Pearson’s Federal Taxation 2022: Corporations, Partnerships, Estates, and Trusts, 35e

(Anderson et al.)
Chapter C3: The Corporate Income Tax

LO1: Corporate Elections

1) A C corporation must use a calendar year as its tax year unless it has a substantial business
purpose to use a fiscal year.
Answer: FALSE
Explanation: Corporation may use fiscal year.
Page Ref.: C:3-5
Objective: 1

2) Identify which of the following statements is true.

A) A corporation is a separate taxpaying entity that must file a tax return annually.
B) A newly formed corporation must select its basic accounting method.
C) The terms "regular corporation" and "C corporation" are synonymous.
D) All of the above are true.
Answer: D
Explanation: See C3-5
Page Ref.: C:3-5
Objective: 1

3) Identify which of the following statements is false.

A) A corporation's fiscal year generally must end on the last day of the month.
B) A fiscal year may not end on December 31.
C) A new corporation can elect a fiscal year that runs from February 16 to February 15 of the
following year.
D) A corporation's first tax year may not cover a full 12-month period.
Answer: C
Explanation: Year end must be last day of the month.
Page Ref.: C:3-5
Objective: 1

4) Identify which of the following statements is true.

A) A corporation that is a member of an affiliated group filing a consolidated tax return may be
allowed a tax year which is different from the group's parent.
B) An S corporation must generally use a calendar year.
C) A corporation's first year must cover a twelve-month period.
D) All of the above are false.
Answer: B
Explanation: Share same tax year of shareholders
Page Ref.: C:3-2 and C:3-3
Objective: 1

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5) Once a corporation has elected a taxable year, it can change the taxable year without IRS
permission if
A) the resulting short period has a net operating loss of $100,000 that the corporation wants to
carry forward.
B) the corporation changed its taxable year seven years ago.
C) the corporation is not an S corporation.
D) a corporation can change its taxable year without IRS permission in all of the above
situations.
Answer: D
Explanation: See C3-4
Page Ref.: C:3-4
Objective: 1

6) A new corporation may generally select one of the following accounting methods with the
exception of
A) cash method.
B) accrual method.
C) retail method.
D) hybrid method.
Answer: C
Explanation: Retail method is not an approved method.
Page Ref.: C:3-4 and C:3-5
Objective: 1

7) Newco Corporation has asked you to help determine whether it should use the accrual method
or the cash method of accounting. What are the tax issues involved in making this determination?
Answer:
• Is Newco a farming corporation?
• If so, does it have gross receipts of less than $25 million?
• Is the corporation engaged in the performance of services in the fields of health, law,
engineering, architecture, accounting, actuarial science, performing arts, or consulting?
• If so, is substantially all of its stock held by current or retired employees performing the
services listed above, by their estates, or (for two years only) by persons who inherited stock
from such employees?
• Has the corporation had average gross receipts of less than $25 million the last three tax
years?
• If the corporation has not been in existence for three years, has it had average gross receipts
of less than $25 million during its existence?
• Is it an S corporation?
A corporation must use the accrual method of accounting unless it is a qualified family farming
corporation, a qualified personal service corporation, meets the $5 million gross receipts test, or
is an S corporation.
Page Ref.: C:3-4 and C:3-5
Objective: 1

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LO2: Determining a Corporation's Taxable Income

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

Answer: FALSE
Explanation: Capital losses may only offset capital gains.
Page Ref.: C:3-7
Objective: 2

2) Organizational expenses incurred after 2019 are amortized over five years.
Answer: FALSE
Explanation: Over 15 years
Page Ref.: C:3-9
Objective: 2

3) Corporations may deduct the adjusted basis of inventory plus one-half of the excess of the
property's FMV over its adjusted basis if the inventory is provided to a qualified charitable
organization that utilizes the inventory for the care of the ill, needy, or infants.
Answer: TRUE
Explanation: Corporations may deduct the adjusted basis of inventory plus one-half of the
excess of the property's FMV over its adjusted basis if the inventory is used for the care of the ill,
needy, or infants.
Page Ref.: C:3-12
Objective: 2

4) Corporations may carry charitable contributions in excess of the income limitation forward for
five years.
Answer: TRUE
Explanation: Corporations may carry charitable contributions in excess of the income limitation
forward for five years.
Page Ref.: C:3-13
Objective: 2

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

dividends payable to individual shareholders.
Answer: FALSE
Explanation: To corporate shareholders
Page Ref.: C:3-15
Objective: 2

6) Sparks Corporation receives a dividend of $100,000 from Jill Corporation, a C corporation.

Sparks owns 70% of Jill Corporation stock. Sparks' dividends-received deduction is $65,000.
Answer: TRUE
Explanation: Sparks Corporation receives a dividend of $100,000 from Jill Corporation, a C
corporation. Sparks owns 70% of Jill Corporation stock. Sparks' dividends-received deduction is
$65,000.
Page Ref.: C:3-15
Objective: 2

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7) NOLs arising in tax years ending after 2017 carry over to subsequent tax years indefinitely.
Answer: TRUE
Explanation: NOLs arising in tax years ending after 2017 carry over to subsequent tax years
indefinitely.
Page Ref.: C:3-18
Objective: 2

8) If a controlling shareholder sells depreciable property to a controlled corporation and the

property is depreciable by the purchaser, any gain on the sale is a 1231 gain.
Answer: FALSE
Explanation: A gain on the sale of the property would be Sec. 1239 gain, treated as ordinary
income as a transaction between related parties pursuant to Sec. 267.
Page Ref.: C:3-20
Objective: 2

9) All of the taxable income of a personal service corporation is taxed at a flat 21% rate.
Answer: TRUE
Explanation: All of the taxable income of a personal service corporation is taxed at a flat 21%
rate.
Page Ref.: C:3-5
Objective: 2

10) Identify which of the following statements is false.

