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Chapter 14

C Corporations

Teaching SuggestionsDiscuss the differences between the calculation of taxable income for corporations and individual taxpayers.

Discussion should include:

1. Dividends received deduction

2. Charitable contributions

3. Capital gains and losses

4. Organizational and start-up costs

Solutions to Questions and Problems1. The tax laws now allow businesses to “check-the-box� to determine which type of entity they wished to be

taxed as for purposes of Federal income taxes. ¶1401.

2. ¶1401.01.

a. Normally no gain or loss is recognized by either the shareholder or the corporation when property istransferred to the corporation solely in exchange for stock upon the formation of the corporation.

b. Sanchez’s basis in the stock is her $30,000 basis in the land she contributes to the corporation.

c. Sanchez’s $30,000 basis in the land becomes the corporation’s basis in the land.

3. ¶1401.01.

a. Normally no gain or loss is recognized by either the shareholder or the corporation when property istransferred to the corporation solely in exchange for stock upon the formation of the corporation.

b. Diaz’s basis in the stock is his $30,000 basis in the land he contributes to the corporation.

c. Diaz’s $30,000 basis in the land becomes the corporation’s basis in the land.

4. ¶1401.01.

a. Neither Howard nor the corporation recognize any gain or loss on the transfer of property during theformation of the corporation. O’Brien recognizes $25,000 of ordinary income for the services sheperforms in exchange for the stock in the corporation.

b. Howard’s basis in his shares is the $25,000 he contributes to the corporation.

c. O’Brien’s basis in her shares is the $25,000 she contributes to the corporation (by paying tax on theservice income).

5. a. Certain items related to the business of a sole proprietor are not deducted in computing the profits ofthe business on Schedule C. These include all gains and losses from the sale of business property, thededuction for the proprietor’s health insurance, retirement plan contributions and one-half of the self-employment tax. Although these deductions reduce AGI, they do not reduce the net profits of thebusiness. Furthermore, all charitable contributions made by an individual are deductible as itemizeddeductions. In contrast, all business deductions are deducted from gross income on the corporate taxreturn. ¶1402.

b. Corporations do not have personal deductions. Therefore they do not distinguish between deductionsfor and from AGI. ¶1402.

6. A short-year return is a tax return that is for less than 12-months (one year). Corporations can have a taxyear shorter than 12 months in three situations. The first is in the year in which the corporation is formed.The second generally occurs in the last year of the corporation’s operations. The third is when acorporation changes its tax year. ¶1402.02.

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7. ¶1402.02.

a. A calendar year is a 12-month period that ends in December. A fiscal year is any other 12-month periodthat ends in a month other than December.

b. A 52-53 week tax year is a tax accounting period that ends on the same day of the week each year. Theday may be either the last one occurring in the last month of their tax year or the one occurring closestto their normal year end. Corporations select this tax year when they want their tax year to end on thesame day of the week each year, for example the last Friday in December.

c. A corporation that changes its tax year from October 31 to July 31 must get permission from the IRS tochange its accounting period. For corporations, this is done by filing Form 1128, Application to Adopt,Change, or Retain a Tax Year. Once permission is granted, the corporation must file a short-year returnin the year of the change. For example, if the corporation wants to change its tax year effective July 31,20x5, the period included on the short-year return would be from November 1, 20x4-July 31, 20x5. Itsnext tax year would include the period from August 1, 20x5-July 31, 20x6.

8. a. Unlike individuals who receive a lower tax rate on net capital gains, corporations pay tax on net capitalgains at the ordinary tax rates. That is, the same tax rates as all other types of ordinary income.¶1402.04.

b. Unlike individuals who can use up to $3,000 of net capital losses to offset ordinary income, corporationscan only deduct capital losses to the extent they have capital gains. Any excess loss is carried backthree years and then carried over five years. ¶1402.04.

9. a. The correct taxable income is $90,000 [$80,000 + ($17,000 − $7,000)]. ¶1402.04.

b. The taxable income is $65,000. The capital loss ($9,000) can be taken only to the extent of the capitalgain ($7,000). The short-term capital loss carryover is $2,000 ($9,000 − $7,000). ¶1402.04.

c. The carryover to the next tax year is $13,000, and it is all short-term. The nature of a capital losscarryback or carryover for a corporation is always short-term. ¶1402.04.

10. Unless the corporation can justify why it paid its CEO more than $1 million for the year, its tax deductionwill be limited to $1 million for the payments made to the CEO. The CEO will be taxed on the entire $2million of compensation. ¶1402.05.

11. The direct write-off method is the only acceptable method for tax purposes. This method must be used byboth cash and accrual basis taxpayers. ¶1402.05.

12. $4,700. The corporation can take a bad debt deduction for only those receivables that it specificallyidentifies as being uncollectible. It cannot take a percentage of its sales as an allowance for bad debts as isdone for financial accounting. ¶1402.05.

