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CHAPTER 2 CORPORATIONS: INTRODUCTION AND OPERATING RULES SOLUTIONS TO PROBLEM MATERIALS

Question/ Problem 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Status: Present Edition

Topic Tax and nontax factors in entity selection Corporation versus partnership: treatment of income; no distributions Corporation versus partnership: treatment of losses Corporation versus proprietorship: treatment of losses Corporation versus proprietorship and S corporation Expenses to avoid double taxation Unreasonable compensation Taxation of dividends and salary Check-the-box regulations: classification rules Benefits of LLC: sole member Accounting periods: limitation on fiscal year Accounting methods: limitation on cash method Accounting methods: limitation on accrual of expenses to cash basis related party Capital gain treatment of corporation and individual Capital loss treatment of corporation and individual Passive loss rules: closely held C corporations and PSCs contrasted Passive loss rules: closely held C corporation Charitable contributions: year of deduction for corporate and noncorporate taxpayers Charitable contributions: corporate contribution of inventory Charitable contributions: year-end planning issues with carryover Domestic production activities deduction: limitations NOL, dividends, and LTCL issues Dividends received deduction: corporate versus individual treatment

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2009 Corporations Volume/Solutions Manual

Question/ Problem 24 25 26 27 28 29 30 31 32 33 34 35 *36 37 *38 39 40 41 42 43 44 45 46 47 48 49 50 *51 *52 53 *54 *55

Topic Organizational expenditures Start-up expenditures Tax liability of related corporations Schedule M-1: adjustments Schedule M-3: objective of schedule Schedule M-3: income from partnership Financial accounting considerations: FAS 109 deferred tax assets and liabilities Financial accounting considerations: FIN 48 applicable entities Compare LTCL treatment for corporations and for proprietorships Tax treatment of income and distributions from partnership, S and C corporations Corporation versus proprietorship: with distributions Corporation versus single-member LLC: losses Corporation versus proprietorship: after-tax comparison Comparison of deduction for casualty loss for individual and corporate taxpayers Tax liability determination as proprietorship or corporation Personal service corporation: salary requirements for use of fiscal year and tax rate Accounting methods: related party expense; cash versus accrual Capital gains and losses: tax rate on LTCG for corporation versus individual Capital loss of corporation Comparison of treatment of capital losses for individual and corporate taxpayers Capital gains and losses of a corporation; carryback/carryover Passive loss of closely held corporation; PSC Charitable contribution of inventory by corporation Corporate charitable contribution Charitable contributions of corporation; carryover Timing of charitable contributions deduction: taxable income limit Domestic production activities deduction Net operating loss: computed with dividends received deduction Dividends received deduction Organizational expenses Organizational expenses Determine corporate income tax liability

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Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman Question/ Problem *56 57 58 59 60 61 62 63

Topic

Status: Present Edition

Q/P in Prior Edition

Schedule M-1, Form 1120 Schedule M-1, Form 1120 Schedule M-3, Form 1120 Schedule M-3, Form 1120 Schedule M-3, Form 1120 Schedule M-3, Form 1120 Financial accounting considerations: FIN 48 recognition and measurement Tax issues involved in starting a new business in the corporate form

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Corporation income tax (Form 1120) Corporation income tax (Form 1120)

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Member’s personal liability for unpaid employment taxes of single-member LLC Dividends received deduction Expenditures incurred on behalf of corporation Internet activity Internet activity Internet activity

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55 56 57 58

Tax Return Problem 1 2 Research Problem 1 2 3 4 5 6

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*The solution to this problem is available on a transparency master.


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2009 Corporations Volume/Solutions Manual CHECK FIGURES


32.a. 32.b. 33.a. 33.b. 33.c. 35.a. 35.b. 36.a. 36.b. 36.c. 37.a. 37.b. 38.a. 38.b. 38.c. 38.d. 39.a. 39.b. 40.a. 40.b. 41.a. 41.b. 42.a. 42.b. 43.a. 43.b. 44.a.

Andrew will report profit $20,000 and capital loss $5,000. Andrew’s income is not increased. Each partner reports $100,000 net profit and LTCG of $30,000. Same as a. Corporation reports $260,000 income. Shareholder reports $40,000 dividend income. Losses not passed through to shareholder. Deduct $153,000. After-tax income $73,328. After-tax income $66,702. After-tax income $59,256. $50,900 itemized deduction. $67,500. $36,050. $29,450. $23,420. $33,658. $60,000. $24,000. $0. $110,000. $22,250. $15,000. $75,000. $93,000. $18,000 deducted 2008; $6,000 carried forward to 2009. $15,000 deducted 2008; $9,000 carried back to 2005, then 2006, etc. Offset short-term capital gain of $90,000 against net long-term capital

loss of $570,000. The $480,000 net capital loss is carried back 3 years and forward 5 years. 44.b. Total carryback $420,000. 44.c. $60,000; carry forward to 2009, etc. 44.d. Deduct $93,000 in 2008, $477,000 carried forward indefinitely. 45. Offset $80,000 of passive loss against active income. No offset if a PSC. 46.a. $30,000. 46.b. $50,000. 46.c. $60,000. 48.a. $29,000. 48.b. Excess $6,000 carried forward. 49. 2008. 50.a. $36,000. 50.b. $37,500. 51.a. $116,000. 51.b. Carryback 2 then forward 20. 52. Green $70,000; Orange $140,000; Yellow $112,000. 53.a. $5,072. 53.b. $6,107. 53.c. $5,072. 53.d. $6,107. 54. $3,700. 55. Purple $7,200; Azul $108,050; Pink $113,900; Turquoise $2,278,000; Teal $7,910,000. 56. $120,000. 57. $195,000.

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2009 Corporations Volume/Solutions Manual

DISCUSSION QUESTIONS 1. You should ask questions that will enable you to assess both tax and nontax factors that will affect the entity choice. Some relevant questions are addressed in the following table, although there are many additional possibilities. Question

Reason for the question

What type of business are you going to operate?

This question will provide information that may affect the need for limited liability, ability to raise capital, ease of transferring interests in the business, how long the business will continue, and how the business will be managed.