A) A corporation with annual gross receipts of $25,000,000 or less can use the accrual method to
account for sales, cost of goods sold, inventories, accounts receivable and payable, and the cash
method for other income and expenses.
B) Casualty losses incurred by a corporation are deductible subject to a nondeductible floor
similar to those applicable to individuals.
C) The passive loss rules do not apply to widely held C corporations.
D) Corporations may receive a deduction for dividends received from other corporations.
Answer: B
Explanation: Corporations are not subject to floor similar to individuals.
Page Ref.: C:3-4 and C:3-5
Objective: 2

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11) Identify which of the following statements is true.
A) A corporate capital loss can be carried back three years, and then can be carried forward five
years.
B) Corporate capital loss carrybacks can offset corporate ordinary income earned in previous
years.
C) At the election of a corporation, a net capital loss carryback can be forgone and carried
forward only.
D) All of the above are false.
Answer: A
Explanation: A corporate capital loss can be carried back three years, and then can be carried
forward five years.
Page Ref.: C:3-7
Objective: 2

12) Trail Corporation has gross profits on sales of $140,000 and deductible expenses of
$180,000. In addition, Trail has a net capital gain of $60,000. Trail's taxable income is
A) a $20,000 loss.
B) a $40,000 loss.
C) $60,000.
D) $20,000.
Answer: D
Explanation: 140 + 60-180 = 20
Page Ref.: C:3-6; Example C:3-2
Objective: 2

13) Identify which of the following is false.

A) Corporations that sell real property at a gain must report an additional 20% of the entire gain
as ordinary income.
B) Corporations selling real property that previously had been depreciated using an accelerated
method are subject to Sec. 291.
C) Section 291 reduces the amount of net Sec. 1231 gains that can be offset by corporate capital
losses.
D) Section 291 recapture applies to Sec. 1250 property.
Answer: A
Explanation: If a taxpayer sells Sec. 1250 property at a gain, Sec. 1250 requires that the taxpayer
report the recognized gain as ordinary income to the extent the depreciation taken exceeds the
depreciation that would have been allowed had the taxpayer used the straight-line method. This
ordinary income is known as Sec. 1250 depreciation recapture. For individuals, any remaining
gain is characterized as a combination of unrecaptured Sec. 1250 gain and Sec. 1231 gain.
Corporations, however, must recapture as ordinary income an amount equal to 20% of the
ordinary income that would have been recognized had the property been Sec. 1245 property
instead of Sec. 1250 property.
Page Ref.: C:3-7
Objective: 2

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14) Dallas Corporation, not a dealer in securities, realizes taxable income of $60,000 from the
operation of its business. Additionally, in the same year, Dallas realizes a long-term capital loss
of $10,000 from the sale of marketable securities. If the corporation realizes no other capital
gains or losses, what is the proper treatment for the $10,000 long-term capital loss on the tax
return?
A) Use $3,000 of the loss to reduce taxable income and carry $7,000 of the long-term capital loss
forward for five years.
B) Use $6,000 of the loss to reduce taxable income and carry $4,000 of the long-term capital loss
forward for five years.
C) Use $10,000 of the long-term capital loss to reduce taxable income.
D) Carry the $10,000 long-term capital loss back three years as a short-term capital loss, then
forward five years.
Answer: D
Explanation: Corporation carries back the loss 3 years (oldest year first). Any unused portion is
carried forward 5 years.
Page Ref.: C:3-7
Objective: 2

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

Capital Gain
Year
Net Income
Y1 $10,000
Y2 11,000
Y3 5,000

A) The loss is used to offset the gains from Y3 and then carried back to offset $10,000 of the
gains in Y1.
B) The loss is used to offset the $11,000 of the Y2 gains and then carried back to offset $4,000 of
the year Y1 net gain.
C) The loss is used to offset $3,000 of Y1, Y2, and Y3 capital gains, remaining amount carried
forward at $3,000 a year until expired.
D) The loss is used to offset the year Y1 net gains, then $5,000 of the year Y2 net gains.
Answer: D
Explanation: The net capital loss is carried back to the year Y1 and then used to offset capital
gains in subsequent tax years.
Page Ref.: C:3-7; Example C:3-3
Objective: 2

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16) Booth Corporation sells a building classified as a residential rental property for $200,000.
The MACRS straight-line depreciation taken is $20,000 and the adjusted basis of the building is
$170,000. Booth Corporation must recognize ordinary income of
A) $30,000.
B) $20,000.
C) $4,000.
D) $0.
Answer: C
Explanation:
Sales price $200,000

Minus: adjusted basis (170,000)

Realized gain $ 30,000
Minus: ordinary income (Lesser of: (1) $20,000
under (4,000) depreciation recapture under
Sec. 291 Sec. 1245 × 0.20 or (2) $30,000
realized gain × 0.20)

Sec. 1231 gain $ 26,000

Page Ref.: C:3-7 and C:3-8; Example C:3-4

Objective: 2

17) Organizational expenditures include all of the following except for

A) costs incurred when issuing stock.
B) legal costs incident to the creation of the corporation.
C) expenses of organizational meetings.
D) fees paid to the state of incorporation.
Answer: A
Explanation: Costs incurred when issuing stock is not an organizational expenditure.
Page Ref.: C:3-9
Objective: 2

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18) Green Corporation is incorporated on March 1 and begins business on June 1. Green's first
tax year ends on October 31, i.e., a short year. Green incurs the following expenses during the
year:

Month Type Amount

February Draft charter $ 2,000
March Stock commission 30,000
March Accounting fees to set up books 2,000
April Temporary director fees 2,000
December Charter modification fee 1,000

What is the deduction for organizational expenses if Green chooses to deduct its costs as soon as
possible?
A) $36,000
B) $5,028
C) $667
D) $500
Answer: B
Explanation: Amortization of organizational expenses does not include the stock commission,
which reduces paid-in capital, and the charter modification, which is incurred after the initial
year-end.

$2,000 + $2,000 + $2,000 = $6,000 - $5,000 = $1,000/180 mo. × 5 mo. = $28

$5,000 + 28 = $5,028
Page Ref.: C:3-8 and C:3-9; Example C:3-5
Objective: 2

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19) Edison Corporation is organized on July 31. The corporation starts business on August 10.
The corporation adopts a November 30 fiscal year end. The following expenses are incurred
during the year:

Date Type Amount

Attorney's fees associated with obtaining charter
6-30 Underwriter fees for stock sale $ 10,000
7-10 Transfer cost for property contributed to the corporation for 25,000
7-15 stock 3,000
6-30 Costs of organizational meetings 2,000
12-6 Legal fees to modify charter 4,000

What is the maximum amount of organizational expenditures that can be deducted by the
corporation for its first tax year ending November 30?
A) $16,000
B) $12,000
C) $5,156
D) $800
Answer: C
Explanation: The underwriter fees and asset transfer cost are not organizational costs. The legal
fee to modify charter is incurred after the November 30 initial year end.

