CPA-Corp-Tax-06

Becker Professional Review 2K5 Exported Questions

1

2K5 Exported Questions–Regulation 3 Export Date: 7/11/2005

2K5 Exported Questions Becker Professional Review

2

C Corporations, Depreciation, and MACRS CPA-01659 Type1 M/C A-D Corr Ans: B PM R 3-01

1. CPA-01659 ARE Nov 95 #3 Page 19

A C corporation's net capital losses are: a. Carried forward indefinitely until fully utilized. b. Carried back 3 years and forward 5 years. c. Deductible in full from the corporation's ordinary income. d. Deductible from the corporation's ordinary income only to the extent of $3,000. CPA-01659 Explanation Choice "b" is correct. A C corporation's net capital losses are carried back 3 years and forward 5 years; they expire after 5 years. In addition, a C corporation can not deduct net capital losses from ordinary income.

Choice "a" is incorrect. A C corporation's net capital losses can not be carried forward indefinitely. They expire after 5 years.

Choices "c" and "d" are incorrect. A C corporation cannot deduct net capital losses from ordinary income. CPA-01665 Type1 M/C A-D Corr Ans: D PM R 3-01

2. CPA-01665 ARE Nov 95 #7 Page 19

Baker Corp., a calendar year C corporation, realized taxable income of $36,000 from its regular business operations for calendar year 1994. In addition, Baker had the following capital gains and losses during 1994:

Short-term capital gain $8,500 Short-term capital loss (4,000) Long-term capital gain 1,500 Long-term capital loss (3,500)

Baker did not realize any other capital gains or losses since it began operations. What is Baker's total taxable income for 1994? a. $46,000 b. $42,000 c. $40,500 d. $38,500 CPA-01665 Explanation Choice "d" is correct. Capital losses offset capital gains. If a corporation has net capital gains, they are taxed at ordinary (corporate) income tax rates.

Taxable income from business operations $36,000 Short-term capital gain $8,500 Short-term capital loss (4,000) $4,500 Long-term capital gain 1,500 Long-term capital loss (3,500) (2,000) Net capital gain 2,500 Taxable income $38,500

CPA-01807 Type1 M/C A-D Corr Ans: B PM R 3-01

3. CPA-01807 ARE R03 #5 Page 34

At the beginning of the year, Westwind, a C corporation, had a deficit of $45,000 in accumulated earnings and profits. For the current year, Westwind reported earnings and profits of $15,000.


3

Westwind distributed $12,000 during the year. What was the amount of Westwind's accumulated earnings and profits at year-end?

a. $30,000 b. $42,000 c. $45,000 d. $57,000 CPA-01807 Explanation Choice "b" is correct. Accumulated earnings and profits include all prior and current year earnings and profits at year-end. The key here is recognizing that the beginning accumulated earnings and profits is a deficit. Thus the calculation would be as follows:

Beginning deficit in Accumulated E&P ($45,000) Plus: Current year E&P 15,000 Less: Amounts distributed ( 12,000) End of year Accumulated E&P ($42,000)

Note: The examiners did not ask whether or not the accumulated earnings and profits at year-end was a deficit, rather they asked solely for the dollar amount.

Choice "a" is incorrect. This choice does not take into consideration the amounts distributed during the year.

Choice "c" is incorrect. This choice does not take into account any of the current year activity that becomes part of accumulated earnings and profits at year-end.

Choice "d" is incorrect. This choice treats the distributions of $12,000 as an addition to the deficit, making it $57,000. It ignores the current year earnings and profits entirely. CPA-01867 Type1 M/C A-D Corr Ans: D PM R 3-01

4. CPA-01867 Nov 91 II #41 Page 19

A corporation's capital loss carryback or carryover is: a. Not allowable under current law. b. Limited to $3,000. c. Always treated as a long-term capital loss. d. Always treated as a short-term capital loss. CPA-01867 Explanation Choice "d" is correct. A corporation's capital loss carryback or carryover is always treated as a short-term capital loss.

Rule: Corporations may not deduct any capital loss from ordinary income, but instead only carry it back 3 years and forward 5 years as a "short-term" capital loss to deduct from "net capital" or Section 1231 gains. CPA-01991 Type1 M/C A-D Corr Ans: A PM R 3-01

5. CPA-01991 ARE R03 #1 Page 45

Jackson, a single individual, inherited Bean Corp. common stock from Jackson’s parents. Bean is a qualified small business corporation under Code Sec. 1244. The stock cost Jackson’s parents $20,000 and had a fair market value of $25,000 at the parents’ date of death. During the year, Bean declared bankruptcy and Jackson was informed that the stock was worthless. What amount may Jackson deduct as an ordinary loss in the current year? a. $0 b. $3,000 c. $20,000 d. $25,000


4

CPA-01991 Explanation Choice "a" is correct. Losses resulting from the sale, exchange or worthlessness of Section 1244 qualifying stock (also called Small Business Stock) are treated as ordinary losses up to $50,000 in any tax year. However, this loss is only available to original owners of the stock. Because Jackson inherited the stock, he is not the original owner. Therefore, in this case, no ordinary loss may be deducted. (Note that Jackson would be allowed a capital loss in the year the stock was deemed entirely worthless. The capital loss would be deducted under the personal capital loss rules and calculated using the likely transfer basis of $25,000.)

Choice "b" is incorrect. An ordinary loss is allowed on the worthlessness of Sec. 1244 stock if taken by an original owner. It appears as if this answer was attempting to "trick" the candidate into choosing this option (a $3,000 deduction as would be the case if the loss were a capital loss, rather than an ordinary loss) and not considering that the question referenced the deductibility of an ordinary loss.

Choices "c" and "d" are incorrect. Both these answers utilize either the basis of Jackson's parents or the fair market value to determine the ordinary loss. In this instance, no ordinary loss is available to Jackson because he is not the original owner of the stock. CPA-01995 Type1 M/C A-D Corr Ans: C PM R 3-01

6. CPA-01995 ARE C03 #1 Page 39

Which of the following is not true with regard to personal holding companies (PHCs)? a. The additional tax (penalty) is self-assessed by the PHC. b. Personal holding companies are not subject to the accumulated earnings tax. c. Personal holding companies, as specifically defined by the Code, are corporations that meet

certain "closely-held" ownership criteria and have over 50% of their adjusted gross income consisting of net rent (less than 50% of ordinary gross income), taxable interest, most royalties, and dividends from an unrelated domestic corporation.

d. There is no penalty if net earnings are distributed, as the penalty only applies to income that has not been distributed.

CPA-01995 Explanation Choice "c" is correct. While most of the information in the item is correct, it is when over 60% of the adjusted gross income of a closely-held (more than 50% owned by 5 or less individuals either directly or indirectly at any time during the last half of the tax year) corporation consists of "NIRD" that it is defined as a personal holding company, not over 50% (as in the selection).

Choice "a" is incorrect, as the additional tax is self-assessed by the taxpayer by filing a separate schedule 1120PH along with the Form 1120.

Choice "b" is incorrect, as the accumulated earnings tax indeed does not apply to personal holding companies (which are not allowed to accumulate any earnings without penalty!).

Choice "d" is incorrect, as provided the net earnings are distributed, there is not penalty. CPA-01999 Type1 M/C A-D Corr Ans: A PM R 3-01

7. CPA-01999 ARE R02 #4 Page 19

Mock operates a retail business selling illegal narcotic substances. Which of the following item(s) may Mock deduct in calculating business income?

I. Cost of merchandise. II. Business expenses other than the cost of merchandise.

a. I only. b. II only. c. Both I and II. d. Neither I nor II.


5

CPA-01999 Explanation Choice "a" is correct. A gain from an illegal activity is includible in income. To determine the gain, a deduction is permitted for cost of merchandise. Business expenses, other than the cost of merchandise, are not permitted as deduction for operating an illegal business.

Choices "b", "c", and "d" are incorrect. Each of these answers does not answer either I or II correctly. CPA-02016 Type1 M/C A-D Corr Ans: B PM R 3-01

8. CPA-02016 ARE R02 #9 Page 39

Which of the following taxpayers may use the cash method of accounting? a. A tax shelter. b. A qualified personal service corporation. c. A C corporation with annual gross receipts of $50,000,000. d. A manufacturer. CPA-02016 Explanation Choice "b" is correct.

Rule: The general rule is that the accrual method of accounting will be required by tax shelters, large C corporations and manufacturers. The IRS has the authority to require that a taxpayer use a method of accounting to accurately reflect the proper income and expenses. Personal Service Corporations are permitted the use of the cash method.

Choices "a", "c", and "d" are incorrect, per the above rule. CPA-02017 Type1 M/C A-D Corr Ans: C PM R 3-01

9. CPA-02017 ARE R01 #3 Page 39

On January 1, 1999, Locke Corp., an accrual-basis, calendar-year C corporation, had $30,000 in accumulated earnings and profits. For 1999, Locke had current earnings and profits of $20,000, and made two $40,000 cash distributions to its shareholders, one in April and one in September of 1999. What amount of the 1999 distributions is classified as dividend income to Locke's shareholders? a. $0 b. $20,000 c. $50,000 d. $80,000 CPA-02017 Explanation Choice "c" is correct. Dividends are distributions of a corporation's earnings & profits, including accumulated (prior year) and current year E&P. Because the corporation had both accumulated E&P of $30,000 and current E&P of $20,000, the total amount of distributions classified as dividends is $50,000.

Choice "a" is incorrect. If a corporation has accumulated E&P or current year E&P the distribution (depending upon amount) would be taxable as a dividend.

Choice "b" is incorrect. The amount taxable as a dividend is total E&P, not the difference between one distribution and current E&P.

Choice "d" is incorrect. The total distributions exceeds E&P. The excess will be treated as a return of basis and any remaining excess will be capital gain. CPA-02021 Type1 M/C A-D Corr Ans: C PM CQ #7 R 3-01

10. CPA-02021 ARE R99 #5 (Adapted) Page 25


6

On January 2 of the current year, Shaw Corp., an accrual-basis, calendar-year C corporation, purchased all the assets of a sole proprietorship, including $300,000 in goodwill. Current-year federal income tax expense of $110,100, and $7,500 for goodwill impairment were deducted to arrive at Shaw's reported book income of $239,200. What should be the amount of Shaw's current-year taxable income, as reconciled on Shaw's Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return? a. $239,200 b. $329,300 c. $336,800 d. $349,300 CPA-02021 Explanation Choice "c" is correct. $336,800 should be reported as Shaw's current-year taxable income, reconciled as follows on Shaw's Schedule M-1 on the Form 1120:

Book income $ 239,200

Add: Federal income tax expense 110,100 [1]

Less: Excess of tax amortization over book impairment of goodwill (12,500) [2]

Taxable income $ 336,800

[1] Federal income taxes paid are not deductible for tax purposes.

[2] The excess amortization is determined as follows:

Total purchased goodwill $ 300,000 Divided by 15 years /15 [tax amortization period]

Tax amortization $ 20,000

Less: Book impairment (given) (7,500)

Excess tax amortization for the current year $ 12,500

Choice "a" is incorrect. This answer is the amount of book income without any adjustments.

Choice "b" is incorrect. This answer adds back the federal income tax expense paid $110,100 (as is proper) and also deducts the entire $20,000 of tax amortization as additional expense (which is not proper because $7,500 of this amount is already deducted from the book income).

Choice "d" is incorrect. This answer adds back the federal income tax expense of $110,100 but does not deduct the additional $12,500 of tax amortization for the year. CPA-02024 Type1 M/C A-D Corr Ans: B PM R 3-01

11. CPA-02024 ARE R97 #5 (Adapted) Page 19

How are a C corporation's net capital losses used? a. Deducted from the corporation's ordinary income only to the extent of $3,000. b. Carried back three years and forward five years. c. Deductible in full from the corporation's ordinary income. d. Carried forward 20 years. CPA-02024 Explanation Choice "b" is correct. A C corporation's net capital losses are carried back three years and forward five years.

Choice "a" is incorrect. This is incorrect because it states the rule for an individual taxpayer.

Choice "c" is incorrect. A corporation's capital losses can be used only to offset capital gains, and any excess is carried back three years and forward five years.


7

Choice "d" is incorrect. A C corporation's net operating losses may be carried back two years and forward twenty years. CPA-02026 Type1 M/C A-D Corr Ans: D PM CQ #17 R 3-01

12. CPA-02026 ARE R97 #6 Page 42

Elm Corp. is an accrual-basis calendar-year C corporation with 100,000 shares of voting common stock issued and outstanding as of December 28, 1995. On Friday, December 29, 1995, Hall surrendered 2,000 shares of Elm stock to Elm in exchange for $33,000 cash. Hall had no direct or indirect interest in Elm after the stock surrender. Additional information follows: Hall's adjusted basis in 2,000 shares of Elm on December 29, 1995 ($8 per share) $16,000 Elm's accumulated earnings and profits at January 1, 1995 25,000 Elm's 1995 net operating loss (7,000)

What amount of income did Hall recognize from the stock surrender? a. $33,000 dividend. b. $25,000 dividend. c. $18,000 capital gain. d. $17,000 capital gain. CPA-02026 Explanation Choice "d" is correct. Hall's gain is the difference in the $33,000 he received for his stock and his basis of $16,000, for a gain of $17,000 which is a capital gain.

Choice "a" is incorrect. Because this is a sale of Hall's interest in Elm, this is not a dividend.

Choice "b" is incorrect. The accumulated earnings of Elm have no relationship to the stock surrender.

Choice "c" is incorrect. The amount of the capital gain calculated on the stock surrender is not based on the end of year amount of accumulated earnings and profits. CPA-02027 Type1 M/C A-D Corr Ans: D PM CQ #18 R 3-01

13. CPA-02027 ARE R97 #7 Page 43

Mintee Corp., an accrual basis calendar-year C corporation, had no corporate shareholders when it liquidated in 1996. In cancellation of all their Mintee stock, each Mintee shareholder received in 1996, a liquidating distribution of $2,000 cash and land with tax basis of $5,000 and a fair market value of $10,500. Before the distribution, each shareholder's tax basis in Mintee stock was $6,500. What amount of gain should each Mintee shareholder recognize on the liquidating distribution? a. $0 b. $500 c. $4,000 d. $6,000 CPA-02027 Explanation Choice "d" is correct. When a corporation liquidates and distributes assets to shareholders, gain is recognized to the extent that the fair market value of assets distributed to a shareholder exceeds the shareholder's basis in the corporation's stock.

Choice "a" is incorrect. In a corporate liquidation, gain is recognized to the extent that fair market value of the assets received exceeds the shareholder's basis in the stock.

Choice "b" is incorrect. The gain is figured using the fair market value of assets received, not the basis of the assets received.

Choice "c" is incorrect. This is simply the difference in the fair market value of the land and the shareholder's basis in the stock, and is not how the gain is computed.


8

CPA-02030 Type1 M/C A-D Corr Ans: A PM CQ #1 R 3-01

14. CPA-02030 ARE R96 #8 Page 3

Lind and Post organized Ace Corp., which issued voting common stock with a fair market value of $120,000. They each transferred property in exchange for stock as follows:

Fair Percentage Adjusted market of Ace stock Property basis value acquired Lind Building $40,000 $82,000 60% Post Land $5,000 $48,000 40%

The building was subject to a $10,000 mortgage that was assumed by Ace. What amount of gain did Lind recognize on the exchange? a. $0 b. $10,000 c. $42,000 d. $52,000 CPA-02030 Explanation Choice "a" is correct. The formation of a corporation under these circumstances is a nontaxable event. Thus Lind would report zero gain upon the formation of the corporation.

