15-11

31) The IRS will issue a ruling
A) on prospective transactions only.
B) only if regulations have been issued on the subject.
C) on a completed transaction for which a return has been filed.
D) to clarify the tax treatment of a transaction.
Answer:
Page Ref.: C:15-11
32) Identify which of the following statements is false.
A) The IRS issues annually a revenue procedure that prescribes how a letter ruling should be requested and the information to be contained in the ruling request.
B) The request for a ruling may contain a suggested conclusion (or answer) that the taxpayer proposes that the IRS adopt in the described situation.
C) As a practical consideration, taxpayers always find it preferable to obtain an advance ruling on questionable tax situations.
D) Third parties may not cite private letter rulings as authority for the tax consequences of their transactions.
Answer:
Page Ref.: C:15-11 through C:15-12

33) Identify which of the following statements is false.
A) The IRS will not issue a ruling on the topic of whether compensation is reasonable.
B) Tax returns for all taxpayers must be filed on or before the fifteenth day of the fourth month following the year-end.
C) A corporation must file a tax return even if it has no gross income.
D) Extensions of time for filing tax returns may be obtained.
Answer:
Page Ref.: C:15-12

34) Identify which of the following statements is true.
A) A partnership is not required to file a return if the partnership has no income for the year.
B) The “automatic” extension period for filing an individual return is five months.
C) Individuals and corporations may obtain six-month extensions for paying taxes and filing their returns for the taxable year by filing the appropriate extension requests.
D) All of the above are false.
Answer:
Page Ref.: C:15-12 and C:15-13

35) An automatic extension of time from the regular filing date for an individual tax return may be received, without giving the IRS a reason, for
A) 2 months.
B) 3 months.
C) 4 months.
D) 6 months.
Answer:
Page Ref.: C:15-13

36) If a return’s due date is extended, a taxpayer
A) also extends the period in which to pay taxes without interest.
B) still should pay the tax by the original return due date.
C) has 30 days following the original due date to pay estimated taxes without penalty.
D) has 30 days following the original due date to pay estimated taxes without interest.
Answer:
Page Ref.: C:15-13
37) In which of the situations below will a taxpayer not be assessed interest on the tax remitted?
A) An extension is obtained and the tax is paid within the extension period.
B) A timely return is filed but the taxpayer must delay payment of the taxes.
C) The return is audited and additional tax is owed.
D) None of the above situations.
Answer:
Page Ref.: C:15-14

38) Identify which of the following statements is false.
A) Interest is imposed on any tax not paid by the due date of the return (determined without regard to extensions).
B) Interest is charged on underpayments, or paid on overpayments, at a rate of three percentage points higher than the federal short-term rate.
C) Interest on underpayments is calculated using daily compounding and covers a time period from the original due date of the return until the date of payment.
D) Any tax not paid by the due date for the return is subject to an interest charge.
Answer:
Page Ref.: C:15-14

39) Identify which of the following statements is false.
A) In addition to interest, taxpayers may be subject to penalties for failure to file on time and failure to pay taxes by the due date for the return.
B) The failure-to-file penalty is levied against taxpayers who do not file a return by its due date at a rate of 5% per month (or fraction of a month) with a maximum additional penalty of 25%.
C) The failure-to-pay penalty is imposed at a rate of 5% per month (or fraction of a month) with a maximum penalty of 25%.
D) A different interest rate is charged to corporate and noncorporate taxpayers.
Answer:
Page Ref.: C:15-15 through C:15-19

40) A calendar-year individual taxpayer files last year’s income tax return on October 17 of the current year. No extension was requested, and there is not a reasonable cause for the late filing. The return shows a balance due of $1,500 of tax. The late filing penalty is
A) $0.
B) $75.
C) $375.
D) $450.
Answer:
41) A calendar-year individual taxpayer files last year’s income tax return on July 1 of the current year. No extension was requested, and there is not a reasonable cause for the late filing. The return shows a balance due of $800 of tax. The late filing penalty is
A) $0.
B) $40.
C) $80.
D) $120.
Answer:

42) Gerald requests an extension for filing his last year’s individual income tax return. His tax liability is $10,000, of which $8,000 was withheld, leaving a balance due of $2,000 when he files on August 1 of the current year. His penalty for failure to pay the tax on time is
A) $0.
B) $40.
C) $300.
D) $400.
Answer:

43) If Brad files his last year’s individual tax return on July 5 of the current year after having requested an extension, what is the amount of his failure-to-pay penalty if his total tax is $10,000 and he paid $9,500 through timely withholding and $500 with the return?
A) $0
B) $6
C) $60
D) none of the above
Answer:

44) Identify which of the following statements is true.
A) The failure-to-pay penalty is waived if the additional tax due with the filing of the extended return does not exceed 15% of the tax owed for the year.
B) If both the failure-to-file and the failure-to-pay penalties are owed, the taxpayer will incur a maximum addition to tax of 5.5% per month.
C) Individuals having substantial income from sources not subject to regular withholding generally should make quarterly estimated tax payments to the IRS.
D) All of the above are false.
Answer:
Page Ref.: C:15-19

45) Your client wants to avoid any penalty for underpayment of estimated taxes by making timely deposits. Determine the amount of the minimum quarterly estimated tax payments required to avoid the penalty. Assume your client’s adjusted gross income last year was $140,000.

Last year’s tax liability $40,000
This year’s estimated total tax 44,000
Taxes to be withheld for this year 9,000

A) $7,650
B) $7,750
C) $8,750
D) $11,000
Answer:
Page Ref.: C:15-19 through C:15-22

46) A taxpayer can automatically escape the penalty for underpayment of taxes by
A) owing less than $1,000 in taxes over and above the taxes withheld from wages.
B) owing taxes in the previous year.
C) having a casualty loss.
D) none of the above
Answer:
Page Ref.: C:15-21

47) A taxpayer’s return is audited and additional taxes are assessed. The IRS also asserts that a negligence penalty should be assessed. The taxpayer concurs with the additional $15,000 tax liability; $7,000 of this amount is attributable to negligence. What is the amount of the penalty for negligence?
A) $700
B) $1,400
C) $5,600
D) $1,750
Answer:
Page Ref.: C:15-22; Example C:15-20

48) A substantial understatement of tax liability involves which of the following?
A) understatement of tax exceeding the greater of 10% of tax required to be shown on the return or $5,000 for individuals
B) underpayment of tax exceeding the greater of 15% of the tax required to be shown on the return or $5,000 for individuals
C) underpayment of tax exceeding the lesser of 25% of the tax required to be shown on the return or $5,000 for individuals
D) $10,000 or more difference between the amount shown on the return and the correct amount due
Answer:
Page Ref.: C:15-23

49) Which of the following is not a reason for relief from the substantial understatement penalty?
A) disclosure of the relevant facts pertaining to the questionable tax return position
B) substantial authority for the tax return position
C) reliance on a tax return preparer
D) reasonable cause and a good faith effort to comply with the tax law
Answer:
Page Ref.: C:15-23

50) What is the requirement for a substantial understatement of tax for individuals?
A) The understatement exceeds 10% of the tax required to be shown on the return.
B) The understatement exceeds $5,000.
C) The understatement exceeds the lesser of 10% of the tax required to be shown on the return or $5,000.
D) The understatement exceeds the greater of 10% of the tax required to be shown on the return or $5,000.
Answer:
Page Ref.: C:15-23

51) Identify which of the following statements is true.
A) An individual taxpayer may be subject to a penalty for underpayment of estimated taxes if his balance of tax due when he files is $500.
B) A penalty for substantial understatement will potentially be assessed on an individual if the underpayment of tax exceeds the greater of 15% of the tax shown on the return or $5,000.
C) Substantial authority exists for a position that is supported by a decision rendered by the Court of Appeals for the taxpayer’s own circuit.
D) All of the above are true.
Answer:
Page Ref.: C:15-24