$10,000 + $2,000 = $12,000 - $5,000 = $7,000

($7,000/180) × 4 = $156; $5,000 + 156 = $5,156
Page Ref.: C:3-8 and C:3-9; Example C:3-5
Objective: 2

20) Identify which of the following statements is true.

A) Organizational expenditures incurred by a corporation do not include the cost of accounting
services necessary to create the corporation.
B) Organizational expenditures incurred by a corporation do not include the cost of printing
stock.
C) Unamortized organizational expenses cannot be deducted when the corporation is liquidated.
D) All of the above are false.
Answer: B
Explanation: Organizational expenditures incurred by a corporation do not include the cost of
printing stock.
Page Ref.: C:3-9
Objective: 2

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21) Identify which of the following statements is true.
A) A corporation that accrues compensation payable to an employee must pay the amount within
two and one-half months after the close of the taxable year to deduct the amount in the year of
the accrual.
B) Accrued compensation that is deductible in the year of accrual is considered to be part of an
IRS deferred compensation plan.
C) Accrued compensation not paid within three and one-half months after the close of the
corporation tax year is deducted in the year following the accrual.
D) All of the above are false.
Answer: A
Explanation: A corporation that accrues compensation payable to an employee must pay the
amount within two and one-half months after the close of the taxable year to deduct the amount
in the year of the accrual.
Page Ref.: C:3-10
Objective: 2

22) Super Corporation gives a painting to a museum for public display on August 6. The painting
was purchased on April 3 of the same year for $20,000 and is worth $30,000 at the date of gift.
Also, Super accrues a charitable contribution on December 30 and pays the $12,000 contribution
on February 1 of the next year. Super Corporation is a calendar-year corporation that uses the
accrual method of accounting. Before considering the 10% limitation rule, the maximum
deduction for the current year is
A) $12,000.
B) $20,000.
C) $30,000.
D) $32,000.
Answer: D
Explanation: The $20,000 basis for the painting is used to compute the deduction since it is held
less than one year and the appreciation would be a short-term capital gain if sold. As long as the
pledge is paid in the first 2 1/2 months of the next tax year, the corporation may deduct the entire
$12,000 in the current year. The total deduction is $32,000 ($12,000 + $20,000).
Page Ref.: C:3-11 and C:3-12
Objective: 2

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23) Identify which of the following statements is true.
A) "Ordinary income property" with regard to the charitable contribution deduction does not
include property whose sale would have produced a short-term capital gain.
B) The Twilight Corporation purchases inventory for $5,000. Its FMV on the date it is donated to
the Blue-Gray Hospital for the care of the needy is $13,000. The maximum charitable
contribution deduction available for the donation is $9,000.
C) Corporations' charitable deductions are limited to 20% of their adjusted taxable income.
D) All of the above are false.
Answer: B
Explanation: The Twilight Corporation purchases inventory for $5,000. Its FMV on the date it is
donated to the Blue-Gray Hospital for the care of the needy is $13,000. The maximum charitable
contribution deduction available for the donation is $9,000 (cost plus 1/2 of normal gain on the
inventory or ($5,000 + (($13,000-$5,000)*50%)).
Page Ref.: C:3-12
Objective: 2

24) In February of the current year, Brent Corporation donates computer equipment that it
purchased six months ago to Eastside High School for use in its educational program. The
donated property had a $20,000 adjusted basis to Brent and a $40,000 FMV. What is the amount
of the gift?
A) $20,000
B) $30,000
C) $35,000
D) $50,000
Answer: B
Explanation: [$20,000 + .50 ($40,000 - $20,000)] = $30,000
Page Ref.: C:3-12
Objective: 2

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25) Garth Corporation donates inventory having an adjusted basis of $40,000 and an FMV of
$150,000 to a qualified public charity. The inventory will be used by the charity to care for the
ill. The maximum charitable contribution deduction before consideration of the 10% limitation is
A) $40,000.
B) $55,000.
C) $80,000.
D) $95,000.
Answer: C
Explanation:
FMV $150,000
Minus: basis ( 40,000)
Appreciation $110,000 × 0.50 = $55,000 = 1/2 profit
Plus: donated property's basis 40,000
Tentative charitable contribution
deduction $95,000
Limited to twice the basis ($40,000 × 2) = $80,000

Page Ref.: C:3-11 and C:3-12

Objective: 2

26) Blueboy Inc. contributes inventory to a qualified charity for use in feeding the needy. The
inventory has a $70,000 FMV and a $30,000 adjusted basis. Blueboy Inc. can take a charitable
contribution deduction of
A) $20,000.
B) $30,000.
C) $50,000.
D) $60,000.
Answer: C
Explanation:
FMV $70,000
Minus: basis ( 30,000)
Appreciation $40,000 × 0.50 = $20,000 = 1/2 profit
Plus: donated property's basis 30,000
Tentative charitable contribution
deduction $50,000
Limited to 2 × basis = $60,000

Page Ref.: C:3-11 and C:3-12; Example C:3-10

Objective: 2

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27) Identify which of the following statements is true.
A) When a corporation donates appreciated capital gain property to a charity, the amount of the
contribution deduction generally equals the property's FMV.
B) When a corporation donates appreciated capital gain property to a private nonoperating
foundation, the corporation's contribution is limited to the property's FMV minus the ordinary
gain that would have resulted from the property's sale.
C) When a corporation contributes appreciated property to a charity, the charitable contribution
deduction is the property's FMV or adjusted basis, depending on the election made by the
taxpayer.
D) All of the above are false.
Answer: A
Explanation: When a corporation donates appreciated capital gain property to a charity, the
amount of the contribution deduction generally equals the property's FMV.
Page Ref.: C:3-11 and C:3-12
Objective: 2

28) If a corporation's charitable contributions exceed the deduction limitation in a particular year,
the excess
A) is not deductible in any future year.
B) becomes a carryover to a maximum of five succeeding years.
C) may be carried back to the third preceding year.
D) is carried over indefinitely.
Answer: B
Explanation: Excess charitable deductions carry forward five years.
Page Ref.: C:3-12
Objective: 2