What amount and type of income (loss) do you expect from the business?

Income from a business will eventually be reported on the tax returns of the owners.

What is the amount and type of income (loss) that you expect from other sources?

For example, income (loss) from a partnership, S corporation, or LLC will ‘‘flow through” to the owners. Dividends from a C corporation must be reported on the tax returns of the shareholders. Any income (loss) from other sources will also be reported on the returns of the owners. Thus, for planning purposes, it is important to know all sources and types of income (loss) that the owners will have.

Do you expect to have losses in the early years of the business?

Losses of partnerships, S corporations, and LLCs flow through to the owners and represent potential deductions on their individual returns. Losses of a C corporation do not flow through.

Will you withdraw profits from the business or leave them in the business so it can grow?

Profits from a partnership, S corporation, or LLC will ‘‘flow through” to the owners, and will be subject to taxation on their individual tax returns. Profits of a C corporation must be reported on the tax returns of the shareholders only if such profits are paid out to shareholders as dividends. Thus, in the case of a partnership, S corporation, or LLC, owners must pay tax on profits before plowing funds back into the business. In the case of a C corporation, the corporation must pay tax on its profits.


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman pp. 2-2 to 2-6 2. Arnold does not report any of Yellow Corporation’s income because no dividends were paid during the year. However, he must report his $49,000 (35% partnership interest × $140,000 partnership income) share of Pastel Partnership’s income on his individual tax return. p. 2-3 3. Art should consider operating the business as a sole proprietorship for the first three years. If he works 15 hours per week in the business, he will exceed the minimum number of hours required to be a material participant (52 × 15 = 780). Therefore, he will be able to deduct the losses against his other income. When the business becomes profitable, Art should consider incorporating. If he reinvests the profits in the business, the value of the stock should grow accordingly, and he should be able to sell his stock in the corporation for long-term capital gain. pp. 2-2 to 2-6 4. Losses of sole proprietorships are passed through to their owners, but losses (operating or capital) of regular corporations are not. Capital losses of sole proprietorships retain their character when reported by the proprietor. The capital loss of the sole proprietorship is passed through to Lucille, and she is allowed to report it on her tax return as a capital loss. She can offset the loss against capital gains or deduct it against ordinary income (up to $3,000) if she has no capital gains for the year. The capital loss of Mabel’s corporation is reported on the tax return of the corporation, which is a separate taxable entity. It has no effect on her taxable income. The operating loss is passed through to Lucille, and she is allowed to deduct it on her tax return (subject to at-risk and passive loss limitations). The operating loss of the corporation has no effect on Mabel’s tax return. pp. 2-2, 2-3, and 2-12 5. Conner should report the information on his individual tax return as follows: If SE is

Conner should report

a.

A proprietorship

$120,000 profit on Schedule C, $5,000 capital loss on Schedule D (subject to capital loss limitation). The $80,000 withdrawal would have no impact on Conner’s individual tax return.

b.

A C corporation

$80,000 dividend (profit withdrawn from SE). Neither the $120,000 profit nor the $5,000 capital loss would flow through.


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2009 Corporations Volume/Solutions Manual

c.

An S corporation

$120,000 profit and $5,000 capital loss would flow through from SE to Conner and be reported on his individual tax return. The capital loss would be combined with any personal capital gains (losses), and would be subject to the $3,000 limit. The $80,000 withdrawal would have no impact on Conner’s individual tax return.

pp. 2-2 to 2-6 6. If Tanesha buys the warehouse and rents it to the corporation, she can charge the corporation the highest amount of rent that is reasonable. The rental operation can help her to bail some profits out of the corporation and avoid double taxation on corporate income. The depreciation and other expenses incurred in connection with the warehouse will be deductible by Tanesha, which should enable her to offset some or all of the rental income. If the rental property produces a loss, Tanesha can use the loss to offset any passive income she might have. If Tanesha has the corporation buy the warehouse, the revenue and expenses related to the building will be included in the computation of corporate income. If there is a profit, Tanesha can bail it out as a dividend, which will be taxed at a 15% rate. pp. 2-4, 2-35, and 2-36 7. To the extent a salary paid to a shareholder-employee is considered reasonable, the corporation is allowed a deduction. To the extent a salary payment is considered unreasonable, the payment is treated as a dividend and is not allowed as a deduction. a. Vivian reports the $400,000 as salary and pays tax on it at a marginal rate of 35%. The corporation has a $400,000 deduction. b. Vivian reports the $400,000 as dividend income and pays tax at a preferential rate of 15%. The corporation is not allowed to deduct the $400,000 dividend. c. Since the shareholder-employee is taxed on both salary ($300,000) and dividends ($100,000), double taxation on $100,000 has occurred. The preferential rate of 15% applies to the dividends. The corporation has a deduction for the reasonable compensation amount, or $300,000, but not the $100,000 dividend. p. 2-4 8. Al will be subject to a 15% rate on the $20,000 that ABC pays him as a dividend, but ABC will not be allowed to deduct the amount in computing corporate taxable income. Jay will report the additional $20,000 that JKL pays him as salary and will be taxed at his marginal rate of 35%. JKL will be allowed to deduct the salary payment in computing corporate taxable income. p. 2-4 9. The “check-the-box” Regulations guide the Federal taxation of LLCs. In the case of an LLC with two or more members, an election may be made to treat the entity as a corporation. Absent such an election, the LLC is treated as a partnership for Federal tax purposes. In the case of a single-member LLC, an election may be made to treat the entity as a corporation. Absent this election, the entity is disregarded for Federal tax purposes and


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman the sole member (proprietor) reports the income (loss) of the LLC on his or her individual return. p. 2-8 10.

The primary nontax advantage of LLC status is limited liability for the sole member. Depending on the laws of the state of formation, other nontax advantages (e.g., centralized management, free transferability of ownership interests) may exist. The primary tax advantage of LLC status is that Erica can avoid the double taxation effect associated with a C corporation. Under the “check-the-box� Regulations and absent an election to the contrary, the LLC is disregarded and Erica reports the income (loss) of the LLC on her individual return. p. 2-8


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2009 Corporations Volume/Solutions Manual

11.