52) Identify which of the following statements is false.
A) If fraud is asserted in a tax transaction, the burden of proof falls on the IRS.
B) The civil fraud penalty consists of 75% of the tax underpayment attributable to fraud plus 25% of the interest payable on the portion of the underpayment resulting from the fraud.
C) The government must prove its case “beyond a reasonable doubt” in order for the court or jury to convict a taxpayer of criminal fraud.
D) The fraud penalty can be imposed with respect to income, gift, and estate tax returns.
Answer:
Page Ref.: C:15-24
53) A six-year statute of limitation rule applies if the taxpayer
A) understates taxable income by 25%.
B) understates AGI by 25%.
C) understates gross income by 25%.
D) none of the above
Answer:
Page Ref.: C:15-26

54) On April 15, 2010, a married couple filed their joint 2009 tax return showing gross income of $120,000. Their return was prepared by a professional tax preparer who mistakenly omitted $45,000 of income, which the preparer in good faith considered to be nontaxable. No information with regard to this omitted income was disclosed on the return or attached statements. By what date must the IRS assert a notice of deficiency before the statute of limitations expires?
A) April 15, 2015
B) December 31, 2011
C) April 15, 2009
D) December 31, 2009
Answer:
Page Ref.: C:15-26

55) Identify which of the following statements is true.
A) The statute of limitations, which stipulates the time frame within which either the government or the taxpayer may request a redetermination of tax due, usually expires six years after the date on which the return is filed.
B) The statute of limitations limits the time during which a taxpayer may claim a refund of an overpayment of tax.
C) If a taxpayer omits from gross income an amount in excess of 25% of the gross income shown on his return, the statute of limitations is five years.
D) All of the above are true.
Answer:
Page Ref.: C:15-29

56) Terry files his return on March 31. The return shows taxes of $6,000, and Terry pays this entire amount when he files his return. By what time must he file a claim of refund?
A) the later of two years from the return filing or three years from the date the tax is paid
B) the later of three years from the return due date or two years from the date the tax is paid
C) two years from the payment of tax date, if the IRS mails a notice of deficiency in the third year following the due date of the return
D) four years from the payment of tax date, if the IRS mails a notice of deficiency
Answer:
Page Ref.: C:15-29

57) Steve files his return on April 1 and pays the entire amount of tax for the year at that time, $5,000. He is audited and pays the deficiency of $1,500 two years later. The maximum amount Steve may file a claim for refund for eighteen months later is
A) $6,500.
B) $5,000.
C) $1,500.
D) some other amount.
Answer:
Page Ref.: C:15-29

58) Identify which of the following statements is true.
A) If a taxpayer fails to file a return, the statute of limitations is extended to 10 years.
B) If a couple files a joint return but only one spouse had income, only the spouse with income is responsible for paying any tax due.
C) Joint and several liability means that each spouse is potentially liable for the full amount of tax due.
D) All of the above are false.
Answer:
Page Ref.: C:15-29

59) The innocent spouse relief provision from tax liability covers all of the following except
A) improper deductions.
B) improper credits.
C) improper basis.
D) All are understatements subject to minimum thresholds.
Answer:
Page Ref.: C:15-30

60) All of the following requirements must be met in order to establish innocent spouse relief except which of the following?
A) The return contains an understatement of tax attributable to the erroneous item(s) of an individual filing it.
B) The request for innocent spouse relief is made no later than one year after the IRS begins its collection efforts.
C) The requesting individual establishes that he or she neither knew nor had reason to know of any or all of the understatement.
D) Based on all the facts and circumstances, holding the other individual for the deficiency would be inequitable.
Answer:
Page Ref.: C:15-30

61) Tax return preparers can be penalized for the following activities except
A) failure to sign a return.
B) failure to give a copy of the return to the taxpayer.
C) failure to maintain IRS continuing education requirements.
D) failure to provide the preparer’s identification number on the return.
Answer:
Page Ref.: C:15-31
62) What is the penalty for a tax return preparer who willfully attempts to understate taxes, or intentionally disregards the tax rules and regulations?
A) $50
B) $250
C) $5,000
D) 20% of the understatement
Answer:
Page Ref.: C:15-32

63) What is the penalty for a tax return preparer who lacks substantial authority to take a return position?
A) $50
B) $250
C) $1,000
D) 20% of the understatement
Answer:
Page Ref.: C:15-32

64) What is the IRS guideline for determining whether a tax return position has substantial authority?
A) A person knowledgeable in the tax law concludes that the position has a something less than 50% likelihood of being supported.
B) A person knowledgeable in the tax law concludes that the position has at least a 50% likelihood of being supported.
C) A person knowledgeable in the tax law concludes that the position has at least a two-thirds likelihood of being supported.
D) A person knowledgeable in the tax law concludes that the position has at least a 75% likelihood of being supported.
Answer:
Page Ref.: C:15-32

65) Identify which of the following statements is true.
A) The “innocent spouse provision,” if applicable, relieves both spouses from an assessment of tax caused by a spouse’s understating income or gain and/or overstating deductions, losses, or credits.
B) The IRS is precluded from assessing any residual tax liability against transferees and fiduciaries because the initial filers are responsible for meeting the tax payments in a timely fashion.
C) Treasury Department Circular 230 regulates the practice of attorneys, CPAs, enrolled agents, and enrolled actuaries before the IRS.
D) All of the above are false.
Answer:
Page Ref.: C:15-33
66) According to Circular 230, what should a CPA do upon discovery of an error in a client’s prior-year return?
A) Notify the IRS of the error.
B) Inform the client of the error and its tax consequences.
C) File an amended return for the client.
D) Do nothing.
Answer:
Page Ref.: C:15-33
67) Which of the following statements regarding Circular 230 is false?
A) Circular 230 applies to all tax return preparers.
B) Circular 230 defines practice before the IRS.
C) Circular 230 provides guidance as to the level of authority necessary for a CPA to take a tax return position.
D) Circular 230 applies to CPAs, enrolled agents, enrolled actuaries, and attorneys.
Answer:
Page Ref.: C:15-33

68) The “Statement on Practice in the Field of Federal Income Taxation” includes all of the following areas of mutual competence except
A) preparing federal income tax returns.
B) determining the tax effect of proposed transactions.
C) representing clients in criminal investigations.
D) representing taxpayers before the U.S. Tax Court.
Answer:
Page Ref.: C:15-37 and C:15-38

69) Which of the following activities is protected by accountant-client privilege?
A) written communications between a CPA and a corporation regarding a tax shelter
B) communications related to tax return preparation
C) communications related to criminal tax evasion
D) advice given regarding tax issues in a divorce
Answer:
Page Ref.: C:15-35

70) Which, if any, of the following could result in penalties against an income tax return preparer?
I. Knowing or reckless disclosure or use of tax information obtained in preparing a return.
II. A willful attempt to understate any client’s tax liability on a return or claim for a refund.
A) I only
B) II only
C) neither I nor II
D) both I and II
Answer:
Page Ref.: C:15-35

71) On August 13 of the following year, Joy files her current calendar-year tax return and pays the amount due without having requested an extension. The tax shown on her return is $25,000. Her current-year withholding tax is $15,000. Joy pays no estimated taxes and does not claim any tax credits on her current- year return. Calculate the penalties that the IRS is likely to assess. Ignore the penalty for underpayment of estimated taxes. Assume she did not commit fraud.
Answer:
Page Ref.: C:15-15 through C:15-19

72) On August 13 of the following year, Joy files her current calendar-year tax return and pays the amount due without having requested an extension. The tax shown on her return is $25,000. Her current-year withholding tax is $15,000. Joy pays no estimated taxes and does not claim any tax credits on her current- year return. Will Joy owe interest, and if so, on what amount and for how many days?
Answer
Page Ref.: C:15-19 through C:15-22

73) On July 25 of the following year, Joy files her current calendar- year tax return. She had requested extensions as required. On October 8, she pays the amount due. The tax shown on her return is $22,000. Her current-year withholding tax is $21,000. Joy pays no estimated taxes and does not claim any tax credits on her current-year return. Calculate the penalties that the IRS is likely to assess. Ignore the penalty for underpayment of estimated taxes. Assume she did not commit fraud.
Answer:
Page Ref.: C:15-19 through C:15-22

74) On July 25 of the following year, Joy files her current calendar-year tax return without having requested an extension. On October 8, she pays the amount due. The tax shown on her return is $25,000. Her current-year withholding tax is $20,000. Joy pays no estimated taxes and does not claim any tax credits on her current-year return. Assume she did not commit fraud. Will Joy owe interest, and if so, on what amount and for how many days?
Answer:
Page Ref.: C:15-18