29) Richards Corporation has taxable income of $280,000 calculated before the charitable
contribution deduction and before its dividends-received deduction of $34,000. Richards makes
cash contributions of $35,000 to charitable organizations. What is Richards Corporation's
charitable contribution deduction for the current year?
A) $24,600
B) $28,000
C) $31,400
D) $35,000
Answer: B
Explanation: $280,000*.10 = $28,000
Page Ref.: C:3-13
Objective: 2

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

Gross receipts from sales $60,000

Dividends received from 15% owned domestic
corporation 40,000
Expenses connected with sales 30,000

The taxable income of Island Corporation is

A) $100,000.
B) $70,000.
C) $47,000.
D) $50,000.
Answer: D
Explanation:
Sales $ 60,000
Plus: dividends 40,000
Gross income $100,000
Minus: expenses ( 30,000)
Taxable income before DRD $ 70,000
Minus: 50% DRD (0.50 × $40,000) ( 20,000)
Taxable income $ 50,000

Page Ref.: C:3-15; Example C:3-15

Objective: 2

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31) Maxwell Corporation reports the following results:

Gross income from operations $90,000

Dividends received from 18% owned domestic
corporation 70,000
Expenses 100,000

Maxwell's dividends-received deduction is

A) $30,000.
B) $35,000.
C) $56,000.
D) $70,000.
Answer: A
Explanation: The dividends-received deduction is limited to $30,000 unless using the full
$35,000 dividends-received deduction will produce a NOL (i.e., taxable income would be
$25,000 ($60,000 - $35,000). As shown below, the full dividends-received deduction does not
produce a NOL.

Gross income from

operations $ 90,000
Plus: dividends 70,000 × 0.50 = $35,000 (Tentative DRD)
Gross income $160,000
Minus: expenses ( 100,000)
Taxable income before DRD $ 60,000 × 0.50 = $30,000 (DRD Limit)

Page Ref.: C:3-15

Objective: 2

32) Identify which of the following statements is true.

A) The dividends-received deduction is designed to reduce double taxation of corporate
dividends.
B) The full 65% dividends-received deduction is available without restriction.
C) If a corporation receives dividends eligible for the 65% dividends-received deduction and the
50% dividends-received deduction, the 50% dividends-received deduction reduces taxable
income prior to the 65% deduction.
D) All of the above are false.
Answer: A
Explanation: The dividends-received deduction is designed to reduce double taxation of
corporate dividends.
Page Ref.: C:3-15
Objective: 2

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33) Identify which of the following statements is false.
A) The 50% dividends-received deduction is limited to 50% of the taxable income of the
corporation without regard to any NOL deduction, any capital loss carryback, and the dividends-
received deduction itself unless the dividends-received deduction produces an NOL.
B) Members of an affiliated group can claim a 90% dividends-received deduction for dividends
received from other group members that is not subject to a taxable income limitation.
C) A corporate dividends-received deduction is not allowed for dividends received on stock held
for 40 days.
D) All of the above are false.
Answer: B
Explanation: Members of an affiliated group can claim a 100% dividends-received deduction for
dividends received from other group members that is not subject to a taxable income limitation.
Page Ref.: C:3-16
Objective: 2

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

Gross profit on sales: $200,000

Expenses: 700,000
Dividends received from less-than-20%-owned domestic
corporations: 20,000

What is Money's net operating loss?

A) $490,000
B) $494,000
C) $520,000
D) $220,000
Answer: A
Explanation:
Gross income from
operations $200,000
Plus: dividends 20,000
Gross income $220,000
Minus: expenses ( 700,000)
Taxable income before DRD ($480,000)
Minus: DRD ($20,000 × 0.5) ( 10,000)
NOL ($490,000)

Page Ref.: C:3-16

Objective: 2

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35) Miller Corporation has gross income of $100,000, which includes $60,000 of dividends from
a 10%-owned corporation. In addition, Miller has $80,000 of expenses. Miller's taxable income
or loss is
A) $20,000.
B) $6,000.
C) $0.
D) ($10,000).
Answer: D
Explanation: The dividends-received deduction of 50% of dividends received is not limited,
since using the entire $20,000 amount will produce a NOL.

Other income $ 40,000

Plus: dividends 60,000
Gross income $100,000
Minus: expenses ( 80,000)
Taxable income before DRD $ 20,000
Minus: DRD (0.50 × $60,000 ( 30,000)
Taxable income ($ 10,000)

Page Ref.: C:3-16

Objective: 2

36) Two days before the ex-dividend date, Drexel Corporation buys 100 shares of Zebra
Corporation stock (less than 1%) for $200,000. Drexel Corporation receives $10,000 of
dividends from Zebra Corporation. Two weeks after the ex-dividend date, Drexel Corporation
sells the Zebra Corporation stock for $190,000. Which of the following statements is correct?
A) Drexel Corporation cannot recognize a capital loss.
B) Drexel Corporation cannot take a dividends-received deduction on the Zebra Corporation
dividend.
C) Drexel Corporation will be allowed a 50% dividends-received deduction when reporting the
Zebra Corporation dividend.
D) Drexel Corporation will receive no dividends-received deduction because the stock was
purchased ex-dividend.
Answer: B
Explanation: The forty-six-day minimum stock ownership requirement prevents taking a
dividends-received deduction.
Page Ref.: C:3-17
Objective: 2

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37) West Corporation purchases 50 shares (less than 1%) of Perch Corporation common stock on
April 3. The ex-dividend date is April 4. West Corporation pays $50,000 for the stock and
receives a dividend of $5,000 on the Perch stock. On May 1, West Corporation sells the Perch
stock for $45,000. West's taxable income before the dividends-received deduction is $4,000.
West's dividends-received deduction is
A) $3,500.
B) $3,200.
C) $2,800.
D) $0.
Answer: D
Explanation: The forty-six-day minimum stock ownership requirement prevents taking a
dividends-received deduction.
Page Ref.: C:3-17
Objective: 2

38) Identify which of the following statements is true.

A) A corporate NOL can be carried back two years and forward 15 years.
B) An NOL incurred before 2018 carries forward 20 years and is not subject to the 80% of
taxable income limitation.
C) In computing an NOL for the current year, a deduction is allowed for NOLs from previous
years.
D) All of the above are false.
Answer: B
Explanation: An NOL incurred before 2018 carries forward 20 years and is not subject to the
80% of taxable income limitation.
Page Ref.: C:3-18 and C:3-19
Objective: 2

39) Identify which of the following statements is true.