Choices "b", "c", and "d" are incorrect. Because the formation of this corporation is a nontaxable event, no gain or loss would be reported by Lind. CPA-02032 Type1 M/C A-D Corr Ans: C PM R 3-01

15. CPA-02032 ARE R02 #3 Page 27

Which of the following conditions must be satisfied for a taxpayer to expense, in the year of purchase, under Internal Revenue Code Section 179, the cost of new or used tangible depreciable personal property? I. The property must be purchased for use in the taxpayer's active trade or business. II. The property must be purchased from an unrelated party.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-02032 Explanation Choice "c" is correct. To qualify for I.R.C. Section 179, the property must be tangible personal property acquired by purchase from an unrelated party for use in the active conduct of a business or trade.

Statement I and II are both correct statements concerning the criteria for property to qualify under IRC Section 179.

CPA-02034 Type1 M/C A-D Corr Ans: B PM CQ #2 R 3-01

16. CPA-02034 ARE R96 #9 Page 3


Fair Percentage Adjusted market of Ace stock Property basis value acquired


9

Lind Building $40,000 $82,000 60% Post Land $5,000 $48,000 40%

The building was subject to a $10,000 mortgage that was assumed by Ace. What was Ace's basis in the building? a. $30,000 b. $40,000 c. $72,000 d. $82,000 CPA-02034 Explanation Choice "b" is correct. Ace's basis in the building is the same as Lind's basis immediately prior to its contribution to the corporation.

Choice "a" is incorrect. Ace's basis in the building is computed separately from any debt that it assumes related to the building.

Choice "c" is incorrect. Ace uses Lind's basis, not the building's fair market value, as its basis. Furthermore, the debt assumed by Ace does not affect the basis of the building to Ace.

Choice "d" is incorrect. Ace uses Lind's basis, not the building's fair market value, as its basis. CPA-02036 Type1 M/C A-D Corr Ans: C PM CQ #3 R 3-01

17. CPA-02036 ARE R96 #10 Page 4


Fair Percentage Adjusted market of Ace stock Property basis value acquired Lind Building $40,000 $82,000 60% Post Land $5,000 $48,000 40%

The building was subject to a $10,000 mortgage that was assumed by Ace. What was Lind's basis in Ace stock? a. $82,000 b. $40,000 c. $30,000 d. $0 CPA-02036 Explanation Choice "c" is correct. Lind computes his basis as the basis of property and cash (none here) contributed, less the amount of any debt he is relieved of. Here he contributes property with an adjusted basis of $40,000, but the $10,000 debt he is relieved of must be subtracted, resulting in a net basis of $30,000. This can also be thought of as giving Lind a basis equivalent to the amount of equity he had in the contributed building.

Choice "a" is incorrect. The basis of Lind's stock is based on his basis in the contributed property, not its fair market value.

Choice "b" is incorrect. Lind must subtract the $10,000 of debt he is relieved of from his $40,000 basis in the property to arrive at his basis in the stock.

Choice "d" is incorrect. Because Lind contributed property with a basis above zero, his basis in the stock is greater than zero. CPA-02039 Type1 M/C A-D Corr Ans: C PM CQ #5 R 3-01


10

18. CPA-02039 ARE Nov 95 #1 Page 25

In 1994, Starke Corp., an accrual-basis calendar year corporation, reported book income of $380,000. Included in that amount was $50,000 municipal bond interest income, $170,000 for federal income tax expense, and $2,000 interest expense on the debt incurred to carry the municipal bonds. What amount should Starke's taxable income be as reconciled on Starke's Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return? a. $330,000 b. $500,000 c. $502,000 d. $550,000 CPA-02039 Explanation Choice "c" is correct. Municipal bond interest, interest on debt incurred to carry the municipal bonds, and federal income tax expense are not included in taxable income.

Reported book income $ 380,000 Municipal bond interest (50,000) Federal income tax expense 170,000 Interest to carry municipal bonds 2,000 Taxable income $ 502,000

Choices "a", "b", and "d" are incorrect. Each of these answers does not take into account at least one of the items of the above calculation. CPA-02042 Type1 M/C A-D Corr Ans: D PM CQ #10 R 3-01

19. CPA-02042 ARE R01 #2 Page 27

Bent Corp., a calendar-year C corporation, purchased and placed into service residential real property during February 1998. No other property was placed into service during 1998. What convention must Bent use to determine the depreciation deduction for the alternative minimum tax?

a. Full-year. b. Half-year. c. Mid-quarter. d. Mid-month. CPA-02042 Explanation Choice "d" is correct. Real property (buildings) are subject to the mid-month convention under MACRS. Only personal property (machinery & equipment) are subject to the half-year and/or mid-quarter conventions.

CPA-02044 Type1 M/C A-D Corr Ans: C PM R 3-01

20. CPA-02044 ARE Nov 95 #5 Page 26

Data Corp., a calendar year corporation, purchased and placed into service office equipment during November 1994. No other equipment was placed into service during 1994. Under the general MACRS depreciation system, what convention must Data use?

a. Full-year. b. Half-year. c. Mid-quarter. d. Mid-month. CPA-02044 Explanation Choice "c" is correct. When a taxpayer places 40% or more of its property (other than certain qualifying real property) into service in the last quarter of the taxable year, the corporation must use the mid-quarter convention for MACRS depreciation purposes. With this method the


11

acquisitions are segregated by quarter, and treated as if placed in service in the middle of each respective quarter.

CPA-02045 Type1 M/C A-D Corr Ans: D PM R 3-01

21. CPA-02045 ARE Nov 95 #2 Page 6

Lake Corp., an accrual-basis calendar year corporation, had the following 1994 receipts: 1995 advanced rental payments where the lease ends in 1996 $125,000 Lease cancellation payment from a 5-year lease tenant 50,000

Lake had no restrictions on the use of the advanced rental payments and renders no services. What amount of income should Lake report on its 1994 tax return? a. $0 b. $50,000 c. $125,000 d. $175,000 CPA-02045 Explanation Choice "d" is correct. Assuming these were Lake's only transactions for the year, its taxable income was $175,000. The advanced rental payments are taxable when received even though they are not included in financial income because there is no restriction on their use. The lease cancellation payment is also included in taxable income in 1994, when received.

Choices "a", "b", and "c" are incorrect, per the above explanation. CPA-02047 Type1 M/C A-D Corr Ans: D PM CQ #9 R 3-01

22. CPA-02047 ARE Nov 95 #4 Page 22

In 1994, Best Corp., an accrual-basis calendar year C corporation, received $100,000 in dividend income from the common stock that it held in an unrelated domestic corporation. The stock was not debt-financed, and was held for over a year. Best recorded the following information for 1994: Loss from Best's operations $(10,000) Dividends received 100,000 Taxable income (before dividends-received deduction) $ 90,000 Best's dividends-received deduction on its 1994 tax return was: a. $100,000 b. $80,000 c. $70,000 d. $63,000 CPA-02047 Explanation Choice "d" is correct. The dividends-received deduction (DRD) is 70% of the lesser of: i) taxable income (70% x $90,000 = $63,000), or ii) dividends received (70% x $100,000 = $70,000). In this case, $63,000 is the dividends-received deduction. 70% is used in this case because the question indicates the corporations are "unrelated" (i.e., less than 20% owned).

Choice "a" is incorrect. The 100% DRD is available only when 80-100% of the stock is owned (making theses entities related).

Choice "b" is incorrect. The 80% DRD is used when 20-80% of the stock is owned.

Choice "c" is incorrect. The deduction is limited to 70% of the lesser of taxable income or the dividends received. CPA-02048 Type1 M/C A-D Corr Ans: B PM R 3-01


12

23. CPA-02048 ARE Nov 95 #8 Page 16

In 1994, Cable Corp., a calendar year C corporation, contributed $80,000 to a qualified charitable organization. Cable's 1994 taxable income before the deduction for charitable contributions was $820,000 after a $40,000 dividends-received deduction. Cable also had carryover contributions of $10,000 from the prior year. In 1994, what amount can Cable deduct as charitable contributions? a. $90,000 b. $86,000 c. $82,000 d. $80,000 CPA-02048 Explanation Choice "b" is correct. A C corporation can deduct charitable contributions up to 10% of its taxable income after adding back the dividends-received deduction; $820,000 taxable income + $40,000 dividends-received deduction = $860,000. 10% × $860,000 = $86,000, the maximum allowable charitable contribution deduction. $4,000 is carried forward to 1995. A corporate charitable deduction that exceeds the limit for deduction in one year can be carried over to the succeeding five tax years. It cannot be carried back. CPA-02050 Type1 M/C A-D Corr Ans: C PM R 3-01

24. CPA-02050 ARE Nov 95 #9 Page 16

If a corporation's charitable contributions exceed the limitation for deductibility in a particular year, the excess: a. Is not deductible in any future or prior year. b. May be carried back or forward for one year at the corporation's election. c. May be carried forward to a maximum of five succeeding years. d. May be carried back to the third preceding year. CPA-02050 Explanation Choice "c" is correct.

Rule: A corporate charitable deduction that exceeds the limit for deduction in one year can be carried over to the succeeding five tax years. It cannot be carried back.

Choices "a", "b", and "d" are incorrect, per the above rule. CPA-02052 Type1 M/C A-D Corr Ans: B PM R 3-01

25. CPA-02052 ARE Nov 95 #10 Page 6

In 1994, Stewart Corp. properly accrued $5,000 for an income item on the basis of a reasonable estimate. In 1995, after filing its 1994 federal income tax return, Stewart determined that the exact amount was $6,000. Which of the following statements is correct? a. No further inclusion of income is required as the difference is less than 25% of the original

amount reported and the estimate had been made in good faith. b. The $1,000 difference is includible in Stewart's 1995 income tax return. c. Stewart is required to notify the IRS within 30 days of the determination of the exact amount

of the item. d. Stewart is required to file an amended return to report the additional $1,000 of income. CPA-02052 Explanation Choice "b" is correct. Under these facts the estimate was accurate based on information available when the return was filed. When the exact amount is known, the difference is included in income in the year the amount is received or the exact amount is determined.

Choice "a" is incorrect. The income must be reported despite the good-faith error in estimate.


13

Choice "c" is incorrect. There is no need to notify the IRS of the error.

Choice "d" is incorrect. An amended return is not filed. Stewart based the estimate on information known at the time. CPA-02053 Type1 M/C A-D Corr Ans: D PM R 3-01

26. CPA-02053 ARE May 95 #2 (Adapted) Page 27

Browne, a self-employed taxpayer, had 2004 business net income of $100,000 prior to any expense deduction for equipment purchases. In 2004, Browne purchased and placed into service, for business use, office machinery (5-year MACRS property) costing $30,000. This was Browne's only 2004 capital expenditure. Browne's business establishment was not in an economically distressed area. Brown elected to not take the additional 50% first year depreciation. Browne made a proper and timely expense election to deduct the maximum amount under code Sec. 179. Browne was not a member of any pass through entity. What is Browne's deduction under the election?

a. $6,000 b. $10,000 c. $25,000 d. $30,000 CPA-02053 Explanation Choice "d" is correct. A taxpayer who spends less than $410,000 on equipment can deduct the cost of equipment purchases up to a maximum of $102,000 per tax year in 2004. The deduction is limited to the amount that will reduce taxable income to zero. Since Brown's net income is greater than the $30,000 allowable deduction, the limitation does not apply.

Choice "a" is incorrect. Under Section 179 of the Internal Revenue Code, a taxpayer may elect to deduct a limited amount of the cost of property purchased for use in a trade or business. This deductible amount may be greater than the depreciation otherwise allowable under MACRS.

Choice "b" is incorrect. $10,000 was the limitation on Section 179 deductions for tax years prior to 1993.

Choice "c" is incorrect. The limitation is $102,000 for 2004. CPA-02054 Type1 M/C A-D Corr Ans: A PM R 3-01

27. CPA-02054 ARE Nov 95 #12 Page 39

Kane Corp. is a calendar year domestic personal holding company. Which deduction(s) must Kane make from 1994 taxable income to determine undistributed personal holding company income prior to the dividend-paid deduction? Net long-term capital gain Federal less related income taxes federal income taxes a. Yes Yes b. Yes No c. No Yes d No No CPA-02054 Explanation Choice "a" is correct. A personal holding company deducts federal income taxes in computing undistributed personal holding company income. A personal holding company deducts net long-term capital gain less related federal income taxes in computing undistributed personal holding company income.


14

Choices "b", "c", and "d" are incorrect, per the above explanation. CPA-02057 Type1 M/C A-D Corr Ans: D PM R 3-01

28. CPA-02057 ARE Nov 95 #13 Page 25

Bank Corp. owns 80% of Shore Corp.'s outstanding capital stock. Shore's capital stock consists of 50,000 shares of common stock issued and outstanding. Shore's 1994 net income was $140,000. During 1994, Shore declared and paid dividends of $60,000. In conformity with generally accepted accounting principles, Bank recorded the following entries in 1994: Debit Credit Investment in Shore Corp. common stock $112,000

Equity in earnings of subsidiary $112,000

Cash 48,000 Investment in Shore Corp. common stock 48,000

In its 1994 consolidated tax return, Bank should report dividend revenue of: a. $48,000 b. $14,400 c. $9,600 d. $0 CPA-02057 Explanation Choice "d" is correct. In filing a consolidated federal income tax return, a corporate group eliminates the dividends from group members. Shore would have to be included in Bank's group consolidated income tax return because Bank owns 80% of Shore.

Choices "a", "b", and "c" are incorrect, per the above explanation. CPA-02058 Type1 M/C A-D Corr Ans: D PM CQ #11 R 3-01

29. CPA-02058 ARE May 95 #5 Page 27

On August 1, 1994, Graham purchased and placed into service an office building costing $264,000 including $30,000 for the land. What was Graham's MACRS deduction for the office building in 1994? a. $9,600 b. $6,000 c. $3,600 d. $2,250 CPA-02058 Explanation Choice "d" is correct. Only the building is depreciable, so the depreciable portion is $264,000 less $30,000 land, for a net of $234,000. The MACRS rules provide a 39-year life, straight-line depreciation, and a "mid-month" acquisition convention that treats the property as acquired in the middle of the month, regardless of the actual date of acquisition. Therefore, the August 1, 1994, service date provides a half-month's depreciation for August, plus a full month for September through December, for a total of 4.5 months for 1994. ($234,000/39 years) × (4.5/12) = $2,250.

Choice "a" is incorrect. The recovery period for nonresidential real property is 39 years and the mid-month convention is used. The building is treated as if acquired in the middle of the month, regardless of the actual date of acquisition. Depreciation may only be taken for the months after the building was placed in service.

Choice "b" is incorrect. The mid-month convention is used for real property. The building is treated as if acquired in the middle of the month, regardless of the actual date of acquisition. Depreciation may only be taken for the months after the building was placed in service.

Choice "c" is incorrect. The recovery period for nonresidential real property is 39 years.


15


30. CPA-02059 ARE Nov 94 #39 Page 27

How is the depreciation deduction of nonresidential real property, placed in service in 1994, determined for regular tax purposes using MACRS?

a. Straight-line method over 40 years. b. 150% declining-balance method with a switch to the straight-line method over 27.5 years. c. 150% declining-balance method with a switch to the straight-line method over 39 years. d. Straight-line method over 39 years. CPA-02059 Explanation Choice "d" is correct. Nonresidential realty is depreciated over 39 years straight-line if placed in service after May 1993.