A personal service corporation (PSC) generally must use the calendar year for tax purposes. A PSC is a corporation whose principal business activity is the performance of personal services (e.g., legal, accounting, architectural, health) and such services are substantially performed by shareholder-employees. A fiscal year may be elected in some cases (e.g., business purpose for year can be demonstrated). S corporations are subject to similar limitations on the use of fiscal tax years. p. 2-10

12.

In general, a corporation is not allowed to use the cash method of accounting for Federal tax purposes. However, S corporations, qualified personal service corporations, and C corporations engaged in the trade or business of farming or timber are exceptions to this rule. Further, a C corporation with $5 million or less of average gross receipts over the past three years is allowed to use the cash method. a. Red Corporation has $8 million of average gross receipts over the 2005-2007 period. Thus, Red must use the accrual method of accounting (unless it satisfies one of the other exceptions). b. White Corporation has $4 million of average gross receipts over the 2005-2007 period. Thus, White satisfies the gross receipts exception and may use the cash method of accounting. p. 2-11

13.

A corporation that uses the accrual method cannot claim a deduction for an expense involving a related party until the recipient reports that amount as income. Jeong, a cash basis taxpayer, must report the rent income in 2009, the year she receives the payment. The corporation may deduct the rent expense in 2009, the year Jeong is required to report it as income. p. 2-11

14.

Both corporations and individuals include recognized net capital gains in their taxable income. For a corporate taxpayer, such income receives no preferential rate treatment and is taxed at the same rates as the entity’s ordinary income. For an individual taxpayer, however, a net capital gain is taxed at maximum rate of 15%. p. 2-12

15.

Kathy may use her $25,000 LTCL to offset any capital gains she has during the year. If she has losses in excess of gains, she may deduct up to $3,000 of the losses as a deduction for AGI, and any remaining losses may be carried forward indefinitely. Eagle Corporation may use the capital loss to offset any capital gains recognized during the year. Any excess losses may be carried back three years and forward five years. When carried back or forward, a long-term capital loss is treated as a short-term loss. p. 2-12

16.

a. If Osprey is a personal service corporation, it cannot deduct any of the passive loss. A personal service corporation cannot offset a passive loss against either active or portfolio income. b. A closely held corporation that is not a personal service corporation can offset passive losses against active income but not against portfolio income. Therefore, Osprey can deduct $180,000 of the $270,000 passive loss. p. 2-12


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman 17.

A closely held C corporation that is not a personal service corporation can offset a passive loss against active income, but not against portfolio income. Hummingbird can deduct only $70,000 of the $90,000 passive loss. Example 15

18.

Individuals cannot deduct contributions until they are actually made. Therefore, Andrea must wait until 2009 to deduct the contribution. Aqua Corporation, whose board of directors authorized the contribution in 2008, can deduct the contribution in 2008, as the pledge was paid on or before March 15, 2009. Example 16

19.

In general, a charitable deduction for a contribution of appreciated inventory is limited to the basis of the contributed property. However, in the case of a contribution of inventory to a charitable organization that uses the property for the care of the ill, needy, or infants, a corporate taxpayer may obtain an increased deduction. In such cases, the charitable deduction is limited to the lesser of (1) the sum of the property’s basis plus 50% of the appreciation on the property or (2) twice the property’s basis. Example 20

20.

The following tax issues should be considered. ●

Is Orange an accrual method taxpayer and, if so, will the contribution be made by March 15, 2009, so as to obtain a deduction in 2008?

Will the contribution consist of property or cash?

If the contribution consists of property, what is the character of the property (capital gain or ordinary income property) and amount of the contribution deduction?

What is the current year’s taxable income limitation on the deductibility of charitable contributions?

In what tax year did the charitable contribution carryover originate and when does the 5-year period for such carryover expire?

If the $45,000 sum of the current year’s contribution plus the carryover amount exceeds the taxable income limitation, should the current year’s gift be deferred to the subsequent tax year?

pp. 2-13 to 2-15 21.

The domestic productions activities deduction for 2008 is equal to 6% of the lesser of the taxpayer’s (1) qualified productions activities income or (2) taxable income. However, the deduction cannot exceed 50% of the corporation’s W-2 wages related to qualified productions activities income. p. 2-15

22.

Finch Corporation must determine whether it had a net operating loss (NOL) in 2009. In making this determination, consider the operating loss, the dividend received, and the dividends received deduction. The long-term capital loss (LTCL) is not allowed. However, Finch may carry the LTCL back to 2007 and 2008 to offset any capital gain in those years. An NOL may be carried back two years and forward 20 years to offset taxable income. If Finch has an NOL for 2009, it must decide whether to carry the NOL back to prior years or forward to future years. It should forgo the NOL carryback if tax rates in the two preceding years were low and if higher rates are expected in the future. Before electing to forgo an NOL carryback, however, a corporation should be able to predict with confidence that future profits will be higher.


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2009 Corporations Volume/Solutions Manual Examples 24 and 40

23.

Otter Corporation will be allowed a dividends received deduction equal to 80% of the $240,000 dividend (subject to possible limitations described in Example 25). It will pay tax at the applicable corporate tax rate of 25% on the remaining portion of the dividend. Gerald must include the entire $240,000 dividend and will pay tax at the 15% rate applicable to individuals. Examples 3 and 25

24.

a. Expenditures that qualify for amortization include the following: legal services incident to organization (such as costs of drafting the corporate charter, the bylaws, the minutes, and the terms of original stock certificates); necessary accounting services; expenses of temporary directors and of organizational meetings of directors or stockholders; and fees paid to the state of incorporation. b. Expenditures that do not qualify are those connected with the issuing or selling of shares of stock or other securities (e.g., commissions, professional fees, and printing costs) or with the transfer of assets to a corporation. c. Amortization is over a period of 180 months. The period begins with the month in which the corporation begins business. Amortization is conditioned on an election. If an election is not made, organizational expenditures cannot be deducted until the corporation ceases to do business and liquidates. However, if the corporate charter limits the life of the corporation, the expenditures could be amortized over such life. d. Expenses must be incurred before the end of the taxable year in which the corporation begins business. Expenses paid by a cash basis corporation in a subsequent year would still qualify. In this regard, the corporation’s method of accounting is of no consequence. e. The special election allows immediate expensing of the first $5,000 of qualifying organizational costs. The exception is phased out on a dollar-for-dollar basis when organizational costs exceed $50,000. f. The election is made in a statement attached to the corporation’s return for its first taxable year. The return and statements must be filed no later than the due date of the return (including any extensions). pp. 2-19, 2-20, and Example 27

25.