A) The charitable contribution deduction is computed after the deduction for an NOL.
B) The charitable contribution deduction is computed after the dividends-received deduction.
C) The NOL deduction claimed by a corporation must be taken after the dividends-received
deduction.
D) All of the above are false.
Answer: C
Explanation: The NOL deduction claimed by a corporation must be taken after the dividends-
received deduction.
Page Ref.: C:3-19
Objective: 2

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40) Webster, who owns all the Bear Corporation stock, purchases a dump truck from Bear
Corporation in January. The truck cost $12,000 and has a $10,000 adjusted basis at the time of
the sale. Webster pays Bear the truck's $8,000 FMV. Later in the same year, Webster sells the
dump truck to an unrelated party for $6,000. Webster can recognize a loss of
A) $4,000.
B) $2,000.
C) $3,000.
D) $5,000.
Answer: B
Explanation: Webster and Bear Corporation are related parties under Sec. 267(b). The $2,000
loss on Bear Corporation's sale to Webster is disallowed. However, no disallowance of the
$2,000 loss occurs on the sale by the purchaser to an unrelated party. The disallowed loss on the
first sale cannot be used by Webster when he sells the truck unless he has a gain to offset it
against. In this problem, he has a $2,000 loss ($6,000 sales price - $8,000 basis).
Page Ref.: C:3-20
Objective: 2

41) Walter, who owns all of the Ajax Corporation stock, purchases a truck from Ajax
Corporation in January. The truck cost $12,000 and has a $10,000 adjusted basis. Walter pays
the truck's $8,000 FMV. Later in the same year, Walter sells the truck to an unrelated party for
$13,000. With respect to these transactions
A) Ajax Corporation reports a loss of $2,000 and Walter reports a gain of $5,000.
B) Ajax Corporation reports no loss and Walter reports a gain of $3,000.
C) Ajax Corporation reports a loss of $4,000 and Walter reports a gain of $5,000.
D) Ajax Corporation reports no loss and Walter reports a gain of $5,000.
Answer: B
Explanation: Ajax recognized no loss on the sale because of the Sec. 267(a) related party sale
transaction rules (i.e., Ajax Corporation and Walter are related parties). When Walter sells the
truck for a $5,000 ($13,000 - $8,000) gain, he is allowed to use the $2,000 disallowed loss as an
offset.
Page Ref.: C:3-20
Objective: 2

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42) Lass Corporation reports a $25,000 net capital loss this year. The corporation reports the
following net capital gains during the past three years.

Net Long-Term Net Short-Term

Year
Capital Gain Capital Gain
Third previous year $5,000 $6,000
Year before last 7,000 3,000
Last year 0 0

Determine the amount of net capital loss carried back to each preceding tax year and the amount
of capital loss, if any, available as a carryforward.
Answer: The capital loss offsets all $11,000 of capital gain reported in the third previous year,
and $14,000 can be carried over to the year before last. $10,000 of the carryover is used in the
year before last, leaving $4,000 to be carried over to next year.
Page Ref.: C:3-7
Objective: 2

43) Delux Corporation, a retail sales corporation, has a taxable income of $500,000. Delux
Corporation's regular tax liability is
A) $158,250.
B) $162,200.
C) $105,000.
D) $175,000.
Answer: C
Explanation: $ 500,000 × 0.21 = $105,000
Page Ref.: C:3-5
Objective: 2

44) Access Corporation, a large manufacturer, has a taxable income of $16,000,000. Access
Corporation's tax is
A) $5,440,000.
B) $3,360,000.
C) $5,600,000.
D) $3,680,000.
Answer: B
Explanation: $16,000,000 * .21 = 3,360,000
Page Ref.: C:3-23
Objective: 2

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45) Baxter Corporation is a personal service corporation. Baxter Corporation has taxable income
of $10,000. Baxter Corporation's tax is
A) $1,500.
B) $2,400.
C) $2,100.
D) $2,900.
Answer: C
Explanation: Personal service corporations pay an income tax liability equal to 21% of taxable
income.
Page Ref.: C:3-5
Objective: 2

46) Identify which of the following statements is true.

A) For expenses incurred after December 31, 2017, no deduction is allowed for any activities
involving entertainment, amusement, or recreation, including expenses related to a facility used
in connection with these activities.
B) The Dividends Received Deduction for individuals is limited to 50%.
C) Domestic Production Activities Deduction carry overs that originated from pre 2018 tax years
are limited to 50% of taxable income until 2025.
D) Deductibility of business interest in a given year is limited to 80% of adjusted taxable
income.
Answer: A
Explanation: For expenses incurred after December 31, 2017, no deduction is allowed for any
activities involving entertainment, amusement, or recreation, including expenses related to a
facility used in connection with these activities.
Page Ref.: C:3-11
Objective: 2

47) Identify which of the following statements is true.

A) Any amount of net business interest disallowed due to limitation may be carried over
indefinitely.
B) If a corporation accrues an obligation to pay compensation, the corporation must make the
payment by year-end to be able to deduct during the current year.
C) Corporations can deduct up to $10,000 in capital losses per year.
D) Net business interest is limited to 50% of adjusted taxable income.
Answer: A
Explanation: Any amount of net business interest disallowed due to limitation may be carried
over indefinitely.
Page Ref.: C:3-11
Objective: 2

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48) Jackson Corporation, not a dealer in securities, realizes taxable income of $80,000 from the
operation of its business. Additionally, Jackson Corporation realizes a $10,000 long-term capital
loss from the sale of marketable securities. Explain the treatment of the loss on the corporate
return for this and any other years.
Answer: The loss cannot be deducted this year since Jackson did not report any capital gains.
The loss must be carried back to the three preceding tax years and used as a short-term capital
loss. If part or all of the loss is unused as a carryback, it can be carried forward as a short-term
capital loss for five years.
Page Ref.: C:3-7
Objective: 2

