Test Bank For Pearson's Federal Taxation 2026 Comprehensive, 39th Edition by Luke E. Richardson Mitc

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Which of the following citations is the primary citation for a U.S. District Court case?

A) 40 F.Supp. 453 B) 43 AFTR 2d 79-1023 C) 79-1 USTC &9323 D) 55 F.2d 930

1)

2) 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) forwarded to the Senate Finance Committee for consideration.

D) voted upon by the entire House.

2)

3) 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 and sign the return as usual.

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, but not sign the tax return.

3)

4) 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 be used, but Jane should disclose their use to the IRS. B) The Statements on Standards for Tax Services do not address the use of estimates.

C) Estimates may not be used.

D) Estimates may be used without disclosing their use to the IRS.

4)

5) Identify which of the following statements is true.

A) The Statements on Standards for Tax Services recommend that only written tax advice be provided to the client in all situations.

B) Tax planning is an integral part of both closed-fact situations and open-fact situations.

C) The first step in conducting tax research is to clearly understand the issues involved.

D) All of the above are false.

5)

6) Final regulations are A) equal in authority to legislation.

B) presumed to be valid and to have almost the same weight as the IRC. C) equal in authority to legislation if interpretative.

D) equal in authority to legislation if statutory.

6)

7) Final regulations can take effect on any of the following dates except A) the date on which related temporary regulations were first published in the Federal Register.

B) the date on which they were issued in final form.

C) 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.

D) the date on which final regulations were proposed.

7)

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8) Which of the following best describes the weight of a revenue ruling?

A) Revenue rulings should never be used as authority since they only apply to the taxpayer requesting the ruling.

B) Revenue rulings carry more weight than federal court decisions.

C) Revenue rulings carry more weight than regulations.

D) Regulations carry more weight than revenue rulings.

8)

9) The citation "Rev. Rul. 2006-8, 2006-1 C.B. 541" refers to A) the 1st ruling of 2006 found on page 541 in the 2006 volume of the Cumulative Bulletin.

B) the 541st ruling of 2006 found on page eight in Vol. 1 of the 2006 Cumulative Bulletin.

C) the eighth ruling of 2006 found on page 541 in the 2006 volume of the Cumulative Bulletin.

D) the eighth ruling of 2006 found on page 541 in Vol. 1 of the 2006 Cumulative Bulletin.

9)

10) 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) AICPA. B) SEC. C) IRS. D) None of the above. The CPA does not report the false information to any external agencies, unless required by law.

10)

11) Identify which of the following statements is true.

A) The American Federal Tax Reports contain only tax cases.

B) The citation, 41 TCM 1272, refers to a Tax Court regular decision published by Commerce Clearing House.

C) The Federal Supplement contains only tax cases.

D) All of the above are false.

11)

12) Identify which of the following statements is true.

A) Title 26 of the United States Code and the Internal Revenue Code of 1986 are synonymous.

B) The Internal Revenue Code contains chapters, which are further subdivided into titles.

C) Before 1939, tax statutes were codified or compiled into one document.

D) Paragraph references are most commonly used when citing or referring to the tax statutes.

12)

13) Which tax service is usually deemed to be the most authoritative?

A) Standard Federal Tax Reporter B) United States Tax Reporter C) Federal Tax Coordinator 2d D) All are equally authoritative.

13)

14) A tax case cannot be appealed when initiated in the A) U.S. Tax Court.

B) U.S. Court of Federal Claims.

C) U.S. Tax Court using the small case procedures.

D) none of the above

14)

15) The number appearing immediately following the decimal place in a regulation citation refers to the A) subsection of the Code section being interpreted.

B) general subject matter of the regulation.

C) sequential number of the regulation.

D) Code section being interpreted.

15)

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16) 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) He would appeal first to the U.S. Court of Appeals for the Federal Circuit.

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 Federal Claims.

D) There is no appeal.

16)

17) The primary citation for a federal circuit court of appeals case would be A) 40 AFTR 2d 78-1234.

B) 79-2 USTC & 9693.

C) 3 F.3d 134.

D) 44 F.Supp. 403.

17)

18) Identify which of the following statements is false.

A) Published articles and tax services are examples of secondary sources of authority.

B) Dicta are not authoritative.

C) When a court opinion discusses facts and issues on which the court does not rule, the comments are called dicta.

D) Dicta in a court opinion has no influence on other tax proceedings.

18)

19) Title 26 of the U.S. Code includes A) alcohol and tobacco tax legislation only.

C) income tax legislation only.

19)

B) gift tax and estate tax legislation only.

D) all of the tax legislation mentioned above.

20) A jury trial is permitted in the A) U.S. Court of Federal Claims.

B) U.S. Tax Court.

C) U.S. District Court.

D) U.S. Tax Court when the small case procedures are used.

20)

21) Which of the following is secondary authority?

A) Revenue Ruling C) RIA and CCH tax services

21)

B) Treasury Regulations D) Internal Revenue Code

22) The Tax Court departs from its general policy of ruling uniformly for all taxpayers where A) the IRS has indicated that it will acquiesce.

B) the U.S. Court of Federal Claims has ruled differently on the issue in the taxpayer's jurisdiction.

C) a U.S. District Court has ruled differently on the issue in the taxpayer's jurisdiction.

D) the Court of Appeals in the circuit to which the Tax Court decision would be appealed has ruled differently on the issue.

22)

23) The phrase "Entered under Rule 155" indicates that A) only one Tax Court judge reviewed the case.

B) the computation of the exact amount of the tax deficiency has been left to the litigating parties.

C) the court has not reached a decision concerning the appropriate tax treatment of an issue.

D) the parties have agreed not to appeal the decision.

23)

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24) Identify which of the following statements is false.

A) Members from both the House and the Senate are on the Conference Committee.

B) Records of committee hearings are helpful in determining Congressional intent.

C) When tax advisors speak of the "tax law," they usually have in mind just the Internal Revenue Code.

D) All of the above are false.

24)

25) Internet versions of topical tax services include A) Court cases involving tax issues.

B) Code and Regulations.

C) Revenue rulings, letter rulings, and revenue procedures.

D) All of the above.

25)

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

D) the AICPA.

26)

27) The Senate equivalent of the House Ways and Means Committee is the Senate A) Joint Conference Committee.

B) Tax Committee.

C) Ways and Means Committee.

D) Finance Committee.

27)

28) The committee that is responsible for holding hearings on tax legislation for the House of Representatives is the A) Conference Committee.

B) Ways and Means Committee.

C) Finance Committee.

D) Joint Committee on Taxation.

28)

29) 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 American Federal Tax Reports.

B) not published in United States Tax Cases.

C) settled out of court.

D) not published in the Federal Supplement.

29)

30) 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) legislative regulations.

B) statutory regulations.

C) interpretative regulations.

D) congressional regulations.

30)

31) Which regulation deals with the gift tax?

A) Reg. Sec. 25.2518-5 C) Reg. Sec. 301.7002-5

31)

B) Reg. Sec. 20.2014-5 D) Reg. Sec. 1.165-5

32) Identify which of the following statements is false.

A) The U.S. Tax Court follows the previous decisions of the U.S. Court of Appeals to which the tax matter is appealable.

B) The opportunity for "forum shopping" occurs when different precedents on the same point exist.

C) The U.S. Tax Court may intentionally issue conflicting decisions.

D) The U.S. Tax Court must follow the previous decisions of the U.S. District Court for the district in which the taxpayer lives.

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32)

33) 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) The case was tried in 1989 and was appealed in 1992.

D) This citation refers to a taxpayer conference between the IRS and the taxpayer.

33)

34) If the U.S. Supreme Court decides to hear an appeal of a tax case, it will grant a A) writ of appeal.

B) writ of detainer.

C) writ of certiorari.

D) writ of habeas corpus.

34)

35) Identify which of the following statements is true.

A) Annotations are summaries of IRS pronouncements and court opinions.

B) An annotated tax service is organized by broad subject areas.

C) RIA United States Tax Reporter and CCH Standard Federal Tax Reporter are topical tax services.

D) All of the above are false.

35)

36) When a court discusses issues not raised by the facts, the comments A) are not dicta.

B) may be referenced by the parties in other cases having the same facts.

C) are excluded from the formal court opinion.

D) will cause the court's decision to be declared invalid.

36)

37) 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 recognized-fact situation.

B) a restricted-fact situation.

C) an open-fact situation.

D) a closed-fact situation.

37)

38) Identify which of the following statements is true.

A) Regulations have more authoritative weight than tax statutes.

B) Legislative regulations are more likely to be invalidated by the courts than are interpretative regulations.

C) 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.

D) All of the above are false.

38)

39) Which of the following courts is not a trial court for tax cases?

A) U.S. Tax Court B) U.S. Bankruptcy Court C) U.S. District Court D) U.S. Court of Federal Claims

39)

40) Identify which of the following statements is true.

A) Federal district court decisions and federal courts of appeals decisions are not printed by the U.S. Government Printing Office.

B) The U.S. Court of Federal Claims hears cases only in Washington, D.C. C) Each state has at least one U.S. District Court.

D) All of the above are false.

40)

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41) Which of the following steps, related to a tax bill, occurs first?

A) consideration by the entire Senate B) signature or veto by the President of the United States C) consideration by the Senate Finance Committee D) consideration by the House Ways and Means Committee

41)

42) Identify which of the following statements is false.

A) A U.S. Supreme Court opinion in a tax matter has the same status as Congressional tax legislation.

B) Citations to the AFTR and the USTC are referred to as secondary citations.

C) 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.

D) Circuit Court decisions are reported in the Federal Reporter.

42)

43) The term "tax law" includes A) Ways and Means Committee Report.

B) legislation, treasury regulations & judicial decisions.

C) third-party tax advice websites.

D) IRS Instructions.

43)

44) Investigation of a tax problem that involves a closed-fact situation means that A) the client's tax return has yet to be filed.

B) the client's transactions have already occurred and the tax questions must now be resolved.

C) research is primarily concerned with applying the law to the facts as they exist.

D) future events may be planned and controlled.

44)

45) 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) Forum shopping rule.

C) Acquiescence rule.

D) Conformity rule.

45)

46) Which of the following is a true statement regarding primary authority of tax law?

A) Tax services are sources of primary tax authority.

B) The Bloomberg BNA Daily Tax Reporter is a source of primary tax authority.

C) Articles in The Journal of Taxation are viewed as primary authority.

D) Primary authority includes the Code, as well as administrative and judicial interpretations.

46)

47) 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) inform the IRS of the error, regardless of whether the client grants permission.

B) ask the client for permission to disclose the error to the IRS. C) correct the error in the current year's tax return.

D) withdraw from the engagement.

47)

48) Identify which of the following statements is false.

A) A technical advice memorandum is made available as a letter ruling.

B) The citation Ltr. Rul. 200611075 usually indicates the ruling was made public in the 11th week of 2006.

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

D) Rev. Proc. 2006-19 is a revenue procedure that was published in 2006.

48)

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49) A Technical Advice Memorandum is usually A) an internal IRS document describing alternative legislative proposals.

B) issued by the national office in response to an audit request.

C) requested by the taxpayer before entering into a taxable transaction.

D) part of a Tax Court decision.

49)

50) Which regulation deals with Code Section 165?

A) Reg. Sec. 1.165-5 C) Reg. Sec. 165-5

50)

B) Reg. Sec. 1.5-165 D) Reg. Sec. 165.183-5

51) Identify which of the following statements is false.

A) Letter rulings are binding only with respect to the taxpayer requesting the ruling.

B) 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.

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.

51)

52) When the House and Senate versions of a tax bill are not in agreement, the disagreements are resolved by the A) Mediation Committee.

B) Revenue Committee.

C) Joint Conference Committee.

D) Ways and Means Committee.

52)

53) Which of the following documents is issued by the IRS to a specific taxpayer?

A) revenue procedure B) information release C) letter ruling D) regulation

53)

54) Why does a researcher use a citator?

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

54)

55) Which of the following citations denotes a regular decision of the Tax Court?

A) 41 USSC 1099 B) 41 TCM 1272 C) 39 AFTR 2d 77-640 D) 35 T.C. 1083 (2003)

55)

56) The taxpayer need not pay the disputed tax in advance when the suit is initiated in A) U.S. District Court.

B) U.S. Tax Court.

C) U.S. Court of Federal Claims.

D) both A and B

56)

57) Small case procedures of the U.S. Tax Court requires that the amount in dispute not exceed A) $10,000.

B) $5,000.

C) $50,000.

D) $100,000.

57)

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58) Identify which of the following statements is false.

A) 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.

B) The citation Ann. 2006-12, I.R.B. 2006-51, 22 refers to an annotation of an Internal Revenue Service release.

C) Announcements are more technical than information releases.

D) Letter rulings are not published by the U.S. Government Printing Office.

58)

59) A citator is used to find A) the cases that have cited a case subsequent to the issuance of the opinion.

B) whether a case has been overturned.

C) the judicial history of a case.

D) all of the above.

59)

60) The citation "Reg. Sec. 1.199-2" refers to A) a regulation that can be found on page 199.

B) the second regulation issued in 1999.

C) a regulation that interprets Code Section 199.

D) the first regulation issued in 1999.

60)

61) The acquiescence policy of the IRS extends to the A) U.S. Supreme Court decisions.

C) U.S. District Court decisions.

B) U.S. Tax Court regular decisions.

D) both B and C

61)

62) 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) the Cumulative Bulletin.

B) the Committee Reports.

C) a citator.

D) the Treasury Regulations.

62)

63) Which of the following statements regarding proposed regulations is not correct?

A) Proposed regulations do not provide any insight into the IRS's interpretation of the tax law.

B) Practitioners and other interested parties may comment on proposed regulations.

C) Proposed and temporary regulations are generally issued simultaneously.

D) Proposed regulations expire after three years.

63)

64) Identify which of the following statements is false.

A) The Board of Tax Appeals preceded the Tax Court.

B) 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.

C) The citation Cristofani, 97 T.C. 74 (1991) indicates that the decision is a regular decision of the Tax Court.

D) Regular and memorandum decisions of the Tax Court are published by the government in the Tax Court of the United States Reports.

64)

65) Identify which of the following statements is false.

A) The Cumulative Bulletin is issued semiannually while the Internal Revenue Bulletin is issued weekly.

B) 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.

C) The number "5" in the citation Reg. Sec. 1.166-5 refers to the paragraph number.

D) All of the above are false.

65)

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66) Which of the following statements about the Statements on Standards for Tax Services is true?

A) 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.

B) A CPA is never allowed to use a taxpayer's estimates when preparing a tax return.

C) The CPA must tell the IRS upon becoming aware that an error has been made on a past tax return.

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.

66)

67) The tax statutes with the popular name "The Internal Revenue Code of 1986" are contained in which Title of the Code?

A) 301 B) 26 C) 25 D) 20

67)

68) Tax Court memorandum decisions A) are not published.

B) have less precedential value than regular decisions.

C) usually deal with factual variations of issues litigated previously.

D) cannot be appealed.

68)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

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

69)

70) According to the Statements on Standards for Tax Services, CPAs must verify all tax return information submitted by reviewing client documentation.

70)

71) Final regulations have almost the same authoritative weight as the IRC.

71)

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

72)

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

73)

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

74)

75) Tax compliance is the biggest component of a tax practice.

75)

76) The tax consultant can give an opinion on a tax fact pattern without all the facts.

76)

77) 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.

77)

78) 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.

78)

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

79)

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

80)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

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

82) Compare and contrast "interpretative" and "statutory" regulations.

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

84) A client approaches you regarding the tax implications of an acquisition of a competitor's business. Describe the six basic steps of tax research process to assist the client.

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

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

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

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

89) 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?

90) 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?

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

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

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

94) When should oral client communications be followed up in writing?

95) 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"?

96) Discuss the conflict between advocacy for a client and responsibility to the IRS. 97) Distinguish between an annotated tax service and a topical tax service.

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

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99) 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?

100) 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, 25 AFTR 2d 70-827, 70-1 USTC & 9289 (1970).

101) Explain the difference between tax compliance versus tax consulting.

102) What is an information release?

103) 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?

104) There are no questions for this section.

105) Explain the legislative reenactment doctrine.

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

107) 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?

108) Discuss the purposes and scope of temporary regulations.

109) What is the purpose of Treasury Regulations?

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

111) Outline and discuss the tax research process.

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

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

114) Describe the format of a client memo.

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

116) What is "forum-shopping"?

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

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

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

120) What is the purpose of a citator?

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

122) Describe the appeals process in tax litigation.

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Answer Key Testname: C1

1) A 2) A 3) B 4) A 5) D 6) B 7) C 8) D 9) D 10) D 11) A 12) A 13) D 14) C 15) D 16) D 17) C 18) D 19) D 20) C 21) C 22) D 23) B 24) C 25) D 26) D 27) D 28) B 29) D 30) A 31) A 32) D 33) B 34) C 35) C 36) B 37) C 38) C 39) B 40) C 41) D 42) C 43) B 44) B 45) A 46) D 47) B 48) C 49) B 50) A 13

Answer Key Testname: C1

51) B 52) C 53) C 54) A 55) D 56) B 57) C 58) B 59) D 60) C 61) D 62) C 63) A 64) D 65) C 66) A 67) B 68) C 69) TRUE 70) FALSE 71) TRUE 72) FALSE 73) FALSE 74) FALSE 75) FALSE 76) FALSE 77) TRUE 78) TRUE 79) TRUE 80) FALSE 81) The Tax Court, the U.S. Court of Federal Claims, or the U.S. district court for the taxpayer's jurisdiction is where tax-related litigation may begin. The taxpayer would be interested in the precedent, if any, existing within each jurisdiction. The taxpayer might prefer to avoid parting with cash to pay the proposed deficiency. If so, the taxpayer would want to litigate in the Tax Court. If the taxpayer would like to have a jury trial address questions of fact, he or she should opt for the U.S. district court.

82) Both types of regulations are issued by the Treasury Department. Interpretative regulations make the statutory language easier to understand and apply. Statutory regulations are issued when Congress delegates its rule-making authority to the Treasury Department. This delegation of authority is made explicitly in the legislation.

The courts are less likely to invalidate a statutory regulation than an interpretative regulation. The reluctance of the court to invalidate a statutory regulation is based on the recognition that Congress has abdicated its rule-making authority to the Treasury Department.

83) The tax practitioner owes the client the following duties: (1) to inform the client of (a) the potential adverse consequences of a tax return position, (b) how the client can avoid a penalty through disclosure, (c) errors in a previously filed tax return, and (d) corrective measures to be taken; (2) to inquire of the client (a) when the client must satisfy conditions to take a deduction and (b) when information provided by him or her appears incorrect, incomplete, or inconsistent on its face, and (3) not to disclose tax-related errors without the client's consent.

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Answer Key Testname: C1

84) In both open- and closed-fact situations, the tax research process involves six basic steps: 1. Determine the facts.

2. Identify the issues (questions).

3. Locate the applicable authorities.

4. Evaluate the authorities and choose those to follow where the authorities conflict.

5. Analyze the facts in terms of the applicable authorities.

6. Communicate conclusions and recommendations to the client.

85) Proposed regulations are not authoritative, but they do provide guidance concerning how the Treasury Department interprets the IRC. Temporary regulations, which have the same effect as final regulations, often are issued after major revisions to the IRC so that taxpayers and tax advisers will have guidance concerning procedural and/or computational matters. Final regulations, which are issued after the public has had time to comment on the proposed regulations, have nearly the same authoritative weight as the IRC. 86) A citation should contain, at a minimum, the name of the case, the reporter that publishes the case, a volume number, a page or paragraph number, the year the case was decided, and the court that decided the case.

87) The small cases procedure allows a taxpayer the advantage of having a day in court without the expense of an attorney. But if the taxpayer loses, the decision cannot be appealed.

88) No; Title 26 deals with all taxation matters, not just income taxation. It covers estate tax, gift tax, employment tax, alcohol and tobacco tax, and excise tax matters.

89) According to Statement on Tax Standards, the CPA should explain to the client that this action is a violation of the tax law and would trigger IRS penalties. If the client insists on the deduction, the CPA should consider withdrawing from the engagement.

90) The Tax Court will hold that the expenditure is deductible except in the Ninth Circuit. The taxpayers in the Ninth Circuit will be denied the deduction.

91) Differences: 1) Regular decisions involve an issue decided for the first time. A memorandum decision frequently involves a variation in the facts for an issue where the law has been previously decided.

2) The IRS's acquiescence policy extends to regular decisions but not to memorandum decisions.

3) Regular decisions are published by the U.S. Government Printing Office in the Tax Court of the United States Reports, while memorandum decisions are published by private companies.

Similarity: 1) Regular and memorandum decisions have the same precedential value.

92) Yes. If the Tax Court is issuing two decisions that are appealable to different circuit courts and these circuit courts have previously reached different conclusions on the issue, the Tax Court follows the respective precedent in each circuit and issues conflicting decisions. This is a result of the Golsen rule.

93) 1) Use a key word search.

2) Read the applicable material.

3) Check the supplementary (current developments) material.

4) Read the cases and rulings referenced in the database.

5) Use a citator to determine the current status of the relevant cases and rulings and if there are any additional cases and rulings.

6) Analyze the information; make analogies and reach a conclusion.

7) Communicate the conclusions to the client.

8) Refine the issues and perhaps return to step 1.

94) Written communications are recommended in important, unusual, substantial dollar value, or complicated transactions.

15

Answer Key Testname: C1

95) The term is not defined in the IRC. Because the provision is relatively new, few courts have had an opportunity to interpret what "credible evidence" means. In the absence of relevant statutory or judicial authority, you might look to the committee reports to ascertain what Congress intended by the term. Senate Report No. 105-174 states that "credible evidence" means evidence of a quality, which, "after critical analysis, the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted."

96) The CPA's primary duty is to his or her client, not the IRS. The CPA should provide quality advice based on sound legal authority. CPAs do not have to verify client data unless it appears inconsistent, erroneous, or incomplete. CPAs also are not required to report most potential tax law violations to the IRS. If a client refuses to correct a tax-related error, the CPA may terminate the relationship.

97) An annotated tax service is organized by IRC section. The IRC-arranged subdivisions of this service are likely to encompass several topics. A topical tax service is organized by broad topic. The topically arranged subdivisions of this service are likely to encompass several IRC sections.

98) Factors to consider include each court's published precedents pertaining to the issue; the desirability of a jury trial; the tax expertise of each court; the effect on the taxpayer's cash flow.

99) The CPA should have a good faith belief that the pro-taxpayer position is warranted in existing law or can be supported by a good-faith argument for an extension, modification, or reversal of existing law. The position should have a realistic possibility of being sustained administratively or judicially on its merits if challenged.

100) This case appears in Vol. 397, page 301, of the United States Supreme Court Reports. It is also recorded in Vol. 25, pages 70-827, of the American Federal Tax Reports, Second Series, and in Vol. 1, paragraph 9289 of the 1970 CCH reporter the U.S. Tax Cases.

101) Tax compliance is assisting taxpayers in preparing and filing necessary tax forms and often includes responding to communications from tax authorities. Tax consulting is research and analysis, often referred to as tax planning, that addresses various scenarios to determine the best tax outcome given the law and the underlying facts in the case. Tax consulting will vary depending if the facts are closed or open. Closed facts generally involve tax compliance. Open facts allow for the flexibility to structure transactions for the best possible outcome.

102) The IRS issues information releases when it wants to release information to the general public. They are written in lay terms and are sent to thousands of newspapers throughout the country.

103) The Golsen rule provides that the Tax Court rules consistently with decisions of the circuit court of appeals to which the taxpayer's case is appealable. If the new case is appealable to the Tenth Circuit, the Tax Court will hold the expenditure is deductible, thereby following its own precedent. In a case appealable to the Fifth Circuit, the Tax Court will rule that it is not deductible, thereby following the appellate court's earlier decision.

104) 105) Under the legislative reenactment doctrine, a Treasury Regulation is deemed to have been endorsed by Congress if the regulation was finalized before a related IRC provision was enacted, and during the interim, Congress did not amend the provision to which the regulation relates.

106) Citations serve two purposes. First, they substantiate propositions, and second, they enable the reader to locate underlying authority.

107) Any U.S. District court within the Eleventh Circuit must follow that circuit's decision. The U.S. District Court for Rhode Island must rule consistently with its previous ruling. Tax Court decisions are not binding on district courts, thus all district courts other than the one for Rhode Island and those in the Eleventh Circuit are free to decide the issue independently.

108) Temporary regulations are issued by the Treasury Department after statutory changes have occurred to give guidance with respect to procedural and computational matters. Temporary regulations are also issued as proposed regulations with the same authoritative value as final regulations.

109) The Treasury Department issues regulations that expound upon the IRC. Treasury Regulations often contain examples with computations that provide valuable assistance in understanding the statutory language.

110) A taxpayer-requested letter ruling deals with prospective transactions, whereas a TAM deals with past or consummated transactions.

16

Answer Key Testname: C1

111) 1) The facts must be determined. However, some facts may not have occurred in an open-fact situation. Where facts have not yet occurred, it is useful to review tax research material to determine which facts would produce the most favorable outcome.

2) The issues must be determined. The issues may not always be clear and may be different than the client believes.

Thus, only a thorough understanding of the facts permits an adequate formulation of the issues.

3) Determine which authorities are applicable.

4) Evaluate the authorities. Choose the ones to follow when there are conflicting authorities.

5) Communicate the result to the client. The communication with the client should not result in a misunderstanding.

While discussions with the client may be suitable, it is recommended by the AICPA's Statements on Standards for Tax Services that the communication be written where issues are important, unusual or complicated. Many firms require that conclusions be communicated in writing.

112) Committee reports can help resolve ambiguities in statutory language by revealing Congressional intent. They are indicative of this intent.

113) Not really. A letter ruling is binding only on the taxpayer to whom the ruling was issued. However, the rulings can be useful in proving insights as to the IRS opinion about the tax consequences of various transactions.

114) A client memo should include a statement of the facts, a list of issues, a discussion of relevant authority, analysis, and recommendations of appropriate actions to the client based on the research results.

115) Researchers should note the date on which a Treasury Regulation was adopted because the IRC may have been revised subsequent to the date of adoption. That is, the regulation may not interpret the current version of the IRC. Discrepancies between the IRC and the regulation occur when the Treasury Department has not updated the regulation to reflect the current statute.

116) Forum-shopping involves choosing where among the various courts to file a lawsuit. Since courts often disagree as to the appropriate tax treatment of the same item, a taxpayer can file in the jurisdiction that has precedents that favor his circumstances.

117) In a closed-fact situation, the transaction has occurred and the facts are not subject to change. In an open-fact situation, the transaction is in the formative or projected stage, and the taxpayer is able to structure the facts so that the tax consequences of the transaction can be more favorable.

118) It is important to consider nontax objectives as well as tax objectives. For instance, if a wealthy client wants to minimize her estate taxes while passing the greatest value possible to her descendants, you would not suggest that she leave the majority of her estate to charity and only a few hundred thousand dollars to her descendants. Although this would reduce her estate tax liability to zero, it would be inconsistent with her objective of allowing her descendants to receive as much after-tax wealth as possible.

119) The regular opinions are found in the Tax Court of the United States Reporter, published by the U.S. Government Printing Office, and the memo decisions are published by both RIA and CCH in their own court reporters.

120) Citators give a history of the case, and they list other authorities such as other cases or revenue rulings that cite the case in question.

121) A tax advisor might consult the provisions of a tax treaty if a U.S. taxpayer engages in transactions in a foreign country.

The United States has tax treaties with about 55 countries.

122) Appeals from Tax Court and U.S. district court decisions are made to the circuit court of appeals for the taxpayer's jurisdiction. U.S. Court of Federal Claims decisions are appealable to the circuit court of appeals for the Federal Circuit.

Appeals from any of the circuit courts of appeals may be brought to the U.S. Supreme Court.

17

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) 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 $10,000 loss.

B) He recognizes a $5,000 gain and a $10,000 loss.

C) He recognizes a $5,000 loss.

D) He recognizes neither a gain nor a loss.

1)

2) Under Sec. 351, corporate stock may include all of the following except A) voting stock.

B) qualified preferred stock.

C) nonvoting stock.

D) stock warrants.

2)

3) 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.

3)

4) 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) increased by the FMV of boot received from the corporation.

D) decreased by liabilities assumed by the corporation.

4)

5) Business assets of a sole proprietorship are owned by A) an individual.

B) a member.

C) a partner.

D) a stockholder.

5)

6) Identify which of the following statements is true.

A) Section 351 was enacted to allow taxpayers to incorporate without incurring adverse tax consequences.

B) Section 351 threshold for stock ownership is 50%.

C) The repeal of Sec. 351 would result in more existing businesses being incorporated.

D) The exchange of stock for services rendered is not a taxable transaction.

6)

7) 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) a $15,000 capital gain.

B) no gain.

C) a $25,000 capital gain.

D) a $50,000 capital gain.

7)

1

8) 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) $13,000.

B) $40,000.

C) $8,000.

D) $20,000.

8)

9) Identify which of the following statements is false.

A) A sole proprietorship is a separate taxable entity.

B) A solely owned corporation is a sole proprietorship.

C) A sole proprietor is considered to be an employee of the business.

D) All of the above are false.

9)

10) 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) $0 income; $0 basis B) $250,000 income; $250,000 basis C) $0 income; $250,000 basis D) $250,000 income; $0 basis

10)

11) 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) Wayne must report the FMV of the stock received as ordinary income.

B) Wayne must report the FMV of the stock received as capital gain.

C) Rose and Wayne must recognize their realized gains, if any.

D) Rose and Wayne are not required to recognize their realized gains.

11)

12) 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) 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.

C) income recognition in the amount of $60,000 to the corporation 12 months after the time of contribution.

D) a zero basis in the land and a $60,000 basis reduction in other assets.

12)

13) Which of the following statements is incorrect?

A) S corporation losses can offset shareholder income from other sources.

B) S corporations must allocate income and expenses to their shareholders based on their proportionate ownership interest.

C) The number of S corporation shareholders is unlimited.

D) S corporation income is taxed to shareholders when earned.

13)

14) 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) $10,000.

B) $0.

C) $20,000.

D) $5,000.

14)

2

15) Identify which of the following statements is true.

A) Section 351 stock ownership requirement threshold is 50%.

B) 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.

C) 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.

D) Only transfers to newly created corporations qualify for Sec. 351 treatment.

15)

16) 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) $10,000 realized; $10,000 recognized.

B) $80,000 realized; $15,000 recognized.

C) $20,000 realized; $10,000 recognized.

D) $80,000 realized; $20,000 recognized.

16)

17) The transferee corporation's basis in property received in a Sec. 351 exchange is A) the transferor's basis for the property plus gain recognized by the transferee corporation.

B) the transferor's basis for the property plus gain recognized by the transferor.

C) the FMV of the property received.

D) the transferee corporation's basis in the stock exchanged.

17)

18) Identify which of the following statements is true.

A) If a C corporation does not distribute its income to its shareholders annually, double taxation cannot occur.

B) C corporation operating losses are deductible by the individual shareholders.

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.

18)

19) Identify which of the following statements is true.

A) Section 351 only applies to individual transferors.

B) Section 351 threshold for stock ownership is 50%.

C) Section 351 applies to property transfers in exchange for stock.

D) Section 351 applies exclusively to the formation of a new corporation.

19)

20) 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) $100,000.

B) $0.

C) $80,000.

D) $50,000.

20)

21) 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 FMV of the property exchanged exceeds the FMV of the stock received.

C) if the transferor receives property other than stock.

D) both A and B

21)

3

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) $95,000 B) $180,000 C) $35,000 D) $100,000

22)

23) For Sec. 351 purposes, the term "property" does not include A) services rendered.

B) inventory.

C) accounts receivable.

D) cash.

23)

24) Three members form an LLC in the current year. Which of the following statements is incorrect?

A) 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.

B) The LLC can elect to have its default classification ignored.

C) The LLC's default classification under the check-the-box rules is as a partnership.

D) The LLC can elect to be taxed as a C corporation with no special tax consequences.

24)

25) 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 a $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) $5,000 ordinary income B) $5,000 capital gain C) $15,000 capital gain D) $15,000 ordinary income

25)

26) Identify which of the following statements is true.

A) C corporation and S corporation are synonymous terms.

B) A partner is generally considered to be an employee of the partnership.

C) C corporation is subject to double taxation.

D) All of the above are false.

26)

27) 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 a $10,000 gain and the stock basis is zero.

D) Lynn recognizes no gain and the stock basis is $50,000.

27)

28) 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) $95,000.

B) $100,000.

C) $80,000.

D) $85,000.

28)

4

29) 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 applies regardless if the transaction qualifies for Sec. 351.

C) The assignment of income doctrine is a legislative requirement that income be taxed to the person who earns it.

D) 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.

29)

30) Identify which of the following statements is false.

A) A business need not be incorporated under state or federal law to be taxed as a corporation.

B) An LLC that has only two members (owners) must be taxed as a partnership.

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

D) Once an election is made to change its classification, an entity cannot change again for 60 months.

30)

31) 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) $100,000 C) $75,000 D) $37,500

31)

32) The transferor's holding period for any boot property received in a Sec. 351 stock exchange A) is the same as the holding period of the stock received in the exchange.

B) includes the holding period for the boot transferred.

C) begins on the day after the exchange.

D) begins on the day of the exchange.

32)

33) Identify which of the following statements is true.

A) The definition of stock under Sec. 351 includes stock rights and warrants.

B) 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.

C) Section 351 stock ownership requirement threshold is 80%.

D) The receipt of property other than stock by the transferor will trigger the recognition of gain or loss under Sec. 351.

33)

34) 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) $1,600.

B) $1,333.

C) $1,868.

D) $500.

34)

35) Which of the following statements is incorrect?

A) In a limited partnership, all partners participate in managerial decision making.

B) In a general partnership, all partners have unlimited liability for partnership debts.

C) Limited partners' liability for partnership debt is limited to their amount of investment.

D) All of the above are correct.

35)

5

36) 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) $0.

B) $60,000.

C) $50,000.

D) $10,000.

36)

37) 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 B) Ordinary loss Capital loss Capital loss $10,000 $0 $10,000 $10,000

37)

C) Ordinary loss $0

D) Ordinary loss $20,000

Capital loss $20,000

Capital loss $0

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) qualify under Sec. 351 only if an advance ruling has been obtained.

B) qualify with respect to Sheila under Sec. 351 whether Matt qualifies or not.

C) not qualify under Sec. 351.

D) qualify under Sec. 351 if Matt can show that the sale to Paul was not part of a prearranged plan.

38)

39) 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 corporation is either required to redeem the stock or is likely to exercise a right to redeem the stock.

B) The shareholder can require the corporation to redeem the stock.

C) The stock is limited and preferred as to dividends.

D) The dividend rate on the stock may not vary with interest rates, commodity prices, or other similar indices.

39)

40) Which of the following statements about a partnership is true?

A) Partners are taxed on distributions from a partnership.

B) Partners are taxed on their allocable share of income whether it is distributed or not.

C) Partners are considered employees of the partnership.

D) A partnership is a taxpaying entity.

40)

41) 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) Corporation may utilize the most advantageous depreciation method on property acquired via a qualified Sec. 351 transaction.

D) 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.

41)

6

42) 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) $80,000.

B) $130,000.

C) $150,000.

D) $200,000.

42)

43) Identify which of the following statements is true.

A) 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.

B) Section 351 stock ownership requirement is 50%.

C) A transferor's gain or loss that goes unrecognized when Sec. 351 applies is permanently exempt from taxation.

D) If a taxpayer transfers property and services as part of a transaction meeting the Sec. 351 requirements in which shareholders own at least 80% collectively, all of the stock received is counted in determining whether the property transferors have acquired control.

43)

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

B) $5,000.

C) $4,000.

D) $6,000.

44)

45) Identify which of the following statements is true.

A) The transferee corporation's holding period for assets acquired in an exchange meeting the Sec. 351 requirements does not include the transferor's holding period for the property.

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) 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.

45)

46) Identify which of the following statements is true.

A) 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.

B) 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.

C) Under Sec. 351, corporate stock may include voting and nonvoting stock.

D) 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.

46)

7

47) 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.

FMV Basis

Asset One $30,000 35,000

Max's recognized gain is A) $5,000.

Asset Two $45,000 40,000

47)

Asset Three $25,000 20,000

B) $7,000.

C) $10,000.

D) $3,000.

48) 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) $40,000.

B) $35,000.

C) $30,000.

D) none of the above

48)

49) Which of the following is an advantage of a sole proprietorship over other business forms?

A) tax-exempt treatment of fringe benefits B) low tax rates on dividends C) Sole proprietorship losses may offset nonbusiness income of the taxpayer.

D) the deduction for compensation paid to the owner

49)

50) Which of the following statements is true?

A) Distributions of C corporation income are not taxable.

B) C corporation losses remain in the C corporation and can offset capital gain income from other years.

C) C corporation shareholders are taxed based on their proportionate share of income.

D) Shareholders in a C corporation can use C corporation losses to offset shareholder income from other sources.

50)

51) 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.

51)

Cash Equipment Accounts receivable Accounts payable (deductible expenses) Note payable (on equipment)

Adjusted Basis $10,000 80,000 0 0 50,000

FMV $ 10,000 100,000 120,000 60,000 50,000

Martin must recognize a gain of ________ and has a stock basis of ________.

A) $20,000; $40,000 B) $20,000; $30,000 C) $0; $30,000 D) $0; $40,000

8

52) 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 costs $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 no gain and Marc recognizes $2,000 as ordinary income.

C) Carmen recognizes a $2,000 Sec. 1231 gain and Marc recognizes $5,000 as ordinary income.

D) Carmen recognizes a $2,000 Sec. 1231 gain and Marc recognizes a $5,000 Sec. 1231 gain.

52)

53) 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) Kenya may defer the recognition of any tax until the stock is sold.

B) No gain will be recognized by Kenya.

C) The transaction results in $10,000 of ordinary income for Kenya.

D) The transaction results in $10,000 of capital gain for Kenya.

53)

54) 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) Section 351 stock ownership requirement threshold is 50%.

D) 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.

54)

55) 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) $100,000 ordinary loss; $50,000 capital loss.

B) $150,000 capital loss.

C) $150,000 ordinary loss.

D) $100,000 ordinary loss; $50,000 ordinary loss carryforward.

55)

56) 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) $160,000 C) $60,000 D) $20,000

56)

57) 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) $70,000.

B) $65,000.

C) $75,000.

D) $60,000.

57)

9

58) 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 taxed on their proportionate share of earnings that are distributed.

C) S shareholders are taxed on their proportionate share of earnings whether or not distributed.

D) S shareholders are only taxed on distributions.

58)

59) 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) $85,000.

B) $100,000.

C) $95,000.

D) $90,000.

59)

60) 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 of the exchange.

C) begins on the day after the exchange.

D) begins on the day of original issue.

60)

61) Mr. Big, a nonshareholder, who is not a customer, potential customer, governmental entity, or civic group, contributes $60,000 cash and land worth $100,000 to induce Carrie Corporation to relocate to his municipality. Carrie Corporation spent $50,000 of the cash within the first 12 months of his contribution to purchase machinery. The contribution results in A) Carrie Corporation recognizes no income as a result of the contribution, the land and machinery have a basis of zero.

B) Carrie Corporation recognizes no income as a result of the contribution, the land has a basis of $100,000, and the machinery has a basis of $60,000.

C) Carrie Corporation recognizes no income as a result of the contribution, the land has a basis of zero, and the machinery has a basis of $50,000.

D) Carrie Corporation recognizes $160,000 of income.

61)

62) Identify which of the following statements is true.

A) 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.

B) The transferee corporation's holding period for assets acquired in an exchange meeting the Sec. 351 requirements does not include the transferor's holding period for the property.

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) Section 351 provides for nonrecognition of gain for the transferee corporation when it distributes appreciated land that is boot property to a shareholder.

62)

63) 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 doctor must include the $40,000 as ordinary income in her personal income tax return at the time of incorporation.

B) The $40,000 of receivables is included as ordinary income in the corporation's income tax return when collected.

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 on the doctor's personal income tax return when collected by the corporation.

63)

10

64) 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) $35,000.

B) $40,000.

C) $30,000.

D) none of the above

64)

65) Identify which of the following statements is true.

A) An unincorporated business may not be taxed as a corporation.

B) Under the check-the-box regulations, an LLC that has one member (owner) may be disregarded as an entity separate from its owner.

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.

65)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

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

66)

67) 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.

67)

68) A business must be incorporated in the state where the founder is a resident.

68)

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

69)

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

70)

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

71)

72) 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.

72)

73) 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.

73)

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

74)

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

75)

76) 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.

76)

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

77)

78) Federal laws dictate the legal requirements for forming a corporation.

78)

11

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

79)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

80) 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?

81) 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?

82) 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?

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

84) 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?

85) Severs Corporation employs Susan as an Advertising Director. 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?

86) 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?

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

88) Yolanda transfers land, a capital asset, having a $70,000 adjusted basis and a $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?

12

89) 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?

90) 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?

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

92) 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?

93) Discuss the tax treatment and compliance reporting of a single member LLC owned by an individual.

94) The City of Providence owns 100% of Triple A Baseball Corporation, a minor league baseball team in their community. The City donates land worth $125,000 to Triple A Corporation so the major league team will not revoke the City's minor league franchise. 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?

95) 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?

96) 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?

97) 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?

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

13

99) 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 an $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?

100) 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?

101) 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?

102) 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?

103) 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?

104) 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 Sec. 351 apply to Gwen's exchange? What is the amount of her realized gain or loss? How much is recognized?

105) 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?

106) What is the tax treatment for a contribution of capital to a corporation by a nonshareholder who is not a customer, potential customer, government entity, or civic group?

107) 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?

108) 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?

14

109) 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.

110) 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?

111) The legal requirements for forming a corporation usually include: 112) In January of the current year, Rae purchases 100% of C Corporation stock for $30,000. C Corporation reports taxable income of $20,000 in the current year, on which it pays tax of $4,200. None of the remaining $15,800 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?

113) 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?

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

115) 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?

15

116) 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?

117) 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?

118) 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?

119) 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. 120) What is an advantage of S-corporation pass through profits compared to a Limited Liability Company (LLC) taxed as a partnership pass through profits?

121) 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?

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

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

16

124) 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?

125) 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?

126) On July 9, Year 1, 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 Year 1. On February 9, Year 2, 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 Year 1 claimed by Tom? What is the amount of depreciation for Year 2 claimed by Brewer Corporation? What is Brewer's basis in the computer on the date of transfer?

127) 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?

128) 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?

17

Answer Key Testname: C2

1) D 2) D 3) D 4) D 5) A 6) A 7) A 8) A 9) D 10) B 11) A 12) A 13) C 14) A 15) C 16) B 17) B 18) D 19) C 20) B 21) C 22) D 23) A 24) A 25) A 26) C 27) C 28) C 29) D 30) B 31) B 32) C 33) C 34) A 35) A 36) C 37) B 38) D 39) D 40) B 41) D 42) C 43) D 44) D 45) D 46) C 47) B 48) A 49) C 50) B 18

Answer Key Testname: C2

51) D 52) B 53) C 54) B 55) A 56) D 57) D 58) C 59) A 60) A 61) A 62) C 63) B 64) C 65) B 66) TRUE 67) TRUE 68) FALSE 69) TRUE 70) FALSE 71) FALSE 72) FALSE 73) TRUE 74) TRUE 75) FALSE 76) FALSE 77) FALSE 78) FALSE 79) TRUE 80) Both Abby and Bart are transferors, so Sec. 351 does apply. Neither Abby nor Bart recognizes any gain on the exchange.

81) Gene recognizes no gain when he transfers the land to Dee Corporation. Dee Corporation's basis in the land will be $200,000. All gain on the subsequent sale will be ordinary income to Dee Corporation. This alternative results in the precontribution gain that accrued prior to Gene's transfer and the postcontribution profit originating from subdividing the land being taxed at Dee Corporation's marginal tax rate. Gene could transfer the land to Dee Corporation in exchange for stock and $330,000 of debt instruments. In this case, Gene would recognize $330,000 of long-term capital gain and Dee Corporation's basis in the land would be $530,000. The $330,000 of precontribution capital gain (net of any capital losses that Gene has recognized) is taxed at the taxpayer's applicable capital gains rate of either 0%, 15%, or 20%.

82) a) Neither Lynn nor Fred recognizes any gain or loss on the exchange since Sec. 351 applies. b) Since the exchange is disproportionate, it is likely that Fred has made a gift of 25 shares of Florida stock to Lynn.

Lynn's basis in her 75 shares is $88,000 ($56,000 basis in property transferred by Lynn + $32,000 basis in the 25 shares received from Fred). (This answer assumes no gift taxes were paid by Fred on the transfer.) c) Fred's basis in his 25 shares is $32,000 [$64,000 - (0.50 × $64,000)].

19

Answer Key Testname: C2

83) A transferor may want the corporation to have a higher basis in the property transferred. A higher basis would allow greater depreciation deductions and reduce the gain recognized if the corporation sells the property. The increased depreciation and/or reduced gain may be an advantage because the corporation may be in a higher tax bracket than the transferor. A transferor's gain also may be a capital gain that is reduced by a capital loss so as to be tax-free.

Nonrecognition can be avoided by selling the property to the corporation for cash or cash and debt. The 80% control test may be intentionally avoided by issuing property for services. Also, by using debt in an amount that exceeds the transferor's basis or by having debt assumed or acquired without a business purpose, the transferor can be required to recognize gain.

84) Bob must recognize $20,000 ($30,000 - $10,000) of gain on the exchange. Since Ellen only contributed cash, she does not recognize any gain or loss. If Ellen obtained additional stock worth at least 10% of the value of the stock she already owns (i.e., at least 10 shares worth $10,000), her stock would be counted for control purposes and then Sec. 351 would apply. Alternatively, if Bob acquired sufficient stock to own 80% of the outstanding stock after the exchange, Sec. 351 would also apply. If Sec. 351 applies, Bob will recognize no gain on the exchange.

85) Since Susan is not a shareholder in Severs Corporation, her loss of $45,000 ($50,000 × .90) is an ordinary loss and is fully deductible in the year she incurs the loss.

86) Whitney must pay taxes on $30,000, his 50% share of Museum Corporation's income, whether it is distributed to him or not. Museum Corporation pays no corporate income taxes. If Museum Corporation reports a $40,000 loss, Whitney's $20,000 share of the loss reduces his taxable income.

87) The general rule is that the assumption does not invalidate the Sec. 351 exchange. The liabilities that are assumed are not considered to be boot (Sec. 357(a)). If the assumption or acquisition of any of the liabilities fails to have a business purpose or has a tax avoidance purpose, then all of the liabilities are considered to be money (Sec. 357(b)). Gain is recognized equal to the lesser of the realized gain or money received. If the amount of liabilities assumed or acquired exceeds the adjusted basis of the property transferred, then gain must be recognized in the amount of the excess (Sec. 357(c)).

88) Yolanda has a realized gain of $55,000 ($125,000 - $70,000). Even though Yolanda does not receive any boot, she must recognize a $30,000 ($100,000 - $70,000) capital gain, the amount by which the liabilities assumed by Jazz Corporation exceed the basis of the land and the cash transferred by Yolanda. Yolanda's basis in the Jazz stock is $0.

Yolanda's basis in the land transferred $ 70,000 Plus: Cash transferred 10,000 Gain recognized 20,000 Minus: Boot received (liabilities assumed by Jazz) ($100,000) Yolanda's basis in the Jazz Stock $0 89) Zeema must recognize a $34,000 ($66,000 - $32,000) gain on the sale. Of this gain, $18,000 is ordinary income recaptured under Sec. 1245. The remaining $16,000 is Sec. 1231 gain.

90) a) Since Sec. 351 does not apply because 25% (20 shares out of 80 total shares) of the stock is issued for services, John must recognize $15,000 of capital gain. b) John's basis in his shares is $30,000 and his holding period begins on the day after the exchange date. c) Meg recognizes a $5,000 Sec. 1231 loss. d) Meg's basis in her shares is $30,000 and her holding period begins on the day after the exchange date. e) Karen must recognize $20,000 of ordinary income. f) Karen's basis in her shares is $20,000. Her holding period begins on the day after the exchange date. g) Frost Corporation has a $30,000 basis in the land and a $30,000 basis in the machinery. Its holding period for each asset begins on the day after the exchange date. The services, if capitalized, would have a $20,000 basis. The services may be amortizable if they are organizational or start-up expenditures.

91) $320,000 income is recognized. Dotcom Corporation's basis in the land is $200,000.

92) Rames will recognize a $10 capital gain on the repayment of the debt instrument. Ra will deduct the $10 premium paid as interest expense.

93) Under the check-the-box regulations a single-member LLC is typically treated as as a disregarded entity. If the owner is an individual, he is taxed as a sole proprietor, filing Sch C via Form 1040.

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Answer Key Testname: C2

94) The corporation recognizes no income and the land has a $0 basis because the City is the majority shareholder.

95) No gain or loss is recognized by either Dan or Sylvia. However, since the stock was not received in proportion to the relative FMVs of the properties contributed, the IRS may attempt to reconstruct the transaction in the form that Dan has received 667 shares of stock and made a gift of 167 shares to his daughter Sylvia. Dan's basis in his 500 shares of stock is $37,538 [(500/667) × $50,000 basis in property transferred]. Sylvia's basis in her 500 shares is $37,462 [$25,000 basis in property transferred + ($50,000 - $37,538) basis in the shares received as a gift from Dan].