75) The taxes shown on Kate’s tax returns for 2008 and 2009 were $6,000 and $9,000, respectively. Kate’s withholding tax for 2009 was $7,000 and she paid no estimated taxes. Kate filed her 2009 return on April 3, 2010, but she did not have sufficient funds to pay the balance due. She pays the $2,000 balance due on June 19, 2011. Kate’s AGI for 2009 did not exceed $150,000. Calculate the penalties Kate owes on her 2009 tax return.
Answer:
Page Ref.: C:15-19 through C:15-22

76) Pete has reported a tax liability of $3,500 on his 2009 tax return. His 2009 withholding was $3,800. He did not file his 2009 return until June 12, 2010. What penalties does Pete owe?
AnswerPage Ref.: C:15-19 through C:15-22

77) Lucy files her current-year individual income tax return on August 5 of the following year, without having requested an extension. Her total tax is $10,000. Lucy pays $7,500 in a timely manner and the $2,500 balance when she files the return. Lucy did not engage in fraud and has no reasonable cause for late filing and late payment. Compute Lucy’s penalties.
Answer:
Page Ref.: C:15-19; Example C:15-14

78) On July 25 of the following year, Joy files her current calendar-year tax return without having requested an extension. On October 8, she pays the amount due. The tax shown on her return is $25,000. Her current-year withholding tax is $20,000. Joy pays no estimated taxes and does not claim any tax credits on her current year return. Calculate the penalties that the IRS is likely to assess. Ignore the penalty for underpayment of estimated taxes. Assume she did not commit fraud.
Answer:
Page Ref.: C:15-19; Example C:15-15

79) Billy, a calendar-year taxpayer, files his current year individual tax return on August 17 of the following year without having requested an extension. His return reports an amount due of $5,000. Billy pays this amount on November 23 of the following year. What are Billy’s penalties for his failure to file and his failure to pay his tax on time? Assume Billy did not commit fraud.
Answer:
Page Ref.: C:15-19; Example C:15-15

80) Paul’s tax liability for last year was $30,000. Paul projects that his tax for this year will be $40,000. Paul is self-employed and, thus, will have no withholding. His AGI for last year did not exceed $150,000. How much estimated tax should Paul pay for this year to avoid the penalty for underpayment of estimated taxes?
Answer:
Page Ref.: C:15-19 through C:15-22

81) Jeff’s tax liability for last year was $30,000. Jeff projects that his tax for this year will be only $25,000. Jeff is self-employed and, thus, will have no withholding. His AGI for last year did not exceed $150,000. How much estimated tax, at a minimum, should Jeff pay for this year to avoid the penalty for underpayment of estimated taxes? How would your answer change if his income exceeded last year’s due to a large capital gain at the end of the year?
Answer:
Page Ref.: C:15-19 through C:15-22

82) Linda’s individual tax return for the current year is subject to an IRS audit. The IRS assesses a $10,000 deficiency, $4,000 of which is due to Linda’s negligence. What is Linda’s negligence penalty?
Answer:
Page Ref.: C:15-22 through C:15-26

83) The IRS audits Kiara’s current-year individual return and determines that, among other errors, she negligently did not report dividend income of $10,000. The deficiency with respect to the dividends is $2,800. The IRS argues for an additional $12,000 deficiency for various other errors that do not involve negligence. What is Kiara’s negligence penalty for the $14,800 in deficiencies?
Answer:
Page Ref.: C:15-22 through C:15-26

84) Pablo, a bachelor, owes $80,000 of additional taxes, all due to fraud. What is the amount of the civil fraud penalty? What criminal fraud penalty might be imposed under Sec. 7201?
Answer:
Page Ref.: C:15-24 through C:15-25

85) Kelly, a calendar-year taxpayer, files her 2008 individual return on March 30, 2009, and pays the amount due at the same time. Later, she discovers some deductions that she should have claimed on the return. By what date must she file a claim for refund?
Answer:
Page Ref.: C:15-28

86) Kristina and Victor filed a joint return for the current year. They are in the 31% marginal tax bracket. Victor did not know that Kristina failed to report a prize valued at $16,000 that she won. She used the money to buy Victor a motorcycle. Does Victor meet the tests for relief under the innocent spouse provisions?
Answer:
Page Ref.: C:15-29

87) One of your corporate clients comes to you asking for advice regarding a proposed merger with XYZ Company. You (a) issue an opinion concerning the FMV of XYZ, (b) prepare pro forma financials for the merged entity to be, (c) draft shareholder resolutions for your client approving the proposed merger, (d) file a shareholder proxy statement with the U.S. Securities and Exchange Commission, and (e) advise your client’s board of directors concerning the advantages of a Type A versus a Type B reorganization. Which of these activities, if any, constitutes the unauthorized practice of law?
Answer:
Page Ref.: C:15-36 and C:15-37

88) One of your corporate clients has recently filed for bankruptcy. In the course of the proceedings, you (a) prepare a plan of reorganization that alters the rights of preferred stockholders, (b) notify the company’s creditors of an impending bulk transfer of the company’s assets, (c) review IRS secured claims against these assets, (d) restructure the company’s debt by reducing its principal amount and extending its maturity, and (e) advise the bankruptcy court as to how this restructuring will impact the company’s NOLs. Which of these activities, if any, constitutes the unauthorized practice of law?
Answer:
Page Ref.: C:15-36 and C:15-37
89) Which of the following communications between an accountant and client are privileged?
a) During the preparation of her 2008 tax return, Tammy informs her accountant that she contributed $25,000 to a qualified charitable organization.
b) After filing his tax return, a client mentions to his accountant that he forgot to report a $7,000 prize that he won playing bingo. He asks how he should correct the error.
c) A client tells his accountant that he will no longer pay alimony to his ex-wife.
Answer:
Page Ref.: C:15-37 and C:15-38

90) Which of the following communications between an accountant and client are not privileged?
a) An accountant orally communicates to his client that he should set up a foreign subsidiary to shift taxable income to a lower tax jurisdiction.
b) An accountant privately submits to the client a plan for shifting taxable income to a lower tax jurisdiction.
c) During a meeting in which a client is asking for advice relating to criminal fraud, the client tells his accountant that he lied to the IRS.
Answer:
Page Ref.: C:15-37 and C:15-38

91) Explain how the Internal Revenue Service is organized to be efficient and client-oriented.
Answer:
Page Ref.: C:15-3

92) Explain the four conditions that must be met in civil cases for the burden of proving any factual issue relevant to the determination of taxpayer liability to rest with the IRS.
Answer:
Page Ref.: C:15-10

93) Explain one of the two exceptions to imposing interest from the original due date of the tax return until the date the tax deficiency is paid.
Answer:
Page Ref.: C:15-14

94) How does a taxpayer determine if “substantial authority” exists for a tax treatment the taxpayer desires to adopt?
Answer:
Page Ref.: C:15-24

95) What is the difference between the burden of proof for civil and criminal fraud?
Answer:
Page Ref.: C:15-24 and C:15-25

96) For innocent spouse relief to apply, five conditions must be met. Explain them.
Answer:
Page Ref.: C:15-29 and C:15-30

97) Jayne and Jon jointly file a tax return this year. Jayne fraudulently reports two expenses on on Schedule C: $2,000 and $2,500. The IRS audits the return, assesses a $1,050 deficiency, and begins collection efforts two years after the timely filing by Jayne and Jon. What must Jon do to be relieved of the $1,050 tax liability?
Answer:
Page Ref.: C:15-30; Example C:15-37

98) How does the IRS regulate the activities of compensated tax return preparers? In particular, list six acts that will cause a compensated tax return preparer to incur a penalty.
Answer:

Page Ref.: C:15-31 through C:15-33

99) Christie and Billy jointly file this year. Billy intentionally omits $5,000 in gambling winnings. Christie fraudulently deducts $1,000 in business expenses. The IRS audits the return, assesses a $2,500 deficiency and begins collection efforts two years after the timely filing of the return. Christie and Billy divorced one year before the deficiency was assessed. Can Christie receive any tax relief from the full $2,500 deficiency?
Answer:
Page Ref.: C:15-31; Example C:15-39