49) Bright Corporation purchased residential real estate five years ago for $450,000, of which
$50,000 was allocated to the land and $400,000 was allocated to the building. Bright booked
straight-line MACRS deductions of $55,000 during the past five years. This year, Bright sells the
property for $550,000, of which $100,000 is allocated to the land and $450,000 is allocated to
the building. What is the amount and character of Bright's recognized gain or loss on the sale?
Answer: Bright recognizes $50,000 ($100,000 - $50,000) of Sec. 1231 gain on the sale of the
land. Bright also recognizes $105,000 [$450,000 - ($400,000 - $55,000)] on the sale of the
building, of which $11,000 (20% of the lesser of (1) $55,000 depreciation claimed, or (2)
$105,000 gain recognized) is ordinary income recaptured under Sec. 291. The remaining $94,000
($105,000 - $11,000) gain on the sale of the building is a Sec. 1231 gain.
Page Ref.: C:3-7
Objective: 2

50) Ryan Corporation sells a commercial building and land. The sales proceeds attributable to
the building is $145,000. When purchased, the building is allocated $75,000 of the purchase
price. The firm has depreciated the building using the MACRS rules. The MACRS deductions
taken total $60,000. What is the amount and character of Ryan's recognized gain?
Answer: Realized gain: $145,000 - ($75,000 - $60,000) = $130,000
Sec. 291 gain: $15,000 × 20% = $3,000
Sec. 1231 gain = $127,000, Sec. 291 gain - $3,000

Since the building is Sec. 1250 property, straight-line depreciation is recaptured to the extent of
20% under Sec. 291. The remaining $127,000 gain is a Sec. 1231 gain.
Page Ref.: C:3-7
Objective: 2

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51) The following expenses are incurred by Salter Corporation when it is organized on July 1:

Attorney fees to draft charter $20,000

Underwriter fees for stock sale 10,000
Transfer cost for property contributed to the corporation for stock 4,000
Costs of organizational meetings before beginning business 5,000
Costs of directors' meetings after beginning business 8,000

Salter commenced business on September 8. What is the maximum amount of organizational

expenditures that can be deducted by the corporation for its first tax year ending December 31?
Answer: ($20,000 + $5,000) = $25,000 total organizational costs. Deduction is $5,000 + [6 ×
(20,000/180)] = $5,667.
Page Ref.: C:3-8 and C:3-9; Example C:3-5
Objective: 2

52) On December 10 of the past year Dell Corporation (a calendar-year taxpayer) accrued an
obligation for a $100,000 bonus to Muriel, a sales representative who had had an outstanding
year. Muriel owns no Dell Corporation stock. The bonus is paid on May 5 of the current year.
What is Dell's deduction for last year? What is Dell's deduction for this year?
Answer: Dell is allowed $0 deduction for last year as the bonus is not paid by March 15 of the
current year. Dell will take the $100,000 deduction in current year.
Page Ref.: C:3-10; Example C:3-7
Objective: 2

53) Chambers Corporation is a calendar year taxpayer using the accrual method of accounting.
Last year its board of directors authorizes a $20,000 contribution to the Boy Scouts. Chambers
pays the contribution on March 12 of the current year. What is the maximum contribution
allowed for last year? What is the maximum contribution allowed in the current year?
Answer: The maximum allowable for last year is $20,000. Chambers may elect to treat all or
part of the contribution as having been made in the year in which it was accrued. If Chambers
makes this election, it may take the remaining amount in current year. In this case, $0 would be
remaining. If Chambers does not make the election, the $20,000 contribution is deductible when
paid in current year.
Page Ref.: C:3-11
Objective: 2

54) Prince Corporation donates inventory having an adjusted basis of $26,000 and an FMV of
$40,000 to County Hospital, which is a qualified public charity. What is the amount of Prince's
deduction?
Answer: Prince may deduct the adjusted basis plus 50% of the excess of the property's FMV
over the adjusted basis (not to exceed twice the property's adjusted basis) for a total of $33,000
[$26,000 + (.50 × $14,000)] provided the property is related to the donee's exempt function, and
it is used solely for the care of the ill.
Page Ref.: C:3-12
Objective: 2

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55) During the year, Soup Corporation contributes some of its inventory to a qualified charity for
use in feeding the needy. The inventory has an FMV of $85,000 and an adjusted basis of
$25,000. What is the amount of Soup Corporation's charitable contribution deduction for the
donation of the inventory as determined without regard to the overall charitable contribution
limitation?
Answer: Soup Corporation can claim a $50,000 deduction. $25,000 + 0.50 ($85,000 - $25,000)
= $55,000 tentative deduction. This amount is limited to twice the property's adjusted basis, or
$50,000 (2 × $25,000).
Page Ref.: C:3-12
Objective: 2

56) Bermuda Corporation reports the following results in Year 1 and Year 2?
Y1 Y2
Adjusted taxable income $400,000 $600,000
Charitable contributions 70,000 50,000

What is Bermuda's contribution deduction in Y1 and Y2? What is the disposition of any
remaining amount?
Answer: Bermuda's Y1 contribution deduction is limited to $40,000 (0.10 × $400,000).
Bermuda has a $30,000 ($70,000 - $40,000) contribution carryover to Y2. The Y2 contribution
deduction is limited to $60,000 (0.10 × $600,000). Bermuda's deduction for Y2 is composed of
the $50,000 donated in Y2, and $10,000 of the Y1 carryover. A $20,000 carryover from Y1
carries over to Y3, Y4, and Y5.
Page Ref.: C:3-13; Example C:3-11
Objective: 2

57) Zerotech Corporation donates the following property to an elementary school:

• Computer printer purchased three years ago for $1,000. The printer has a $500 FMV and $0
adjusted basis on contribution date.
• Computer equipment acquired one year ago at a cost of $5,000. The equipment has an $8,000
FMV and $0 adjusted basis on contribution date.
• Computer software acquired two months ago at a cost of $10,000. The software will be used
in a prekindergarten program. Its FMV on the contribution date is $10,000 and it has an adjusted
basis of $0.

a) Identify any donation qualifying for special treatment.

b) What is Zerotech's charitable contribution deduction?
Answer:
a) None of the equipment qualifies for a special deduction.
b) There is no charitable deduction.
Page Ref.: C:3-11
Objective: 2

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58) Francine Corporation reports the following income and expense items for the tax year ending
December 31:

Gross receipts from sales $50,000

Dividends received from 15%-owned domestic corporation 30,000
Expenses connected with sales 20,000

What is Francine Corporation's taxable income?

Answer: $50,000 + $30,000 - $20,000 - (0.50 × $30,000) = $45,000. The dividends-received
deduction is $15,000 which is less than the limitation is $30,000 [($50,000 + $30,000 - $20,000)
× 050] and does not apply.
Page Ref.: C:3-15
Objective: 2

59) Bebop Corporation reports the following results in the current year:

Gross income from operations $150,000

Dividends from 15% owned domestic corporation 50,000
Expenses 140,000

What is Bebop's taxable income?