96) South realizes a $5,000 ($15,000 - $10,000) gain on the exchange. None of it is recognized.

97) • Was the loan evidenced by a security?

• Was there a business purpose for making the loan?

• Is the shareholder an employee of the corporation?

• If so, was the loan made in his capacity as an employee or as a shareholder?

• What are the relative dollar amounts of his stock investment and his compensation?

The type of loss allowed if a shareholder lends money to a corporation that is not repaid depends on the nature of the loan. If the unpaid loan was not evidenced by a security, it is either a business or nonbusiness bad debt. Nonbusiness bad debts are deductible only as short-term capital losses when the debt is determined to be totally worthless. Business bad debts are deductible as ordinary deductions without limit when they are either partially or totally worthless. The IRS generally treats a loan made by a shareholder to a corporation in connection with his stock investment as a nonbusiness activity. If the loan is made to protect the shareholder's employment with the corporation, it may be treated as an ordinary loss under the business bad debt rules.

98) • Is it equity capital or debt?

• Is there a written unconditional promise to pay on demand or on a specific date a certain sum of money in return for an adequate consideration in money or money's worth, and to pay a fixed interest rate?

• Is the debt subordinate to or preferred over other indebtedness of the corporation?

• What is the ratio of debt to equity?

• If debt, is the debt convertible into stock?

• What is the relationship between holdings of stock in the corporation and holdings of the interest in question?

It is important to distinguish between capital and debt. Interest paid with respect to a debt instrument is deductible by the payor corporation, whereas dividends paid are not.

99) a) Norman's realized gain is $60,000 [($51,000 + $84,000) - ($45,000 + $30,000)]. He must recognize $9,000 of gain, the amount by which the liability transferred ($84,000) exceeds the basis of all property transferred by Norman ($45,000 + $30,000). b) Norman's basis for his Elnor stock is 0 ($45,000 + $30,000 - $84,000 + $9,000 gain). c) Elnor's basis in the machinery is $54,000 ($45,000 + $9,000). d) Kate does not recognize any gain or loss. e) Kate's basis is $51,000. f) Norman's holding period includes his holding period for the machinery. Kate's holding period starts on the day after the exchange.

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Answer Key Testname: C2

100) • • • • • • • • • •

Does the property transfer meet the Sec. 351 requirements?

Has Jana transferred property?

Is Jana in control of the corporation following the transfer?

What is Jana's recognized gain?

What is Jana's basis for her stock?

Should Jana elect to take a reduced basis in the stock so that Amish will have a $140,000 basis in the land?

What is Jana's holding period for her stock?

Does Amish Corporation recognize gain when it issues its stock?

What is Amish Corporation's basis for the property received from Jana?

What is Amish Corporation's holding period for the property received from Jana?

The property transfer meets all the Sec. 351 requirements. Neither Jana nor Amish has gain or loss on the exchange.

Jana can elect to take a basis of $120,000 in the Amish stock and Amish will have a $140,000 basis in the land. If no election is made, Amish will have a basis of $120,000 in the land and Jana's basis in the stock is $140,000. If Amish has a basis of $120,000 in the land, its holding period for the land will begin on the day after the exchange. If Amish takes Jana's basis of $140,000 and Jana reduces her basis in the stock, Amish's holding period for the land begins on December 2, 2000. Jana's holding period for the stock includes the period for which she held the land.

101) Nathan owes tax on 54% of NT Partnership's profits whether they are distributed or not to him. Thus, he owes 35% of $54,000, or $18,900.

102) Yes. Since Frans owned 80% (100 ÷ 125) of the Vogel stock and is in control of Vogel Corporation, Frans does not recognize any gain on the exchange.

103) Darnell has a $20,000 ordinary loss and a $10,000 capital loss.

Proceeds Adjusted basis in the stock Realized loss

$30,000 $60,000 $30,000

For Sec. 1244 purposes, his basis is $50,000. Therefore only $20,000 ($30,000 - $50,000) qualifies as an ordinary loss. The remaining $10,000 is a capital loss.

104) Section 351 does not apply because Gwen owns only 50% of the Midwest stock after the exchange and is not in control of Midwest Corporation. Gwen has a realized gain of $85,000 ($100,000 - $15,000), all of which must be recognized.

105) Phil's exchange of assets for stock qualifies for Sec. 351(a) treatment, thus is tax-free. Nick's exchange of services for stock is not tax-free under Sec. 351. Thus, Nick must recognize $10,000 of ordinary income, the FMV of the Philnick stock received. Nick's basis in the Philnick stock received is $10,000, its FMV. 106) The corporation does not recognize income as a result of the capital contribution. The basis of any property contributed by a nonshareholder is zero. The basis of property acquired with a money contribution made by a nonshareholder must be reduced by the amount of the contributed money used toward the purchase. Any money that was contributed and not spent during the 12 months following the contribution reduces the basis of other assets. The order of reduction is: First, depreciable property; then amortizable property; then depletable property; and finally, all other property.

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Answer Key Testname: C2

107) • Does the property transfer meet the Sec. 351 requirements?

• Have Michael and his son transferred property?

• Are the transferors in control of the corporation following the transfer?

• Do the transferors receive transferee corporation stock?

• Does the property contribution/receipt of stock as outlined in the facts reflect the true nature of the transaction? Or has a gift or other event occurred?

• What is each shareholder's recognized gain?

• What is each shareholder's basis for his stock?

• What is each shareholder's holding period for his stock?

• If a gift has occurred, has Michael made a taxable gift to his son? (This question could be rewritten for events other than a gift e.g., repayment of a loan.)

• What is Miller Corporation's basis for the property received from Michael?

• What is Miller Corporation's holding period for the property received from Michael?

The contribution is tax-free since it meets all the Sec. 351 requirements, and Michael and Michael Jr. own all the Miller stock. Michael Jr. receives a disproportionate amount of stock compared to his $10,000 capital contribution. It appears that the transaction should be recast so that Michael receives 40 shares of stock, each valued at $1,000. He then gifts 15 shares to Michael Jr. The gift leaves each shareholder with 25 shares of stock. Neither shareholder recognizes any gain, and Michael takes a $25,000 adjusted basis for the 40 shares he receives. He recognizes no gain on the transfer of 15 shares to Michael Jr., and $9,375 [(15/40) × $25,000] of his basis accompanies the gifted shares. Michael's basis for his remaining 25 shares is $15,625 ($25,000 - $9,375). Michael, Jr.'s basis for his 25 shares is $19,375 ($10,000 + $9,375).

108) Double taxation occurs when corporate earnings are distributed as dividends to the shareholders. Since corporate earnings have already been taxed at the corporate level, the shareholders must pay personal income tax as a second tax when the corporate earnings are distributed as dividends.

109) a) Not met. Transferors of property receive only 75% and they do not have 80% control. b) Met. Bob transferred more than a nominal amount of property. The 80% control test is met since all of Bob's stock is counted for this purpose. c) Not met. Cindy owns only one-third of the stock immediately after the exchange. No attribution occurs from Cindy's parents to Cindy. d) Met. John and Pam own 100% of PJ Corporation. The transfers do not have to be simultaneous. e) Not met. John had a prearranged plan to sell a sufficient amount of shares to cause the control requirement not to be met.

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Answer Key Testname: C2

110) • • • • • • • • • • •

Does the property transfer meet the Sec. 351 requirements?

Have Stu and Megan transferred property?

Does the fact that Stu controls Lance Corporation prior to the transfer change the general Sec. 351 rules?

Are the transferors in control of the corporation following the transfer?

Do the transferors receive transferee corporation stock?

What is each shareholder's recognized gain?

What is each shareholder's basis for his or her stock?

What is each shareholder's holding period for his or her stock?

Does Lance Corporation recognize gain when it issues its stock?

What is Lance Corporation's basis for the property received from Megan?

What is Lance Corporation's holding period for the property received from Megan?

The property transfer meets all the Sec. 351 requirements. Stu and Megan are considered to own all 390 of the Lance shares immediately after the exchange. Stu's contribution of cash for stock is not considered to be a nominal amount, according to the IRS rules for private letter rulings (i.e., it equals or exceeds 10% of the value of Stu's prior stock holdings) and permits his stock to be counted toward the 80% minimum stock ownership for control. Megan recognizes no gain on the asset transfer and takes a $100,000 basis for the Lance shares she receives. The holding period for the Lance shares includes her holding period for the property transferred. Lance recognizes no gain when it issues its stock and takes a $100,000 basis for the property.

111) 1. Investing a minimum amount of capital 2. Filing articles of incorporation 3. Issuing stock 4. Paying incorporation fees to the state or other jurisdiction 112) Rae must report a capital gain of $21,250 ($51,250 - $30,000).

113) a) Since Sec. 351 would apply to the exchange, John would not recognize any gain or loss. b) John's basis is $25,000. His holding period begins in his year of purchase four years ago. c) Meg does not recognize any loss. d) Meg's basis is $50,000. Her holding period begins in her year of purchase four years ago. e) Karen must recognize $15,000 of ordinary income. f) Karen's basis for her shares is $20,000 and her holding period begins on the day after the exchange date. g) Frost Corporation's basis in the land and machinery are $25,000 and $30,000, respectively. Because Meg contributed loss property, unless an election is made, the basis in the loss property must be reduced to FMV by the corporation. Frost's holding period for the land begins four years ago. Frost's holding period for the machinery begins the day after transfer to Frost Corporation. The services, if capitalized, would have a $15,000 basis. The services may be amortizable if they are organizational or start-up expenditures.

114) • Was the stock sold to a related party (Bill) as defined by Sec. 267(b)? If so, John cannot recognize the loss, and the remaining issues do not have to be examined.

• Is the stock a capital asset?

• Is Jersey Corporation a qualifying small business corporation?

• If a qualifying small business corporation, does the stock qualify for Sec. 1244 stock treatment?

• If Sec. 1244 stock, what is John's marital and filing status?

• Has John's basis for the stock changed from its initial acquisition cost?

• What is the amount and character of John's recognized loss?

John's stock sale results in a $65,000 ($150,000 - $85,000) long-term capital loss, provided the purchaser was not a related party. If the purchaser is a related party, Sec. 267(a) prevents John from recognizing any loss. Since John is the original holder of the stock, the loss may be characterized as ordinary under Sec. 1244 if the various requirements of Sec. 1244 are satisfied.

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Answer Key Testname: C2

115) If not for Sec. 351, Maria would recognize a gain on the incorporation of her business. She has a $1.1 million ($1.5 million - $400,000) realized gain on her contribution of the proprietorship's assets to a new corporation in exchange for 60% of its outstanding shares. However, under Sec. 351, she recognized none of the gain. Section 351 does not affect Bill and John as they are each simply purchasing 20% of the new corporation's stock for $500,000 cash. They do not realize or recognize any gain whether Sec. 351 applies or not.

116) The owners may elect to have the LLC taxed as a corporation. However, if they do not make the election, the LLC will be taxed as a partnership.

117) No, this prearranged plan means Anton, Bettina, and Caleb do not have control immediately after the exchange, so Sec. 351 does not apply.

118) Nikki has a $15,000 ($5,000 - $20,000) recognized loss. Her ordinary loss under Sec. 1244 is $11,000 ($5000 - $16,000 Sec. 1244 basis). The remaining $4,000 loss is a capital loss.

119) The plan should be formulated to allow the contributor to avoid Sec. 351 and be able to recognize the loss. This can be done by having the transferor sell the property to an unrelated party and then have the transferor contribute cash. The transferor must be careful to avoid the related party rules of Sec. 267, which could prevent the loss from being recognized if the property is sold directly to the corporation. Several other suggestions are explored on pages C:2-34 and C:2-35.

120) S-corporation profits are not subject to self-employment tax (which at current rates is 15.3%). This is the #1 reason to convert an LLC for tax purposes to an S-corporation.

121) a) Yes, the transaction meets the requirements of Sec. 351. Transferors of property (Kiara, Victor, & Pam) own 88.2% (750/850 = 0.882) of the Newco stock. b) Kiara must recognize a $10,000 gain, the amount by which the $60,000 mortgage assumed by Newco exceeds the $50,000 basis ($12,000 + $38,000) of all the assets transferred by Kiara. The character of the gain is a Sec. 1231 gain.

Victor must recognize $10,000 of gain (the lesser of his realized gain of $15,000 on the boot received of $10,000). The gain is ordinary income recaptured under Sec. 1245. Pam realized a $5,000 loss, which is not recognized even though she received cash. Joe must recognize $10,000 ordinary income on compensation for his services. Newco Corporation recognizes neither a gain nor a loss on the issuance of its stock or note. c) Kiara's basis is zero ($12,000 + $38,000 - $60,000 + $10,000 gain). Her holding period includes her holding period for the land and building. Victor's basis is $25,000 ($25,000 + $10,000 gain - $10,000 boot). His holding period includes his holding period for the equipment. Pam's basis for her stock is $10,000 ($15,000 - $5,000 boot). Her holding period includes the holding period for the van. Joe's basis for his stock is $10,000. His holding period begins on the day after the exchange. d) Newco Corporation's basis is: Land $15,000 [$12,000 + (0.30 × $10,000)] Building $45,000 [$38,000 + (0.70 × $10,000)] The gain is allocated between the two assets based on their relative FMVs. The holding period includes Kiara's holding period.

Equipment: $35,000 ($25,000 + $10,000).

The holding period includes Victor's holding period.

Van: $15,000.

The holding period includes Pam's holding period.

The $10,000 in accounting services is deductible by Newco Corporation if received subsequent to the start of operations. If they are preoperating expenses, they should be analyzed under Sec. 248.

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Answer Key Testname: C2

122) Both the transferor-shareholders and the transferee corporation must attach a statement to their tax returns for the period that includes all the facts pertinent to the exchange and discloses the date of the exchange.

The transferor-shareholder statement would include: • a description of the property transferred and its adjusted basis to the transferor.

• a description of the stock received in the exchange, including its kind, number of shares, and FMV. • a description of the securities received in the exchange, including the principal amount, terms, and FMV. • the amount of money received.

• a description of any other property received, including its FMV. • a statement of the liabilities transferred to the corporation, including the nature of the liabilities, when and why they were created, and the corporate business reason for their transfer.

The transferee corporation statement would include: • a complete description of all property received from the transferors.

• the adjusted basis of the property to the transferors.

• a description of the stock issued to the transferors.

• a description of the securities issued to the transferors.

• the amount of money distributed to the transferors.

• a description of any other property distributed to the transferors.

• information regarding the transferor's liabilities that are assumed by the corporation.

123) Cash is treated as property when it is contributed. No gain or loss is recognized by the transferor when a contribution of cash is made. Stock received by a transferor who contributes cash for the stock has his shares counted for purposes of the 80% control test.

124) Able Corporation's basis in the receivables is zero as the corporation will include the receivables in income as they are collected. $75,000 125) a) Amount realized ($50,000 + $15,000 + $10,000) Minus: Basis in land ( 20,000) Realized gain $55,000 Boot received (bond and note) $25,000 Gain recognized (capital gain) $25,000

b) Basis of stock and ten-year bond: Basis of stock: $20,000 + $25,000 - $25,000 = $20,000 Basis of bond: $15,000 (FMV) Basis of short-term note: $10,000 (FMV) c) Basis of land to Jet Corporation is: $20,000 + $25,000 = $45,000.

126) Brewer Corporation must use the same MACRS recovery period and method that Tom used. Depreciation for Year 2 is $1,920 (0.32 × $6,000), which is allocated between Tom and Brewer Corporation. The computer is considered to be held

by Tom for one month and by Brewer Corporation for 11 months. Therefore, Tom claims $160 and Brewer claims $1,760 in depreciation for Year 2. On February 9, Year 2, Brewer's basis in the computer is $4,640.

Original cost of computer $6,000 Minus Year 1 depreciation taken by Tom (1,200) Year 2 depreciation taken by Tom ( 160) Adjusted basis on transfer date $4,640 127) Azar realizes a $20,000 ($40,000 + $10,000 - $30,000) gain on the land transfer, of which $10,000 must be recognized.

Hat Corporation recognizes a $7,500 capital gain ($10,000 - $2,500) when transferring the Cap Corporation stock to Azar.

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Answer Key Testname: C2

128) S corporations generally are exempt from taxation. Income flows through and is taxed to the shareholders. The shareholders' marginal tax rates may be lower than a C corporation's marginal tax rate. Losses flow through to shareholders and can be used to offset income earned from other sources unless limitations apply. This feature is particularly important to corporations just beginning their operations. Passive loss and basis rules may limit loss deductions to shareholders. Because income, loss, and other pass-through items retain their character when they flow through to the shareholders, individual shareholders are taxed on capital gains as though the individual earned the gains. An individual may be able to offset those gains with capital losses from other sources or have them taxed at the appropriate capital gain tax rate. Shareholders generally can contribute money to or withdraw money from an S corporation without gain recognition. Shareholders are taxed only on the annual income of the S corporation.

Corporate profits are taxed only at the shareholder level. Shareholders are taxed on all of an S corporation's current year profits whether those profits are distributed or not. Tax-free corporate fringe benefits generally are not available to S corporation shareholders who are employed by the business. Fringe benefits provided by an S corporation are deductible by the corporation and taxable to the shareholder. S corporations generally cannot defer income by choosing a fiscal year for the S corporation other than a calendar year unless the S corporation can establish a business purpose for a fiscal year or unless it makes a special election.

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Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) 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) $0.

C) $2,800.

D) $3,200.

1)

2) Identify which of the following statements is true.

A) 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.

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 donates appreciated capital gain property to a charity, the amount of the contribution deduction generally equals the property's FMV. D) All of the above are false.

2)

3) Which of the following items indicate that a company does not need a valuation allowance?

A) a strong history of earnings without considering the deferred tax asset B) existing sales contracts that will produce sufficient income to realize the deferred tax asset C) excess of appreciated asset value over tax basis sufficient to realize the deferred tax asset D) All of the above are correct.

3)

4) Identify which of the following statements is false.

A) A corporation with annual gross receipts of $31,000,000 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) The passive loss rules do not apply to widely held C corporations.

C) Casualty losses incurred by a corporation are deductible subject to a nondeductible floor similar to those applicable to individuals.

D) Corporations may receive a deduction for dividends received from other corporations.

4)

1

5) Evans Corporation has a $15,000 net capital loss in Year 4. The corporation reported the following capital gain netting in income during the past three years. Identify which of the following statements is true.

Year Y1 Y2 Y3

5)

Capital Gain Net Income $10,000 11,000 5,000

A) The loss is used to offset $3,000 of Y1, Y2, and Y3 capital gains, remaining amount carried forward at $3,000 a year until expired.

B) The loss is used to offset the gains from Y3 and then carried back to offset $10,000 of the gains in Y1.

C) The loss is used to offset the year Y1 net gains, then $5,000 of the year Y2 net gains.

D) The loss is used to offset the $11,000 of the Y2 gains and then carried back to offset $4,000 of the year Y1 net gain.

6) Identify which of the following statements is true.

A) If a corporation receives dividends eligible for the 65% dividends-received deduction and the 50% dividends-received deduction, the 50% dividends-received deduction reduces taxable income prior to the 65% deduction.

B) The dividends-received deduction is designed to reduce double taxation of corporate dividends.

C) The full 65% dividends-received deduction is available without restriction.

D) All of the above are false.

6)

7) 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) $28,000 B) $24,600 C) $35,000 D) $31,400

7)

8) Delux Corporation, a retail sales corporation, has a taxable income of $500,000. Delux Corporation's regular tax liability is A) $158,250.

B) $175,000.

C) $162,200.

D) $105,000.

8)

9) ABC Corporation has gross profit of $140,000 before deductible expenses of $180,000. In addition, ABC capital gain of $30,000. ABC taxable income is: A) 10,000 B) 0 C) (10,000) D) (40,000)

9)

10) Which of the following items is a permanent difference between taxable and financial accounting income?

A) depreciation B) net capital loss C) bad debts D) dividends-received deduction

10)

2

11) 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: (Round your calculations to the nearest whole dollar.)

Month February March March April December

Type Draft charter Stock commission Accounting fees to set up books Temporary director fees Charter modification fee

11)

Amount $ 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) $667 B) $36,000 C) $500 D) $5,028

12) Identify which of the following statements is true.

A) The terms "regular corporation" and "C corporation" are synonymous.

B) A corporation is a separate taxpaying entity that must file a tax return annually.

C) A newly formed corporation must select its basic accounting method.

D) All of the above are true.

12)

13) 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) $60,000.

B) $20,000.

C) a $20,000 loss.

D) a $40,000 loss.

13)

14) Identify which of the following statements is true.

A) Organizational expenditures incurred by a corporation do not include the cost of printing stock.

B) Organizational expenditures incurred by a corporation do not include the cost of accounting services necessary to create the corporation.

C) Unamortized organizational expenses cannot be deducted when the corporation is liquidated.

D) All of the above are false.

14)

15) 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) $30,000.

B) $32,000.

C) $20,000.

D) $12,000.

15)

16) If a corporation's charitable contributions exceed the deduction limitation in a particular year, the excess A) is carried over indefinitely.

B) becomes a carryover to a maximum of five succeeding years.

C) may be carried back to the third preceding year.

D) is not deductible in any future year.

16)

3

17) Winter Corporation's taxable income is $500,000. In addition, Winter has the following items: Depreciation for tax purposes Depreciation for financial accounting purposes Net capital loss Interest on loan to acquire tax-exempt securities

17)

$60,000 40,000 (2,000) 7,000

What is Winter's financial accounting income?

A) $520,000 B) $518,000

C) $513,000

D) $511,000

18) Which of the following statements is correct?

A) Deferred tax assets/liabilities are always classified as current on the balance sheet.

B) Deferred tax assets are classified based on their expected reversal dates.

C) The classification of deferred tax assets/liabilities depends on whether the related asset is current or noncurrent.

D) Deferred tax assets/liabilities are classified as noncurrent on the balance sheet.

18)

19) Once a corporation has elected a taxable year, it can change the taxable year without IRS permission if A) the corporation is not an S corporation.

B) the resulting short period has a net operating loss of $100,000 that the corporation wants to carry forward.

C) the corporation changed its taxable year seven years ago.

D) a corporation can change its taxable year without IRS permission in all of the above situations.

19)

20) Miller Corporation has gross income of $100,000, which includes $60,000 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) ($10,000).

C) $6,000.

D) $0.

20)

21) Identify which of the following statements is true.

A) The NOL deduction claimed by a corporation must be taken after the dividends-received deduction.

B) The charitable contribution deduction is computed after the dividends-received deduction.

C) The charitable contribution deduction is computed after the deduction for an NOL. D) All of the above are false.

21)

22) ABC Corporation has gross profit of $140,000 before deductible expenses of $130,000. In addition, ABC capital loss of $30,000. ABC taxable income is: A) (40,000) B) (10,000) C) 0 D) 10,000

22)

23) Identify which of the following statements is true.

A) Accrued compensation that is deductible in the year of accrual is considered to be part of an IRS deferred compensation plan.

B) 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.

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.

23)

4

24) Identify which of the following statements is true.

A) 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 $13,000. The maximum charitable contribution deduction available for the donation is $9,000.

B) Corporations' charitable deductions are limited to 20% of their adjusted taxable income.

C) "Ordinary income property" with regard to the charitable contribution deduction does not include property whose sale would have produced a short-term capital gain.

D) All of the above are false.

24)

25) Identify which of the following statements is false.

A) 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.

B) A corporate dividends-received deduction is not allowed for dividends received on stock held for 40 days.

C) The 50% dividends-received deduction is limited to 50% 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. D) All of the above are false.

25)

26) 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) $80,000.

C) $55,000.

D) $95,000.

26)

27) Maxwell Corporation reports the following results:

27)

Gross income from operations Dividends received from 18% owned domestic corporation Expenses Maxwell's dividends-received deduction is A) $56,000.

B) $35,000.

C) $70,000.

$90,000 70,000 100,000

D) $30,000.

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

Shareholder Arthur Brenda Charles David

Sun Corporation 50% 20% 30% 0%

Moon Corporation 60% 40% 0% 0%

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 under the 50%-80% requirements? (Assume the two corporations are equally valued.)

A) Arthur must acquire an additional 30% of Moon Corporation.

B) Charles must acquire an additional 10% of Moon Corporation.

C) No stock ownership change is required.

D) Charles must acquire an additional 5% of Sun Corporation.

5

28)

29) Identify which of the following statements is true.

A) Any amount of net business interest disallowed due to limitation may be carried over indefinitely.

B) Corporations can deduct up to $10,000 in capital losses per year.

C) If a corporation accrues an obligation to pay compensation, the corporation must make the payment by year-end to be able to deduct during the current year.

D) Net business interest is limited to 50% of adjusted taxable income.

29)

30) Which of the following items will not create a deferred tax liability?

A) Operating loss or tax credit carryforwards exist.

B) Revenues or gains are recognized earlier for book purposes than for tax purposes.

C) Expenses or losses are deductible earlier for tax purposes than for book purposes.

D) Tax basis of an asset is less than its book basis.

30)

31) Which of the following are examples of tax deferred fringe benefits?

A) qualified pension plan B) stock bonus plan C) profit sharing plan D) all of the above

31)

32) Identify which of the following statements is true.

A) The Dividends Received Deduction for individuals is limited to 50%.

B) For expenses incurred after December 31, 2017, no deduction is allowed for any activities involving entertainment, amusement, or recreation, including expenses related to a facility used in connection with these activities.

C) Deductibility of business interest in a given year is limited to 80% of adjusted taxable income.

D) Domestic Production Activities Deduction carry overs that originated from pre 2018 tax years are limited to 50% of taxable income until 2025.

32)

33) Identify which of the following statements is false.

A) There are three categories of control groups: parent-subsidiary, brother-sister, and combined.

B) The controlled group test is applied on December 31.

C) 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.

D) A controlled group must apportion certain tax benefits among its members.

33)

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

34)

Gross receipts from sales Dividends received from 15% owned domestic corporation Expenses connected with sales The taxable income of Island Corporation is A) $50,000.

B) $47,000.

C) $100,000.

$60,000 40,000 30,000

D) $70,000.

35) Which of the following types of evidence indicate that a valuation allowance is needed to reduce the deferred tax asset?

A) short carryback or carryover periods B) existing contracts or sales backlogs, which will generate significant future income C) excess of appreciated asset values over basis D) history of profits 6

35)

36) ABC Corporation has gross profit of $100,000 before deductible expenses of $90,000. In addition, ABC capital loss of $15,000. In previous years, Y3 capital gain of 20,000 while Y2 and Y1 were capital gain / loss of zero. How much of the current capital loss is available to be carried back to Y3?

A) 0 B) 5,000 C) 10,000 D) 15,000

36)

37) Identify which of the following statements is true.

A) A corporation with gross receipts, total income, and total assets of $1,000,000 or less is permitted to file Form 1120-A. B) A corporation is required to file a tax return even if it has no taxable income.

C) A corporate tax return must be filed by the fifteenth day of the third month following the close of the corporation's tax year.

D) All of the above are false.

37)

38) Baxter Corporation is a personal service corporation. Baxter Corporation has taxable income of $10,000. Baxter Corporation's tax is A) $2,100.

B) $2,900.

C) $2,400.

D) $1,500.

38)

39) 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) $35,000 B) $20,000 C) $30,000 D) $50,000

39)

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

40)

Shareholder Arthur Brenda Charles David

Sun Corporation 50% 20% 30% 0%

Moon Corporation 60% 40% 0% 0%

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 under the 50% requirements? (Assume the two corporations are equally valued.)

A) Arthur must acquire an additional 30% of Moon Corporation.

B) Arthur sells 4/5ths of his shares in Sun to David.

C) Arthur sells his 2/3rds of his shares to David.

D) No stock ownership change is required.

41) 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) Andy acquires an additional 10% of North stock and Barbara acquires an additional 10% of Tent stock.

B) Barbara acquires an additional 10% of North stock.

C) Barbara acquires an additional 10% of North stock and an additional 10% of Tent stock.

D) no stock ownership change occurs.

7

41)

42) 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 will receive no dividends-received deduction because the stock was purchased ex-dividend.

B) Drexel Corporation cannot recognize a capital loss.

C) Drexel Corporation cannot take a dividends-received deduction on the Zebra Corporation dividend.

D) Drexel Corporation will be allowed a 50% dividends-received deduction when reporting the Zebra Corporation dividend.

42)

43) Fringe benefits provide what types of tax advantages?

A) deferral B) exclusion C) accrual

43)

D) both A and B

44) Which of the following items is a temporary difference between tax income and financial accounting income?

A) dividends-received deduction B) production activities deduction C) proceeds on life insurance on a key executive D) depreciation

44)

45) 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) Joker, Klue, Lion, and Mark Corporations B) Joker, Klue, and Lion Corporations C) Joker and Klue Corporations D) Klue, Lion, and Mark Corporations

45)

46) 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: (Round your calculations to the nearest whole dollar.)

46)

Date 6-30 7-10 7-15 6-30 12-6

Type 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

Amount $ 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) $12,000 B) $5,156 C) $16,000 D) $800

8

47) 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 Depreciation claimed on the tax return Depreciation reported on the financial accounting books Life insurance proceeds on death of a corporate officer

A) $620,000

B) $560,000

47)

$240,000 135,000 75,000 100,000

C) $520,000

D) $660,000

48) 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 no loss and Walter reports a gain of $3,000.

B) Ajax Corporation reports a loss of $4,000 and Walter reports a gain of $5,000.

C) Ajax Corporation reports a loss of $2,000 and Walter reports a gain of $5,000.

D) Ajax Corporation reports no loss and Walter reports a gain of $5,000.

48)

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

49)

Gross profit on sales: Expenses: Dividends received from less-than-20%-owned domestic corporations: What is Money's net operating loss?

A) $520,000 B) $490,000

C) $220,000

$200,000 700,000 20,000

D) $494,000

50) Identify which of the following statements is true.

A) A corporation's first year must cover a twelve-month period.

B) 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.

C) An S corporation must generally use a calendar year.

D) All of the above are false.

50)

51) Access Corporation, a large manufacturer, has a taxable income of $16,000,000. Access Corporation's tax is A) $3,360,000.

B) $5,440,000.

C) $5,600,000.

D) $3,680,000.

51)

9

52) 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 $10,000 of the long-term capital loss to reduce taxable income.

B) Carry the $10,000 long-term capital loss back three years as a short-term capital loss, then forward five years.

C) Use $3,000 of the loss to reduce taxable income and carry $7,000 of the long-term capital loss forward for five years.

D) Use $6,000 of the loss to reduce taxable income and carry $4,000 of the long-term capital loss forward for five years.

52)

53) A new corporation may generally select one of the following accounting methods with the exception of A) accrual method.

B) cash method.

C) hybrid method.

D) retail method.

53)

54) Dreyfuss Corporation reports the following items:

54)

Unappropriated retained earnings, beginning of year: Net income: Federal income tax refund for last year taken directly to retained earnings: Cash dividends paid this year:

$800,000 700,000 50,000 500,000

The unappropriated retained earnings at year-end are A) $1,500,000.

B) $2,050,030.

C) $1,000,000.

D) $1,050,000.

55) Identify which of the following statements is false.

A) A new corporation can elect a fiscal year that runs from February 16 to February 15 of the following year.

B) A corporation's fiscal year generally must end on the last day of the month.

C) A corporation's first tax year may not cover a full 12-month period.

D) A fiscal year may not end on December 31.

55)

56) 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) Section 291 recapture applies to Sec. 1250 property.

C) Section 291 reduces the amount of net Sec. 1231 gains that can be offset by corporate capital losses.

D) Corporations selling real property that previously had been depreciated using an accelerated method are subject to Sec. 291.

56)

10

57) 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 Alternative minimum tax Total tax due

57)

$248,000 40,000 $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) $280,000.

B) $240,000.

C) $248,000.

D) $288,000.

58) Identify which of the following statements is true.

A) In computing an NOL for the current year, a deduction is allowed for NOLs from previous years.

B) An NOL incurred before 2018 carries forward 20 years and is not subject to the 80% of taxable income limitation.

C) A corporate NOL can be carried back two years and forward 15 years.

D) All of the above are false.

58)

59) Which of the following results in a deferred tax asset?

A) Expenses are deductible earlier for tax purposes than for book purposes.

B) Operating loss or tax credit carryforwards exist.

C) Revenue or gains are recognized earlier for book purposes than for tax purposes.

D) Tax basis of an asset is less than its book.

59)

60) Identify which of the following statements is true.

A) Corporate capital loss carrybacks can offset corporate ordinary income earned in previous years.

B) A corporate capital loss can be carried back three years, and then can be carried forward five 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.

60)

61) 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) $20,000.

B) $4,000.

C) $0.

D) $30,000.

61)

62) Identify which of the following statements is true.

A) Schedule M-1 (Form 1120) is an analysis of the corporation's retained earnings.

B) 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.

C) Form 1120 Schedule L contains the corporation's income statement.

D) All of the above are false.

62)

11

63) 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) $5,000.

B) $2,000.

C) $3,000.

D) $4,000.

63)

64) Identify which of the following statements is false.

A) 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.

B) A corporation must file a tax return annually.

C) A corporation can obtain an automatic six-month extension of time to file its tax return.

D) The IRS can rescind the extension period.

64)

65) 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) $50,000.

C) $30,000.

D) $60,000.

65)

66) Organizational expenditures include all of the following except for A) legal costs incident to the creation of the corporation.

B) costs incurred when issuing stock.

C) expenses of organizational meetings.

D) fees paid to the state of incorporation.

66)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

67) Calendar year corporate estimated tax payments are due April 15, June 15, September 15, and January 15.

67)

68) 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 provided to a qualified charitable organization that utilizes the inventory for the care of the ill, needy, or infants.

68)

69) In a closely held corporation with a shareholder employee, a fringe benefit can be offered solely to the shareholder employee.

69)

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

70)

71) 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 $65,000.

71)

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

72)

73) 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 Sec. 1231 gain.

73)

74) Closely held corporations retain C corporation status to benefit from nontaxable fringe benefits such as health and accident insurance. These fringe benefits are nontaxable to the employee and deductible by the corporation.

74)

12

75) NOLs arising in tax years ending after 2017 carry over to subsequent tax years indefinitely.

75)

76) If a corporation distributes all its profits as deductible reasonable salary and fringe benefit payments, it will eliminate double taxation.

76)

77) Organizational expenses incurred after 2019 are amortized over five years.

77)

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

78)

79) All of the taxable income of a personal service corporation is taxed at a flat 21% rate.

79)

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

80)

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

81)

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

82)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

83) 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?

84) 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?

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

86) When computing corporate taxable income, what is the proper sequencing of deductions?

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

88) Francine Corporation reports the following income and expense items for the tax year ending December 31: Gross receipts from sales Dividends received from 15%-owned domestic corporation Expenses connected with sales

$50,000 30,000 20,000

What is Francine Corporation's taxable income?

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

90) 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?

13

91) 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 Third previous year Year before last Last year

Net Long-Term Capital Gain $5,000 7,000 0

Net Short-Term Capital Gain $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.

92) Bebop Corporation reports the following results in the current year: Gross income from operations Dividends from 15% owned domestic corporation Expenses

$150,000 50,000 140,000

What is Bebop's taxable income?

93) 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?

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

95) Westwind Corporation reports the following results for the current year: Gross profit on sales Long-term capital gain Long-term capital loss Short-term capital gain Short-term capital loss Operating expenses

$250,000 25,000 10,000 7,500 12,500 80,000

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

96) Gilbreath Corporation is a C corporation and has the following items of income and expense during the current year.

Gross Income Interest Income COGS Interest Expense Depreciation

$100,000 5,000 (70,000) (15,000) (10,000)

What is taxable income before limitation? What is the net business interest expense? What is adjusted taxable income for purposes of the net business income limitation? How much of the net business interest expense may Gilbreath deduct during the current year?

14

97) On December 10 of the past year Dell Corporation (a calendar-year taxpayer) accrued 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 of the current year. What is Dell's deduction for last year? What is Dell's deduction for this year?

98) Courtney Corporation had the following income and expenses for the tax year: Gross profit on sales Expenses Dividends received from less-than-20%owned domestic corporations

$300,000 $600,000 $ 20,000

Courtney had taxable income for the past three years of: Y1 Y2 Y3

$100,000 $120,000 $ 80,000

Determine the corporation's NOL for the current year.

99) The following expenses are incurred by Salter Corporation when it is organized on July 1: Attorney fees to draft charter Underwriter fees for stock sale Transfer cost for property contributed to the corporation for stock Costs of organizational meetings before beginning business Costs of directors' meetings after beginning business

$20,000 10,000 4,000 5,000 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?

100) Jackel, Inc. has the following information for the current tax year: Gross sales Cost of goods sold Dividends received (10%) Operating expenses Charitable contributions

$350,000 50,000 40,000 30,000 45,000

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

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

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

103) What are start-up expenditures?

104) Cricket Corporation has a $50,000 NOL in the current year. Cricket does not have pre 2018 NOLs. Cricket expects its taxable income for next year to exceed $40,000. What issues should be considered with respect to the use of the NOL? 15

105) 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?

106) 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?

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

108) 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?

109) What are the four principles underlying ASC 740?

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

111) 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?

112) 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?

113) James Corporation purchased residential real estate in Year 1 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 Year 1 through Year 5. In the current year, Year 6, 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?

114) 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?

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

116) 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.

16

117) 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?

118) 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?

119) 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 and makes the payment on March 10. What are the tax consequences of the transactions to both taxpayers in preceding year and current year?

120) Bermuda Corporation reports the following results in Year 1 and Year 2:

Adjusted taxable income Charitable contributions

Y1 $400,000 70,000

Y2 $600,000 50,000

What is Bermuda's contribution deduction in Y1 and Y2? What is the disposition of any remaining amount?

121) Dexter Corporation reports the following results for the current year: Gross income from operations Dividends from less than 20%-owned corporations Operating expenses Charitable contributions

$90,000 50,000 75,000 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?

122) 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 Depreciation claimed on the tax return Depreciation recorded on the financial accounting records Dividends-received deduction Life insurance proceeds on death of corporate officer

$272,000 140,000 80,000 48,000 90,000

123) 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?

17

124) 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?

125) 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?

18

Answer Key Testname: C3

1) B 2) C 3) D 4) C 5) C 6) B 7) A 8) D 9) C 10) D 11) D 12) D 13) B 14) A 15) B 16) B 17) D 18) C 19) D 20) B 21) A 22) D 23) B 24) A 25) A 26) B 27) D 28) B 29) A 30) A 31) D 32) B 33) C 34) A 35) A 36) D 37) B 38) A 39) C 40) D 41) A 42) C 43) D 44) D 45) B 46) B 47) A 48) A 49) B 50) C 19

Answer Key Testname: C3

51) A 52) B 53) D 54) D 55) A 56) A 57) B 58) B 59) B 60) B 61) B 62) B 63) B 64) A 65) B 66) B 67) FALSE 68) TRUE 69) FALSE 70) FALSE 71) TRUE 72) TRUE 73) FALSE 74) TRUE 75) TRUE 76) TRUE 77) FALSE 78) FALSE 79) TRUE 80) TRUE 81) FALSE 82) FALSE 83) a) Deferred tax asset Federal income tax expense (benefit) b)

Deferred tax asset Liability for unrecognized tax benefit Federal income tax expense (benefit)

170,000

170,000

20

170,000

85,000 85,000

Answer Key Testname: C3

84) • What is Vanda Corporation's realized gain or loss?

• What is Vanda Corporation's recognized loss?

• Does the sale of property to a shareholder at a loss trigger the application of the Sec. 267 related party rules?

• Is Vanessa related to any other Vanda Corporation shareholders (e.g., spouses, siblings, or other entities) whose attribution of stock ownership causes her stock ownership to exceed 50% of Vanda's outstanding stock?

• If a loss is disallowed, can the transaction be restructured to permit recognition of the loss?

• What is Vanessa's basis for the truck? Does it reflect an adjustment for the disallowed loss?

The primary issue is whether Vanessa is a related party to Vanda Corporation under the Sec. 267 rules. If so, the loss on the sale of the truck is disallowed. In this case, since Vanessa does not own more than 50% of the Vanda stock, she is not a related party, and Vanda may deduct a $20,000 ($50,000 - $30,000) loss. The loss is a Sec. 1231 loss if the truck was used by Vanda in the conduct of its trade or business. However, if Vanessa's spouse, siblings, or other parties or entities related to her own more than 25% of the stock, Vanessa is deemed to own more than 50% of Vanda Corporation, and the loss will be disallowed under Sec. 267.

85) Individuals may use up to $3,000 per year of net capital losses to offset ordinary income, cannot carry back net capital losses, but can carry forward net capital losses indefinitely. Corporations may not use any net capital losses to offset ordinary income, can carry net capital losses back three years, and can carry net capital losses forward for only five years.

86) The correct order for taking deductions is: (1) all deductions other than the charitable contributions deduction, the dividends-received deduction, and the NOL deduction; (2) the charitable contributions deduction; (3) the dividends-received deduction; (4) the NOL deduction; (5) the production activities deduction.

87) Advantages include: 1) profits of one member of the group can be offset against losses of another member of the group; 2) capital gains of one member of the group can be offset against capital losses of another member of the group; and 3) profits or gains reported on intercompany transactions are deferred until a sale outside the group takes place.

Disadvantages include: 1) the election is binding on all subsequent tax years unless the IRS grants permission to discontinue filing consolidated returns or the affiliated group is terminated; 2) losses on intercompany transactions are deferred until a sale outside the group takes place; 3) Sec. 1231 losses are offset by Sec. 1231 gains instead of being reported as an ordinary loss; 4) losses of an unprofitable member may reduce the deduction or credit limits of the group below what would be available if separate tax returns were filed, and additional administrative costs may be incurred in maintaining records needed to file a consolidated return.

88) $50,000 + $30,000 - $20,000 - (0.50 × $30,000) = $45,000. The dividends-received deduction is $15,000 which is less than the limitation is $30,000 [($50,000 + $30,000 - $20,000) × 050] and does not apply.

89) Filing consolidated returns allows the group to offset losses of one corporation against the profits of other members of the group.

90) • What is Quality's current-year taxable income?

• What is Quality's expected taxable income next year?

• What is Quality's marginal tax rate this year?

• What is Quality's expected marginal tax rate next year?

• Is Quality in the 5% surtax range this year or next year?

91) 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.

21

Answer Key Testname: C3

$150,000 92) Gross income from operations Dividends received 50,000 Gross income $200,000 Minus: expenses (140,000) Taxable income before special deductions $ 60,000 Minus: dividends-received deduction (0.5 × 50,000) ( 25,000) Taxable income $ 35,000 93) • What is the tax liability for Duright Corporation? For Northwest Corporation?

• Are Duright and Northwest Corporations C corporations? S corporations?

• Are Duright and Northwest Corporations members of a controlled group?

• Are Margo and Dudley related parties for purposes of the controlled group stock ownership tests?

• What effect does being a member of the controlled group have on the reduced tax rate benefits of each corporation?

• Are Duright and Northwest Corporations personal service corporations?

• What amounts (if any) are Duright and Northwest Corporations paying to Dudley and Margo?

• Have the taxpayers divided up the payments among the three entities (Duright, Northwest, and the joint return) to minimize their tax liabilities?

• Can the taxpayers adjust their salaries and/or fringe benefits to reduce their total tax costs?

• If Duright and/or Northwest Corporations are C corporations, would an S election be advisable?

The primary issue is the appropriate corporation classification for Duright and Northwest Corporations. If both corporations are C corporations, they constitute a controlled group and must share the tax benefits of the reduced 15, 25%, and 34% tax brackets. Two other important issues are: (1) can either one of the corporations benefit from an S election? and (2) what amount of salaries and fringe benefits should be withdrawn from each of the two corporations to maximize the corporate and shareholder benefits? The last two points are too complicated to arrive at a definitive answer with the limited facts given here.

94) Corporations may not deduct charitable contributions in excess of 10% of adjusted taxable income. Excess charitable contributions are eligible for a five-year carryforward but cannot be carried back. Excess charitable contributions are subject to the same 10% limitation in the carryover years.

95) The net capital gain is $10,000 [($25,000 - $10,000) + ($7,500 - $12,500)].

Gross profit on sales Plus: net capital gain Minus: operating expenses Taxable income

$250,000 10,000 ( 80,000) $180,000

Tax on $180,000 of taxable income

$ 37,800

22

Answer Key Testname: C3

96) Taxable Income Before Limitation Gross Income Interest Income COGS Interest Expense Depreciation Taxable Income Before Limitation

$100,000 5,000 (70,000) (15,000) (10,000) 10,000

Net Business Interest Expense Interest Income Interest Expense Net Business Interest Expense

$5,000 (15,000) (10,000)

Adjusted Taxable Income Taxable Income Before Limitation Add: Net Business Interest Expense Adjusted Taxable Income

10,000 10,000 20,000

Deduction Limit: Adjusted Taxable Income 20,000 * 30% = 6,000 + 5,000 interest income = $11,000. $11,000 deductible current year with $4,000 interest expense nondeductible current year allowable carry forward.

97) Dell is allowed $0 deduction for last year as the bonus is not paid by March 15 of the current year. Dell will take the $100,000 deduction in current year.

Gross income from operations $300,000 98) Plus: dividends 20,000 Gross income $320,000 Minus: expenses 600,000 Taxable income before DRD (280,000) Minus: DRD ($20,000 × 0.5 ( 10,000) NOL ($290,000) 99) ($20,000 + $5,000) = $25,000 total organizational costs. Deduction is $5,000 + [6 × (20,000/180)] = $5,667.

100) $350,000 Gross sales 40,000 Plus: dividend income ( 50,000) Minus: cost of sales ( 30,000) Minus: operating expenses $310,000 Taxable income before DRD and charitable contributions × 0.10 $ 31,000 Charitable contribution limit The 10% charitable contribution deduction limitation is computed before the dividends-received deduction. The $14,000 ($45,000 - $31,000) excess contributions are carried over for up to 5 years. $310,000 ( 31,000) $279,000 ( 20,000) $259,000

Taxable income before DRD Minus: charitable deduction Taxable income before DRD Minus: dividends-received deduction Taxable income

23

Answer Key Testname: C3

101) • What is the amount of federal income tax expense?

• Is there an excess of capital losses over capital gains?

• Is there any income subject to tax but not recorded on the books this year?

• Are there any expenses recorded on the books that are not deductible for tax purposes this year?

• Is there any income recorded on the books this year that is not taxable in the current year?

• Are there any items of deduction or loss that can be claimed on the tax return that do not reduce book income in the current year?

Some book income is not taxable (e.g., tax-exempt interest). Some gross income is not reflected in book income for the current period (e.g., prepaid rent). Some financial accounting expenses are not deductible for tax purposes (e.g., federal income taxes). Some deductions allowed for tax purposes are not expenses in determining book income for the current period (e.g., asset costs expensed under Sec. 179).

102) The NOL deduction must be computed twice. The NOL must first be calculated in determining taxable income for the charitable contribution deduction. The NOL deduction is then added back to taxable income and recomputed after both the charitable contribution and dividends-received deductions have been computed.

103) Start-up expenditures usually occur before the actual operation of a trade or business and involve the costs incurred in investigating and creating an active trade or business.

104) The primary issue is calculating the NOL limitation. In current year, the NOL limitation is $32,000 ($40,000 * .80).

105) • Does either Beta or XYZ have losses?

• Does one corporation have capital gains and the other capital losses?

• Have there been transactions between the two companies?

• Would the two companies want to file a consolidated return in future years?

• Does one corporation have Sec. 1231 losses and the other Sec. 1231 gains?

• Will any deductions or credits be reduced if a consolidated return is filed?

If the group members file separate returns, members with NOLs or capital losses must either carry back these losses to earlier years or carry them forward to future years. Although the losses of one group member can offset the profits of another group member when the group files a consolidated return, some important limitations apply to the use of a member corporation's NOL. These limitations prevent one corporation from purchasing another corporation's NOL carryovers to offset its own taxable income or purchasing a profitable corporation to facilitate the use of its own NOL carryovers. If an election is made to file a consolidated return, it is binding on all subsequent tax years unless IRS permission is granted to discontinue the filing or the affiliated group is terminated. Profits and losses on intercompany transactions are deferred until a sale outside the group takes place. One member's Sec. 1231 losses are offset by another member's Sec. 1231 gains instead of being reported as ordinary losses.

106) 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.

107) The maximum allowable for last year 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 current year. In this case, $0 would be remaining. If Chambers does not make the election, the $20,000 contribution is deductible when paid in current year.

108) If a corporate shareholder owns less than 20% of another corporation's stock, their DRD% is 70%. If a corporate shareholder owns at least 20% but less than 80% of another corporation's stock, their DRD% is 80%. If a corporate shareholder owns 80% or more of another corporation's stock, their DRD% is 100%.

24

Answer Key Testname: C3

109) 1) Recognize a current-year tax liability or asset for taxes payable or refundable on current year tax returns.

2) Recognize a deferred tax liability or asset for future tax effects attributable to temporary differences and carryforwards.

3) Measure current and deferred tax liabilities and assets using only enacted tax law, not anticipated future changes.

4) Reduce deferred tax assets by the amount of tax benefits the firm does not expect to realize, based on available evidence and adjusted via a valuation allowance.

110) An individual must make adjustments to his taxable income to calculate his NOL. A corporation's NOL is simply the excess of its deductions over its income.

111) • Is Newco a farming corporation?

• If so, does it have gross receipts of less than $30 million?

• Is the corporation engaged in the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting?