13. The charter and incorporation fees which total $1,700 are organizational costs. Corporations can elect tocurrently expense up to $5,000 of its organizational costs. The stock issue costs are not organizationalcosts. These costs are offset against the stock issue proceeds. ¶1402.05.

14. a. $5,889 ($5,000 + ($40,000/180 × 4 months)). Up to $5,000 of a corporation’s organizational costs can beexpensed provided that the total organizational costs do not exceed $50,000. The rest of the cost mustbe amortized over a period of 180 months beginning with the month that the corporation’s businessbegins. ¶1402.05.

b. $4,089 (($5,000 − $2,000 excess) + ($49,000/180 × 4 months)). When the corporation’s organizationalcosts exceed $50,000, the $5,000 that can be expensed is reduced by the excess costs over $50,000.¶1402.05.

c. $1,667 ($75,000/180 × 4 months). ¶1402.05.

15. a. $5,556 ($5,000 + ($10,000/180 × 10 months)) in 2007; $667 in 2008 ($10,000/180 × 12). Up to $5,000 of acorporation’s start-up costs can be expensed provided that the total start-up costs do not exceed$50,000. The rest of the cost must be amortized over a period of 180 months beginning with the monththat the corporation’s business begins. ¶1402.05.

b. $6,433 in 2007 (($5,000 − $1,200 excess) + ($47,400/180 × 10 months)); $3,160 in 2008 ($47,400/180 ×12). When the corporation’s start-up costs exceed $50,000, the $5,000 that can be expensed is reducedby the excess costs over $50,000. ¶1402.05.

c. $3,611 in 2007 ($65,000/180 × 10 months); $4,333 in 2008 ($65,000/180 × 12). ¶1402.05.

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16. The total charitable contribution deduction for a C corporation is limited to 10% of the corporation’s taxableincome before deducting any charitable contributions, dividends received deduction, domestic productionactivities deduction, NOL carryback, and any capital loss carryback for the tax year. Any charitablecontributions that exceed the 10% rule can be carried over for five succeeding tax years. ¶1402.06.

17. a. The maximum allowable contributions deduction is $2,500. ¶1402.06.

Gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $115,000

Less: Business deductions exclusive of contributions . . . . . . . . . . . . . . . . . . . . . . (90,000)

Taxable income before deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25,000

Limitation for contributions (10% × $25,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,500

b. Taxable income is $20,900. ¶1402.06.

Taxable income before contributions and special deductions . . . . . . . . . . . . . . . $25,000

Less deductions:

Charitable contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,500

Dividends received deduction (80% × $2,000) . . . . . . . . . . . . . . . . . . . . . . . 1,600 (4,100)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,900

c. The amount of the contribution deduction carryover is $250 ($2,750 − $2,500). ¶1402.06.

18. $17,500. M Company can deduct its basis in the blankets of $10,000 plus one-half of the appreciation invalue $7,500 (($25,000 − $10,000) ÷ 2). ¶1402.06.

19. The corporation can deduct $10,700 against gross income in the current year ($107,000 × 10%). It will carryforward the $19,300 excess for five years ($30,000 − $10,700). ¶1402.06.

20. ¶1402.06.

a.

Gross sales and receipts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $700,000

Less: Returns and allowances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ( 12,000)

Net Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $688,000

Less: Cost of good sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (330,000)

Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $358,000

Plus: Interest received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000

Less Expenses:

Rent expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 55,000

Wage expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140,000

Other operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75,000

Depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000 (285,000)

Taxable income before CC deduction . . . . . . . . . . . . . . . . . . . . . . . . . . $ 93,000

Charitable contribution deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9,300)

Taxable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 83,700

b. The corporation carries forward for five years the $2,700 ($12,000 − $9,300) excess charitablecontributions.

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21. a. ¶1402.06.

Dividend income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 50,000

Sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000

Less: Operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (375,000)

Taxable income before DRD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 75,000

Less: DRD ($50,000 × 80%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (40,000)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 35,000

b. Treeline’s DRD would be $35,000 ($50,000 × 70%). Its taxable income would be $40,000 ($75,000 −$35,000). ¶1402.06.

c.

Dividend income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 50,000

Sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370,000

Less: Operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (375,000)

Taxable income before DRD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 45,000

Less: DRD ($45,000 × 80%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (36,000)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,000

Because deducting 80% of the dividends received would not produce a taxable loss ($45,000 − $40,000 =$5,000 taxable income), the taxable income limit would apply and the corporation’s DRD equals $36,000(the lesser of (i) 80% × $50,000 or (ii) 80% of $45,000). ¶1402.06.

22. a.

Dividend income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $120,000

Sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370,000

Less: Operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (390,000)

Taxable income before DRD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000

Less: DRD ($100,000 × 80%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (80,000)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 20,000

Because deducting 80% of the dividends received would not produce a taxable loss ($100,000 − $96,000= $4,000 taxable income), the taxable income limit would apply and the corporation’s DRD equals$80,000 (the lesser of (i) 80% × $120,000 or (ii) 80% of $100,000). ¶1402.06.

b. Treeline’s DRD would be $120,000 ($120,000 × 100%). This would result in a taxable loss of $20,000($100,000 − $120,000). When 80% or more of the corporation’s stock is owned, the DRD increases to100%. Furthermore, the taxable income limitation does not apply when ownership equals or exceeds80%. ¶1402.06.