31. CPA-02060 ARE Nov 95 #14 Page 37

Dart Corp., a calendar year domestic C corporation, is not a personal holding company. For purposes of the accumulated earnings tax, Dart has accumulated taxable income for 1994. Which step(s) can Dart take to eliminate or reduce any 1994 accumulated earnings tax? I. Demonstrate that the "reasonable needs" of its business require the retention of all or part of

the 1994 accumulated taxable income. II. Pay dividends by March 15, 1995. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-02060 Explanation Choice "c" is correct. Dart can take both actions to eliminate or reduce any 1994 accumulated earnings tax. A corporation that can demonstrate its reasonable business needs require it to accumulate earnings can escape the accumulated earnings tax on the portion reasonably accumulated. Dividends paid by the 15th day of the third month after the close of the corporation's tax year reduce the accumulated earnings subject to the accumulated earnings tax.

Choices "a", "b", and "d" are incorrect. Each of these answers treats either I or II (or both) incorrectly. CPA-02061 Type1 M/C A-D Corr Ans: D PM R 3-01

32. CPA-02061 PII Nov 92 #17 Page 28

Platt owns land that is operated as a parking lot. A shed was erected on the lot for the related transactions with customers. With regard to capital assets and Section 1231 assets, how should these assets be classified? Land Shed a. Capital Capital b. Section 1231 Capital c. Capital Section 1231 d. Section 1231 Section 1231 CPA-02061 Explanation


16

Choice "d" is correct. Because the parking lot and the shed constitute real estate and depreciable assets used in a trade or business, they are not capital assets per the definition below.

Note: The parking lot and shed will fall under Section 1231 (provided they are used in the business over 12 months) and possibly Section 1250 and 1245, respectively, upon sale of the assets.

Capital assets are defined as all property held by the taxpayer except:

1. Property normally included in inventory or held for sale to customers in the ordinary course of business.

2. Depreciable property and real estate used in business. 3. Accounts and notes receivable arising from sales or services in the taxpayer’s business. 4. Copyrights, literary, musical or artistic compositions. 5. Treasury stock. CPA-02062 Type1 M/C A-D Corr Ans: A PM R 3-01

33. CPA-02062 ARE Nov 95 #15 Page 36

Eastern Corp., a calendar year corporation, was formed January 3, 1994, and on that date placed five-year property in service. The property was depreciated under the general MACRS system. Eastern did not elect to use the straight-line method. The following information pertains to Eastern:

Eastern's 1994 taxable income $300,000 Adjustment for the accelerated depreciation taken on 1994 five-year property 1,000 1994 tax-exempt interest from specified private activity bonds issued after August 7, 1986 5,000

What was Eastern's 1994 alternative minimum taxable income before the adjusted current earnings (ACE) adjustment? a. $306,000 b. $305,000 c. $304,000 d. $301,000 CPA-02062 Explanation Choice "a" is correct. Eastern's alternative minimum taxable income before the ACE adjustment (and ignoring the exemption allowable) is $306,000:

Taxable income $300,000 Adjustment for regular tax accelerated depreciation 1,000 Tax preference for private activity bond interest 5,000 AMTI $306,000

Choices "b", "c", and "d" are incorrect. Both the adjustment for accelerated depreciation and the preference for private activity bond interest are addbacks to taxable income to arrive at AMTI. CPA-02064 Type1 M/C A-D Corr Ans: D PM R 3-01

34. CPA-02064 ARE Nov 95 #16 Page 32

A civil fraud penalty can be imposed on a corporation that underpays tax by: a. Omitting income as a result of inadequate recordkeeping. b. Failing to report income it erroneously considered not to be part of corporate profits. c. Filing an incomplete return with an appended statement, making clear that the return is

incomplete.


17

d. Maintaining false records and reporting fictitious transactions to minimize corporate tax liability.

CPA-02064 Explanation Choice "d" is correct. Imposition of the civil fraud penalty requires conduct that transcends negligence or stupidity. Maintaining false records and reporting fictitious transactions is adequate to demonstrate civil fraud, a willful and deliberate attempt to evade taxes.

Choice "a" is incorrect. Negligence such as omitting income as a result of inadequate recordkeeping will support a penalty, but not the civil fraud penalty.

Choice "b" is incorrect. Failing to report income erroneously considered not to be part of corporate profits will support a penalty, but not the civil fraud penalty.

Choice "c" is incorrect. Filing an incomplete tax return will support a penalty, but not the civil fraud penalty. CPA-02066 Type1 M/C A-D Corr Ans: B PM R 3-01

35. CPA-02066 ARE Nov 95 #17 Page 6

A corporation may reduce its regular income tax by taking a tax credit for: a. Dividends-received exclusion. b. Foreign income taxes. c. State income taxes. d. Accelerated depreciation. CPA-02066 Explanation Choice "b" is correct. Under certain conditions a taxpayer may take a credit against its U.S. income tax for foreign income taxes paid.

Choice "a" is incorrect. The dividends-received deduction (not exclusion) reduces taxable income; it is not a tax credit.

Choice "c" is incorrect. State income taxes reduce taxable income; they are not tax credits.

Choice "d" is incorrect. Accelerated depreciation reduces taxable income; it is not a tax credit. CPA-02068 Type1 M/C A-D Corr Ans: D PM R 3-01

36. CPA-02068 ARE Nov 95 #18 Page 37

The accumulated earnings tax can be imposed: a. On both partnerships and corporations. b. On companies that make distributions in excess of accumulated earnings. c. On personal holding companies. d. Regardless of the number of stockholders in a corporation. CPA-02068 Explanation Choice "d" is correct. The imposition of the accumulated earnings tax does not depend on the number of shareholders a corporation has.

Choice "a" is incorrect. Partnerships are not liable for the accumulated earnings tax, but most corporations are potentially liable.

Choice "b" is incorrect. Corporations that make distributions in excess of accumulated earnings are not liable for the accumulated earnings tax. There would be no accumulated earnings left to tax.

Choice "c" is incorrect. Personal holding companies are not liable for the accumulated earnings tax.


18


37. CPA-02070 ARE Nov 95 #19 Page 39

The following information pertains to Dahl Corp.: Accumulated earnings and profits at January 1, 1994 $120,000 Earnings and profits for the year ended December 31, 1994 160,000 Cash distributions to individual stockholders during 1994 360,000

What is the total amount of distributions taxable as dividend income to Dahl's stockholders in 1994? a. $0 b. $160,000 c. $280,000 d. $360,000 CPA-02070 Explanation Choice "c" is correct. Distributions out of the sum of current and accumulated earnings and profits are taxable as dividends to the recipients.

Accumulated E&P at 1/1/94 $ 120,000 Earnings in 1994 160,000 Taxable dividends to recipients $ 280,000 Excess distributed 80,000 Total distributed $ 360,000

Any excess reduces the shareholder's basis in Dahl stock, and any amount beyond that required to reduce the shareholder's basis to zero is treated as received on the sale or exchange of the stock and is capital gain.

Choice "a", "b", and "d" are incorrect, per the above calculation and explanation. CPA-02073 Type1 M/C A-D Corr Ans: C PM R 3-01

38. CPA-02073 ARE Nov 95 #20 Page 39

Ridge Corp., a calendar year C corporation, made a nonliquidating cash distribution to its shareholders of $1,000,000 with respect to its stock. At that time, Ridge's current and accumulated earnings and profits totaled $750,000 and its total paid-in capital for tax purposes was $10,000,000. Ridge had no corporate shareholders. Ridge's cash distribution: I. Was taxable as $750,000 in ordinary income to its shareholders. II. Reduced its shareholders' adjusted bases in Ridge stock by $250,000.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-02073 Explanation Choice "c" is correct. Distributions out of current and accumulated earnings and profits are taxable as ordinary income dividends to non-corporate shareholders.

Any distribution from a corporation that exceeds its earnings and profits reduces its shareholders' basis in their shares by the amount of the excess; any amount beyond that required to reduce the basis to zero is treated as received on the sale or exchange of the stock and is capital gain. Assuming all of Ridge's shareholders had enough basis to absorb their proportionate part of the $250,000 excess over the distribution of earnings and profits, it would all be treated as a reduction of shareholder's basis.

Choices "a", "b", and "d" are incorrect. Each of the theses addresses I and/or II incorrectly.


19


39. CPA-02075 ARE Nov 95 #21 Page 4

Clark and Hunt organized Jet Corp. with authorized voting common stock of $400,000. Clark contributed $60,000 cash. Both Clark and Hunt transferred other property in exchange for Jet stock as follows: Other property Fair Percentage Adjusted market of Jet stock basis value acquired Clark $ 50,000 $100,000 40% Hunt 120,000 240,000 60%

What was Clark's basis in Jet stock? a. $0 b. $100,000 c. $110,000 d. $160,000 CPA-02075 Explanation Choice "c" is correct. The formation of a corporation under these conditions is a nontaxable event. Clark's basis will be the $60,000 cash he contributed plus the $50,000 adjusted basis of the non-cash property for a total of $110,000.

Choice "a" is incorrect. Clark contributed both cash and property. Thus, Clark's basis in Jet's stock is greater than zero.

Choice "b" is incorrect. The amount of cash that Clark contributed must also be considered in determining Clark's basis in Jet stock.

Choice "d" is incorrect. When property is contributed to form a corporation, it is contributed at its adjusted basis, not at its fair market value. CPA-02081 Type1 M/C A-D Corr Ans: A PM CQ #19 R 3-01

40. CPA-02081 ARE Nov 95 #22 Page 43

Ace Corp. and Bate Corp. combine in a qualifying reorganization and form Carr Corp., the only surviving corporation. This reorganization is tax-free to the: Shareholders Corporations a. Yes Yes b. Yes No c. No Yes d. No No CPA-02081 Explanation Choice "a" is correct. Rule: A qualifying corporate reorganization is tax-free to all corporations involved and to all their shareholders.

Choices "b", "c", and "d" are incorrect, per the above rule. CPA-02083 Type1 M/C A-D Corr Ans: C PM R 3-01

41. CPA-02083 ARE Nov 95 #23 Page 32

Bass Corp., a calendar year C corporation, made qualifying 1994 estimated tax deposits based on its actual 1993 tax liability. On March 15, 1995, Bass flied a timely automatic extension request for its 1994 corporate income tax return. Estimated tax deposits and the extension payment totaled $7,600. This amount was 95% of the total tax shown on Bass' final 1994


20

corporate income tax return. Bass paid $400 additional tax on the final 1994 corporate income tax return filed before the extended due date. For the 1994 calendar year, Bass was subject to pay:

I. Interest on the $400 tax payment made in 1995. II. A tax delinquency penalty.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-02083 Explanation Choice "c" is correct. A taxpayer does not extend the time for payment of tax by extending the filing deadline for the return. If there is tax owed when the return is filed, interest must be paid at the rate prescribed by IRC §6621. There is no delinquency penalty if the payments made by the due date of the return are 100% of the tax shown on the return when filed.

Choices "a", "b", and "d" are incorrect, per the above discussion. CPA-02085 Type1 M/C A-D Corr Ans: B PM CQ #12 R 3-01

42. CPA-02085 ARE Nov 95 #24 Page 32

Edge Corp., a calendar year C corporation, had a net operating loss and zero tax liability for its 1994 tax year. To avoid the penalty for underpayment of estimated taxes, Edge could compute its first quarter 1995 estimated income tax payment using the: Annualized Preceding income method year method a. Yes Yes b. Yes No c. No Yes d. No No CPA-02085 Explanation Choice "b" is correct. Edge should use the annualized income method for calculating its estimated tax payments. Edge cannot use the preceding year method because it did not have an income tax liability in the preceding taxable year.

Choices "a", "c", and "d" are incorrect, per the above discussion. CPA-02087 Type1 M/C A-D Corr Ans: B PM R 3-01

43. CPA-02087 ARE Nov 95 #25 Page 32

A corporation's tax year can be reopened after all statutes of limitations have expired if: I. The tax return has a 50% nonfraudulent omission from gross income. II. The corporation prevails in a determination allowing a deduction in an open tax year that was

taken erroneously in a closed tax year.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-02087 Explanation Choice "b" is correct. If the prior omission was nonfraudulent, the statute of limitations cannot be reopened after it has expired.

To mitigate the unfair effects of the statute of limitations in some rare cases, it can be reopened to avoid hardship for the taxpayer or the IRS. In the case in which an item is ruled deductible in a


21

subsequent year after having been taken in a year now closed by the statute of limitations, the IRS will reopen the statute of limitations to disallow the deduction in the previous year.

Choices "a", "c", and "d" are incorrect. Each of these answers incorrectly addresses I and/or II. CPA-02090 Type1 M/C A-D Corr Ans: B PM CQ #14 R 3-01

44. CPA-02090 ARE May 95 #23 Page 39

Edge Corp. met the stock ownership requirements of a personal holding company. What sources of income must Edge consider to determine if the income requirements for a personal holding company have been met? I. Interest earned on tax-exempt obligations. II. Dividends received from an unrelated domestic corporation.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-02090 Explanation Choice "b" is correct.

I. Interest is normally included in personal holding company income, but only if it is included in the receiving corporation's gross income. Since interest income from tax-exempt obligations is not included in gross income, it is not personal holding company income.

II. Dividend income from unrelated domestic corporations is personal holding company income.

Choices "a", "c", and "d" are incorrect. Each of these answers treats I or II incorrectly. CPA-02092 Type1 M/C A-D Corr Ans: D PM R 3-01

45. CPA-02092 ARE May 95 #24 Page 40

Kent Corp. is a calendar year, accrual basis C corporation. In 2004, Kent made a nonliquidating distribution of property with an adjusted basis of $150,000 and a fair market value of $200,000 to Reed, its sole shareholder. The following information pertains to Kent: Reed's basis in Kent stock at January 1, 2004 $500,000 Accumulated earnings and profits at January 1, 2004 125,000 Current earnings and profits for 2004 (from operations) 60,000 What was taxable as dividend income to Reed for 2004? a. $60,000 b. $150,000 c. $185,000 d. $200,000 CPA-02092 Explanation Choice "d" is correct. A dividend paid in property other than money is taxable to an individual taxpayer to the extent of the property's fair market value, but not in excess of the current and accumulated earnings and profits of the distributing corporation. In this case the fair market value of the dividend is $200,000. It is taxable to the extent that Kent had current earnings ($60,000) plus accumulated earnings and profits ($125,000) plus any gain generated on the distribution itself ($50,000); thus the dividend is taxable to the extent of $200,000.

Choice "a" is incorrect. The maximum taxable amount of a property dividend is equal to the sum of both current earnings and accumulated earnings (plus any gain to the corporation on the distribution itself).

Choice "b" is incorrect. A dividend paid in property other than money is taxable to an individual taxpayer to the extent of the property's fair market value (not its basis). However, the taxable


22

dividend amount is no more than the current and accumulated earnings and profits of the distributing corporation (plus any gain to the corporation on the distribution itself).

Choice "c" is incorrect. This answer did not take into account the gain generated on the distribution of the appreciated property. CPA-02095 Type1 M/C A-D Corr Ans: B PM R 3-01

46. CPA-02095 ARE May 95 #25 Page 43

Jaxson Corp. has 200,000 shares of voting common stock issued and outstanding. King Corp. has decided to acquire 90 percent of Jaxson's voting common stock solely in exchange for 50 percent of its voting common stock and retain Jaxson as a subsidiary after the transaction. Which of the following statements is true? a. King must acquire 100 percent of Jaxson stock for the transaction to be a tax-free

reorganization. b. The transaction will qualify as a tax-free reorganization. c. King must issue at least 60 percent of its voting common stock for the transaction to qualify

as a tax-free reorganization. d. Jaxson must surrender assets for the transaction to qualify as a tax-free reorganization. CPA-02095 Explanation Choice "b" is correct. The acquisition of a controlling (usually 80%) interest by one corporation in the stock of another corporation solely for stock is a tax-free (Type B) reorganization.

Choice "a" is incorrect. King need not acquire 100% of Jaxson's stock, just a controlling interest.