• If so, is substantially all of its stock held by current or retired employees performing the services listed above, by their estates, or (for two years only) by persons who inherited stock from such employees?

• Has the corporation had average gross receipts of less than $30 million the last three tax years?

• If the corporation has not been in existence for three years, has it had average gross receipts of less than $30 million during its existence?

• Is it an S corporation?

A corporation must use the accrual method of accounting unless it is a qualified family farming corporation, a qualified personal service corporation, or is an S corporation.

112) Whether total assets are under $10 million.

25

Answer Key Testname: C3

113) Land: Sales Price Minus: basis (original price) Sec. 1231 gain on land Building: Sales Price Minus: basis (original price) Minus: depreciation Recognized gain

$ 60,000 ( 25,000) $ 35,000

$200,000 ( 30,000)

$225,000 (170,000) $ 55,000

Recapture amount on building as if Sec. 1245 property: Lesser of: $30,000 (depreciation claimed) or $55,000 (recognized gain) Times: Sec. 291 percentage Ordinary income under Sec. 291

$ 30,000 × 0.20 $ 6,000

Sec. 1231 gain on building: Recognized gain Minus: ordinary income portion Sec. 1231 gain on building

$ 55,000 ( 6,000) $ 49,000

Summary: Type of Gain Asset Sec. 1231 Ordinary Total Land $35,000 $ 0 $35,000 Building 49,000 6,000 55,000 Total $84,000 $6,000 $90,000 114) Bright 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.

115) Every corporation that expects to owe more than $500 tax for the current year must pay four installments of estimated tax, each equal to 25% of its required annual payment. If a corporation is not a large one, its required annual payment is the lesser of 100% of the tax shown on the current year's return or 100% of the tax shown on the preceding year's return. If a corporation is a large one, its required annual payment is 100% of the tax shown on the current year's return. Its first estimated tax payment may be based on the preceding year's tax liability, but any shortfall must be made up when the second installment is due. Special rules apply if the corporation bases its estimated tax payments on the annualized income or adjusted seasonal income methods.

116) 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.

117) Five or fewer individuals own at least 80% (they own 100%) of each corporation's stock. However, those same individuals own only 45% of each corporation's stock, taking into account only their common ownership. The common ownership is 25% for John and 20% for Sarah for a total of 45%. Because the more-than-50% test is not met, Woods and Tiger are not members of a brother-sister controlled group.

26

Answer Key Testname: C3

118) The corporation could not recognize the $2,000 ($11,000 - $9,000) realized loss on the sale of the truck since Paul and the corporation are related parties (Sec. 267(a)(1)). Paul would recognize a gain of only $3,000 [($12,000 - $7,000) $2,000 disallowed loss] on his subsequent sale.

119) Little Corporation cannot deduct the interest in preceding year, but must wait until Renee reports the income in current year. There are no tax consequences to either taxpayer in preceding tax year.

120) Bermuda's Y1 contribution deduction is limited to $40,000 (0.10 × $400,000). Bermuda has a $30,000 ($70,000 - $40,000) contribution carryover to Y2. The Y2 contribution deduction is limited to $60,000 (0.10 × $600,000). Bermuda's deduction for Y2 is composed of the $50,000 donated in Y2, and $10,000 of the Y1 carryover. A $20,000 carryover from Y1 carries over to Y3, Y4, and Y5. $140,000 121) Gross income (90,000 + 50,000) Minus: operating expenses ( 75,000) Income before special deductions $ 65,000 Minus: charitable contribution ( 4,000)a dividends-received deduction NOL Taxable income

( 25,000) ( 25,000) $ 11,000

a The charitable contribution is limited to $4,000 [0.10 × ($65,000 - $25,000)]. The dividends-received deduction is not

limited by the 50% DRD limitation [($65,000 - $4,000) × 0.50 = $30,500].

122) $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.

123) Soup Corporation can claim a $50,000 deduction. $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).

124) a) None of the equipment qualifies for a special deduction. b) There is no charitable deduction.

125) 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.

27

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) 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 assets will be treated as a partial liquidation if A) 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."

B) 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.

C) the corporation discontinues the line of business and the transaction is "essentially equivalent to a dividend."

D) the corporation so elects.

1)

2) 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. How much of the $500,000 compensation was taxable to Marie when originally paid and how much is taxable in the current year?

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 not include the agreed-upon amount in her return since it is not deductible.

C) Marie must amend the return of two years ago to adjust her taxable compensation to the agreed- upon reasonable amount.

D) 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.

2)

3) 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) some other treatment B) sale transaction C) return of capital D) dividend income

3)

4) 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) Distributions made out of accumulated E&P are allocated ratably between multiple distributions made during the tax year.

C) Tax exempt interest is excluded from E&P calculation.

D) Losses on property sales to related parties are not deductible when computing E&P.

4)

1

5) 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) no gain or loss.

C) a $70,000 capital gain.

D) a $50,000 capital gain.

5)

6) 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.

6)

Date April 1 June 1 August 1 November 1

Amount Distributed $20,000 20,000 15,000 5,000

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

B) $5,000 is taxable as a dividend from current E&P, and $10,000 is tax-free as a return of capital.

C) $15,000 is taxable as a dividend; $5,000 from current E&P and the balance from accumulated E&P. D) $15,000 is taxable as a dividend from accumulated E&P.

7) Which of the following statements is not true about redemptions?

A) Redemptions to pay death taxes are treated as dividends to the shareholder.

B) Redemptions of Sec. 306 stock are generally treated as dividends to the shareholder.

C) A sale of stock from one controlled corporation to another controlled corporation is treated as a redemption.

D) A distribution in redemption of stock is generally a dividend.

7)

8) Identify which of the following statements is true.

A) If the shareholder's ownership percentage increases, the redemption is treated as a sale.

B) Generally in a stock redemption, if the shareholder's ownership percentage is substantially reduced, the redemption is treated as a sale.

C) The family attribution rules of Sec. 318 are as inclusive as the family attribution rules of Sec. 267.

D) 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.

8)

9) Poppy Corporation was formed three years ago. Poppy's E&P history is as follows:

9)

Year 2005 2006 2007

Current E&P $6,000 5,000 1,000

Distributions $4,000 1,000 0

Poppy Corporation's accumulated E&P on January 1 will be A) $7,000.

B) $5,000.

C) $0.

2

D) $12,000.

10) Which of the following transactions does not have the potential of creating a constructive dividend?

A) purchase of corporate property by the shareholder B) shareholder's rental of corporate property C) compensation paid by a corporation to a shareholder-employee D) All of the above can result in a constructive dividend.

10)

11) 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) $11,000 return of capital.

B) $8,000 dividend and a $3,000 return of capital.

C) $4,100 dividend and a $6,900 tax free return of capital.

D) $4,100 dividend and a $6,900 capital gain.

11)

12) 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 no gain; the shareholder will recognize dividend income of $60,000.

B) The corporation will recognize a $15,000 gain; the shareholder will recognize dividend income of $60,000.

C) The corporation will recognize a $15,000 gain; the shareholder will recognize dividend income of $75,000.

D) The corporation will recognize no gain; the shareholder will recognize dividend income of $75,000.

12)

13) Identify which of the following statements is true.

A) 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.

B) Only stock included in the decedent's gross estate can be redeemed under the Sec. 303 provisions.

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.

13)

14) 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 must have purchased the redeemed stock from a person whose stock ownership would be attributed to Buddy.

C) Buddy cannot be an officer of the corporation after the redemption.

D) Buddy cannot acquire an interest, even by inheritance, for 10 years unless the bequest was made prior to the redemption.

14)

3

15) 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) ($10,000) B) $0 C) $10,000 D) $5,000

15)

16) 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 $10,000 dividend $10,000 dividend

16)

B) Arnold $8,000 capital gain

Acorn Corporation $8,000 capital gain

C) Arnold $10,000 dividend

Acorn Corporation $8,000 capital gain

D) Arnold $8,000 capital gain

Acorn Corporation $10,000 dividend

17) 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) A corporation recognizes gain when distributing money as a dividend to its shareholders.

C) The shareholder's basis in property received in a nonliquidating distribution is the property's FMV reduced by liabilities assumed by the shareholder.

D) All of the above are false.

17)

18) 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) $80,000.

C) $20,000.

D) $60,000.

18)

19) Which of the following requirements must be met for a redemption to be treated as substantially disproportionate?

A) After the redemption, the shareholder must own less than 80% of his percentage ownership of voting stock prior to the redemption.

B) The shareholder must own less than 50% of the outstanding stock (in terms of voting power) after 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.

19)

4

20) 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) The holding period for the rights begins on the day the rights are distributed in all cases.

C) A shareholder cannot allocate any basis to the rights.

D) The basis in the rights is zero unless a shareholder makes a valid election to allocate basis to the rights.

20)

21) Current E&P does not include A) life insurance proceeds where the corporation is the beneficiary.

B) federal income tax refunds from prior years.

C) tax-exempt interest income.

D) All of the above are included.

21)

22) 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) 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.

C) Corporations without E&P can distribute preferred stock as a stock dividend that is Sec. 306 stock.

D) All of the above are false.

22)

23) 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 in full with sale or exchange treatment only if the proceeds are used to pay the death taxes and funeral and administrative costs.

B) redeemed with dividend treatment.

C) redeemed to the extent of the death taxes and the estate's funeral and administrative costs with sale or exchange treatment.

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.

23)

24) Identify which of the following statements is false.

A) The distribution of stock rights is generally tax free under Sec. 305.

B) 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.

C) The holding period for stock rights includes the holding period for the underlying stock.

D) 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.

24)

25) 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) $43,000.

C) $100,000.

D) $8,600.

25)

5

26) Identify which of the following statements is true.

A) Once attributed to an individual under one set of attribution rules, stock ownership may be reattributed to another individual under the same set of rules.

B) Waiver of the Sec. 318 family attribution rules is permitted for all related party stock transactions.

C) 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.

D) For a redemption to be essentially equivalent to a dividend, the shareholder must not have control of the corporation immediately following the redemption.

26)

27) 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; return of capital; return of capital B) return of capital; return of capital; dividend C) dividend; dividend; return of capital D) return of capital; dividend; dividend

27)

28) 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 $65,000 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 $75,000 basis in the land.

28)

29) Identify which of the following statements is true.

A) Corporate payments for the shareholder's benefit may be a taxable dividend.

B) Loans made to shareholders in proportion to their stock ownership in the corporation is evidence that the loans are disguised dividends.

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.

29)

30) 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) No recognized gain or loss; its E&P is reduced by $60,000.

B) No recognized gain or loss; its E&P is unchanged by the distribution.

C) A recognized loss of $10,000; its E&P is unchanged.

D) A recognized loss of $10,000; its E&P is reduced by $70,000.

30)

6

31) Identify which of the following statements is false.

A) 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.

B) 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.

C) Under Sec. 311, a corporation does not recognize a loss when it distributes property that has declined in value.

D) Generally, little or no gain is recognized by the redeeming shareholder in a qualified Sec. 303 redemption.

31)

32) Identify which of the following statements is true.

A) Under the attribution rules relating to stock redemptions, a person who has an option to purchase stock is considered to own the stock.

B) 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.

C) A stock redemption that qualifies as substantially disproportionate is a safe harbor for capital gain treatment.

D) All of the above are true.

32)

33) Which of the following is not a condition that permits a stock redemption to be treated as a sale?

A) It is not essentially equivalent to a dividend.

B) The redemption is substantially disproportionate.

C) The redemption completely terminates the shareholder's interest.

D) It provides funds for payment of income taxes.

33)

34) Identify which of the following increases Earnings & Profits.

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

34)

35) Which of the following statements best describes a bootstrap acquisition?

A) The shareholder exchanges his stock for stock of a different corporation.

B) The shareholder sells his stock in exchange for cash and debt.

C) The shareholder sells part of his or her stock to a purchaser and then the corporation redeems the original shareholder's remaining stock.

D) none of the above

35)

36) Identify which of the following statements is true.

A) To qualify as a partial liquidation, a distribution must result in a bona fide contraction of the corporate business at the corporate level.

B) A partial liquidation of a corporation must be pro rata.

C) A corporate shareholder treats the redemption of his or her stock as a sale whether or not the distribution is pro rata.

D) 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.

36)

7

37) Identify which of the following statements is false.

A) An individual is considered to own the stock owned by his parents, children, spouse, and grandchildren under the family attribution rules of Sec. 318.

B) An individual is not considered to own stock owned by a brother under the family attribution rules of Sec. 318.

C) A person who has an option to purchase stock is considered to own the stock.

D) A stock redemption is treated as a sale or exchange only if the shareholder's ownership of one particular class of stock is terminated.

37)

38) 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 buys 70 shares from Van for $70,000 and Van causes Valley Metal Corporation to redeem his remaining shares for $30,000.

B) 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.

C) 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.

D) Karen contracts to acquire all the stock of the corporation on an installment plan and then uses corporate funds to pay the installment obligations.

38)

39) What are the consequences of a stock redemption to the distributing corporation?

A) If the redemption is treated as a dividend, E&P is reduced in the same manner as for a regular dividend.

B) If the redemption is treated as a sale, only accumulated earnings and profits is reduced.

C) E&P is increased for a redemption that is treated as a dividend.

D) The corporation recognizes a gain or loss as if it had sold the distributed property for its FMV immediately before the redemption.

39)

40) 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 (Round your calculations to the nearest whole dollar.)

A) $9.00.

B) $9.52.

C) $9.50.

D) $10.00.

40)

41) 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) $40,000.

B) $8,000.

C) $0.

D) $50,000.

41)

42) For purposes of determining current E&P, which of the following items cannot be deducted in the year incurred?

A) capital losses in excess of capital gains B) life insurance premiums (in excess of the increase in cash surrender value for the policy) paid on the lives of key employees C) charitable contribution in excess of the 10% limitation D) dividends-received deduction

42)

8

43) 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, the corporation's E&P is reduced by the property's FMV even though the property's basis is greater than its FMV. C) When making a nonliquidating distribution, a corporation recognizes gains and losses.

D) All of the above are false.

43)

44) Which of the following is not a reason for a stock redemption?

A) No outside market exists for the stock.

B) Redemption of shares is a good corporate investment.

C) Desire by shareholders to reduce the corporate tax liability.

D) Desire by remaining shareholders to retain control.

44)

45) 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 be treated as having received a $15,000 dividend from Parent Corporation.

B) Rose will be treated as having received a $15,000 dividend distribution from Child Corporation.

C) Rose will recognize a $5,000 capital gain.

D) Rose will be treated as having sold stock to Parent Corporation and recognize a $15,000 capital gain.

45)

46) 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) 54 shares B) 60 shares C) 80 shares D) 30 shares

46)

47) Identify which of the following statements is false.

A) The function of E&P is to provide a measure of a corporation's economic ability to pay dividends.

B) At formation, a corporation's E&P depends on the amount of capital contributed by the shareholders.

C) For E&P dividend distribution purposes, property as defined in Sec. 317(a) includes money.

D) Adjustments to taxable income when computing E&P do not include tax-exempt interest.

47)

48) One consequence of a property distribution by a corporation to a shareholder is that A) the holding period of the distributed property includes the holding period of the distributing corporation.

B) the shareholder's basis in the distributed property is the same as the distributing corporation's basis.

C) any liabilities assumed by the shareholder do not reduce the shareholder's basis.

D) the amount of the distribution is increased by any liability assumed by the shareholder.

48)

9

49) 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) $0.

B) $7,500.

C) $67,500.

D) $22,500.

49)

50) 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 but no loss.

B) the sale is recast as a dividend paid to John, first by June and then by May. C) the transaction is treated as a contribution to May's capital and a redemption of June stock.

D) John has sold his stock and reports a capital gain or loss.

50)

51) 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) $15,000.

B) $60,000.

C) $5,000.

D) $20,000.

51)

52) 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) $31,000.

B) $25,000.

C) $4,000.

D) $10,000.

52)

53) 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) $1,000.

B) $5,000.

C) $0.

D) $4,000.

53)

54) Identify which of the following statements is true.

A) The value of decedent's stock satisfies the Sec. 303 minimum if it is less than 35% of the decedent's gross estate.

B) Attribution rules do apply to qualified Sec. 303 stock redemptions.

C) Attribution rules do not apply to qualified Sec. 303 stock redemptions.

D) 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.

54)

55) 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 $100,000 in dividend income.

B) recognize dividend income of $50,000 and a capital gain of $10,000.

C) recognize a capital gain of $10,000.

D) recognize a capital gain of $60,000.

55)

56) 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) $40,000.

C) $48,000.

D) $28,000.

56)

10

57) Identify which of the following statements is true.

A) A shareholder can redeem part of his stock and recognize a capital gain if the corporation has only one shareholder.

B) A stock redemption can be used to withdraw some assets from a corporation prior to a sale of the business.

C) The distributing corporation's E&P must be reduced by the FMV of nontaxable stock rights distributed to shareholders.

D) All of the above are false.

57)

58) 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.

58)

59) 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) $3,000.

B) $14,000.

C) $15,000.

D) $1,500.

59)

60) 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) $30,000 capital gain.

C) $14,000 capital gain.

D) $20,000 capital gain.

60)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

61) 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.

61)

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

62)

63) 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.

63)

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

64)

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

65)

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

66)

67) Distributed amounts that exceed a corporation's E&P are treated as a return of capital that reduces the shareholder's basis in his or her stock may create a negative basis in the stock.

67)

11

68) 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.

68)

69) Qualified dividends received by a noncorporate shareholder are subject to a maximum tax rate of 36%.

69)

70) 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.

70)

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

71)

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

72)

73) 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.

73)

74) A stock redemption is always treated as if the shareholder sold his stock to the corporation.

74)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

75) 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?

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

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

78) 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?

79) 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?

80) 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?

81) 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?

12

82) 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?

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

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

85) 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?

86) 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 $2,500 down payment this year and will pay Ho $2,500 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?

87) 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?

88) In Y1, Tru Corp. deducted $5,000 of bad debts. It received no tax benefit from the deduction because it had an NOL in Y1 that it was unable to carry back or forward. In Y2, Tru recovered $4,000 of the amount due. a) What amount must Tru include in income in Y2? b) What effect does the $4,000 have on E&P in Y2, if any?

89) 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?

13

90) 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) b) c) d) e)

What is the amount and character of income Alan recognizes when he receives the rights?

What is the amount and character of gain or loss Alan recognizes when he sells the rights?

What is the amount and character of gain or loss Alan recognizes when he exercises the rights?

What is the amount and character of gain or loss Alan recognizes when he sells the new common stock?

What basis does Alan have in his remaining shares?

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

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

a) b) c) d)

Current E&P $30,000 50,000 (73,000) (20,000)

Accumulated E&P $100,000 (50,000) 40,000 (50,000)

93) 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?

94) 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? 95) 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?

96) 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?

14

97) 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).

98) 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?

99) 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?

100) 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.

101) 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? 102) Define Sec. 306 stock.

103) Omega Corporation is formed in Year 1. Its current E&P and distributions for each year through Year 5 are as follows: Year Y2 Y3 Y4 Y5

Current E&P (deficit) $(20,000) 30,000 36,000 16,000

Distributions 0 0 $18,000 0

Is the distribution made from current or accumulated E&P? At the beginning of Y6, what is accumulated E&P?

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

15

105) 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?

106) 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?

107) 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? 108) 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?

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?

110) 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 April 1 June 1 August 1 November 1

Amount Distributed $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?

111) 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?

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

113) 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 1 2 3 4

Current E&P (Deficit) ($20,000) 8,000 ( 5,000) 25,000

Distributions $ 2,000 4,000 0 4,000

What is Peach's accumulated E&P at the beginning of each year for last five years?

114) 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.

115) Maury Corporation has 200 shares of stock outstanding as follows: Name Amy (an individual) APB Partnership (Amy is a 20% partner) ABC Partnership (Amy is a 70% partner) Silver Corporation (Amy is a 30% shareholder) Gold Corporation (Amy is a 60% shareholder) Total

Shares 30 25 50 50 45 200

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

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Answer Key Testname: C4

1) B 2) D 3) B 4) A 5) D 6) B 7) A 8) B 9) A 10) D 11) C 12) B 13) D 14) C 15) B 16) D 17) A 18) C 19) D 20) D 21) D 22) B 23) B 24) D 25) B 26) C 27) A 28) C 29) D 30) B 31) A 32) D 33) D 34) B 35) C 36) A 37) D 38) A 39) A 40) B 41) A 42) D 43) A 44) C 45) B 46) A 47) B 48) C 49) B 50) B 18

Answer Key Testname: C4

51) A 52) C 53) C 54) C 55) C 56) A 57) B 58) D 59) A 60) A 61) TRUE 62) TRUE 63) TRUE 64) TRUE 65) FALSE 66) FALSE 67) FALSE 68) TRUE 69) FALSE 70) TRUE 71) TRUE 72) FALSE 73) TRUE 74) FALSE 75) • What reasons might cause the sale to be $125,000 below the apparent prevailing market?

• What gain or loss does Winter Harbor recognize on the sale?

• What is Winter Harbor Corporation's E&P balance?

• Do the related party sale rules apply to the sale?

• If the $125,000 shortfall is a dividend, what gain or loss does Winter Harbor recognize on the distribution?

• What is the shareholder's gross income?

• What is the shareholder's basis for the land?

• What is the shareholder's holding period for the land?

• What is the distributing corporation's gain or loss on the distribution?

• What effect does the distribution have on the distributing corporation's E&P? One issue is whether Winter Harbor can recognize a $25,000 loss on the sale of the land to Jerry for $275,000 ($275,000 sale - $300,000 adjusted basis). It appears that Sec. 267 will prevent the recognition of the loss since Jerry and Winter Harbor Corporation are related parties under Sec. 267(b). An additional issue is whether Jerry has a constructive dividend. If similar land has sold recently for $400,000, it appears that the sale should have been $400,000 instead of $275,000. The $125,000 difference between the actual sales and the amount paid for similar land therefore should be considered a constructive dividend. Classifying the difference as a constructive dividend causes Winter Harbor to recognize a $100,000 ($400,000 - $300,000) capital gain on the deemed land sale that occurs under Sec. 311(b) when appreciated property is distributed. It also will trigger a $21,000 ($100,000 × 0.21) income tax liability that will reduce E&P. Jerry will take a $400,000 basis in the land. The distribution will reduce E&P by $125,000.

76) Usually at year-end. However, if a current deficit exists, the E&P available for measuring dividend income is determined at the distribution date.

77) Stock dividends generally are nontaxable because they do not add anything to the property the shareholder already owns, nor do they reduce the property of the corporation. As a general rule, the distribution is taxable whenever a stock dividend changes or has the potential to change the shareholder's proportionate interest in the distributing corporation.

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Answer Key Testname: C4

78) Gould recognizes a $60,000 ($90,000 - $30,000) capital gain, as though Gould had sold the property.

79) • Is the redemption a sale?

• Is the redemption not a sale?

If the redemption is treated as a sale, Steve has a $2,000 capital gain ($10,000 - $8,000). If the redemption is not treated as a sale, Steve has a $10,000 distribution that is a dividend to the extent of Stone Corporation's current and accumulated E&P. In the dividend case, Steve's $8,000 basis in the redeemed stock is added to his basis in his remaining stock.

80) The transaction is recast as a redemption by Daisy Corporation of Alice's Daisy stock that was received as a result of the capital contribution of the May stock. To test for exchange treatment, the Sec. 302(b) rules are applied to Alice's interest in May Corporation. Alice's interest in May Corporation after the distribution is 39% [25% direct ownership + 14% (56% × 25%) indirect ownership]. Since this is less than 80% of her pre-redemption ownership (50% × 0.80 = 40%), the transaction is treated as a substantially disproportionate redemption that is taxed as an exchange. This results in an $11,000 [$30,000 - (0.50 × $38,000)] capital gain being recognized by Alice.

81) a) The $100,000 in disallowed salary and bonuses will be nondeductible by Strong Corporation and taxable as a dividend to Stedman. How the IRS will treat this is unclear. Since salary reclassified as dividend income will be taxed at a maximum of 15%, the IRS is not likely to allow an offsetting ordinary deduction upon repayment. b) The repayment may be deductible by Stedman. How the IRS will treat this is unclear. Since salary reclassified as dividend income will be taxed at a maximum of 15%, the IRS is not likely to allow an offsetting ordinary deduction upon repayment.

82) Since Peter still owns 100% of Parker Corporation's stock, the redemption is treated as a dividend. Peter has a $90,000 dividend taxed at a maximum of 15%. His basis in his remaining 75 shares remains at $30,000. Parker Corporation's E&P is reduced by $90,000.

83) Distributions are treated as follows: (1) dividends to the extent of corporate E&P, (2) return of capital to the extent of the shareholder's stock basis, and (3) gain from the sale of stock.

84) Taxable income Plus: income excluded from taxable income (e.g., tax-exempt interest, life insurance proceeds) Plus: income deferred to a later year when computing taxable income (e.g., installment sales, income reported on percentage of completion method) Plus or minus: income and deduction items that must be recomputed when computing E&P (e.g., excess depreciation over straight-line, percentage depletion in excess of cost depletion).

Plus: deductions not allowed in computing E&P (e.g., NOL deduction, dividends-received deduction) Minus: expenses and losses not deductible in computing taxable income (e.g., federal income taxes, nondeductible political contributions) Equals: current E&P (or E&P deficit).

85) • Since the two cash distributions exceed E&P, what portion of each distribution comes out of E&P? • What portion of each shareholder's distribution is a return of capital?

• What portion of the return of capital distribution(s) reduces the basis of the shareholder's stock?

• What portion of each shareholder's return of capital distribution is a capital gain?

• Is the capital gain recognized long-term or short-term?

The issue is to what extent Tia's distribution is a dividend. Main Corporation has $18,000 of current and accumulated E&Ps, so only $18,000 can be a dividend to either Betty or Tia. Current E&P is allocated ratably to Betty and Tia ($6,000 each), and accumulated E&P is allocated on a first-in, first-out basis, so the remaining $6,000 of E&P is allocated to Tia. Therefore, Tia has a $12,000 dividend and a $3,000 return of capital. Betty has a $6,000 dividend and a $9,000 return of capital. Any amount received by Tia or Betty after recovering their stock basis is a capital gain. The return of capital distribution reduces the basis of Tia's stock investment and will cause a corresponding increase (decrease) in the capital gain (capital loss) reported on her sale of the Main stock to Betty.

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Answer Key Testname: C4

86) In the current year, Ho recognizes $1,000 of gain [($4,000/$10,000 × $2,500] in computing taxable income. Ho will also recognize $1,000 of gain in computing taxable income in each of the next three years. All $4,000 of Ho's realized gain must be included in current E&P. As Ho collects the installments, E&P will need to be reduced by $1,000 in each of those years since all $4,000 was included in E&P in the current year.

87) a) The sale is recast as a redemption. Since Susan still owns more than 50% of Parent after the redemption, [100 shares directly and 20 (50% × 80% × 50) shares indirectly out of 200 outstanding shares], or 60% of Parent's stock, the $40,000 is taxed as a dividend to Susan. b) Susan's basis in her remaining 100 shares of Parent stock is $15,000. c) Subsidiary Corporation's E&P is reduced to $20,000 ($60,000 - $40,000). d) Subsidiary Corporation's basis in the Parent shares is $40,000. e) The recast redemption is substantially disproportionate {75% before the redemption and 70 [50 + 20 (25% × 80% × 100)] shares, or 35%, after the redemption}. Therefore, Susan has a capital gain of $70,000 [$80,000 - (100/150 × $15,000)].

88) a) Tru excludes the $4,000 from gross income in Y2 because it received no tax benefit from the bad debt deduction in Year 1. b) Tru must add the $4,000 to its income for purposes of determining current E&P since it was deducted in a prior year.

89) The transaction is recast under Sec. 304 as a distribution from Ameriparent in redemption of Taxpayer's stock. The $20,000 purchase is a dividend under Sec. 301 since Taxpayer's interest was not less than 80% of what it was prior to the redemption [20% direct + 14% indirect = 34%, which is not less than the 32% (40% × 80% = 32%) minimum needed for substantially disproportionate treatment]. The redemption might be eligible for capital gain treatment if the distribution is considered to be not essentially equivalent to a dividend. It is possible that this interpretation will be accepted, since Taxpayer goes from one minority position to another minority position.

90) a) Alan recognizes no income when he receives the rights. b) Since the value of the rights ($15) is more than 15% of the value of the underlying stock ($75), the basis of the stock must be allocated to the stock and the right. Alan's basis in his stock is: $10,000 × ($75/$90) = $8,333.33 ($41.67 per share). Alan's basis in his rights is $10,000 × ($15/$90) = $1,666.67 ($8.33 per right). Alan recognizes a long-term capital gain of $1,166.67 ($2,000 - $833.33) when he sells the 100 rights. c) Alan recognizes no gain when he exercises the rights. Their basis is added to the basis of the stock purchased with the rights ($6,000 + $833.33 = $6,833.33). d) Alan recognizes a gain of $700 [(60 × $80) - (60 × $68.33)] on the stock sale. The gain is a short-term capital gain since the holding period begins on the September 10 exercise date. e) Alan's basis in his remaining shares is as follows: Alan's original 200 shares: $8,333.33 ($10,000 - $1,666.67). Alan's 40 remaining shares purchased with the rights: $2,733.33 (40 shares × $68.33).

91) The basic purpose of Form 5452, Corporate Report of Nondividend Distributions, is to report the E&P of the distributing corporation so that the IRS can determine whether the distributions are indeed nontaxable to shareholders.

The corporation must include its current and accumulated E&P, the amounts paid to shareholders during the year and the percentage of each payment that is taxable and nontaxable, and a detailed computation of the corporation's E&P since incorporation.

92) a) $120,000 is a dividend to Evan. b) $50,000 is dividend. $35,000 is a return of capital, which reduces Evan's basis to zero. The remaining $35,000 is taxable as a capital gain. c) Green's accumulated E&P as of March 1 is $28,200 {$40,000 - [$73,000 × (59/365)]}. Therefore, $28,200 is taxable as a dividend. $35,000 is a return of capital and the remaining $56,800 is taxable as a capital gain. d) $35,000 is a return of capital, which reduces Evan's basis to zero, and the remaining $85,000 is a capital gain.

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Answer Key Testname: C4

93) a) The sale is recast as a redemption of Oz stock issued as a result of Rich's capital contribution of the Rainbow stock to Oz. The Sec. 302 stock ownership is tested by looking at Rich's ownership of the Rainbow stock.

• Rich's ownership of Rainbow stock before the redemption: 60% of Rainbow stock.

• Rich's ownership after the redemption: 30 shares directly and 80% × 30 shares indirectly = 54 shares = 54% of Rainbow stock.

The redemption is treated as a $50,000 dividend to Rich since the combined E&P of Rainbow and Oz Corporations is $65,000 ($25,000 + $40,000). b) Rich's basis in his remaining Rainbow stock is $6,000 (30/60 × $12,000). Rich's basis in his Oz stock is increased to $14,000 by his $6,000 basis in the redeemed Oz stock. c) Oz's E&P is reduced by the first $40,000 of the distribution, and Rainbow's E&P is reduced by the remaining $10,000 ($50,000 - $40,000) of the distribution. d) Oz's basis in its Rainbow shares is $6,000, the same as Rich's pre-sale basis. e) If Rich owned only 50% of the Oz stock before the sale, Rich owns 60% of the Rainbow stock before and 45% after the sale [30 shares + (50% × 30 shares)], so the redemption is treated as a sale under Sec. 302(b)(2). Rich has a capital gain of $44,000 ($50,000 - $6,000 basis).

94) River must add back the $10,000 DRD and the $5,000 NOL. Therefore, current E&P is $40,000 ($25,000 + $10,000 + $5,000).

95) A stock redemption is the acquisition by a corporation of its own stock. Some reasons for a redemption are listed on pages C:4-16. Some redemptions that substantially change the shareholder's proportionate interest closely resemble a sale of stock to a third party and are treated as a sale or exchange, while others that do not produce such a change are essentially equivalent to a dividend and are taxed as a dividend.

96) a) The stock dividend is nontaxable (Sec. 305(a)). b) Bert's basis in each share is $1,818.18 ($200,000/110 shares). Therefore, his gain on the sale is $11,818.20 [$30,000 (10 × $1,818.18)].

97) a) $60,000 dividend to Wilhelmina; $15,000 out of current E&P and $45,000 out of accumulated E&P. b) $25,000 is a dividend to Wilhelmina; $25,000 is a return of capital that reduces Wilhelmina's basis to zero; the excess $10,000 is taxable as a capital gain. c) White's accumulated E&P as of March 1 (of a nonleap year) is $65,000 - [($36,500/365) × 59] = $59,100. Therefore, $59,100 is taxable as a dividend. $900 is a return of capital that reduces Wilhelmina's stock basis to $24,100. d) $25,000 is a return of capital that reduces Wilhelmina's basis to zero; the excess $35,000 is taxable as a capital gain.

98) a) The distribution amount is the FMV of all property received. If the shareholder assumes or acquires a liability in connection with the distribution, it reduces the amount of the distribution (but not below zero). b) The distribution amount is a dividend to the extent it is paid out of the current and accumulated E&P of the corporation. c) The basis of any property received is its FMV. Any liability assumed or acquired by the shareholder in connection with the distribution does not reduce the property's basis. d) The holding period for the property begins on the day after the distribution date.

The answers would not change if the distribution was made to a corporate shareholder because Sec. 301(c) applies the same dividend rules to each type of shareholder. However, a corporation shareholder may be eligible for the dividend-received deduction.

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Answer Key Testname: C4

99) • The employee's qualifications • The nature, extent, and scope of the employee's work • The size of the business • The complexities of the business • A comparison of the salaries paid with the corporation's gross and net incomes • The prevailing general economic conditions • Whether the corporation has paid any dividends • Compensation for comparable positions in comparable concerns • The corporation's salary policy to its employees • The amount of compensation paid to the particular employees in previous years • The amount of compensation voted by the board of directors.

100) a) This is a complete termination of interest and therefore Sec. 302(b)(3) applies. Dave recognizes a gain of $120,000 ($300,000 - $180,000 basis). Erica and Faye each retain a basis of $180,000 in their shares. News's E&P is reduced by $240,000 [(100/300 shares) × $720,000]. b) If Erica is Dave's mother and a waiver of the family attribution rules is not elected, Dave is considered to own 200/300 or 66 2/3% before the redemption and 100/200 or 50% after the redemption. Therefore, the redemption is treated as a dividend of $300,000 to Dave. Erica's $180,000 basis is increased by Dave's $180,000 basis in the shares surrendered to $360,000. Faye's basis remains the same at $180,000. News's E&P is reduced by $300,000, the amount of the dividend paid to Dave.

Alternatively, Dave could elect under Sec. 302(c) to waive the family attribution rules. If such an election is made, the Sec. 302(b)(3) rules that applied in determining the answer in part (a) will provide capital gain treatment.

101) a) Betty has a taxable dividend of $104,000 ($120,000 - $16,000). b) Betty's basis for the land is $120,000, its FMV. c) Pearl Corporation recognizes a $60,000 ($120,000 FMV - $60,000 basis) gain on the distribution. d) Pearl Corporation's E&P is increased by the $60,000 gain and decreased by the $104,000 ($120,000 - $16,000) net amount of the distribution plus the $20,400 (0.34 × $60,000) of federal income taxes imposed on the gain, or a net reduction of $64,400.

102) Sec. 306 stock is stock, other than common stock, issued with respect to common stock that is received in a nontaxable stock dividend. It can also be stock, other than common stock, acquired in an exchange to which Sec. 351 applies if the receipt of money (in lieu of stock) would have been treated as a dividend. Sec. 306 stock also includes stock, other than common stock, received in a tax-free corporate reorganization or corporate division if the effect of the transaction was substantially the same as the receipt of a stock dividend or if the stock was received in exchange for Sec. 306 stock.

Finally, Sec. 306 stock is any stock whose basis is determined by reference to the basis of Sec. 306 stock (i.e., a substituted or transferred basis). Sec. 306 stock can only be issued by a corporation having E&P in the year of issuance.

The Sec. 306 stock designation lapses upon inheritance since the basis of such stock is its FMV on the date of death (or alternative valuation date).

103) The $18,000 distribution is made from Y4's current E&P. At the beginning of Y5, Omega's accumulated E&P is $28,000, (-$20,000 + $30,000 + $36,000 - $18,000). At the beginning of Y6, Omega's accumulated E&P is $44,000, ($28,000 + $16,000).

104) The taxpayer must calculate a gain or loss separately for taxable income and E&P purposes.

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Answer Key Testname: C4

105) • What is Ned's stock ownership before and after the redemption?

• Are any shares attributed to Ned from his mother?

• Can Ned elect to waive the family stock attribution rules?

• What is the amount and character of Ned's gain or income on the stock redemption?

• What is Ned's basis in the 30 shares of stock he received as a gift from his mother?

• If the transaction is a dividend, what happens to Ned's basis in his stock?

• What is Ned's mother's basis for her stock after the redemption (i.e., is any of Ned's remaining basis transferred to his mother)?

• Does the corporation recognize any gain on the repurchase of the shares?

• What is its basis for the shares repurchased?

• What effect does the redemption have on Nichol Corporation's E&P? The issue is whether the redemption should be treated as a sale or a dividend. Ned is deemed to own the shares owned by his mother. Therefore, he is deemed to have owned 70 shares before the redemption (70/100 = 70% of the Nichol stock) and 40 shares after the redemption (40/70 = 57% of the Nichol stock). Thus, the redemption is not substantially disproportionate under Sec. 302(b)(2).

The second issue is whether Ned can sign a waiver to have the family attribution rules waived under Sec. 302(b)(3).

The problem is that he received his shares as a gift from his mother. If Ned can show that tax avoidance was not the principal purpose for the gift of the Nichol stock, he can sign a waiver, and the redemption will be treated as a sale. In such case, he has a $19,000 ($35,000 - $16,000) LTCG. E&P will be reduced by 30% of the current and accumulated E&P, or $30,000 (0.30 × $100,000). If a waiver of the family attribution rules is not possible, Ned will most likely have a $35,000 dividend. It is not likely that the Sec. 302(b)(1) "not essentially equivalent to a dividend" rules will apply since Ned still maintains a majority stock ownership position in Nichol following the redemption. If the transaction is a dividend, his basis for all 30 shares will be reallocated to his mother since she is the individual whose stock ownership prevented the redemption from receiving capital gain treatment. E&P will be reduced by the $35,000 distributed to Ned. The corporation's basis for the redeemed shares is not important since it recognizes no gain or loss when it issues new or treasury stock (Sec. 1032).

106) a) The distribution amount is $25,000 ($30,000 - $5,000), all of which is a dividend to Dave as it does not exceed Digger's E&P balance. b) Dave's basis in the property is $30,000, its FMV. c) Dave's holding period starts on March 2.

107) Splash deducts the entire $20,000 in computing current E&P. Therefore, $15,000 must be deducted from taxable income of $45,000 ($50,000 - $5,000) to compute current E&P. In future years, when the $15,000 carryover is deducted in determining taxable income, it must be added to taxable income in arriving at current E&P. 108) The basis allocated of the common stock is: $30,000 × [$40,000/($40,000 + $80,000)] = $10,000

The redemption of Bart's preferred stock is treated as a dividend under Sec. 301. Bart's dividend income under Sec. 306 is limited to Atlas Corporation's E&P at the time of the stock redemption, or $25,000. Consequently, Bart has $25,000 of dividend income, $10,000 treated as a return of capital, and $40,000 of capital gain [$75,000 - ($25,000 + $10,000)].

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Answer Key Testname: C4

109) • What is Lion's E&P balance immediately preceding the distribution?

• If $50,000 in cash is withdrawn from the business, will it be treated as a dividend to Kiara?

• Can the $50,000 withdrawn from the business be considered to have been received as part of Kiara's stock sale?

• Can the tax results for the transaction be improved if Kiara has some of her stock redeemed for the $50,000 cash?

• Are the tax consequences of the transaction different if the $50,000 is withdrawn from the business either before or as part of the stock sale?

• Can the $50,000 payment be classified as payment of back wages to Kiara? Would such an amount be deductible by the corporation?

• What is the amount and character of the gain recognized on Kiara's sale of the stock?

The primary issue is whether the $50,000 Kiara receives from Lion's is a dividend or is part of the amount she receives for her stock. If Lion redeems 25% of her stock for $50,000 in cash as part of the same transaction in which her remaining stock is sold to Tia for $150,000, quite likely she can treat the entire $200,000 as being received in exchange for her stock under the bootstrap redemption rules. In such case, she has a $130,000 ($200,000 - $70,000) capital gain.

However, if she receives $50,000 from Lion before entering into the sale agreement with Tia, she will have a $50,000 dividend and then an $80,000 ($150,000 - $70,000) capital gain on a later sale of her stock to Tia. It is not likely that Lion can treat the $50,000 payment as additional compensation (e.g., a bonus or payment made because of lower-than-normal salary payments made in prior years) and then deduct the payment in computing its corporate tax liability. A possibility might be to treat the $50,000 payment as being paid to Kiara in exchange for a covenant not to compete for a certain period of time. Such payment generally is ordinary income for the recipient but is deductible by the payer over 15 years in accordance with Sec. 197.

110) The current E&P is allocated ratably to each distribution. Accumulated E&P is allocated to the four distributions in chronological order, starting with the April 1 distribution. The taxability of the distributions is as follows:

Date April 1 June 1 August 1 November 1

Amount Distributed $20,000 20,000 15,000 5,000 $60,000

Current E&P $ 9,333 9,334 7,000 2,333 $28,000

Accumulated E&P $10,667 8,333 0 0 $19,000

Return of Capital 0 $2,333 8,000 2,667 $13,000

Capital Gain 0 0 0 0 0

111) a) Randy receives a taxable dividend of $52,000 ($60,000 - $8,000). b) Randy's basis for the land is $60,000, its FMV. c) Red Corporation recognizes a $30,000 [($52,000 net FMV + $8,000 release from liability) - $30,000] capital gain on the distribution. d) Red Corporation's E&P is increased by the $30,000 E&P gain, which is the excess of the land's FMV over its E&P adjusted basis. (Note that the E&P gain and the tax gain are the same in this problem.) E&P is decreased by the $52,000 ($60,000 FMV - $8,000 mortgage) net amount of the distribution and by the $10,200 (0.34 × $30,000) of federal income taxes imposed on the gain, or a net reduction of $32,200.

112) A constructive dividend (or undeclared distribution) is an indirect payment made to a shareholder without a formal declaration. Such dividends are most likely to arise in the context of a closely held corporation. Examples of constructive dividends include excess compensation paid to a shareholder-employee or excess lease payments made to a shareholder-lessor.

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Answer Key Testname: C4

113) 1: ($20,000)a 2: ($16,000)b 3: 4:

($21,000)c 0d

a A distribution does not reduce a current E&P deficit. b (-$20,000) + ($8,000 - $4,000) = (-$16,000) c (-$16,000) + ($5,000) = (-$21,000)

d (-$21,000) + ($25,000 - $4,000) = $0

114) Sarah and Matt must each recognize $80,000 (0.50 × $160,000) of dividend income. This portion of the distribution reduces Delta's E&P to zero. The additional $40,000 that each shareholder receives is treated as a return of capital or capital gain as summarized in the table below.

Distribution Dividend income Remaining distribution Return of capital Capital Gain

Sarah $120,000 ( 80,000) $ 40,000 ( 40,000) $ 0

Matt $120,000 ( 80,000) $ 40,000 ( 20,000) $ 20,000

Total $240,000 (160,000) $ 80,000 ( 60,000) $ 20,000

115) Amy owns: 30 shares directly 5 shares through APB Partnership (0.20 × 25 shares) 35 shares through ABC Partnership (0.70 × 50 shares) 0 shares through Silver Corporation 27 shares through Lime Corporation (0.60 × 45 shares) Thus, total deemed constructive ownership is 97 shares.

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Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) In determining accumulated taxable income for the purpose of the accumulated earnings tax, which one of the following is allowed as a deduction?

A) net operating loss deduction B) net capital loss for the current year C) excess charitable contributions D) dividends-received deduction

1)

2) Identify which of the following statements is false.

A) The corporate AMT liability is reported on Form 4626.

B) A corporation files a Schedule PH to report its PHC tax for the tax year.

C) A corporation files a Schedule AE to report the amount of its accumulated earnings tax liability for the tax year.

D) 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.

2)

3) The personal holding company penalty tax rate is A) 35%.

B) 15%.

3)

C) 20%.

D) 10%.

4) Identify which of the following statements is true.

A) The Bardahl formula provides mathematical exactness when calculating reasonable working capital needs for accumulated earnings tax purposes.

B) 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.

C) The Bardahl formula uses the concept of working capital, cash over current liabilities.

D) All of the above are false.

4)

5) Identify which of the following statements is true.

A) 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.

B) 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.

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

D) The accumulated earnings tax is levied on the corporation's total accumulated earnings balance, but only on its current-year addition to the balance.

5)

6) The accumulated earnings tax is imposed at what rate?

A) 35% B) 20% C) 15%

6)

D) 10%

7) A corporation cannot reasonably accumulate earnings to A) protect against pending litigation.

B) redeem stock of an elderly shareholder where such accumulation occurs prior to the shareholder's death.

C) fund an employee retirement plan.

D) self-insure.

1

7)

8) Which of the following is not permitted an accumulated earnings credit based on reasonable needs of the business?

A) an incorporated engineer B) an investment company C) an operating company D) All of the above are permitted a credit based on reasonable business needs.

8)

9) The personal holding company tax might be imposed A) on companies whose gross income arises solely from rentals, if the lessors render no services to the lessees.

B) on small business investment companies licensed by the Small Business Administration.

C) on both partnerships and corporations.

D) a corporation meets the stock ownership requirement of a PHC for a tax year if five or fewer individuals own more than 50% of its stock at any time during the last half of its tax year

9)

10) The accumulated earnings tax does not apply to corporations that A) are members of a controlled group.

B) are personal holding companies.

C) have more than one class of stock.

D) are closely held corporations.

10)

11) 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

11)

12) Identify which of the following statements is true.

A) Income from personal service contracts are not included in personal holding company income.

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) 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) The personal holding company taxes that are paid by a corporation can be used as a credit against its regular tax amount.

12)

13) Identify which of the following statements is false.

A) 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.

B) The 80% dividends-received deduction can be claimed when computing a corporation's undistributed personal holding company income (UPHCI).

C) Rental expenses in excess of rental income are added back to taxable income to arrive at personal holding company income (PHCI).

D) The PHC tax is assessed at 20%.

13)

2

14) 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) $100,000.

C) $80,000.

D) $90,000.

14)

15) A personal holding company cannot take a dividends-paid deduction for A) preferential dividends.

B) deficiency dividends.

C) consent dividends.

D) throwback dividends.

15)

16) Which of the following is not an adjustment to taxable income when computing the personal holding company tax?

A) NOL carryover from immediately preceding tax year B) dividends-paid deduction C) dividends-received deduction D) All of the above are adjustments.

16)

17) 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) Make a cash distribution within 2 1/2 months of the end of the tax year.

B) Sell additional stock to other family members.

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.

17)

18) Identify which of the following statements is true.

A) A health service corporation can claim an accumulated earnings credit of $250,000.

B) All corporations are exempt from the accumulated earnings tax on their first $250,000 of accumulated earnings.

C) Payment of deficiency dividends will prevent the imposition of the accumulated earnings tax.

D) All of the above are false.

18)

19) 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

19)

20) 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) Make a cash distribution within 2 1/2 months after the end of the tax year.

B) Make a deficiency distribution within 90 days of the date on which the IRS determines that an accumulated earnings tax liability is owed.

C) Create plans to invest retained earnings in a plant expansion.

D) Liquidate the corporation.

20)

3

21) Which of following generally does not indicate an unreasonable earnings accumulation?

A) investments in properties or securities unrelated to the activities of the corporation B) planned expansion of business facilities C) loans to shareholders D) expenditure of corporate funds for the personal benefit of the shareholders

21)

22) 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) 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.

C) 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.

D) The personal holding company tax is levied to prevent closely held corporations from sheltering passive income.

22)

23) Which of the following entities is subject to the accumulated earnings tax?

A) S corporation B) C corporation C) Sec. 501 tax-exempt corporation D) personal holding company

23)

24) Identify which of the following statements is false.

A) A person who holds an option to acquire stock is considered to own the stock for purposes of the PHC stock requirements.

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) Askew Corporation has ten unrelated shareholders, each of whom owns 10% of the outstanding stock. This corporation is a personal holding company.

24)

25) Identify which of the following statements is true.

A) Consent dividends are cash dividends paid following an authorizing vote of the shareholders.

B) Dividends paid by a personal holding company in the first 2 1/2 months of a tax year are automatically throwback dividends.

C) 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.

D) All of the above are false.

25)

26) The personal holding company tax A) qualifies as a tax credit, which may be used by the shareholders to reduce their individual income taxes.

B) may be imposed regardless of the number of equal stockholders in a corporation.

C) may be eliminated by the payment of a deficiency dividend.

D) applies to any corporation whose shareholders satisfy the stock ownership requirement.

26)

4

27) When computing the accumulated earnings tax, the dividends-paid deduction is not available for A) property dividends.

B) stock dividends.

C) dividends paid during the tax year.

D) throwback dividends.

27)

28) Identify which of the following statements is true.

A) 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.

B) A corporation cannot reasonably accumulate earnings to protect against pending litigation.

C) A corporation accumulates earnings to fund a buy-sell agreement. Such an accumulation of earnings is a reasonable business need.

