Chapter c8

Prentice Hall's Federal Taxation 2016: Corporations, 29e (Pope)Chapter C8: Consolidated Tax Returns

LO1: Definition of an Affiliated Group

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

2) Brother-sister controlled groups can elect to file a consolidated tax return.Answer: FALSEPage Ref.: C:8-4Objective: 1

3) Identify which of the following statements is true.A) To be part of an affiliated group, a corporation must be at least 80% directly owned by another group member.B) Only common stock is considered when determining if the 80% ownership test is met for affiliated group eligibility.C) An affiliated group electing to file a consolidated return may be composed of as few as two corporations.D) All of the above are false.Answer: CPage Ref.: C:8-2 and C:8-3Objective: 1

4) Which of the following corporations is an includible corporation for purposes of filing a consolidated tax return?A) insurance companiesB) S corporationsC) car manufacturing corporationD) foreign corporationsAnswer: CPage Ref.: C:8-3Objective: 1

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5) Diana Corporation owns stock of Tomika Corporation. For Diana and Tomika to qualify for the filing of consolidated returns, at least what percentage of Tomika's total voting power and total value of stock must be directly owned by Diana?

A) Total voting power

Total Value of stock

51% 51%

B) Total voting power


51% 80%

C) Total voting power


80% 51%

D) Total voting power


80% 80%

Answer: DPage Ref.: C:8-3Objective: 1

6) Ajak Corporation owns 85% of the single class of Utech Corporation stock. Utech Corporation owns 35% of Tech Corporation. Ajak Corporation also owns 50% of Tech Corporation, and Tech Corporation owns 75% of Baxter Corporation.A) Ajak, Tech, Utech, and Baxter Corporations are an affiliated group.B) Ajak, Tech, and Baxter Corporations are an affiliated group.C) Ajak, Tech, and Utech Corporations are an affiliated group.D) None of the above are correct.Answer: CPage Ref.: C:8-3Objective: 1

7) 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. 501B) real estate investment trustsC) closely held corporationsD) foreign corporationsAnswer: CPage Ref.: C:8-3Objective: 1


8) Identify which of the following statements is true.A) If 100% of the stock of two corporations is owned by the same individual, the two corporations are eligible to file a consolidated return.B) The check-the-box regulations permit partnership and LLCs to elect C corporation tax treatment.C) A group of corporations that meets the parent-subsidiary controlled group requirements is always eligible to file a consolidated return.D) All of the above are false.Answer: BPage Ref.: C:8-4Objective: 1

9) Jeffrey Corporation owns 85% of Placer Corporation and 25% of Mercer Corporation. Placer Corporation owns 60% of Mercer Corporation and 45% of Tyson Corporation. Jeffrey Corporation also owns 85% of Apple Corporation and Apple Corporation owns 30% of Tyson Corporation. Which of these corporations are members of an affiliated group if all percentages represent voting power and value held by the respective corporations?Answer: Jeffrey Corporation is the parent corporation with Placer, Mercer, and Apple Corporations as members of the affiliated group. The 75% (30% + 45%) ownership of Tyson Corporation stock does not meet the 80% ownership minimum.Page Ref.: C:8-3Objective: 1

10) Toby Corporation owns 85% of James Corporation's single class of stock and 35% of Mony Corporation's single class of stock. James Corporation owns 45% of Mony's stock. The remainder of James and Mony's stock is owned by 80 individual shareholders. Are the corporations part of an affiliated group, and can they elect to file a consolidated tax return?Answer: Since Toby owns more than 80% of the stock of James and therefore satisfies the direct ownership requirement, and Toby and James together own 80% (45% + 35%) of Mony's stock, they are affiliated corporations. The Toby, James, and Mony group can elect to file a consolidated tax return.Page Ref.: C:8-3; Example C:8-1Objective: 1

11) Toby owns all of the single class of stock of James and Mony Corporations. James Corporation owns all of Volt Corporation's stock. Mony owns all of Wegnin Corporation. Mony and Wegnin Corporations are foreign corporations. Toby, James, and Volt are domestic corporations. Are the corporations part of an affiliated group?Answer: Toby, James, and Volt constitute the affiliated group. Toby is the common parent. Mony and Wegnin are not included, as they are foreign corporations.Page Ref.: C:8-2 and C:8-3; Example C:8-3Objective: 1

12) Explain the requirements a group of corporations must meet in order to elect to file a consolidated return.Answer: The parent corporation must own at least 80% of the total voting power and at least 80% of the total value of all outstanding stock in at least one includible corporation. Each additional corporation that is included must also meet the two 80% stock ownership rules either directly or indirectly. Eligible affiliated groups must make a consolidated return election by filing a timely consolidated tax return.Page Ref.: C:8-2 and C:8-3Objective: 1

13) What types of corporations are not includible corporations for purposes of determining whether or not an affiliated group exists?Answer: 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 corporationsPage Ref.: C:8-3Objective: 1

14) What are the differences between a controlled group and an affiliated group?Answer: Three forms of controlled groups are permitted — brother-sister groups, parent-subsidiary groups, and combined groups. Only parent-subsidiary groups and the parent-subsidiary portion of a combined group can elect to file a consolidated tax return. Four primary differences between a controlled group and an affiliated group exist. First, the two 80% stock ownership tests must be met to have an affiliated group. Only one of the tests needs to be met to have a controlled group. Second, the controlled group definition uses certain stock attribution rules and included and excluded corporation rules that are not used in testing for an affiliated group. Third, certain special status corporations are excluded from the affiliated group definition that may be included in a controlled group. Fourth, the controlled group definition is tested only at December 31. The affiliated group definition must be tested on each day of the year. See Chapter C3 for further discussion of controlled group topics.Page Ref.: C:8-4Objective: 1

15) What issues determine whether an affiliated group exists?Answer: In determining whether an affiliated group exists, three questions must be answered.• Does a corporation (common parent) directly own 80% or more of at least one includible corporation?• What are the includible corporations?• What chains of includible corporations are connected by at least 80% ownership?Page Ref.: C:8-3Objective: 1

LO2: Consolidated Tax Return Election

1) A Canadian subsidiary cannot file as part of the consolidated group with its U.S. parent.Answer: FALSEPage Ref.: C:8-4Objective: 2

2) The election to file a consolidated return is made annually.Answer: FALSEPage Ref.: C:8-5Objective: 2