Choice "c" is incorrect. There is no specific amount of acquiring corporation stock that must be issued in a tax-free reorganization; the acquiring corporation must acquire 80% or more of the target's stock, however.

Choice "d" is incorrect. There is no requirement that Jaxson surrender assets for the reorganization to qualify as tax-free. CPA-02096 Type1 M/C A-D Corr Ans: B PM R 3-01

47. CPA-02096 ARE Nov 94 #31 Page 19

Banks Corp., a calendar year corporation, reimburses employees for properly substantiated qualifying business meal expenses. The employees are present at the meals, which are neither lavish nor extravagant, and the reimbursement is not treated as wages subject to withholdings. For 1994, what percentage of the meal expense may Banks deduct? a. 0% b. 50% c. 80% d. 100% CPA-02096 Explanation Choice "b" is correct. Only 50% of business meal and entertainment expense is deductible.

Choice "a", "c", and "d" are incorrect. Each of these is an incorrect percentage. CPA-02099 Type1 M/C A-D Corr Ans: C PM R 3-01

48. CPA-02099 ARE Nov 94 #32 Page 25

For the year ended December 31, 1993, Kelly Corp. had net income per books of $300,000 before the provision for Federal income taxes. Included in the net income were the following items: Dividend income from an unaffiliated domestic taxable corporation (taxable

income limitation does not apply and there is no portfolio indebtedness) $50,000


23

Bad debt expense (represents the increase in the allowance for doubtful accounts) 80,000 Assuming no bad debt was written off, what is Kelly's taxable income for the year ended December 31, 1993? a. $250,000 b. $330,000 c. $345,000 d. $380,000 CPA-02099 Explanation Choice "c" is correct.

Book net income $300,000 Nondeductible bad debt expense 80,000 Dividends received deduction (35,000) $345,000

Choice "a" is incorrect. The bad debt expense taken on the allowance method is disallowed. For tax purposes, the corporation must use the direct write-off method. In addition, Kelly Corp. is allowed a 70% dividends received deduction.

Choice "b" is incorrect. Only 70% of the DRD is allowed as a deduction.

Choice "d" is incorrect. Kelly Corp. is allowed a 70% DRD. CPA-02101 Type1 M/C A-D Corr Ans: B PM CQ #8 R 3-01

49. CPA-02101 ARE Nov 94 #33 (Adapted) Page 19

For the year ended December 31, 2004, Taylor Corp. had a net operating loss of $200,000. Taxable income for the earlier years of corporate existence, computed without reference to the net operating loss, was as follows: Taxable income 1999 $5,000 2000 $10,000 2001 $20,000 2002 $30,000 2003 $40,000 What amount of net operating loss will be available to Taylor for the year ended December 31, 2005? a. $200,000 b. $130,000 c. $110,000 d. $95,000 CPA-02101 Explanation Choice "b" is correct. 2002 - 2003, Taylor will carry its NOL back two years and forward until it is used (but not more than 20 years). Carrying the NOL back to 2002 - 2003 absorbs $70,000 of the $200,000 NOL generated in 2004 leaving $130,000 to be absorbed in 2005 and later years.

Choice "a" is incorrect. Taylor does not waive the two year carryback, therefore the NOL will carry back to the second preceding tax year.

Choice "c" is incorrect. The NOL carryback goes first to the second preceding tax year (2002), not the third preceding year (2001).

Choice "d" is incorrect. The NOL carryback goes first to the second preceding tax year (2002), not the fifth preceding year (1999). CPA-02106 Type1 M/C A-D Corr Ans: B PM CQ #4 R 3-01


24

50. CPA-02106 ARE Nov 94 #36 Page 15

Axis Corp. is an accrual basis calendar year corporation. On December 13, 1993, the Board of Directors declared a two percent of profits bonus to all employees for services rendered during 1993 and notified them in writing. None of the employees own stock in Axis. The amount represents reasonable compensation for services rendered and was paid on March 13, 1994. Axis' bonus expense may: a. Not be deducted on Axis' 1993 tax return because the per share employee amount cannot be

determined with reasonable accuracy at the time of the declaration of the bonus. b. Be deducted on Axis' 1993 tax return. c. Be deducted on Axis' 1994 tax return. d. Not be deducted on Axis' tax return because payment is a disguised dividend. CPA-02106 Explanation Choice "b" is correct. The deduction is an ordinary and necessary business expense treated just as any other compensation expense is treated. Axis is an accrual basis taxpayer, and the deduction is taken on the return for the year in which the expense accrued.

Choice "a" is incorrect. The bonus was declared 11 ½ months into the taxable year, so the amount, while not precisely known, could be determined with reasonable accuracy.

Choice "c" is incorrect. The deduction accrued is in 1993 and is taken on the 1993 return. An accrual-basis taxpayer deducts expenses in the year in which they accrue, not the year in which they are paid.

Choice "d" is incorrect. Since none of the recipient employees are shareholders of Axis, the bonus will not be a disguised dividend. CPA-02109 Type1 M/C A-D Corr Ans: D PM R 3-01

51. CPA-02109 ARE Nov 94 #37 Page 16

Tapper Corp., an accrual basis calendar year corporation, was organized on January 2, 1993. During 1993, revenue was exclusively from sales proceeds and interest income. The following information pertains to Tapper: Taxable income before charitable contributions for the year ended December 31, 1993 $500,000 Tapper's matching contribution to employee- designated qualified universities made during 1993 10,000 Board of Directors' authorized contribution to a qualified charity (authorized December 1, 1993, made February 1, 1994) 30,000

What is the maximum allowable deduction that Tapper may take as a charitable contribution on its tax return for the year ended December 31, 1993? a. $0 b. $10,000 c. $30,000 d. $40,000 CPA-02109 Explanation Choice "d" is correct. Tapper's college matching contributions are deductible; Tapper made the contributions; the employees merely directed the proceeds. The Board's authorized contribution is also deductible since it satisfies the two rules under which an accrual-basis corporation can deduct an accrued contribution: 1) it was authorized to a qualified charity by board resolution before the end of the taxable year and 2) it was paid by the 15th day of the 3rd month after the end of the taxable year of accrual.


25

Choices "a", "b", and "c" are incorrect. Based on the above explanation, both items are allowable as charitable contributions. CPA-02111 Type1 M/C A-D Corr Ans: C PM R 3-01

52. CPA-02111 ARE Nov 94 #38 Page 17

Which of the following costs are amortizable organizational expenditures? a. Professional fees to issue the corporate stock. b. Printing costs to issue the corporate stock. c. Legal fees for drafting the corporate charter. d. Commissions paid by the corporation to an underwriter. CPA-02111 Explanation Choice "c" is correct. The costs of organizing the corporation are amortizable, but the costs of selling stock are not. The only expense listed that qualifies for amortization is the legal fees for drafting the corporate charter; the others relate to the sale of stock.

Choices "a", "b", and "d" are incorrect. These are expenses of selling the corporation's stock and are not a cost of organizing the corporation and therefore cannot be amortized. CPA-02112 Type1 M/C A-D Corr Ans: A PM R 3-01

53. CPA-02112 ARE Nov 94 #46 Page 34

With regard to consolidated tax returns, which of the following statements is correct? a. Operating losses of one group member may be used to offset operating profits of the other

members included in the consolidated return. b. Only corporations that issue their audited financial statements on a consolidated basis may

file consolidated returns. c. Of all intercompany dividends paid by the subsidiaries to the parent, 70% are excludible from

taxable income on the consolidated return. d. The common parent must directly own 51% or more of the total voting power of all

corporations included in the consolidated return. CPA-02112 Explanation Choice "a" is correct. A significant advantage of consolidated tax returns is the ability to offset gains and losses among group members as if they were a single taxpayer.

Choice "b" is incorrect. Corporations need not have audited financial statements to file a consolidated tax return.

Choice "c" is incorrect. 100% of dividends received by the parent are eliminated on a consolidated tax return.

Choice "d" is incorrect. The common parent must own directly or indirectly 80% of the total voting power of all corporations included in the consolidated tax return. CPA-02114 Type1 M/C A-D Corr Ans: A PM R 3-01

54. CPA-02114 ARE Nov 94 #47 Page 34

In the filing of a consolidated tax return for a corporation and its wholly owned subsidiaries, intercompany dividends between the parent and subsidiary corporations are: a. Not taxable. b. Included in taxable income to the extent of 20%. c. Included in taxable income to the extent of 80%. d. Fully taxable. CPA-02114 Explanation


26

Choice "a" is correct. Dividends received from other group members are eliminated from the parent's taxable income in consolidation; no dividends received deduction is allowed. Since the parent eliminates the subsidiary dividends in consolidation, they are effectively not taxable.

Choices "b", "c", and "d" are incorrect. The regulations require elimination of intercompany dividends in consolidation. CPA-02115 Type1 M/C A-D Corr Ans: A PM R 3-01

55. CPA-02115 ARE Nov 94 #48 Page 19

A corporation's penalty for underpaying federal estimated taxes is: a. Not deductible. b. Fully deductible in the year paid. c. Fully deductible if reasonable cause can be established for the underpayment. d. Partially deductible. CPA-02115 Explanation Choice "a" is correct.

Rule: The penalty for underpayment of federal estimated taxes is not deductible.

Choices "b", "c", and "d" are incorrect, per the above rule. CPA-02117 Type1 M/C A-D Corr Ans: A PM R 3-01

56. CPA-02117 ARE Nov 94 #49 Page 20

Which of the following credits is a combination of several tax credits to provide uniform rules for the current and carryback-carryover years? a. General business credit. b. Foreign tax credit. c. Minimum tax credit. d. Enhanced oil recovery credit. CPA-02117 Explanation Choice "a" is correct. The general business credit combines several nonrefundable tax credits and provides rules for their absorption against the taxpayer's liability.

Choice "b" is incorrect. The foreign tax credit does not combine more than one credit.

Choice "c" is incorrect. The minimum tax credit does not combine more than one credit.

Choice "d" is incorrect. The enhanced oil recovery credit does not combine more than one credit. CPA-02119 Type1 M/C A-D Corr Ans: C PM R 3-01

57. CPA-02119 ARE Nov 94 #50 Page 32

Blink Corp., an accrual basis calendar year corporation, carried back a net operating loss for the tax year ended December 31, 1993. Blink's gross revenues have been under $500,000 since inception. Blink expects to have profits for the tax year ending December 31, 1994. Which method(s) of estimated tax payment can Blink use for its quarterly payments during the 1994 tax year to avoid underpayment of federal estimated taxes? I. 100% of the preceding tax year method. II. Annualized income method.

a. I only. b. Both I and II. c. II only. d. Neither I nor II.


27

CPA-02119 Explanation Choice "c" is correct. Blink cannot use the 100% of preceding-year method in 1994 because it did not pay income tax in 1993. Blink can use the annualized income method.

Choices "a", "b", and "d" are incorrect. Each of these answers treats I and/or II incorrectly. CPA-02120 Type1 M/C A-D Corr Ans: C PM CQ #16 R 3-01

58. CPA-02120 ARE Nov 94 #51 Page 41

Tank Corp., which had earnings and profits of $500,000, made a nonliquidating distribution of property to its shareholders in 1993 as a dividend in kind. This property, which had an adjusted basis of $20,000 and a fair market value of $30,000 at the date of distribution, did not constitute assets used in the active conduct of Tank's business. How much gain did Tank recognize on this distribution? a. $30,000 b. $20,000 c. $10,000 d. $0 CPA-02120 Explanation Choice "c" is correct. The property distributed by Tank is treated as if it were sold to the shareholder at its fair market value on the date of distribution. Tank recognizes gain to the extent of the fair market value ($30,000) over the adjusted basis ($20,000) or $10,000.

Choice "a" is incorrect. Gain is computed as the difference between the FMV and adjusted basis of the property.

Choice "b" is incorrect. Gain is not equal to the adjusted basis of the property.

Choice "d" is incorrect. Gain is recognized. CPA-02122 Type1 M/C A-D Corr Ans: C PM R 3-01

59. CPA-02122 ARE Nov 94 #53 Page 43

In a type B reorganization, as defined by the Internal Revenue Code, the: I. Stock of the target corporation is acquired solely for the voting stock of either the acquiring

corporation or its parent. II. Acquiring corporation must have control of the target corporation immediately after the

acquisition. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-02122 Explanation Choice "c" is correct. Both requirements listed are necessary in a Type B reorganization. In a Type B reorganization the target is acquired using the stock of the acquiring corporation or the acquiring corporation's parent (triangular acquisition). In a Type B reorganization the acquiring corporation must be in control of the target immediately after the acquisition.

Choices "a", "b", and "d" are incorrect. Each of these answers treats I or II incorrectly. CPA-02124 Type1 M/C A-D Corr Ans: C PM R 3-01

60. CPA-02124 ARE Nov 94 #54 Page 32

Jackson Corp., a calendar year corporation, mailed its 1993 tax return to the Internal Revenue Service by certified mail on Friday, March 11, 1994. The return, postmarked March 11, 1994,


28

was delivered to the Internal Revenue Service on March 18, 1994. The statute of limitations (for assessments) on Jackson's corporate tax return begins on: a. December 31, 1993. b. March 11, 1994. c. March 16, 1994. d. March 18, 1994. CPA-02124 Explanation Choice "c" is correct. The 1993 return of a calendar year corporation is due on March 15, 1994, so the statute of limitations begins on the next day, March 16, 1994. Rule: The statute of limitations for assessments runs from the date of the filing of the return, or, if later, the due date of the return.

Choices "a", "b", and "d" are incorrect, per the above rule. CPA-02126 Type1 M/C A-D Corr Ans: D PM R 3-01

61. CPA-02126 ARE May 94 #23 Page 34

Tech Corp. files a consolidated return with its wholly-owned subsidiary, Dow Corp. During 1993, Dow paid a cash dividend of $20,000 to Tech. What amount of this dividend is taxable on the 1993 consolidated return? a. $20,000 b. $14,000 c. $6,000 d. $0 CPA-02126 Explanation Choice "d" is correct. Intercompany dividends are eliminated when preparing a consolidated return. The $20,000 came from income of Dow and is reported as part of consolidated income. The receipt of the dividend by Tech is not included again.

Choice "a" is incorrect. As the two corporations file a consolidated return, 100% of the dividends are eliminated, not taxable.

Choice "b" is incorrect. This answer is 70% of the $20,000 dividend. 100% of the dividend is eliminated when a consolidated return is filed.

Choice "c" is incorrect. This answer is 30% of the $20,000 dividend. 100% is eliminated upon consolidation. This answer assumes Tech is entitled to a 70% dividend received deduction. CPA-02128 Type1 M/C A-D Corr Ans: B PM R 3-01

62. CPA-02128 ARE May 94 #24 Page 22

Kisco Corp.'s taxable income for 1993 before taking the dividends received deduction was $70,000. This includes $10,000 in dividends from an unrelated taxable domestic corporation. Given the following tax rates, what would Kisco's income tax be before any credits? Tax Partial rate table rate Up to $50,000 15% Over $50,000 but not over $75,000 25% a. $10,000 b. $10,750 c. $12,500 d. $15,750 CPA-02128 Explanation Choice "b" is correct. The $10,000 dividend is from an unrelated corporation. This means less than 20% of the company is owned. A 70% dividends received deduction is available.