D) 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.

28)

29) When computing the accumulated earnings tax, which of the following is not a reduction to arrive at accumulated taxable income?

A) NOL deduction claimed B) accrued federal income taxes C) accumulated earnings credit D) dividends-paid deduction

29)

30) All of the following are recognized as reasons for accumulating earnings except A) redemption of stock of deceased shareholder.

B) working capital needs.

C) product liability loss reserves.

D) All of the above are recognized reasons for accumulating earnings.

30)

31) 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 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.

C) 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. D) All of the above are false.

31)

32) 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 interest and/or underpayment penalty even if the PHC tax is avoided by a deficiency dividend.

B) 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.

C) A deficiency dividend is not permitted to be paid by Dragon.

D) Dragon Corporation will owe no interest and/or underpayment penalty if the PHC tax is avoided by a deficiency dividend.

32)

5

33) Identify which of the following statements is true.

A) A corporation bears the burden of proving that its earnings are not being accumulated to avoid income taxes.

B) In practice, the accumulated earnings tax applies only to closely held corporations.

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.

33)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

34) A low tax bracket individual can enhance the avoidance of income taxes through a C corporation by having the corporation retain its after tax earnings rather than paying them out as a dividend.

34)

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

35)

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

36)

37) A corporation can change the amount and type of its income by adding "operating" activities to its business to decrease the proportion of passive or investment earning in its total income to avoid the PHC tax.

37)

38) A high tax bracket individual can enhance the avoidance of income taxes through a C corporation by having the corporation retain its after tax earnings rather than paying them out as a dividend.

38)

39) Corporations are subject to the 3.8% net investment tax in addition to the corporate tax rate of 21%.

39)

40) 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.

40)

41) A corporation can exclude certain categories of income (e.g., adjusted income from rents) from PHCI through the payment of dividends sufficient to reduce the amount of other PHCI to 10% or less of OGI.

41)

42) A high tax bracket individual can enhance the avoidance of income taxes through a C corporation by having the corporation retain its after tax earnings so that when the individual dies, his or her heirs can liquidate the corporation and realize little to no gain because of a step-up in basis.

42)

43) A corporation's required estimated tax payment includes PHC tax.

43)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

44) What is the effect of the two-pronged test that allows the exclusion from PHCI of certain AIR (adjusted income from rents)?

6

45) 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 Long-term capital gain Short-term capital gain Dividends (from 25%-owned domestic corporation) Interest Gross income Minus: general and administrative expenses Minus: salaries "Adjusted" taxable income Minus: charitable contributions Taxable income before special deductions Minus: dividends-received deduction Taxable income

$150,000 20,000 20,000 200,000 150,000 $540,000 ( 40,000) ( 30,000) $470,000 ( 47,000) $423,000 (130,000) $293,000

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.

46) 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?

47) 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 Cost of goods sold Purchases Average accounts receivable balance Average credit sales Average accounts payable balance Operating expense Depreciation claimed as operating expense Federal income taxes Advances to suppliers

$ 33,000 300,000 250,000 80,000 320,000 30,000 400,000 50,000 25,000 30,000

48) Eagle Corporation, a personal holding company, has the following results: Taxable income Dividends-received deduction Excess charitable contributions Long-term capital gains Federal income taxes

$200,000 30,000 10,000 10,000 61,000

Calculate the PHC tax.

49) What is a personal holding company?

50) How is the accumulated earnings tax liability computed?

7

51) Define personal holding company income.

52) There are no items in this section.

53) 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?

54) Lawrence Corporation reports the following results during the current year: Taxable income Federal income taxes Dividends paid: June 5 Accumulated E&P balance: January 1

$500,000 105,000 50,000 800,000

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?

55) Raptor Corporation is a PHC for the current year and reports $200,000 of taxable income on its federal income tax return.

Operating profit Long-term capital gain Dividends (20%-owned corporation) Interest Gross income Salaries expense General and administrative expense Dividends-received deduction Taxable income Regular tax liability

$100,000 80,000 90,000 100,000 370,000 (50,000) (25,000) (72,000) $223,000 $ 46,830

What is Raptor's PHC tax, assuming that it does not pay any dividends?

56) 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?

8

57) Lake Corporation is a personal holding company. Lake reports the following results for the current year: Rental income Operating profit Dividend income Interest income Depreciation Mortgage interest expense Real estate taxes Other expenses

$100,000 80,000 30,000 20,000 30,000 18,000 8,000 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.

58) 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?

59) 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 Dividends from savings and loan associations on passbook savings accounts Interest earned on notes receivable Net rental income

$10,000 $2,000 $5,000 $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?

60) 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 $7,350 [($70,000 dividends - $35,000 DRD) × .21 = $7,350]. The IRS audits this corporation and sends a tax bill in the amount of $12,530 ($62,650 UPHCI × 0.20 = $12,530) 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?

9

61) Khuns Corporation, a personal holding company, reports the following: Rental income Depreciation Interest expense Real estate taxes Maintenance expenses Administrative expenses

$50,000 10,000 5,000 2,000 5,000 5,000

Calculate Khuns Corporation's adjusted income from rents (AIR).

62) Green Corporation, a closely held operating corporation, reports the following: Taxable income Long-term capital gain Dividends-received deduction Federal income taxes on long-term capital gain Accumulated earnings credit Federal income taxes

$200,000 30,000 20,000 11,700 80,000 42,000

Calculate Green's accumulated taxable income.

63) The following information is reported by Acme Corporation.

Cost of goods sold Average inventory balance Average accounts receivable balance Sales (all on account) Average accounts payable balance Operating expenses (excluding depreciation) Purchases

$350,000 35,000 65,000 325,000 45,000 500,000 40,000

What is Acme Corporation's average operating cycle as a percentage of the year?

10

Answer Key Testname: C5

1) B 2) C 3) C 4) B 5) B 6) B 7) B 8) B 9) D 10) B 11) B 12) B 13) B 14) C 15) A 16) D 17) B 18) D 19) B 20) B 21) B 22) D 23) B 24) D 25) C 26) C 27) B 28) D 29) A 30) D 31) D 32) A 33) D 34) FALSE 35) TRUE 36) FALSE 37) TRUE 38) TRUE 39) FALSE 40) TRUE 41) TRUE 42) TRUE 43) FALSE 44) The effect of the two-pronged test is that it makes it difficult to use rents to shelter other passive income. PHCI does not include rents if (1) AIR is at least 50% of AOGI, and (2) the dividends-paid deduction equals or exceeds the amount by which nonrental PHCI exceeds 10% of OGI.

11

Answer Key Testname: C5

45) Corporate Income tax liability (293,000 * .21)

$61,530

Taxable income Plus: dividends-received deduction Minus: excess charitable contributions ($75,000 - $47,000) Federal income tax Long-term capital gain (net of taxes) UPHCI Times: tax rate PHC tax

$293,000 130,000 ( 28,000) ( 61,530) ( 15,800)a $317,670 × 0.20 $ 63,534

a $20,000 - ($20,000 × 0.21) = $15,800 Payment of the PHC tax can be avoided by paying a timely deficiency dividend in the amount of $296,980.

46) • Expansion of a business or replacement of plant • Acquisition of a business enterprise • Debt retirement • Working capital • Loans to suppliers or customers • Product liability losses • Stock redemptions • Business contingencies 47) Inventory turnover (as a percent of the year) = $33,000/$300,000 = 0.11.

Accounts receivable turnover = $80,000/$320,000 = 0.25.

Credit turnover = $30,000/($400,000 - $50,000 + $250,000) = 0.05.

Operating cycle = (0.11 + 0.25 - 0.05) = 0.31.

Working capital needs = 0.31 × ($400,000 - $50,000 + $300,000 + $25,000) = $209,250. $200,000 48) Taxable income Plus: dividends-received deduction 30,000 Minus: excess charitable contributions ( 10,000) Long-term capital gains (net of taxes)* ( 7,900)* Federal income taxes ( 42,000) Undistributed personal holding company income $170,100 × 0.20 Times: rate Personal holding company tax $ 34,020 *$10,000 - (0.21 × $10,000) = $7,900 49) A personal holding company is any corporation that (1) has five or fewer individual shareholders who own more than 50% of the corporation's outstanding stock at any time during the last half of its tax year, and (2) has personal holding company income that is at least 60% of its adjusted ordinary gross income for the tax year. Corporations that have certain special tax status generally are excluded from the PHC definition. Among those excluded are S corporations and tax-exempt organizations.

50) See Page C:5-19.

51) Personal holding company income includes dividends, interest, annuities, adjusted income from rents, royalties, produced film rents, income from personal service contracts involving a 25% or more shareholder, rental income for corporate property used by a 25% or more shareholder, and distributions from estates or trusts.

52) False

12

Answer Key Testname: C5

53) The following tax issues need to be addressed about Navy Corporation's earnings accumulation: • Has Navy Corporation accumulated earnings beyond the reasonable needs of the business?

• If Navy Corporation has accumulated earnings beyond the reasonable needs of the business, was tax avoidance one of the directors' motivations for retaining the earnings?

• What business needs can Navy Corporation's management use to justify the current and prior years' earnings accumulation?

• What business needs can Navy Corporation's management use to justify any future earnings accumulations?

• What steps can Navy Corporation take to reduce its current accumulated earnings tax exposure? Its future accumulated earnings tax exposure?

• Should Navy Corporation bring the accumulated earnings tax issue to the IRS's attention?

• Should an S election be made to reduce future exposure to the accumulated earnings tax?

Navy Corporation has a large E&P balance ($3 million currently), which is growing annually at a $200,000 rate. Few dividends have been paid, and a substantial portion of the current-year profit has been invested in portfolio investments or loaned to shareholders. The investment activities and loans indicate a possible accumulated earnings tax problem. Guidance should be provided to Navy Corporation that "active business" investments should replace "portfolio" investments if the corporation is to avoid the accumulated earnings penalty tax. The corporation is well past its statutory exemption and needs to document that the earnings are being retained to meet the reasonable needs of the business. No indication has been given whether such documentation exists, although there is an indication that some of the investments are being made to protect against a business downturn, which is a legitimate use of corporate earnings. $500,000 54) Taxable income Minus: long-term capital gain $50,000 Minus: income taxes (10,500) ( 39,500) Minus: federal income taxes (105,000) Minus: dividends-paid deduction ( 50,000) Minus: accumulated earnings credit ( 20,500)* Accumulated taxable income $285,000 Times: tax rate × 0.20 Accumulated earnings tax $ 57,000 *$60,000 reasonable needs of business accumulation - $39,500 capital gains net of taxes = $20,500.

223,000 55) Taxable income Less: federal tax (46,830) Less: Net capital gain (net of taxes)* (63,200) Plus DRD 72,000 PHCI 184,970 PHC Tax (0.20 tax rate) 36,994

* 80,000 - (80,000 * .21) = 63,200

13

Answer Key Testname: C5

56) The following tax issues need to be addressed about Church Corporation's first year of operations: • Will Church Corporation be classified as a PHC based on its first-year income projections? Do the projections forecast that this will be a long-term problem?

• If Church Corporation is projected to be a PHC for its initial year of operation, what action can be taken before year-end to avoid being classified as a PHC? • Would Church Corporation benefit by making a timely S election applicable to its initial tax year? To a later tax year?

• If Church Corporation is a PHC for its initial year of operation, what action (e.g., throwback distributions) can be taken after year-end to avoid incurring the PHC penalty tax?

Projections indicate that 70% of Church Corporation's gross income will be interest and dividends. The remaining 30% is net rental income. Therefore, it appears that all of Church's income is personal holding company income. Since Church has only two shareholders (both of whom are related), it is quite likely that Church Corporation will be classified as a personal holding company. Church can attempt to change the nature of its activities to increase net rental income above 50% of AOGI and reduce the level of other PHCI earned (e.g., dividends and interest). If such changes are made, perhaps personal holding company status can be avoided in the initial tax year. If personal holding company status cannot be avoided for the initial year, the PHC can pay a large enough amount of dividends to minimize the penalty tax, interest, and penalties. Alternatively, Church Corporation might consider an S election for its initial year or its second year, although the built-in gains tax may pose a possible problem when the corporation has retained C corporation status in its initial tax year and makes an S election for its second tax year. $230,000 57) OGI Minus: rental expenses ( 56,000) AOGI $174,000 Rental income Minus: depreciation interest real estate taxes AIR

$100,000 ( 30,000) ( 18,000) ( 8,000) $ 44,000

The rents cannot be excluded since AIR ($44,000) does not exceed 50% of AOGI ($87,000 = $174,000 × 0.50).

58) $90,000 - $40,000 accumulated earnings credit* = $50,000 accumulated taxable income.

1.* Accumulated E&P $210,000 2. Lifetime minimum credit 250,000 2a. Current year minimum credit 40,000 3. Current E&P 65,000 3a. Current E&P retained for reasonable needs 35,000 3b. Current E&P greater than reasonable needs 30,000 4. Accumulated earnings credit (greater of 2a or 3a) 40,000 59) Investors is not a personal holding company since it is not more than 50% owned by five or fewer shareholders.

60) This additional tax that was imposed is the personal holding company tax. The dentists should arrange to have the corporation pay deficiency dividends so as to avoid the penalty tax. The interest and penalties that have been imposed cannot be avoided by the payment of the deficiency dividend. The dentists should consider liquidating the corporation and have the assets held individually by the shareholders. The liquidating distributions are eligible for the dividends-paid deduction and can reduce the UPHCI amount. An S election might be considered. It could alleviate the personal holding company problem for future tax years, but not for prior tax years.

14

Answer Key Testname: C5

61) Rental income Minus: depreciation interest Real estate taxes Adjusted income from rents 62) Taxable income Plus: dividends-received deduction Minus: LTCG (net of taxes)* Minus: accumulated earnings credit Minus: federal income taxes Accumulated taxable income

$50,000 (10,000) ( 5,000) ( 2,000) $33,000 $200,000 20,000 ( 23,700) ( 80,000) ( 42,000) $ 74,300

*$30,000 * 21% = $6,300 $30,000 - $6,300 = $23,700 63) Inventory turnover = ($35,000/$350,000) × 365 = 36.50 days Receivables turnover = ($65,000/$325,000) × 365 = 73.00 days Payables turnover = [$45,000/($40,000 + $500,000)] × 365 = 30.42 days Operating cycle = [(36.50 + 73.00 - 30.42)/365] × 100 = 21.67% of a year

15

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) 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 loss C) $25,000 gain D) No gain or loss is recognized.

1)

2) 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's basis for determining the loss will be $200.

B) Keke Corporation may recognize a loss of $200.

C) Keke Corporation may recognize a loss of $1,800.

D) Keke Corporation's basis for determining the loss will be $2,000.

2)

3) 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 not recognize any gain but Premier will recognize some gain.

C) Both Carly and Premier will recognize some gain.

D) Carly will recognize some gain but Premier Corporation will not recognize any gain.

3)

4) 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 long-term capital loss.

B) a $500,000 ordinary loss.

C) a $500,000 bad debt deduction.

D) a $500,000 short-term capital loss.

4)

5) 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) $2,000.

B) 0.

C) $3,000.

D) $11,000.

5)

1

6) 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 loss of $2,000 last year and a loss of $2,000 this year.

B) a gain of $8,000 last year and a loss of $12,000 this year.

C) no loss last year and a $4,000 loss this year.

D) none of the above.

6)

7) Identify which of the following statements is true.

A) 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.

B) 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.

C) 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).

D) All of the above are false.

7)

8) 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's existence is preserved.

C) Moya Corporation retains its state charter.

D) Moya Corporation has been liquidated for tax purposes.

8)

9) 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) $200,000 gain.

B) $300,000 gain.

C) $0 gain.

D) none of the above

9)

10) Identify which of the following statements is true.

A) 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.

B) The liquidating corporation does not recognize gains and losses when making a distribution of nonmoney property.

C) 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.

D) All of the above are false.

10)

11) A plan of liquidation A) must be completed in one year.

B) must be a formal plan.

C) details the steps to be undertaken in carrying out the liquidation.

D) must be written.

11)

2

12) 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) 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.

C) Losses claimed in a tax return filed before the adoption of the plan of liquidation are not restricted by Sec. 336(d)(2).

D) All of the above are false.

12)

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 liquidation of a corporation means it has undergone dissolution.

C) The corporation divests itself of substantially all its properties.

D) The corporation ceases to be a going concern.

13)

14) 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 B) Doggie Cowboy Cowboy $400,00 $350,000 $10,000 $0

14)

C) Doggie $350,000

D) Doggie $0

Cowboy $400,000

Cowboy $0

15) 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 ordinary loss.

B) $6,000 long-term capital loss.

C) $6,000 short-term capital loss.

D) none of the above.

15)

16) When a corporation liquidates, it performs three activities. What is the general order of these activities in a plan of liquidation?

A) pay debts, wind up its affairs, and distribute property to shareholders B) wind up its affairs, pay debts, and distribute property to shareholders C) pay debts, distribute property to shareholders, and wind up its affairs D) wind up its affairs, distribute property to shareholders, pay debts

16)

17) A Sec. 332 liquidation requires a complete statement be filed with the distributee's tax return A) when the liquidation plan is adopted.

B) when the liquidation is compiled.

C) when a liquidating distribution is received.

D) No statement is required with the return.

17)

3

18) 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) both the ordinary loss and gain properties this year.

B) the $30,000 of ordinary gain property in the current year and the $30,000 of ordinary loss property next year.

C) both the ordinary losses and gains properties next year.

D) the $30,000 of ordinary loss property in the current year and the $30,000 of ordinary gain property next year.

18)

19) The general rule for tax attributes of liquidating corporations is A) they carry over for an indefinite period of time.

B) they carry over for five years.

C) they disappear only for controlled subsidiary corporations.

D) they disappear when the liquidation is complete.

19)

20) 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) $70,000.

B) $0.

C) $100,000.

D) none of the above

20)

21) Liquidation rules generally are applied the same to the following organizations except for A) subsidiary corporations (80% controlled).

B) C corporations.

C) subsidiary corporations (less than 80% controlled).

D) S corporations.

21)

22) When a liquidating corporation pays off an unsecured debt obligation, A) the corporation recognizes no gain or loss if it uses cash.

B) the corporation recognizes no gain or loss if it uses appreciated property.

C) the corporation recognizes losses but not gains realized.

D) the corporation recognizes any gains but not losses realized.

22)

23) 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 B) Gain Liquidation Expenses Liquidation Expenses $50,000 $2,000 $55,000 $3,000

23)

C) Gain $50,000

D) Gain $45,000

Liquidation Expenses $1,000

4

Liquidation Expenses $3,000

24) 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) a $10,000 loss.

B) a $20,000 loss.

C) no loss.

D) none of the above

24)

25) 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 an $80,000 mortgage, which Marty assumes.

Marty's basis in the Robot stock surrendered is $50,000. Marty must recognize A) no gain or loss.

B) a $40,000 loss.

C) a $60,000 gain.

D) none of the above.

25)

26) Identify which of the following statements is true.

A) 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.

B) 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.

C) 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.

D) All of the above are false.

26)

27) 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) $500,000.

B) no gain recognized.

C) $300,000.

D) $200,000.

27)

28) 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) $70,000 capital gain.

B) $30,000 capital loss.

C) $0 gain.

D) $10,000 capital loss.

28)

29) 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.

29)

March 31, Year 1 July 15, Year 1 November 15, Year 1 January 15, Year 2

$10,000 10,000 10,000 10,000

The amount of the final distribution is not known on December 31, Year 1. What are the tax consequences of the distributions?

A) Sandy will recognize a loss of $4,500 in Year 1 and a $1,500 loss in Year 2.

B) Sandy will recognize the entire loss in Year 2.

C) Sandy will recognize the entire loss in Year 1.

D) None of the above is correct.

5

30) 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 provisions permitting a tax-free liquidation of a subsidiary corporation apply to both corporate and noncorporate shareholders of the subsidiary.

C) The liquidation of a subsidiary corporation must be completed within one tax year to receive nonrecognition treatment.

D) All of the above are false.

30)

31) The stock of Cooper Corporation is 70% owned by Carole and 30% owned by Carole's brother, Chris. During Year 1, Chris transferred property (basis of $100,000 and FMV of $120,000) as a contribution to the capital of Cooper. During February Year 2, 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) $6,000 B) $12,000 C) $20,000 D) $0

31)

32) Identify which of the following statements is false.

A) 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.

B) 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.

C) 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.

D) A corporation that distributes the stock of a subsidiary may elect to treat the distribution as a sale of the subsidiary's assets.

32)

33) 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) Section 336 prevents recognition of a loss when making a pro rata distribution of property to a related person.

C) A subsidiary corporation can recognize losses on distributions to either the parent corporation or minority shareholders in a Sec. 332 liquidation.

D) All of the above are false.

33)

34) 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) recognize losses but not gains on the redemption.

B) recognize gains but not losses on the redemption.

C) recognize gains and losses on the redemption.

D) not recognize any gains and losses on the redemption.

34)

6

35) 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) $500,000.

B) 0.

C) $200,000.

D) cannot be determined from the facts presented

35)

36) 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 $0

36)

B) Basis $250,000

Recognized Gain/Loss $110,000 loss

C) Basis $250,000

Recognized Gain/Loss $0

D) Basis $300,000

Recognized Gain/Loss $110,000 loss

37) 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) Recapture the loss on the tax return for the year the plan for liquidation was adopted.

B) Recognize a gain of $100 for the current year.

C) File an amended tax return for the tax year in which the tax loss was originally claimed.

D) none of the above

37)

38) If a liquidating subsidiary corporation primarily has loss property to distribute, the parent corporation should A) follow Sec. 332 rules but avoid Sec. 337.

B) follow Sec. 332 rules.

C) avoid Sec. 332 rules.

D) none of the above.

38)

39) 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 commences on the day after the distribution date.

B) 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.

C) a basis equal to its FMV. Its holding period commences on the day after the distribution date.

D) 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.

39)

7

40) When a subsidiary corporation is liquidated into its parent corporation under a formal plan of liquidation, the distributions must take place within A) the current and next three tax years.

B) a six-month period.

C) a 12-month period.

D) the current and next tax years.

40)

41) Identify which of the following statements is true.

A) 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.

B) The FMV of property distributed by a liquidating corporation can be less than the amount of the liability assumed or acquired by the shareholder.

C) 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.

D) All of the above are false.

41)

42) 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) a $300,000 gain.

B) a $100,000 gain.

C) no gain or loss.

D) none of the above

42)

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 recognized gains on the liquidation are: A) Ball B) Ball Jack Jack $200,000 $50,000 $0 $0

43)

C) Ball $600,000

D) Ball $0

Jack $100,000

Jack $100,000

44) 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) $3,000.

B) $11,000.

C) 0.

D) $2,000.

44)

45) Identify which of the following statements is true.

A) A liquidating corporation treats expenses associated with selling its property as an offset against the sales proceeds.

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) Upon liquidation, any capitalized expenditures unamortized at the time of liquidation should be deducted if they have no further value to the corporation.

D) All of the above are true.

45)

8

46) 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) 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.

D) A plan of liquidation must be produced in writing in order to be accepted by the Internal Revenue Service.

46)

47) 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 B) John Bass Bass $30,000 gain $10,000 loss $20,000 gain $10,000 loss

47)

C) John $30,000 gain

D) John $20,000 gain

Bass $0

Bass $0

48) 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 B) Dusty Susan Susan $400,000 $20,000 $300,000 $20,000 C) Dusty $540,000

D) Dusty $400,000

Susan $60,000

48)

Susan $60,000

49) 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) $400,000.

B) $500,000.

C) $300,000.

D) none of the above

49)

50) Identify which of the following statements is false.

A) 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.

B) The terms "liquidation" and "dissolution" are synonymous.

C) The tax attributes of the liquidating corporation carry over to the shareholders when the liquidation is conducted under the general liquidation rules.

D) All of the above are false.

50)

9

51) 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 recognized by a corporate shareholder on the worthlessness of the controlled subsidiary's stock is an ordinary loss.

C) 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.

D) All of the above are false.

51)

52) During Year 1, Track Corp. 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 Year 2. 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) $0 gain in Year 1.

B) $3,000 gain in Year 2.

C) $3,000 gain in Year 1, which is reported on an amended current-year tax return that is filed in Year 2.

D) none of the above

52)

53) 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) whether the shareholders' realized gain is recognized or not.

C) that is filed with the national IRS office.

D) by the shareholders.

53)

54) Identify which of the following statements is false.

A) Section 332 is applicable to both the parent corporation and the minority shareholders 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) Minority shareholders involved in a Sec. 332 subsidiary liquidation must recognize a gain or loss under the Sec. 331 general liquidation rules.

D) Property received by a minority shareholder takes a basis equal to its fair market value.

54)

55) 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) $200,000 of ordinary income.

B) $100,000 of ordinary income.

C) no gain.

D) $100,000 of long-term capital gain.

55)

10

56) 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 B) Ball Jack Jack $800,000 $200,000 $200,000 $100,000 C) Ball $400,000

D) Ball $400,000

Jack $50,000

56)

Jack $200,000

57) 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) $1,000.

B) $14,000.

C) $0.

D) $4,000.

57)

58) Identify which of the following statements is false.

A) The IRS asserts that the open transaction doctrine should be used only in extraordinary circumstances.

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) 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.

58)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

59) Generally, a corporation recognizes a gain, but not a loss, on a liquidating distribution.

59)

60) Liquidation and dissolution have the same legal meaning.

60)

61) The liquidation of a subsidiary corporation must be completed within one tax year to receive nonrecognition treatment.

61)

62) A subsidiary recognizes no gain or loss on a distribution to a parent corporation owning the majority of the subsidiary's stock in a complete liquidation.

62)

63) 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.

63)

64) In a complete liquidation, a liability assumed by a shareholder reduces the shareholder's amount realized.

64)

65) A plan of liquidation must be reduced to writing in order to be accepted by the Internal Revenue Service.

65)

11

66) A corporation is required to file Form 966 within 30 days after the adoption of a plan of liquidation.

66)

67) Liquidating expenses are generally deducted as ordinary and necessary business expenses.

67)

68) The adjusted basis of property received in a complete liquidation is its fair market value on the distribution date.

68)

69) Section 336 prevents recognition of a loss when making a pro rata distribution of property to a related person.

69)

70) A subsidiary must recognize depreciation recapture income when the subsidiary is liquidated into the parent.

70)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

71) Under what circumstances does a liquidating corporation not recognize a gain or loss when making a distribution?

72) 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?

73) 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?

74) 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?

75) 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?

76) In a Sec. 332 liquidation, can a subsidiary corporation recognize losses on distributions to either the parent corporation or minority shareholders?

77) 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? 78) 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?

79) 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?

12

80) Are liquidation and dissolution the same? Explain your answer.

81) What attributes of a controlled subsidiary corporation are carried over to the parent when the subsidiary is liquidated?

82) 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?

83) 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 are distributed to Parent Corporation in exchange for all of Subsidiary's outstanding stock.

84) 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 Y1. Midwest subsequently lost a lawsuit and Penny paid an additional $3,000 in Y3 as her part of the settlement. What are the tax consequences to Penny in Y3 of the $3,000 additional payment she made?

85) 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 March 31 of Y1 July 15 of Y1 November 15 of Y1 January 15 of Y2

Amount $10,000 10,000 10,000 10,000

What are the amount and character of the gain or loss that Jack will recognize during Y1? During Y2?

86) How is the gain/loss calculated if a shareholder has acquired stock at different times and at varying prices?

87) 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?

88) For the 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.

89) 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?

90) What is the IRS's position regarding whether a liquidating transaction will be considered open or closed?

13

91) What event determines when a cash or accrual method of accounting taxpayer reports a liquidating distribution?

92) In a Sec. 332 liquidation, what bases do both the parent and minority shareholders take in the assets received?

93) DEF Corporation has owned a building for 50 years. DEF has fully depreciated the building. DEF has a basis in the land under the building of $10,000. FMV of the building and land is $100,000. DEF distributes the building and land to its sole shareholder who has a basis in his stock at $100,000. Six months later the sole shareholder sells the building and land for $150,000. How much is the gain to the sole shareholder? What is the nature of the gain?

94) 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?

95) 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?

96) 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?

97) 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?

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98) 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?

99) Explain the difference in tax treatment between a partial liquidation and a complete liquidation.

100) 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?

101) What basis do both the parent and minority shareholders take in the assets received in a Sec. 332 liquidation?

102) 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?

103) 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?

104) 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?

15

Answer Key Testname: C6

1) B 2) A 3) C 4) B 5) C 6) C 7) B 8) A 9) C 10) C 11) C 12) A 13) B 14) D 15) B 16) B 17) C 18) D 19) D 20) A 21) A 22) A 23) D 24) C 25) B 26) C 27) B 28) C 29) B 30) A 31) D 32) A 33) A 34) D 35) C 36) D 37) B 38) C 39) C 40) A 41) C 42) A 43) D 44) D 45) D 46) D 47) B 48) D 49) A 50) D 16

Answer Key Testname: C6

51) B 52) A 53) B 54) A 55) B 56) D 57) C 58) C 59) FALSE 60) FALSE 61) FALSE 62) FALSE 63) TRUE 64) TRUE 65) FALSE 66) TRUE 67) TRUE 68) TRUE 69) FALSE 70) FALSE 71) A liquidating corporation does not recognize gain or loss under four circumstances. These are: 1) Liquidation of a subsidiary corporation - The liquidating corporation recognizes no gain or loss on liquidating distributions made to a parent corporation that owns at least 80% of the subsidiary's stock.

2) Distributions to minority shareholders - The liquidating corporation recognizes gain but not loss on liquidating distributions made to minority shareholders when the Sec. 332 nonrecognition rules apply to the parent corporation.

3) Distributions to related persons - Loss recognition is disallowed when the liquidating corporation makes a distribution to a related person, as defined in Sec. 267(b), if (1) the distribution is not pro rata or (2) the property distributed is disqualified property. Disqualified property is property acquired by the corporation in a Sec. 351 tax-free formation or as a capital contribution during the five-year period ending on the distribution date or property having an adjusted basis that carries over from a disqualified property.

4) Sales having a tax-avoidance purpose - Loss recognition is restricted where property is transferred to the corporation in a Sec. 351 transaction or capital contribution after a date two years before the date that the corporation adopts a plan of complete liquidation. Tax avoidance is inferred in these situations unless the corporation uses the property in its trade or business.

A less-often encountered situation involves distributions or sales of a subsidiary corporation's stock. A corporation can elect under Sec. 336(e) to treat the sale, exchange, or distribution of a subsidiary's stock as a disposition of all the subsidiary's assets, resulting in no gain or loss being recognized on the sale, exchange, or distribution of the stock.

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Answer Key Testname: C6

72) Penny and Victor should consider the following tax issues: • What gains or losses does Bluebird recognize on the two distributions?

• Does Bluebird have to file a corporate tax return for the portion of the final tax year that it is in existence? If so, what income and expenses are included in the return?

• Can Bluebird deduct the liquidation expenses on its final tax return?

• What are the amounts and characters of the gain or loss that Penny and Victor recognize upon surrendering their Bluebird stock?

• What basis does Victor take for the noncash assets that he receives?

• What happens to Bluebird's tax attributes?

• What type of entity will Victor operate going forward?

Bluebird Corporation will need to recognize any gain realized on the distribution of the Bluebird busses, support vehicles, repair parts inventory, tools, and equipment. Bluebird recognizes no loss on the disposition of these items because they are distributed to a related party (Victor owns 80% of Bluebird). Penny recognizes no gain on the distribution because she receives only cash. Victor and Penny will need to determine their realized and recognized gains on the liquidation. Bluebird Corporation can deduct the liquidation expenses in its final tax return. Any NOLs incurred in the final year can be carried back to the two preceding tax years. A substantial cost may be incurred in liquidating the corporation. Perhaps Victor should consider buying Penny's stock and keep operating Bluebird Corporation in the new city. This way the liquidation tax (e.g., on corporate and shareholder-level gains) will be avoided.

73) A corporation that is 100% owned by another corporation can file a consolidated tax return. As a result, the parent and its subsidiary are treated as a single entity. This result is the same as if the subsidiary were one of a number of divisions of a single corporation. An extension of the single entity concept is that a subsidiary corporation can be liquidated tax-free into its parent corporation. An individual and his corporation are treated as two separate tax entities. As separate entities, nonliquidating distributions are taxable. The same principle applies to liquidating distributions.

74) Sam Topeka's amount realized is $44,000 ($24,000 + $20,000). His recognized gain on the liquidation is $12,000 ($44,000 - $32,000).

75) Shareholders receiving liquidating distributions generally recognize gain or loss under Sec. 331 on the exchange of their stock interest. A special rule applies to the parent corporation when a controlled subsidiary corporation is liquidated. The parent corporation (80% distributee) recognizes neither gain nor loss when it receives a liquidating distribution (Sec. 332). A minority shareholder on the other hand recognizes gain or loss when receiving the distribution under the general Sec. 331 rules. Two exceptions to the general Sec. 336 gain or loss recognition rules apply to property distributions made by a controlled subsidiary corporation. First, under Sec. 337 the subsidiary corporation does not recognize gain or loss when it makes a liquidating distribution to an 80% distributee corporation.

Second, under Sec. 336(d)(3) the subsidiary corporation recognizes gain (but not loss) when it makes a liquidating distribution to a minority shareholder.

76) No. Section 332 liquidations are an exception to the general rule that losses are recognized by the liquidating corporation. Losses are not recognized on distributions to either the parent corporation or the minority shareholders.

77) Specialty recognizes an $80,000 ($130,000 - $50,000) Sec. 1231 gain. Sam recognizes a $30,000 ($130,000 - $100,000) capital gain. $ 5,000 78) Cash Plus: FMV of other property received 10,000 Amount realized $15,000 Minus: basis of stock ( 8,000) Recognized gain $ 7,000 79) Jefferson's amount realized is $9,000 ($5,000 + $6,000 - $2,000). His recognized gain on the liquidation is $1,000 ($9,000 - $8,000).

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Answer Key Testname: C6

80) Liquidation status continues from the time the plan of liquidation has been formally or informally adopted until the corporation ceases to be a going concern or until it has divested itself of all its property. Dissolution is a legal term that implies that the corporation has surrendered the charter it originally received from the state. A corporation generally may complete its liquidation prior to undergoing dissolution. Dissolution may never occur if the corporation retains its charter to protect its corporate name from being acquired by another party.

81) NOL carryovers, earnings and profits, capital loss carryovers, and the general business and other tax credit carryovers are carried over to the parent when a controlled subsidiary is liquidated. The carryover amount is determined as of the close of the day on which the distribution of all the subsidiary corporation's property is completed.

82) New York has a recognized gain of $13,000 ($15,000 - $2,000) and a $500 liquidation expense for legal counsel on its current-year income tax return.

83) Parent Corporation recognizes no gain or loss on the redemption of its Subsidiary stock because all of the Sec. 332 requirements have been satisfied prior to the adoption of the plan of liquidation.

84) The $3,000 that she paid personally is treated in Y3 as a long-term capital loss.

85) Because Jack's $36,000 basis has not been recovered by the end of Y1, Jack will have no recognized gain in Y1. His unrecovered basis at the end of Y1 is $6,000 ($36,000 - $30,000). He will recognize a $4,000 gain in Y2 ($10,000 $6,000). The gain will be a long-term capital gain.

86) A shareholder who has purchased blocks of stock at different times and prices must calculate the gain or loss on each block separately. It is possible to have both gains and losses existing in the same liquidating distribution and for the gains and losses to have different characters. $15,000 87) FMV of property received Plus: cash 5,000 Minus: mortgage assumed ( 3,000) Amount realized $17,000 Minus: basis of stock (10,000) Recognized gain $ 7,000 88) Parent recognizes no gain on the liquidation and takes a $125,000 basis in the land. Subsidiary recognizes no gain or loss on the distribution of the land or the cash. Melisa recognizes a $25,000 ($50,000 - $25,000) capital gain on the receipt of the money.

89) The liquidation will not qualify for nonrecognition treatment under Sec. 332, because no liquidating distribution was made to the corporate shareholder. Parent Corporation recognizes an ordinary loss for its investment in Subsidiary Corporation under the special Sec. 165(g)(3) worthless security rules. Vic recognizes a capital loss to the extent of his investment under the Sec. 331 general liquidation rules. Vic may recognize an ordinary loss under the Sec. 1244 rules if its requirements are satisfied.

90) The IRS's position is that the open transaction method may be used only in unusual circumstances. The IRS prefers the closed transaction alternative. In a closed transaction, gain or loss is determined based on the FMV of the property distributed on the distribution date. This FMV amount becomes the property's basis. At the time the property is sold, collected, or its value is definitely determined, gain or loss is computed by comparing the property's value at that time to its adjusted basis.

91) A shareholder who uses the accrual method of accounting reports the gain or loss using accrual concepts (i.e., the gain or loss is recognized when all the events have occurred that fix the amount of the liquidating distribution and when the shareholders are entitled to receive the distribution upon surrender of their shares). A shareholder who uses the cash method of accounting reports the gain when he or she has actual or constructive receipt of the liquidating distribution.

92) Because no gain/loss is recognized by the parent corporation, the parent corporation takes a carryover basis in its assets. However, since the minority shareholders are involved in a taxable exchange, the minority shareholders take an FMV basis in their assets.

93) $50,000 ordinary (holding period less than 1 year) Section 334(a) provides that the shareholder's basis of property received under the general liquidation rules is its FMV on the distribution date. The holding period for the property starts on the day after the distribution date. And since the holding period is less than a year, the gain is short-term and therefore the character of the gain is ordinary.

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Answer Key Testname: C6

94) Chip and Dale should consider the following tax issues: • Can the personal holding company tax be avoided by changing the investment/operating decisions of Tree Corporation?

• What gain or loss does Tree Corporation recognize if a liquidation occurs?

• What gains or losses do Chip and Dale recognize if Tree Corporation is liquidated?

• Is it possible for the open transaction doctrine to apply to the liquidation of Tree Corporation due to an inability to value the Conifer stock?

• Can the personal holding company tax be avoided by having Tree Corporation make an S election?

• What tax increase will occur if Chip and Dale personally own the property currently held by Tree Corporation?

Tree Corporation should determine whether the personal holding company (PHC) tax could be avoided by increasing the portion of Tree's income earned from rental real estate activities to permit the rental income to be excluded from the personal holding company income (PHCI). This technique may require that Tree shift asset composition from stocks and bonds to real estate.

If a liquidation occurs, an appraisal of the Conifer stock will be needed. The IRS is unlikely to permit the open transaction doctrine to apply to the Tree Corporation liquidation merely because market quotations for Conifer stock are lacking.

95) Illinois Corporation recognizes a $40,000 ($60,000 - $20,000) Sec. 1231 gain when it makes the liquidating distribution.

Springer recognizes a capital gain to the extent that the land's FMV exceeds his basis in the Illinois stock. Springer's basis for the land is its $60,000 FMV. 96) The managements of Parent and Subsidiary should consider the following tax issues: • What gain or loss does Parent Corporation recognize on the transfer of its remaining property to the mortgage lender?

• Does Subsidiary Corporation have to recognize cancellation of indebtedness income from not having repaid its debts?

• Does Subsidiary Corporation have to file a corporate tax return for the portion of the final tax year that it is in existence? If so, what income and expenses are included in the return?

• Can Subsidiary Corporation deduct the liquidation expenses on its final tax return?

• What is the amount and character of the loss that Parent Corporation recognizes upon surrendering its Subsidiary stock? Upon not being repaid for the open account indebtedness?

• What happens to Subsidiary Corporation's tax attributes?

Because Parent Corporation received nothing for its investment in Subsidiary Corporation, it can claim a worthless security loss for the $500,000 investment. This loss should be an ordinary loss under Sec. 165(g)(3). Subsidiary's $35,000 debt to Parent should be deductible as a bad debt under Sec. 166. Because corporations do not have a distinction between business and nonbusiness debts, Subsidiary can claim an ordinary loss deduction for the bad debt in its final tax return.

Income from cancellation of indebtedness is not taxable if taxpayer is insolvent. Also, the subsidiary has an Payable due to the parent. The parent is the taxpayer with the uncollectible A/R to write off the bad debt not the subsidiary.

97) a) Land: ($105,000 net FMV + $20,000 liabilities) - $50,000 = $75,000 long-term capital gain. stock: $40,000 - $70,000 = $30,000 realized long-term capital loss. Jack recognizes the entire loss because the stock is not disqualified property and is distributed in the same proportion (25% for Mark and 75% for Sherri) as Mark and Sherri's stockholdings. b) Sherri: ($30,000 + $125,000 + $30,000 - $20,000 liabilities) - $125,000 = $40,000 capital gain.

Mark: ($10,000 + $45,000) - $50,000 = $5,000 capital gain. c) Sherri: land, $125,000; stock, $30,000. Mark: stock, $10,000.

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Answer Key Testname: C6

98) a) $325,000 - $275,000 = $50,000 realized gain, but no recognized gain (Sec. 337). b) $325,000 - $40,000 liabilities - $100,000 = $185,000 realized gain, but no recognized gain (Sec. 332). c) $275,000 carryover basis. d) The basis for the Parent stock disappears and is replaced by the basis of each of the individual assets. Subsidiary's E&P balance carries over to Parent.

99) A complete liquidation is defined by Reg. Sec. 1.3322(c) as one or a series of distributions made by a liquidating corporation that completely cancels or redeems all of its stock in accordance with a plan of liquidation. A partial liquidation is defined by Sec. 302(e) as a distribution that (1) is not essentially equivalent to a dividend (when determined at the corporate level rather than at the shareholder level), and (2) is pursuant to a plan of liquidation and occurs within the tax year in which the plan is adopted or within the succeeding tax year. Generally, a partial liquidation involves the corporation either ceasing to conduct a trade or business (while still continuing to conduct a second trade or business) or contracting its business activities. In either case, the corporation remains in existence after the partially liquidating distribution.

A complete liquidation is taxed under Code Secs. 331 and 336. A partial liquidation is taxed under Code Secs. 302(b) and 311. The complete liquidation is taxed to the extent the shareholder recognizes a gain or loss, which is computed by comparing the FMV of the property received to the adjusted basis of the stock redeemed. When the shareholder receives a series of liquidating distributions, the distribution is taxed once the FMV of the property received exceeds the adjusted basis of the stock held. All basis is recovered first before the shareholder recognizes any gain. A partial liquidation results in exchange treatment for a noncorporate shareholder under Sec. 302(b)(4). A corporate shareholder is eligible for exchange treatment only if the distribution qualifies as an exchange under the stock redemption rules of Secs. 302(b)(1)-(b)(3). The shareholder recognizes a loss only when he or she receives the final liquidating distribution.

100) No amendment is made to the prior year's tax return. The additional payment results in a loss recognized in the year of payment. The character of the loss is dependent on the nature of the gain or loss recognized by the shareholder in the year of liquidation.

101) Since the parent recognizes no gain or loss in the transaction, it takes a carryover basis. Since the minority shareholders have a taxable transaction, they take an FMV basis for the assets received in the transaction.

102) Sandy will recognize a $5,000 capital loss on the distribution [($90,000 - $65,000) - $30,000]. The basis of the building to Sandy will be $90,000. The holding period for the building begins on the day after the distribution. The $90,000 FMV of the assets is reduced by the $65,000 liability assumed in determining the amount of the distribution to Sandy. Lake Corporation will recognize a $65,000 [($25,000 net FMV of assets + $65,000 release from liabilities) - $25,000 adjusted basis] Sec. 1231 gain on the distribution. Some of the gain may be ordinary income under Sec. 291 (see Chapter C3).

103) $30,000 + $21,000 + $11,000 + $25,000 = $87,000 total distribution; $87,000 - $200,000 = ($113,000) recognized loss; $100,000 ordinary loss under Sec. 1244 and $13,000 long-term capital loss. The Sec. 1244 loss ceiling is $100,000 for a married couple filing a joint return, thereby causing the remaining $13,000 to be a long-term capital loss.

104) a) Charlene: $60,000 - $80,000 = $20,000 long-term capital loss.

Dennis: [($140,000 - $90,000) + $10,000] - $40,000 = $20,000 long-term capital gain. Here, the liability reduces the amount realized. b) Charlene, $60,000 cash; Dennis, $140,000 basis for land and $10,000 cash.

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Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Identify which of the following statements is true.

A) Depreciation recapture rules do not override the nonrecognition of gain or loss rules.

B) A target corporation will recognize a gain when it distributes stock to its shareholders.

C) The basis of property acquired in a reorganization is its FMV. D) The acquisition of liabilities by an acquiring corporation will trigger a gain.

1)

2) 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 IRS may apply the step transaction doctrine.

B) The IRS may collapse the two transactions into a single transaction, resulting in denial of tax-free reorganization treatment.

C) The asset transfer by Motor Corporation meets the statutory Type C reorganization requirements.

D) All of the above statements are correct.

2)

3) American Corp. acquires the noncash assets of Utech Corp. in exchange for $700,000 of its voting stock plus $50,000 of cash. Utech assets are worth $750,000. Utech 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.

3)

4) Identify which of the following statements is true.

A) "Creeping acquisitions" are not allowed in a Type B reorganization.

B) 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.

C) A Type B reorganization must be accomplished in one transaction.

D) All of the above are false.

4)

5) Identify which of the following statements is true.

A) Tax attributes carry over from the target corporation to the acquiring corporation in all acquisitive reorganizations.

B) 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.

C) The step-transaction doctrine has always been used by the IRS to convert a tax-free transaction into a taxable transaction.

D) All of the above are false.

5)

1

6) 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) $200,000.

B) $400,000.

C) $350,000.

D) 0.

6)

7) 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) a dividend.

C) compensation for services.

D) All of the above are correct.

7)

8) When gain is realized by a target corporation from disposing of its assets in a tax-free reorganization, the gain is A) never recognized.

B) recognized if boot is received and retained.

C) recognized without exception.

D) recognized if boot is received and immediately distributed to its shareholders.

8)

9) 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) Tax-free reorganizations generally do not involve actual redemptions of the stock of the target corporation's shareholders.

D) 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.

9)

10) 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) For purposes of Sec. 382, ownership changes are tested any time a 5% shareholder has a stock transaction affecting his ownership.

C) 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.

D) One advantage of a tax-free reorganization is that losses realized as part of a tax-free reorganization are not recognized.

10)

2

11) Identify which of the following statements is true.

A) Strict adherence to legislative guidelines with regard to reorganizations is sufficient for tax-free treatment.

B) A suitable business purpose for a tax-free reorganization is to permit the minimization of shareholder taxes.

C) 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.

D) All of the above are false.

11)

12) Virtuous, a East Tennessee corporation, decides to change its state of incorporation to Delaware to avoid a corrupt administrator with political ambitions named No Lande. Virtuous can take advantage of the Type F reorganization rules by A) exchanging the East Tennessee corporation's assets for the Delaware corporation's stock and liquidating the East Tennessee corporation.

B) merging the East Tennessee corporation stock into an existing Delaware corporation.

C) liquidating the East Tennessee corporation and reincorporating in Delaware.

D) recapitalizing the East Tennessee corporation.

12)

13) 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) November 30 of this year.

B) June 30 of this year.

C) June 30 of next year.

D) August 15 of next year.

13)

14) In a Sec. 338 election, the target corporation A) will no longer file a separate return.

B) will have a holding period for assets beginning on the day after the acquisition date.

C) must use the preacquisition tax year.

D) is considered to be a continuation of the old target corporation for purposes of the tax attribute carryover rules.

14)

15) Identify which of the following statements is true.

A) In tax-free reorganizations, one transaction cannot qualify for more than one type of tax-free reorganization.

B) 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.

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.

15)

16) 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) dividend distribution B) split-up C) spin-off D) split-off

16)

3

17) 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) $275,000 B) $200,000 C) $250,000 D) $50,000

17)

18) 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

18)

19) 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) 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.

C) 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. D) All of the above are false.

19)

20) Identify which of the following statements is false.

A) In a Type C reorganization, shareholders of the acquiring corporation generally do not have to approve the acquisition.

B) To qualify as a Type C reorganization, the target corporation must be formally dissolved.

C) A Type C reorganization is less flexible than a Type A reorganization because of the solely-for-voting stock requirement of a Type C. D) In a Type C reorganization, the acquired corporation must distribute stock, securities, and other property it receives to its shareholders.

20)

21) 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) split-up C) spin-off D) Type C reorganization

21)

22) 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) An acquiring corporation in a taxable acquisition transaction must acquire all of the assets and liabilities of the target corporation.

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) 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.

22)

4

23) Identify which of the following statements is true.

A) 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.

B) 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.

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.

23)

24) 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) divisive Type D reorganization.

B) Type C reorganization.

C) Type A reorganization.

D) acquisitive Type D reorganization.

24)

25) 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 51% of Hill Corporation stock by December 31 of this year.

C) an additional 50% of Hill Corporation stock by July 30 of next year.

D) an additional 51% of Hill Corporation stock by July 30 of next year.

25)

26) 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 $150,000 as dividend income.

C) Buddy recognizes $150,000 as a capital gain.

D) Buddy recognizes $200,000 as a capital gain.

26)

27) 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) $300,000.

C) $600,000.

D) $500,000.

27)

5

28) Identify which of the following statements is true.

A) Common stock can be exchanged for preferred stock in the same corporation as a Type E reorganization.

B) The control requirement for Sec. 355 differs from the control requirement under Sec. 351.

C) 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.

D) All of the above are false.

28)

29) 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) fails the business purpose requirement.