100) Explain accountant-client privilege. What are the similarities and differences between it and attorney-client privilege?
Answer:
Page Ref.: C:15-37 and C:15-38

101) The IRS audited the tax returns of Dan Jackson, a gifted painter. It contended that, between 2003 and 2005, Jackson received $500,000 for his paintings, but reported only $75,000. Jackson attributed the shortfall to his receipt of cash at art fairs and street fairs. He allegedly concealed the cash payments in separate bank accounts unbeknownst to his CPA. What tax compliance issues regarding the alleged underreporting are pertinent to the CPA?
Answer:
Page Ref.: C:15-15 through C:15-17, C:15-20 through C:15-29, and C:15-31 through C:15-33

102) You are preparing the tax return for Agre Corporation, which has sales of $50 million. Agre made a $2 million expenditure for which the appropriate tax treatment, deductible or capitalizable, is a gray area. The corporation’s Chief Financial Officer wants you to deduct the expenditure. What tax compliance issues should you consider in deciding whether to deduct the expenditure?
Answer:
Page Ref.: C:15-20 through C:15-23 and C:15-31 through C:15-33
103) Latka Novatny gave you the following information to use in the preparation of his current year’s tax return:

Salary $120,000
Dividends 20,000
Itemized deductions 35,000

In addition, he received $40,000 from a relative for whom he had worked previously. You have researched whether the $40,000 should be classified as a gift or compensation and are confident that substantial authority exists for classifying it as a gift. What tax compliance issues should you consider in deciding whether to report or exclude the $40,000?
Answer:
Page Ref.: C:15-21 through C:15-23 and C:15-25 through C:15-29

104) Richard recently won a popular television reality show and its one million dollar prize. However, he omitted the prize money from his tax return for the year. What penalties can the IRS assess?
Answer:
Page Ref.: C:15-22 through C:15-26

Prentice Hall’s Federal Taxation 2013: Corporations, (Pope/Anderson/Kramer)
Chapter C16 U.S. Taxation of Foreign-Related Transactions

1) U.S. citizens, resident aliens, and domestic corporations are taxed by the U.S. government on their worldwide income at regular U.S. tax rates.
Answer:
Page Ref.: C:16-2

2) If foreign taxes on foreign income exceed U.S. taxes on foreign income, the excess foreign taxes are credited against U.S. taxes in the current year.
Answer:
Page Ref.: C:16-5
3) Income derived from the sale of merchandise inventory (i.e., final goods purchased for resale) are sourced in the country where the sale occurs.
Answer:
Page Ref.: C:16-6

4) Excess foreign tax credits can be carried back one year and forward five years.
Answer:
Page Ref.: C:16-6

5) Excess foreign taxes in one basket cannot offset limitation amounts in another basket.
Answer:
Page Ref.: C:16-7

6) U.S. citizens and resident aliens working abroad may qualify for the foreign-earned income exclusion of $91,400 in 2009.
Answer:
Page Ref.: C:16-9

7) A taxpayer who is physically present in a foreign country for 330 full days out of a 12-month period and maintains a tax home there has satisfied the bona fide foreign resident test.
Answer:
Page Ref.: C:16-9

8) Nonresident aliens are not allowed to claim the standard deduction.
Answer:
Page Ref.: C:16-17

9) U.S. shareholders are not taxed on dividends paid by a foreign subsidiary as long as the earnings are not remitted to them as dividends.
Answer:
Page Ref.: C:16-19

10) A U.S. corporation can claim a credit for foreign taxes withheld from dividends paid by a foreign corporation in which it owns at least 10% of the stock.
Answer:
Page Ref.: C:16-20

11) Under the Subpart F rules, controlled foreign corporations (CFCs) are required to distribute a certain portion of their income as dividends to their U.S. shareholders.
Answer:
Page Ref.: C:16-25 and C:16-26

12) A nonresident alien can elect to be considered a resident alien if the nonresident alien is married to a U.S. citizen or a resident alien on the last day of the tax year and both spouses consent.
Answer:
Page Ref.: C:16-36
13) Identify which of the following statements is true.
A) U.S. citizens, resident aliens, and domestic corporations are taxed by the U.S. government on their worldwide income at regular U.S. tax rates.
B) Nonresident aliens and foreign corporations are not subject to U.S. taxation on their non-U.S. source investment income and part or all of their non-U.S. source trade or business income.
C) In a particular year, the overall foreign tax credit limitation permits a taxpayer to offset “excess” foreign taxes paid in one country against “excess” limitation amounts originating in other countries.
D) All of the above are true.
Answer:
Page Ref.: C:16-2

14) Which of the following characteristics is not used by the U.S. government to determine the tax treatment accorded foreign-related transactions?
A) the taxpayer’s country of citizenship
B) the taxpayer’s country of residence
C) the taxpayer’s type of business
D) the type of income earned
Answer:
Page Ref.: C:16-2

15) Julia, an accrual-method taxpayer, is a U.S. citizen and a resident of a foreign country. Her tax year for both countries is a calendar year. Julia accrues 50,000 coras for the foreign country tax liability on December 31 of last year when the exchange rate is one cora = $1. Julia pays the tax to the foreign country on its due date, March 1 of the current year. The exchange rate on that date is one cora = $1.50. ( Julia files her U.S. tax return for last year on April 15 of the current year when the exchange rate is one cora = $2. Julia’s foreign tax credit is
A) $50,000.
B) $75,000.
C) $100,000.
D) none of the above
Answer:
16) Ashley, a U.S. citizen, works in England for part of the year. She earns $40,000 in England, paying $10,000 in income taxes to the British government. Her U.S. income is $60,000 and she pays $12,000 in U.S. taxes. Her taxes on her worldwide income are $20,000. What is Ashley’s foreign tax credit? Assume she does not qualify for the foreign-earned income exclusion.
A) $8,000
B) $10,000
C) $12,000
D) none of the above
Answer:
17) Ashley, a U.S. citizen, works in England for part of the year. She earns $40,000 in England, paying $10,000 in income taxes to the British government. Her U.S. income is $60,000 and she pays $12,000 in U.S. taxes. Her U.S. taxes on her worldwide income are $20,000. What is Ashley’s excess foreign tax credit? Assume she does not qualify for the foreign-earned income exclusion.
A) $0
B) $2,000
C) $4,000
D) none of the above
Answer:

Page Ref.: C:16-5; Example C:16-2

18) Alan, a U.S. citizen, works in Germany and earns $70,000, paying $20,000 in German taxes. His U.S. income is $40,000 and he pays $8,000 in U.S. taxes. His U.S. taxes on his worldwide income are $22,500. What is Alan’s foreign tax credit? Assume he does not qualify for the foreign-earned income exclusion.
A) $12,000
B) $14,318
C) $20,000
D) none of the above
Answer:

Page Ref.: C:16-5; Example C:16-2

19) Alan, a U.S. citizen, works in Germany and earns $70,000, paying $20,000 in German taxes. His U.S. income is $40,000 and he pays $8,000 in U.S. taxes. His U.S. taxes on his worldwide income are $22,500. What is Alan’s excess foreign tax credit? Assume he does not qualify for the foreign-earned income exclusion.
A) $0
B) $5,682
C) $8,000
D) none of the above
Answer:

Page Ref.: C:16-5; Example C:16-2
20) For the foreign credit limitation calculation, income derived from the sale of inventory which is produced by the seller, is considered earned
A) where production occurs.
B) where the sale occurs.
C) where the seller is a resident.
D) partially where produced and partially where sold.
Answer:
Page Ref.: C:16-6

21) A U.S. citizen accrued $120,000 of creditable foreign taxes last year. The citizen’s foreign tax credit limitation for last year is $90,000 (only a single limitation need be calculated). The excess foreign tax credit limitation for the year preceding the year in which the excess foreign taxes were incurred is $2,000. A similar $2,000 excess foreign tax credit limitation position is expected in each of the next 10 years. What portion of the excess foreign taxes can be expected to be noncreditable because of the foreign tax credit limitation?
A) $0
B) $2,000
C) $8,000
D) none of the above
Answer:
Page Ref.: C:16-6; Example C:16-3