29

Taxable income $ 70,000 Less: Dividends received deduction (70% × 10,000) (7,000) Taxable income $ 63,000 Income tax 15% × $50,000 $ 7,500 + [25% × ($63,000 − $50,000)] 3,250 $ 10,750

Choices "a", "c", and "d" are incorrect. The $10,000 dividend is from an unrelated corporation. [This means less than 20% of the company is owned. A 70% dividend received deduction is available.] CPA-02131 Type1 M/C A-D Corr Ans: C PM CQ #15 R 3-01

63. CPA-02131 ARE May 94 #25 Page 40

On January 1, 1993, Kee Corp., a C corporation, had a $50,000 deficit in earnings and profits. For 1993 Kee had current earnings and profits of $10,000 and made a $30,000 cash distribution to its stockholders. What amount of the distribution is taxable as dividend income to Kee's stockholders? a. $30,000 b. $20,000 c. $10,000 d. $0 CPA-02131 Explanation Choice "c" is correct. Taxable dividend income is paid out of the corporation's current or accumulated earnings and profits. Since Kee had a deficit, only current earnings of $10,000 are available for dividends.

Choice "a" is incorrect. Taxable dividend income is paid out of the corporation's current or accumulated earnings and profits, it is not based solely on the distributed property's fair market value (cash in this instance).

Choice "b" is incorrect. Taxable dividend income is paid out of the corporation's current or accumulated earnings and profits, it is not calculated as the difference between current E&P and the cash distributed.

Choice "d" is incorrect. Taxable dividend income is paid out of the corporation's current or accumulated earnings and profits. CPA-02134 Type1 M/C A-D Corr Ans: D PM R 3-01

64. CPA-02134 ARE May 94 #52 Page 3

Adams, Beck, and Carr organized Flexo Corp. with authorized voting common stock of $100,000. Adams received 10% of the capital stock in payment for the organizational services that he rendered for the benefit of the newly formed corporation. Adams did not contribute property to Flexo and was under no obligation to be paid by Beck or Carr. Beck and Carr transferred property in exchange for stock as follows: Fair Percentage of

Adjusted market Flexo stock basis value acquired

Beck 5,000 20,000 20% Carr 60,000 70,000 70%

What amount of gain did Carr recognize from this transaction? a. $40,000


30

b. $15,000 c. $10,000 d. $0 CPA-02134 Explanation Choice "d" is correct. Carr has no taxable income because he transferred appreciated property to Flexo in a transaction that qualifies as nontaxable.

Choices "a", "b", and "c" are incorrect. Beck and Carr have no taxable income because they transferred appreciated property to Flexo. However, Adams' contribution of services is not "property" for this purpose, so the receipt of stock is taxable. CPA-02136 Type1 M/C A-D Corr Ans: C PM R 3-01

65. CPA-02136 PII Nov 93 #41 Page 6

In 1992, Brun Corp. properly accrued $10,000 for an income item on the basis of a reasonable estimate. In 1993, Brun determined that the exact amount was $12,000. Which of the following statements is correct? a. Brun is required to file an amended return to report the additional $2,000 of income. b. Brun is required to notify the IRS within 30 days of the determination of the exact amount of

the item. c. The $2,000 difference is includible in Brun's 1993 income tax return. d. No further inclusion of income is required as the difference is less than 25% of the original

amount reported and the estimate had been made in good faith. CPA-02136 Explanation Choice "c" is correct. Under the accrual basis of accounting, when you include an amount in gross income on the basis of a reasonable estimate, and you later determine the exact amount, the difference (if any) is taken into account in the tax year in which the determination is made. Therefore, in this case, the additional $2,000 is included in Brun's 1993 income.

Choice "a" is incorrect. There is no requirement to file an amended return as a result of an inaccurate but reasonable estimate of income in a prior year.

Choice "b" is incorrect. There is no requirement to notify the IRS.

Choice "d" is incorrect. The additional $2,000 must be included in income in 1993. The 25% rule cited pertains to unintentional underreporting on income and its effect on the statute of limitations, increasing it from 3 to 6 years. CPA-02139 Type1 M/C A-D Corr Ans: A PM R 3-01

66. CPA-02139 PII Nov 93 #42 Page 25

In 19X2, Cape Co. reported book income of $140,000. Included in that amount was $50,000 for meals and entertainment expense and $40,000 for federal income tax expense. In Cape's Schedule M-1 of Form 1120, which reconciles book income and taxable income, what amount should be reported as taxable income? a. $205,000 b. $190,000 c. $150,000 d. $140,000 CPA-02139 Explanation Choice "a" is correct. The M-1 reconciliation of book income to taxable income would be as follows:

Book income $140,000 Federal income tax expense deductible from book income,

but not deductible for tax purposes + 40,000


31

180,000 50% × $50,000 meals and entertainment expenses not deductible for tax purposes,

but deductible from book income + 25,000 Taxable income $205,000

Choice "b" is incorrect. 50% of the $50,000 meals and entertainment expenses are disallowed for tax purposes.

Choice "c" is incorrect. The $40,000 federal income tax expense is not deductible for tax purposes.

Choice "d" is incorrect. The $40,000 federal income tax expense and 50% of the $50,000 meals and entertainment expenses are not deductible for tax purposes. CPA-02140 Type1 M/C A-D Corr Ans: D PM R 3-01

67. CPA-02140 PII Nov 93 #43 Page 32

When computing a corporation's income tax expense for estimated income tax purposes, which of the following should be taken into account? Corporate Alternative tax credits minimum tax a. No No b. No Yes c. Yes No d. Yes Yes CPA-02140 Explanation Choice "d" is correct. When computing a corporation's income tax expense for estimated income tax purposes, both corporate tax credits and the alternative minimum tax should be taken into account.

Choices "a", "b", and "c" are incorrect. Each of theses answers treats one of the above items incorrectly. CPA-02142 Type1 M/C A-D Corr Ans: D PM R 3-01

68. CPA-02142 PII Nov 93 #45 Page 3

Jones incorporated a sole proprietorship by exchanging all the proprietorship's assets for the stock of Nu Co., a new corporation. To qualify for tax-free incorporation, Jones must be in control of Nu immediately after the exchange. What percentage of Nu's stock must Jones own to qualify as "control" for this purpose? a. 50.00% b. 51.00% c. 66.67% d. 80.00% CPA-02142 Explanation Choice "d" is correct.

Rule: In a tax-free incorporation, the percentage for "control" is 80%, (i.e., control exists if the transferor/shareholder owns at least 80% of the total voting power and at least 80% of the total number of shares of all other classes of stock).

Choices "a", "b", and "c" are incorrect, per the above rule. CPA-02144 Type1 M/C A-D Corr Ans: A PM R 3-01

69. CPA-02144 PII Nov 93 #46 Page 42


32

A corporation was completely liquidated and dissolved during 19X2. The filing fees, professional fees, and other expenditures incurred in connection with the liquidation and dissolution are: a. Deductible in full by the dissolved corporation. b. Deductible by the shareholders and not by the corporation. c. Treated as capital losses by the corporation. d. Not deductible either by the corporation or shareholders. CPA-02144 Explanation Choice "a" is correct. The corporation generally deducts its liquidation expenses (i.e., filing fees, professional fees) from its final tax return.

Choice "b" is incorrect. These expenditures are deductible by the liquidating corporation, not its shareholders.

Choice "c" is incorrect. These expenditures are ordinary deductions, not capital losses.

Choice "d" is incorrect. These expenditures are deductible by the liquidating corporation, in its final tax return. CPA-02149 Type1 M/C A-D Corr Ans: C PM CQ #6 R 3-01

70. CPA-02149 PII May 93 #44 Page 17

Brown Corp., a calendar-year taxpayer, was organized and actively began operations on July 1, 2004, and incurred the following costs: Legal fees to obtain corporate charter $41,000 Commission paid to underwriter 25,000 Other stock issue costs 10,000

Brown wishes to amortize its organizational costs over the shortest period allowed for tax purposes. In 2004, what amount should Brown deduct for the amortization of organizational expenses? a. $1,200 b. $5,000 c. $6,200 d. $8,600 CPA-02149 Explanation Choice "c" is correct. Organizational costs are amortizable over a minimum period of 15 years (180 months). In addition, subject to a $50,000 total expenditure limitation, a $5,000 deduction is allowed in year one. Allowable costs in connection with the corporate organization are legal fees to obtain the corporate charter, necessary accounting services, expenses of temporary directors, and incorporation fees paid to the state. Organizational costs exclude stock issue costs and commissions paid to underwriters to help sell the shares. Only the legal fees of $41,000 qualify as organizational costs. $41,000 -$5,000 = $36,000/180 months = $200 x 6 months = $1,200 + $5,000 (expense in year 1) = $6,200. CPA-02145 Type1 M/C A-D Corr Ans: C PM R 3-01

71. CPA-02145 PII May 93 #41 Page 22

In 19X2, Acorn Inc. had the following items of income and expense: Sales $500,000 Cost of sales 250,000 Dividends received 25,000

The dividends were received from a corporation of which Acorn owns 30%. In Acorn's 19X2 corporate income tax return, what amount should be reported as income before special deductions? a. $525,000


33

b. $505,000 c. $275,000 d. $250,000 CPA-02145 Explanation Choice "c" is correct. Income before special deductions includes sales, dividends received and cost of sales. It excludes the dividends received deduction, which is a "special" deduction.

Sales $ 500,000 Cost of sales (250,000) Gross profit 250,000 Dividends received 25,000 Income before special deductions $ 275,000

Choice "a" is incorrect. Cost of sales must be deducted.

Choice "b" is incorrect. Cost of sales must be deducted and 100%, not 80%, of the dividends received are included in income before special deductions.

Choice "d" is incorrect. The $25,000 dividend must be included in income before special deduction. CPA-02147 Type1 M/C A-D Corr Ans: D PM R 3-01

72. CPA-02147 PII May 93 #42 Page 6

Ace Rentals Inc., an accrual-basis taxpayer, reported rent receivable of $35,000 and $25,000 in its 19X2 and 19X1 balance sheets, respectively. During 19X2, Ace received $50,000 in rent payments and $5,000 in nonrefundable rent deposits. In Ace's 19X2 corporate income tax return, what amount should Ace include as rent revenue? a. $50,000 b. $55,000 c. $60,000 d. $65,000 CPA-02147 Explanation Choice "d" is correct. Rent revenue under the accrual basis would include the cash received ($50,000) plus the increase in the rent receivable ($10,000 = $35,000 − 25,000), or $60,000. In addition, the $5,000 nonrefundable rent deposit is additional rent revenue, for a total of $65,000.

Choice "a" is incorrect. This answer ignores the change in the rent receivable account and the nonrefundable deposit.

Choice "b" is incorrect. This answer ignores the rent receivable account.

Choice "c" is incorrect. This answer ignores the nonrefundable deposit. CPA-02148 Type1 M/C A-D Corr Ans: D PM R 3-01

73. CPA-02148 PII May 93 #43 Page 25

In 19X2, Portal Corp. received $100,000 in dividends from Sal Corp., its 80%-owned subsidiary. What net amount of dividend income should Portal include in its 19X2 consolidated tax return? a. $100,000 b. $80,000 c. $70,000 d. $0 CPA-02148 Explanation


34

Choice "d" is correct. If a corporation owns 80% or more of another corporation, the dividends received deduction is 100% as the dividend income is eliminated in consolidation. Therefore, the net amount of dividend income is $0.

Choice "a" is incorrect. 100% of the dividend is eliminated, not included in the consolidated tax return.

Choice "b" is incorrect. This answer is 80% of the dividend received. In a consolidated return, 100% of the dividend is eliminated.

Choice "c" is incorrect. This answer is 70% of the dividend received. In a consolidated return, 100% of the dividend is eliminated. CPA-02150 Type1 M/C A-D Corr Ans: C PM R 3-01

74. CPA-02150 PII May 93 #45 Page 22

In 19X2, Garland Corp. contributed $40,000 to a qualified charitable organization. Garland's 19X2 taxable income before the deduction for charitable contributions was $410,000. Included in that amount is a $20,000 dividends-received deduction. Garland also had carryover contributions of $5,000 from the prior year. In 19X2, what amount can Garland deduct as charitable contributions? a. $40,000 b. $41,000 c. $43,000 d. $45,000 CPA-02150 Explanation Choice "c" is correct. The charitable contribution deduction is limited to 10% of taxable income before the dividends received deduction and the charitable contribution deduction. 10% ($410,000 + $20,000) = $43,000. The deduction consists of $40,000 from the current year and $3,000 from the prior year contribution carryover. That leaves a $2,000 carryover from 19X1 to 19X3. CPA-02151 Type1 M/C A-D Corr Ans: B PM R 3-01

75. CPA-02151 PII May 93 #47 Page 19

When a corporation has an unused net capital loss that is carried back or carried forward to another tax year: a. It retains its original identity as short-term or long-term. b. It is treated as a short-term capital loss whether or not it was short-term when sustained. c. It is treated as a long-term capital loss whether or not it was long-term when sustained. d. It can be used to offset ordinary income up to the amount of the carryback or carryover. CPA-02151 Explanation Choice "b" is correct.

Rule: Unused capital losses of a corporation that are carried back or forward are treated as short-term capital losses whether or not they were short-term or long-term when sustained. Capital losses can only be used to offset capital gains up to the amount of the carryback or carryover, not ordinary income.

Choices "a", "c", and "d" are incorrect, per the above rule. CPA-02153 Type1 M/C A-D Corr Ans: B PM R 3-01

76. CPA-02153 PII May 93 #48 Page 15

Soma Corp. had $600,000 in compensation expense for book purposes in 19X2. Included in this amount was a $50,000 accrual for 19X2 nonshareholder bonuses. Soma paid the actual 19X2


35

bonus of $60,000 on March 1, 19X3. In its 19X2 tax return, what amount should Soma deduct as compensation expense? a. $600,000 b. $610,000 c. $550,000 d. $540,000 CPA-02153 Explanation Choice "b" is correct. An accrual basis employer may deduct bonuses paid to nonshareholder employees in the year of accrual if the bonuses are subsequently paid within 2 ½ months after the close of the tax year. Since the $50,000 accrued at year-end 19X2 was paid by March 15, 19X3 (2 ½ months), the $50,000 accrual is deductible as compensation expenses. The additional $10,000 bonus paid on March 1, 19X3 is also deductible in 19X2, even though it was not accrued at year-end 19X2. Therefore, the total compensation is $600,000 + $10,000, or $610,000.

Choice "a" is incorrect. The additional $10,000 of bonus that was paid by March 15 of the next year is deductible in year 19X2.

Choice "c" is incorrect. Both the $50,000 accrual and the additional $10,000 expense is deductible, assuming it is paid by March 15, 19X3.

Choice "d" is incorrect. This answer assumes that the candidate is subtracting the entire $60,000 of bonus paid by March 15 from deductible compensation expense. This is incorrect because both the $50,000 accrual and the additional $10,000 paid by March 15, 19X3 are deductible. CPA-02155 Type1 M/C A-D Corr Ans: D PM R 3-01

77. CPA-02155 PII May 93 #49 Page 33

Potter Corp. and Sly Corp. file consolidated tax returns. In January 19X1, Potter sold land, with a basis of $60,000 and a fair value of $75,000, to Sly for $100,000. Sly sold the land in December 19X2 for $125,000. In its 19X2 and 19X1 tax returns, what amount of gain should be reported for these transactions in the consolidated return? 19X2 19X1 a. $25,000 $40,000 b. $50,000 $0 c. $50,000 $25,000 d. $65,000 $0 CPA-02155 Explanation Choice "d" is correct. The $40,000 gain realized by Potter ($100,000 − $60,000) on the sale to Sly is an intercompany gain that is eliminated in consolidation. Therefore, the 19X1 consolidated return gain is $0. In 19X2 when Sly sells the land to an outside party, the full gain of $65,000 is recognized ($125,000 − $60,000 original basis) on the consolidated return.

Choice "a" is incorrect. The $40,000 gain on the sale from Potter to Sly is intercompany gain and would be eliminated during consolidation. Once the sale is completed from Sly to another party (not in the consolidated return), the full $65,000 gain would be recognized in the tax return.