Answer: Gross income from operations $150,000
Dividends received 50,000
Gross income $200,000
Minus: expenses (140,000)
Taxable income before special deductions $ 60,000
Minus: dividends-received deduction (0.5 × 50,000) ( 25,000)
Taxable income $ 35,000
Page Ref.: C:3-15; Example C:3-15
Objective: 2

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60) Jackel, Inc. has the following information for the current tax year:

Gross sales $350,000

Cost of goods sold 50,000
Dividends received (10%) 40,000
Operating expenses 30,000
Charitable contributions 45,000

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

Answer:
$350,000 Gross sales
40,000 Plus: dividend income
( 50,000) Minus: cost of sales
( 30,000) Minus: operating expenses
$310,000 Taxable income before DRD and charitable contributions
× 0.10
$ 31,000 Charitable contribution limit

The 10% charitable contribution deduction limitation is computed before the dividends-received
deduction. The $14,000 ($45,000 - $31,000) excess contributions are carried over for up to 5
years.

$310,000 Taxable income before DRD

( 31,000) Minus: charitable deduction
$279,000 Taxable income before DRD
( 20,000) Minus: dividends-received deduction
$259,000 Taxable income
Page Ref.: C:3-15 through C:3-18
Objective: 2

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61) Dexter Corporation reports the following results for the current year:

Gross income from operations $90,000

Dividends from less than 20%-owned corporations 50,000
Operating expenses 75,000
Charitable contributions 10,000

In addition, Dexter has a $25,000 NOL carryover from the preceding tax year. What is Dexter's
taxable income for the current year?
Answer:
Gross income (90,000 + 50,000) $140,000
Minus: operating expenses ( 75,000)
Income before special deductions $ 65,000
Minus:
charitable contribution ( 4,000)a
dividends-received deduction ( 25,000)
NOL ( 25,000)
Taxable income $ 11,000

a The charitable contribution is limited to $4,000 [0.10 × ($65,000 - $25,000)]. The dividends-
received deduction is not limited by the 50% DRD limitation [($65,000 - $4,000) × 0.50 =
$30,500].
Page Ref.: C:3-19 and C:3-20
Objective: 2

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62) Courtney Corporation had the following income and expenses for the tax year:

Gross profit on sales $300,000

Expenses $600,000
Dividends received from less-than-20%-
owned domestic corporations $ 20,000

Courtney had taxable income for the past three years of:

Y1 $100,000
Y2 $120,000
Y3 $ 80,000

Determine the corporation's NOL for the current year.

Answer:
a) Gross income from operations $300,000
Plus: dividends 20,000
Gross income $320,000
Minus: expenses 600,000
Taxable income before DRD (280,000)
Minus: DRD ($20,000 × 0.5 ( 10,000)
NOL ($290,000)
Page Ref.: C:3-19
Objective: 2

63) Paul, who owns all the stock in Rodgers Corporation, purchases a truck from the corporation
in January. The truck cost $11,000 and has an adjusted basis of $9,000. Paul pays Rodgers the
truck's $7,000 FMV. Paul sells the truck later in the tax year to an unrelated party for $12,000.
What is the amount and character of the income that Paul will report on this year's tax return?
Answer: The corporation could not recognize the $2,000 ($11,000 - $9,000) realized loss on the
sale of the truck since Paul and the corporation are related parties (Sec. 267(a)(1)). Paul would
recognize a gain of only $3,000 [($12,000 - $7,000) - $2,000 disallowed loss] on his subsequent
sale.
Page Ref.: C:3-20
Objective: 2

64) Little Corporation uses the accrual method of accounting. Little's sole shareholder, Renee,
uses the cash method of accounting. Both taxpayers use the calendar year as their tax year. The
corporation accrues a $25,000 interest payment to Renee on December 25 and makes the
payment on March 10. What are the tax consequences of the transactions to both taxpayers in
preceding year and current year?
Answer: Little Corporation cannot deduct the interest in preceding year, but must wait until
Renee reports the income in current year. There are no tax consequences to either taxpayer in
preceding tax year.
Page Ref.: C:3-20
Objective: 2

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65) How does the use of a net capital loss differ for individual and corporate taxpayers?
Answer: Individuals may use up to $3,000 per year of net capital losses to offset ordinary
income, cannot carry back net capital losses, but can carry forward net capital losses indefinitely.
Corporations may not use any net capital losses to offset ordinary income, can carry net capital
losses back three years, and can carry net capital losses forward for only five years.
Page Ref.: C:3-7
Objective: 2

66) James Corporation purchased residential real estate in Year 1 for $225,000, of which
$25,000 was allocated to land and $200,000 was allocated to the building. James Corporation
took straight-line MACRS deductions of $30,000 during Year 1 through Year 5. In the current
year, Year 6, James Corporation sold the property for $285,000, of which $60,000 is allocated to
the land and $225,000 is allocated to the building. What are the amounts and character of James
Corporation's recognized gain or loss on the sale?
Answer:
Land:
Sales Price $ 60,000
Minus: basis (original price) ( 25,000)
Sec. 1231 gain on land $ 35,000

Building:
Sales Price $225,000
Minus: basis (original price) $200,000
Minus: depreciation ( 30,000) (170,000)
Recognized gain $ 55,000

Recapture amount on building as if

Sec. 1245 property:
Lesser of:
$30,000 (depreciation claimed) or
$55,000 (recognized gain) $ 30,000
Times: Sec. 291 percentage × 0.20
Ordinary income under Sec. 291 $ 6,000

Sec. 1231 gain on building:

Recognized gain $ 55,000
Minus: ordinary income portion ( 6,000)
Sec. 1231 gain on building $ 49,000

Summary: Type of Gain

Asset Sec. 1231 Ordinary Total
Land $35,000 $ 0 $35,000
Building 49,000 6,000 55,000
Total $84,000 $6,000 $90,000
Page Ref.: C:3-7
Objective: 2

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67) What are start-up expenditures?
Answer: Start-up expenditures usually occur before the actual operation of a trade or business
and involve the costs incurred in investigating and creating an active trade or business.
Page Ref.: C:3-9 and C:3-10
Objective: 2