22) Identify which of the following statements is false.
A) An accrual-basis taxpayer must make an adjustment to their foreign tax credit which reflects the change in exchange rates between the accrual date and the payment date.
B) Dividend income received by a U.S. individual from a foreign corporation earning nearly all of its income from outside the United States is foreign-source income.
C) Income from the sale of personal property (other than inventory) by a U.S. resident is considered earned in the country where the personal property is delivered.
D) Itemized deductions are allocated between U.S. and foreign-source income.
Answer:
Page Ref.: C:16-6

23) Identify which of the following statements is true.
A) Foreign taxes paid in excess of the foreign tax credit limitation can be carried back to the previous three tax years and then carried over to the succeeding five tax years.
B) When a taxpayer reports excess foreign tax credits in more than one year, the excess credits are used in a last-in-first-out (LIFO) manner.
C) When computing the foreign tax credit limitation, taxable income for individual taxpayers is computed without a personal exemption deduction.
D) All of the above are false.
Answer:
Page Ref.: C:16-6
24) What are the carryback and carryforward periods for the foreign tax credit?
A) back two years; forward five years
B) back three years; forward ten years
C) back one year; forward ten years
D) back two years; forward twenty years
Answer:
Page Ref.: C:16-6

25) Karen, a U.S. citizen, earns $40,000 of taxable income from U.S. sources, $20,000 in taxable wages from Country A and $20,000 in taxable interest from Country B. The U.S. tax rate is 25%. The tax on Country A income is $8,000, and Country B charges no tax on the interest income. Assuming two baskets are needed for the two types of income because the interest is passive income, Karen’s foreign tax credit that can be claimed is
A) $5,000.
B) $10,000.
C) $20,000.
D) none of the above
Answer:

Page Ref.: C:16-7 and C:16-8; Example C:16-4
26) Karen, a U.S. citizen, earns $40,000 of taxable income from U.S. sources, $20,000 in taxable wages from Country A and $20,000 in taxable interest from Country B. The U.S. tax rate is 25%. The tax on Country A income is $8,000, and Country B charges no tax on the interest income. Assuming only a single basket is required, Karen’s foreign tax credit that can be claimed is
A) $5,000.
B) $8,000.
C) $10,000.
D) none of the above
Answer:
Page Ref.: C:16-7 and C:16-8; Example C:16-4

27) A U.S. citizen, who uses a calendar year as his tax year, is transferred to a foreign country by his employer. The U.S. citizen arrived in the foreign country on November 3 of last year. Residency is expected to be maintained in the foreign country until August 4 of next year. None of the years are a leap year. The first year for which an earned income exclusion can be claimed is
A) last year.
B) the current year.
C) next year.
D) The earned income exclusion cannot be claimed.
Answer:
Page Ref.: C:16-9; Example C:16-5
28) The physical presence test method of qualifying for the foreign-earned income exclusion requires the
A) presence in one foreign country for at least 330 full days during a 12-month period.
B) presence in one or more foreign countries for at least 330 full days during a single tax year.
C) presence in one or more foreign countries for at least 330 full days during a 12-month period.
D) presence in one or more foreign countries for at least 330 consecutive full days during a 12-month period.
Answer:
Page Ref.: C:16-9

29) Identify which of the following statements is false.
A) The foreign-earned income exclusion is $91,400 in 2009.
B) The primary purpose for the foreign-earned income exclusion is to prevent double taxation of income.
C) A taxpayer who is physically present in a foreign country for 330 full days out of a 12-month period satisfies the bona fide foreign resident test.
D) All of the above are false.
Answer:
Page Ref.: C:16-9

30) Identify which of the following statements is true.
A) An individual who is physically present in a foreign country for 330 full days out of a 12-month period can claim the foreign-earned income exclusion only for the days in the 12-month period he/she is physically present in a foreign country.
B) An individual, who is a bona fide resident of a foreign country for at least one full tax year, can claim the foreign-earned income exclusion for all days on which he/she is a resident of the foreign country and physically present in that country.
C) Fringe benefits that are excluded from gross income under a Code Section other than Sec. 911 reduce the annual dollar ceiling for the foreign income exclusion.
D) All of the above are false.
Answer:
Page Ref.: C:16-9 through C:16-11

31) Identify which of the following statements is false.
A) Earned income is excludable from gross income only if it is foreign-source income.
B) Taxable pensions and annuities are excluded from the definition of earned income when computing the foreign-earned income exclusion.
C) An individual meets the bona fide resident test by establishing a home in a foreign country for 330 days.
D) All of the above are false.
Answer:
Page Ref.: C:16-9 through C:16-11
32) Perry, a U.S. citizen, is transferred by his employer to Japan for a three-year assignment. Which one of the following items is not excluded under Sec. 911?
A) base salary
B) cost-of-living allowance
C) housing costs
D) premiums paid on first $50,000 of group term life insurance.
Answer:
Page Ref.: C:16-10

33) U.S. citizen who has a calendar tax year establishes a tax home and residence in a foreign country and qualifies for the foreign-earned income exclusion for 60 days in 2008; 365 days in 2009; and 60 days this year, 2010. The maximum earned income exclusion for this year is?
A) $13,733
B) $15,040.80
C) $13,151
D) none of the above
Answer:
Page Ref.: C:16-11; Example C:16-8

34) U.S. citizen Barry is a bona fide resident of a foreign country for all of 2010. Barry uses a calendar year as his tax year and receives $158,000 in salary and allowances from his employer. Included in the $158,000 is a $25,000 housing allowance. Barry’s housing costs are $30,000. The base housing amount for the current year is $14,640. What amount related to his housing can Barry exclude on his Form 2555?
A) $15,360
B) $25,000
C) $30,000
D) $13,545
Answer:

Page Ref.: C:16-12; Example C:16-9

35) U.S. citizen Patrick is a bona fide resident of a foreign country for all of the current year. Patrick uses a calendar year as his tax year. He has $100,000 of self-employment income and incurs $20,000 in housing expenses. The base housing cost amount is $14,640. The deduction for housing expenses is
A) $13,184 for AGI.
B) $13,184 from AGI.
C) $5,360 for AGI.
D) $6,816 from AGI.
Answer:
Page Ref.: C:16-12
36) Identify which of the following statements is true.
A) If a foreign national has a closer connection with his home country, the individual is taxed as a resident alien.
B) To obtain resident status, an alien must meet both the lawful permanent resident test and the substantial presence test.
C) An individual who is a resident alien of the United States is taxed on his or her worldwide income at the same tax rates that would apply to a U.S. citizen.
D) All of the above are false.
Answer:
Page Ref.: C:16-14

37) Identify which of the following statements is true.
A) Capital gains earned in the United States, other than in the conduct of a U.S. trade or business, are taxed to a nonresident alien only if the alien is physically present in the United States for at least 183 days during the tax year.
B) Aliens, who are U.S. residents, are taxed only on their U. S. income.
C) A nonresident alien from a nontreaty country is taxed at a 35% rate on U.S. source investment income without the benefit of any deductions.
D) All of the above are true.
Answer:
Page Ref.: C:16-16
38) Pedro, a nonresident alien, licenses a patent to a U.S. company for an $11 per unit fee for each unit produced. As a result of receiving the fee, Pedro must recognize the fee as
A) ordinary income taxable in the United States.
B) capital gain taxable in the United States.
C) no gain or income taxed in the United States.
D) a portion of the gain, depending on the number of days Pedro is physically present in the United States during the current year.
Answer:
Page Ref.: C:16-16; Example C:16-13

39) A nonresident alien earns $10,000 of dividends from a domestic corporation, which is the alien’s only U.S. source income. Which one of the following statements is incorrect?
A) The nonresident alien’s U.S. tax rate is 30% unless reduced by a tax treaty.
B) The domestic corporation must withhold the U.S. taxes from the alien’s dividend payment.
C) The 30% tax rate is applied against gross income.
D) The nonresident alien must pay estimated taxes on the dividend income at a 30% rate.
Answer:
Page Ref.: C:16-16