Choice "b" is incorrect. The gain recognized by Sly on the sale should be calculated as the difference between the original basis to Potter, $60,000, and not the fair market value of $75,000.

Choice "c" is incorrect. The 19X1 gain in this question is utilizing the fair market value of the land instead of the basis. The gain reported in 19X2 is also incorrect as discussed in the explanation to answer "b" above. CPA-02156 Type1 M/C A-D Corr Ans: B PM R 3-01

78. CPA-02156 PII May 93 #50 Page 32

Which of the following tax credits cannot be claimed by a corporation?


36

a. Foreign tax credit. b. Earned income credit. c. Alternative fuel production credit. d. General business credit. CPA-02156 Explanation Choice "b" is correct. The earned income credit can only be claimed by individuals, not corporations.

Choice "a" is incorrect. Corporations can claim the foreign tax credit.

Choice "c" is incorrect. Corporations can claim the alternative fuel production credit.

Choice "d" is incorrect. Corporations can claim the general business credit. CPA-02157 Type1 M/C A-D Corr Ans: D PM R 3-01

79. CPA-02157 PII May 93 #52 Page 38

Acme Corp. has two common stockholders. Acme derives all of its income from investments in stocks and securities, and it regularly distributes 51% of its taxable income as dividends to its stockholders. Acme is a: a. Corporation subject to tax only on income not distributed to stockholders. b. Corporation subject to the accumulated earnings tax. c. Regulated investment company. d. Personal holding company. CPA-02157 Explanation Choice "d" is correct. A corporation is a personal holding company (PHC) if (1) at any time during the last half of the taxable year more than 50% of the value of the outstanding stock is owned by 5 or fewer individuals, and (2) at least 60% of its adjusted ordinary gross income for the year is investment-type income.

Choice "a" is incorrect. A PHC is subject to the regular tax on corporate income as well as a 15% tax on its undistributed PHC income.

Choice "b" is incorrect. As a personal holding company, Acme is not subject to the accumulated earnings tax.

Choice "c" is incorrect. A regulated investment company must be registered under the Investment Company Act of 1940 or file an election to be a regulated investment company. CPA-02158 Type1 M/C A-D Corr Ans: B PM R 3-01

80. CPA-02158 PII May 93 #53 Page 3

In 19X2, Stone, a cash basis taxpayer, incorporated her CPA practice. No liabilities were transferred. The following assets were transferred to the corporation: Cash (checking account) $ 500 Computer equipment

Adjusted basis 30,000 Fair market value 34,000 Cost 40,000

Immediately after the transfer, Stone owned 100% of the corporation's stock. The corporation's total basis for the transferred assets is: a. $30,000 b. $30,500 c. $34,500 d. $40,500


37

CPA-02158 Explanation Choice "b" is correct. In a corporate formation, the corporation's basis in the transferred assets is the carryover adjusted basis from the shareholder, $500 + $30,000 = $30,500.

Choice "a" is incorrect. This answer does not take into account Stone's basis in the cash she contributed.

Choice "c" is incorrect. This answer utilizes the property's fair market value as the corporation's basis; it should be the property's adjusted basis.

Choice "d" is incorrect. This answer utilizes the property's cost basis as the corporation's basis; it should be the property's adjusted basis. CPA-02159 Type1 M/C A-D Corr Ans: D PM R 3-01

81. CPA-02159 PII May 93 #54 Page 42

What is the usual result to the shareholders of a distribution in complete liquidation of a corporation? a. No taxable effect. b. Ordinary gain to the extent of cash received. c. Ordinary gain or loss. d. Capital gain or loss. CPA-02159 Explanation Choice "d" is correct.

Rule: Shareholders treat property received in a complete liquidation of a corporation as full payment for their stock. Therefore, the shareholder must recognize capital gain or loss equal to the difference between the fair market value of the property received and the basis of the stock surrendered.

Choices "a", "b", and "c" are incorrect, per the above rule. CPA-02160 Type1 M/C A-D Corr Ans: C PM R 3-01

82. CPA-02160 PII May 93 #55 Page 37

Kari Corp., a manufacturing company, was organized on January 2, 1992. Its 1992 federal taxable income was $400,000 and its federal income tax was $100,000. What is the maximum amount of accumulated taxable income that may be subject to the accumulated earnings tax for 1992 if Kari takes only the minimum accumulated earnings credit? a. $300,000 b. $150,000 c. $50,000 d. $0 CPA-02160 Explanation Choice "c" is correct. For the accumulated earnings tax, in this case, accumulated taxable income would equal taxable income ($400,000) minus federal income taxes ($100,000) minus the minimum accumulated earnings credit ($250,000) for manufacturing companies or $50,000.

Choice "a" is incorrect. Generally, the accumulated earnings tax is imposed when a corporation has accumulated earnings in excess of $250,000. Thus, the amount of earnings subject to the accumulated earnings tax must first be reduced by the $250,000.

Choice "b" is incorrect. Federal income tax is subtracted from the earnings of a corporation in calculating the amount of excess earnings subject to the accumulated earnings tax.

Choice "d" is incorrect. Accumulated taxable income is $400,000. This amount ($400,000) minus federal income tax ($100,000) minus the credit of $250,000 equals $50,000, which is the excess subject to the accumulated earnings tax.


38

CPA-02161 Type1 M/C A-D Corr Ans: A PM R 3-01

83. CPA-02161 PII May 93 #56 Page 43

Corporations A and B combine in a qualifying reorganization, and form Corporation C, the only surviving corporation. This reorganization is tax-free to the: Shareholders Corporation a. Yes Yes b. Yes No c. No No d. No Yes CPA-02161 Explanation Choice "a" is correct. This is a "Type A" reorganization in the form of a consolidation (e.g., A + B = C). Generally, no gain or loss is recognized by the shareholders of the various corporations except when they receive cash or other consideration in addition to the stock or securities. In addition, no gain or loss is recognized by the acquired corporations or the acquiring corporation pursuant to a tax-free reorganization.

Choices "b", "c", and "d" are incorrect, per the above. CPA-02162 Type1 M/C A-D Corr Ans: C PM CQ #13 R 3-01

84. CPA-02162 PII May 93 #57 Page 35

If a corporation's tentative minimum tax exceeds the regular tax, the excess amount is: a. Carried back to the first preceding taxable year. b. Carried back to the third preceding taxable year. c. Payable in addition to the regular tax. d. Subtracted from the regular tax. CPA-02162 Explanation Choice "c" is correct. If a corporation's tentative minimum tax exceeds the regular tax, the excess amount is the alternative minimum tax which is payable in addition to the regular tax.

Choice "a" is incorrect. There is no carryback of the alternative minimum tax.

Choice "b" is incorrect. There is no carryback of the alternative minimum tax.

Choice "d" is incorrect. The excess amount is added to the regular tax to get the total tax liability. CPA-02163 Type1 M/C A-D Corr Ans: B PM R 3-01

85. CPA-02163 PII May 93 #59 Page 40

The following information pertains to Lamb Corp.: Accumulated earnings and profits at January 1, 19X2 $ 60,000 Earnings and profits for the year ended December 31, 19X2 80,000 Cash distributions to individual stockholders during 19X2 180,000

What is the total amount of distributions taxable as dividend income to Lamb's stockholders in 19X2? a. $180,000 b. $140,000 c. $80,000 d. $0 CPA-02163 Explanation


39

Choice "b" is correct. Dividend income is distributions to shareholders first out of current earnings and profits, then out of accumulated earnings and profits. After earnings and profits have been depleted, the distribution is a liquidating return of capital. Since there is a total of $140,000 in earnings and profits ($80,000 + $60,000), $140,000 is dividend income. The remaining $40,000 is a liquidating return of capital.

Choice "a" is incorrect. Distributions are considered dividends to the shareholders to the extent a corporation has current or accumulated earnings and profits. Therefore, the dividend treatment is limited to $140,000 of the distribution.

Choice "c" is incorrect. The corporation had accumulated earnings and profits of $60,000 that must also be considered.

Choice "d" is incorrect. Distributions from a corporation to its shareholders are considered dividend income to the extent the corporation has current and accumulated earnings and profits. Any additional amounts are a return of capital and any excess beyond capital are considered capital gain. CPA-04731 Type1 M/C A-D Corr Ans: D PM R 3-01

86. CPA-04731 Released 2005 Page 39

Bridge, a C corporation, had $15,000 in accumulated earnings and profits at the beginning of the current year. During the current year, Bridge reported earnings and profits of $10,000 and paid $20,000 in cash distributions to its shareholders in both March and July. What amount of the July distribution should be classified as dividend income to Bridge's shareholders? a. $20,000 b. $15,000 c. $10,000 d. $5,000 CPA-04731 Explanation Choice "d" is correct. When a corporation makes multiple distributions during the taxable year, current E&P is first allocated to each distribution on a pro rata basis; then, accumulated E&P is applied in chronological order beginning with the earliest distribution. In this example, where there are two distributions made by Bridge, the current and accumulated E&P are allocated as follows:

March distribution $20,000 Current E& P - $20,000 (March distribution)/$40,000 (total distributions) x $10,000 (Current E&P) = Amount out of Current E&P $5,000 Accumulated E&P = allocate first come first serve = chronological until either Acc E&P is used up or entire distribution is dividend. Here $15,000 Acc E&P = $15,000 remaining distribution; thus use $0 remaining in Accumulated E&P $15,000 Entire distribution is a dividend $20,000 July distribution $20,000 Current E& P - $20,000 (July distribution)/$40,000 (total distributions) x $10,000 (Current E&P) = Amount out of Current E&P $5,000 Accumulated E&P = all used in March distribution = $0 Dividend amount $5,000 Choices "a", "b", and "c" are incorrect per the above explanation.


40

NOTE: This is the first and only time the AICPA has asked this particular nuance. Given it is a disclosed question, it may or may not appear again. We do not discuss this in our text and understanding this question should be adequate for preparation. CPA-04755 Type1 M/C A-D Corr Ans: D PM R 3-01


Tan Corp. calculated the following taxes for the current year:

Regular tax liability $210,000 Tentative minimum tax 240,000 Personal holding company tax 65,000

What is Tan's total tax liability for the year?

a. $210,000 b. $240,000 c. $275,000 d. $305,000 CPA-04755 Explanation Choice "d" is correct. Tan's tax liability is calculated as follows:

Tan's regular tax liability $210,000 *Plus: Tan's AMT ($240,000 - 210,000) 30,000 **Plus: Tan's PHC tax 65,000 Tan's tax liability $305,000

*Tan will pay alternative minimum tax (AMT) to the extent that AMT exceeds regular tax.

**Tan will pay personal holding company tax in addition to its regular and alternative minimum taxes.

Choices "a", "b", and "c" are incorrect. CPA-04758 Type1 M/C A-D Corr Ans: C PM R 3-01


Dole, the sole owner of Enson Corp., transferred a building to Enson. The building had an adjusted tax basis of $35,000 and a fair market value of $100,000. In exchange for the building, Dole received $40,000 cash and Enson common stock with a fair market value of $60,000. What amount of gain did Dole recognize?

a. $0 b. $5,000 c. $40,000 d. $65,000 CPA-04758 Explanation Choice "c" is correct. As a general rule, a shareholder who contributes property to corporation in exchange for common stock will not recognize gain or loss if immediately after the transaction, provided that the transferring shareholders (there can be more than one transferor) own at least 80% of the corporation and the shareholder does not receive any boot. In this case, Dole as the sole shareholder owns more than 80% but receives boot, cash of $40,000. Therefore, Dole will recognize gain to the lesser of cash received or realized gain as follows: Dole *Amount Realized $100,000 **Adjusted basis (35,000) Realized Gain $ 65,000 Recognized gain = Lesser of realized gain


41

($65,000) or boot received ($40,000) $ 40,000 *Amount Realized = Cash $40,000 + Common stock $60,000

** Adjusted basis = the adjusted basis (NBV) of the building = $35,000

Choices "a", "b", and "d" are incorrect per the above explanation.

CPA-04762 Type1 M/C A-D Corr Ans: A PM R 3-01


Dove Corp. began operating a hardware store in the current year after constructing a building at a total cost of $100,000 on land previously acquired for $50,000. In the current year, the land had a fair market value of $60,000. Dove paid real estate taxes of $5,000 in the current year. What is the total depreciable basis of Dove's business property?

a. $100,000 b. $150,000 c. $155,000 d. $160,000 CPA-04762 Explanation Choice "a" is correct. The only amount that may be depreciated is the $100,000 that Dove spent to contrast the building. The $50,000 cost of the land is not depreciable as land is not a depreciable asset. The fair market value of the land ($60,000) is irrelevant for depreciation purposes. The real estate taxes ($5,000) are a deductible expense to the business that would not be capitalized.

Choice "b" is incorrect. The cost of the land is not a depreciable expense.

Choice "c" is incorrect. The cost of the land is not a depreciable expense. The real estate taxes ($5,000) are a deductible expense to the business that would not be capitalized.

Choice "d" is incorrect. The fair market value of the land ($60,000) is irrelevant for depreciation purposes.



Aztec, a C corporation, distributed an asset to Burn, a shareholder. The asset had a fair market value of $30,000 and was subject to a $40,000 liability, assumed by Burn. The asset had an adjusted basis of $25,000. What amount of gain must Aztec recognize?

a. $0 b. $5,000 c. $10,000 d. $15,000 CPA-04763 Explanation Choice "d" is correct. When a corporation distributes assets to a shareholder, the corporation recognizes a gain as if it had sold the asset. The gain is calculated as follows: Amount Realized - greater of FMV of asset =$30,000 or the amount of liability assumed by the shareholder $40,000 Less Adjusted basis of property sold ($25,000) Realized and recognized gain $15,000 Choice "a", "b", and "c" are incorrect per the above explanation.


42

CPA-04894 Type1 M/C A-D Corr Ans: C QZ#1 R 3-01

91. CPA-04894 Regulation Online Quiz Page 1

On June 1, 2004, Green Corp. adopted a plan of complete liquidation. On December 1, 2004, Green distributed to its stockholders installment notes receivable that Green had acquired in connection with the sale of land in 2003. The following information pertains to these notes:

Green's basis $ 90,000 Fair market value $162,000 Face amount $185,000

How much gain must Green recognize in 2004 as a result of this distribution? a. $0 b. $23,000 c. $72,000 d. $95,000 CPA-04894 Explanation Choice "c" is correct. Distributions in complete liquidation of the corporation are subject to two levels of taxation. First, the corporation must recognize gain or loss as if it sold the assets for the fair market value. The gain on the sale would be the fair market value of $162,000 less $90,000 basis for a gain of $72,000. Secondly, the shareholders would report gain or loss determined by the difference between the fair market value of the assets received and the shareholders' adjusted basis of the stock.

Choices "a", "b", and "d" are incorrect per the above explanation. CPA-04895 Type1 M/C A-D Corr Ans: A QZ#2 R 3-01


The accumulated earnings tax can be imposed: a. On regular corporations not classified as personal holding companies. b. On both partnerships and corporations. c. On companies that make distributions in excess of accumulated earnings. d. Only on parent-subsidiary affiliated groups. CPA-04895 Explanation Choice "a" is correct. The accumulated earnings tax can be imposed on regular corporations not classified as personal holding companies.

Choice "b" is incorrect. The accumulated earnings tax can be imposed on regular corporations ("C" corporations) or on personal service corporations.

Choice "c" is incorrect. The accumulated earnings tax may be imposed on a corporation whose accumulated (retained) earnings is in excess of $250,000 (less for personal service corporations) and for which no justified reason for the retention exists.