Expenses incurred before any revenue is produced by a business are treated as start-up expenditures under § 195. A taxpayer may elect to expense $5,000 of such expenses and amortize the balance over a period of 180 months, beginning with the month the corporation begins business. Therefore, Teal can elect to deduct $5,389 in 2008 {$5,000 + [($12,000 – $5,000)  180  10]}. p. 2-20

26.

George’s plan will not reduce corporate income taxes. Palmetto, Poplar, and Spruce would be related corporations and would be subject to special rules for computing the corporate income tax. Therefore, the total corporate tax liability would remain unchanged. Examples 30 and 31

27.

The starting point on Schedule M-1 is net income per books. Additions and subtractions are entered for items that affect net income per books and taxable income differently. An example of an addition is Federal income tax expense, which is deducted in computing net income per books but is disallowed in computing taxable income. An example of a


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman subtraction is a charitable contributions carryover that was deducted for book purposes in a prior year but deducted in the current year for tax purposes.


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2009 Corporations Volume/Solutions Manual ADDITIONS b. Travel and entertainment expenses in excess of deductible limits c. Book depreciation in excess of allowable tax depreciation d. Federal income tax per books e. Charitable contributions in excess of deductible limits f. Premiums paid on life insurance policy on key employee i. Interest incurred to carry tax-exempt bonds SUBTRACTIONS a. Charitable contributions carryover from previous year g. Proceeds of life insurance paid on death of key employee h. Tax-exempt interest p. 2-23 and Example 32

28.

The government’s objectives were (1) to create greater transparency between corporate financial statements and tax returns, and (2) to identify corporations that engage in aggressive tax practices. p. 2-24

29.

The ordinary income from Fox as well as the short-term capital gain and charitable contributions flow through to Wolf. Wolf must report book income on its Schedule M-3. It must also calculate income per tax return (ordinary income + short-term capital gain – charitable contributions), and show the difference between book income and income per tax return as a permanent difference. Example 35

30.

Deferred tax assets and liabilities develop due to the differences between the accounting for income taxes for financial and tax purposes. Deferred taxes result from temporary differences between the financial accounting and the tax treatment of an item. A deferred tax liability arises when the book basis of an item exceeds its tax basis (e.g., the excess of MACRS over straight-line deprecation). A deferred tax asset arises when the tax basis of an item exceeds its book basis (e.g., accrual of warranty expense). A deferred tax asset is recognized only when it satisfies the “more likely than not” threshold required under FAS 109 (as supplemented by FIN 48). p. 2-27

31.

What the statement is describing are the requirements for the application of Schedule M-3, not FIN 48. Instead, FIN 48 applies to all entities that issue financial statements in conformance with generally accepted accounting principles. While corporations may be the form of entity most affected by the requirements of FIN 48, other types of entities (e.g., partnerships, nonprofit organizations) which issue financial statements under GAAP are also affected. p. 2-24

PROBLEMS 32.

a. Revenues, expenses, gains, and losses of a proprietorship flow through to the proprietor. Consequently, Andrew reports the $20,000 net profit and $5,000 capital loss on his individual tax return. b. Shareholders are required to report income from a C corporation only to the extent of dividends received. Therefore, Andrew does not report the net profit or capital loss on his individual return. pp. 2-2 and 2-3


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman 33.

a. Otter, a partnership, is not a taxpaying entity. Its profit (loss) and separate items flow through to the partners. The partnership’s Form 1065 reports net profit of $200,000 ($500,000 income – $300,000 expenses). The partnership also reports the $60,000 longterm capital gain as a separately stated item on Form 1065. Ellie and Linda each receive a Schedule K-1 reflecting net profit of $100,000 and separately stated long-term capital gain of $30,000, which each reports on her own return. The withdrawals do not affect taxable income but decrease their basis in the partnership. Example 2 b. Otter, an S corporation, is not a taxpaying entity. Its profit (loss) and separate items flow through to the shareholders. The S corporation’s From 1120S reports net profit of $200,000 ($500,000 income – $300,000 expenses). The S corporation also shows the $60,000 long-term capital gain as a separately stated item on Form 1120S. Ellie and Linda both receive a Schedule K-1 reporting net profit of $100,000 and separately stated long-term capital gain of $30,000, which each reports on her own return. The withdrawals do not affect taxable income but decrease their basis in the S corporation. p. 2-3 c. Otter, a C corporation, is a taxpaying entity. Otter’s Form 1120 reports net operating profit of $200,000 ($500,000 income – $300,000 expenses) and the $60,000 long-term capital gain. Ellie and Linda report dividend income of $40,000 each. The dividend income is subject to a maximum tax rate of 15%. pp. 2-3 to 2-5 and Example 3

34.

Since Mesquite is a corporation, the $150,000 net profit is taxable at the corporate level, resulting in corporate tax of $41,750 [$22,250 + .39($150,000 – $100,000)]. Sheryl will pay tax of $16,237.50 on the dividend income ($108,250 × 15%). Total taxes amount to $57,987.50 ($41,750 + $16,237.50). If Mesquite were a proprietorship instead, Sheryl must pay tax of $52,500 ($150,000 × 35%). In the case of a corporation, FICA taxes would add to the tax burden of the corporation and the individual. In the case of the proprietorship, the individual would be subject to self-employment taxes. pp. 2-2 to 2-5 and Examples 5 and 6

35.