B) does not meet the statutory definition of a divisive Type D reorganization.

C) results in a capital gain to Peter.

D) None of the above is correct.

29)

30) 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 must file a consolidated tax return.

B) Acquiring Corporation assumes all of the tax attributes of Target Corporation.

C) Acquiring Corporation must step up or step down the basis of the Target Corporation's assets to their FMV on the acquisition date.

D) Acquiring and Target Corporations can elect to file a consolidated tax return.

30)

31) A stock acquisition that is not treated as a purchase for purposes of meeting the Sec. 338 rules is A) stock acquired from a decedent.

B) stock acquired in a tax-free reorganization.

C) stock whose adjusted basis is determined by its basis in the hands of the person from whom it was acquired.

D) All of the above are correct.

31)

32) Identify which of the following statements is true.

A) 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. B) 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.

C) Tax-free split-offs and spin-offs coming under Sec. 355 require the surrender of shareholder stock.

D) All of the above are false.

32)

6

33) 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 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.

C) The residual method ensures that any premium paid for the target stock is reflected in depreciable assets.

D) All of the above are false.

33)

34) 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) Tax attributes of the target corporation are not lost when a Sec. 338 deemed liquidation election is made.

C) A Sec. 338 election requires the adoption of the old target corporation's tax year by the new target corporation.

D) All of the above are false.

34)

35) Identify which of the following statements is true.

A) Corporate purchasers generally prefer Sec. 338 treatment because of the significant tax savings originating from the step-up in basis.

B) The Sec. 338 deemed liquidation rules require that 100% of the target corporation's stock be purchased.

C) A deemed liquidation election is available when a target corporation is liquidated into its parent corporation.

D) All of the above are false.

35)

36) 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) Grand's basis for the New assets is $600,000.

C) Annie's basis in the New stock is $300,000.

D) Annie recognizes a $500,000 capital gain on the exchange of the Grand stock for the New stock.

36)

37) Identify which of the following statements is false.

A) The tax-free reorganization rules are an example of the wherewithal to pay concept.

B) Taxable acquisition transactions can either be a purchase of assets or a purchase of stock.

C) Sales of depreciable assets as part of a taxable acquisition result in depreciation recapture.

D) A taxable acquisition of a target corporation's assets results in the nonrecognition of gain or loss on the disposition of each individual asset.

37)

7

38) Identify which of the following statements is true.

A) 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.

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) The acquired corporation in a Type C reorganization may retain its corporation charter.

D) All of the above are false.

38)

39) Identify which of the following statements is true.

A) 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.

B) Both a Type B reorganization or a reverse triangular merger will not allow the target corporation to remain in existence.

C) 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.

D) All of the above are false.

39)

40) 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 D reorganization.

C) Type C reorganization.

D) The transaction does not qualify as a tax-free reorganization.

40)

41) Which one of the following is not a corporate reorganization as defined in the Internal Revenue Code?

A) stock redemption B) mere change in identity C) recapitalization D) merger

41)

42) 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) required to recognize dividend income of $10,000 if Hope Corporation's current and accumulated E&P is at least $10,000.

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) not required to recognize any gain or loss.

D) able to recognize capital gain income of $10,000 without regard to his post-acquisition interest in Moth Corporation.

42)

8

43) Identify which of the following statements is false.

A) 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.

B) A Sec. 338 election usually triggers taxation to the target corporation.

C) In a Sec. 338 deemed sale election, the shareholders of the target corporation sell their stock to the acquiring corporation.

D) 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.

43)

44) Identify which of the following statements is true.

A) In a tax-free reorganization, if the acquiring corporation uses nonmonetary boot property, gains or losses will be recognized by the acquiring corporation.

B) 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.

C) 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.

D) All of the above are false.

44)

45) 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) $200,000 dividend income.

B) $650,000 capital gain.

C) $200,000 capital gain.

D) $0.

45)

46) 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) The exchange is a Type F reorganization, assuming all requirements are met.

B) The basis of the Class A common stock received is equal to its FMV. C) The exchange is tax-free even if no plan of reorganization has been created.

D) If boot is added to the exchange, the entire gain realized on the exchange is recognized in full.

46)

47) Identify which of the following statements is true.

A) The target corporation's tax attributes are lost in a Type B reorganization.

B) A Type B reorganization can be accomplished without formal shareholder approval.

C) 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.

D) All of the above are false.

47)

9

48) 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) 80% C) 50% D) Any acquisition of Target stock will cause the Sec. 382 loss limitation to apply.

48)

49) The acquiring corporation does not obtain the target corporation's tax attributes in A) an acquisitive Type C reorganization.

B) a Type B reorganization.

C) an acquisitive Type D reorganization.

D) a Type A reorganization.

49)

50) 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 B) Broom Docker Docker $100,000 $0 $100,000 $50,000

50)

C) Broom $0

D) Broom $0

Docker $50,000

Docker $0

51) Pursuant to a reorganization, Bob exchanges 4,000 shares of Beetle Corporation stock that he had purchased for $800,000 for 6,000 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 B) Recognized Gain Basis Basis $0 $1,000,000 $200,000 $1,000,000 C) Recognized Gain $0

D) Recognized Gain $100,000

Basis $800,000

51)

Basis $800,000

52) Identify which of the following statements is true.

A) Advance rulings are required for all reorganizations.

B) A plan of reorganization must be a written document.

C) The IRS will issue an advance ruling on any proposed tax-free reorganization.

D) All of the above are false.

52)

53) Identify which of the following statements is true.

A) A Type A reorganization has the advantage of avoiding the acquisition of unknown and contingent liabilities.

B) A merger usually involves the approval of all of the shareholders of both corporations.

C) Per IRS Treasury Regulations, to qualify as a Type A reorganization, at least 40% of the total consideration used must be acquiring corporation stock.

D) All of the above are false.

53)

10

54) 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.

54)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

55) 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.

55)

56) Advance rulings are required for all reorganizations.

56)

57) The Sec. 338 deemed sale rules require that 70% of the target corporation's stock be owned.

57)

58) Taxable acquisition transactions can either be a purchase of assets or a purchase of stock.

58)

59) In a triangular Type A merger, the acquiring subsidiary corporation must obtain substantially all of the target corporation's assets.

59)

60) The acquiring corporation does not recognize gain or loss in a reorganization where it receives boot.

60)

61) Tax attributes of the target corporation are lost when a Sec. 338 deemed liquidation election is made.

61)

62) In a nontaxable reorganization, the acquiring corporation has a holding period for the acquired assets that begins on the day after the transaction date.

62)

63) In a nontaxable reorganization, the holding period for the stock received by the target shareholders includes the holding period of the stock surrendered.

63)

64) Type A reorganizations include mergers and consolidations.

64)

65) In a nontaxable reorganization, shareholders of the target corporation recognize gain or loss.

65)

66) In a taxable asset acquisition, the purchaser does not acquire unknown and contingent liabilities.

66)

67) A Type C reorganization is a change in identity, legal form, or state of incorporation in which the shareholders retain the same equity interest.

67)

68) 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.

68)

69) In a stock acquisition, the target corporation remains intact as a subsidiary of the acquiring corporation.

69)

11

70) An acquiring corporation must use the acquisition method for financial statement purposes whether the business combination is a taxable purchase or a nontaxable reorganization.

70)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

71) 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?

72) 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?

73) 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?

12

74) 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?

75) What are the advantages of a triangular merger?

76) 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?

77) Zebra Corporation transfers assets with a $120,000 basis and a $250,000 FMV to Hat Corporation for common stock worth $200,000 and cash of $50,000. The exchange qualifies as a tax-free reorganization. Zebra Corporation distributes the stock and cash to its shareholders pursuant to its liquidation. How much gain must Zebra Corporation recognize?

78) 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.)

79) 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?

80) What are the advantages and disadvantages of a Type C reorganization?

81) As part of a plan of corporate reorganization, Sally exchanged 1,000 shares of Tone Corporation common stock that she had purchased for $85,000, for 3,000 shares of Fade Corporation voting common stock having an $87,000 FMV. What is the amount and character of Sally's recognized gain and her basis in the Tone stock as a result of the exchange?

82) 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?

83) 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?

13

84) 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?

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

86) 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?

87) 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?

88) 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?

89) 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?

90) What are the two steps of a Sec. 338 deemed liquidation election?

91) 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.

92) 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?

93) What are the advantages and disadvantages of a Type A reorganization?

94) 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?

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95) 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?

96) 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?

97) Define the seven classes of assets used in allocating basis when using the residual method.

98) What are the advantages and disadvantages of a Type B reorganization?

99) 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?

100) 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?

101) 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?

102) 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?

103) 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?

104) 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?

105) 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?

106) Briefly describe A, B, C, D, and G reorganization types.

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1) A 2) D 3) D 4) B 5) D 6) A 7) D 8) B 9) A 10) D 11) C 12) A 13) D 14) B 15) B 16) C 17) B 18) C 19) D 20) B 21) B 22) B 23) A 24) A 25) C 26) C 27) D 28) A 29) A 30) D 31) D 32) A 33) B 34) A 35) D 36) D 37) D 38) C 39) A 40) C 41) A 42) B 43) D 44) C 45) C 46) C 47) B 48) C 49) B 50) D 16

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51) C 52) D 53) C 54) C 55) TRUE 56) FALSE 57) FALSE 58) TRUE 59) TRUE 60) TRUE 61) TRUE 62) FALSE 63) TRUE 64) TRUE 65) FALSE 66) TRUE 67) FALSE 68) FALSE 69) TRUE 70) TRUE 71) ADSP = [$200,000 + $20,000 - (0.34 × $165,000)]/(1 - 0.34) = ($220,000 - $56,000)/0.66 = $248,333 Purchase price of stock $200,000 Plus: Target Corp. non tax liabilities 20,000 Plus: federal tax on deemed sale ($248,333 - $165,000) × 0.34 28,333 Adjusted grossed-up basis of stock $248,333 72) The following points should be addressed in connection with the MCI-WorldCom merger: • Reorganization Type: What type of reorganization did WorldCom and MCI engage in?

• MCI Regular Shareholder Issues: What gain or loss (if any) does a shareholder recognize when he or she receives WorldCom stock in exchange for MCI common stock? What is the character of the recognized gain? What gain or loss (if any) does a shareholder recognize when he or she receives cash in lieu of fractional WorldCom shares the shareholders are entitled to? What is the character of the recognized gain? What basis does each shareholder take in the WorldCom shares received? What holding period does each shareholder have in the WorldCom shares received? Is the conversion of MCI options into WorldCom options a taxable or tax-free event for the option holders?

• British Telecommunications (BT) Issues: What gain or loss (if any) does BT recognize when it receives cash in exchange for the MCI Class A common stock? What is the character of the recognized gain?

• WorldCom Issues: What gain or loss (if any) does WorldCom recognize when it transfers WorldCom stock and cash to create the TC Investments Corporation subsidiary? What gain or loss does WorldCom recognize when TC Investments Corporation is renamed MCI Communications Corporation? What gain or loss does WorldCom recognize when WorldCom is renamed MCI WorldCom? • TC Investments Corporation Issues: What gain or loss does TC Investments Corporation recognize when WorldCom creates it as a subsidiary? What gain or loss (if any) does TC Investments Corporation recognize when it exchanges the WorldCom stock for the MCI common stock? What basis and holding period does TC Investments Corporation take for the MCI regular common stock and the MCI Class A common stock acquired? What gain or loss does TC Investments Corporation recognize when it surrenders the MCI stock upon the liquidation of MCI into TC Investments Corporation? What basis does TC Investments Corporation take in the MCI assets? Is any goodwill 17

Answer Key Testname: C7

created on the tax books by the acquisition? Is the goodwill on the tax books amortizable? Do the MCI tax attributes become available to TC Investments Corporation? If so, are the NOLs subject to the Sec. 382 limitations? Is the employee severance pay deductible?

• MCI Issues: What gain or loss does MCI recognize when it liquidates into TC Investments Corporation?

Had MCI not liquidated into TC Investments Corporation, the transaction would have been a failed triangular B reorganization because of the cash used in the transaction. However, because MCI liquidated, the transaction qualifies as a triangular reorganization (a variation on the Type A reorganization). The cash did not exceed 50% of the total consideration, or conversely, the stock comprised more than 50% of the consideration. Therefore, the acquisition has sufficient continuity of interest to satisfy the IRS's ruling policy.

MCI shareholders recognize no gain or loss on exchanging their MCI stock for WorldCom stock (Sec. 354).

Shareholders recognize gain only when they receive cash in lieu of fractional shares of WorldCom stock (Sec. 1001).

The receipt of cash is treated as a stock redemption of the WorldCom fractional share the shareholders were entitled to receive. Thus, this part of the transaction should receive capital gain treatment under Sec. 302(b)(1) since all MCI shareholders own less than 50% of WorldCom's outstanding stock at the time of the hypothetical redemption. Each shareholder takes a carryover basis for his or her WorldCom stock that references the basis of the MCI shares surrendered (Sec. 358). The holding period for the WorldCom shares includes the holding period for the MCI shares (Sec. 1223(1)). The conversion of the MCI stock options for WorldCom stock options is a nontaxable event (Secs. 424(a) and (c)).

BT recognizes gain when it exchanges the MCI Class A common shares for cash (Sec. 1001). The capital gain should be long-term, although a corporate taxpayer receives no tax rate advantage with long-term capital gains. No holding period or basis issues are involved with the cash received.

WorldCom recognizes no gain or loss when it transfers cash and WorldCom stock to TC Investments Corporation in exchange for TC's initial stock issue (Sec. 351 or Sec. 361). Nor does TC Investments Corporation recognize a gain or loss on its formation (Sec. 1032). TC Investments Corporation recognizes no gain or loss when it subsequently exchanges the WorldCom stock for MCI common stock (Sec. 354). The basis for the MCI common stock carries over from MCI to TC Investments Corporation (Sec. 362). TC Investments Corporation's holding period for the MCI common stock includes that of the shareholders from whom it acquired the stock (Sec. 1223). The basis for the MCI Class A common stock acquired from BT is its acquisition cost (Sec. 1012). The holding period for the Class A common stock begins on the day after the acquisition date.

Neither TC Investments Corporation nor MCI recognize gain or loss when MCI liquidates as part of the tax-free reorganization. The basis and holding period for MCI's assets carry over to TC Investments Corporation from MCI (Secs. 362 and 1223). Likewise, MCI's tax attributes carry over to TC Investments Corporation (Sec. 381). Quite likely, MCI's NOL carryovers are subject to the Sec. 382 limitation because an equity structure shift and a substantial change in stock ownership has occurred. The problem does not provide sufficient information to assess the extent of the Sec. 382 limitation. The transaction created no goodwill since the carryover basis rules apply. Consequently, no goodwill amortization is available under Sec. 197. The name of TC Investments Corporation was changed to MCI. Communication Corporation is a Type F reorganization and should be tax-free. No basis adjustment occurs as a result of the change. Similarly, the subsequent renaming of WorldCom as MCI WorldCom should have no tax consequences.

The employee severance pay is deductible by the "new" MCI under Sec. 162.

73) The liquidation may be considered to be part of a Type C reorganization by the IRS (Rev. Rul. 67-274) if the stock acquisition and liquidation are considered to be part of a single plan. As a result, no gain or loss is recognized by either Town or Country on the liquidation. Town's basis for the assets would be $60,000 ($50,000 + $10,000). If they are not part of an integrated plan, the liquidation would still qualify as tax-free under Sec. 332. The cash and land would be received tax-free by Town and have the same $60,000 basis on Town's books that they had on Country's books. This amount is also the same as if received in a Type C reorganization.

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74) The following issues need to be addressed in examining the tax consequences of the distribution of the Associated First Capital stock: • What type of distribution is Ford Motor Company making?

• Does the transaction meet the requirements for a tax-free distribution under Sec. 355?

• What is the amount and character of the gain or loss that Ford Motor Company recognizes on the distribution of the Associated First Capital stock?

• Does any allocation of or reduction in Ford's E&P occur as a result of making the distribution?

• What is the amount and character of the gain recognized by Ford Motor Company's shareholders on receiving the Associates First Capital stock?

• What is the basis of the Associated First Capital stock in the hands of Ford Motor Company's shareholders? When does the shareholders' holding period for the shares received in the distribution begin?

The transaction is a spin-off because the Ford common and Class B shareholders receive Associated stock and do not surrender any Ford stock. The transaction meets all six requirements for a tax-free distribution under Sec. 355 that are outlined in the text. A number of business purposes exist for the transaction. The first is that the Associated First Capital stock is apparently undervalued by the marketplace. By having the stock trade separately, the Ford shareholders may be able to increase the total value of their stock holdings. A logical reason for the undervaluing is that the Ford stock being treated as partially an automotive company and partially a finance company. The distribution of the Associated stock permits each shareholder to decide whether to hold the stock of a finance company and/or an automotive company and not be forced to hold both. Thus, the corporate division probably has three intended economic consequences: (1) increase the value of the distributing and controlled corporations; (2) reduce the risk of the distributing and controlled corporations; and (3) increase the shareholders' total value. The transaction is a tax-free distribution to the Ford shareholders, except to the extent they receive cash in lieu of a fractional share of the Associated stock (Sec. 355(a)). The receipt of cash is treated as a stock redemption of the Associated fractional share the shareholders are entitled to receive. Thus, this part of the transaction should receive capital gain treatment under Sec. 302(b)(1) since none of the Ford shareholders own sufficient stock to have a majority ownership position. No E&P reduction occurs as a result of the stock distribution except to the extent required by the deemed redemption. The basis of the Ford stock is allocated between the Ford and Associated stocks held after the transaction according to their relative FMVs. The holding period for the Ford stock carries over to the Associated stock. Ford recognizes no gain upon distributing the Associates stock to its shareholders. Neither the Associated nor the Ford stock should be disqualified stock because no Ford shareholder should own a 50% or greater (actual or constructive) interest in Ford and/or Associated following the distribution so as to trigger the disqualified stock rules (Sec. 355(c)).

75) Target corporation's assets and liabilities become the responsibility of the subsidiary. Obtaining shareholder approval is relatively easy.

76) In a taxable asset acquisition, the purchaser's basis for the assets is their acquisition cost (Sec. 1012). In this instance, the acquisition cost is $600,000 cash plus the assumption of $250,000 in liabilities for a total of $850,000.

77) No gain is recognized if the boot received by the target corporation is distributed to the corporation's shareholders and/or creditors.

78) The lesser of Target's NOL carryover ($100,000) or Acquiring's taxable income for the postmerger portion of the tax year ($73,000 = $146,000 × 6/12) can be offset by Target's NOL carryover. Therefore, the answer is $73,000.

79) The Sec. 382 loss limitation is $300,000 (0.06 × $5,000,000) for the current year. Since Florida Corporation's taxable income exceeds the Sec. 382 limitation, it may be reduced by the full $300,000 amount. Florida Corporation's taxable income is $400,000 ($700,000 - $300,000).

80) Do not have to comply with state merger laws like a Type A reorganization, shareholders need to approve the transaction. Tighter restrictions thus unable to use non voting stock, tighter boot restrictions, restrictions on selling off assets after the transaction.

81) Her realized gain is $2,000 ($87,000 - $85,000). Since no boot is received, her recognized gain is zero. She has an $85,000 basis for her Fade stock. This basis (as well as her holding period) carries over from her Tone stock.

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82) The correct answer is $120,000. Frank's basis in the Baxter stock surrendered carries over to the Duke stock that is received (Sec. 358).

83) Baker stock $18,000 Basis of Gator stock $21,000 Plus: Baker securities 6,000 Minus: boot received ( 6,000) Amount realized $24,000 Plus: gain recognized 3,000 $18,000 Minus: basis (21,000) Basis of Baker stock $ 3,000 Gain recognized 84) Duke has a carryover basis of $300,000.

85) A number of advantages and disadvantages are connected with a tax-free reorganization. Some of these include: • A tax-free reorganization permits a deferral of taxes by the shareholders unless boot is received. The reorganization alternative may permit a shareholder to retain a higher percentage of the capital after payment of any income tax liability.

• A reorganization requires the owner to retain a proprietary interest; thus, he or she must continue to own an equity interest. A taxable transaction permits the equity to be converted into more liquid assets (e.g., cash).

• Losses realized in a reorganization cannot be recognized as they can in a taxable transaction.

• A taxable transaction usually results in capital gain treatment for the shareholders, while in a reorganization, it may result in dividend income being recognized.

• In a taxable transaction, the basis in the assets is stepped up, while in a reorganization, usually the basis is a carryover basis from the target corporation's books.

• In a reorganization, the depreciation and ITC recapture rules do not usually apply, while they do apply in a taxable transaction.

• A reorganization requires less cash than a taxable transaction because large amounts of stock are generally used.

The larger amount of stock, however, may dilute the ownership interests of the acquiring corporation's shareholder group.

• The reorganization permits the target corporation to avoid recognizing gain on an asset transfer or distribution of stock or securities as is typically required in a taxable transaction.

• A reorganization permits the preservation of tax attributes, which are lost in a taxable transaction.

86) Acquiring: Acquiring Corporation does not recognize any gain when it issues its common stock in exchange for Target's assets (Sec. 1032). The assets take a $2,300,000 adjusted basis on Acquiring's books (Sec. 362). Acquiring assumes Target's $600,000 E&P balance (Sec. 381).

Target: Target realizes a $2,700,000 [($3,000,000 + $2,000,000) - $2,300,000 adjusted basis] gain on the transfer of its assets. No boot is received and retained, so no gain is recognized (Sec. 361(a)). No gain is recognized on the distribution of the Acquiring Corporation stock to Target's sole shareholder (Sec. 361(c)).

Paula: Paula realizes a $2,000,000 ($3,000,000 - $1,000,000) gain on the exchange of her Target stock for the Acquiring stock. None of the gain is recognized (Sec. 354). Her basis for the Acquiring stock is $1,000,000 (Sec. 358). Her holding period for the Acquiring stock includes her holding period for the Target stock (Sec. 1223).

87) Although the motivation for the tax-free acquisition comes from the target corporation and the target's shareholders, there are two reasons the acquiring corporation may also desire the acquisition be tax-free. First, if the acquiring corporation has no cash to acquire the assets, it must use stock as consideration for the purchase. Second, the target corporation may have favorable tax attributes that the acquiring corporation would like to use.

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Answer Key Testname: C7

88) The following tax issues should be considered by John Van Kirk when evaluating Pam's proposal and by Pam in drafting her proposal: John: • What is the amount and character of the gain or loss Monmouth Restaurant will recognize on the sale of the noncash assets? On distributing the installment obligation?

• What is the amount and character of the gain or loss John will recognize on surrendering his Monmouth Restaurant stock? On receipt of the subsequent payments?

• Does Monmouth Restaurant have to file a corporate tax return for the portion of the final tax year it is in existence?

If so, what income and expenses are included in the return?

• Can Monmouth Restaurant deduct the liquidation expenses on its final tax return?

• Can Monmouth Restaurant deduct any unamortized organizational costs on the final return? Start-up costs?

• What is the relative tax cost (and nontax benefits) of receiving a lump-sum cash payment? Of selling the Monmouth Restaurant stock to Pam? • How will the interest income from the installment obligations be taxed to John?

• Would it be advantageous to lower the interest rate charged on the installment sale to below 10% and increase the sales price?

• What are the tax costs and benefits of Monmouth Restaurant remaining in business to collect the installment payments and then liquidating?

Pam: • What will Pam's total basis be for the noncash assets to be acquired? What portion of the total basis is allocated to each individual asset?

• What capital recovery rules apply to each individual asset?

• What business form and capital structure should be used to conduct the business?

• What are the tax consequences of transferring the assets to the business entity form that is selected?

• Should the asset be acquired by Pam or by her business entity?

• What tax year and accounting methods should Pam elect for her new business?

• Are any of her preacquisition costs deductible? Capitalizable as start-up expenses? Are any capitalized costs amortizable?

• Is the interest paid on the installment sale deductible?

The gain realized on the asset sale may be reportable under the installment sale rules. If so, the total gain can be reported by the Monmouth Restaurant Corporation over a six-year period. The installment sale method cannot be used if Monmouth Restaurant uses the accrual method of accounting. The interest income earned on the installment obligations will be reported as ordinary income by the corporation while it holds the debt. Pam can deduct the interest expense incurred on the installment debt. A special tax advantage is available if Monmouth Restaurant uses the cash method of accounting. If the corporation sells the assets using an installment sale and liquidates within a 12-month period, it will have to recognize any realized gain (i.e., the difference between FMV of the obligations and their basis on the corporation's books) when the obligations are distributed to the shareholders. John does not have to recognize his gain on the sale or exchange of his stock as part of Monmouth Restaurant's liquidation except to the extent he receives cash on the liquidation date. His remaining gain is recognized as the installment obligations are collected. John might consider the stock sale alternative to defer his total tax burden. Pam may find she has a major disadvantage-no step-up in basis for the acquired assets.

89) Gain is recognized in a Type A reorganization to the extent of the lesser of the realized gain ($10,000) or the sum of the money received plus the FMV of the other boot property received which in this fact pattern is $6,000.

90) First, the target corporation's shareholders sell their stock to the acquiring corporation. Then the acquiring corporation makes a Sec. 338 deemed liquidation election with respect to the acquisition of the target corporation's stock. This election results in a hypothetical sale of the "old" target corporation's assets to a "new" target corporation for their FMV in a transaction that requires the seller ("old" target) to recognize all gains and losses.

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Answer Key Testname: C7

91) Bold Corporation will recognize a $2 million gain on the deemed sale. The gain is the difference between the FMV of the assets ($3,000,000) and the corporation's basis in the assets ($1,000,000). Assuming a 34% corporate tax rate, the tax liability on the gain is $680,000 ($2,000,000 × 0.34). The grossed-up basis for the recently purchased stock is $2,500,000 [$2,000,000 × (100%/80%)]. The assets take a total basis of $3,680,000 ($2,500,000 grossed-up basis + $500,000 nontax liabilities + $680,000 taxes). This basis is allocated to the individual assets by using the residual method. Assuming none of the $3,000,000 FMV for the assets given in the facts relates to Class IV assets (e.g., goodwill), $680,000 of the total basis will be allocated to goodwill.

92) FMV of $3,500,000 less basis of $2,000,000 equals a recognized gain of $1,500,000.

93) Type A more flexible than other reorganizations. Other types of assets maybe utilized versus pure stock. To be eligible, entity must comply with jurisdiction legal requirements permitting reorganization. All liabilities of target corporation must be assumed. $237,000 94) Adjusted grossed-up basis Minus: Class I FMV ( 55,000) Class II FMV ( 60,000) Class V FMV (100,000) Allocation to Class VI assets $ 22,000 95) The following points should be addressed in connection with the Johnson-Alive spin-off: • Johnson Issues: What gain or loss does Johnson recognize when it transfers the assets of the aluminum sheet, consumer-products packaging, and ceramic units to Alive? What basis does Johnson take in the Alive stock received?

What gain or loss does Johnson recognize when it distributes the Alive stock to its shareholders?

• Johnson Shareholders' Issues: What gain or loss do the Johnson shareholders recognize when they receive Alive stock? Is any gain recognized by the shareholders when they receive cash in lieu of fractional Alive shares? What is the character of the recognized gain? What basis do the shareholders take in the Alive shares they receive?

• Alive Issues: What gain or loss does Alive recognize when it issues its stock in exchange for the assets it acquires from Johnson? What basis does Alive take in the assets it acquires from Johnson? What tax attributes does Alive acquire from Johnson?

The transfer of the Johnson assets to Alive was tax-free as part of a tax-free Type D (spin-off) reorganization. Johnson recognizes no gain on the asset transfer unless it receives and retains boot. The Alive stock takes a carryover basis in Johnson's hands that references the bases of the assets transferred. The subsequent distribution of the stock to the Johnson shareholders is tax-free. No gain is recognized by either Johnson or its shareholders except to the extent that fractional Alive shares are redeemed for cash. The shareholders allocate the basis for their Johnson stock between the Johnson and Alive stocks based on their relative fair market values. The holding period for their Johnson stock carries over to the Alive stock. Fractional shares redeemed for cash receive an allocation of the basis from the Johnson stock, and the recognized gain is a capital gain for most shareholders. Johnson recognizes no gain on the asset transfer to Alive, and the assets transferred take a carryover basis and holding period in Alive's hands.

96) 0.20 × $500,000 = $100,000 noncash consideration - $70,000 liabilities = $30,000 cash. $30,000 in cash can be used in addition to the $400,000 of Gulf voting stock and the assumption of $70,000 of Beamer liabilities.

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Answer Key Testname: C7

97) The residual method requires the adjusted grossed-up basis amount be allocated to the corporation's tangible and intangible property on a priority basis.

Class I: Cash, demand deposits, and similar accounts in banks, savings and loan associations, etc.

Class II: Actively traded personal property (as defined in Sec. 1092(d)(1)) such as stock this is part of a straddle, U.S. government securities and publicly traded securities.

Class III: Accounts receivable, mortgages and credit card receivables from customers that arise in the ordinary course of business.

Class IV: Inventory or other property held primarily for sale to customers in the ordinary course of the taxpayer's trade or business.

Class V: All assets other than Class I, II, III, IV, VI, and VII assets. Included here would be tangible and intangible property without regard to whether they are depreciable, depletable, or amortizable.

Class VI: All amortizable Sec. 197 assets except those in the nature of goodwill and going concern value.

Class VII: Sec. 197 intangible assets in the nature of goodwill and going concern value.

98) Advantage - can usually be accomplished in one transaction that does not require shareholder approval, target corporation remains in existence, goodwill, licenses, etc. may be maintained. Disadvantage - only voting stock may be utilized, must obtain at least 80% of target corporation stock.

99) Marty must recognize $6,000 of his $13,000 realized gain and the Young securities have a basis equal to their $6,000 FMV. [($108,000 + $10,500) - $95,000] = $23,500 100) Realized gain: Boot: $10,500 Recognized gain: $10,500 $400,000 101) Fisher stock basis Minus: boot received (200,000) Plus: gain recognized ($800,000 - $600,000) 200,000 Acme stock basis $400,000 102) Revbo stock $42,000 Basis of Target stock $41,000 Plus: Revbo securities 8,000 Minus: boot received ( 8,000) Amount realized $50,000 Plus: gain recognized 8,000 $41,000 Minus: adjusted basis (41,000) Basis in Revbo stock $ 9,000 Gain realized $ 8,000 Gain recognized 103) • Continuity of the investor's proprietary interest • Continuity of the business enterprise • A business purpose for the transaction • The step transaction doctrine, which collapses a series of related transactions into a single transaction reflecting their economic substance. $ 80,000 104) FMV of Slider stock received Plus: cash received 20,000 Amount realized $100,000 Minus: basis of Paris stock ( 90,000) Realized gain $ 10,000 Recognized gain $ 10,000 The recognized gain is taxed as a capital gain under the Sec. 302(b) rules. The shareholder receives $20,000 cash in exchange for part of his/her Paris stock, which is followed by an exchange of the remaining Paris stock for the Slider stock. The redemption reduces the shareholder's interest from 50% (100/200 = 50%) to 44% (80/180 = 44.44%) which should be "not essentially equivalent to a dividend" under Sec. 302(b)(1). See Rev. Rul. 93-62.

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Answer Key Testname: C7

105) Grossed-up basis of recently purchased stock = $1,000,000 × [(100% - 5%)/80%] = $1,187,500.

Total grossed-up basis of stock = $1,187,500 (grossed-up basis of recently purchased stock) + $100,000 (basis of nonrecently purchased stock) = $1,287,500.

Adjusted grossed-up basis (allocated to individual assets) = $1,287,500 + $150,000 nontax liabilities + $300,000 taxes = $1,737,500. This basis is allocated to the individual assets by using the residual method.

106) A is a merger or consolidation acquisition.

B is a stock-for-stock acquisition.

C is an asset-for-stock acquisition.

D has two types: Divisive Split-off, Spin-off, Split-up; and Acquisitive assets for stock.

G is a bankruptcy.

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Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Identify which of the following statements is true.

A) The consolidated dividends-received deduction percentage for dividends received by one affiliated group member from another affiliated group member is always 100%.

B) 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).

C) 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.

D) All of the above are false.

1)

2) Apple Corporation and Banana Corporation file consolidated returns. In January Y3, 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 Y4 for $200,000. What amount of gain should be reported for these transactions in the consolidated returns for Y3 and Y4?

A) Y3 B) Y3 Y4 Y4 $0 $50,000 $0 $80,000

2)

C) Y3 $30,000

D) Y3 $30,000

Y4 $50,000

Y4 $80,000

3) 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 from Parent and a $50,000 capital gain from Subsidiary are included in consolidated taxable income when Subsidiary sells the land.

B) 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.

C) 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.

D) None of the above are correct.

1

3)

4) 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 $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).

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 $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.

D) None of the above are correct.

4)

5) Identify which of the following statements is true.

A) A consolidated NOL is computed in part by including the consolidated capital gain in taxable income.

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) The basic dividends-received deduction rules generally do not apply to the calculation of the consolidated dividends-received deduction.

D) All of the above are false.

5)

6) 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 Year 3. Zipper Corporation filed separate returns previously. Pants, Skirt, and Zipper filed a consolidated return for Year 3 are reported the following taxable incomes:

6)

Corporation Pants Skirt Zipper

Taxable Income Year 2 $18,000 9,000 (17,000)

Taxable Income Year 3 $ 12,000 8,000 20,000

How much of the Year 1 Zipper NOL be used to offset CTI in Year 2?

A) $17,000 B) $20,000 C) $16,000

D) $0

7) Identify which of the following statements is true.

A) The dividends-received deduction cannot be taken in full on a consolidated return if the deduction amount creates or increases a consolidated NOL. 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) 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.

D) All of the above are false.

2

7)

8) 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 without limit.

C) to a consolidated return year and Jackson's loss is a SRLY loss.

D) to a consolidated return year and Tanker's loss is a SRLY loss.

8)

9) 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) September 1 B) November 1 C) June 1 D) The original affiliated group does not terminate.

9)

10) 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 departure of the purchasing group member from the affiliated group when its stock is sold to a nonmember of the group B) the purchasing group member depreciating the machine C) the purchasing group member selling the machine for cash to a nonmember of the group D) All of the above are recognition events.

10)

11) 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) Additional administrative costs may be incurred when filing a consolidated tax return.

C) Permission to discontinue the filing of consolidated tax returns is sometimes granted by the IRS. D) All of the above are true.

11)

12) 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 deduction is taken when Parent reports the interest income.

B) the interest expense is deductible when accrued.

C) the interest expense and interest income may be reported in different consolidated return years.

D) the interest income is reported when the interest expense is accrued by Subsidiary.

12)

3

13) 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%

13)

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

14) 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) 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.

C) 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.

D) All of the above are false.

14)

15) 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. What entities are in the affiliated group?

A) Ajak, Tech, Utech, and Baxter Corporations are an affiliated group.

B) Ajak, Tech, and Utech Corporations are an affiliated group.

C) Ajak, Tech, and Baxter Corporations are an affiliated group.

D) None of the above are correct.

15)

16) An affiliated group elects the use of the consolidated method for filing its tax return by A) filing Form 1120.

B) filing an affiliations schedule.

C) filing a consent to the election from each member of the affiliated group in the initial year.

D) All of the above are necessary for the election.

16)

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) closely held corporations C) foreign corporations D) real estate investment trusts

17)

4

18) 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 $90,000 September 2 of this year B) Basis $90,000

Holding Period Begins On January 2 of last year

C) Basis $60,000

Holding Period Begins On January 2 of last year

18)

D) none of the above 19) Which of the following events is an intercompany transaction?

A) dividend payment received from a subsidiary corporation to its parent corporation; the subsidiary corporation is not an includible corporation B) a parent corporation's sale of stock of a subsidiary corporation to a nonmember of the group C) a capital contribution D) accrual of interest on a loan made by one group member to another group member; both group members use the accrual method of accounting

19)

20) Identify which of the following statements is true.

A) An affiliated group electing to file a consolidated return may be composed of as few as two corporations.

B) Only common stock is considered when determining if the 80% ownership test is met for affiliated group eligibility.

C) To be part of an affiliated group, a corporation must be at least 80% directly owned by another group member.

D) All of the above are false.

20)

21) 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) Once consolidated tax returns have been filed for two consecutive years, the affiliated group must pay estimated taxes on a consolidated basis.

C) The entire consolidated tax liability cannot be collected from one group member.

D) All of the above are false.

21)

22) 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) undistributed subsidiary earnings B) intercompany dividends C) intercompany sale D) None of the above items create temporary differences.

22)

5

23) Parent and Subsidiary Corporations form an affiliated group. In Year 1, the initial year of operation, Parent and Subsidiary filed separate returns. In Year 2, the group files a consolidated tax return. The results for Year 1 and Year 2 are:

Parent Subsidiary

23)

Taxable Income Year 1 Year 2 ($10,000) $50,000 30,000 (25,000)

How much of Subsidiary's loss can be carried back to Year 1?

A) $20,000 B) $25,000 C) $0 D) none of the above

24) A consolidated return's tax liability is owed by A) all group members in equal portions.

B) the parent corporation.

C) the group member responsible for that portion of the tax liability.

D) all group members who are severely liable.

24)

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

25)

Corporation Boxcar Sidecar

Ordinary Income $10,000 30,000

STCG/STCL

LTCG/LTCL

$10,000 (12,000)

($ 5,000) 16,000

The affiliated group's consolidated taxable income is (Abbreviations used: STCG = short-term capital gain; STCL = short-term capital loss; LTCG = long-term capital gain; LTCL = long-term capital loss.)

A) $49,000.

B) $51,000.

C) $40,000.

D) $52,000.

26) Identify which of the following statements is false.

A) Inventory sales between group members are an example of an intercompany transaction.

B) The holding period for property acquired in an intercompany transaction begins when the corresponding item is reported.

C) The basis to the purchasing member of property acquired in an intercompany transaction is the amount of cash paid to the selling member.

D) In general, buyers and sellers engaging in an intercompany transaction are treated as separate entities.

6

26)

27) 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

Blair Cannon

($5,000) 6,000

$6,000 (7,000)

27)

Sec. 1231 Gains and Losses $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? (Abbreviations used: STCG = short-term capital gain; STCL = short-term capital loss; LTCG = long-term capital gain; LTCL = long-term capital loss.)

A) The affiliated group reports a $4,000 net Sec. 1231 gain.

B) The consolidated group must report a net long-term capital gain of $9,000 and a net short-term capital gain of $1,000.

C) Cannon Corporation's separate return reports a $6,000 net long-term capital gain.

D) None of the above statements are incorrect.

28) Which of the following events is an intercompany transaction that requires the deferral and later recognition of income?

A) sale of inventory from a subsidiary corporation to its parent corporation B) cash dividend payment from a subsidiary corporation to its parent corporation C) 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 D) None of the above transactions require the deferral and later recognition of income.

28)

29) Which of the following is not reported by an affiliated group on a consolidated basis?

A) capital gain B) casualty & theft gain C) section 1231 gain D) All of the above are included.

29)

30) 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) 0% B) 50% C) 100% D) none of the above

30)

7

31) Parent and Subsidiary Corporations form an affiliated group. In Year 1, the initial year of operation, Parent and Subsidiary filed separate returns. In Year 2, the group files a consolidated return.

Parent Subsidiary

31)

Taxable Income Year 1 Year 2 ($16,000) $20,000 10,000 (21,000)

How much of the Subsidiary loss can be carried back to Year 1?

A) $10,000 B) $0 C) $1,000 D) none of the above

32) Identify which of the following statements is true.

A) A consolidated return election may be revoked after 5 years.

B) 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.

C) All members of a consolidated group must use the same tax year.

D) All of the above are false.

32)

33) 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):

33)

Corporation Blue Gold Green (since acquisition)

Taxable Income $150,000 ( 25,000) 100,000

Which of the following statements is correct?

A) 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.

B) 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.

C) 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.

D) Last year's NOL cannot be carried back.

34) 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) 50% B) 100% C) 0% D) none of the above

8

34)

35) P and S comprise an affiliated group that filed consolidated returns in Years 1, 2 and 3. They report the following for Year 1, 2, and 3.

Taxable Income Year 1 Year 2 Year 3 Parent 100 200 200 Subsidiary (500) 100 100

35)

How much of the Subsidiary Year 1 loss can be utilized against consolidated net income in Year 1?

A) $300 B) $240 C) $80 D) $400

36) 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 a $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) $110,000 B) $60,000 C) $90,000 D) No estimated tax payments are required.

36)

37) 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.

37)

Corporation

STCG/STCL

LTCG/LTCL

Blair Cannon

($5,000) 6,000

$6,000 (7,000)

Sec. 1231 Gains and Losses $3,000 (3,000)

Which of the following statements is correct? (Abbreviations used: STCG = short-term capital gain; STCL = short-term capital loss; LTCG = long-term capital gain; LTCL = long-term capital loss.)

A) Cannon Corporation's separate return reports a $1,000 net long-term capital loss.

B) Blair Corporation's separate return reports a $4,000 net long-term capital gain.

C) The consolidated group reports a net short-term capital gain of $1,000.

D) All three of the above are correct.

38) 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) 75% B) 0% C) 80% D) 50%

9

38)

39) Identify which of the following statements is true.

A) 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. B) 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.

C) The basic accounting method elections that are used by the seller in intercompany transactions do not override the intercompany transaction rules.

D) All of the above are true.

39)

40) Identify which of the following statements is true.

A) A member leaving an affiliated group cannot use capital loss carryovers that originated in one of its previous separate return years.

B) 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.

C) Capital loss carrybacks and carryforwards are all treated as short-term capital losses.

D) All of the above are false.

40)

41) The Alpha-Beta affiliated group has consolidated taxable income of $400,000 and tentative general business credit of $80,000 in the current year. The maximum general business credit that can be used on the consolidated return is A) $69,250.

B) $80,000.

C) $14,750.

D) $64,000.

41)

42) Which of the following statements is true?

A) The general business credit can be carried back 3 years and forward 15 years.

B) The general business credit can be carried forward indefinitely.

C) A consolidated group determines its general business credit on a consolidated basis.

D) The general business credit cannot be carried forward or backward.

42)

43) 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) 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.

C) Section 382 adopts a single-entity approach in determining ownership changes.

D) All of the above are false.

43)

10

44) Mako and Snufco Corporations are affiliated and have filed consolidated returns for the first time in Year 2 Mako acquired 100% of Zebco stock on January 1 of Year 2, the date of Zebco's formation.

Mako, Snufco, and Zebco, report the following taxable incomes for Year 1 and Year 2.

Corporation Mako Snufco Zebco

Taxable Income Year 1 $18,000 9,000 (25,000)

44)

Taxable Income Year 2 $ 12,000 8,000 15,000

How much of the Year 1 Zebco NOL be used to offset CTI in Year 2?

A) $0 B) $12,000 C) $20,000

D) $15,000

45) Identify which of the following statements is true.

A) 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.

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) A corporation may be required to file a separate return and file with an affiliated group in the same calendar year.

D) All of the above are false.

45)

46) 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 B) Alto Bass Bass 100% 75% 75% 75%

46)

C) Alto 100%

D) none of the above

Bass 100%

47) Key and Glass Corporations were organized in Year 1. They became an affiliated group and filed separate tax returns. In Year 2, the corporations begin filing a consolidated tax return. Key and Glass report the following results: Consolidated Key Glass

Income (loss) Year 1 ($30,000) 10,000

Income (loss) Year 2 $50,000 (35,000)

Which of the following statements is not correct?

A) Key's current year income must first be offset by Glass's current year loss.

B) Key's last year NOL cannot offset this year's consolidated taxable income.

C) Key's last year NOL cannot offset Glass's last year profits.

D) All of the above are correct.

11

47)

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

Ordinary Income $10,000 30,000

STCG/STCL

LTCG/LTCL

$10,000 (12,000)

($ 5,000) 16,000

48)

What is the affiliated group's consolidated regular tax liability? (Abbreviations used: STCG = short-term capital gain; STCL = short-term capital loss; LTCG = long-term capital gain; LTCL = long-term capital loss.)

A) $7,700 B) $11,000 C) $10,290 D) $49,000

49) 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) Intercompany dividends and undistributed subsidiary earnings do not create temporary differences for affiliated companies filing a consolidated return.

D) An intercompany transaction generally results in the selling member and buying member in a property transaction being treated as divisions of a single corporation.

49)

50) 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.

50)

Corporation Trix Track Consolidated Taxable Income

Taxable Income Last year ($12,000) ( 10,000) ($22,000)

Taxable Income Current year $34,000 ( 2,000) $32,000

Which of the following statements is incorrect?

A) Track's last year loss can be used to offset the current year's consolidated taxable income.

B) Last year is an SRLY (separate return limitation year) with respect to Track Corporation.

C) Track's last year loss is offset against the consolidated current taxable income.

D) None of Track's last year's loss can be used to offset the current year's consolidated taxable income.

51) Which of the following corporations is an includible corporation for purposes of filing a consolidated tax return?

A) S corporations B) foreign corporations C) car manufacturing corporation D) insurance companies

12

51)

52) 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 Roland Shedrick Tyrone

Ordinary Income $25,000 30,000 20,000

STCG/STCL

LTCG/LTCL

$4,000 (2,000) (3,000)

($2,000) 14,000 8,000

52)

Sec. 1231 Gains and Losses ($5,000) ( 2,000) ( 3,000)

Which of following statements is incorrect? (Abbreviations used: STCG = short-term capital gain; STCL = short-term capital loss; LTCG = long-term capital gain; LTCL = long-term capital loss.)

A) No Sec. 1231 recapture can occur this year.

B) The Sec. 1231 loss is treated as an ordinary loss.

C) The net capital gain is $20,000.

D) The net capital gain is taxed at the regular corporate tax rates.

53) Identify which of the following statements is true.

A) The check-the-box regulations permit partnership and LLCs to elect C corporation tax treatment.

B) If 100% of the stock of two corporations is owned by the same individual, the two corporations are eligible to file a consolidated return.

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.

53)

54) 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 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.

C) An intercompany transaction is a transaction that takes place between two corporations that are members of the same affiliated group immediately after the transaction.

D) All of the above are false.

54)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

55) 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.

55)

56) 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.

56)

57) 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.

57)

58) The treatment of capital loss carrybacks and carryovers is similar to NOLs.

58)

13

59) To be an affiliated group, the parent corporation must directly own at least 80% of another group member.

59)

60) The IRS can attempt to collect taxes owed on a consolidated return from any of the members of the consolidated group.

60)

61) Intercompany dividends and undistributed subsidiary earnings do not create temporary differences for affiliated companies filing a consolidated return.

61)

62) A Canadian subsidiary cannot file as part of the consolidated group with its U.S. parent.

62)

63) 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.

63)

64) The election to file a consolidated return is made annually.

64)

65) Intercompany sales between members of an affiliated group filing separate returns cause deferred tax assets to be recognized by both buyer and seller.

65)

66) Brother-sister controlled groups can elect to file a consolidated tax return.

66)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

67) 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?

68) 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?

69) 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?

70) 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?

14

71) A consolidated Year 1 NOL carryover is $36,000 at the beginning of Year 2 is exists. Of the Year 1 NOL, 25% 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 $36,000 NOL can Duke use on its first separate return?

72) What types of corporations are not includible corporations for purposes of determining whether or not an affiliated group exists?

73) Penish and Sagen Corporations are calendar based entities and have filed consolidated tax returns for several years. At the end of September Penish Corporation sells all of its Sagen stock to an unrelated individual. What are the tax consequences to each corporation?

74) What are the five steps in calculating consolidated taxable income?

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?

76) Why are other intercompany transactions not given any special treatment?

77) How do intercompany transactions affect the calculation of capital gains/losses?

15

Answer Key Testname: C8

1) C 2) B 3) D 4) A 5) A 6) C 7) C 8) B 9) D 10) D 11) D 12) D 13) C 14) D 15) B 16) D 17) B 18) A 19) D 20) A 21) B 22) D 23) B 24) D 25) A 26) B 27) C 28) A 29) D 30) C 31) B 32) C 33) B 34) A 35) C 36) B 37) D 38) D 39) D 40) C 41) A 42) C 43) C 44) B 45) C 46) A 47) B 48) C 49) B 50) A 16

Answer Key Testname: C8

51) C 52) C 53) A 54) B 55) TRUE 56) TRUE 57) TRUE 58) TRUE 59) TRUE 60) TRUE 61) TRUE 62) FALSE 63) TRUE 64) FALSE 65) FALSE 66) FALSE 67) Gee Corporation must report the $10,000 Sec. 1231 gain recognized on the sale of the land last year to Wilkers in its separate taxable income. The gain is deferred by the affiliated group in determining consolidated taxable income until the year the property is sold outside the group. The recomputed gain is $25,000. Wilkers recognizes a $3,000 gain Sec. 1231 gain ($15,000 × 0.20) in the current year when it sells the land to a nonmember of the group and collects the first installment. The group then restores the $10,000 balance of the recomputed gain as a Sec. 1231 gain ratably as the five installments are collected. $2,000 ($10,000 × 1/5) of gain is restored when each of the five payments is received. A similar amount of gain is recognized when each subsequent installment is collected.