3) A separate return year is a corporation's tax year for which it files a separate tax return or files a consolidated tax return with another affiliated group.Answer: TRUEPage Ref.: C:8-5Objective: 2

4) Cardinal and Bluebird Corporations both use a calendar year as their tax year. At the close of business on June 30, Cardinal Corporation buys all of Bluebird Corporation's stock. If the two corporations file a consolidated return and both corporations earn their income evenly throughout the year, what portion of Cardinal's income will be included in the consolidated return? (Assume all months have 30 days.)A) 100%B) 50%C) 0%D) none of the aboveAnswer: APage Ref.: C:8-5; Example C:8-6Objective: 2

5) Cardinal and Bluebird Corporations both use a calendar year as their tax year. At the close of business on June 30, Cardinal Corporation buys all of Bluebird Corporation's stock. If the two corporations file a consolidated return and both corporations earn their income evenly throughout the year, what portion of Bluebird's income will be included in the consolidated return? (Assume all months have 30 days.)A) 100%B) 50%C) 0%D) none of the aboveAnswer: BPage Ref.: C:8-5; Example C:8-6Objective: 2

6) Parent Corporation owns all of the stock of Richards and Smith Corporations on January 1. The three corporations have filed consolidated tax returns for a number of calendar years. Parent sells all of the stock of Richards Corporation on June 1. Parent purchases all of the stock of Taylor Corporation on September 1. Parent sells all of the stock of Smith Corporation on November 1. When does the affiliated group terminate?A) June 1B) September 1C) November 1D) The original affiliated group does not terminate.Answer: DPage Ref.: C:8-5Objective: 2


7) 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 Bass100% 100%

B) Alto Bass100% 75%

C) Alto Bass75% 75%

D) none of the aboveAnswer: BPage Ref.: C:8-5Objective: 2

LO3: Consolidated Taxable Income

1) Identify which of the following statements is true.A) When a new corporation joins an affiliated group, all of its income and expense items for the tax year, including the acquisition date, must be allocated between the separate tax return and consolidated tax return that are to be filed based on the number of days included in each of the two tax years.B) A consolidated return election may be revoked after 5 years.C) All members of a consolidated group must use the same tax year.D) All of the above are false.Answer: CPage Ref.: C:8-6 through C:8-8Objective: 3

2) Identify which of the following statements is true.A) Corporations that join in a consolidated return must adopt the same tax year as the parent corporation.B) Permission to discontinue the filing of consolidated tax returns is sometimes granted by the IRS.C) Additional administrative costs may be incurred when filing a consolidated tax return.D) All of the above are true.Answer: DPage Ref.: C:8-6 through C:8-8Objective: 3


3) Identify which of the following statements is true.A) A corporation may be required to file a separate return and file with an affiliated group in the same calendar year.B) When a corporation joins in filing a consolidated return, taxable income of the member is combined with other members' taxable income prior to any adjustments.C) If a corporation becomes a member of an affiliated group within the first thirty days of the corporation's tax year, the corporation can elect not to file a short-period tax return.D) All of the above are false.Answer: APage Ref.: C:8-6 and C:8-7Objective: 3

4) Penish and Sagen Corporations have filed consolidated tax returns for several calendar years. At the close of business on September 30, 2012, Penish Corporation sells its all of its Sagen stock to June. What are the tax consequences to each corporation?Answer: All of Penish's income is included in the consolidated tax return for 2012. Only nine months of Sagen Corporation's income is included in the consolidated tax return for 2012. Sagen must also file a separate tax return for the period October 1 through December 31, 2012.Page Ref.: C:8-7Objective: 3

5) What are the five steps in calculating consolidated taxable income?Answer: 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.Page Ref.: C:8-9; Table C:8-1Objective: 4


6) Marietta and Alpharetta Corporation, two accrual method of accounting corporations that use the calendar year as their tax year, have filed consolidated tax returns for a number of years. Alpharetta Corporation, a 100% owned subsidiary of Marietta, is transferring a patent, equipment, and working capital to newly created Georgia Corporation in exchange for 100% of its stock. In 2011, the corporation will begin to produce parts for the computer industry. Georgia Corporation expects to incur organizational expenditures of $10,000 and start-up expenditures of $60,000. What tax issues should Georgia Corporation consider with respect to the selection of its overall accounting method, inventory method, and tax year, and the proper reporting of its organizational and start-up expenditures?Answer: • What tax year can Georgia Corporation elect?• What overall method of accounting can Georgia Corporation elect?• What inventory method can Georgia Corporation elect?• How does Georgia Corporation treat its organizational expenditures? Its start-up expenditures?

Georgia Corporation must use the same tax year as the other two corporations in its affiliated group. In general, Georgia Corporation can elect to use the cash, accrual, or hybrid methods of accounting. However, since it is producing parts for the computer industry, inventories will be a material income producing factor, and it must use the accrual method of accounting for its sales-related activities. It is possible for Georgia Corporation to use the hybrid accounting method, and if such an election were made, Georgia would not be required to use the accrual method of accounting for its other income and expense items. It need not use the same accounting methods as the other two corporations in the affiliated group. Georgia Corporation can elect any of the inventory methods acceptable under Sec. 471. It does not need to use the same inventory method as the other two corporations in its affiliated group. Georgia Corporation can elect to amortize its organizational expenditures and its start-up costs whether or not the other two corporations have made similar elections. There is no restriction under Code Secs. 195 and 248, or the consolidated tax return regulations, that similar treatment of such expenditures be followed by all three corporations.Page Ref.: C:8-6 through C:8-8Objective: 3

LO4: Intercompany Transactions

1) P and S are members of an affiliated group that has filed consolidated tax returns for a number of years. The sale of inventory by P that was acquired from S in an intercompany transaction outside the affiliated group triggers the recognition of gain by S.Answer: TRUEPage Ref.: C:8-18Objective: 4


2) 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)

BasisHolding Period Begins On

$60,000 January 2 of last year

B)


$90,000 January 2 of last year

C)


$90,000 September 2 of this year

D) none of the aboveAnswer: CPage Ref.: C:8-10 and C:8-11Objective: 4

3) Which of the following events is an intercompany transaction?A) a capital contributionB) accrual of interest on a loan made by one group member to another group member; both group members use the accrual method of accountingC) dividend payment received from a subsidiary corporation to its parent corporation; the subsidiary corporation is not an includible corporationD) a parent corporation's sale of stock of a subsidiary corporation to a nonmember of the groupAnswer: BPage Ref.: C:8-10 and C:8-11Objective: 4