Losses of a C corporation are not passed through to the shareholders. The corporation may carry net operating losses to other years (back two years, forward 20). Capital losses of corporations are not deductible in the year incurred, but can be carried back three years or forward five years. Under the “check-the-box” regulations, a single-member LLC is treated as a disregarded entity (unless an election is made to be treated as a corporation). In such cases, the LLC is taxed as a proprietorship and its income (loss) is reported on the individual return of the sole member. Operating losses of a proprietorship are deductible if the proprietor is a material participant. Net capital losses are passed through to and reported by the proprietor (subject to capital loss limitation). a. The corporation’s losses are subject to the NOL and capital loss carryback provisions. The losses are not passed through to the shareholder. b. Chris is a material participant in Orange Company. Chris has enough other income to be in the 35% bracket, so he will not be in a net operating loss situation after deducting the operating loss from Orange Company. In 2008, he can deduct $153,000 ($150,000 operating loss + $3,000 capital loss). In addition, Chris will have a $17,000 long-term capital loss carryover to 2009. pp. 2-6, 2-8, and 2-12


2-16 36.

2009 Corporations Volume/Solutions Manual Johnson Company has net income of $90,000 ($200,000 revenue – $110,000 expenses). If the company is a proprietorship, Ed must report this amount as income, regardless of the amount he withdraws. If the company is a corporation, it must pay corporate tax on the income and Ed must report any dividends he receives from the company as income. a. Ed’s after-tax income is computed below: Income from proprietorship ($200,000 – $110,000) Less deductions ($5,450 standard deduction + $3,500 exemption) Taxable income

$90,000 (8,950) $81,050

Tax on $81,050 (see Appendix A for Tax Rate Schedules)

$16,672

After-tax income ($90,000 – $16,672.25)

$73,328

b. Tax on corporation’s net income of $90,000: Tax on $90,000

$18,850

Corporation’s after-tax income ($90,000 – $18,850)

$71,150

Ed’s taxable income ($71,150 dividend – $5,450 standard deduction – $3,500 exemption)

$62,200

Ed’s tax on $62,200 at rates applicable to dividends [($32,550 × 0%) + .15($62,200 – $32,550)]

$ 4,448

Ed’s after-tax income ($71,150 – $4,448)

$66,702

c. The corporation will have $18,850 taxable income ($200,000 revenue – $71,150 salary – $110,000 other expenses). Ed will have taxable income of $62,200 ($71,150 – $5,450 standard deduction – $3,500 exemption). His tax will be $11,894, and his after-tax income will be $59,256 ($71,150 – $11,894). pp. 2-2 to 2-4 37.

a. Wilson can claim an itemized deduction of $50,900 [$112,500 – $45,000 (insurance recovery) – $100 (floor on personal casualty losses) – $16,500 (10% of $165,000 AGI)]. b. Wilson can deduct $67,500 [$112,500 – $45,000 (insurance recovery)]. Corporations are not subject to the $100 floor or the 10%-of-AGI limitation. p. 2-9

38.

a. Gross income Ordinary deductions Taxable income (to owner of proprietorship) Tax @ 35%

$200,000 (97,000) $103,000

$36,050


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman b. Gross income of corporation Ordinary deductions Salary Taxable income Corporate tax

$200,000 (97,000) (70,000) $ 33,000

Gross income of shareholder Salary Tax @ 35% Total tax

$ 70,000

c. Gross income of corporation Ordinary deductions Taxable income Corporate tax d. Gross income of corporation Ordinary deductions Salary Taxable income Corporate tax

$200,000 (97,000) $103,000 $200,000

Tax paid by shareholder On salary ($70,000 × 35%) On dividend [($33,000 – $4,950) × 15%] Total tax $33,658 e.

(97,000) (70,000) $ 33,000

$ 24,500 4,208

$ 4,950

24,500 $29,450

$23,420

$ 4,950

28,708

Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 December 3, 2008 Mr. Robert Benton 1121 Monroe Street Ironton, OH 45638 Dear Mr. Benton: This letter is in response to your inquiry as to the tax effects of incorporating your business in 2009. I have analyzed the tax results under both assumptions, proprietorship and corporation. I cannot give you a recommendation until we discuss the matter further and you provide me with some additional information. My analysis based on information you have given me to date is presented below. COMPUTATION 1 Total tax on $103,000 taxable income if you continue as a proprietorship (35% tax rate)

$36,050


2-18

2009 Corporations Volume/Solutions Manual Total tax if you incorporate: Individual tax on $70,000 salary @ 35% Corporate tax on $33,000 corporate taxable income Total

$24,500 4,950 $29,450

Although this analysis appears to favor incorporating, it is important to consider that there will be additional tax on the $28,050 of income left in the corporation if you withdraw that amount as a dividend in the future, as calculated below: COMPUTATION 2 After-tax income left in corporation ($33,000 taxable income – $4,950 corporate tax)

$28,050

Tax on $28,050 @ 15%

$ 4,208

Total tax paid if you incorporate ($29,450 + $4,208)

$33,658

Comparison of computations 1 and 2 appears to support incorporating. If you incorporate and recover the income left in the corporation as long-term capital gain in the future, the total tax cost of incorporating will be the same, as shown in computation 3 below. COMPUTATION 3 After-tax income left in corporation ($33,000 taxable income – $4,950 corporate tax)

$28,050

Tax on $28,050 @ 15% LTCG rate

$ 4,208

Total tax paid if you incorporate ($29,450 + $4,208)

$33,658

In summary, incorporation appears to be the most attractive option, whether you recover income left in the corporation as capital gain or as dividend income. Keep in mind, however, that there are important nontax considerations with respect to this decision. We can discuss those issues at our next meeting. Thank you for consulting my firm on this important decision. We are pleased to provide analyses that will help you make the right choice. Sincerely, Jon Thomas, CPA pp. 2-2 to 2-4 and 2-20 39.