68) The basis of the machine to Parent on the sale date is $16,000 ($20,000 - $4,000). This basis and the MACRS depreciation rules carry over to Subsidiary from Parent for this portion of the acquisition cost. Parent recognizes a $2,000 gain ($18,000 - $16,000), which is deferred when the consolidated tax return is filed. Subsidiary steps up its basis for the asset by the $2,000 amount, thereby providing a total basis of $18,000. The basis increase is treated as a new asset by Subsidiary under the MACRS rules. Subsidiary's depreciation calculation is: Carryover basis: $20,000 × 0.32 = $6,400 Basis increase: $ 2,000 × 0.20 = 400 Total depreciation $6,800 69) Gee Corporation must report the $10,000 Sec. 1231 gain recognized on the sale of the land last year to Wilkers in its separate taxable income. The gain is deferred by the affiliated group in determining consolidated taxable income until the year the property is sold outside the group. The recomputed gain is $25,000. Wilkers recognizes a $15,000 Sec. 1231 gain in the current year when it sells the land for cash to a nonmember of the group. The group then restores the $10,000 balance of the recomputed gain as a Sec. 1231 gain.

17

Answer Key Testname: C8

70) • What advantages would accrue if the Hartz-Ryder affiliated group elected to file a consolidated tax return?

• Can the profits earned by Hartz Corporation on an intercompany inventory sale to Ryder Corporation be deferred for tax purposes?

• Can the current-year losses of Ryder Corporation offset the current-year profits of Hartz Corporation? Are there any restrictions or limitations on deducting the losses?

• Can the preaffiliation losses of Ryder Corporation offset the consolidated taxable income? Are there any restrictions or limitations on deducting the losses?

• What disadvantages would accrue if the Hartz-Ryder affiliated group elected to file a consolidated tax return?

• Is additional recordkeeping involved in filing a consolidated return instead of two separate tax returns?

• What types of corporate groups can file a consolidated tax return?

• What are the stock ownership and includible corporation requirements for an affiliated group?

• Do Hartz and Ryder Corporations as brother-sister corporations satisfy these requirements?

• If an affiliated group does not exist, what changes to the corporate structure must be made to create an affiliated group?

The current brother-sister relationship for Hartz and Ryder Corporations does not permit the filing of a consolidated tax return. If a parent-subsidiary relationship were established (e.g., by Morgen's capital contribution of the Ryder stock to Hartz Corporation), a consolidated tax return could be filed. Postchange NOLs for Ryder Corporation could offset the profits of Hartz Corporation in the consolidated tax return. The prechange NOLs are SRLY losses and can be used by the affiliated group only to the extent that Ryder subsequently earned profits. An adjustment to the transfer price charged for the product produced by Ryder might permit additional profits to be earned by Ryder and accelerate the use of the SRLY losses. Profits earned on the intercompany inventory sales are deferred under the consolidated return rules. Too large of a transfer price change may be indicative of tax avoidance and cause the IRS to apply Sec. 482 to the intragroup transfers. These deferrals have increased annually over the last five years. Depending on the inventory method employed (e.g., LIFO or FIFO), the tax deferral could either be short-term or long-term. Two drawbacks to the filing of a consolidated return are the additional recordkeeping involved in maintaining the records and preparing the tax returns, and the smaller deduction and credit limits faced by the group over what Hartz Corporation would have on a separate return basis.

Duke contribution to current year CTI 71) $ 15,000 25,000 Plus: other members' contribution to current-year CTI $ 40,000 Current-year CTI $40,000 * 80% = 32,000 limitation

Year 1 NOL 36,000 - $32,000 limitation = balance $4,000 $4,000 balance * Duke's percentage 25% = $1,000 Duke can use $1,000 against its first year separate return.

72) Special tax status corporations are not includible corporations.

• Exempt corporations under Sec. 501 • Insurance companies subject to tax under Sec. 801 • Foreign corporations • Corporations claiming the Puerto Rico and U.S. possessions tax credit • Regulated investment companies • Real estate investment trusts • Domestic international sales corporations • S corporations 73) All of Penish's income is included in the consolidated tax return for this year. Only nine months of Sagen Corporation's income is included in the consolidated tax return. Sagen must also file a separate tax return for the period October 1 through December 31.

18

Answer Key Testname: C8

74) Generally, the five steps are: 1) Compute each group member's taxable income (or loss) based on the member's own accounting methods as if the corporation were filing its own separate tax return.

2) Make adjustments to each group member's taxable income for certain intercompany transactions, inventory adjustments, dividends received, excess loss (negative investment basis) accounts, and built-in deductions.

3) Remove certain gains, losses, and deductions from each member's taxable income since they must be computed on a consolidated basis (e.g., NOLs, capital gains and losses, Sec. 1231 gains and losses, charitable contribution deductions, dividends-received deduction, percentage depletion under Sec. 613A).

4) Steps 1 through 3 result in the member's separate taxable income. Combine these amounts to equal the group's combined taxable income.

5) Adjust the group's combined taxable income for items reported on a consolidated basis to equal the consolidated taxable income.

75) Toby, James, and Volt constitute the affiliated group. Toby is the common parent. Mony and Wegnin are not included, as they are foreign corporations.

76) Since both sides of the transaction are reported in the same consolidated return, they simply net each other out. If, due to accounting methods, the items would be reported in different tax periods, both the income and deduction must be reported in the later of the two tax years.

77) Deferred intercompany gains/losses are included in the netting of capital gains/losses only when a corresponding item triggers the recognition of the intercompany item.

19

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) 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 B) Nicholas Michelle Michelle $180,000 $100,000 $100,000 $100,000 C) Nicholas $ 60,000

D) Nicholas $140,000

Michelle $ 60,000

1)

Michelle $ 60,000

2) Which of the following is false?

A) A large partnership is subject to a different system of audits.

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 must not be a service partnership.

2)

3) Identify which of the following statements is true.

A) Partnerships make most of the tax elections for the partnership rather than the partners.

B) A partner can elect the depreciation method to be applied to the partner's share of the partnership's depreciable assets.

C) 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.

D) All of the above are false.

3)

4) 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) $13,000 guaranteed payment (ordinary income), $6,001 ordinary income, $38,820 capital gain B) $40,000 guaranteed payment (ordinary income), $9,000 ordinary income, $6,000 capital gain C) $40,000 guaranteed payment (ordinary income), $3,000 ordinary loss, $18,000 capital gain D) $40,000 guaranteed payment (ordinary income), $15,000 capital gain

4)

5) 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) $25,000 B) $33,000 C) $30,000 D) $5,000

5)

1

6) 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) $25,000 capital gain B) $15,000 capital gain and $10,000 ordinary income C) $10,000 ordinary income D) $25,000 ordinary income

6)

7) 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 Sec. 1231 gain and $100,000 of capital gain.

B) $200,000 of Sec. 1231 gain.

C) $200,000 of ordinary income.

D) $100,000 of ordinary income and $100,000 of Sec. 1231 gain.

7)

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

8)

Ordinary income Short-term capital gain Guaranteed payment

$30,000 $18,000 $36,000

What is his self-employment income?

A) $84,000 B) $66,000

C) $36,000

D) $48,000

9) Identify which of the following statements is true.

A) 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.

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) 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.

D) All of the above are true.

9)

10) 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) $14,000.

B) $12,000.

C) $30,000.

D) $10,000.

10)

2

11) 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) $30,000.

B) $10,000.

C) $20,000.

D) $40,000.

11)

12) 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 of last year. His holding period for the partnership interest begins A) June 2 of the current year.

B) March 2 of last year.

C) June 1 of the current year.

D) March 1 of last year.

12)

13) 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) a $30,000 short-term capital gain.

B) a $30,000 Sec. 1231 gain.

C) no gain or loss.

D) a $30,000 ordinary income.

13)

14) When computing the partnership's ordinary income, a deduction is allowed for A) contributions to charitable organizations.

B) guaranteed payments to partners.

C) net short-term capital losses.

D) net operating losses.

14)

15) 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) $23,000 ordinary income, $1,000 Sec. 1231 loss B) $19,000 ordinary income, $3,000 LTCG C) $20,000 ordinary income, $3,000 LTCG, $1,000 Sec. 1231 loss D) $22,000 ordinary income

15)

16) 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) $1,200 capital loss.

B) $3,000 capital gain.

C) $3,000 capital loss.

D) $1,200 capital gain.

16)

17) Identify which of the following statements is true.

A) 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.

B) Distribution of partnership income in the form of cash to partners is generally tax-free to the partners and the partnership.

C) When partners receive cash distributions from the partnership, they pay taxes on those distributions.

D) All of the above are true.

17)

3

18) Identify which of the following statements is true.

A) Dividends received by a partnership from a domestic corporation are included in the partnership's ordinary income.

B) A partnership cannot make charitable contributions.

C) A partnership cannot have an NOL carryback or carryforward.

D) All of the above are false.

18)

19) 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) current year B) She may elect either year.

C) last year D) She does not need to report guaranteed payments on her return.

19)

20) Identify which of the following statements is true.

A) A partner may not recognize ordinary income when receiving a capital and profits interest in a partnership in exchange for services.

B) The contribution of Sec. 1245 property to a partnership triggers recognition of ordinary income by the contributor at the time of the transfer.

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.

20)

21) Identify which of the following statements is true.

A) 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.

B) Valid family partnership partners may be subject to the "kiddie tax."

C) 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.

D) All of the above are false.

21)

22) 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) $10,000 ordinary income.

B) a $5,000 capital gain.

C) a $5,000 Sec. 1245 gain.

D) no gain or loss.

22)

23) Identify which of the following statements is true.

A) A limited partnership cannot have a corporate general partner.

B) A limited partnership must have at least two general partners.

C) All of the partners in a limited partnership have limited liability.

D) All of the above are false.

23)

4

24) 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 $80,000 B) Distributive Share 0

Guaranteed Payment $80,000

C) Distributive Share $40,000

Guaranteed Payment 0

D) Distributive Share $40,000

Guaranteed Payment $40,000

25) The XYZ Partnership reports the following operating results for the current year: Net long-term capital loss Net Sec. 1231 loss Ordinary income

24)

25)

($40,000) ( 16,000) 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) $12,500.

B) $10,000.

C) $8,500.

D) $6,800.

26) Identify which of the following statements is true.

A) For federal income tax purposes, formation of a partnership is governed by Sec. 721.

B) A contribution of services for a partnership interest is a tax-free transaction.

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.

26)

27) 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 non-leap 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) $16,425.

B) $16,380.

C) $21,900.

D) $16,470.

27)

28) Identify which of the following statements is true.

A) Partnership gains and losses from two different casualty and theft occurrences in one year are passed through to the partners as two separate items.

B) Tax-exempt interest received by a partnership is taxable to the partners if distributed.

C) The amount and character of any gains/losses are determined at the partnership level.

D) All of the above are false.

28)

5

29) 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 Short-term capital gain Guaranteed payment

29)

$30,000 $18,000 $36,000

What is his self-employment income?

A) $66,000 B) $48,000

C) $36,000

D) $84,000

30) 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) $60,000 B) $50,000 C) $30,000 D) $40,000

30)

31) 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) $12,000 ordinary income D) $4,000 short-term capital gain

31)

32) 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) August 1 of the current year.

C) August 2 of the current year.

D) July 3 of last year.

32)

33) 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) 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.

C) In order to shift income/loss between partners, there must be substantial economic effect.

D) Partners must make up negative balances in their capital accounts upon liquidation of the partnership.

33)

6

34) 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) $40,000 ordinary income.

B) $10,000 ordinary loss.

C) $20,000 ordinary income.

D) $30,000 ordinary income.

34)

35) 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) $32,000 B) $0 C) $52,000 D) $64,000

35)

36) William and Irene each contributed $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) $20,000.

B) $21,000.

C) $22,000.

D) $19,000.

36)

37) The definition of a partnership does not include A) a pool.

C) a syndicate.

37)

B) a group.

D) All of the above are included.

38) 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) October 31 B) September 30 C) June 30 D) December 31

38)

39) In computing the ordinary income of a partnership, a deduction is allowed for A) net Sec. 1231 losses.

B) foreign income taxes paid.

C) bad debts.

D) charitable contributions.

39)

40) Identify which of the following statements is true.

A) 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.

B) When adjusting a partner's basis in a partnership interest, the negative basis adjustments are made prior to the positive basis adjustments.

C) 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.

D) All of the above are false.

40)

7

41) 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) Gain recognized by a contributing partner because of the assumption of liabilities by the partnership increases the partnership's basis in the contributed property.

C) When a partnership assumes any liabilities of the transferor, the transferor has an increase in the basis of his or her partnership interest.

D) All of the above are false.

41)

42) 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) $1,000 capital gain.

B) $0 gain or loss.

C) $5,000 capital gain.

D) $4,000 capital gain and $1,000 Sec. 1231 gain.

42)

43) 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 ordinary income and the partnership deducts the $500,000 over the building's MACRS recovery period as a depreciation expense.

B) 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.

C) Ali recognizes no income and the partnership can deduct nothing in the current year.

D) Ali recognizes $500,000 of ordinary income and the partnership can deduct $500,000 in the current year.

43)

44) 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) $40,000.

B) $10,000.

C) $15,000.

D) $25,000.

44)

45) Bao had investment land that he purchased ten years ago 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 $4,000 capital loss and a $30,000 ordinary loss.

B) a $34,000 ordinary loss.

C) a $34,000 capital loss.

D) a $30,000 capital loss and a $4,000 ordinary loss.

45)

8

46) When determining the guaranteed payment, which of the following statements is correct?

A) Guaranteed payments are payments determined with regard to the partnership income.

B) 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.

C) 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.

D) The distinction between guaranteed payments and distributive shares is clear in practice.

46)

47) 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) $140,000 B) $60,000 C) $86,000 D) $80,000

47)

48) Identify which of the following statements is true.

A) 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.

B) 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.

C) Although a partner's basis in the partnership cannot go below zero, a partner's book capital account (equity) may be negative.

D) All of the above are false.

48)

49) 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) $20,000.

B) $12,500.

C) $35,000.

D) $27,500.

49)

50) 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) $32,000 C) $40,000 D) $16,000

50)

51) 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) $30,000 B) $10,000 C) $5,000 D) $20,000

51)

9

52) Identify which of the following statements is true.

A) It may be necessary for the partnership to capitalize a partner's guaranteed payment.

B) Guaranteed payments are ordinary income to the recipient.

C) A partner who performs services for a partnership is usually not considered an employee of the partnership.

D) All of the above are true.

52)

53) 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 gain due to the contribution of $6,000 and a zero basis in the partnership interest.

B) a capital loss due to the contribution of $6,000 and a zero basis in the partnership interest.

C) a $43,000 basis in the partnership interest and no gain or loss.

D) a $34,000 basis in the partnership interest and no gain or loss.

53)

54) Identify which of the following statements is true.

A) Formation of a partnership requires legal documentation.

B) 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.

C) An individual engaged in the active conduct of a business must elect not to be taxed as a partnership.

D) All of the above are false.

54)

55) 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 $160,000 $80,000

55)

B) Distributive Share $160,000

Guaranteed Payment $160,000

C) Distributive Share $160,000

Guaranteed Payment 0

D) Distributive Share $80,000

Guaranteed Payment $80,000

56) 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) $34,000.

B) $11,000.

C) $18,000.

D) $22,000.

10

56)

57) Identify which of the following statements is true.

A) 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.

B) The partner's distributive share is the partner's share of any assets distributed by the partnership.

C) 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.

D) All of the above are false.

57)

58) 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) $3,500.

B) $2,000.

C) $3,900.

D) $1,500.

58)

59) Identify which of the following statements is true.

A) For tax purposes, the partnership takes a carryover basis in the contributed property that references the contributing partner's basis.

B) 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.

C) 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.

D) All of the above are false.

59)

60) 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) $13,200.

B) $30,000.

C) $12,000.

D) $10,800.

60)

61) Electing large partnership rules differ from other partnership rules in all of the following areas except A) partnership income reporting.

B) partnership audits.

C) partnership termination.

D) All of the above are large partnership rule differences.

61)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

62) A partner's "distributive share" is the partner's share of any assets distributed by the partnership.

62)

63) Guaranteed payments are always ordinary income to the recipient.

63)

64) A partner's basis for his partnership interest can be negative.

64)

11

65) A partner's share of nonrecourse debt increases that partner's share of basis.

65)

66) A partner's basis for his or her partnership interest is increased by his share of the partnership's tax-exempt income.

66)

67) A partnership cannot make charitable contributions.

67)

68) No gain is recognized on the sale of property between a partnership and a more-than-50% partner.

68)

69) ABC Partnership distributes $12,000 to partner Al. Al's distributive share of partnership income is $20,000. Al is taxed on $20,000.

69)

70) Limited partners must consider the at-risk, basis, and passive loss limitations when determining the amount of their deductible loss.

70)

71) If a partner takes a guaranteed payment, that partner's after-tax cash flow will increase even though the partner's self-employment (SE) tax will increase and the qualified business income deduction (QBI) deduction will decrease.

71)

72) 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.

72)

73) A partnership must file Form 1065 only if its income exceeds $1,000.

73)

74) Formation of a partnership requires legal documentation filed with the Secretary of State.

74)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

75) 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?

76) 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?

77) 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?

78) 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?

12

79) 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?

80) 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?

81) 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?

82) 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 Net Sec. 1231 gain Ordinary income

$50,000 45,000 110,000

What is Tracy's distributive share?

83) Under what conditions will a special allocation of partnership depreciation be recognized? Assume the partnership has no nonrecourse liabilities.

84) 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?

85) 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?

13

Answer Key Testname: C9

1) D 2) B 3) A 4) C 5) D 6) D 7) C 8) B 9) D 10) A 11) A 12) D 13) D 14) B 15) C 16) D 17) B 18) C 19) C 20) C 21) B 22) D 23) D 24) D 25) A 26) A 27) D 28) C 29) C 30) A 31) D 32) C 33) B 34) C 35) B 36) B 37) D 38) C 39) C 40) D 41) A 42) A 43) A 44) B 45) D 46) B 47) C 48) C 49) D 50) A 14

Answer Key Testname: C9

51) A 52) D 53) A 54) B 55) C 56) C 57) C 58) C 59) A 60) C 61) D 62) FALSE 63) TRUE 64) FALSE 65) TRUE 66) TRUE 67) FALSE 68) FALSE 69) TRUE 70) TRUE 71) TRUE 72) FALSE 73) FALSE 74) FALSE 75) Basis of contributed property Plus: Jane's share of existing partnership liabilities ($8,000 × 0.25) Minus: Jane's liabilities assumed by the other partners ($40,000 × 0.75) Jane's basis in her partnership interest

$80,000 2,000 (30,000) $52,000

Jane does recognize any gain on the partnership's assumption of her liability because the deemed cash distribution from the assumption of her $30,000 in liabilities by the partnership does not exceed her $82,000 basis in the partnership interest immediately preceding the fictional distribution.

76) George recognizes $35,000 of ordinary income because the partnership interest is property that he received in exchange for his services.

77) • What is Samantha's deductible loss from her partnership investment?

• What is Samantha's Sec. 704(d) basis in her partnership interest?

• What is Samantha's at-risk basis in her partnership interest?

• Is the loss from the XYZ Partnership a passive loss?

• Does Samantha have passive income from this investment or other investments? If so, can she deduct her losses? If not, do the losses carry over to later years?

As a limited partner, Samantha is presumed not to materially participate in the partnership. Therefore, because it is a loss from a passive activity, her loss cannot be deducted unless she has passive income from other investments, or she terminates her interest in the limited partnership. If no such income exists, the losses carry over to later years.

15

Answer Key Testname: C9

78) The loss allocation is: Martin: $15,000 × 0.40 = $6,000 Clark: $15,000 × 0.30 = $4,500 Lewis: $15,000 × 0.30 = $4,500 Martin and Clark are limited to deducting $6,000 and $4,500, respectively, by their allocation of the partnership loss and not by their bases for their partnership interests under Sec. 704(d). Lewis, on the other hand, has his $4,500 share of the partnership loss limited by his $2,500 basis for the partnership interest under Sec. 704(d). These amounts may be further restricted by the at-risk rules and the passive activity limitations.

79) Shaad's distributive share of loss is $16,000 ($48,000 × 0.333). His loss deduction is first limited to his $5,000 adjusted basis under Sec. 704(d). His loss is further restricted by the passive loss rules and, since he has no passive income, he cannot deduct any of the loss from this partnership.

80) Bob Carol $40,000 $25,000 Basis of contributed property 15,000 15,000 Plus: share of partnership's liability $55,000 $40,000 Basis in partnership interest

81) Janice will report the guaranteed payment of $50,000. She will also report her distributive share of the partnership's ordinary loss, $6,000 [0.30 × ($30,000 - $50,000)] and her distributive share of the partnership's long-term capital gain, $30,000 (0.30 × $100,000).

82) The partnership has a $105,000 ($110,000 + $45,000 - $50,000) net profit for the year. Tracy's distributive share is calculated using her profits interest percentage, 25%.

Net long-term capital loss Net Sec. 1231 gain Ordinary income

$12,500 11,250 27,500

The loss percentage is only used in years in which the partnership has a net loss.

83) A special allocation must be stated in the partnership agreement or the amount will be allocated in accordance with the partners' interest in the partnership. In addition, the allocation must have substantial economic effect. To have economic effect, the allocation must meet all of the following requirements throughout the term of the partnership: • Capital accounts must be maintained under the capital account maintenance rules of the Sec. 704 regulations.

• Upon liquidation of the partnership, liquidating distributions must be made in accord with positive capital accounts.

• If a partner has a deficit capital account balance after all adjustments for the year of liquidation, that partner must be unconditionally obligated to restore the deficit. (The regulations provide some alternatives to an unconditional obligation to restore the deficit, but the alternatives are not covered in this introductory textbook.)

For the economic effect of the special allocation to be considered substantial, there must be a reasonable possibility that the allocation will substantially affect the dollar amounts to be received by the partners independent of any tax consequences.

84) Daryl's basis would be unaffected by the guaranteed payment. It would be reduced by $9,000 for the portion of the ordinary loss that he is allocated and would total $66,000 ($75,000 - $9,000).

85) Jason must include the $5,000 in his current-year gross income. The legal services were a fringe benefit to the employees and therefore, not taxable to them. The ABC Partnership can deduct the $5,000 in the current year and will allocate the $5,000 expense to all partners other than Jason.

16

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) 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) $6,000.

B) $9,000.

C) $2,500.

D) $7,500.

1)

2) 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, another partner in the partnership 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) $1,000.

B) $4,000.

C) $0.

D) $5,000.

2)

3) Identify which of the following statements is true.

A) The partnership tax year closes when a partner transfers his interest by gift.

B) 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.

C) 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.

D) All of the above are false.

3)

4) 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) $200,000 increase in Han's share of the basis in partnership assets B) $0 C) $1,000,000 increase in partnership assets D) $150,000 increase in Han's basis in his partnership interest

4)

5) The total bases of all distributed property in the partner's hands following a nonliquidating distribution is limited to A) the partnership's bases in the distributed property.

B) the predistribution FMV of the partner's partnership interest.

C) the partner's predistribution basis in his partnership interest.

D) the FMV of the property distributed.

5)

6) 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 December 31.

B) terminates on March 31.

C) does not terminate.

D) terminates on October 31.

6)

1

7) The XYZ Partnership owns the following assets on December 31:

Cash Unrealized receivables Inventory Land (Sec. 1231 asset)

Basis $20,000 0 $30,000 40,000

7)

FMV $20,000 15,000 35,000 70,000

By how much must XYZ reduce its unrealized receivables to avoid meeting the substantially appreciated inventory test?

A) $15,000 B) $10,000 C) $14,000 D) No amount of reduction of unrealized receivables will affect meeting the substantially appreciated inventory test.

8) 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 B) Mirabelle Sergio Sergio $4,000 $3,000 0 0 C) Mirabelle $5,500

D) Mirabelle $4,000

Sergio $1,500

8)

Sergio 0

9) Identify which of the following statements is true.

A) The partnership's tax year closes with respect to a partner whose interest is transferred by gift.

B) 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.

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 Year 6 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.

9)

10) 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) $8,000.

B) $0.

C) $20,000.

D) $5,000.

10)

11) 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) $17,000 B) $22,000 C) $20,000 D) $5,000

11)

2

12) 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) The new partnership is a continuation of the old partnership.

B) Sally must conform her tax year with the partnership tax year.

C) Sally's tax return will include partnership distributive shares for periods ending March 31 and October 3.

D) Sally's tax return will include a partnership distributive share only for the period ending March 31.

12)

13) 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) seven B) unlimited C) three D) five

13)

14) 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:

14)

Cash Unrealized receivables Inventory Land (Sec. 1231)

Basis $20,000 0 10,000 110,000

FMV $20,000 40,000 40,000 100,000

The receivables and inventory are Sec. 751 assets. There is no agreement concerning the allocation of the sales price. Steve must recognize A) $12,000 ordinary income.

B) $14,000 ordinary income and $2,000 capital loss.

C) no gain or loss.

D) $12,000 capital gain.

15) 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) $50,000 B) $0 C) $10,000 D) $60,000

15)

16) 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:

16)

Cash Unrealized receivables Inventory Land (Sec. 1231)

Basis $20,000 0 10,000 110,000

FMV $20,000 40,000 40,000 100,000

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) $16,000.

B) $12,000.

C) $6,000.

D) $14,000.

3

17) The XYZ Partnership owns the following assets on December 31:

Cash Unrealized receivables Inventory

Basis $10,000 0 $25,000

17)

FMV $10,000 10,000 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) $3,000 ordinary income.

B) $3,000 capital gain and $1,000 ordinary income.

C) $4,000 capital gain.

D) $3,000 ordinary income and $1,000 capital gain.

18) For tax purposes, a partner who receives retirement payments ceases to be regarded as a partner A) on the day on which the partner retires.

B) on the last day of the month in which the partner retires.

C) on the last day of the taxable year in which the partner retires.

D) only after the partner's last payment is received.

18)

19) 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) $4,000 long-term capital loss and $2,000 ordinary loss B) $4,000 long-term capital loss C) $4,000 short-term capital loss and $2,000 ordinary loss D) $0

19)

20) 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) $3,000.

B) $2,500.

C) $5,000.

D) $0.

20)

21) 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) $4,000.

B) $3,000.

C) $8,000.

D) $6,000.

21)

22) 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) $4,000 B) $7,000 C) $0 D) none of the above

22)

4

23) 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) $10,000.

B) $5,000.

C) $6,000.

D) $7,000.

23)

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 B) Plastic Tubes Drip Pipe Drip Pipe $3,375 $5,000 $3,000 $6,000

24)

C) Plastic Tubes $2,250

D) Plastic Tubes $3,000

Drip Pipe $3,750

Drip Pipe $5,000

25) 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) $300,000 B) $0 C) $100,000 D) none of the above

25)

26) What is the definition of "substantially appreciated inventory"?

A) inventory with a FMV greater than 120% of its basis B) inventory and unrealized receivables with a FMV greater than 120% of their basis C) inventory and unrealized receivables with a FMV greater than their basis D) inventory with a FMV greater than its basis

26)

27) 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) A partnership can revoke a Sec. 754 election every 5 years.

D) The Sec. 754 election applies to only current and nonliquidating distributions.

27)

28) Identify which of the following statements is true.

A) 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. B) A liquidating distribution that terminates a partnership interest cannot include more than one distribution.

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.

28)

5

29) A partnership terminates for federal income tax purposes if A) a partnership interest of more than 50% is gifted.

B) state partnership law terminates the partnership.

C) a partner in a two partner partnership sells his interest to the other partner.

D) a general partner who owns a majority interest dies.

29)

30) If a partner dies, his or her tax year closes A) on the day before death.

C) on some other date.

30)

B) on the day after death.

D) on the date of death.

31) 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 Cash Receivables Inventory Building Land Total

Basis $ 20,000 10,000 22,000 80,000 30,000 $162,000

31)

FMV $ 20,000 12,000 28,000 85,000 21,667 $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 basis of Marika and Zoe in the new LM Partnership is: A) Marika B) Marika Zoe Zoe $64,800 $100,000 $66,667 $ 97,200

C) Marika $64,800

D) Marika $66,667

Zoe $ 97,200

Zoe $100,000

32) 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) $4,000 increase B) $7,000 increase C) $4,000 decrease D) 0

32)

33) 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) a recognized gain of $5,000 and a partnership interest basis of $5,000.

C) no recognized gain or loss.

D) a recognized gain of $5,000 and a partnership interest basis of zero.

33)

6

34) The definition of "inventory" for purposes of Sec. 751 includes A) depreciation recapture potential on Sec. 1231 assets.

B) marketable securities not held by dealers.

C) land held for investment.

D) cash.

34)

35) 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) $10,000 capital loss and $20,000 ordinary loss.

D) $2,000 ordinary loss.

35)

36) The ABC Partnership owns the following assets on December 31.

36)

Cash Unrealized receivables Inventory Land (Sec. 1231 asset)

Basis $20,000 0 $20,000 50,000

FMV $20,000 40,000 30,000 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 the inventory is $30,000 while its adjusted basis is $20,000.

C) the FMV of all assets except land is $90,000 while their bases is $40,000.

D) the FMV of the inventory and unrealized receivables is $70,000 while their adjusted bases is $20,000.

37) Identify which of the following statements is true.

A) A partner's holding period for a partnership interest is never considered when determining the holding period for property distributed in a liquidating distribution.

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) 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.

D) All of the above are false.

7

37)

38) 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) The payment for partnership property to a retiring partner is not deductible by the partnership and often not income to the retiring partner.

C) An exchange of partnership interests in different partnerships qualifies under the like-kind exchange rules.

D) All of the above are false.

38)

39) 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 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.

C) The basis of unrealized receivables and inventory distributed by a partnership in liquidation of a partnership interest are never increased above their basis in the hands of the partnership.

D) All of the above are false.

39)

40) 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 B) Parcel One Parcel Two Parcel Two $6,000 $18,000 $3,000 $9,000

40)

C) Parcel One $7,059

D) Parcel One $5,000

Parcel Two $16,941

Parcel Two $12,000

41) The Internal Revenue Code includes which of the following assets in the definition of Sec. 751 properties?

A) capital assets B) cash C) inventory, which is substantially appreciated D) Sec. 1231 assets

41)

42) 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) $9,000 B) $10,125 C) $6,000 D) $10,000

42)

8

43) 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) $0.

B) ($4,000).

C) $5,000.

D) $1,000.

43)

44) 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. 1250 property.

C) recapture potential on Sec. 1245 property.

D) right to payment for services performed by an accrual-basis taxpayer.

44)

45) 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) $100,000 increase in Patrick's share of the basis in the partnership assets B) $300,000 increase in the basis of partnership assets C) $100,000 increase in Patrick's basis in the partnership assets D) $0

45)

46) Identify which of the following statements is true.

A) A partner's individual income tax return, under some circumstances, may include the results of partnership operations for a period exceeding 12-months.

B) 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.

C) 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.

D) The TCJA repealed the so called technical termination of a partnership in which at least 50% interest changed within a 12 month period.

46)

47) For purposes of Sec. 751, inventory includes all of the following except A) accounts receivable.

B) capital assets or 1231 property.

C) items held for sale in the ordinary course of business.

D) All of the above are inventory per Sec. 751.

47)

48) Identify which of the following statements is true.

A) 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.

B) The partner's basis in the partnership interest is normally reduced by the FMV of property distributed in a nonliquidating distribution.

C) 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.

D) All of the above are false.

48)

9

49) When must a partnership make mandatory basis adjustments?

A) on any sale of a partnership interest for $250,000 or more B) 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 C) on any distribution of assets with a value of $250,000 or more D) on any sale of a 20% or greater partnership interest

49)

50) A partnership terminates for tax purposes A) when a partnership tax return (Form 1065) ceases to be filed by the partnership.

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) only when it terminates under local partnership law.

50)

51) Which of the following is a 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) A partnership can reduce its basis in assets upon cash distributions to partners.

C) Partnerships can increase, but not decrease, their basis in partnership assets.

D) Partners are able to increase their basis in the partnership interest upon the sale of a partnership interest.

51)

52) 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) $36,000.

B) $20,000.

C) $15,000.

D) $40,000.

52)

53) 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) AB. B) CD. C) BC. D) none of the partnerships.

53)

54) 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 C corporation.

B) a partnership if it has more than one member.

C) an S corporation.

D) Unable to determine from the facts presented.

54)

10

55) 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.

55)

56) Identify which of the following statements is true.

A) The primary purpose of Sec. 751 is to prevent partnerships from converting capital gains into ordinary income.

B) Unrealized receivables include rights to payments on the sale of a capital asset.

C) 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.

D) All of the above are false.

56)

57) Identify which of the following statements is true.

A) The length of time a partner owns a partnership interest is relevant when determining the holding period for distributed property.

B) A partner's partnership capital account balance cannot be less than zero.

C) 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.

D) All of the above are false.

57)

58) Identify which of the following statements is true.

A) For Sec. 751 purposes, "substantially appreciated inventory" means property held for sale to customers whose market value exceeds its adjusted basis.

B) The depreciation recapture potential for a Sec. 1245 property is not included in the definition of a Sec. 751 asset.

C) Inventory for Sec. 751 purposes includes all property except cash, capital assets, and Sec. 1231 assets.

D) All of the above are false.

58)

59) Identify which of the following statements is true.

A) A partnership is "publicly traded" only if its interests are traded on an established securities exchange.

B) When a partnership is divided into two or more new partnerships, all of the resulting partnerships must be considered new partnerships.

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.

59)

11

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

60) If the transferor partner receives payment for his or her interest in the partnership's Sec. 751 assets, he or she must recognize ordinary income no matter how the transaction is structured.

60)

61) 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.

61)

62) The sale of a partnership interest always results in capital gain or loss rather than ordinary income.

62)

63) A partner's holding period for a partnership interest is never considered when determining the holding period for property distributed in a liquidating distribution.

63)

64) 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.

64)

65) For Sec. 751 purposes, "substantially appreciated inventory" means property held for sale to customers whose market value exceeds its adjusted basis.

65)

66) A partner's holding period for property distributed as a current distribution begins on the date of distribution.

66)

67) A partnership cannot recognize a gain or loss on a current distribution.

67)

68) A partner can recognize gain, but not loss, on a liquidating distribution.

68)

69) 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 basis in the distributed property.

69)

70) 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.

70)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

71) What are the advantages of a firm being formed as a limited liability company (LLC) instead of as a limited partnership?

72) 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?

12

73) The Tandy Partnership owns the following assets on December 31: Assets Cash Unrealized receivables Inventory Land, Sec. 1231 property Total

Basis $20,000 0 20,000 35,000 $75,000

Fair Market Value $ 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.

74) 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?

75) 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?

76) What conditions are required for a partner to recognize a loss upon receipt of a distribution from a partnership?

77) The HMS Partnership, a cash method of accounting entity, has the following balance sheet at December 31 of last year: Assets Cash Accounts receivable Total

Basis $51,000 0 $51,000

Fair Market Value $ 51,000 210,000 $261,000

Equities Notes payable Henry, capital Mark, capital Sam, capital Total

Basis $30,000 7,000 7,000 7,000 $51,000

Fair Market Value $ 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?

13

78) 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 Cash Accounts receivable Inventory Land Total

Basis $30,000 0 15,000 45,000 $90,000

Fair Market Value $ 30,000 20,000 25,000 90,000 $165,000

Equities Notes payable Kate, capital Lynn, capital Mark, capital Total

Basis $30,000 12,000 24,000 24,000 $90,000

Fair Market Value $ 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?

79) 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?

80) 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?

81) The CHS Partnership's balance sheet presented below is prepared on a cash basis at September 30 of the current year.

Assets Cash Accounts receivable Land (capital asset) Total

Basis $12,000 0 63,000 $75,000

Fair Market Value $ 12,000 48,000 90,000 $150,000

Equities Notes payable Cindy, Capital Helen, Capital Sally, Capital Total

Basis $30,000 15,000 15,000 15,000 $75,000

Fair Market Value $ 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?

14

Answer Key Testname: C10

1) A 2) B 3) D 4) A 5) C 6) D 7) C 8) D 9) C 10) A 11) A 12) C 13) A 14) B 15) C 16) D 17) D 18) D 19) B 20) C 21) C 22) A 23) C 24) C 25) B 26) B 27) B 28) C 29) C 30) D 31) A 32) A 33) D 34) A 35) B 36) D 37) A 38) B 39) C 40) C 41) C 42) C 43) C 44) D 45) A 46) D 47) B 48) D 49) B 50) B 15

Answer Key Testname: C10

51) A 52) B 53) B 54) B 55) A 56) D 57) C 58) C 59) C 60) TRUE 61) TRUE 62) FALSE 63) TRUE 64) TRUE 65) FALSE 66) FALSE 67) FALSE 68) FALSE 69) TRUE 70) TRUE 71) From a legal standpoint, all the owners of a limited liability company (LLC) have limited liability for the firm's debts.

In a limited partnership, all general partners have significant liability for firm debts. Under the check-the-box regulations, an LLC can choose whether to be taxed as a partnership or as an association taxed as a corporation. If the LLC chooses partnership taxation, there is virtually no difference between the taxation of the LLC and the limited partnership. $30,000 72) Predistribution basis Minus: money received (cash and FMV of marketable securities) (34,000) Gain recognized $ 4,000 73) For purposes of the substantially appreciated inventory test, both Tandy's unrealized receivables and inventory are included. The "inventories" FMV of $55,000 exceeds 120% of its adjusted basis, $20,000. Therefore, the Tandy Partnership has substantially appreciated inventory.

74) $11,000 - $10,000 cash = $1,000 remaining basis. This basis is assigned to the land.

75) • Should Brown choose to be taxed as a partnership or as a corporation?

• How much will be kept in the business for growth, and how much will be distributed to the owners each year? The larger the percentage of earnings that will be distributed, the more advantageous a flow-through entity such as a partnership can be.

• What is the marginal tax rate for Gene, Susan, and Sandra? If Gene, Susan, and Sandra have lower marginal tax rates than does Brown, partnership status has advantages.

• How should Gene's pay for operating the business be structured? If the business is taxed as a corporation, a generous but reasonable salary will decrease the amount of income subject to double taxation. If the business is structured as a partnership, the partners need to decide whether to structure the payment as distributive share, as an outright guaranteed payment, or whether to establish a guaranteed minimum that may be some combination of the two.

76) A partner can recognize a loss on a distribution only if the distribution is a liquidating distribution that consists of money, unrealized receivables, and inventory. The partner recognizes a loss if the amount of money and the carryover basis of the receivables and inventory are less than the partner's predistribution basis in his or her partnership interest.

77) Amount realized = $77,000 + $10,000 liabilities assumed = $87,000.

Realized and recognized gain = $87,000 - $17,000 = $70,000.

The recognized gain is all ordinary income, since it equals his share of the unrealized receivables.

16

Answer Key Testname: C10

78) Divide the payments between Sec. 736(a) and Sec. 736(b) payments.

Total received ($28,000 + $6,000) Minus: FMV of assets (Sec. 736(b)) Sec. 736(a) payment - guaranteed payment taxable as ordinary income

$34,000 ( 33,000) $ 1,000

Analysis of the Sec. 736(b) payment of $33,000.

Kate is first deemed to receive her share of Sec. 751 assets from the partnership and then immediately sell them to the partnership for cash.

Sec. 751 Assets Amount realized - FMV $ 9,000 Minus: adjusted basis ( 3,000) Ordinary income $ 6,000 The remaining Sec. 736(b) payment of $24,000 ($33,000 - $9,000 deemed paid for the Sec. 751 assets) is analyzed as a liquidating distribution.

Predistribution basis in partnership Minus: Sec. 751 deemed distribution Basis in partnership interest after Sec. 751 transaction Minus: remaining Sec. 736(b) distribution Excess or capital gain to be recognized

$18,000 ( 3,000) $15,000 ( 24,000) $ 9,000

Summary: Kate recognizes a $1,000 guaranteed payment, $6,000 of ordinary income, and a $9,000 capital gain.

79) She has a recognized loss of $26,000 [($20,000 + $24,000) - $70,000]. Her basis in the inventory she receives is $24,000.

80) • The LLC is taxed as a partnership under the check-the-box rules. As such, the basic operating restrictions that are imposed on an S corporation do not apply to an LLC. These include, but are not limited to: a 100 shareholder limit; restrictions on the type of eligible shareholders; a single class of stock; and the limitation on amount of passive income that can be earned by an S corporation.

• The corporate-level taxes imposed on an S corporation, such as the built-in gains tax and excess net passive income tax, do not apply to an LLC. • The loss limitation is larger for an LLC than for an S corporation because of the treatment of general debts incurred by the LLC under the partnership taxation rules.

• All states have enacted LLC laws, so that the problem with a lack of developed legal structure for handling general legal problems has disappeared. The application of basic legal principles to S corporations was no problem since in most cases they followed the basic rules for corporations.

81) No gain or loss is recognized by Cindy or the partnership on the distribution of the Sec. 751 properties, since Cindy received only her proportionate share of the partnership's assets and liabilities and the amount of cash deemed distributed ($14,000 = $4,000 cash + $10,000 release from liabilities) is less than her $25,000 ($15,000 + $10,000 liabilities) basis for the partnership interest.

17

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) 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) An S corporation generally will not owe the built-in gains tax if the corporation has never been a C corporation.

C) The built-in gains tax applicable to S corporations can be avoided if the property is held for ten years.

D) All of the above are true.

1)

2) 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 dividends declared on April 5 of the current year on stock purchased on February 14 of the current year B) collection of interest income earned in the current year on bonds purchased on January 1 of last year C) collection of accounts receivable in the current year that resulted from services performed last year D) None of the above are built-in gains.

2)

3) The passive income test relating to an S corporation election is applied A) quarterly.

B) daily.

C) monthly.

3)

D) annually.

4) Identify which of the following statements is true.

A) Special allocations of ordinary income or loss and separately stated items that are available for partnerships are also permitted with S corporations.

B) 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.

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.

4)

5) Trusts that can own S corporation stock include all of the following except A) grantor trusts.

B) testamentary trusts.

C) charitable remainder unitrusts.

D) QSSTs.

5)

6) Identify which of the following statements is true.

A) An S corporation cannot own 100% of the stock of another S corporation.

B) An S corporation cannot own any stock of another 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.

6)

1

7) 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) three months.

B) six months.

C) one month.

D) two months.

7)

8) Identify which of the following statements is true.

A) 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.

B) Section 444 permits an S corporation to elect to use a fiscal year other than a permitted year.

C) The natural business year for fiscal-year election purposes is any tax year that ends within six months after the peak period of business.

D) All of the above are false.

8)

9) Cactus Corporation, an S Corporation, had accumulated earnings and profits of $100,000 at the beginning of Year 1. Tex and Shirley each own 50% of the stock. Cactus does not make any distributions during Year 1, but had $200,000 of ordinary income. In Year 2, ordinary income was $100,000 and distributions were $100,000. What is Tex's ordinary income for Year 2?

A) $200,000 B) $50,000 C) $100,000 D) $0

9)

10) Which of the following statements about stock ownership is not correct?

A) A tax-exempt charity can own stock of an S corporation.

B) A C corporation can own stock of an S corporation.

C) An S corporation can own stock of a Qualified Subchapter S Subsidiary.

D) An S corporation can own stock of a C corporation.

10)

11) Identify which of the following statements is true.

A) The loss pass-throughs from an S corporation may produce a net operating loss for the shareholder.

B) 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.

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.

11)

12) Which of the following items is not separately stated for an S corporation?

A) charitable contribution B) Section 1245 gain C) dividend income D) short-term capital gain

12)

13) 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) December 15.

B) March 15 of the next year.

C) September 15.

D) June 30 of the next year.

13)

14) Which of the following corporate tax levies are imposed on an S corporation?

A) accumulated earnings tax B) corporate alternative minimum tax C) corporate income tax D) None of these taxes are imposed on an S corporation.

14)

2

15) Identify which of the following statements is true.

A) The S corporation's separately stated items are in general the same ones that apply in partnership taxation.

B) An S corporation cannot claim a dividends-received deduction.

C) An election for an S corporation to use the Sec. 179 expensing election is made by the corporation and not by its shareholders.

D) All of the above are true.

15)

16) 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) An S election will not be terminated due to excess passive income if the corporation does not have Subchapter C E&P. C) A revocation of an S corporation election can be retrospective to any date.

D) All of the above are true.

16)

17) 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) $5,959 B) $6,000 C) $25,000 D) $15,000

17)

18) 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) not make the S election due to two classes of stock.

D) make the S election at any time.

18)

19) Identify which of the following statements is true.

A) The terms "small business corporation" and "S corporation" are synonymous.

B) An S corporation should have a buy-sell agreement to guard itself against an ill-advised sale of its stock.

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.

19)

20) 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 has 30 days to terminate the S election, otherwise the election remains in place for the entire year and all subsequent years.

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 must consent to the S election, otherwise the election terminates at the close of business on May 31.

D) None of the above statements are correct.

20)

3

21) Identify which of the following statements is true.

A) 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.

B) Section 318 stock attribution rules are used to define 2% or more shareholders of S corporation's stock.

C) Fringe benefits limited by the more-than-2%-shareholder rule include stock options, group term life insurance premiums, and medical insurance premiums.

D) All of the above are false.

21)

22) 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) likely treat the termination as inadvertent and will probably approve a continued S election if the corporation distributes the Subchapter C E&P. D) treat the error as such and allow the election to continue unbroken.

22)

23) April Corporation's Subchapter S election was voluntarily terminated for Year 1. The first year that April would be eligible to reelect S corporation status is A) Year 4.

B) Year 2.

C) Year 3.

D) Year 5.

23)

24) Dixon Corporation was incorporated on January 1 fifteen years ago. The corporation made its S election on April 1 three years later. 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) amortization of organizational expenditures B) tax-exempt bond interest income C) long-term capital gains and losses D) ordinary income or loss

24)

25) 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

25)

26) Which one of the following individuals or entities is ineligible to be an S corporation shareholder?

A) resident alien of the United States B) a partnership where all of the partners are U.S. citizens C) a voting trust where all of the beneficiaries are U.S. citizens D) an estate

26)

27) Identify which of the following statements is false.

A) 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.

B) The election form can be signed by a person authorized to sign the S corporation tax return.

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.

27)

4

28) Cactus Corporation, an S corporation, had accumulated earnings and profits of $100,000 at the beginning of Year 3. Tex and Shirley each own 50% of the stock and have a basis in their stock of $50,000 on January 1, Year 3. Cactus does not make any distributions during Year 3, but had $200,000 of ordinary income. In Year 4, ordinary income was $100,000 and distributions were $100,000. What is Tex's basis at January 1, Year 5?

A) $200,000 B) $150,000 C) $100,000 D) $250,000

28)

29) Pressley Corporation was incorporated on January 1 ten years ago. The corporation made its S election on March 1 five years ago. 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) E&P; AAA B) AAA; PTI; E&P C) AAA; OAA; E&P D) AAA; E&P

29)

30) 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) Tax-exempt interest earned by an S corporation is not reported to its shareholders because it is excluded from the shareholders' gross income.

C) 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.

D) All of the above are false.

30)

31) An electing S corporation has a $30,000 ordinary loss for the non-leap 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) $6,000 C) $15,000 D) $10,000

31)

32) 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 be an "ineligible" corporation.

C) The corporation must not have any foreign-sourced income.

D) The corporation must have only one class of stock.

32)

33) 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 next year.

B) October 31 of next year.

C) December 31 of this year.

D) March 15 of next year.

33)

5

34) Identify which of the following statements is false.

A) The AAA represents the cumulative income/loss recognized in post-1982 S corporation years.

B) Tax-exempt income does not increase the AAA but increases the basis of the S corporation stock.

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) The AAA balance can be negative, but the shareholder's basis in the S corporation stock cannot be less than zero.

34)

35) Which of the following would terminate a Subchapter S election?

A) Voting trust becomes a shareholder.

B) Partnership becomes a shareholder.

C) Grantor trust becomes a shareholder.

D) Estate becomes a shareholder.

35)

36) An S corporation is permitted an automatic extension of time for filing its tax return. The automatic extension period is A) six months.

B) two months.

C) three months.

D) one month.

36)

37) 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) October 15 B) September 15 C) July 15 D) March 15 of the next year

37)

38) 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) no limit C) 50% of gross receipts D) 80% of gross receipts

38)

39) 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) Only shareholders who own stock on the date an S election takes effect must consent to the election.

C) S corporation consent by shareholders is binding on the current tax year and all future tax years.

D) All of the above are false.

39)

40) An S corporation is permitted to claim A) the dividends-received deduction.

B) a deduction based on the amortization of organizational expenditures.

C) a net operating loss.

D) a personal exemption.

40)

41) The recognition period for the built-in gains tax extends for how many years after the S election takes effect?

A) five years B) one year C) three years D) ten years

41)

6

42) An S corporation is not treated as a corporate taxpayer with respect to which one of the following fringe benefits?

A) group term life insurance premiums B) stock options C) qualified retirement plans D) nonqualified deferred compensation

42)

43) 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 non-leap year), assuming that a special income allocation election is not made?

A) 254 B) 111 C) 110 D) 255

43)

44) Which of the following conditions will not cause an S election to be terminated?

A) creating a second class of stock having a dividend preference B) failing to file a timely tax return C) selecting an improper tax year D) exceeding the 100-shareholder limit

44)

45) Identify which of the following statements is true.

A) An S corporation can have more than 100 shareholders, since families are treated as a single shareholder.

B) A partnership can be an S corporation shareholder.

C) A nonresident alien can be an S corporation shareholder.

D) All of the above are false.

45)

46) 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) $40,000 D) $50,000

46)

47) 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) a charitable remainder unitrust.

B) a testamentary trust.

C) a small business trust.

D) her estate.

47)

48) Identify which of the following statements is true.