4) Subsidiary Corporation purchases a used machine from Parent Corporation in an intercompany transaction. Which of the following events is a corresponding event for the intercompany transaction?A) the purchasing group member depreciating the machineB) the purchasing group member selling the machine for cash to a nonmember of the groupC) the departure of the purchasing group member from the affiliated group when its stock is sold to a nonmember of the groupD) All of the above are recognition events.Answer: DPage Ref.: C:8-10 and C:8-11Objective: 4


5) Which of the following events is an intercompany transaction that requires the deferral and later recognition of income?A) accrual of rentals on a lease of real property owned by one group member that is used by another group member; both group members use the accrual method of accountingB) cash dividend payment from a subsidiary corporation to its parent corporationC) sale of inventory from a subsidiary corporation to its parent corporationD) None of the above transactions require the deferral and later recognition of income.Answer: CPage Ref.: C:8-9Objective: 4

6) Identify which of the following statements is false.A) Inventory sales between group members are an example of an intercompany transaction.B) The basis to the purchasing member of property acquired in an intercompany transaction is the amount of cash paid to the selling member.C) The holding period for property acquired in an intercompany transaction begins when the corresponding item is reported.D) In general, buyers and sellers engaging in an intercompany transaction are treated as separate entities.Answer: CPage Ref.: C:8-8 through C:8-10Objective: 4

7) Identify which of the following statements is true.A) The basic accounting method elections that are used by the seller in intercompany transactions do not override the intercompany transaction rules.B) P and S are members of an affiliated group that has filed consolidated tax returns for a number of years. The sale of inventory by P, which was acquired from S in an intercompany transaction, outside the affiliated group triggers the restoration of gain by S.C) Last year, P, S, and T Corporations have filed consolidated tax returns for a number of years. Last year P Corporation sold land (a Sec. 1231 asset) to T at a $75,000 profit. The gain was deferred by P in last year's consolidated tax return. P sold the T stock to Mike on June 1 of this year. The stock sale will require P to report in its income the gain that was deferred on the land sale.D) All of the above are true.Answer: DPage Ref.: C:8-9 and C:8-10Objective: 4


8) Parent Corporation sells land (a capital asset) to Subsidiary Corporation in an intercompany transaction, realizing a $25,000 gain. Subsidiary uses the land for five years in its trade or business before selling the land to a nonmember of the group in a cash sale in which a $50,000 gain is realized. Which statement is correct?A) A $25,000 capital gain is included in consolidated taxable income when Parent sells the land to Subsidiary Corporation. A $50,000 Sec. 1231 gain is included in consolidated taxable income when Subsidiary sells the land.B) A $25,000 capital gain and a $50,000 Sec. 1231 gain are included in consolidated taxable income when Subsidiary sells the land.C) A $75,000 Sec. 1231 gain ($25,000 from Parent and $50,000 from Subsidiary) is included in consolidated taxable income in the year Subsidiary sells the land (assuming no recapture of previously deducted Sec. 1231 losses must occur).D) None of the above are correct.Answer: CExplanation: The recomputed gain is $75,000 of Sec. 1231 gain. $50,000 of gain is reported by Subsidiary. $25,000 is reported by Parent. Both Sec. 1231 gains are reported in the year of Subsidiary's sale. The $25,000 amount reported by Parent is a restoration that reflects the fact that $25,000 was included in Parent's separate taxable income in the year of the original sale to Subsidiary, which was deferred when determining the group's consolidated taxable income.Page Ref.: C:8-12Objective: 4

9) Apple Corporation and Banana Corporation file consolidated returns. In January 2007, Apple sold Banana property with a basis of $120,000 for its fair value of $150,000. Banana sold the property to an unrelated party in April 2008 for $200,000. What amount of gain should be reported for these transactions in the consolidated returns for 2011 and 2012?

A) 2007 2008$30,000 $50,000

B) 2007 2008$0 $50,000

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

D) 2007 2008$0 $80,000

Answer: DPage Ref.: C:8-12Objective: 4


10) Parent Corporation sells land (a capital asset) to Subsidiary Corporation in an intercompany transaction, recognizing a $25,000 gain. Subsidiary holds the land as an investment for five years before selling the land to a nonmember of the group on an installment basis in a sale in which a $50,000 gain is realized. The sales proceeds are collectible in four equal installments with an appropriate interest amount being charged to the purchaser. Which statement is correct?A) A $25,000 capital gain is included in consolidated taxable income when Parent sells the land to Subsidiary Corporation. A $50,000 capital gain is included in consolidated taxable income when Subsidiary sells the land.B) A $25,000 capital gain from Parent and a $50,000 capital gain from Subsidiary are included in consolidated taxable income when Subsidiary sells the land.C) The $25,000 capital gain from Parent and $50,000 capital gain from Subsidiary are included ratably in consolidated taxable income, commencing in the year the first installment is received.D) None of the above are correctAnswer: DExplanation: The recomputed gain is $75,000 of capital gain. $15,000 ($75,000/5) of the recomputed gain is recognized as each installment is collected. $10,000 of this gain is reported by Subsidiary and $5,000 by Parent as each installment is collected. The $25,000 amount reported by Parent is a restoration that reflects the fact that $25,000 was included in Parent's separate taxable income in the year of the original sale to Subsidiary, which was deferred when determining the group's consolidated taxable income.Page Ref.: C:8-11; Example C:8-15Objective: 4

11) Parent and Subsidiary Corporations have filed calendar-year consolidated tax returns for several years. Parent Corporation uses the cash method of accounting while Subsidiary Corporation uses the accrual method of accounting. If Parent lends Subsidiary money,A) the interest expense is deductible when accrued.B) the interest expense and interest income may be reported in different consolidated return years.C) the interest income is reported when the interest expense is accrued by Subsidiary.D) the interest expense deduction is taken when Parent reports the interest income.Answer: CPage Ref.: C:8-16; Example C:8-24Objective: 4