40) Income is “effectively connected” with the conduct of a U.S. business only if
A) the asset-use test is met.
B) the business activities test is met.
C) activities of the U.S. business are a material factor in the realization of the income.
D) Either A, B, or C can be correct.
Answer:
Page Ref.: C:16-17
41) Identify which of the following statements is false.
A) A nonresident alien can elect to have income earned on a passive real estate investment treated as trade or business income.
B) Nonresident aliens may use either the standard deduction or claim itemized deductions.
C) Nonresident aliens are generally allowed to claim only a single personal exemption.
D) All of the above are false.
Answer:
Page Ref.: C:16-17

42) Overseas business activities conducted by U.S. corporations receive which one of the following favorable tax breaks?
A) Foreign subsidiaries of U.S. corporations are exempt from the U.S. corporate income tax unless they earn U.S.-source investment or trade or business income.
B) Foreign subsidiaries of U.S. corporations are always exempt from the U.S. corporate income tax even if they earn U.S.-source investment or trade or business income.
C) Domestic corporations conducting business in a foreign country through a branch office or facility can exempt non-U.S. income from the U.S. corporate income tax.
D) All of the above are correct.
Answer:
Page Ref.: C:16-18

43) Which of the following is an advantage of conducting foreign operations through a branch?
A) Foreign branch losses can offset domestic income.
B) Foreign branch income is taxed at a lower rate than domestic income.
C) The parent’s assets are protected from foreign branch creditors.
D) Foreign branch income is taxed by both the United States and the host country.
Answer:
Page Ref.: C:16-18

44) U.S. Corporation, a domestic corporation, owns all of Foreign Corporation’s stock. Foreign Corporation is incorporated in France. This year, Foreign Corporation reports $100,000 in aftertax profits in France, none of which is Subpart F income. U.S. Corporation
A) must include the $100,000 profit in its current-year U.S. tax return.
B) never has to include Foreign Corporation’s profits in its U.S. tax return.
C) reports Foreign Corporation’s profits in its U.S. tax return in the same manner it would if Foreign Corporation were instead a foreign branch.
D) must include Foreign Corporation’s profits in its U.S. tax return when they are paid to U.S. Corporation in the form of a dividend.
Answer:
Page Ref.: C:16-20; Example C:16-16

45) U.S. Corporation, a domestic corporation, owns all of Foreign Corporation’s stock. Foreign Corporation is incorporated in France. This year, Foreign Corporation suffers a $100,000 net operating loss (NOL) in France. What amount of the $100,000 NOL can U.S. Corporation use to reduce its current-year U.S. taxable income?
A) $100,000
B) $50,000
C) $0
D) none of the above
Answer:
Page Ref.: C:16-20; Example C:16-17
46) U.S. Corporation owns 45% of the stock of Foreign Corporation. Foreign Corporation is incorporated in France. During the current year, Foreign Corporation reports $100,000 of E&P, pays $30,000 in foreign income taxes, and remits $40,000 of dividends ratably to its shareholders. In prior post-1986 tax years, Foreign Corporation reported $60,000 of E&P, paid foreign income taxes of $20,000, and paid no dividends. What is U.S. Corporation’s deemed paid foreign tax credit for the current-year dividend?
A) $5,000
B) $5,625
C) $18,000
D) $22,000
Answer:
Page Ref.: C:16-21; Example C:16-18

47) Cane Corporation owns 45% of the stock of Edmonton Airline Corporation. In its first year of operations, Edmonton Airline, a Canadian corporation, earns $400,000 of E&P and pays a $100,000 dividend to Cane Corporation. Edmonton Airline pays $50,000 in Canadian income taxes. All amounts are expressed in U.S. dollars. What is Cane Corporation’s deemed paid foreign tax credit for the dividend?
A) $ 0
B) $12,500
C) $50,000
D) none of the above
Answer:
Page Ref.: C:16-21; Example C:16-18

48) U.S. Corporation owns 45% of the stock of Foreign Corporation. Foreign Corporation is incorporated in Country T. In its first year of operations, Foreign Corporation earns 60,000 frugs of E&P, pays a 40,000- frug dividend, and pays 5,000 frugs in income taxes. The exchange rate between the dollar and the frug is: first year average, 1 frug = $0.20; yearend, 1 frug = $0.25; tax payment date, 1 frug = $0.30; and dividend payment date, 1 frug = $0.28. What is the translated dividend amount?
A) $5,400
B) $4,500
C) $5,040
D) $3,600
Answer:
Page Ref.: C:16-21; Example C:16-19
49) U.S. Corporation owns 45% of the stock of Foreign Corporation. Foreign Corporation is incorporated in Country T. In its first year of operations, Foreign Corporation earns 100,000 frugs of E&P, pays a 20,000- frug dividend to U. S. Corporation, and pays 5,000 frugs in income taxes. The exchange rate between the dollar and the frug is: first year average, 1 frug = $0.20; yearend, 1 frug = $0.25); tax payment date, 1 frug = $0.30; and dividend payment date, 1 frug = $0.28. What is the translated foreign tax amount attributable to the dividend for deemed paid foreign tax credit purposes?
A) $200.00
B) $250.00
C) $300.00
D) $280.00
Answer:
Page Ref.: C:16-21; Example C:16-19

50) Identify which of the following statements is true.
A) The losses of a foreign corporation that is 100% owned by a domestic corporation can be deducted by the domestic corporation to offset its gross income in the year incurred.
B) The deemed paid foreign tax credit was enacted so as not to discourage foreign direct investment through foreign branches.
C) A dividend remittance made by a noncontrolled foreign corporation is translated into U.S. dollars at the current exchange rate for the date the dividend is paid.
D) All of the above are false.
Answer:
Page Ref.: C:16-21

51) Identify which of the following statements is true.
A) The foreign income taxes withheld from a dividend remittance made by a foreign corporation are translated into U.S. dollars at the current exchange rate in effect for the date the dividend is paid.
B) A U.S. subsidiary that is used by a foreign parent corporation to conduct its U.S. business activities is required to withhold 30% of dividends paid to the foreign corporation unless a treaty provides for a lower withholding rate.
C) A foreign corporation that conducts a U.S. trade or business may be required to pay the corporate income tax, the corporate alternative minimum tax, and the branch profits in a single year.
D) All of the above are false.
Answer:
Page Ref.: C:16-22
52) A foreign corporation is owned by five unrelated individuals. John, Sam, and David are U.S. citizens who own 30%, 18% and 9%, respectively, of the foreign corporation’s single class of stock. Alberto and Manuel are nonresident aliens who own 37% and 6%, respectively, of the foreign corporation’s stock. Which of the following statements is true?
A) There are three “U.S. shareholders” and the foreign corporation is a controlled foreign corporation (CFC).
B) There are three “U.S. shareholders” and the foreign corporation is not a controlled foreign corporation (CFC).
C) There are two “U.S. shareholders” and the foreign corporation is not a controlled foreign corporation (CFC).
D) There are two “U.S. shareholders” and the foreign corporation is a controlled foreign corporation (CFC).
Answer:
Page Ref.: C:16-25; Example C:16-22

53) Identify which of the following statements is true.
A) For a foreign corporation to be a controlled foreign corporation (CFC), more than 40% of its voting stock, or more than 40% of the value of its outstanding stock, must be owned by U.S. shareholders on any day of the corporation’s tax year.
B) Under the Subpart F rules, controlled foreign corporations (CFCs) are required to distribute a certain portion of their income as dividends to their U.S. shareholders.
C) When a controlled foreign corporation (CFC) earns Subpart F income, such income is considered to be a constructive distribution to the CFC’s U.S. shareholders on the last day of the CFC’s tax year, or the last day on which CFC status is retained.
D) All of the above are true.
Answer:
Page Ref.: C:16-24 through C:16-26

54) A controlled foreign corporation (CFC) is incorporated in Country B, and is 100% owned by American Manufacturing Corporation. It purchases raw materials from its U.S. parent corporation, manufactures widgets, and sells 70% of the widgets to unrelated purchasers in Country A and 30% to unrelated purchasers in Country B. All widgets will be used in the countries in which they are purchased. The sales produce $100,000 of taxable income. The foreign-base company sales income reportable by American Manufacturing Corporation under the Subpart F rules is
A) $0.
B) $30,000.
C) $70,000.
D) $100,000.
Answer:
Page Ref.: C:16-27; Example C:16-24
55) Phoenix Corporation is a controlled foreign corporation (CFC) incorporated in Country X. It is 100% owned by its U.S. parent corporation. Phoenix has $80,000 of taxable income from the sale of widgets that were purchased from their U.S. parent corporation. All widgets are intended for use or consumption within Country X and have the same gross profit. Sixty percent of the widgets were sold through a Country X wholesaler that is 100% owned by Phoenix, and 40% are sold through unrelated Country X wholesalers. What amount of profits will be constructively distributed as foreign-base company sales income to the U.S. parent company?
A) $0
B) $32,000
C) $48,000
D) $80,000
Answer:
Page Ref.: C:16-27; Example C:16-24