A) A testamentary trust can be converted into a QSST trust.

B) A trust can own S corporation stock and have a C corporation as a beneficiary as long as the corporation is the sole beneficiary.

C) 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.

D) All of the above are false.

48)

7

49) Identify which of the following statements is false.

A) 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.

B) 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.

C) A shareholder's S corporation stock basis will increase when the shareholder acts as guarantor on a corporate indebtedness.

D) Debt basis is restored before stock basis.

49)

50) 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 (Y5).

The election must be made by ________ (assuming permission can be obtained to continue using the fiscal year from the IRS).

A) September 15 of the current year (Y5) B) June 30 of the next year (Y6) C) September 15 of the next year (Y6) D) June 30 of the current year (Y5)

50)

51) 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) yes, if Helmut and Nils agree to file a short-period return and Sergei also agrees to the return B) not for the current year but for the next year C) yes, if Helmut and Nils agree to report all of the corporation's income for the entire year D) yes, if Sergei will also join in the election with Helmut and Nils

51)

52) Identify which of the following statements is true.

A) Allocation of tax preference items for AMT generally occurs on a daily basis.

B) An S corporation may be subject to the corporate alternative minimum tax.

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.

52)

53) Cactus Corporation, an S Corporation, had accumulated earnings and profits of $100,000 at the beginning of Year 1. Tex and Shirley each own 50% of the stock. Cactus does not make any distributions during Year 1, but had $200,000 of ordinary income. In Year 2, ordinary income was $100,000 and distributions were $100,000. What is Tex's ordinary income for Year 1?

A) $0 B) $100,000 C) $50,000 D) $200,000

53)

54) Identify which of the following statements is false.

A) An S corporation that owes the built-in gains tax or the excess net passive income tax must make quarterly estimated tax payments.

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 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.

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.

54)

8

55) Identify which of the following statements is false.

A) 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.

B) A C corporation short-year income tax liability must be determined on an annualized basis.

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.

55)

56) 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 payments are refundable if the S election is terminated.

C) The Sec. 444 payment is allocated ratably to each shareholder and claimed as a tax payment on their own tax return(s).

D) The Sec. 444 payments must be made quarterly on the same dates that the S corporation's estimated tax payments are otherwise due.

56)

57) Which one of the following special loss limitations applies to an S corporation?

A) passive activity limitation rules B) at-risk rules C) hobby loss rules D) All of the above apply.

57)

58) 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 permit restoration of the S election only if the event causing the termination was not within the control of the corporation.

C) will permit restoration of the S election if a majority of the shareholders consent to the reinstatement.

D) will not permit the corporation to restore its S election until the completion of a five-year waiting period.

58)

59) 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) 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.

C) 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.

D) All of the above are true.

59)

60) Identify which of the following statements is true.

A) 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.

B) A majority of shareholders must consent to the S corporation election.

C) Convertible debt issues might be considered "stock" for purposes of the S corporation single class of stock requirement.

D) All of the above are false.

60)

9

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

61) 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.

61)

62) Up to six generations of a family are considered as one shareholder for purposes of the 100-shareholder limit.

62)

63) By electing to use the S corporation's tax accounting method to allocate profits or losses between the C short year and S short year in the termination year, the corporation can shift losses into an S short year where the shareholders obtain an immediate benefit at a marginal tax rate of up to 37%, or it can shift profits into a C short year to take advantage of the 21% corporate tax rate.

63)

64) A corporation must make an S election for the current year after March 15 in the case of a calendar-year corporation.

64)

65) All shareholders must consent to the revocation of S status.

65)

66) Even if the termination of an S election is considered to be inadvertent, the election to terminate is irrevocable.

66)

67) A testamentary trust can be an S shareholder for two years, beginning on the date the stock transfers to the trust.

67)

68) As a general rule, the S corporation's ordinary income or loss and separately stated items are allocated based on the amount of stock owned by each shareholder on each day of the S corporation's tax year.

68)

69) 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.

69)

70) 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.

70)

71) The election of Subchapter S status by a corporation is valid only if all shareholders consent to the election.

71)

72) Corporations and partnerships can be S corporation shareholders.

72)

73) Fringe benefits paid to an S corporation shareholder employee with 2% or more ownership are non-deductible by the S corporation unless taxable to the shareholder employee.

73)

74) S-corporation shareholder employees with 2% or more ownership must include educational assistance program fringe benefits as part of their taxable income.

74)

75) S shareholders cannot increase the basis of their stock by a ratable share of the general S corporation liabilities.

75)

10

76) Tax-exempt interest earned by an S corporation is not reported to its shareholders because it is excluded from the shareholders' gross income.

76)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

77) 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?

78) 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?

79) Power Corporation reports the following results: Service income (not passive income) Dividend income Interest income Passive income-related expenses Other expenses

$40,000 30,000 60,000 20,000 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?

80) Chuck Corporation reports the following results for this year: Service (nonpassive) income Dividend income Interest income Passive income-related expenses Other expenses

$17,500 18,500 14,000 5,000 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.

81) 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?

11

82) Connie's Restaurant has been an S corporation since it was formed in 2006. Its results for the previous year are as follows: Sales Supplies Salaries Depreciation Interest on business loan Charitable contributions Advertising Utilities expense Property taxes Gain on the sale of investment land (long-term)

$200,000 90,000 50,000 5,000 1,000 3,000 4,000 6,000 1,000 8,000

What are Connie's separately stated items? What is the S corporation's ordinary income?

83) 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?

84) If losses are suspended due to the lack of basis in S corporation stock, do the losses expire when the S election terminates?

85) 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?

86) 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?

87) Rocky Corporation, an S corporation, reports the following results for the current year: Ordinary income Long-term capital gain Municipal bond interest income Domestic corporate dividends Charitable contributions

$70,000 20,000 10,000 6,000 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.

88) 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?

12

89) What is a permitted year?

90) 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?

91) 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?

92) Potter Corporation reports the following results for the current year: Operating income Dividend income Interest income Other expenses Passive income-related expenses

$40,000 35,000 25,000 25,000 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?

93) 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?

94) List and discuss five advantages and five disadvantages of electing to be taxed as an S corporation over a C corporation or a partnership.

95) 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)?

96) 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?

97) 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?

13

98) 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?

99) 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?

100) Robert Elk paid $100,000 for all of the single class of stock of Elkom Corporation, an electing S corporation, when incorporated in January Year 1. Elkom's operating results and dividend distribution are as follows: Tax Year Ending Year 1 Year 2 Year 3

Ordinary Income ($40,000) 60,000 30,000

Distribution

$20,000 (9/30)

What is Elk's basis for his Elkom stock on December 31 of 2019?

101) Can loss or credit carryforwards from a previous C corporation tax year help reduce the built-in gains tax?

102) 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?

103) 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?

104) 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?

105) 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?

106) 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?

14

107) Martha, a U.S. citizen, owns 40% of the stock of George Corporation, an electing S corporation. At the time of her death this year, the George stock passes to her estate. The stock is subsequently transferred to a trust provided for in Martha's will. Can the testamentary trust hold the George stock for a two-year period before the S election is terminated?

15

Answer Key Testname: C11

1) D 2) C 3) D 4) C 5) C 6) C 7) A 8) B 9) B 10) B 11) A 12) B 13) B 14) D 15) D 16) B 17) B 18) D 19) B 20) D 21) A 22) C 23) D 24) B 25) C 26) B 27) A 28) B 29) D 30) D 31) C 32) C 33) B 34) C 35) B 36) A 37) B 38) B 39) C 40) B 41) A 42) A 43) B 44) B 45) A 46) A 47) A 48) A 49) C 50) A 16

Answer Key Testname: C11

51) D 52) A 53) B 54) C 55) C 56) B 57) D 58) A 59) D 60) C 61) TRUE 62) TRUE 63) TRUE 64) FALSE 65) FALSE 66) FALSE 67) TRUE 68) TRUE 69) TRUE 70) TRUE 71) TRUE 72) FALSE 73) TRUE 74) FALSE 75) TRUE 76) FALSE 77) If Swamp revokes its S election before March 16 of the current year and has the election terminated at the close of business on December 31 of the previous year, the S election is retroactively revoked to January 1 of that year. If the revocation election is made after March 15 of the current year, it does not take effect until January 1 of next year.

Swamp may also specify a prospective current-year revocation date as long as the date specified is on or after the date the revocation is made.

78) Basis = $50,000 + $60,000 + $10,000 - $5,000 - $20,000 = $95,000. The distribution is tax-free since the $115,000 predistribution basis exceeds the amount distributed.

79) The excess net passive income is: {[$30,000 + $60,000 - $20,000] × [$90,000 - (0.25 × $130,000)]/$90,000} = $44,722.

80)

The excess net passive income tax is: $44,722 × 0.21 = 9,392.

Excess net passive income

=

Net passive income

$16,923 = ($32,500 - $5,000) ×

×

Passive investment income - 25% of gross receipts Passive investment income

$32,500 - 25%($50,000) $32,500

17

Answer Key Testname: C11

81) What is Troy's allocable share of the Dot.Com ordinary loss?

• What portion of the loss is limited by the basis of the S corporation stock and debt? The at-risk rules? The passive activity loss rules? The hobby loss rules?

• If his use of the loss is limited only by the basis of the S corporation stock and debt, should Troy invest additional amounts before year-end to increase the basis of the stock and/or debt? When should such an investment be made?

Before year-end? After year-end? Should he not make an additional investment and use the loss against future profits?

Troy should anticipate a $437,500 ordinary loss pass-through, which exceeds his $300,000 basis for the Dot.Com stock.

The additional investment should be made only if it is economically wise. Even if Troy makes the additional investment, he still might not be able to deduct the loss. The passive activity loss rules may deny the loss until Troy has passive income from this or another activity or until he completely disposes of his investment. The tax year to make the additional investment, and deduct the loss, will be the year in which Troy anticipates the highest marginal tax rate (discounted for the time value of money.)

82) The separately stated items, other than ordinary income, are the long-term capital gain of $8,000 and the charitable contributions of $3,000. The S corporation ordinary income is calculated as follows: Sales $200,000 Supplies 90,000 Salaries (employees) 50,000 Depreciation 5,000 Interest on business loan 1,000 Advertising 4,000 Utilities expense 6,000 Property taxes 1,000 157,000 Ordinary income $43,000 83) Olga, Garret, and Hans must consent to the election. If Olga refuses to consent to the election, the election will not begin until next year.

84) No. These loss carryovers may be deducted in the post-termination transition period if the shareholder creates additional stock basis in that period of time.

85) Zinc can earn an unlimited amount of passive income during a tax year because it has never been taxed as a C corporation and has no Subchapter C E&P. 86) • What gain or loss does Cook's Outlet recognize on making the distribution? Does the gain or loss trigger any built-in gains tax liability? Excess net passive income tax liability?

• What is each shareholder's basis for the Cook's Outlet stock immediately preceding the distribution?

• What basis reduction does the distribution cause for each shareholder? Does the basis reduction trigger the recognition of any income by the shareholder (e.g., if the distribution reduces the shareholder's basis to zero)?

• What is each shareholder's basis for the Cook's Outlet stock immediately following the distribution?

• What is each shareholder's basis and holding period for the land received?

Cook's Outlet will recognize a $150,000 ($200,000 - $50,000) gain on the distribution. This gain may be subject to the Sec. 1374 or Sec. 1375 tax, but insufficient facts are provided to make such a determination. This gain and Cook's Outlet's ordinary income from operations will flow through to the shareholders and increase their stock bases. Davis and Dane take $315,000 ($150,000 + $75,000 + $90,000) and $340,000 ($175,000 + $75,000 + $90,000) bases, respectively, assuming no corporate-level taxes are imposed. Each shareholder will reduce his basis by $100,000 (0.50 × $200,000) for the distribution.

18

Answer Key Testname: C11

87) The basis of the shareholder's stock is increased to $210,000 ($120,000 + $70,000 + $20,000 + $10,000 + $6,000 - $16,000)

by Rocky's current year operations.

Rocky's AAA balance before any current year distributions is $160,000 ($80,000 + $70,000 + $20,000 + $6,000 - $16,000). $80,000 {[$100,000/($100,000 + $100,000)] × $160,000 = $80,000} of each distribution comes from Rocky's AAA and is tax-free because the $160,000 amount coming from AAA is less than the $210,000 basis of the Rocky stock.

The remaining $20,000 of each distribution comes from Rocky's accumulated E&P and is a taxable dividend. This portion of the distribution does not reduce the basis of the stock. The year-end accumulated E&P is $10,000.

In addition, Rocky has a $10,000 balance in its Other Adjustments Account from the current year tax-exempt income.

This amount is not a separate earnings pool for distribution purposes, but is reflected in the shareholder's stock basis.

The basis of the Rocky stock is $50,000 at year-end ($210,000 - $160,000).

88) Ordinary income is $45,000 and long-term capital gain income is $10,000.

89) A permitted year is defined as a taxable year ending on December 31 (including a 52-53 week year) or any fiscal year for which the corporation established a business purpose. $ 30,000 90) 1/1 Adjusted basis Plus: dividend income 5,000 tax-exempt income 15,000 $ 50,000 Minus: ordinary loss ( 30,000) LTCL ( 20,000) STCL ( 30,000) 12/31 Tentative basis ($30,000)

Only $50,000 of the $80,000 total loss can be used, and the stock basis goes to $0. A $30,000 carryover is composed of ratable portions of each of the three types of losses.

91) Basis adjustments for distributions made by an S corporation during the tax year are taken into account before applying the loss limitation. Distributions reduce the adjusted basis for determining the allowable loss, but the loss does not reduce the adjusted basis for determining the tax status of distributions.

Basis Long-term capital gain Minus: distribution Postdistribution basis

$40,000 10,000 (50,000)* $0

*Distributions cannot reduce basis below zero. The $5,000 excess distribution is a long-term capital gain.

Dividends 92) $35,000 25,000 Interest $60,000 Gross passive income ( 20,000) Minus: related expenses $40,000 Net passive income

Excess net passive income =

$60,000 - (0.25 × $100,000) × $40,000 = $23,333 $60,000

19

Answer Key Testname: C11

$100,000 93) 1/1 Basis Plus: gain on distribution 10,000 ordinary income 40,000 Predistribution basis $150,000 Minus: distribution ( 50,000) 12/31 Basis $100,000 94) Some of the advantages and disadvantages which might be included in the answer are: Advantages: • The corporation's income is exempt from the corporate income tax.

• The corporation's losses are passed through to the shareholders.

• Undistributed income that has been taxed to the shareholder is not taxed again when subsequently distributed.

• Capital gains dividends and tax-exempt income are separately stated and pass through to the shareholders.

• Deductions, losses, and tax credits are separately stated and passed through to the shareholders.

• S corporations are not subject to the alternative minimum tax.

• S corporations are not subject to the personal holding company tax.

• S corporations are not subject to the accumulated earnings tax.

• S corporations profits are not subject to SE tax similar to a partner of a partnership.

• S corporations may split income between family members.

Disadvantages: • A C corporation is treated as a separate tax entity and can use the 21% tax bracket.

• S corporation earnings are taxed to the shareholder even if not distributed.

• S corporations are subject to an excess net passive income tax, LIFO recapture tax, and built-in gains tax.

• Dividends received by the S corporation are not eligible for the dividends-received deduction.

• Allocation of income and loss is based on stock owned on each day of the tax year. Special allocations are not permitted.

• The loss limitation is smaller for an S corporation than a partnership because of the treatment of general debts incurred by the S corporation.

• An S corporation and its shareholders are subject to the at-risk, passive activity, and hobby loss limitations with respect to their loss and deduction pass-throughs.

• An S corporation is restricted in the type and number of shareholders allowed and types of investments that can be made.

• S corporations are generally restricted to using a calendar year as their tax year.

The advantages and disadvantages are summarized on pages C:11-3 and C:11-4.

95) He must report $5,000 ordinary income and $4,000 ordinary loss.

Last year: Basis of stock Basis of debt Total basis Minus: loss utilized Basis of stock and debt Loss carryover to current year

$32,000 4,000 $36,000 ( 36,000) 0 $ 4,000

Current year: Ordinary income earned $5,000 Loss carryover from last year (4,000)

20

Answer Key Testname: C11

96) 1/1 Basis Minus: Year 1 loss 12/31 Basis Plus: Year 2 income 12/31 Basis Amount realized Minus: adjusted basis Capital gain

Stock $50,000 ( 50,000) 0 0 0

Debt $30,000 ( 25,000) $ 5,000 10,000 $15,000 $30,000 ( 15,000) $15,000

97) Yes, Bellows Corporation can immediately apply for reelection of S corporation status because more than 50% ownership change has occurred since the date of termination.

98) $110,000 × 0.21 = $23,100 99) The questions listed below are based on the presumption that an S election is going to be advantageous and that the S corporation is in fact the best entity choice for the corporation.

• What procedures must be followed to make an S election?

• By what date must the corporation make the election?

• What format does the election take?

• What consents are required of the shareholders?

• What tax year should the S corporation elect? Does this tax year have to be the same tax year used by the C corporation?

• What accounting methods should the S corporation elect? Do these accounting methods have to be the same accounting methods used by the C corporation?

• What possible built-in gains tax liability will be incurred while an S corporation?

• Should the corporation obtain an appraisal of the assets as of the first day of the S election?

• What tax attributes (e.g., NOLs and capital losses) will be suspended as a result of making the S election?

• What possible excess net passive income tax liability will the S corporation incur?

• Should the corporation consider distributing its Subchapter C E&P to eliminate this tax liability?

• What possible LIFO recapture tax liability will the corporation incur in its final C corporation tax year?

The corporation must file an S election (Form 2553) in a timely manner, and the appropriate consents must be obtained from the shareholders. The S corporation cannot automatically use a tax year different from the C corporation, but it may have to change to a required tax year. The S corporation must continue to use the accounting methods the C corporation has used.

A built-in gains tax liability will be imposed on asset dispositions occurring within ten years of the first day of the S election period. An appraisal is suggested to establish the amount of the built-in gains and losses to minimize the built-in gains tax liability. C corporation NOLs and net capital losses can reduce the built-in gains tax liability but cannot pass through to the shareholders. In addition, if the S corporation has Subchapter C E&P, it may incur the excess net passive income tax liability if it earns a substantial amount of passive income. Also, the S corporation may incur the LIFO recapture tax if it used the LIFO inventory method in its final C corporation tax year.

100) $100,000 - $40,000 + ($60,000 - $20,000) + $30,000 = $130,000.

Last year's distribution is tax-free since Elk's basis for his stock is $120,000 ($100,000 - $40,000 + $60,000) at the end of last year before any reduction for the distribution.

21

Answer Key Testname: C11

101) Yes. Both NOL and capital loss carryforwards reduce the amount of recognized built-in gains taxed under Sec. 1374.

The general business and minimum tax credit carryforwards reduce the actual built-in gains.

102) Ordinary income, $6,400 (0.10 × $64,000).

Short-term capital gain, $1,600 (0.10 × $16,000).

The distribution does not result in any income or gain being recognized since it does not exceed any shareholder's basis for their stock.

103) Yes, since Shamrock Corporation is treated as having only one class of stock outstanding.

104) $90,000 × 0.50 = $45,000 105) [$50,000 + ($16,000 × 0.25 × 90/360) + ($32,000 × 0.25 × 90/360)] = $53,000.

Amount realized Minus: Adjusted basis Recognized gain (long-term capital gain)

$56,000 ( 53,000) $ 3,000

22

Answer Key Testname: C11

106) • Does the incorporation transaction qualify as tax-free under Sec. 351?

• Are there advantages to be gained by transferring the partnership's assets to the corporation in exchange for its stock and then liquidating the partnership?

• Are there advantages to be gained by first liquidating the partnership and then transferring the assets to the corporation in exchange for its stock?

• What are the amount and character of the gain or loss recognized on the incorporation by the partnership? The S corporation? The partners?

• What is the basis of the assets to the S corporation?

• What is the basis of the S corporation stock to each shareholder?

• When does the holding period start for the assets? The S corporation's stock?

• What tax year should the corporation elect? Does this tax year have to be the same tax year used by the partnership?

• What accounting methods should the corporation elect? Do these accounting methods have to be the same accounting methods used by the partnership?

• What procedures must be followed to make an S election?

• By what date must the corporation make the election?

• What format does the election take?

• What consents are required of the shareholders?

One underlying question that might be brought up is: Should the tax practitioner and the transferor consider using an LLC instead of an S corporation?

The method of incorporation does matter. In fact, the entity making the selection does not have to be a corporation.

Under the check-the-box regulations, a noncorporate entity can elect to be taxed as a corporation and then make a selection. The tax consequences (gain recognized, basis amounts, etc.) can be different depending on which of the three basic methods are used to terminate the partnership and transfer the assets to the corporation. The three methods are: (1) the partnership transfers assets to the corporation in exchange for stock, and the partnership transfers the stock to its partners in liquidation; (2) the partnership transfers assets to its partners in liquidation, and the former partners transfer the assets to the corporation in exchange for stock; and (3) the partners transfer their partnership interests to the corporation in exchange for stock, and the partnership transfers the assets to the corporation in liquidation.

Without further information, the gain and basis amounts cannot be determined, nor can we say which of the three ways is best. The S corporation can use a tax year different from the partnership, but it does have to be a required year.

Likewise, the S corporation can elect any accounting method that it chooses, without regard to the method employed by the partnership. The corporation must file an S election (Form 2553) in a timely manner and the appropriate consents must be obtained from the shareholders. A transfer of assets from a partnership to an LLC is covered by rules different from a corporate formation (see Chapter C10).

107) The trust can hold the S corporation stock for an indefinite period of time only if the trust's income beneficiary makes an election to have it treated as a QSST or small business trust. Otherwise, the S election will be terminated at the end of the two-year period.

23

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) 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 loss.

C) $1,000 gain.

D) none of the above

1)

2) 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) $0.

B) $60,000.

C) $50,000.

D) $100,000.

2)

3) A Sec. "2503(c) trust" A) is intended for beneficiaries over the age of 20.

B) can be formed only by the parent(s) of the beneficiaries.

C) requires distribution of trust assets to the beneficiary at age 21.

D) is a discretionary trust for a beneficiary of any age.

3)

4) A husband transfers $90,000 by gift directly to his wife. The marital deduction for the transfer is A) $90,000.

B) $0 unless he elects to claim one.

C) $71,000.

D) none of the above.

4)

5) 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) $0.

C) $170,000.

D) $120,000.

5)

6) 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) Exercising a general power of appointment constitutes a gift.

C) Vonda makes a $100,000 gift to Rick.

D) Tia has made a gift of $100,000 to Vonda.

6)

7) Identify which of the following statements is false.

A) A gift occurs when a revocable trust is funded.

B) Transfers to an irrevocable trust can be deemed incomplete.

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) A gift does not occur until the transfer is complete.

7)

1

8) Identify which of the following statements is true.

A) Prospective donors should not dispose of property that has declined in value by selling it rather than gifting it.

B) 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.

C) A $18,000 annual exclusion per donee is available for both gift tax and estate tax purposes.

D) All of the above are false.

8)

9) 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) George's transfer of property to the trust is a gift of a future interest.

B) George's transfer of property to the trust is not taxed under gift tax rules at the date of transfer.

C) The transfer by George is eligible for the annual gift tax exclusion.

D) The beneficiaries receive a present interest in the trust property when George transfers the assets to the trust.

9)

10) Vincent makes the following property transfers in the current year:

10)

• • • • •

$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 a political 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) $0.

B) $3,000.

C) $19,500.

D) $19,000.

11) Gloria makes the following gifts during the year:

11)

$19,000 cash to her son, Andy Stock with a basis of $10,000 and a $36,000 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) $53,000 B) $121,000 C) $17,000

D) $95,000

12) Identify which of the following statements is true.

A) A present interest is an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property.

B) 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.

C) The gift tax exclusion is available only for a gift of a present interest.

D) All of the above are true.

2

12)

13) Identify which of the following statements is true.

A) 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.

B) A taxable gift may occur when property is sold in an arm's length transaction for less than its FMV. 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.

13)

14) The computation of the gift tax liability for a current year A) requires knowledge of the total gift taxes paid in previous years.

B) requires the use of current-year tax rates only.

C) is made without reference to previous years.

D) requires the use of different rates, depending on when the gifts were made.

14)

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) $260,000.

B) $300,000.

C) $140,000.

D) $520,000.

15)

16) Identify which of the following statements is true.

A) One of the tests that a qualified disclaimer must meet is that it must be an irrevocable, unqualified, written refusal to accept property.

B) An individual making a qualified disclaimer can determine to whom the disclaimed property will pass.

C) 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.

D) All of the above are false.

16)

17) Which of the following statements is true?

A) 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.

B) Gift tax returns are due March 15 in the year following the gift.

C) If the donor does not pay the gift tax, the donee is personally liable for the tax.

D) When a married couple elects gift splitting, each spouse is potentially liable for 50% of the gift tax.

17)

18) 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) a $14,000 loss.

B) no loss.

C) a $4,000 loss.

D) none of the above

18)

19) Why are Crummey trusts popular for minors?

A) Donors are only subject to the gift tax when funds are distributed from Crummey trusts.

B) They are considered gifts of a present interest, permitting an annual gift tax exclusion.

C) They are considered gifts of a future interest and allow the donor to take an exclusion.

D) Crummey trusts require annual distributions to minors.

19)

3

20) A split-interest gift transfer A) cannot qualify for a deduction if a future interest is given to a charitable organization.

B) qualifies for a charitable contribution deduction if the recipient charity receives a guaranteed annuity, which is a present interest.

C) involves two public (charitable) organizations.

D) involves two present interests.

20)

21) Identify which of the following statements is false.

A) 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.

B) The interpolated terminal reserve is similar to a life insurance policy's cash surrender value.

C) The payment of premiums on an insurance policy that is owned by another does not constitute a gift.

D) A gift occurs when the owner of an insurance policy irrevocably assigns all ownership rights in the policy to another.

21)

22) 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) $0.

B) $1,500 loss.

C) $1,000 gain.

D) none of the above

22)

23) Identify which of the following statements is false.

A) Transfers of community property are eligible for the marital exclusion.

B) 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).

C) The marital deduction is generally allowed since the transfer remains within the economic (husband/wife) unit.

D) The marital deduction for gift tax purposes is limited to one-half the value of the property transferred.

23)

24) 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) $12,000.

C) $24,000.

D) $0.

24)

25) A gift-splitting election A) results in a $7,500 per donee annual exclusion for each spouse.

B) is binding on future years.

C) requires each spouse to give property.

D) may reduce the amount of the taxable gifts of the donor-decedent.

25)

26) 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) Crummey trust.

B) Clifford trust.

C) 2503(c) trust.

D) none of the above.

26)

4

27) 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) For transfer tax purposes, both the charitable contribution deduction and the marital deduction are unlimited.

C) Individuals may not give more than $14,000 per person in gifts each year before being taxed on the transfer.

D) All of the above are false.

27)

28) 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 next year.

B) April 15 of the current year.

C) December 31 of the current year.

D) nine months after his date of death.

28)

29) 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 $30,000 per year. Sandra contributes $30,000 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) $12,000.

B) $0.

C) $15,500.

D) $34,000.

29)

30) 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) $40,000.

B) $90,000.

C) $120,000.

D) cannot be determined from the facts given

30)

31) Identify which of the following statements is true.

A) Since municipal bond interest is exempt from federal income taxation, gifting the bonds escapes the gift tax.

B) The creation of a joint bank account constitutes a taxable gift.

C) 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.

D) The naming of a life insurance policy beneficiary constitutes a gift for transfer tax purposes.

31)

32) Identify which of the following statements is true.

A) The gift tax is not a part of the unified transfer tax system.

B) The gift tax is a wealth transfer tax that applies to transfers during a person's lifetime and transfers at death.

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.

32)

5

33) 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) Ned has made a gift to Martha of $500.

B) Martha has made a gift to Ned of $600.

C) Martha has made a gift to Ned of $1,000.

D) Martha has made a gift to Ned of $100.

33)

34) Which of the following transfers is subject to the gift tax?

A) Julia establishes a trust benefiting her nieces and nephews. Julia will determine the amount of any distributions made.

B) Matilda contributes $5,000 to a Senate candidate's political organization.

C) Lance purchases land, titling it in the names of Lance and Sheryl, joint owners.

D) Frank gives $30,000 to a lobbying group promoting stricter environmental regulations.

34)

35) Identify which of the following statements is false.

A) Receipt of an extension of time for filing a gift tax return does not extend the due date for payment of the gift tax.

B) Gift tax returns are due annually by April 15 following the year of the gift. No extensions are allowed.

C) The donor pays the gift tax generally.

D) Gift tax returns are filed on a calendar-year basis.

35)

36) In Year 1, 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 Year 1 gift is A) $189,000.

B) $0.

C) $200,000.

D) $800,000.

36)

37) In the current year, Letty makes taxable gifts totaling $4 million. Her only other taxable gifts amount to $1 million, all of which were made in three years ago. What is Letty's current year gift tax liability before the unified credit?

A) $1,600,000 B) $1,875,000 C) $1,840,800 D) $2,220,800

37)

38) A Crummey trust A) provides the donor with the ability to retrieve the property.

B) allows the donor an annual exclusion for transfers.

C) receives property that is not eligible for the annual exclusion.

D) prohibits the beneficiary from withdrawing assets.

38)

39) On January 1, Jeff loans his friend Patrick $7,000 to buy a used car. Patrick signs a noninterest-bearing demand note. The applicable interest rate is 5%. Which of the following statements is correct?

A) Jeff has made a gift to Patrick that is not taxable since it is less than $11,000.

B) Jeff has made a taxable gift to Patrick of $3,500.

C) Jeff must report interest income of $3,500 from Patrick.

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.

39)

6

40) Which of the following statements is true?

A) If the donor retains the power to change the trust beneficiary, the gift is complete.

B) Transfers to an irrevocable trust can be deemed incomplete due to powers retained by the grantor.

C) Transfers to a revocable trust are completed gifts.

D) All of the above are false.

40)

41) Interest-free or below-market loans A) must always have interest imputed on them.

B) result in treating the entire loan proceeds as a gift.

C) may result in treating the borrower as paying interest.

D) will always result in at least $1,000 of interest income being imputed.

41)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

42) The gift tax is a wealth transfer tax that applies to transfers during a person's lifetime and transfers at death.

42)

43) The annual exclusion permits donors to make gifts of $19,000 each to multiple donees.

43)

44) 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.

44)

45) Molly sells her car, valued at $30,000, to her nephew Todd for $18,000. Molly has made a gift subject to gift tax before annual exclusion or unified tax credit.

45)

46) 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.

46)

47) 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.

47)

48) Gift tax returns are filed on a calendar-year basis.

48)

49) 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.

49)

50) The changing of a life insurance policy beneficiary from a spouse to an adult daughter constitutes a gift for transfer tax purposes.

50)

51) The purchase of a $20,000 engagement ring generates a taxable gift necessitating the filing of a gift tax return.

51)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

52) 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?

53) Discuss the ways in which the estate and gift tax system is a unified system.

7

54) Describe the penalties for undervaluing gifts on a gift tax return.

55) Discuss the negative aspects of gifts.

56) What is a "net gift" and what is the potential income tax problem associated with making a net gift?

57) What is the due date for the gift tax return? Are there any exceptions? If so, what are they?

58) Bryce pays $40,000 for his adult grandson's tuition at medical school and $20,000 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?

59) Husband and Wife gift their son a home with a FMV of $80,000 they purchased ten years ago for $45,000. Husband and Wife elect to gift split the property. How much does each party have to report on Form 709 to the IRS? 60) 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?

61) 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?

62) Discuss at least two reasons for making inter vivos (lifetime) gifts.

8

Answer Key Testname: C12

1) C 2) D 3) C 4) C 5) A 6) A 7) A 8) B 9) A 10) B 11) C 12) D 13) A 14) B 15) C 16) A 17) C 18) C 19) B 20) B 21) C 22) A 23) D 24) B 25) D 26) A 27) B 28) D 29) D 30) A 31) C 32) C 33) D 34) C 35) B 36) C 37) A 38) B 39) D 40) B 41) C 42) FALSE 43) TRUE 44) FALSE 45) TRUE 46) FALSE 47) FALSE 48) TRUE 49) TRUE 50) FALSE 9

Answer Key Testname: C12

51) TRUE 52) Marian's unified credit is reduced by $6,000 (20% of $30,000). Her death tax base does not include her 1976 gifts.

53) The same tax rates apply for both gift and estate tax purposes. Taxable gifts made subsequent to 1976 affect the estate tax base and, consequently, the rates at which the estate is taxed. The same unified credit is used for both gift and estate tax purposes. For 2025, the exclusion is $13,990,000 with a unified credit amount of $5,541,800. These amounts are annually indexed for inflation and will apply through 2025.

54) Sec. 6662 imposes a penalty, at one of two rates, on underpayment of gift or estate taxes resulting from too low a valuation of property. The penalty is imposed on the amount of the transfer tax understatement. If the valuation shown on the tax return exceeds 65% of the valuation determined upon audit or court trial, there is no penalty. If the value reported on the return is 65% or less of the correct value, the penalty rate is: Ratio of value per return to correct value More than 40% but 65% or less 40% or less

Penalty rate 20% 40%

A taxpayer is exempt from the penalty if the underpayment is less than $5,000. The IRS will not levy the penalty if the taxpayer shows good faith and reasonable cause.

55) The donor loses complete control of the asset prior to death. The step-up in basis permitted at death is not available when gifts are made. The step-up in basis may not be significant if the donee has no intention of selling the asset. Also, the step-up in basis is not as significant if the asset is not depreciable. The gift tax is actually an early payment of the estate tax; thus, the donor loses the use of the cash used to pay the gift tax. Such cash, however, is excluded from the donor's estate, thus reducing the estate tax.

56) A potential donor who wants to freeze a property's value but who lacks sufficient liquid assets to pay the gift tax might be interested in making a net gift (a transfer in which the donee agrees to pay the gift tax as a condition of receiving the gift). The donor of a net gift must recognize a gain if the gift tax the donee pays exceeds the adjusted basis of the property transferred.

57) Gifts always are reportable on a calendar-year basis. The due date for a gift tax return generally is April 15th of the year following the year in which the donor made the gifts, even if the donor reports on a fiscal year for income tax purposes. If the donor dies during the year, the gift tax return must be filed no later than the due date for the estate tax return (nine months after the date of death). If an extension is requested for filing the donor's individual income tax return, an extension until October 15 also is granted for filing the gift tax return.

58) Section 2503(e) exempts the payment of tuition from being treated as a gift. The room and board payments are a gift to the grandson but after the $19,000 annual exclusion, he has a taxable gift of $1,000.

59) Each spouse has to report $21,000 on Form 709 to the IRS. $80,000 - (19,000 * 2) / 2 = $21,000 has to be reported.

60) • Do the estate freeze rules apply to this transaction?

• If they do, what is the amount of the deemed gift from Jason to Paula?

• What is the significance of the 6.5% income yield?

The estate freeze rules of Sec. 2702 do apply to this transaction. Jason makes a transfer for the benefit of a family member (a daughter) and retains an interest in such trust. His retained interest, however, is not an annuity interest or a unitrust interest (a specified percentage of the fair market value of the trust assets, as redetermined annually).

Because Jason did not keep an annuity interest or a unitrust interest, the value of his retained interest is treated as being zero. Thus, he is deemed to have made a gift to Paula of the total value, or $1.5 million.

If Jason had kept an annuity interest or a unitrust interest, the Sec. 7520 10% interest rate would have been used to value his interest. The actual income yield of 7.5% would not be relevant in arriving at the valuation.

10

Answer Key Testname: C12

61) Connie is considered to have made a gift to her daughter of $1,000,000, the excess of the land's FMV over the consideration received. If this is the only gift that Connie makes to her daughter during the year, she will be able to subtract the $19,000 annual exclusion to arrive at taxable gifts for the current period. To the remaining $981,000, she will add taxable gifts for all prior periods. The gift tax will then be computed, at current rates, on the cumulative taxable gifts. Next, she will subtract the tax on prior gifts computed at current rates and any unified credit available to her. The remaining amount is her gift tax liability for the current period.

62) The $19,000 per donee annual exclusion allows large sums to pass to donees without any transfer tax being imposed.

There is no estate tax counterpart. Inter vivos gifts remove postgift appreciation from the tax base. Gift tax amounts are also removed from the tax base unless the transfer occurs within three years of death. Gifts made in contemplation of death to a donee-spouse may allow use of the full unified credit for the donee-spouse. Most states do not impose a gift tax. Gifts to charity may also result in an income tax deduction.

11

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Identify which of the following statements is false.

A) Life insurance can help provide liquidity for paying estate taxes.

B) Life insurance is always part of the estate of the insured.

C) Life insurance has the potential for large appreciation.

D) The insured does not have to be the owner of the policy.

1)

2) Appraisal methods used to value real estate for estate tax purposes may include A) capitalization of earnings.

B) reproduction cost.

C) comparable sales.

D) all of the above

2)

3) A stock redemption to pay death taxes under Sec. 303 is generally treated as A) a sale or exchange of property.

B) ordinary income.

C) a return of capital.

D) a dividend.

3)

4) Identify which of the following statements is true.

A) Reversionary interests of less than 5% are includible in the gross estate.

B) 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.

C) A reversionary interest means a chance exists that the property may pass back to the transferor under the terms of the transfer.

D) All of the above are false.

4)

5) 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) a credit for foreign death taxes C) credit for estate taxes paid on certain prior transfers D) All of the above are credits for the federal estate tax.

5)

6) 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) take a casualty loss of $250,000 on the estate tax return.

B) include the beach house in the gross estate at $0.

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 $250,000.

6)

7) Four years ago, Roper transferred to his son ownership of a $100,000 life insurance policy that Roper purchased on his own life in Y1. The cash value of the policy on the transfer date was $25,000. Roper died on March 1st of Y5. The amount included in Roper's gross estate due to the life insurance policy is A) $35,000.

B) $0.

C) $100,000.

D) $25,000.

7)

1

8) The GSTT's (generation-skipping transfer tax) purpose is A) to impose some form of transfer tax every other generation.

B) to impose a graduated transfer tax every other generation.

C) to impose some form of transfer tax one time a generation.

D) to impose a graduated transfer tax one time a generation.

8)

9) 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) $300,000.

D) $180,000.

9)

10) A qualified disclaimer is a valuable estate planning tool because A) it allows the person making the disclaimer to determine the recipient.

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 establishes the value of the disclaimed assets.

10)

11) 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) the value of the stock at death will be included in Martin's estate.

B) the value of the stock less the present value of the income receivable by Martin will be included in Martin's estate.

C) the stock's value at the time of transfer to the trust will be included in Martin's estate.

D) none of the stock will be included in Martin's estate.

11)

12) 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) 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.

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.

12)

13) Which of the following credits is available for estate tax purposes?

A) credit for income taxes paid on decedent's final return B) credit for estate taxes paid on certain prior transfers C) investment tax credit D) All of the above are available.

13)

14) When computing the federal estate tax liability in the current year, which of the following taxable estates (not tentative tax) would the unified credit for the current year eliminate all of the tax is A) $15,555,800.

B) $13,600,100.

C) $17,800,800.

D) $14,000,000.

14)

2

15) Joe dies late in Y1 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 Y3. 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 deduction for $2,000,000 of Joe's estate tax.

C) Claudia's estate receives a credit for $1,000,000 of Joe's estate tax.

D) Claudia's estate receives a credit for $2,000,000 of Joe's estate tax.

15)

16) 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) $2,000,000.

B) $0.

C) $3,600,000.

D) $1,800,000.

16)

17) 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) only interest and dividends received after the date of death B) all interest and dividends received in the year of death C) only interest and dividends received prior to the date of death D) none of the interest and dividends received

17)

18) 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

18)

19) 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 $19,000 to one donee in one year.

IV. Donor dies within three years of gifting land.

A) II, IV B) I, II and III C) I, II D) III, IV

19)

20) Identify which of the following statements is false.

A) Every grantor is entitled to a $5.25 million exemption from the GSTT in 2025.

B) If Greg transfers assets directly to his grandson, this transaction would be an example of a direct skip.

C) The GSTT is levied at a flat rate, the highest (not higher) estate tax rate.

D) 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.

20)

3

21) Identify which of the following statements is true.

A) Special powers of appointment give the power holder less restricted powers than a general power of appointment.

B) 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.

C) 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.

D) All of the above are false.

21)

22) Following are the fair market values of Wilma's assets at her date of death:

22)

Personal effects and jewelry Land which Wilma bought and held as a joint tenant with right of survivorship with her sister

$150,000 800,000

The executor of Wilma's estate did not elect the alternate valuation date. The amount includible in Wilma's gross estate is A) $550,000.

B) $950,000.

C) $800,000.

D) $150,000.

23) Identify which of the following statements is true.

A) Dower rights are not the same as courtesy rights.

B) A courtesy interest is a widower's interest in his deceased wife's property.

C) All gifts made within three years of the date of death must be included in the gross estate.

D) All of the above are false.

23)

24) 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) Funeral expenses are not deductible from the gross estate.

C) Property included in a decedent's gross estate consists of only that property to which the decedent held title.

D) All of the above are false.

24)

25) Identify which of the following statements is true.

A) Administrative expenses are not deductible on the estate's income tax return.

B) There is a limitation of $100,000 on the charitable contribution deduction for estate tax purposes.

C) Casualty or theft losses incurred during the administration of the estate are not deductible on the estate tax return.

D) All of the above are false.

25)

26) Which of the following is deductible in arriving at the amount of the taxable estate?

A) charitable contributions B) expenses incurred in administering the estate C) casualty losses that occurred while administering the estate D) All of the above are deductible.

26)

4

27) Identify which of the following statements is true.

A) The estate tax return is due, ignoring extensions, 12 months after the decedent's date of death.

B) 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 (basic exclusion).

C) Estate taxes must be paid when the return is filed, including any extensions.

D) All of the above are false.

27)

28) Identify which of the following statements is true.

A) 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.

B) 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.

C) The deduction for state death taxes is not limited.

D) All of the above are false.

28)

29) In February of this 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) $435,000.

B) $2,300,000.

C) $2,000,000.

D) none of the above.

29)

30) The FMV of an asset for gift or estate tax purposes is the same except for A) life insurance policies.

B) land.

C) patents.

D) marketable securities.

30)

31) In Y1, 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 Y5 when the condominium has a $300,000 value. How much is included in Polly's estate?

A) $300,000 B) $180,000 C) $120,000 D) $200,000

31)

32) 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) $180,000 B) $600,000 C) $0 D) $420,000

32)

33) 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 (Round your answer to the nearest cent.)

A) $91.67.

B) $95.33.

C) $99.00.

D) $93.50.

33)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

34) The estate tax return is due, ignoring extensions, 3-1/2 months after the decedent's date of death.

34)

35) Taxpayers can avoid the estate tax by making gifts at least a year prior to death.

35)

5

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

36) Yee made $3 million of taxable gifts in Y1 and paid gift taxes (less the unified credit) of $1,098,000. Yee died with a taxable estate of $15,000,000. At current rates, the gift taxes payable on $3 million would be $1,145,800. Yee died in a year when the unified credit was $5,600,100. Determine her estate tax liability.

37) Praneh Patel, a widower, died in March of the current year. His gross estate is $11,000,000, 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?

38) 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?

39) Compare the tax treatment of administration expenses with that of the decedent's debts.

40) Compare the credits available for estate tax purposes with the credits available for gift tax purposes. What differences exist?

41) 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 $10 million, and her Sec. 2053 deductions are very small. Rick, who is in poor health, already owns about $6 million of property. What tax issues should Rick consider with respect to the property bequeathed to him by his wife?

42) 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.

43) Donna died on June 1 of the current year. The executor considers the following information when preparing her estate tax return: • Ten years ago, 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.

• Nine years ago, 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.

• Eight years ago, 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?

44) 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?

6

45) In 2010, 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?

46) 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 $11 million, and her Sec. 2053 deductions are very small. Dan, who is in poor health, already owns about $6 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?

47) 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?

48) List the various categories of estate tax deductions, and compare them with the categories of gift tax deductions.

What differences exist?

49) Ten years ago, 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?

50) 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?

51) Explain how shares of stock traded on a stock exchange are valued. What is the blockage rule?

52) 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?

7

53) 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?

54) 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?

55) Wally died on November 15. His gross estate includes 100 shares of ABC Corporation stock. On November 15, ABC's stock trades were 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?

56) Discuss some of the factors to be considered in determining the amount of property that should pass under the marital deduction.

57) Briefly discuss how inter vivos gifts can be used to reduce the size of the estate tax base.

58) 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?

59) Explain why living trusts are popular tax-planning vehicles.

60) In 2016, Clara made taxable gifts of $2 million. This year, Clara dies with a taxable estate of $14 million. At the time of her death, the FMV of the property Clara gifted in 2016 is $8 million. What is the amount of the estate tax base?

61) 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?

62) 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?

63) Outline and briefly describe the estate tax computation, beginning with the gross estate.

64) In 2002, Gert made a $5,000,000 taxable gift. The 2002 gift tax on $5,000,000 was $2,275.800. Gert was entitled to a unified credit of $345,800, resulting in a gift tax of $1,193,000. The marginal tax rate in 2002 is 50%. For the year of Gert's death (2022), the marginal rate for $5,000,000 of transfers is 40%. the tax on $5,000,000 would equal $1,945,800 before subtracting any credit. In arriving at Gert's estate tax liability, what is the amount subtracted for 2002 gift taxes paid?

65) Discuss the transferor provisions relating to the estate tax, and provide three examples of transactions governed by the transferor provisions.

8

66) On December 1, 1976, Bart made a gift and claimed a $30,000 specific exemption. When Bart died in 2024, his tax base was $14,000,000. Assuming the maximum unified credit is $5,389,800, what is the credit available when computing Bart's estate tax?

9

Answer Key Testname: C13

1) B 2) D 3) A 4) C 5) D 6) B 7) B 8) C 9) A 10) C 11) A 12) B 13) B 14) B 15) D 16) C 17) C 18) D 19) B 20) C 21) C 22) B 23) B 24) A 25) D 26) D 27) B 28) C 29) A 30) A 31) B 32) B 33) A 34) FALSE 35) FALSE 36) Unified transfer tax base Current tax Less unified credit Less credit for gift taxes paid Tax liability

$18,000,000 $7,145,800 ($5,600,100) ($1,145,800) $ 399,900

10

Answer Key Testname: C13

37) • • • •

What deductions will Praneh's estate receive?

Where should the administrative expenses be deducted?

What is the amount of his taxable estate and estate tax base?

Has Praneh made any prior taxable gifts?

Praneh's estate will receive a $40,000 deduction for the debts, a $280,000 deduction for the charitable contribution, and up to a $55,000 deduction for the administration expenses.

After deducting the debts and the charitable contribution, Praneh's taxable estate is $5,005,000 ($5,325,000 - $320,000).

Thus, none of the administrative expenses should be deducted on the estate tax return.

Praneh's taxable estate and estate tax base will be less than the unified credit equivalent meaning no estate tax will have to be paid.

The facts do not indicate whether Praneh has made any taxable gifts. Bonus credit could be given to students who spot that such information is missing and recognize the implications of the missing information. The above answers were prepared on the basis that Praneh made no taxable gifts. If Praneh made some, however, some amount of administrative expenses should be deducted on the estate tax return.

38) $300,000 × ($40,000 ÷ ($40,000 + $60,000)) = $120,000 39) Administration expenses may be deducted on either the estate tax return or the estate's income tax return or some in each place. The executor should deduct them on the return where they will be the same since the top estate tax rate and income tax rate are the same. If there is no estate tax liability, then administrative expenses should be deducted on the income tax return if at all possible.

40) The four credits available for estate tax purposes and illustrations of each are as follows: • Gift tax credit prior to 1977, the decedent made a gift of a remainder interest in property in which he kept a life estate and paid gift tax. The gifted property is in the donor's gross estate.

• Previously taxed property credit the decedent received property that was taxed in the estate of a person who predeceased the decedent by not more than ten years.

• Foreign death tax credit the decedent owned real property in a foreign country and paid death taxes to that country.

• Unified credit $13,990,000 for 2025 for estate tax and gift tax purposes.

The only credit available for gift tax purposes is the unified credit.

41) • Should Rick consider making a disclaimer? If so, of how much?

Unless Rick makes a disclaimer, Lily's estate will waste its exemption equivalent. Rick should disclaim at least $10,000,000 to allow Mary's estate to make use of the full unified credit. Portability of the unified credit between spouses makes this problem less difficult post 2024.

42) The copyright is a terminable interest; however, it qualifies for the marital deduction because no one other than Mrs. Howell receives an interest in the copyright. The trust is also a terminable interest, but it does not qualify for the marital deduction. The trust should be examined under the QTIP rules. Mrs. Howell is entitled to all of the income from the property payable at least annually, and no person has a power to appoint any portion of the property to anyone other than her. However, Mrs. Howell does not have a qualifying income interest for life because her trust interest terminates if she remarries, whereupon the children receive their interests without paying adequate consideration.

43) $100,000 (residence) + 0 (irrevocable trust) + $300,000 (revocable trust) = $400,000 44) Since the trust is revocable, Mary may change the terms during her lifetime. Mary's gross estate will include the date-of-death value of the entire trust.

45) 0.30 × $210,000 = $63,000 11

Answer Key Testname: C13

46) •

The issue is what marital deduction (if any) should be claimed on the trust?