12) Gee Corporation purchased land from an unrelated corporation several years ago for $105,000. The land was used by Gee as a storage lot for company trucks. Gee sold the land to Wilkers, its 85%-owned subsidiary corporation, last year (July 3) for $115,000. The land was also used in Wilkers' trade or business. Wilkers Corporation sold the land for cash this year (August 22) for $130,000 to a corporation that was not a member of the affiliated group. What gains and losses are recognized, deferred, or restored by Gee and Wilkers Corporations?Answer: 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.Page Ref.: C:8-18Objective: 4


13) Gee Corporation purchased land from an unrelated corporation several years ago for $105,000. The land was used by Gee as a storage lot for company trucks. Gee sold the land to Wilkers, its 85%-owned subsidiary corporation, last year (July 3) for $115,000. The land was also used in Wilkers' trade or business. Wilkers Corporation sold the land this year (August 22) for $130,000 to a corporation that was not a member of the affiliated group. The $130,000 purchase price is to be collected in five equal, annual installments, commencing with the current year's sale date. What gains and losses are recognized, deferred, or restored by Gee and Wilkers Corporations?Answer: 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.Page Ref.: C:8-13Objective: 4

14) Parent Corporation purchases a machine (a five-year property) for $20,000. It claims $4,000 of depreciation under the MACRS rules in the first year it owns the property. At the close of business on the last day of the first year, Parent sells the machine to a 100%-owned corporation (Subsidiary) for $18,000. Subsidiary immediately commences depreciating the machine as a five-year property using the regular MACRS rules. What depreciation can be claimed by Subsidiary Corporation in the first year it uses the machine?Answer: 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 = $6,400Basis increase: $ 2,000 × 0.20 = 400Total depreciation $6,800Page Ref.: C:8-15; Example C:8-21Objective: 4


15) Parent Corporation purchases a machine (a five-year property) for $20,000. It claims $4,000 of depreciation under the MACRS rules in the first year it owns the property. At the close of business on the last day of the first year, Parent sells the machine to a 100%-owned corporation (Subsidiary) for $18,000. Subsidiary immediately commences depreciating the machine as a five-year property using the regular MACRS rules.

What gain is reported by Parent Corporation in the first year that Subsidiary Corporation depreciates the machine?Answer: The restored gain equals the depreciation taken ($400) by Subsidiary Corporation on the step-up in basis. The gain is ordinary income under Sec. 1245. 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. Basis increase: $2,000 × .20 = 400Page Ref.: C:8-15; Example C:8-21Objective: 4

16) Why are other intercompany transactions not given any special treatment?Answer: 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.Page Ref.: C:8-9Objective: 4

17) Define intercompany transactions and explain the two types of transactions.Answer: An intercompany transaction takes place during a consolidated return year between corporations that are members of the same affiliated group immediately after the transaction. The two types of intercompany transactions are property and other intercompany transactions. Intercompany property transaction gains or losses are deferred until a corresponding event occurs. Other intercompany transactions income or expense is reported in the year in which the corresponding event occurs.Page Ref.: C:8-9Objective: 4

LO5: Items Computed on a Consolidated Basis

1) Intercompany dividends and undistributed subsidiary earnings do not create temporary differences for affiliated companies filing a consolidated return.Answer: TRUEPage Ref.: C:8-19Objective: 5

2) The treatment of capital loss carrybacks and carryovers is similar to NOLs.Answer: TRUEPage Ref.: C:9-22Objective: 5


3) Which of the following statements is incorrect with respect to the consolidated alternative minimum tax?A) The starting point for the consolidated alternative minimum taxable income computation is consolidated taxable income before the NOL deduction.B) The difference between the consolidated ACE amount and the consolidated preadjustment AMTI is an adjustment to consolidated taxable income in arriving at AMTI.C) Each corporation is permitted its own $40,000 statutory exemption.D) If the consolidated tentative minimum tax is smaller than the consolidated regular tax, there is no alternative minimum tax liability.Answer: CPage Ref.: C:8-24Objective: 5

4) Identify which of the following statements is true.A) The corporate AMT is determined on a separate return basis and then consolidated.B) All corporations filing consolidated tax returns are subject to the AMT.C) Alternative minimum tax payments from prior consolidated return years that are attributable to timing or permanent differences can be carried over by the affiliated group and claimed as a credit on current or future consolidated returns.D) All of the above are false.Answer: CPage Ref.: C:8-24Objective: 5

5) Which of the following statements is incorrect with respect to the consolidated alternative minimum tax?A) A separate alternative minimum taxable income computation is made for each individual group member. These amounts are then totaled to arrive at consolidated alternative minimum taxable income.B) Positive adjustments that are made with respect to one group member can be offset by negative adjustments that are made with respect to another group member in computing consolidated alternative minimum taxable income.C) The affiliated group's alternative minimum tax payment is available as a credit against its regular tax amount in future tax years.D) The estimated tax payment rules apply to the alternative minimum tax.Answer: APage Ref.: C:8-24Objective: 5

6) Which of the following statements is true?A) A consolidated group determines its general business credit on a consolidated basis.B) The general business credit can be carried back 3 years and forward 15 years.C) The general business credit can be carried forward indefinitely.D) The general business credit cannot be carried forward or backward.Answer: APage Ref.: C:8-25Objective: 5


7) The Alpha-Beta affiliated group has a consolidated regular tax amount of $52,000 and a tentative minimum tax amount of $50,000 in the current year. The maximum general business credit that can be used on the consolidated return isA) $2,000.B) $6,750.C) $50,000.D) none of the aboveAnswer: AExplanation: The general business credit that can be used equals the group's net income tax ($52,000) minus the larger of (1) tentative minimum tax ($50,000), or (2) 25% of net income tax in excess of $25,000 ($6,750) or $2,000 ($52,000 - $50,000).Page Ref.: C:8-25; Example C:8-34Objective: 5

8) Identify which of the following statements is false.A) A corresponding item includes the income, gain, deduction, or loss amount reported by the buyer from an intercompany transaction, or from property acquired in an intercompany transaction.B) Affiliated groups of corporations filing a consolidated tax return are not eligible for the small corporation exemption from the corporate alternative minimum tax.C) An intercompany transaction generally results in the selling member and buying member in a property transaction being treated as divisions of a single corporation.D) Intercompany dividends and undistributed subsidiary earnings do not create temporary differences for affiliated companies filing a consolidated return.Answer: BPage Ref.: C:8-24Objective: 5