Choice "d" is incorrect. A parent-subsidiary group is not a requirement for the imposition of the accumulated earnings tax. CPA-04896 Type1 M/C A-D Corr Ans: C QZ#3 R 3-01


In 2004, Superior Corp. an accrual-basis calendar year corporation, reported book income of $500,000. Included in that amount was $25,000 of municipal bond interest income, $100,000 of federal income tax expense, $10,000 of political party contributions, and $8,000 of tax penalty paid as a result of the audit of the 2001 tax return which was completed during 2004. What


43

amount should Superior Corp.'s taxable income be on the Form 1120, U.S. Corporation Income Tax Return for 2004? a. $600,000 b. $618,000 c. $593,000 d. $585,000 CPA-04896 Explanation Choice "c" is correct. Certain items are treated differently for book and tax purposes. The corporation's book income was $500,000. For tax purposes, the $25,000 of municipal bond interest income is non-taxable, the $100,000 of federal income tax expense is non-deductible, and both the $10,000 of political party contributions and the $8,000 tax penalty are nondeductible.

Book income $500,000 Federal taxes (add) $100,000 Political expenses (add) $10,000 Penalties (add) $8,000 Municipal bond income (subtract) ($25,000) $593,000

Choices "a", "b", and "d" are incorrect per the above calculation. CPA-04897 Type1 M/C A-D Corr Ans: A QZ#4 R 3-01


Dale Corporation's book income before federal income taxes was $435,000 for the year ended December 31, 2004. Dale was organized during 2004. Organization costs of $50,000 are being written off over a ten-year period for financial statement purposes. For tax purposes, these costs are being written off over the minimum allowable period. No additional book/tax differences exist. For the year ended December 31, 2004, Dale Corporation's taxable income was: a. $395,000 b. $432,000 c. $435,000 d. $437,000 CPA-04897 Explanation Choice "d" is correct. The minimum allowable period for tax purposes is 180 months. For tax purposes, an immediate deduction of $5,000 is allowed; and the remainder is amortized over 180 months. The book income of $435,000 must be adjusted for the difference between the book amortization and tax amortization allowed. Book amortization would be $5,000 per year ($50,000 divided by 10 years). Tax amortization/expense is calculated as follows:

$50,000 <5,000> 45,000/180 months 250 per month

Tax amortization would be $3,000 per year ($50,000 − 5,000 ÷ 45,000/180 = 250 × 12 = 3,000). The difference would be a $2,000 lower tax deduction than book. Thus, $435,000 plus 2,000 = $437,000.

Choice "a" is incorrect. This answer assumes 100% of the organizational expenses are deductible in the first year instead of the $5,000.

Choice "b" is incorrect. This answer deducted the $3,000 from book income instead of adjusting book income for the difference between book and tax amortization.

Choice "c" is incorrect. The book income must be adjusted for the book/tax difference due to the different amortization methods.


44

CPA-04898 Type1 M/C A-D Corr Ans: C QZ#5 R 3-01


Roger Corp. had operating income of $300,000 after deducting $12,000 for charitable contributions made during the fiscal year, but not including dividends of $10,000 received from 10%-owned domestic taxable corporation. How much is the base amount to which the percentage limitation should be applied in computing the maximum deduction for the charitable contribution? a. $312,000 b. $300,000 c. $322,000 d. $315,000 CPA-04898 Explanation Choice "c" is correct. The percentage threshold limit for charitable contributions for a corporation is 10% of taxable income. Total taxable income is calculated before the deduction of any charitable contributions, the dividends-received deduction, any net operating loss carryback, or any capital loss carryback. Thus, the $300,000 must be adjusted to add back the charitable contribution deduction of $12,000 plus the $10,000 of dividend income not included in the $300,000. The base equals $322,000.

Choice "a" is incorrect. This answer does not take into account the dividend income not included in the $300,000.

Choice "b" is incorrect. This answer considers operating income without adjustments.

Choice "d" is incorrect. This answer reduced the $322,000 for the $7,000 dividends received deduction that Roger Corp. is entitled to, but this should not go into the calculation of the allowable charitable contribution deduction. CPA-04899 Type1 M/C A-D Corr Ans: B QZ#6 R 3-01


Miyasyke, Inc., a calendar year S corporation, has 5 equal shareholders at the end of the tax year. Miyasyke had $75,000 of taxable income. Miyasyke made distributions to its shareholders of $32,000 each, for a total of $160,000. Each shareholder's basis in the S corporation is 100,000 at the beginning of the tax year. What amount from Miyasyke should be included in each shareholder's gross income? a. $0 b. $15,000 c. $32,000 d. $47,000 CPA-04899 Explanation Choice "b" is correct. Each shareholder reports their pro-rata share of the S corporation's taxable income in his or her gross income. The distributions are not taxable to the extent the shareholders' basis exceeds the distribution (and increased for any income reported by them during the year).

Choice "a" is incorrect. Each shareholder's share of taxable income (non-separately stated) is reported in the shareholder's gross income.

Choices "c" and "d" are incorrect. Choice "c" only includes the distribution, which is not taxable in this case as the shareholder's basis exceeds the distribution. Choice "d" includes both the shareholder's pro rata share of the taxable income and the distribution. The distribution is not taxable in this situation. CPA-04900 Type1 M/C A-D Corr Ans: C QZ#7 R 3-01


45


On March 1, 2004, Nader Corp. adopted a plan of complete liquidation. On June 30, Nader distributed the assets it held at the time as listed below to its shareholders:

Asset Basis FMV Cash $10,000 $10,000 Installment Notes

Receivable $80,000 $135,000

How much gain must Nader recognize as a result of this distribution? a. $0 b. $45,000 c. $55,000 d. $145,000 CPA-04900 Explanation Choice "c" is correct. In a corporate liquidation, distributions are subject to two levels of taxation. First, the corporation must recognize gain or loss as if it sold the assets for the fair market value. Second, the shareholders would report gain or loss determined by the difference between the fair market value of the assets received and the shareholders' adjusted basis of the stock. The gain at the corporate level would be calculated as the combined fair market value of $145,000 less the combined basis of $90,000 or $55,000.

Choices "a", "b", and "d" are incorrect per the above explanation. CPA-04901 Type1 M/C A-D Corr Ans: B QZ#8 R 3-01


Dreamscape, Inc., a widget retailer, had taxable income of $150,000 from operations during its taxable year. In addition, Dreamscape incurred a $35,000 loss from the sale of investment land, a capital asset. No other gains or losses were generated during the taxable year, nor had been in past years. In Dreamscape's tax return for that year, what is the proper treatment of the $35,000 loss? a. The $35,000 capital loss can be used in the current year to reduce taxable income to

$115,000. b. Carry the $35,000 capital loss forward for five years. c. Use $3,000 of the loss to reduce the taxable income of $147,000 carry the remaining $32,000

forward for 3 years. d. Use $3,000 of the loss to reduce the taxable income to $147,000 and carry the remaining

$32,000 forward for 5 years. CPA-04901 Explanation Choice "b" is correct. Capital gains are taxed at the same rate as ordinary income for a corporation. However, capital losses can only be used to offset capital gains. Any amount not utilized in the year of generation can either be carried back 3 years to offset prior capital gain or carried forward for 5 years.

Choice "a" is incorrect. The capital loss cannot be used to offset the taxable income from operations.

Choices "c" and "d" are incorrect. The $3,000 rule is only available to individual taxpayers; not corporations. The inclusion of this in both answers makes them both incorrect. The appropriate carryback and carryforward rule is 3 back; 5 forward. CPA-04902 Type1 M/C A-D Corr Ans: C QZ#9 R 3-01



46

Buster-Copper Corp. received the following dividends during the taxable year. Each investment has been owned for the previous 5 years.

Received from Amount Percentage Owned Ronald Corp. $10,000 10% Donald Corp. $6,000 25% Fence Corp. $1,000 2%

What amount is the dividends received deduction? a. $0 b. $11,900 c. $12,500 d. $13,600 CPA-04902 Explanation Choice "c" is correct. The dividends received from Ronald Corp. and Fence Corp. are subject to the 70% DRD (thus 30% would be taxable). The dividends from Donald Corp. are subject to the 80% DRD (thus 20% would be taxable). The total DRD is $11,000 x 70% plus $6,000 x 80% = $12,500.

Choice "a" is incorrect. The receipt of these dividends by Buster-Copper Corp. qualifies for the dividends received deduction.

Choice "b" is incorrect. This amount is obtained by taking the total dividends of $17,000 x 70% DRD; however the Donald Corp. dividends are subject to the 80% DRD.

Choice "d" is incorrect. This amount is obtained by taking the total dividends of $17,000 x 80% DRD; however the Ronald and Fence Co., dividends are only eligible for the 70% DRD. CPA-04903 Type1 M/C A-D Corr Ans: B QZ#10 R 3-01


Frank is a 1/3 shareholder in an S corporation. At the beginning of the year, Frank's basis in his S corporation interest was $10,000. Frank's share of the S corporation items of income included $35,000 of income from operations; $1,000 of charitable contributions, and $1,000 of capital gains. During the year, Frank also contributed $15,000 of additional capital and received a $3,000 distribution from the S corporation. What is Frank's basis at the end of the tax year? a. $46,000 b. $57,000 c. $60,000 d. $65,000 CPA-04903 Explanation Choice "b" is correct. Frank's basis is calculated as follows:

Beginning Basis: $10,000 Add: Separately and

Non-sep items Income $35,000 Capital gains $ 1,000

Add'l Contrib. $15,000

Less: Distributions $ 3,000

Loss or expense items $ 1,000

Frank's ending basis: $57,000 CPA-04904 Type1 M/C A-D Corr Ans: C R 3-01


47

101. CPA-04904 Regulation Online Quiz Alternate Page 0

Bow, Inc., a calendar year S corporation, has four equal shareholders. For the year ended December 31, 2004, Bow had taxable income of $400,000. Bow made cash distributions totaling $150,000 during 2004 to the four shareholders on a pro rata basis. What amount from Bow should be included in each shareholder's gross income? a. $37,500 b. $62,500 c. $100,000 d. $137,500 CPA-04904 Explanation Choice "c" is correct. Shareholders are taxed on their pro-rata share of the income of an S corporation without regard to whether it is actually distributed. Amounts distributed are not separately taxable; rather they reduce the shareholder's basis.

Choice "a" is incorrect. S corporation shareholders are not taxed on distributions; they are taxable on their pro-rata share of the S corporation's earnings and any separately stated items.

Choice "b" is incorrect. The distribution does not decrease the taxable amount to the shareholders.

Choice "d" is incorrect. S corporation shareholders are not taxable on distributions; they are taxable on their pro-rata share of the S corporation's earnings and any separately stated items. CPA-04905 Type1 M/C A-D Corr Ans: C R 3-01


In 2003, Nam Corp., which is not a dealer in securities, realized taxable income of $160,000 from its business operations. Also in 2003, Nam sustained a capital loss of $24,000 from the sale of marketable securities it purchased in 1997. Nam did not realize any other capital gains or losses in the current or past years. In Nam's income tax returns, what is the proper treatment of the $24,000 long-term capital loss? a. Use $3,000 of the loss to reduce the 2002 taxable income, and carry $21,000 of the capital

loss forward for 5 years. b. Use $3,000 of the loss to reduce the 2002 taxable income, and carry $21,000 of the capital

loss forward for 3 years. c. Carry the $24,000 capital loss carryforward for five years and forego the carryback period. d. Use the entire $24,000 capital loss in the current year to reduce taxable income to $136,000. CPA-04905 Explanation Choice "c" is correct. Capital gains are taxed at the same rate as ordinary income for corporations. However, capital losses can only be used to offset capital gains. Any amount not utilized in the year of generation can either be carried back 3 years to offset prior capital gain or carried forward for 5 years.

Choices "a" and "b" are incorrect. The $3,000 deduction for capital losses against ordinary income available for individuals is not available for corporations.

Choice "d" is incorrect. Corporate capital losses can only be used to offset capital gains. CPA-04906 Type1 M/C A-D Corr Ans: C R 3-01


On Schedule M-1, which of the following is not generally a book/tax difference? a. Depreciation. b. Federal income tax. c. Gross sales from widgets. d. Fines and penalties.


48

CPA-04906 Explanation Choice "c" is correct. Gross sales from widgets are generally computed in the same manner under both book accounting (GAAP) and tax accounting.

Choice "a" is incorrect. Generally, book (GAAP) accounting will depreciate assets straight-line while tax accounting will generally utilize an accelerated method; thus a book/tax difference exists.

Choice "b" is incorrect. Federal income tax is deducted to arrive at book net income but is not deductible for tax purposes.

Choice "d" is incorrect. Fines and penalties are deductible expenses for GAAP purposes but not for tax; thus, it is a book/tax difference. CPA-04907 Type1 M/C A-D Corr Ans: A R 3-01


Pym, Inc. that had earnings and profits of $150,000, distributed land to Alex Rowe, a stockholder, as a dividend in kind. Pym's adjusted basis for this land was $3,000. The land had a fair market value of $20,000. How much was Pym's gain and Rowe's taxable dividend as a result of the distribution?

Pym's Gain Rowe's Taxable Income a. $17,000 $20,000 b. $0 $20,000 c. $17,000 $0 d. $0 $0 CPA-04907 Explanation Choice "a" is correct. When a corporation distributes appreciated property as a dividend, the corporation must recognize gain as if the property were sold at the fair market value. The recipient of the dividends has taxable income at the fair market value of the property received to the extent the corporation has earnings and profits. Pym's gain of $20,000 (FMV) less $3,000 (adjusted basis) = $17,000. Rowe's taxable gain is the fair market value of $20,000.

Choice "b" is incorrect. Distribution of appreciated property results in gain at the corporate level.

Choice "c" is incorrect. If Pym had no earnings and profits, the $20,000 fair market value would reduce Rowe's basis in Pym's stock.

Choice "d" is incorrect per the above explanations. Small Business Corporations (S Corporations) CPA-01771 Type1 M/C A-D Corr Ans: C PM R 3-02

105. CPA-01771 PII Nov 93 #44 Page 9

If an S corporation has no accumulated earnings and profits, the amount distributed to a shareholder: a. Must be returned to the S corporation. b. Increases the shareholder's basis for the stock. c. Decreases the shareholder's basis for the stock. d. Has no effect on the shareholder's basis for the stock. CPA-01771 Explanation Choice "c" is correct. If an S corporation has no accumulated earnings and profits, the amount distributed to a shareholder decreases the shareholder's basis for the stock. The distribution is nontaxable to the extent of the shareholder's basis.


49

Choice "a" is incorrect. The amount distributed to a shareholder does not need to be returned to the S corporation.

Choice "b" is incorrect. Distributions do not increase a shareholder's basis.

Choice "d" is incorrect. Distributions have no effect on a shareholder's basis if they are out of accumulated earnings and profits and are therefore taxable. They would also have no effect on a shareholder's basis if the basis is already zero, which would result in the shareholder recognizing a gain to the extent of the distribution. In this case, we are not told whether or not the basis is already zero. CPA-01941 Type1 M/C A-D Corr Ans: C PM R 3-02

106. CPA-01941 ARE R03 #4 Page 52

Stahl, an individual, owns 100% of Talon, an S corporation. At the beginning of the year, Stahl’s basis in Talon was $65,000. Talon reported the following items from operations during the current year:

Ordinary loss $10,000 Municipal interest income 6,000 Long-term capital gain 4,000 Short-term capital loss 9,000

What was Stahl’s basis in Talon at year-end? a. $50,000 b. $55,000 c. $56,000 d. $61,000 CPA-01941 Explanation Choice "c" is correct. Stahl's basis would be computed as follows:

Beginning basis: $65,000 + Income 6,000 (Tax-free income increases basis.) − Loss (10,000) − Net capital loss (5,000) ($4,000 gain netted with $9,000 loss)

$56,000

Choice "a" is incorrect. This choice excludes the $6,000 of municipal interest income from the above calculation. Remember, both taxable and tax exempt items of income give the taxpayer additional basis.