56) Phoenix Corporation is a controlled foreign corporation (CFC) incorporated in Country X. It is 100% owned by its U.S parent corporation. Phoenix has $80,000 of taxable income from the sale of widgets that were purchased from their U.S. parent corporation. All widgets have the same gross profit. Sixty percent of the widgets were sold through a Country Y wholesaler that is 100% owned by Phoenix, and are destined for use in Country Y. The remaining 40% are sold through unrelated Country X wholesalers and are destined for use in Country X. What amount of profits will be constructively distributed as foreign- base company sales income to the U.S. parent company?
A) $0
B) $32,000
C) $48,000
D) $80,000
Answer:
Page Ref.: C:16-27; Example C:16-24

57) Identify which of the following statements is true.
A) When a controlled foreign corporation (CFC) uses Subpart F income to invest in U.S. property, the investments are characterized as constructive distributions.
B) A controlled foreign corporation (CFC) can avoid the constructive dividend distribution resulting from investments in U.S. property if it invests in U.S. government obligations.
C) Distributions made by a controlled foreign corporation (CFC) are deemed to be paid first from tax-deferred earnings.
D) All of the above are false.
Answer:
Page Ref.: C:16-28 and C:16-29
58) Domestic corporation X owns all the stock of controlled foreign corporation (CFC) T. X’s acquisition cost for the CFC investment is $150,000. The CFC reports E&P of $200,000 since the domestic corporation acquired its interest, of which $120,000 was Subpart F income. The CFC makes a cash distribution of $90,000 to the domestic corporation. What is the domestic corporation’s basis for its investment in T immediately after the cash distribution?
A) $150,000
B) $180,000
C) $230,000
D) none of the above
Answer:
Page Ref.: C:16-29; Example C:16-27

59) Identify which of the following statements is true.
A) Foreign-base company sales income is earned when personal property is purchased by a Country X controlled foreign corporation (CFC) from its U.S. parent corporation and is sold to unrelated persons in Country Z.
B) Section 482 permits the IRS to restructure transactions between related parties as if the transactions were conducted at arm’s length.
C) One tax avoidance practice which Sec. 482 attempts to prevent is the transfer of tangible property to a foreign subsidiary at a price which is below the arm’s-length price that would be used by unrelated parties.
D) All of the above are true.
Answer:
Page Ref.: C:16-30

60) Which of the following statements regarding inversions is incorrect?
A) The objective of an inversion is to avoid U.S. tax on worldwide income.
B) In an inversion, a U.S. corporation reorganizes as a foreign corporation.
C) The IRS will disregard the inversion if the former shareholders of the U.S. corporation continue to own 60% of the foreign corporation’s stock.
D) The IRS will examine whether the foreign corporation conducts substantial business in the foreign country of incorporation to determine if the inversion is valid.
Answer:
Page Ref.: C:16-31 and C:16-32

61) Which of the following is required in order for a transaction to be considered a corporate inversion?
A) A foreign corporation acquires substantially all of the assets of a U.S. corporation.
B) Former shareholders of the U.S. corporation own 80% or more of the stock in the foreign corporation by reason of their U.S. stock ownership.
C) The former U.S. company and its affiliates do not conduct substantial business in the foreign country of incorporation.
D) All of the above are required.
Answer:
Page Ref.: C:16-31 and C:16-32
62) What are the consequences of classification as a corporate inversion?
A) The foreign corporation will be treated as if it is a U.S. corporation.
B) Foreign tax credits will be disallowed on all future earnings.
C) The corporation will be subject to a flat 35% tax rate.
D) If more than half of the shareholders of the new company are the same as the former company, the corporation is considered a U.S. corporation.
Answer:
Page Ref.: C:16-31 and C:16-32

63) A taxpayer may make the election to either deduct or take a credit for foreign income taxes
A) annually.
B) once every five years.
C) only once, and the election applies to all future tax years.
D) No election is available.
Answer:
Page Ref.: C:16-32

64) Which of the following statements is incorrect?
A) A domestic subsidiary’s earnings are taxed in the year earned.
B) A foreign corporation’s (less than 50% ownership) are not taxed until repatriated.
C) All of a controlled foreign corporation’s earnings are taxed as earned.
D) U.S. taxpayers with a foreign branch can reduce part or all of their U.S. taxes by the foreign tax credit.
Answer:
Page Ref.: C:16-33; Topic Review C:16-4

65) Identify which of the following statements is true.
A) When a cash-basis taxpayer elects to take a credit for accrued foreign income taxes, certain other income and expense items must likewise be accrued.
B) The taxpayer may revoke an election to exclude foreign-source earned income if a loss is incurred from foreign employment.
C) A nonresident alien can elect to be considered a resident alien if the nonresident alien is married to a U.S. citizen or a resident alien sometime during the tax year and both spouses consent.
D) All of the above are true.
Answer:
Page Ref.: C:16-35

66) A nonresident alien cannot
A) elect to be treated as a resident alien.
B) elect to be treated as a resident alien before satisfying the substantial presence test for the calendar year following the election year if unmarried.
C) make an irrevocable election to be treated as a resident alien after satisfying the substantial presence test.
D) make an election to be treated as a resident alien if married to a resident alien.
Answer:
Page Ref.: C:16-35
67) In accounting for multinational corporations,
A) SFAS 109 requires companies to include taxes on repatriation of foreign earnings as a deferred tax asset.
B) the deferral of foreign earnings is a temporary difference.
C) SFAS 109 allows the parent to exclude taxes on repatriated foreign earnings if they will not be repatriated in the foreseeable future.
D) a corporation with excess foreign tax credits will record a deferred tax liability.
Answer:
Page Ref.: C:16-39

68) Jose, a U.S. citizen, has taxable income from U.S. sources of $15,000 and taxable income from a foreign country of $35,000. Assume the U.S. tax rate is 25% and Jose paid $12,000 in taxes to the foreign country. What foreign tax credit can be claimed by Jose?
Answer:
Page Ref.: C:16-5; Example C:16-2

69) Michael, a U.S. citizen, earned $100,000 of foreign-earned income and no other U.S. or foreign income in 2010. He also incurred $10,000 of employment-related expenses, none of which were reimbursed. If the full foreign-earned income exclusion is utilized, calculate the deductible employment-related expense (before the 2% nondeductible floor).
Answer:
Page Ref.: C:16-12; Example C:16-10

70) Darlene, a U.S. citizen, has foreign-earned income of $150,000 and employment-related expenses of $15,000. Darlene earns no other income. Darlene also has $12,000 of itemized deductions not directly related to the foreign-earned income. She can exclude $91,500 of foreign-earned income. Darlene incurs $33,750 of Country C income taxes on $150,000 of Country C taxable income. How much of Darlene’s foreign income taxes are noncreditable?
Answer
Page Ref.: C:16-13; Example C:16-11

71) Marcella, an alien individual, is present in the United States for 122 days this year and 122 days each in the past two years. Does she satisfy both the 31-day and 183-day requirements for U. S. Residency status?
Answer:
Page Ref.: C:16-14; Example C:16-12
72) Jacque, a single nonresident alien, is in the United States for 80 days in the current year engaging in the conduct of a U. S. trade or business. Jacque has $3,000 of interest income earned on a bank account in his home county and $1,800 of interest income earned on a bank account located in Addison, Illinois. How will the dividend be taxed and how will the tax be collected?
Answer:
Page Ref.: C:16-15

73) Jacque, a single nonresident alien, is in the United States for 80 days in the current year engaging in the conduct of a U. S. trade or business. Jacque has $30,000 of dividend income paid by a U. S. corporation on a stock investment portfolio unrelated to his trade or business. How will the dividend be taxed and how will the tax be collected?
Answer:
Page Ref.: C:16-16