9) Identify which of the following statements is false.A) Unused general business credit carryforwards, which originate in a consolidated return year, are absorbed in a FIFO manner, beginning with the earliest ending tax year.B) An intercompany transaction is a transaction that takes place between two corporations that are members of the same affiliated group immediately after the transaction.C) An intercompany item includes income reported by the seller on the providing of services by one group member to another group member and the gain/loss reported by the seller on the sale of property to another group member.D) All of the above are false.Answer: CPage Ref.: C:8-25Objective: 5


10) Identify which of the following statements is true.A) P Corporation receives a dividend from its 100%-owned subsidiary corporation S. P and S have filed consolidated tax returns for a number of years. The dividend payment is out of S's earnings and profits and reduces P's investment in S. The dividend is an intercompany transaction and excluded from P's gross income.B) The consolidated dividends-received deduction percentage for dividends received by one affiliated group member from another affiliated group member is always 100%.C) The dividends-received deduction claimed when a $50,000 dividend is received from a 100%-owned nonconsolidated life insurance company is $35,000 (ignoring any dividends-received deduction limitations).D) All of the above are false.Answer: APage Ref.: C:9-22Objective: 5

11) Identify which of the following statements is true.A) A shareholder corporation that receives a nondividend distribution from an affiliated group member is not required to recognize a gain when the distribution amount exceeds the shareholder's basis in the distributing corporation's stock.B) The dividends-received deduction limitation for dividends received by members of an affiliated group from nonmembers is applied to the separate taxable income of each group member.C) The dividends-received deduction cannot be taken in full on a consolidated return if the deduction amount creates or increases a consolidated NOL.D) All of the above are false.Answer: APage Ref.: C:9-22Objective: 5

12) Identify which of the following statements is true.A) The charitable contribution deduction is calculated on a separate return basis for each group member, and the separate company deductions of the individual group members are totaled to arrive at the consolidated deduction.B) An affiliated group member cannot carry over any unused charitable contribution deduction from a consolidated return year to a separate return year if the member leaves the group prior to the end of the current consolidated return year.C) Charitable contributions, which cannot be deducted in a consolidated return due to the 10% deduction limitation, can be carried forward indefinitely by the affiliated group.D) All of the above are false.Answer: DPage Ref.: C:8-21Objective: 5


13) Which of the following statements is true?A) The definition of an affiliated group is the same for purposes of calculating the U.S. production activities deduction as it is for filing a consolidated return.B) The consolidated charitable contributions deduction is limited to 10% of adjusted consolidated taxable income, without regard to the consolidated DRD, consolidated NOL carrybacks, consolidated capital loss carrybacks, and consolidated charitable contributions deduction.C) The definition of an affiliated group for purposes of the U.S. production activities deduction uses a 60% ownership threshold.D) All of the above are true statements.Answer: BPage Ref.: C:8-21 and C:8-22Objective: 5

14) Identify which of the following statements is true.A) Rules for carryforward and carryback of a consolidated net capital loss and a consolidated NOL are the same with the exception of the carryforward period.B) Capital loss carrybacks and carryforwards are all treated as short-term capital losses.C) A member leaving an affiliated group cannot use capital loss carryovers that originated in one of its previous separate return years.D) All of the above are false.Answer: BPage Ref.: C:8-21Objective: 5


15) 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/LTCLSec. 1231Gains and

LossesBlair

Cannon($5,000)

6,000$6,000 (7,000)

$3,000 (3,000)

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

Which one of the following statements is incorrect?A) The consolidated group must report a net long-term capital gain of $9,000 and a net short-term capital gain of $1,000.B) Cannon Corporation's separate return reports a $6,000 net long-term capital gain.C) The affiliated group reports a $4,000 net Sec. 1231 gain.D) None of the above statements are incorrect.Answer: BExplanation: Statement A is correct because the group reports a $1,000 net short-term capital gain [($5,000) + $6,000]. The group reports a $5,000 [($6,000 - $7,000) + $6,000 deferred loss] net long-term capital gain before taking into account the Sec. 1231 gains and losses. The group reports a $4,000 [$3,000 - $3,000 + $4,000 restored gain] net Sec. 1231 gain that is taxed as a long-term capital gain. The total is a $9,000 net long-term capital gain. Statement B is incorrect because Cannon Corporation reports $6,000 of short-term capital gains, $1,000 of long-term capital losses, and $1,000 of Sec. 1231 gains, or a net $6,000 short-term (and not long-term) capital gain. Statement C is correct because the affiliated group reports a $4,000 net Sec. 1231 gain ($3,000 from Blair and $1,000 from Cannon after adding in the restored gain).Page Ref.: C:8-21 and C:8-22Objective: 5


16) 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:

CorporationOrdinary Income STCG/STCL LTCG/LTCL

Sec. 1231Gains and

LossesRoland

ShedrickTyrone

$25,000 30,000 20,000

$4,000 (2,000)(3,000)

($ 2,000) 14,0008,000

($5,000)( 2,000)( 3,000)

Which of following statements is incorrect?A) No Sec. 1231 recapture can occur this year.B) The net capital gain is taxed at the regular corporate tax rates.C) The Sec. 1231 loss is treated as an ordinary loss.D) The net capital gain is $20,000.Answer: DExplanation: The net capital gain is $19,000 ($20,000 - $1,000).Page Ref.: C:8-21 and C:8-22; Example C:8-30Objective: 5

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

Corporation STCG/STCL LTCG/LTCLSec. 1231Gains and

LossesBlair

Cannon($5,000)

6,000$6,000 (7,000)

$3,000 (3,000)

Which of the following statements is correct?A) The consolidated group reports a net short-term capital gain of $1,000.B) Blair Corporation's separate return reports a $4,000 net long-term capital gain.C) Cannon Corporation's separate return reports a $1,000 net long-term capital loss.D) All three of the above are correct.Answer: DPage Ref.: C:8-21 and C:8-22; Example C:8-30Objective: 5


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

Corporation Ordinary Income

STCG/STCL LTCG/LTCL

BoxcarSidecar

$10,000 30,000

$10,000 (12,000)

($ 5,000) 16,000

The affiliated group's consolidated taxable income isA) $40,000.B) $49,000.C) $51,000.D) $52,000.Answer: BExplanation: ($40,000 - $2,000 + $11,000)Page Ref.: C:8-21 and C:8-22; Example C:8-30Objective: 5