The executor could elect to forgo the marital deduction on all or a portion of the QTIP trust. The QTIP trust is a more flexible arrangement because the executor can affect the size of the marital deduction whereas with an outright bequest the amount of the marital deduction will be altered only if Dan is willing to make a disclaimer. In 2025, portability of the unused unified credit between spouses makes this planning problem less difficult. $150,000 47) Home Clothing and personal belongings 3,700 $153,700

Items (1) and (2) are not included in the estate.

48) Estate tax deductions are as follows: marital, charitable contribution, funeral and administration expenses, debts, casualty and theft losses, and state death taxes. Gift tax deductions consist of only the marital deduction and the charitable contribution deduction. $20,000 × $100,000 = $25,000 49) ($20,000 + $60,000)

50) Stock value on September 4; land value on August 30.

51) Shares traded on a stock exchange are valued at the average of their high and low selling prices as of the applicable valuation date. The blockage rule allows a reduction from the average value where the decedent owned a large block of shares that would be difficult to dispose of at one time without using an underwriter and/or accepting a lower price.

52) $490,000 = $5,000 (one-half of joint checking account) + $50,000 (savings account) + $400,000 (Karen's life insurance) + $30,000 (interpolated terminal reserve on daughter's life insurance) + $5,000 (unexpired premiums on daughter's life insurance).

53) All the expenses are deductible: $40,000 + $2,000 + $5,000 + $400 + $2,000 = $49,400. The administration expenses can be deducted by the estate or allocated in whole or in part to the estate's income tax return. It is best to deduct them where they can provide the greatest tax savings. In this case, since no income taxes are expected to be owed, it would be best to claim the deduction against the gross estate.

54) • Does Michael make a gift when he purchases the land?

• What portion of the land will be in Michael's gross estate? (Stated differently, will using this form of ownership reduce his estate taxes?)

• Are there any other estate tax implications?

• What are the generation-skipping transfer tax implications?

At the time of purchase, Michael will make a gift to his grandson of half the land's cost. Because Michael provided all the consideration, under the consideration-furnished test of Sec. 2040, Michael's gross estate will include 100% of the land's date of death value. This strategy will not reduce his estate tax liability.

In addition, his estate tax base will include as an adjusted taxable gift, the taxable gift made upon the purchase of the land as joint tenancy property. The gift will be so large that gift taxes will be owed. Thus, if Michael dies within three years of acquiring the land, there will be a gross-up under Sec. 2035 for the gift taxes he paid. Fortunately, such gift taxes will be subtracted to determine his estate tax payable regardless of how long he survives.

The grandchild is two generations younger than Michael and is a skip person. Generation-skipping transfer taxes will be owed in addition to the gift and estate taxes. The amount of the transfer exceeds the GSTT exemption amount of $5.12 million in 2012.

55) ($100 + $92) × 0.50 = $96

12

Answer Key Testname: C13

56) Except in small estates, an amount equal to the exemption equivalent should pass to someone other than the surviving spouse. Some property should be taxed in the estate of the first decedent to die if the surviving spouse already has a sizable estate and a relatively short life expectancy. The marginal estate tax rates should not be allowed to be appreciably different. In addition, one needs to consider nontax factors such as the cash needs of the surviving spouse and/or children. This last item may be more important to some individuals than the tax factors. For 2024, portability allows any unused credit from the first spouse to die, if elected by the executor, to be used in the estate of the surviving spouse eliminating some of the importance in planning to equalize the estates of both spouses.

57) The $19,000 per-donee, per-year exclusion allows property to be transferred free of any transfer tax consequences.

Postgift appreciation is removed from the estate tax base because adjusted taxable gifts are valued at the date of gift values. If the donor lives for more than three years after making a taxable gift, the gift tax paid is removed from the gross estate.

58) ($100 + 98)/2 = $99 per share × 100 shares = $9,900 59) Revocable trusts, sometimes called living trusts, are popular arrangements from a nontax standpoint because assets held by a revocable trust pass outside of probate. Advantages of avoiding probate include lower probate costs and easier administration for real property owned in a state that is not the decedent's state of domicile. In addition, unlike a will, a revocable trust is not a matter of public record.

60) Taxable estate + post-1976 gifts. $2,000,000 + $14,000,000 = $16,000,000 61) The entire trust will be included since she retained the income from the trust until her death.

62) No, it fails the 35% test in one of the calculations.

Excluding gifts: $400,000 / $1,000,000 = 40% Including gifts: $400,000 / $1,350,000 = 29.63% Property titled to decedent and property gifted if decedent had right to the income or control. Includes gift 63) Sum of: tax paid on gifts in past three years.

Equals: Gross estate Minus: Deductions: expenses, debts, losses, transfers to spouse, state death taxes and charitable contributions Equals: Taxable estate Plus: Adjusted taxable gifts (post-1976 taxable gifts) Equals: Estate tax base Times: Tax rate(s) Equals: Tentative tax on estate tax base Minus: Post-1976 gift taxes (using current year's unified transfer tax rate schedules) Unified credit Pre-1977 gift tax credit Credit for estate taxes paid on prior transfers Foreign death tax credit Equals: Estate tax payable 64) $1,600,000 = $1,945,800 ($5,000,000 taxable transfer at current year rates) - $345,800 (where $1 million is the exemption equivalent for 2002).

13

Answer Key Testname: C13

65) They apply if the decedent earlier made a transfer of a type specified in the Code and the decedent did not receive adequate consideration for the transferred interest. If one of the transferor provisions applies, the transferred property is included in the gross estate at its date-of-death or alternate valuation date value.

One specified transfer is the gifting within three years prior to death of a life insurance policy on the decedent's life that would have been included in the gross estate. Also included are transfers with a retained life estate, transfers taking effect at death, and revocable transfers.

Also, the donor-decedent's gross estate is increased by any gift tax that is paid by the decedent or his estate on any gift that the donor or the donor's spouse makes during the three-year period ending with the decedent's death. This provision is known as the gross-up rule.

The gross estate also includes earlier transferred property if the decedent stipulates that another person must survive the decedent to own the property and the value of the decedent's reversionary interest exceeds 5% of the value of the transferred property.

66) $5,389,800 - ($30,000 × 0.20) = $5,383,800. The unified exemption must be reduced by 20% of any of the old $30,000 exemption used between September 8, 1976, and January 1, 1977.

14

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) 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 Year 1's net accounting income to Marty on January 20, Year 2. No other distributions are made in the Year 2. Marty's taxable income from the trust in Year 2 is A) $50,000.

B) $49,700.

C) $60,000.

D) $0.

1)

2) Beneficiaries of a trust may receive A) a remainder interest only.

C) both an income and a remainder interest.

2)

B) an income interest only.

D) Any of the above is correct.

3) 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) $30,000.

B) $20,000.

C) $0.

D) $10,000.

3)

4) 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) the trust B) Karly's mother C) Karly D) Karly's son

4)

5) Which of the following statements is incorrect?

A) Subchapter K contains the special rules applicable to estates and trusts.

B) The income tax rules governing estates and trusts are generally identical.

C) Income generated by property owned by an estate or trust is reported on that entity's tax return.

D) All of the above are correct.

5)

6) Identify which of the following statements is true.

A) Income received by a trust beneficiary has the same character it had at the trust level.

B) The personal exemption available to a trust is adjusted annually based on changes in the consumer price index.

C) Distributable net income (DNI) excludes tax-exempt income.

D) All of the above are false.

6)

7) 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) $7,000.

B) $0.

C) $2,400.

D) $4,200.

7)

1

8) 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) $100,000.

B) $50,000.

C) $25,000.

D) $75,000.

8)

9) Identify which of the following statements is true.

A) Tier-2 beneficiaries potentially can receive more favorable tax treatment than tier-1 beneficiaries.

B) An individual cannot be both a tier-1 and tier-2 beneficiary in the same year.

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.

9)

10) 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) Interest earned but not received before death is IRD. C) 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.

D) Items of IRD receive a step-up in basis as a result of the decedent's death.

10)

11) 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) $25,000 B) $37,500 C) $12,500 D) $50,000

11)

12) 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) $15,000.

C) $16,667.

D) none of the above

12)

13) Administration expenses incurred by an estate A) an executor must elect where to deduct administration expenses (Form 706 or Form 1041).

B) 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).

C) such expenses are only deductible on Form 706.

D) such expenses are only deductible on Form 1041.

13)

14) Identify which of the following statements is false.

A) The IRS may terminate an estate as a taxpayer after the expiration of a reasonable period of time for performance of the administrative duties.

B) Assets in a revocable trust do not avoid probate.

C) Assets in a revocable trust are included in the gross estate.

D) For purposes of trust administration, the term "sprinkling" relates to the discretionary authority of the trustee to distribute income among various beneficiaries.

14)

2

15) Identify which of the following statements is true.

A) 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.

B) In a complex trust, distributable net income (DNI) does not act as a ceiling on the amount of the distribution deduction.

C) Distributable net income (DNI) is not reduced by the charitable contribution deduction when calculating the deductible discretionary distributions for a complex trust.

D) All of the above are false.

15)

16) 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) $22,500 B) $15,000 C) $6,250 D) $7,500

16)

17) Charitable contributions made by a fiduciary A) must be authorized in the trust instrument in order to be deductible.

B) flows through to be deducted on the beneficiary's tax return.

C) are limited to 50% of fiduciary income.

D) are subject to the 2% floor.

17)

18) 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) $30,000 B) $45,000 C) $15,000 D) $40,000

18)

19) 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) $6,000 B) $15,000 C) $0 D) $40,000

19)

20) Identify which of the following statements is true.

A) Under the tier system, tier-2 beneficiaries are the first to absorb income.

B) Tax-exempt income is allocated among beneficiaries in the proportion that total tax-exempt income bears to total distributable net income (DNI).

C) Both income required to be distributed currently and discretionary income distributions are included in tier-1 distributions.

D) All of the above are false.

20)

21) Michael died in Y1 with a taxable estate and estate tax base of $6,000,000. 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 has no IRD. 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) $80,000.

B) $153,000.

C) $90,000.

D) $122,400.

21)

3

22) A trust that is required to distribute all of its income annually receives a exemption for the year of A) $600.

B) $300.

C) $0, because it retains no income.

D) $100.

22)

23) 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) $50,000 B) $5,000 C) $10,000 D) none of the above

23)

24) Which of the following is the most accurate statement concerning the use of trusts in tax planning?

A) Nontax reasons for the use of trusts (such as avoidance of probate) typically outweigh tax reasons for creating trusts today.

B) The large 15% tax bracket available to trusts allows complex trusts to be used as an income-shifting device.

C) The grantor trust rules allow grantors to shift income into trusts and reduce their own taxes.

D) None of the above statements are correct.

24)

25) 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 simple trust and is allowed a $300 exemption.

C) The trust is a complex trust and is allowed a $100 exemption.

D) The trust is a simple trust and is allowed a $100 exemption.

25)

26) A trust has the following results:

26)

Net tax-exempt interest Net accounting income Trustee fees charged to corpus

$10,000 64,000 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) $62,000 B) $64,000 C) $72,000 D) $74,000

27) Identify which of the following statements is false.

A) The Uniform Act allocates royalties to both principal and income.

B) State trust law preempts the trust document when defining income.

C) The Uniform Act on principal and income requires depreciation to be charged against income.

D) A statement in the trust instrument concerning the allocation of depreciation to principal or income overrides a provision of state law.

27)

28) The conduit approach for fiduciary income tax means A) the distributed income is determined by the trustee annually.

B) the distributed income goes to all beneficiaries proportionately.

C) the distributed income of a remainder interest is determined by the property.

D) the distributed income has the same character in the hands of the beneficiary as it has to the trust.

28)

4

29) A tax entity, often called a fiduciary, includes all of the following except A) complex trusts.

B) estates.

C) testamentary trusts.

D) All of the above are fiduciaries.

29)

30) The exemption amount for an estate is A) $100.

B) $300.

30)

C) $600.

D) $0.

31) Estates and trusts A) receive a $1,000 personal exemption.

B) are taxed on state and municipal bond interest.

C) receive a deduction for administrative expenses not otherwise deducted on the estate tax return (Form 706).

D) are not taxed on capital gains.

31)

32) 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) Capital losses remaining in the final year of a trust do not pass through to the beneficiaries succeeding to the trust property.

C) The income received by the beneficiaries of the trust loses its character once it is distributed.

D) All of the above are false.

32)

33) 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 estate tax year-end but is free to choose any tax year-end for the 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 trust tax year-end but is free to choose any tax year-end for the estate.

D) Joe must choose December 31 as the tax year-end for both the estate and trust.

33)

34) Identify which of the following statements is true.

A) An estate may deduct up to $5,000 of capital losses against the ordinary income taxable in the estate.

B) 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.

C) Income in respect of a decedent (IRD) is the gross income the decedent earned before death but had not collected before death.

D) All of the above are false.

34)

35) An inter vivos trust may be created by all of the following except A) an executor.

B) a grantor.

C) a transferor.

35)

36) Revocable trusts means A) the transferor may not demand the assets be returned.

B) income or estate tax savings for the grantor.

C) the grantor is always the beneficiary.

D) the trust can be revoked.

5

D) a trustor.

36)

37) 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 $10,000 of taxable interest income and $15,000 of tax-free interest income.

B) Gary has $25,000 of ordinary gross income.

C) Gary has $10,000 of capital gain and $15,000 of tax-free interest income.

D) Gary has no taxable income because the trust must pay the tax.

37)

38) Identify which of the following statements is true.

A) Trusts are required to make estimated tax payments.

B) All estates with gross income of at least $500 must file an income tax return.

C) All trusts and estates must use a calendar year-end.

D) All of the above are false.

38)

39) 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) $10,000.

B) $30,000.

C) $15,000.

D) $5,000.

39)

40) Which of the following statements regarding the taxation of a trust is incorrect?

A) Trusts are not subject to double taxation.

B) Trusts are generally not taxed at favorable rates for income shifting.

C) A trust's long-term capital gains are taxed at a top rate of 15%.

D) An irrevocable trust's income is taxed to the grantor.

40)

41) The term "trust income" when not preceded by an explanatory word relates most closely to A) net accounting income.

B) taxable income.

C) gross income.

D) distributable net income.

41)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

42) Distributable net income (DNI) is not reduced by the charitable contribution deduction when calculating the deductible discretionary distributions for a complex trust.

42)

43) A trust receives no standard deduction when computing taxable income.

43)

44) Distributable net income (DNI) does not include capital gains allocated to principal.

44)

45) Grantor trusts are taxed as complex trusts.

45)

46) The personal exemption available to a trust is adjusted annually based on changes in the consumer price index.

46)

47) Trusts are required to make estimated tax payments.

47)

48) For purposes of trust administration, the term "sprinkling" relates to the mandatory distribution of income among various beneficiaries.

48)

49) The distribution deduction for a complex trust is the lesser of the amount distributed or distributable net income, reduced by net tax-exempt income.

49)

6

50) A complex trust permits accumulation of current income, provides for charitable contributions, or distributes principal during the taxable year.

50)

51) The $3,000 limitation on deducting net capital losses does not apply to a trust.

51)

52) Income in respect of a decedent (IRD) is included in the decedent's final income tax return.

52)

53) Income in respect of a decedent (IRD) includes interest earned by a cash-basis taxpayer but not received by the taxpayer before death.

53)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

54) 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.

Dividends Rental income from land Tax-exempt interest Rental expenses Trustee's fees Tax return preparation fee Capital gain on stock sale (stock purchased four years ago) Distribution of net accounting income to: Carol Karen Payment of estimated tax

Amounts Allocable To Income Principal $15,000 2,500 7,500 500 $600 250 6,000 7,000 3,500 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.

55) 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?

56) A client asks about the relevance of state law in classifying items as principal or income. Explain the relevance.

7

57) 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 $15,000 2,500 7,500 500 $600 250 24,250 6,000 1,300

Dividends Rental income from land Tax-exempt interest Rental expenses Trustee fees Tax return preparation fee Capital gain on stock sale (stock purchased five years ago) Distribution of net accounting income 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.

58) 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?

59) What is the benefit of the 65-day rule?

60) Ed Camby sold an apartment building in May Y1 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 Y2 through Y5. Ed died in August Y1. 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?

61) A trust document mentions the treatment for depreciation. The state has adopted the Uniform Act. The trust document states that depreciation is a charge against corpus. The trust results are the following: Business net profits Rental income Depreciation Rent expense

$2,000 1,000 100 100

Calculate net accounting income.

62) Explain the three functions of distributable net income (DNI).

63) A trust reports the following results: Dividend income Capital gains Tax-exempt interest Trustee fees

$20,000 10,000 10,000 3,000

All of the items above are allocated to income. Calculate the maximum amount of trustee fees that are deductible.

8

64) For the first five months of its existence (August through December Y1), the Estate of Christine Lowry had gross income (net of expenses) of $7,000 per month. For January through July Y2, 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 Y2. During Y2, 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?

65) Describe the tier system for trust beneficiaries.

66) Outline the classification of principal and income under the Revised Uniform Principal and Income Act. 67) Explain to a client the significance of the income and principal categorization scheme used for fiduciary accounting purposes.

68) Explain how to determine the deductible portion of trustee's fees.

69) 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?

70) 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?

71) 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?

72) Sukdev Basi funded an irrevocable simple trust in May Y1. 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 Y4, might be the time to sell the stock and take the loss deduction. For Y4, 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?

73) Describe the double taxation of income in respect of a decedent and how it can be reduced.

74) Briefly discuss some of the reasons for using a revocable trust.

9

75) 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 Capital gain Tax return preparation fee Trustee fees, all charged to income

$2,500 1,500 200 100

What is the amount of trust's net accounting income?

76) A trust reports the following results: Interest from corporate bonds Dividends Tax-exempt interest Trustee fees Capital gain

$20,000 10,000 20,000 6,000 10,000

All of the items are allocated to income except the capital gains. Calculate the maximum amount of trustee fees that are deductible.

77) List some common examples of principal and income items.

78) Briefly discuss the reasons for establishing a trust.

79) 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 Net rental income Proceeds from stock sale (including $10,000 gain) Trustee fee (charged to income) Depreciation

$20,000 5,000 50,000 2,000 3,000

What is the amount of the trust's net accounting income?

80) 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?

10

81) A trust reports the following results:

Taxable bond interest Rental income Gain on sale of investment land Property taxes Trustee fees

Allocable to Income Principal $20,000 10,000 10,000 2,000 500

The trust must distribute all of its income annually. Calculate taxable income after the distribution deduction.

82) A simple trust has the following results: DNI Net tax-exempt interest Net accounting income

$60,000 8,000 62,000

Calculate the distribution deduction.

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.

84) What is the basis of inherited IRD items to the beneficiary?

11

Answer Key Testname: C14

1) A 2) D 3) C 4) C 5) A 6) A 7) D 8) D 9) A 10) D 11) B 12) B 13) A 14) B 15) A 16) C 17) A 18) D 19) A 20) B 21) A 22) B 23) C 24) A 25) B 26) A 27) B 28) D 29) D 30) C 31) C 32) A 33) C 34) C 35) A 36) D 37) A 38) A 39) C 40) D 41) A 42) FALSE 43) TRUE 44) TRUE 45) FALSE 46) FALSE 47) TRUE 48) FALSE 49) TRUE 50) TRUE 12

Answer Key Testname: C14

51) FALSE 52) FALSE 53) TRUE 54) (a) DNI = $23,650 ($15,000 + $2,500 + $7,500 - $500 - $250 - $600) (b) Distribution deduction = $7,250 [$10,500 - ($7,320/$23,650 × $10,500)]. Note that $7,320 is the $7,500 of tax-exempt income minus the nondeductible trustee's fee of $180 [($7,500/$25,000) × $600]. (c) Trust taxable income = $14,980 ($15,000 + $2,500 + $6,000 - $500 - $250 - $420 - $100 exemption - $7,250) (d) Carol receives 0.296 ($7,000/$23,650) of the income, and Karen receives 0.148 ($3,500/$23,650) of the income; Carol receives dividends, $4,439.50; rents, $394; and tax-exempt interest, $2,166.50. Karen receives dividends, $2,220; rents, $196.50; and tax-exempt interest, $1,083.50.

55) $50,000 × 0.30 = $15,000 × ($30,000/$50,000) = $9,000 tax-exempt interest income $15,000 - $9,000 = $6,000 taxable interest income 56) In general, state law controls; however, in the event of a discrepancy, provisions in the trust instrument prevail over state law.

57) (a) DNI = $23,650 ($15,000 + $2,500 + $7,500 - $500 - $250 - $600) (b) Distribution deduction = $16,330 [$23,650 - $7,320 (net tax-exempt income)]. Note the nondeductible trustee's fee is $180 [($7,500/$25,000) × $600]. (c) Trust taxable income = $5,700 ($6,000 - $300) (d) Betty's dividends = $15,000; Betty's rental income = $1,330 ($2,500 - $500 - $250 - $420 deductible trustee's fees); Betty's tax-exempt interest = $7,320 ($7,500 - $180) 58) The beneficiary is deemed to receive $20,000 of taxable dividend income and $30,000 of tax-free interest.

59) The benefit of the 65-day rule is that it allows estates or trusts to shift income from being taxed on the fiduciary's tax return to a beneficiary's (or beneficiaries') tax return(s). Sometimes by the end of the year, the exact amount of the fiduciary's income will not be known nor will the tax situation of the beneficiaries necessarily be known. The 65-day rule lets fiduciaries postpone making distributions until early in the next year so that the tax situation of the fiduciary and the beneficiaries can be assessed and an intelligent decision made concerning whether to have income taxed at the fiduciary or the beneficiary level.

60) • When and where will the gain on the sale of the building be reported?

• Will there be any income in respect of a decedent (IRD)?

• If there will be IRD, will there be a 691(c) deduction?

Unless Ed's executor elects on Ed's final individual return (for Y1) not installment reporting for the gain, the portion of the gain attributable to the down payment will be reported on Ed's Y1 individual return, and the remaining gain will be reported on the estate's income tax returns when the principal is collected. The estate need not use a calendar year. If the estate terminates prior to collecting all of the principal, Anna will report the remaining gain as she collects the principal. If the executor elects out of installment reporting, all the gain will be reported on Ed's Y1 return. This election would be a favorable option if Ed has losses that the gain would offset because the losses would otherwise "die" with Ed. The gain inherent in the principal payments on the note will be IRD unless the executor elects out of installment reporting. No step-up in basis is allowed for IRD items.

Ed's estate will owe estate taxes, and a 691(c) deduction will be allowed for the estate taxes attributable to the gain inherent in the note included in the gross estate.

61) $2,000 + $1,000 - $100 = $2,900.

62) DNI establishes the maximum amount on which the beneficiaries may be taxed. DNI establishes the maximum amount the trust or estate may deduct as a distribution deduction. DNI establishes the character of the income or expense in DNI that flows to the beneficiaries.

13

Answer Key Testname: C14

63) ($10,000/$30,000) × $3,000 = $1,000 allocated to tax-exempt income $3,000 - $1,000 = $2,000 deductible 64) • May the estate elect to use a tax year-end other than December 31?

• What year-end should the estate elect if a December 31 year-end is not mandatory?

• What distributions (if any) should the estate make to Jonathan prior to the termination of the estate?

The estate may elect a year-end other than December 31. To do so, it must file an income tax return on a timely basis, meaning by the fifteenth day of the fourth month after the desired year-end.

The estate should consider a December 31 year-end for the reasons discussed below.

The estate should distribute $34,000 to Jonathan by December 31 and elect a December 31 year-end. The estate will have $35,000 of DNI by December 31, and if it distributes $34,000 to Jonathan by this date, the estate will receive a $34,000 distribution deduction, and Jonathan will have $34,000 of income to offset against his NOL, which otherwise will expire. Thus, $34,000 will wind up being untaxed for all practical purposes. The rest, $1,000, will be taxed to the estate at a 10% rate. If the estate chooses a year-end later than December 31 and makes distributions to Jonathan, such distributions will be income on Jonathan's Y6 return and his NOL will have expired and been wasted. Likewise, if the estate makes no distribution, the income will be taxed to the estate, and Jonathan's NOL will be wasted.

65) The tier system distinguishes between mandatory (tier-one) distributions and discretionary (tier-two) distributions.

Tier-one beneficiaries are taxed on the smaller of DNI or the amount of the mandatory distributions. Tier-two beneficiaries are taxed on the lesser of DNI remaining after the mandatory distributions or the amount of the discretionary distributions.

66) Income account: Income: rent, interest, dividends, net business profits, 72 1/2% of royalties.

Expenses: ordinary expenses (e.g., property taxes, insurance, interest, ordinary repairs), taxes levied on accounting income, and depreciation.

Principal account: Income: consideration (including gains) received upon disposition of property, stock dividends, 27-1/2% of royalties.

Expenses: principal payments on debt, extraordinary repairs and capital improvements, taxes on gains and other items of principal.

67) Often the trustee cannot distribute principal, or can do so only in limited circumstances. Many trust instruments mandate that all of the income (meaning income in the accounting, not tax, context) be distributed annually. Thus, the categorization of an income, gain, deduction, or loss item as principal or income often affects the dollar amount that the beneficiary can receive.

68) If the trust has any tax-exempt income, only a portion of the trustee's fees is deductible. The nondeductible amount of the trustee's fee is the following portion of the total fee: tax-exempt income divided by gross accounting income times total trustee's fees. Alternatively, the denominator can be accounting income net of all direct expenses.

69) $20,000 - $1,000 = $19,000 70) ($20,000 + $30,000) × 0.40 = $20,000 71) Last year, the exemption was $100 since the trust did not have to distribute all of its income. Two years from now, the personal exemption will be $300 since it will be required to distribute all of its income.

14

Answer Key Testname: C14

72) Sukdev transferred depreciated property to the trust, something he should not have done. If the trustee sells the Jetco stock at a loss, the trust's basis for determining loss will be $40,000, the stock's value on the date of the gift. (If the trustee sells the property at a gain, the basis will be Sukdev's basis of $44,000.) Thus, if the trust sells the stock for its current value of $33,000, it can recognize only $7,000 of loss (less than the economic loss). Because the trust must distribute all of its income, there will be no noncapital gain income against which to offset the capital loss. The only time the trust will get a tax benefit from the capital loss will be when it has capital gains. Any unused loss will pass through to the beneficiaries when the trust terminates in the distant future. Deferring the stock sale is not necessarily the best strategy, however, because there may be little expectation that the value of the stock will "recover," and, in fact, it could decline further.

73) The taxable estate contains all income earned but not received before death. This income is also taxed to the person entitled to receive it after death. For example, a decedent may have an IRA which is included in his estate. The IRA payments will also be taxed to the person entitled to collect them upon the decedent's death. Section 691(c) provides relief against this double taxation by permitting a deduction for the federal estate tax attributable to IRS on the estate's income tax return.

74) 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.

75) $2,500 - ($200 + $100) = $2,200 76) ($30,000/$50,000) × $6,000 = $3,600. The remaining $2,400 of trustee fees is allocable to tax-exempt income and nondeductible under Sec. 275.

77) A common example of principal includes the gain (plus return of capital) upon the disposition of an asset owned by the fiduciary. Common examples of income include dividends, interest, and rents.

78) Possible tax savings, professional management of assets, restrictions on the donee's use or consumption of assets, protect assets from creditors.

79) $20,000 + $5,000 - $2,000 - $3,000 = $20,000 80) Lee reports $18,000 (30% of $60,000) of trust income and Sarah reports $42,000 (70% of $60,000). Because rents make up one-third ($20,000/$60,000) of DNI, the composition of the income reported by Lee and Sarah is one-third rental income and two-thirds corporate bond interest.

Taxable bond interest 81) $20,000 10,000 Rental income 10,000 Capital gain ( 2,000) Property taxes ( 500) Trustee fees ( 300) Personal exemption (27,500) Distribution deduction $ 9,700 Taxable income Verification of this amount is possible by subtracting the personal exemption ($300) from the capital gain ($10,000) to arrive at taxable income ($9,700).

82) $60,000 - $8,000 = $52,000 83) $6,000 - $300 = $5,700 84) If an item is considered IRD, its basis carries over from the decedent to the beneficiary.

15

Exam Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Identify which of the following statements is true.

A) 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.

B) 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.

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.

1)

2) Identify which of the following statements is false.

A) 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."

B) Appeals officers usually have the operating authority to settle disputes with taxpayers based on the "hazards of litigation."

C) If the taxpayer and the appeals officer fail to reach agreement, the IRS issues a 90-day letter.

D) A Technical Advice Memorandum may be requested by an IRS auditor if the transaction in question involves an especially complex tax issue.

2)

3) The Internal Revenue Service is part of the A) Federal Bureau of Investigation.

C) U.S. Customs Department.

3)

B) Congress.

D) Treasury Department.

4) Identify which of the following statements is false.

A) The IRS is authorized to pay a reward to individuals who provide information resulting in increased collections.

B) The TCMP audit program has been temporarily suspended by the IRS and replaced in part by lifestyle audits.

C) The majority of the individual tax returns that are audited are selected under the DIF program.

D) All of the above are false.

4)

5) Identify which of the following statements is true.

A) The signing of Form 870 allows the taxpayer to wait for 30 interest-free days after the billing date to pay the tax.

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) 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.

D) All of the above are true.

5)

6) What is the penalty for a tax return preparer who lacks substantial authority to take a return position?

A) 20% of the understatement B) $250 C) $1,000 D) $50

6)

1

7) Which of the following is not a reason for relief from the substantial understatement penalty?

A) substantial authority for the tax return position B) reasonable cause and a good faith effort to comply with the tax law C) reliance on a tax return preparer D) disclosure of the relevant facts pertaining to the questionable tax return position

7)

8) If a return's due date is extended, a taxpayer A) has 30 days following the original due date to pay estimated taxes without interest.

B) has 30 days following the original due date to pay estimated taxes without penalty.

C) also extends the period in which to pay taxes without interest.

D) still should pay the tax by the original return due date.

8)

9) Identify which of the following statements is false.

A) Tax returns for all taxpayers must be filed on or before the fifteenth day of the fourth month following the year-end.

B) A corporation must file a tax return even if it has no gross income.

C) The IRS will not issue a ruling on the topic of whether compensation is reasonable.

D) Extensions of time for filing tax returns may be obtained.

9)

10) 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) As a practical consideration, taxpayers always find it preferable to obtain an advance ruling on questionable tax situations.

C) Third parties may not cite private letter rulings as authority for the tax consequences of their transactions.

D) The request for a ruling may contain a suggested conclusion (or answer) that the taxpayer proposes that the IRS adopt in the described situation.

10)

11) Identify which of the following statements is false.

A) 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.

B) 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.

C) 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.

D) All of the above are false.

11)

12) Identify which of the following statements is true.

A) The statute of limitations limits the time during which a taxpayer may claim a refund of an overpayment of tax.

B) 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.

C) 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.

D) All of the above are true.

12)

2

13) The IRS provides advice concerning an issue that arises during an audit by issuing A) an audit memorandum.

B) a revenue ruling.

C) a technical advice memorandum.

D) a private letter ruling.

13)

14) Identify which of the following statements is false.

A) 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%.

B) 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.

C) 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%.

D) A different interest rate is charged to corporate and noncorporate taxpayers.

14)

15) A taxpayer can automatically escape the penalty for underpayment of taxes by A) owing taxes in the previous year.

B) owing less than $1,000 in taxes over and above the taxes withheld from wages.

C) having a casualty loss.

D) none of the above

15)

16) 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) Individuals having substantial income from sources not subject to regular withholding generally should make quarterly estimated tax payments to the IRS. C) 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.

D) All of the above are false.

16)

17) 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 three years from the return due date or two years from the date the tax is paid B) the later of two years from the return filing or three years from the date the tax is paid C) four years from the payment of tax date, if the IRS mails a notice of deficiency D) 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

17)

18) 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 lesser of 25% of the tax required to be shown on the return or $5,000 for individuals C) underpayment of tax exceeding the greater of 15% 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

18)

3

19) Identify which of the following statements is true.

A) Individuals and calendar year-end corporations may obtain six-month extensions for paying taxes and filing their returns for the taxable year by filing the appropriate extension requests.

B) A partnership is not required to file a return if the partnership has no income for the year.

C) The "automatic" extension period for filing an individual return is five months.

D) All of the above are false.

19)

20) Which of the following statements regarding Circular 230 is false?

A) Circular 230 applies to all tax return preparers.

B) Circular 230 applies to CPAs, enrolled agents, enrolled actuaries, and attorneys.

C) Circular 230 defines practice before the IRS. D) Circular 230 provides guidance as to the level of authority necessary for a CPA to take a tax return position.

20)

21) 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) Joint and several liability means that each spouse is potentially liable for the full amount of tax due.

C) 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.

D) All of the above are false.

21)

22) The "Statement on Practice in the Field of Federal Income Taxation" includes all of the following areas of mutual competence except A) representing clients in criminal investigations.

B) determining the tax effect of proposed transactions.

C) representing taxpayers before the U.S. Tax Court.

D) preparing federal income tax returns.

22)

23) Identify which of the following statements is false.

A) 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.

B) Any tax not paid by the due date for the return is subject to an interest charge.

C) Interest is imposed on any tax not paid by the due date of the return (determined without regard to extensions).

D) Interest is charged on underpayments, or paid on overpayments, at a rate of three percentage points higher than the federal short-term rate.

23)

24) 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) $80.

B) $40.

C) $0.

D) $120.

24)

25) Tax return preparers can be penalized for the following activities except A) failure to give a copy of the return to the taxpayer.

B) failure to provide the preparer's identification number on the return.

C) failure to maintain IRS continuing education requirements.

D) failure to sign a return.

25)

4

26) A taxpayer will receive a 30-day letter A) only if the taxpayer does not sign Form 870.

B) only if the taxpayer is more than 30 days late in filing the tax return.

C) to notify him that the return was selected for audit.

D) after a response to the 90-day letter with a protest.

26)

27) 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) $40.

B) $400.

C) $0.

D) $300.

27)

28) Identify which of the following statements is true.

A) A taxpayer can choose to initiate tax litigation in a U.S. district court, the Tax Court, or a Court of Appeals.

B) 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.

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.

28)

29) Which of the following activities is protected by accountant-client privilege?

A) communications related to tax return preparation B) written communications between a CPA and a corporation regarding a tax shelter C) communications related to criminal tax evasion D) advice given regarding tax issues in a divorce

29)

30) Which one of the following statements about letter rulings is false?

A) A ruling is a response to a taxpayer's specific set of facts.

B) Rulings become public information.

C) The IRS issues revenue procedures periodically, which prescribe the information that must be supplied with a ruling request.

D) If a taxpayer requests and pays for a ruling, the IRS must respond to his request by issuing a ruling.

30)

31) According to Circular 230, what should a CPA do upon discovery of an error in a client's prior-year return?

A) File an amended return for the client.

B) Notify the IRS of the error.

C) Inform the client of the error and its tax consequences.

D) Do nothing.

31)

32) Identify which of the following statements is true.

A) 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.

B) Treasury Department Circular 230 regulates the practice of attorneys, CPAs, enrolled agents, and enrolled actuaries before the IRS. C) 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.

D) All of the above are false.

32)

5

33) What is the penalty for a tax return preparer who willfully attempts to understate taxes, or intentionally disregards the tax rules and regulations?

A) 20% of the understatement B) $50 C) $5,000 D) $250

33)

34) Identify which of the following statements is true.

A) Signing of Form 870-AD by the taxpayer does not generally preclude the subsequent filing of a refund claim.

B) 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.

C) Form 870-AD is used if the taxpayer and IRS representative agree to a lesser tax liability than that originally proposed by the Service.

D) All of the above are false.

34)

35) 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) $6 B) $60 C) $0 D) none of the above

35)

36) 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.

36)

Last year's tax liability This year's estimated total tax Taxes to be withheld for this year

A) $7,750

$40,000 44,000 9,000

B) $8,750

C) $7,650

D) $11,000

37) On April 15, Y2, a married couple filed their joint Y1 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) December 31, Y7 B) April 15, Y5 C) April 15, Y8 D) December 31, Y2

37)

38) The innocent spouse relief provision from tax liability covers all of the following except A) improper basis.

B) improper credits.

C) improper deductions.

D) All are understatements subject to minimum thresholds.

38)

39) Identify which of the following statements is false.

A) The fraud penalty can be imposed with respect to income, gift, and estate tax returns.

B) If fraud is asserted in a tax transaction, the burden of proof falls on the IRS. 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 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.

39)

6

40) Which of the following items can be omitted from a taxpayer's request for a ruling?

A) the location of the IRS district office that has examination jurisdiction B) a detailed explanation of the transaction C) the particular conclusion desired by the taxpayer D) names, addresses, and taxpayer identification numbers of all interested parties

40)

41) In which of the situations below will a taxpayer not be assessed interest on the tax remitted?

A) The return is audited and additional tax is owed.

B) A timely return is filed but the taxpayer must delay payment of the taxes.

C) An extension is obtained and the tax is paid within the extension period.

D) None of the above situations.

41)

42) All of the following requirements must be met in order to establish innocent spouse relief except which of the following?

A) The request for innocent spouse relief is made no later than one year after the IRS begins its collection efforts.

B) Based on all the facts and circumstances, holding the other individual for the deficiency would be inequitable.

C) The return contains an understatement of tax attributable to the erroneous item(s) of an individual filing it.

D) The requesting individual establishes that he or she neither knew nor had reason to know of any or all of the understatement.

42)

43) Identify which of the following statements is false.

A) 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.

B) Only the taxpayer can appeal the decision of a court of original jurisdiction to the next higher court.

C) If the Supreme Court decides to hear a case, it grants certiorari.

D) So-called private letter rulings are made public after confidential information is eliminated.

43)

44) A six-year statute of limitation rule applies if the taxpayer A) understates AGI by 25%.

B) understates taxable income by 25%.

C) understates gross income by 25%.

D) none of the above

44)

45) A $500 penalty for each instance of failing to comply with the due diligence requirements for determining eligibility applies to which of the following?

A) Hope and Lifetime Learning Credit B) Head of Household C) Child Tax Credit and Earned Income Tax Credit D) All of the above

45)

46) The program specifically designed to identify returns with a high potential for a deficiency assessment is the A) 1040 program.

B) instant audit program.

C) TCMP. D) DIF program.

46)

7

47) What is the requirement for a substantial understatement of tax for individuals?

A) The understatement exceeds $5,000.

B) The understatement exceeds the greater of 10% of the tax required to be shown on the return or $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 10% of the tax required to be shown on the return.

47)

48) 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 at least a 50% likelihood of being supported.

B) A person knowledgeable in the tax law concludes that the position has at least a 75% likelihood of being supported.

C) A person knowledgeable in the tax law concludes that the position has a something less than 50% likelihood of being supported.

D) A person knowledgeable in the tax law concludes that the position has at least a two-thirds likelihood of being supported.

48)

49) 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) $5,600 B) $1,750 C) $1,400 D) $700

49)

50) 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) $450.

B) $375.

C) $0.

D) $75.

50)

51) 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) 3 months.

B) 2 months.

C) 4 months.

D) 6 months.

51)

52) The IRS will issue a ruling A) on a completed transaction for which a return has been filed.

B) to clarify the tax treatment of a transaction.

C) only if regulations have been issued on the subject.

D) on prospective transactions only.

52)

53) 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) $1,500.

B) $5,000.

C) $6,500.

D) some other amount.

53)

8

54) 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) Interest on a deficiency accrues from the due date of the return through the payment date.

C) During the audit process, if the taxpayer concurs with the assessment of tax by the IRS and signs Form 870 (Waiver of Restrictions on Assessment and Collection of Deficiency in Tax), then the taxpayer is precluded from filing a refund suit.

D) 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.

54)

55) 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

55)

56) The court in which the taxpayer does not have to pay the tax and then litigate for a refund is the A) Federal district court.

B) U.S. Court of Federal Claims.

C) Tax Court.

D) all of the above

56)

57) 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) three months B) 30 days C) 90 days D) 180 days

57)

58) In order to appeal to the Appeals Division, a taxpayer must submit a protest letter to the IRS A) in a field audit involving an assessment of taxes, interest, and penalties in excess of $25,000.

B) if an office audit is involved.

C) if a TCMP audit is involved.

D) as a response to receiving a 30-day letter.

58)

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

59) 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.

59)

60) The majority of the individual tax returns that are audited are selected under the DIF program.

60)

61) 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.

61)

62) If the taxpayer has credible evidence, the IRS bears the burden of proof in a tax dispute.

62)

63) The statute of limitations is unlimited for a tax return that is never filed.

63)

64) A taxpayer who fails to file and fails to pay taxes is subject to a combined 5% monthly penalty on the underpayment.

64)

65) The "automatic" extension period for filing an individual return is seven months.

65)

66) The maximum failure to file penalty is a total of 25% of the underpayment.

66)

9

67) 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.

67)

68) Anyone who prepares a tax return is subject to the provisions of Circular 230.

68)

69) A letter ruling is a written determination that interprets and applies the tax laws to the taxpayer's specific set of facts.

69)

70) Treasury Department Circular 230 regulates the practice of attorneys, CPAs, enrolled agents, and enrolled actuaries before the IRS.

70)

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

71) How does a taxpayer determine if "substantial authority" exists for a tax treatment the taxpayer desires to adopt?

72) 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?

73) 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. 74) Explain accountant-client privilege. What are the similarities and differences between it and attorney-client privilege?

75) The IRS audited the tax returns of Dan Jackson, a gifted painter. The IRS contends for several years, Jackson received $500,000 for his paintings, but reported non cash payments of $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? 76) Latka Novatny gave you the following information to use in the preparation of his current year's tax return: Salary Dividends Itemized deductions

$120,000 20,000 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?

77) The taxes shown on Kate's tax returns for Y1 and Y2 were $6,000 and $9,000, respectively. Kate's withholding tax for Y2 was $7,000 and she paid no estimated taxes. Kate filed her Y2 return on April 3, Y3, but she did not have sufficient funds to pay the balance due. She pays the $2,000 balance due on June 19, Y3. Kate's AGI for Y2 did not exceed $150,000. Calculate the penalties Kate owes on her Y2 tax return.

10

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. Assume she did not commit fraud. Will Joy owe interest, and if so, on what amount and for how many days?

79) For innocent spouse relief to apply, five conditions must be met. Explain them.

80) 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.

81) 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.

11

Answer Key Testname: C15

1) C 2) A 3) D 4) C 5) C 6) C 7) C 8) D 9) A 10) B 11) A 12) A 13) C 14) A 15) B 16) B 17) A 18) A 19) D 20) A 21) B 22) A 23) D 24) D 25) C 26) A 27) A 28) B 29) D 30) D 31) C 32) B 33) C 34) C 35) C 36) C 37) C 38) D 39) D 40) C 41) D 42) A 43) B 44) C 45) D 46) D 47) B 48) A 49) C 50) B 12

Answer Key Testname: C15

51) D 52) B 53) A 54) C 55) D 56) C 57) C 58) A 59) TRUE 60) FALSE 61) TRUE 62) TRUE 63) TRUE 64) TRUE 65) FALSE 66) TRUE 67) FALSE 68) FALSE 69) TRUE 70) TRUE 71) A taxpayer should initially look to primary sources for support for the position on a tax issue. Specifically, the taxpayer should consult Code sections, Treasury regulations, revenue rulings, revenue procedures, determination letters, and judicial opinions to assess the existence of substantial authority. The weight of authorities supporting a position should be "substantial" in relation to authorities going the other way. There can be substantial authority for more than one position.

72) Activities (a), (b), and (c) constitute the unauthorized practice of law because they potentially involve a determination or modification of the rights of the company's stockholders or creditors. Activity (d) falls within the traditional domain of accountants. Activity (e) may properly be conducted by either an accountant or a lawyer.

73) The taxpayer must introduce "credible evidence," evidence of a quality sufficient to serve as the basis of a court decision. The taxpayer must comply with the recordkeeping and substantiation requirements of the IRC, including the proper documentation of meal and entertainment expenses, charitable contributions, and foreign controlled businesses. Also, the taxpayer must cooperate with the reasonable requests of the IRS for witnesses, information, documents, meetings, and interviews. Finally, the taxpayer must be either a legal person with a net worth not exceeding $7 million or a natural person.

74) According to judicial doctrine, certain communications between an attorney and a client are "privileged" ( i.e., nondiscoverable in the course of litigation). In l998, Congress extended this privilege to similar communications between a federally authorized tax practitioner and a client. A federally authorized tax advisor includes a certified public accountant.

The accountant-client privilege is similar to the attorney-client privilege in two respects. First, it encompasses communications for the purpose of obtaining or giving professional advice. Second, it excludes communications for the sole purpose of preparing a tax return. The accountant-client privilege is dissimilar in three respects. First, it is limited only to tax advice. Second, it may be asserted only in a noncriminal tax proceeding before a federal court or the IRS. Third, it excludes written communications regarding a tax shelter between an accountant and a corporation. A tax shelter is any plan or arrangement, a significant purpose of which is tax avoidance or evasion.

The creation of an accountant-client privilege reflects Congress's belief that the selection of a tax advisor should not hinge on the question of privilege. It ensures that all tax advice is accorded the same protection regardless of the tax advisor's professional status.

13

Answer Key Testname: C15

75) Dan Jackson, his agent, and CPA (tax return preparer) face a number of issues, which include: • Did an understatement of income occur as a result of misreporting the income received from the art fairs and street shows?

• Are the tax years in question still open years under the statute of limitations?

• What is the amount of the additional taxes owed (if any) on the underreporting of income?

• What is the amount of the interest and penalties owed on the understatement of the tax liability?

• What is the amount of the civil and criminal penalties that Dan Jackson faces?

• What tax-return-preparer, civil, and criminal penalties can be imposed by the IRS on the taxpayer's agent and/or CPA for the underreporting of Dan Jackson's tax liability?

• What sanctions might the AICPA and/or the appropriate State Board of Accountancy impose on the tax return preparer?

The facts and circumstances of the situation will determine the penalties levied on Dan Jackson and his CPA. At a minimum, a penalty will be imposed for failure to pay taxes. Because Jackson filed his tax return, no failure-to-file penalty will be imposed. In addition, interest may apply to the failure to make the appropriate estimated tax payments. A 20% negligence penalty also may be imposed on Jackson if the IRS can show that the underpayment was due to negligence or disregard of the rules and regulations. Also, a 20% substantial understatement penalty may be imposed under Sec. 6662(d). As an alternative, the IRS may go for imposition of the civil and criminal fraud penalty.

This would depend on the taxpayer's intent.

The statute of limitations may be extended from three to six years if more than 25% of Jackson's gross income was omitted from the tax return. (Whether this penalty applies is not ascertainable from the public press information regarding the fairs.) No statute of limitations would apply if fraud could be proven. Criminal penalties under Secs.

7201, 7203, or 7206 can lead to up to five years in prison. Various provisions potentially apply against the tax return preparer. We do not have enough information to know which civil or criminal penalties, if any, may apply. If the CPA actively participated in the fraudulent activity, he or she may lose the ability to practice as a CPA, or may lose the ability to practice before the IRS. If the CPA had no knowledge of the fair activities, it is unlikely that the CPA would lose his or her license to practice.

76) • Will Latka be liable for a penalty if the $40,000 is excluded from his gross income?

• What statute of limitations will apply?

If you are correct in believing that substantial authority exists for excluding the $40,000, Latka should not be subjected to any penalties, even if his return is audited and he agrees to include the $40,000 in his income.

Unless a disclosure concerning the $40,000 is attached to Latka's return, the statute of limitations will be six years (from the date he files his return, or from the due date for the return if later) instead of the regular three years. The reason is that he will have omitted from this gross income more than 25% of the $140,000 of gross income reported on his return (25% × $140,000 = $35,000). Perhaps Latka would like to make a disclosure to have a shorter statute of limitations. This might be the case, for example, if some of the deductions he claimed fall into the gray area.

77) Kate's Y2 AGI did not exceed $150,000. Therefore, she does not owe the penalty for underpaying estimated tax in Y2 because she paid an amount more than her Y1 tax liability. She does not owe the failure-to-file penalty because she filed a timely return. She owes the failure-to-pay penalty for 15 months. The penalty is $150 (0.005 × $2,000 × 15).

78) Joy owes interest on a $5,000 deficiency from April 16 through October 8 of the current year, or 176 days.

79) Five conditions must be met: 1) A joint return is filed.

2) The return contains an understatement of tax attributable to the erroneous item(s) of an individual filing it.

3) The other individual establishes that he or she neither knew nor had reason to know of the understatement.

4) Based on all the facts and circumstances, holding the other individual liable for the deficiency would be inequitable.

5) The other individual elects innocent spouse relief no later than two years after the IRS begins its collection efforts.

14

Answer Key Testname: C15

80) Failure-to-pay penalty 0.005 × $5,000 × 8 months $ 200 Failure-to-file penalty 0.05 × $5,000 × 5 months $1,250 Minus: failure-to-pay penalty for same time period 0.005 × $5,000 × 5 months ( 125) 1,125 Total penalties $1,325 81) If the IRS fails to send an individual taxpayer a notice within 18 months after the original due date or the date on which a return is timely filed, whichever is later, the accrual of interest (and penalties) will be suspended. The suspension period begins on the day after the 18-month period and ends 21 days after the IRS sends the requisite notice. Beginning in 2004, the notice must be sent within one year after the aforementioned dates.

If the IRS does not issue a notice and demands payment within 30 days after the taxpayer signs Form 870, Waiver of Statutory Notice, no interest can be charged for the period between the end of the 30-day period and the date the IRS issues its notice and demand.

15