a. The salary for the deferral period (October through December) must be at least proportionate to the employee’s salary received for the fiscal year. The amount that Dove Corporation must pay Herbert during the period October 1 through December 31, 2008, to permit the continued use of its fiscal year without negative tax effects is $60,000 ($240,000 × 3/12). Example 11 b. Dove Corporation, a PSC, is subject to a tax rate of 35% on all of its taxable income. The corporation would pay tax of $24,500 ($70,000 × 35%). To illustrate the negative


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman tax impact of classification as a PSC, compare this amount to the $12,500 that a corporation that is not a PSC would pay on taxable income of $70,000. p. 2-20 40.

a. Under the cash method of accounting, the bonuses are deductible in the year they are paid by Pelican, or 2009. Thus, none of the $210,000 of bonuses is deductible in 2008. b. Under the accrual method of accounting, Pelican deducts in 2008 the $110,000 bonus paid to Lucinda but not the $100,000 bonus paid to Charles. An accrual method corporation can not deduct an accrued obligation outstanding at the end of the year if it relates to a cash method, related party (e.g., more than 50% shareholder). In such cases, the corporation deducts the payment in the year it is included in the related party recipient’s income. Thus, the $100,000 bonus paid to Charles is deductible by Pelican in 2009. Example 12

41.

a. If Violet is a corporation, then $22,250 of corporate income tax results in 2008. Corporations do not receive a preferential rate for LTCGs, and such income is taxed at the normal corporate rates resulting in a tax of $22,250 [($50,000 × 15%) + ($25,000 × 25%) + ($25,000 × 34%)]. b. If Violet is a proprietorship, then $15,000 ($100,000 × 15%) of individual income tax results in 2008 for Ramona. The income (or loss) of a proprietorship is reported on the proprietor’s individual return. Individuals receive a preferential tax rate of 15% (or 0%, if the taxpayer is in the two lowest tax brackets) on LTCGs. pp. 2-12 and 2-20

42.

A corporation cannot deduct a net capital loss in the year incurred. The net loss can be carried back for three years and offset against capital gain in the carryback years. If the capital loss is not used up in the carryback years, the excess can be carried forward for five years. Capital gains of corporations are included in taxable income and are not subject to the preferential rate applicable to individuals. a. $600,000 (operating income) – $525,000 (operating expenses) + $45,000 (LTCG) – $45,000 (STCL) = $75,000 taxable income. No deduction is allowed for the net capital loss. b. $600,000 (operating income) – $525,000 (operating expenses) + $96,000 (LTCG) – $78,000 (STCL) = $93,000 taxable income. p. 2-12

43.

a. Of the $24,000 long-term capital loss, $18,000 can be deducted in 2008. The loss will offset the capital gains of $15,000 first; then, an additional $3,000 of the loss may be utilized as a deduction against ordinary income. The remaining $6,000 of the net capital loss is carried forward to 2009 and years thereafter until completely deducted. The loss carryover retains its character as long term. b. Only $15,000 of the loss may be deducted in 2008. The loss deduction is limited to the amount of capital gains ($9,000 STCG + $6,000 LTCG). A corporation may not claim a net capital loss as a deduction against ordinary income. The remaining $9,000 loss can be carried back to the three preceding years to reduce any capital gains in those years. (The loss is carried back first to the tax year 2005.) Any remaining loss not offset


2-20

2009 Corporations Volume/Solutions Manual against capital gains in the three previous years can be carried forward for five years only, to offset capital gains in those years. The long-term capital loss will be treated as a short-term capital loss as it is carried back and forward. Examples 13 and 14

44.

a. Net short-term capital gain Net long-term capital loss Net capital loss

$ 90,000 (570,000) ($480,000)

Gorilla cannot deduct the net capital loss of $480,000 on its 2008 return, but must carry it back to the three preceding years, applying it to 2005, 2006, and 2007, in that order. The net capital loss is carried back or forward as a short-term capital loss. b. 2008 net capital loss Offset against 2005 (net long-term capital gains) 2006 (net short-term capital gains) 2007 (net long-term capital gains) Total carrybacks

($480,000) $120,000 210,000 $420,000

c. $60,000 ($480,000 – $420,000) STCL carryover to 2009, 2010, 2011, 2012, and 2013, in that order. d. Leslie nets these transactions with all other capital transactions for 2008. Assuming these are her only capital transactions in 2008, she offsets $90,000 of capital gains against the capital losses and deducts an additional $3,000 in capital losses. The remaining $477,000 ($570,000 – $90,000 – $3,000) is carried forward indefinitely (as long-term capital loss). p. 2-12 45.

Condor, a closely held corporation that is not a PSC, may offset $80,000 of the $90,000 passive loss against the $80,000 of active business income. However, it may not offset the remaining $10,000 of loss against portfolio income. If Condor were a PSC, it could not offset the passive loss against either active or portfolio income. Example 15

46.

The deduction for a charitable contribution of ordinary income property, such as inventory, is limited to the basis of the property. However, for certain contributions of inventory by a corporation, the amount of the deduction is equal to the lesser of (1) the sum of the property’s basis plus 50% of the appreciation on the property, or (2) twice the property’s basis. a. A contribution of computers to a church that will sell the computers does not qualify for the increased deduction amount. As such, the charitable deduction is limited to Robin’s basis in the computers, or $30,000.


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman b. A contribution to a university that will use the computers in its student computer lab qualifies for the increased deduction amount. Thus, Robin’s charitable deduction is equal to $50,000 [$30,000 (basis) + .5($70,000 – $30,000)]. c. In this case, the ceiling on the increased deduction amount applies, and Robin’s charitable deduction is equal to twice the property’s basis, or $60,000 {$60,000 is less than $65,000 [$30,000 (basis) + .5($100,000 – $30,000)]}. Example 20 47.

Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 December 4, 2008 Mr. Joseph Thompson Jay Corporation 1442 Main Street Freeport, ME 04032 Dear Mr. Thompson: I have evaluated the proposed alternatives for your 2008 year-end contribution to the University of Maine. I recommend that you sell the Brown Corporation stock and donate the proceeds to the University. The four alternatives are discussed below. Donation of cash, the unimproved land, or the Brown stock each will result in a $120,000 charitable contribution deduction. Donation of the Maize Corporation stock will result in only a $20,000 charitable contribution deduction. Contribution of the Brown Corporation stock will result in a less desirable outcome from a tax perspective. However, you will benefit in two ways if you sell the Brown stock and give the $120,000 in proceeds to the University. Donation of the proceeds will result in a $120,000 charitable contribution deduction. In addition, sale of the stock will result in a $50,000 long-term capital loss. If Jay Corporation had capital gains of at least $50,000 and paid corporate income tax in the past three years, the entire loss can be carried back and Jay will receive tax refunds for the carryback years. If Jay Corporation had no capital gains in the carryback years, the capital loss can be carried forward and offset against capital gains of the corporation for up to five years. Jay Corporation should make the donation in time for the ownership to change hands before the end of the year. Therefore, I recommend that you notify your broker immediately so there will be no problem in completing the donation on a timely basis. I will be pleased to discuss my recommendation in further detail if you wish. Please call me if you have questions. Thank you for consulting my firm on this matter. We look forward to serving you in the future. Sincerely, Richard Stinson, CPA


2-22

2009 Corporations Volume/Solutions Manual pp. 2-13 and 2-14


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman 48.

a. Taxable income for purposes of applying the 10% charitable contributions limitation does not include the dividends received deduction or domestic production activities deduction. For purposes of the 10% limitation, taxable income is $290,000 ($500,000 – $240,000 + $30,000). The maximum charitable contribution allowed for the year, therefore, is $29,000 (10% × $290,000). b. The excess $6,000 not allowed ($35,000 contribution – $29,000 allowed) is carried forward to 2009 (5 year carryforward). Example 21

49.

Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 December 3, 2008 Mr. Dan Simms, President Simms Corporation 1121 Madison Street Seattle, WA 98121 Dear Mr. Simms: On December 1 you asked me to advise you on the timing of a contribution by Simms Corporation to the University of Washington. My calculations show that the corporation will maximize its tax savings by making the contribution in 2008. If the corporation makes the contribution in 2008, it can deduct $20,000 as a charitable contribution, which will save $7,800 (39% tax rate × $20,000 deduction) in Federal income tax. However, if the corporation makes the contribution in 2009, the percentage limitations applicable to corporations will limit its 2009 deduction to $10,000 ($100,000 projected profit × 10% limit). The corporation will save $3,400 (34% tax rate × $10,000 deduction) in taxes as a result of this deduction. The corporation may carry the remaining $10,000 forward and deduct the amount in 2010. If the corporation continues at the 2009 profit level, it will save an additional $3,400 in tax in 2010, for a total tax savings of $6,800. This analysis makes it clear that the corporation will save $1,000 more ($7,800 – $6,800) if it makes the contribution in 2008. In addition, all of the savings will occur in 2008. If the corporation makes the contribution in 2009, its tax savings will be split between 2009 and 2010. My advice is that the corporation should make the contribution immediately so ownership of the stock can be transferred by December 31. Sincerely, Alicia Gomez, CPA pp. 2-13 and 2-15


2-24

2009 Corporations Volume/Solutions Manual

50.

a. Cheetah’s domestic production activities deduction for 2008 is 6% of the lesser of  taxable income of $600,000, or  qualified production activities income of $750,000. The tentative deduction is $36,000 ($600,000 × 6%). Because W-2 wages were $75,000, the wage limitation ($75,000 × 50% = $37,500) does not apply. Therefore, Cheetah’s domestic production activities deduction for 2008 is $36,000. b. Cheetah’s domestic production activities deduction for 2010 is 9% of the lesser of  taxable income of $600,000, or  qualified production activities income of $750,000. The tentative deduction is $54,000 ($600,000 × 9%). Because W-2 wages were $75,000, the wage limitation ($75,000 × 50% = $37,500) applies. Therefore, Cheetah’s domestic production activities deduction for 2010 is $37,500. p. 2-15 and Example 23

51.

a. The net operating loss is computed as follows. Gross income From operations Dividends Less: Expenses from operations Dividends received deduction Net operating loss

$400,000 80,000 $540,000 56,000

$480,000 (596,000) ($116,000)

The dividends received deduction is not limited to 70% of taxable income because it creates a net operating loss. Example 24 b. The NOL is carried back two years and forward 20 years to offset taxable income in such years. However, Ruby can elect to forgo the carryback and only carry forward the NOL. Example 40 52.

Following the procedure used in Example 25 in the text, proceed as follows:

Step 1 70% × $100,000 (dividend received) 70% × $200,000 (dividend received) 70% × $200,000 (dividend received)

Green Corporation $ 70,000

Orange Corporation

$140,000

Yellow Corporation

$140,000

Step 2 70% × $200,000 (taxable income) 70% × $100,000 (taxable income) 70% × $160,000 (taxable income)

$140,000

$ 70,000

$112,000


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman


2-26

2009 Corporations Volume/Solutions Manual Step 3 Lesser of Step 1 or Step 2 Generates a net operating loss

$ 70,000

$140,000

$112,000

Consequently, the dividends received deduction for Green Corporation is $70,000 under the general rule. Orange Corporation claims a dividends received deduction of $140,000 because a net operating loss results when the Step 1 amount ($140,000) is subtracted from 100% of taxable income ($100,000). Yellow Corporation, however, is subject to the taxable income limitation and is allowed only $112,000 as a dividends received deduction. pp. 2-16, 2-17, and Example 25 53.

a. $5,000 (amount that can be immediately expensed) + [($18,000 – $5,000) ÷ 180 months  1 month] = $5,072. To qualify for the election, the expenditure must be incurred before the end of the taxable year in which the corporation begins business. Amortization does not apply to the $3,600 of expenses that were incurred after the end of the taxable year. b. $5,000 (amount that can be immediately expensed) + [($21,600 – $5,000) ÷180 months  12 months] = $6,107. c. $5,072 [same as a.]. The corporation’s method of accounting is of no consequence in determining organizational expenditures that qualify for the election to amortize. d. $6,107. [same as b.] Examples 27 and 41

54.