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

Corporation Ordinary Income

STCG/STCL LTCG/LTCL

BoxcarSidecar

$10,000 30,000

$10,000 (12,000)

($ 5,000) 16,000

What is the affiliated group's consolidated regular tax liability?A) $7,700B) $7,350C) $6,650D) $7,950Answer: BExplanation: Ordinary income $40,000 Net STCL ( 2,000)Net LTCG 11,000 Taxable income $49,000Times: tax rate × 0.15 Tax liability $ 7,350

Page Ref.: C:8-21 and C:8-22; Example C:8-30Objective: 5


20) Identify which of the following statements is true.A) When applying the large corporation rules for purposes of determining underpayments, each member of an affiliated group is considered separately.B) The entire consolidated tax liability cannot be collected from one group member.C) Once consolidated tax returns have been filed for two consecutive years, the affiliated group must pay estimated taxes on a consolidated basis.D) All of the above are false.Answer: CPage Ref.: C:8-26Objective: 5

21) The Alto-Baxter affiliated group filed a consolidated return for the first time last year. The group does not come under the "large" corporation rules. For last year, the group reports a tax liability of $60,000. Cooper Corporation has a $30,000 tax liability last year. This year, the Alto-Baxter affiliated group purchased all of the Cooper stock. This year, the Alto-Baxter-Cooper group reports an $110,000 consolidated tax liability. To avoid penalties for the current year, the group must make timely estimated tax payments of how much during the year?A) $60,000B) $90,000C) $110,000D) No estimated tax payments are required.Answer: APage Ref.: C:8-26Objective: 5

22) P-S is an affiliated group that files a consolidated tax return. For the current year, P has separate taxable income of $350,000 and S's separate taxable loss is $150,000. The group can take a tentative $50,000 consolidated general business credit. If the group's regular tax liability is $61,250 and their tentative minimum tax liability is $34,500, what is their general business credit limitation? The only difference between their taxable income and AMTI is the statutory exemption.Answer: Regular tax $61,250Plus: AMT 0Net income tax $61,250Minus: the greater of1. 25% of the group's net regular tax liability

exceeding $25,000 (0.25 × ($61,250 - $25,000)$ 9,0622. The group's tentative minimum tax 34,500 (34,500)General business credit limitation $26,750

The unused general business credit may be carried back one year and forward 20 years.Page Ref.: C:8-27 through C:8-33Objective: 5


23) Jason and Jon Corporations are members of an affiliated group whose taxable incomes (before dividends) are $90,000 and $100,000, respectively. Jason Corporation owns all of the Jon stock. Jon Corporation received a dividend from a less-than-20%-owned corporation of $9,900 and $25,000 from a 100%-owned nonconsolidated insurance company. Jon Corporation distributed a $40,000 dividend to Jason Corporation. Jason Corporation also received dividends from a 25%-owned corporation of $9,500. The consolidated dividends-received deduction for federal income tax purposes is what?Answer: [(0.70 × $9,900) + (0.80 × $9,500) + (1.00 × $25,000)] = $39,530. The $40,000 dividend is excluded from Jason Corporation's gross income in preparing the consolidated return.Page Ref.: C:9-22Objective: 5

24) Parent and Subsidiary Corporations are members of an affiliated group. Their separate taxable incomes (before taking into account any dividends) are $75,000 and $85,000, respectively. Subsidiary Corporation receives a dividend from a less-than-20%-owned corporation of $7,500 and from an affiliated 100%-owned nonconsolidated insurance subsidiary of $40,000. Subsidiary distributes a dividend of $35,000 to Parent Corporation who also receives dividends of $5,500 from a less-than-20%-owned corporation. The consolidated dividends-received deduction is what?Answer: 70% deduction: Consolidated deduction:0.70 × $5,500 = $3,850

100% dividends-received deduction $40,000

0.70 × $7,500 = 5,250

70% dividends-received deduction 9,100

Total $9,100

Total $49,100

Page Ref.: C:8-23; Example C:8-32Objective: 5

25) Alpha, Beta, Gamma, and Delta Corporations form a controlled group. Delta is a nonincludible regulated investment company. Only Alpha, Beta, and Gamma are able to file their income tax returns on a consolidated basis. What options are available for allocating the 15%, 25%, and 34% tax rates to the members of the controlled group?Answer: The benefit that the controlled group receives from the 15%, 25%, and 34% graduated tax rates are limited. The group only receives one rate reduction for each reduced tax rate bracket. Where no special apportionment plan is adopted, each bracket is divided equally between the members of the controlled group. Under our facts, Alpha, Beta, Gamma, and Delta each would be allocated $12,500 of the 15% bracket, $6,250 of the 25% bracket, and $2,481,250 of the 34% bracket. This method will not result in the lowest overall tax liability if, for example, one or more of the four- member corporations of the controlled group incurs a loss or has taxable income below $18,750 ($12,500 + $6,250). In this situation, the tax savings generated by the lower two rate brackets will not be fully used. A solution to this problem is the adoption of a special plan of apportionment. With this plan, the group has the latitude to allocate the brackets so as to achieve the maximum tax savings by allocating the reduced tax rates to each member corporation based on its level of taxable income. This plan must be filed with each corporation's tax return and is elected each year. Therefore, it can be adjusted to fit each year's facts. Since Delta is a nonincludible corporation, it will receive an allocable share of the reduced tax rate benefits unless a special apportionment plan is elected, even though it is not part of the consolidated return.Page Ref.: C:8-24Objective: 5

26) How do intercompany transactions affect the calculation of capital gains/losses?23

Copyright © 2016 Pearson Education, Inc.