Choice "b" is incorrect. This choice excludes both the municipal interest income and the net capital loss from the above calculation. Remember, both taxable and tax exempt and separately and non-separately stated items (stated on the K-1) of income or loss affect a shareholder's basis.

Choice "d" is incorrect. This choice excludes the net capital loss from the above calculation. Remember, both separately and non-separately stated items (stated on the K-1) of loss affect a shareholder's basis. CPA-01952 Type1 M/C A-D Corr Ans: C PM R 3-02

107. CPA-01952 ARE R03 #8 Page 52

Baker, an individual, owned 100% of Alpha, an S corporation. At the beginning of the year, Baker’s basis in Alpha Corp. was $25,000. Alpha realized ordinary income during the year in the amount of $1,000 and a long-term capital loss in the amount of $3,000 for this year. Alpha distributed $30,000 in cash to Baker during the year. What amount of the $30,000 cash distribution is taxable to Baker? a. $0


50

b. $5,000 c. $7,000 d. $30,000 CPA-01952 Explanation Choice "c" is correct. The taxability of distributions to shareholders in S corporations with no C corporation earnings and profits is as follows:

1. To the extent of basis in stock - tax free; treated as return of capital. 2. Any distributions in excess of the shareholder's basis - taxable; treated as capital gain. Based upon this rule and the information in the question, Baker's basis must be calculated as follows:

Beginning basis $ 25,000 Plus: Ordinary income 1,000 Less: LT capital loss ( 3,000) Baker's Basis $ 23,000

Baker's basis should then be compared to the amount distributed to determine how much constitutes return of capital. In this instance, $23,000 would be nontaxable return of basis, and the remaining $7,000 would be taxable capital gain to Baker.

Choice "a" is incorrect. Baker's basis is less than the cash distributed so there would be some gain.

Choice "b" is incorrect. This choice does not take into account the current year activity of the S corporation in determining Baker's basis.

Choice "d" is incorrect. Based upon the above rule, amounts distributed to the extent of the shareholder's basis are not taxable. CPA-01955 Type1 M/C A-D Corr Ans: D PM CQ #23 R 3-02

108. CPA-01955 ARE R99 #4 Page 49

Lane Inc., an S corporation, pays single coverage health insurance premiums of $4,800 per year and family coverage premiums of $7,200 per year. Mill is a ten percent shareholder-employee in Lane. On Mill's behalf, Lane pays Mill's family coverage under the health insurance plan. What amount of insurance premiums is includible in Mill's gross income? a. $0 b. $720 c. $4,800 d. $7,200 CPA-01955 Explanation Choice "d" is correct. $7,200 of insurance premiums (the amount of family coverage premiums, as indicated in the question) is includible in Mill's gross income.

Rule: Fringe benefits paid by an S corporation are deductible by the S corporation only for non-shareholder employees and those employee-shareholders owning 2% or less of the S Corporation. Other fringe benefits paid are deductible by the S corporation if included as part of gross income from the S corporation for the individual receiving the benefits (i.e., included as part of income on the shareholder's W-2).

Choices "a", "b", and "c" are incorrect, per the above rule. CPA-01957 Type1 M/C A-D Corr Ans: B PM CQ #24 R 3-02

109. CPA-01957 ARE R99 #10 Page 52

Beck Corp. has been a calendar-year S corporation since its inception on January 2, 1995. On January 1, 1998, Lazur and Lyle each owned 50% of the Beck stock, in which their respective tax


51

bases were $12,000 and $9,000. For the year ended December 31, 1998, Beck had $81,000 in ordinary business income and $10,000 in tax-exempt income. Beck made a $51,000 cash distribution to each shareholder on December 31, 1998. What was Lazur's tax basis in Beck after the distribution? a. $1,500 b. $6,500 c. $52,500 d. $57,500 CPA-01957 Explanation Choice "b" is correct. Lazur's tax basis after the distribution was $6,500.

Rule: The adjusted basis of S corporation stock goes up for undistributed earnings (including tax-exempt income) and vice-versa, as it would in a partnership.

Rule: Amounts distributed (including distributions not taxable as dividends) reduce the adjusted basis of the stock.

Lazur's basis at 1/1/98 $12,000

Add:

50% of ordinary income 40,500 [$81,000 x 50%] 50% of tax-exempt income 5,000 [$10,000 x 50%]

Less:

Distribution to Lazur (51,000) Basis at 12/31/98 $ 6,500

Choices "a", "c", and "d" are incorrect, per the above rules. CPA-01959 Type1 M/C A-D Corr Ans: B PM R 3-02

110. CPA-01959 ARE May 95 #21 Page 46

Village Corp., a calendar year corporation, began business in 1990. Village made a valid S Corporation election on December 5, 1993, with the unanimous consent of its shareholders. The eligibility requirements for S status continued to be met throughout 1994. On what date did Village's S status become effective? a. January 1, 1993. b. January 1, 1994. c. December 5, 1993. d. December 5, 1994. CPA-01959 Explanation Choice "b" is correct.

Rule: In order to be effective for the current taxable year, the S corporation election must be made by the 15th day of the third month of the taxable year. If the election is made after that date it becomes effective on the first day of the next taxable year, January 1, 1994, in this case.

Choices "a", "c", and "d" are incorrect, per the above rules. CPA-01961 Type1 M/C A-D Corr Ans: D PM R 3-02

111. CPA-01961 ARE May 95 #22 Page 52

A shareholder's basis in the stock of an S corporation is increased by the shareholder's pro rata share of income from: Tax-exempt Taxable interest interest a. No No


52

b. No Yes c. Yes No d. Yes Yes CPA-01961 Explanation Choice "d" is correct.

Rule: Both tax-exempt and taxable interest income increase a shareholder's basis in S corporation stock.

Choices "a", "b", and "c" are incorrect, per the above rule. CPA-01964 Type1 M/C A-D Corr Ans: C PM R 3-02

112. CPA-01964 ARE Nov 94 #41 Page 53

Zinco Corp. was a calendar year S corporation. Zinco's S status terminated on April 1, 1993, when Case Corp. became a shareholder. During 1993 (365-day calendar year), Zinco had nonseparately computed income of $310,250. If no election was made by Zinco, what amount of the income, if any, was allocated to the S short year for 1993? a. $233,750 b. $155,125 c. $76,500 d. $0 CPA-01964 Explanation Choice "c" is correct. ($310,250/365) × 90 = $76,500. Zinco will be taxed as an S corporation from January 1 to March 31, 1993, and a C corporation from April 1 to December 31, 1993. Absent the election to calculate the incomes of the S and C corporation portions of the year separately, Zinco's income is allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year. 1993 has 365 days, 90 of which occurred before April 1.

Choice "a" is incorrect. Absent the election to calculate the incomes of the S and C corporation portions of the year separately, Zinco's income is allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year. This is the income allocated to the C corporation portion of the year.

Choice "b" is incorrect. Absent the election to calculate the incomes of the S and C corporation portions of the year separately, Zinco's income is allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year, not on a 50/50 split.

Choice "d" is incorrect. Zinco's income must be allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year. CPA-01966 Type1 M/C A-D Corr Ans: D PM CQ #22 R 3-02

113. CPA-01966 ARE Nov 94 #42 (Adapted) Page 53

Bristol Corp. was formed as a C corporation on January 1, 2000, and elected S corporation status on January 1, 2002. At the time of the election, Bristol had accumulated C corporation earnings and profits, which have not been distributed. Bristol has had the same 25 shareholders throughout its existence. In 2005 Bristol's S election will terminate if it: a. Increases the number of shareholders to 100. b. Adds a decedent's estate as a shareholder to the existing shareholders. c. Takes a charitable contribution deduction. d. Has passive investment income exceeding 90% of gross receipts in each of the three

consecutive years ending December 31, 2004. CPA-01966 Explanation Choice "d" is correct. S corporations that are former C corporations with undistributed C corporation earnings and profits are restricted in the amount of passive investment income they


53

can realize without terminating their S election. The restriction is 25% of total gross receipts from passive investment income. After 3 years with 90% of its gross receipts from passive sources, Bristol will lose its S corporation status on the first day of its 2005 taxable year.

Choice "a" is incorrect. An S corporation can have as many as 100 shareholders.

Choice "b" is incorrect. A decedent's estate may be an S corporation shareholder.

Choice "c" is incorrect. S corporations pass their charitable contribution deductions through to their shareholders. CPA-01970 Type1 M/C A-D Corr Ans: A PM R 3-02

114. CPA-01970 ARE Nov 94 #43 Page 48

As of January 1, 1993, Kane owned all the 100 issued shares of Manning Corp., a calendar year S corporation. On the 41st day of 1993, Kane sold 25 of the Manning shares to Rodgers. For the year ended December 31, 1993 (a 365-day calendar year), Manning had $73,000 in nonseparately stated income and made no distributions to its shareholders. What amount of nonseparately stated income from Manning should be reported on Kane's 1993 tax return? a. $56,750 b. $54,750 c. $16,250 d. $0 CPA-01970 Explanation Choice "a" is correct. The mid-year change of ownership causes Manning's S corporation income to be allocated between the shareholders on a per-share, per-day basis. The first 40 days' income is allocated 100% to Kane: 40 × ($73,000/365) = $8,000. 75% of the remaining 325 days' income is allocated to Kane: 75% × 325 × ($73,000/365) = $48,750. The total income allocated to Kane is $56,750, ($8,000 + $48,750).

Choice "b" is incorrect. Manning's income will be allocated on a per-share, per-day basis; although Kane owned 75% of the shares starting on April 1, he owned 100% of the shares through March 31.

Choice "c" is incorrect. This is the income that should be allocated to Rodgers; the question asks how much should be allocated to Kane.

Choice "d" is incorrect. The mid-year change of ownership causes Manning's S corporation income to be allocated between the shareholders on a per-share, per-day basis. CPA-01974 Type1 M/C A-D Corr Ans: D PM CQ #21 R 3-02

115. CPA-01974 ARE Nov 94 #44 Page 46

On February 10, 1994, Ace Corp., a calendar year corporation, elected S corporation status and all shareholders consented to the election. There was no change in shareholders in 1994. Ace met all eligibility requirements for S status during the preelection portion of the year. What is the earliest date on which Ace can be recognized as an S corporation? a. February 10, 1995. b. February 10, 1994. c. January 1, 1995. d. January 1, 1994. CPA-01974 Explanation Choice "d" is correct.

Rule: An S election made by the 15th day of the third month of the taxable year is retroactively effective on the first day of the taxable year.

Choices "a", "b", and "c" are incorrect, per the above rule.


54


116. CPA-01976 ARE May 94 #21 Page 53

An S corporation has 30,000 shares of voting common stock and 20,000 shares of non-voting common stock issued and outstanding. The S election can be revoked voluntarily with the consent of the shareholders holding, on the day of the revocation: Shares of Shares of voting stock nonvoting stock a. 0 20,000 b. 7,500 5,000 c. 10,000 16,000 d. 20,000 0 CPA-01976 Explanation Choice "c" is correct. S corporation status can be revoked if stockholders owning more than 50% of the total number of issued and outstanding shares consent. The specific percentage of voting and nonvoting stockholders is not considered, just the total. Holders of more than 25,000 total shares must approve the revocation.

Choices "a", "b", and "d" are incorrect. S corporation status can be revoked if stockholders owning more than 50% of the total number of issued and outstanding shares consent. The specific percentage of voting and nonvoting stockholders is not considered, just the total. CPA-01982 Type1 M/C A-D Corr Ans: B PM R 3-02

117. CPA-01982 ARE May 94 #22 Page 52

The Haas Corp., a calendar year S corporation, has two equal shareholders. For the year ended December 31, 1993, Haas had taxable income and current earnings and profits of $60,000, which included $50,000 from operations and $10,000 from investment interest income. There were no other transactions that year. Each shareholder's basis in the stock of Haas will increase by: a. $50,000 b. $30,000 c. $25,000 d. $0 CPA-01982 Explanation Choice "b" is correct. The basis of a shareholder's stock in an S corporation is increased by any item of income and decreased by any item of loss or deduction that passes through to the shareholder. Each shareholder reports ½ of $60,000.

Choice "a" is incorrect. The S corporation had $50,000 income from operations, of which ½ is reported by each shareholder. However, investment income must also be considered.

Choice "c" is incorrect. Investment income must also be considered.

Choice "d" is incorrect. The basis of a shareholder's stock in an S corporation is increased by any item of income and decreased by any item of loss or deduction that passes through to the shareholder. CPA-01984 Type1 M/C A-D Corr Ans: A PM CQ #20 R 3-02

118. CPA-01984 PII May 93 #51 Page 46

Which of the following conditions will prevent a corporation from qualifying as an S Corporation? a. The corporation has both common and preferred stock. b. The corporation has one class of stock with different voting rights. c. One shareholder is an estate.


55

d. One shareholder is a grantor trust. CPA-01984 Explanation Choice "a" is correct. An S corporation can only have one class of stock outstanding. Common and preferred stock would constitute two classes of stock.

Choice "b" is incorrect. One class of stock with different voting rights is allowed for S corporations.

Choice "c" is incorrect. Individuals, estates, and certain trusts may be shareholders in an S corporation.

Choice "d" is incorrect. Grantor trusts, Section 678 trusts, qualified Subchapter S trusts (QSSTs), certain testamentary trusts, and voting trusts are allowed to be shareholders in an S corporation. CPA-04728 Type1 M/C A-D Corr Ans: D PM R 3-02


Boles Corp., an accrual-basis, calendar-year S corporation, has been an S corporation since its inception and is not subject to the uniform capitalization rules. In the current year, Boles recorded the following: Gross receipts $50,000 Dividend income from investments 5,000 Supplies expense 2,000 Utilities expense 1,500 What amount of net business income should Boles report on its 2003 Form 1120S, U.S. Income Tax Return for an S corporation, Schedule K? a. $53,500 b. $53,000 c. $48,000 d. $46,500 CPA-04728 Explanation Choice "d" is correct. An S corporation reports both separately stated and non-separately stated (net business) items of income. The dividend income is a separately stated item and is not included in the calculation of net business income. Therefore, net business income is calculated as follows: Gross Receipts $50,000 Supplies Expense (2,000) Utilities Expense (1,500) Net business income $46,500 Choice "a" is incorrect. Dividend income is not included in net business income. Supplies expense is included in net business income.

Choice "b" is incorrect. Dividend income is not included in net business income. Utilities expense is included in net business income.

Choice "c" is incorrect. Utilities expense is included in net business income.




56

Boles Corp., an accrual-basis, calendar-year S corporation, has been an S corporation since its inception and is not subject to the uniform capitalization rules. In 2003, Boles recorded the following?

Gross receipts $50,000 Dividend income form investments 5,000 Supplies expense 2,000 Utilities expense 1,500

On Bole's 2003 S corporation Form Schedule K, Shareholders' Shares of Income, Credits Deductions, etc., what amount of income should be separately stated from business income? a. $50,000 b. $48,000 c. $5,000 d. $0 CPA-04842 Explanation Choice “c” is correct. An S corporation reports both separately stated and non-separately stated (net business) items of income. The dividend income is a separately stated item and is not included in the calculation of net business income.

Choice “a” is incorrect. Dividend income is a separately stated item and is not included in net business income. Gross Receipts are included in net business income.

Choice “b” is incorrect. Dividend income is a separately stated item and is not included in net business income. Supplies expenses and utilities expense would be deducted from net business income.

Choice “d” is incorrect. Dividend income is a separately stated item and is not included in net business income. Supplies expenses and utilities expense would be deducted from net business income.

Documents

CPA-Corp-Tax-06