74) Jacque, a single nonresident alien, is in the United States for 80 days in the current year engaging in the conduct of a U. S. trade or business. Jacque has a $15,000 capital gain on the sale of stock in a U. S. corporation while he was in the United States. The capital gain is not connected to his trade or business. How will the capital gain be taxed and how will the tax be collected?
Answer:
Page Ref.: C:16-16

75) Jacque, a single nonresident alien, is in the United States for 80 days in the current year engaging in the conduct of a U. S. trade or business. Jacque has $75,000 of sales income earned while in the United States and $30,000 of non-U. S. sales income earned while he was outside the United States. How will the income be taxed and how will the tax be collected?
Answer:
Page Ref.: C:16-17
76) Cane Corporation owns 45% of the stock of Edmonton Airline Corporation. In its first year of operations, Edmonton Airline, a Canadian corporation, reports $400,000 of E&P and pays a $100,000 dividend to Cane Corporation. Edmonton Airline pays $50,000 in Canadian income taxes. All amounts are expressed in U.S. dollars. What is Cane Corporation’s U.S. tax liability as a result of receiving the dividend? (Assume a 34% U.S. corporate tax rate.)
Answer:
Page Ref.: C:16-21; Example C:16-18

77) A foreign corporation with a single class of stock is owned equally by Jericho Corporation, a U. S. corporation, and Joshua, a U. S. citizen. Joshua owns no Alpha Corporation stock. Is the foreign corporation a controlled foreign corporation (CFC)?
Answer:
Page Ref.: C:16-24 through C:16-26

78) A foreign corporation with a single class of stock is owned equally by Jericho Corporation, a U. S. corporation, and Joshua, a nonresident alien. Joshua owns no Alpha Corporation stock. Is the foreign corporation a controlled foreign corporation (CFC)?
Answer:
Page Ref.: C:16-24 through C:16-26

79) A foreign corporation with a single class of stock is owned 8% by Bert, 49% by Xi Yong, 30% by Ernie, and 13% by Mark. Bert, Ernie, and Mark are U. S. citizens, and Xi Yong is a nonresident alien. The shareholders are not related. Is the foreign corporation a controlled foreign corporation (CFC)?
Answer:
Page Ref.: C:16-24 through C:16-26

80) A foreign corporation with a single class of stock is owned 8% by Bert, 49% by Xi Yong, 30% by Ernie, and 13% by Mark. Bert, Ernie, and Mark are U. S. citizens, and Xi Yong is a nonresident alien. Bert is Ernie’s son. Is the foreign corporation a controlled foreign corporation (CFC)?
Answer: .
Page Ref.: C:16-24 through C:16-26

81) Music Corporation is a CFC incorporated in Country M. Music receives interest and dividends from its two foreign subsidiary corporations, Sharp Corporation and Flat Corporation. Sharp is incorporated in Country S and conducts all of its activities in that country. Flat is incorporated in Country M and conducts all of its activities in that country. Are the interest and dividends received by Music Corporation FPHCI?
Answer:
Page Ref.: C:16-26; Example C:16-23
82) Zeta Corporation, incorporated in Country Z, is 100% owned by Zelda Corporation, a U. S. corporation. Zelda purchases some machines from an unrelated corporation, for use in Country A. The portion of the sales contract covering installation and maintenance of the machines is assigned by Zelda to Zeta. Zeta is to be paid for these services by Zelda. Does this qualify as foreign base company services income?
Answer:
Page Ref.: C:16-27; Example C:16-25

83) Domestic corporation B owns 200 of the 400 outstanding shares of foreign corporation K’s stock. U.S. citizen R owns the remaining K stock. The domestic corporation held the stock for 40 days two years ago, 365 days last year, and 80 days this year. None of K’s income is Subpart F income. The foreign corporation has E&P of $50,000 for each of the three years in question. None of the years is a leap year. On the 80th day of the current year, the stock is sold by B to R in a transaction in which a $100,000 gain is recognized by B. What part of B’s gain is capital gain?
Answer:

Page Ref.: C:16-28 and C:16-29; Example C:16-28

84) A foreign corporation is a CFC that is in its initial year of operation. For the current year, it reports $1 million of earnings and has an aggregate U. S. Property investment of $400,000. If none of the earnings qualified as Subpart F income, explain how the earnings are taxed.
Answer:
Page Ref.: C:16-28; Example 16-26

85) Bell Corporation, a domestic corporation, sells jars to its wholly owned foreign subsidiary, Jam. Jam Corporation is incorporated in and pays taxes to Country J. Bell Corporation normally sells jars to a U.S. wholesaler providing services similar to those provided by Jam at a price of $4 per unit. Both wholesalers incur similar costs. If Bell Corporation sells jars to Jam for $3 per unit, what are the tax effects?
Answer:
Page Ref.: C:16-30; Example C:16-29
86) Define the term “nonresident alien” and discuss the special tax consequences of U.S. taxation on various types of income of a nonresident alien.
Answer:
Page Ref.: C:16-14 through C:16-18

87) Compare the U. S. tax treatment of a nonresident alien and a resident alien, both of whom earn U. S. trade or business and U. S. investment income.
Answer
Page Ref.: C:16-15 through C:16-18
88) Discuss the advantages of conducting overseas business activities through a foreign corporation.
Answer:
Page Ref.: C:16-19

89) What is the branch profits tax? Explain the Congressional intent behind its enactment.
Answer:
Page Ref.: C:16-22 and C:16-23
90) Discuss the use of a “tax haven” nation to reduce taxes and the effect of Subpart F rules on such planning.
Answer:
Page Ref.: C:16-23

91) What are the five major income categories that are taxed under the Subpart F rules? Explain the concept of Subpart F income.
Answer:
Page Ref.: C:16-25; Figure C:16-2

92) Discuss the Sec. 482 rules concerning the sale of goods and services between a domestic parent corporation and a foreign subsidiary at a lower-than-normal price.
Answer:
Page Ref.: C:16-31 and C:16-32
93) What is a corporate inversion and why was this provision enacted?
Answer:
Page Ref.: C:16-31 and C:16-32

94) Explain the alternatives available to individual taxpayers for reporting foreign income taxes that have been paid or accrued.
Answer:
Page Ref.: C:16-32 and C:16-33

95) Compare the foreign tax payment claimed as a deduction versus a similar payment claimed as a credit. Create an example to demonstrate the tax effect. Use 28% as the marginal tax rate in your example.
Answer:
Page Ref.: C:16-33
96) Describe the financial statement implications of the foreign tax credit and a foreign subsidiary.
Answer:
Page Ref.: C:16-37 and C:16-42

97) Guinness Corporation, a U. S. corporation, began operating overseas in the current year. This year, Guinness sold machine tools that it manufactured in the United States to Canadian companies from a branch office located in Toronto, purchased a 40% investment in a Brazilian corporation from which it received a dividend, and received royalties from an English firm that is the licensee of machine tool patents held by Guinness. The English firm uses the patents to manufacturer machine tools it sells in England. What international tax issues should Guinness’s Director of Taxes consider with respect to these activities?
Answer:
Page Ref.: C:16-3 through C:16-8 and C:16-19 through C:16-22

98) Quality Corporation created a foreign subsidiary in Country C this year. The subsidiary receives components from Quality, assembles the components into a finished product using local labor, and sells them to unrelated wholesalers in Countries A, B, and C using its own sales force. The foreign subsidiary has paid no dividends to the parent this year. What tax issues should Quality’s Director of Taxes consider with respect to these activities?
Answer:
Page Ref.: C:16-3 through C:16-8 and C:16-19 through C:16-30

99) In January of the current year, Stan Signowski’s U.S. employer assigned him to their Paris office. This year, he earned salary, a cost-of-living allowance, a housing allowance, a home leave allowance that permits him to return home once each year, and an education allowance to pay for U. S. schooling for his son. Stan and his wife, Jennifer, have rented an apartment in Paris and paid French income taxes. What tax issues does Stan need to consider when preparing his tax return?
Answer:

Page Ref.: C:16-8 through C:16-13 and C:16-32 through C:16-33