23. ¶1403.01.

a. March 15 (2 1/2 months after the close of the year)

b. September 15 (six months after the original March 15 filing deadline)

c. August 15 (2 1/2 months after the close of the year)

d. February 15 (six months after the original August 15 filing deadline)

e. November 15 (2 1/2 months after the close of the year)

f. July 15 (six months after the original January 15 filing deadline)

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24. ¶1403.02.

a. $3,750 ($25,000 × 15%)

b. $32,000 [($50,000 × 15%) + ($25,000 × 25%) + ($25,000 × 34%) + ($25,000 × 39%)]

c. $80,750 [($50,000 × 15%) + ($25,000 × 25%) + ($25,000 × 34%) + ($150,000 × 39%)]

d. $510,000 ($1,500,000 × 34% flat rate) or [($50,000 × 15%) + ($25,000 × 25%) + ($25,000 × 34%) +($235,000 × 39%) + ($1,165,000 × 34%)]

e. $1,275,000 ($3,750,000 × 34%)

f. $11,812,500 ($33,750,000 × 35%)

25. ¶1403.02.

Gross income from business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $150,000

Dividends received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

Gross income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $160,000

Less: Business expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (40,000)

Income before dividends received deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $120,000

Less: Dividends received deduction (70% × $10,000) . . . . . . . . . . . . . . . . . . . . . . . . . (7,000)

Taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $113,000

Tax computation: $ 113,000

50,000 × 15% . . . . . . . $ 7,500

$ 63,000

25,000 × 25% . . . . . . . 6,250

$ 38,000

25,000 × 34% . . . . . . . 8,500

$ 13,000 × 39% . . . . . . . 5,070

Total Tax $27,320

26. a. $20,000 of the distribution comes from E&P (AE&P + CE&P). Therefore, $20,000 is taxed as dividendincome to the shareholder and reduces the corporation’s AE&P to $0. The remaining $4,000 distribu-tion is a return of capital, which is not taxable to the shareholder and reduces the shareholder’s basis inthe stock to $5,000. ¶1405.01.

b. The corporation recognizes $7,000 gain on the distribution of appreciated property ($24,000 − $17,000).This gain increases the corporation’s CE&P to $15,000 ($8,000 + $7,000). Since the corporation’s E&P($12,000 AE&P + $15,000 CE&P) exceeds the amount of the distribution ($24,000 FMV of the propertydistributed), the full amount of the distribution comes from E&P The shareholder reports $24,000 ofdividend income in gross income. The shareholder’s basis in the stock remains at $9,000. Thecorporation’s E&P after the distribution is $3,000 ($27,000 − $24,000). ¶1405.03.

c. The first $20,000 of the distribution comes from E&P (AE&P + CE&P). Therefore, $20,000 is taxed asdividend income to the shareholder and reduces the corporation’s E&P to $0. The next $9,000distributed is a return of capital. This amount is not taxable to the shareholder and reduces theshareholder’s basis in the stock to $0. The remaining $5,000 is taxed as capital gain to the shareholder.¶1405.01.

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27. a.

Gross income1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $960,000

Less deductions2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (704,000)

Taxable income for computing CC deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . $256,000

Less charitable contribution deduction3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (25,600)

Less DPA deduction4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,100)

Taxable income for figuring DRD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $222,300

Less DRD5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (48,000)

Taxable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $174,300

1 $830,000 + ($15,000 capital gains − $15,000 capital losses) + $60,000 + $70,000.2 $444,000 + $260,000.3 $256,000 × 10%.4 $135,000 × 6%.5 Lesser of (i) $60,000 × 80% or (ii) 80% × $222,300.

Tax liability = $51,227 [($50,000 × 15%) + ($25,000 × 25%) + ($25,000 × 34%) × ($74,300 × 39%)] ¶1402,¶1403.

b. The corporation will carryover to 2008 charitable contributions of $46,400 ($72,000 − $25,600) and a$20,000 short-term capital loss ($35,000 − $15,000). ¶1402.06.

28. See Form 1120 and Schedule D for Randolph Manufacturing Company. ¶1403.04.

DPA deduction (Form 1120, line 25): $37,720 × 6% = $2,263.

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253Textbook Solutions

Filled-in Form 1120, page 1, for Randolph Manufacturing Company.

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Filled-in Form 1120, page 2, for Randolph Manufacturing Company.

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Filled-in Form 1120, page 3, for Randolph Manufacturing Company.

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Filled-in Form 1120, page 4, for Randolph Manufacturing Company.

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257Textbook Solutions

Filled-in Schedule D (Form 1120) for Randolph Manufacturing Company.

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