Qualifying organizational expenditures include these items: Expenses of temporary directors and of organizational meetings Fee paid to the state of incorporation Accounting services incident to organization Legal services for drafting the corporate charter and bylaws Total

$14,000 2,000 10,000 27,000 $53,000

Since an appropriate and timely election under § 248 was made, the amount that Hummingbird Corporation may write off for the tax year 2008 is determined as follows: $2,000 + [($53,000 – $2,000) ÷ 180 months × 6 (months in tax year)] = $2,000 + [$283.33 (per month amortization) × 6 months] = $3,700. Only $2,000 of the $5,000 immediate expensing is allowed as the total expenses of $53,000 exceed $50,000 by $3,000. The $2,000 immediately expensed reduces the amount left to be amortized to $51,000 ($53,000 – $2,000). p. 2-19


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman 55.

Purple Corporation: Tax on $48,000 is $7,200 ($48,000 × 15%). Azul Corporation: Tax on—$320,000 Tax on $100,000 Tax on $220,000 × 39% Total tax

$

22,250 85,800 $ 108,050

Pink Corporation: Tax on—$335,000 Tax on $100,000 Tax on $235,000 × 39% Total tax

$

22,250 91,650 $ 113,900

Turquoise Corporation: Tax on—$6,700,000 Tax on $335,000 Tax on $6,365,000 × 34% Total tax

$ 113,900 2,164,100 $2,278,000

Teal Corporation: Tax on $22,600,000 × 35%

$7,910,000

Exhibit 2-1 and Examples 28 and 29 56.

Net income per books is reconciled to taxable income as follows: Net income per books (after tax) Plus: Items that decreased net income per books but did not affect taxable income: + Federal income tax liability + Excess of capital losses over capital gains + Interest paid on loan incurred to purchase tax-exempt bonds + Premiums paid on policy on life of president of the corporation Subtotal Minus: Items that increased net income per books but did not affect taxable income: – Interest income from tax-exempt bonds – Life insurance proceeds received as a result of the death of the corporate president Taxable income

$209,710

30,050 5,550 2,650 4,040 $252,000

(32,000) (100,000) $120,000


2-28

2009 Corporations Volume/Solutions Manual Example 32


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman 57.

Net income per books is reconciled to taxable income as follows: Net income per books (after tax) Plus: Items that decreased net income per books but did not affect taxable income: + Federal income tax liability + Excess charitable contributions + Interest paid on loan incurred to purchase tax-exempt bonds + Premiums paid on policy on life of president of the corporation Subtotal Minus: Items that increased net income per books but did not affect taxable income: – Tax-exempt interest income – Excess of MACRS over book depreciation Taxable income

$134,700

5,000 $209,000

(8,000) $195,000

Example 32 58.

PGW will enter $97 million on Schedule M-3, Part I, line 4 (worldwide consolidated net income) and CGW’s net income of $31 million on line 5a (net income from nonincludible foreign entities). This results in net income per income statement of includible corporations (Part 1, line 11) of $66 million. Example 34

59.

PGW must report these items on Schedule M-3, Part II, line 9 [Income (loss) from U.S. partnerships]. The corporation reports $4,500,000 (book income) on line 9, column (a). PGW reports income per tax return of $3,900,000 ($3,500,000 + $1,500,000 – $1,000,000 – $100,000) in column (d) of line 9, and a permanent difference of $600,000 in column (c). Example 35

60.

PGW must report the amortization on line 28, Part III as follows: $35,000 book amortization in column (a), $30,000 temporary difference in column (b), and $65,000 tax return amortization in column (d). This problem illustrates the Schedule M-3 reporting when book expenses are less than tax return deductions. It also illustrates the reporting of temporary differences. Example 36

61.

These amounts must be reported on line 32, Part III as follows: $215,000 book bad debt expense in column (a), $155,000 temporary difference in column (b), and $60,000 tax return bad debt expense in column (d). This problem illustrates reporting procedures when book expenses are greater than tax return deductions. It also illustrates the reporting of temporary differences. Example 37

62.

Since the tax position has a more than 50% probability of being sustained on examination, the “more-likely-than-not” threshold is satisfied and the tax benefit should be recognized. In measuring the amounts and probabilities of the tax benefit, $75,000 is the largest tax benefit that has a more than 50% chance of being realized upon ultimate settlement. Thus, Concord should recognize a financial statement benefit of $75,000 related to the tax position. Examples 38 and 39


2-30 63.

2009 Corporations Volume/Solutions Manual Organizational expenditures and start-up expenditures were incurred in January and February. The corporation can elect to expense the first $5,000 of qualifying expenditures and amortize the remaining balance over a period of 180 months. Don and Steve should identify the organizational expenditures that qualify for this election, and decide whether to make the election. The corporation must choose cost recovery methods and decide whether to elect immediate expensing under § 179. It is also necessary to select an accounting method. The accrual method will be required for sales and purchases of inventory, but the hybrid method may be chosen as the overall method. This would allow use of the cash method for all items other than purchases and sales. The corporation has a great deal of flexibility in selecting a fiscal or calendar year. The golf retail business is generally seasonal in nature, so the corporation should consider electing a November 30, January 31, or February 28 fiscal year. If Don and Steve are family members (e.g., brothers) as defined under § 267 and the corporation selects the accrual method of accounting, the accrued bonuses will not be deductible until the year of payment. If the payment date is not changed, the deduction for bonuses will be disallowed, which could result in underpayment of estimated payments, which would result in a penalty. pp. 2-10, 2-11, and 2-37

The answers to the Research Problems and the Tax Return Problems are incorporated into the Instructor’s Guide with Lecture Notes to accompany the 2009 Annual Edition of SOUTHWESTERN FEDERAL TAXATION: CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS.


Full file at http://testbank360.eu/solution-manual-south-western-federal-taxationcorporations-2009-32nd-edition-hoffman

Solution manual south western federal taxation corporations 2009 32nd edition hoffman  

solution manual south western federal taxation corporations 2009 32nd edition hoffman. Full file at http://testbank360.eu/solution-manu...