Answer: 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.Page Ref.: C:8-21Objective: 5

LO6: Net Operating Losses (NOLs)

1) A member's portion of a consolidated NOL may be carried back against that member's taxable income from the preceding two separate return years.Answer: TRUEPage Ref.: C:8-28Objective: 6

2) Identify which of the following statements is true.A) The basic dividends-received deduction rules generally do not apply to the calculation of the consolidated dividends-received deduction.B) A member of an affiliated group can elect to carry back its own separate return losses from a consolidated return year to one of its earlier profitable separate return years.C) A consolidated NOL is computed in part by including the consolidated capital gain in taxable income.D) All of the above are false.Answer: CPage Ref.: C:9-22Objective: 6

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

Taxable IncomeLast Current

Parent ($10,000) $50,000 Subsidiary 30,000 (25,000)

How much of Subsidiary's loss can be carried back to last year?A) $0B) $20,000C) $25,000D) none of the aboveAnswer: APage Ref.: C:8-29; Example C:8-38Objective: 6


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

Taxable IncomeLast Current

Parent ($16,000) $20,000 Subsidiary 10,000 (21,000)

How much of the Subsidiary loss can be carried back to last year?A) $0B) $1,000C) $10,000D) none of the aboveAnswer: BPage Ref.: C:8-29; Example C:8-38Objective: 6

5) Identify which of the following statements is true.A) The parent corporation may elect that the affiliated group use its NOL as a carryforward only.B) A portion of a consolidated NOL can be carried back or forward to a separate return year of an individual group member.C) The entire consolidated NOL may be available as a carryback or a carryover to a separate return year of one of the members of an affiliated group.D) All of the above are true.Answer: DPage Ref.: C:8-28 through C:8-30Objective: 6


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

Corporation Taxable IncomeLast year

Taxable IncomeCurrent year

MakoSnufcoZebco

CTI

$18,000 9,000

(25,000) $ 2,000

$ 12,000 8,000

(35,000)($15,000)

The $15,000 consolidated NOL reported in the current yearA) cannot be carried back.B) can be carried back three years ago only.C) can be carried back to last year and the remainder, if any, carried forward to subsequent years.D) can only be used in future years.Answer: CExplanation: The loss can be used to offset the income of Mako and Snufco.Page Ref.: C:8-29; Example C:8-38Objective: 6

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



PantsSkirt

ZipperCTI

$18,000 9,000 7,000 $34,000

$ 12,000 8,000

(29,000)($ 9,000)

The $9,000 consolidated NOL reported in the current yearA) can offset taxable income of Pants and Skirt Corporations from last year.B) can offset Zipper Corporation separate return taxable income only from last year.C) can be used only as a carryover to the future.D) can offset Zipper Corporation separate return taxable income from last year and then be carried forward to offset the affiliated group's subsequent taxable income.Answer: DPage Ref.: C:8-29; Example C:8-38Objective: 6


8) Identify which of the following statements is true.A) An affiliated group member's allocated share of an NOL from a consolidated return year may not be available as a carryback to a separate return year of the common parent corporation.B) If a corporation ceases to be a member of an affiliated group, the corporation is entitled to carry forward its share of the consolidated NOL even if the NOL could be used in full on the consolidated return for the year of cessation.C) The SRLY (separate return limitation year) rules are designed to prevent the affiliated group from offsetting its current year taxable income by purchasing corporations having NOL carryovers in order to use their NOLs.D) All of the above are false.Answer: CPage Ref.: C:8-28 through C:8-30Objective: 6

9) Identify which of the following statements is true.A) An affiliated group member incurring an NOL in a separate return year that is available as a carryback or carryforward to a consolidated return year is subject to a limit on the use of the NOL when the loss year is designated a separate return limitation year (SRLY).B) A consolidated NOL may be carried back one year and carried forward twenty years.C) An NOL incurred in a separate return limitation year by the corporation that is the common parent corporation for the group in the carryover year is subject to the SRLY limitation.D) All of the above are false.Answer: APage Ref.: C:8-30Objective: 6

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

Consolidated

Income (loss)

Last year

Income (loss)

Current yearKey

Glass($10,000) 30,000

$40,000 (15,000)

Which of the following statements is not correct?A) Key's last year NOL cannot offset Glass's last year profits.B) Key's last year NOL cannot offset this year's consolidated taxable income.C) Key's current year income must first be offset by Glass's current year loss.D) Glass cannot carry its current year loss back against last year's income.Answer: BExplanation: Key can offset its last year NOL against the current year consolidated taxable income ($25,000).Page Ref.: C:8-30Objective: 6


11) 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 overA) to a consolidated return year and both are SRLY (separate return limitation year) losses.B) to a consolidated return year and Tanker's loss is a SRLY loss.C) to a consolidated return year without limit.D) to a consolidated return year and Jackson's loss is a SRLY loss.Answer: CExplanation: Since the corporations were affiliated since inception, the SRLY loss limitation does not apply.Page Ref.: C:8-31Objective: 6

12) Identify which of the following statements is true.A) A built-in deduction accrues in a separate return year, but is not recognized in a consolidated return year.B) Section 382 adopts a single-entity approach in determining ownership changes.C) The 50-percentage-point minimum stock ownership change that triggers the Sec. 382 loss limitation rules will not occur in acquisitive transactions involving a group of corporations filing consolidated returns.D) All of the above are false.Answer: BPage Ref.: C:8-33Objective: 6


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

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

Which of the following statements is correct?A) Last year's NOL cannot be carried back.B) The portion of last year's NOL that is not used as a carryback can be carried over the current year but is only used against Blue's taxable income.C) The portion of last year's NOL that is not used as a carryback can be carried over against the current consolidated taxable income, but is subject to the Sec. 382 limitation.D) The portion of last year's NOL that is not used as a carryback can be carried over, but is used only against the Blue's and Gold's taxable income.Answer: CPage Ref.: C:8-31 through C:8-33Objective: 6

14) Mariano owns all of Alpha Corporation, which owns 100% of Beta Corporation's single class of stock. On January 1, Alpha and Beta Corporations report a consolidated NOL carryover from prior years. What is the maximum percentage of Alpha Corporation's single class of stock that Mariano can sell to a single shareholder without triggering the Sec. 382 loss limitation?A) 0%B) 50%C) 75%D) 80%Answer: BPage Ref.: C:8-33Objective: 6


15) 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.



TrixTrack

Consolidated Taxable Income

($12,000)( 10,000)($22,000)

$34,000 ( 2,000)$32,000

Which of the following statements is incorrect?A) Last year is an SRLY (separate return limitation year) with respect to Track Corporation.B) Track's last year loss is offset against the consolidated current taxable income.C) Track's last year loss can be used to offset the current year's consolidated taxable income.D) None of Track's last year's loss can be used to offset the current year's consolidated taxable income.Answer: CPage Ref.: C:8-33Objective: 6

16) Which of the following is not reported by an affiliated group on a consolidated basis?A) capital gainB) section 1231 gainC) casualty & theft gainD) All of the above are included.Answer: DPage Ref.: C:8-9Objective: 4

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

25,000 Plus: other members' contribution to current-year CTI$ 40,000 Current-year CTI( 52,000) Minus: NOL available

($ 12,000) NOL carryover available to be used on separate return or consolidated tax return

× 0 .25 Allocation to Duke$ 3,000 Amount allocated to Duke

The entire $3,000 can be used since it is less than Duke's pre-NOL taxable income.Page Ref.: C:8-29; Example C:8-37Objective: 6


18) What is the carryback and carryforward rule for consolidated NOLs?Answer: A consolidated NOL may be carried back to the two preceding consolidated return years or carried over to the twenty succeeding consolidated return years.Page Ref.: C:8-28Objective: 6

19) What is the consequence of having losses subject to the SRLY limitations?Answer: The effect of having a loss tainted as an SRLY loss is that it can be used only to offset taxable income of the subsidiary member (or possibly loss subgroup) that created the NOL.Page Ref.: C:8-31Objective: 6

20) Blitzer Corporation is the parent corporation of a 10-member group that has filed consolidated tax returns for a number of years. Last year, the group sold all the stock of Wolf Corporation to Jerry Jensen. This year, Wolf Corporation reported a $300,000 NOL. Wolf's taxable income while a group member averaged $200,000 annually for the past five years but is expected to be only $50,000 next year due to start-up costs that will be incurred with the introduction of a new product line. Profits are expected to increase in each succeeding year. What issues should Blitzer have considered when trying to value Wolf's NOL prior to its sale? What tax issues should Wolf now consider when deciding how to use its NOL?Answer: • What alternatives exist for using the NOL?• Can the separate-return NOL of Wolf be carried back to a consolidated tax year of the Blitzer affiliated group?• If so, what special limitations (if any) is the NOL subject to?• What is the projected tax refund if the NOL is carried back to a prior consolidated return year?• Who files for the tax refund? Who receives the refund from the IRS?• Was any provision made for Wolf receiving the NOL refund payment from the Blitzer affiliated group in the stock purchase agreement should a separate NOL be carried back?• What is the projected taxable income of Wolf Corporation in the future?• What is the projected tax refund if the NOL is carried forward to a separate return year(s)?• What special limitations (if any) is the NOL subject to (e.g., Sec. 382 restrictions following a change in ownership)?• How is the election to forgo the NOL carryback made?• What effect does the low taxable income in the future years and the Sec. 382 limitation have on the valuation of the NOL? The company?

A larger tax refund should be available to Wolf Corporation by carrying the NOL back to the prior tax years of Blitzer Corporation. The marginal tax rate for the earlier tax years appears to be 39% while Wolf has a 15% rate for the near future. The separate-return NOL is an SRLY loss when carried back, and its use is subject to the SRLY limitations. The entire loss carryback should be absorbed within the two-year carryback period since Wolf reported separate-return profits of $200,000 annually when part of the affiliated group, Wolf files for the refund based on the carryback. A carryover of the NOL is likely subject to the Sec. 382 loss limitations. We do not know enough about Wolf's new owners to be able to reach a definite conclusion about the Sec. 382 issue. The tax refund from an NOL carryback will be paid to Blitzer. As such, Blitzer may be reluctant to pay the refund to Wolf unless such an event was agreed upon at the time of the sale.


From Wolf's perspective, the sales agreement should include a provision requiring Blitzer to pay the refund to Wolf Corporation.Page Ref.: C:8-27 through C:8-33Objective: 6

LO7: Stock Basis Adjustments

1) On January 1, Alpha Corporation purchases 100% of the stock of Omega Corporation for $2 million. During the year, Omega Corporation earns $350,000 of taxable income, $30,000 of tax-exempt income, and distributes $150,000 in dividends. Each company paid its own tax liability. Assume a 34% tax rate. What basis adjustment must Alpha Corporation make at year-end?Answer: Alpha Corporation's initial basis for the Omega Corporation stock is its $2,000,000 purchase price. The $350,000 of taxable income and $30,000 of tax-exempt interest income earned in the current year increase the stock basis. The $119,000 ($350,000 × 0.34) federal income tax liability decreases the stock basis, as does the $150,000 distribution to the parent corporation (Alpha). The year-end basis is $2,102,000 ($2,000,000 + $350,000 + $30,000 - $119,000 - $159,000). The year-end basis for the Omega Corporation stock is $111,000 ($350,000 + $30,000 - $119,000 - $150,000) higher than its $2,000,000 acquisition cost.Page Ref.: C:8-34 and C:8-35Objective: 7

LO8: Tax Planning Considerations

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

2) All of the stock of Hartz and Ryder Corporations is owned by Morgen. Hartz Corporation has been reporting $150,000 of taxable income for each of the past five years. Ryder Corporation has been reporting $30,000 in NOLs for the same period, which totals $150,000. Approximately one-third of Hartz's profits come from sales to Ryder. Intercompany sales between Hartz and Ryder have increased during each of the last five years. What tax issues should Morgen consider with respect to his investments in Hartz and Ryder Corporations?Answer: • 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.Page Ref.: C:8-36 and C:8-37Objective: 8

LO9: Compliance and Procedural Considerations

1) The IRS can attempt to collect taxes owed on a consolidated return from any of the members of the consolidated group.Answer: TRUEPage Ref.: C:8-39Objective: 9

2) An affiliated group elects the use of the consolidated method for filing its tax return byA) filing Form 1120.B) filing a consent to the election from each member of the affiliated group in the initial year.C) filing an affiliations schedule.D) All of the above are necessary for the election.Answer: DPage Ref.: C:8-37 and C:8-38Objective: 9

3) A consolidated return's tax liability is owed byA) all group members in equal portions.B) the group member responsible for that portion of the tax liability.C) all group members who are severely liable.D) the parent corporation.Answer: CPage Ref.: C:8-39Objective: 9

L10: Financial Statement Implications


1) Intercompany sales between members of an affiliated group filing separate returns cause deferred tax assets to be recognized by both buyer and seller.Answer: FALSEPage Ref.: C:8-39 and C:8-40Objective: 10

2) Which of the following intercompany transactions creates temporary book/tax differences when a parent corporation owns 100% of a subsidiary's stock and the companies file a consolidated return?A) intercompany dividendsB) undistributed subsidiary earningsC) intercompany saleD) None of the above items create temporary differences.Answer: DPage Ref.: C:8-39 through C:8-41Objective: 10


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Chapter c8