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

Answer: Corporations may not deduct charitable contributions in excess of 10% of adjusted
taxable income. Excess charitable contributions are eligible for a five-year carryforward but
cannot be carried back. Excess charitable contributions are subject to the same 10% limitation in
the carryover years.
Page Ref.: C:3-13
Objective: 2

69) What are the various levels of stock ownership by corporate shareholders for the dividends-
received deduction (DRD)? What is the DRD% for each level of ownership?
Answer: If a corporate shareholder owns less than 20% of another corporation's stock, their
DRD% is 70%. If a corporate shareholder owns at least 20% but less than 80% of another
corporation's stock, their DRD% is 80%. If a corporate shareholder owns 80% or more of
another corporation's stock, their DRD% is 100%.
Page Ref.: C:3-15 through C:3-18
Objective: 2

70) How does the use of an NOL differ for individual and corporate taxpayers?
Answer: An individual must make adjustments to his taxable income to calculate his NOL. A
corporation's NOL is simply the excess of its deductions over its income.
Page Ref.: C:3-18
Objective: 2

71) When computing corporate taxable income, what is the proper sequencing of deductions?
Answer: The correct order for taking deductions is: (1) all deductions other than the charitable
contributions deduction, the dividends-received deduction, and the NOL deduction; (2) the
charitable contributions deduction; (3) the dividends-received deduction; (4) the NOL deduction;
(5) the production activities deduction.
Page Ref.: C:3-19
Objective: 2

72) What impact does an NOL carryforward have on the proper sequencing of deductions to
compute corporate taxable income?
Answer: The NOL deduction must be computed twice. The NOL must first be calculated in
determining taxable income for the charitable contribution deduction. The NOL deduction is
then added back to taxable income and recomputed after both the charitable contribution and
dividends-received deductions have been computed.
Page Ref.: C:3-19
Objective: 2

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73) Vanda Corporation sold a truck with an adjusted basis of $50,000 to Barbara for $30,000.
Vanessa owns 25% of the Vanda stock. What tax issues should Vanda and Vanessa consider
with respect to the sale/purchase?
Answer:
• What is Vanda Corporation's realized gain or loss?
• What is Vanda Corporation's recognized loss?
• Does the sale of property to a shareholder at a loss trigger the application of the Sec. 267
related party rules?
• Is Vanessa related to any other Vanda Corporation shareholders (e.g., spouses, siblings, or
other entities) whose attribution of stock ownership causes her stock ownership to exceed 50% of
Vanda's outstanding stock?
• If a loss is disallowed, can the transaction be restructured to permit recognition of the loss?
• What is Vanessa's basis for the truck? Does it reflect an adjustment for the disallowed loss?

The primary issue is whether Vanessa is a related party to Vanda Corporation under the Sec. 267
rules. If so, the loss on the sale of the truck is disallowed. In this case, since Vanessa does not
own more than 50% of the Vanda stock, she is not a related party, and Vanda may deduct a
$20,000 ($50,000 - $30,000) loss. The loss is a Sec. 1231 loss if the truck was used by Vanda in
the conduct of its trade or business. However, if Vanessa's spouse, siblings, or other parties or
entities related to her own more than 25% of the stock, Vanessa is deemed to own more than
50% of Vanda Corporation, and the loss will be disallowed under Sec. 267.
Page Ref.: C:3-21 and C:3-22
Objective: 2

74) Cricket Corporation has a $50,000 NOL in the current year. Cricket does not have pre 2018
NOLs. Cricket expects its taxable income for next year to exceed $40,000. What issues should be
considered with respect to the use of the NOL?
Answer: The primary issue is calculating the NOL limitation. In current year, the NOL
limitation is $32,000
($40,000 * .80).
Page Ref.: C:3-18 through C:3-20
Objective: 2

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75) Quality Corporation, a regular corporation, has an opportunity to realize $50,000 of
additional income in either the current year or next year. What tax issues need to be considered
in determining when to realize the income?
Answer:
• What is Quality's current-year taxable income?
• What is Quality's expected taxable income next year?
• What is Quality's marginal tax rate this year?
• What is Quality's expected marginal tax rate next year?
• Is Quality in the 5% surtax range this year or next year?
Page Ref.: C:3-23
Objective: 3

76) Westwind Corporation reports the following results for the current year:

Gross profit on sales $250,000

Long-term capital gain 25,000
Long-term capital loss 10,000
Short-term capital gain 7,500
Short-term capital loss 12,500
Operating expenses 80,000

What are Westwind's taxable income and regular tax liability before credits for the current year?
Answer: The net capital gain is $10,000 [($25,000 - $10,000) + ($7,500 - $12,500)].

Gross profit on sales $250,000

Plus: net capital gain 10,000
Minus: operating expenses ( 80,000)
Taxable income $180,000

Tax on $180,000 of taxable income $ 37,800

Page Ref.: C:3-23
Objective: 2

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

Gross Income $100,000

Interest Income 5,000
COGS (70,000)
Interest Expense (15,000)
Depreciation (10,000)

What is taxable income before limitation? What is the net business interest expense? What is
adjusted taxable income for purposes of the net business income limitation? How much of the
net business interest expense may Gilbreath deduct during the current year?
Answer:
Taxable Income Before Limitation
Gross Income $100,000
Interest Income 5,000
COGS (70,000)
Interest Expense (15,000)
Depreciation (10,000)
Taxable Income Before Limitation 10,000

Net Business Interest Expense

Interest Income $5,000
Interest Expense (15,000)
Net Business Interest Expense (10,000)

Adjusted Taxable Income

Taxable Income Before Limitation 10,000
Add: Depreciation 10,000
Add: Net Business Interest Expense 10,000
Adjusted Taxable Income 30,000

Deduction Limit: Adjusted Taxable Income 30,000 * 30% = 9,000

Page Ref.: C:3-11
Objective: 2

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LO3: Controlled Group of Corporations

1) Joker Corporation owns 80% of Klue Corporation. Joker Corporation also owns 45% of Lion
Corporation and 45% of Mark Corporation. Klue Corporation owns 40% of Lion Corporation
and 10% of Mark Corporation. Which corporations are members of a controlled group?
A) Klue, Lion, and Mark Corporations
B) Joker, Klue, Lion, and Mark Corporations
C) Joker, Klue, and Lion Corporations
D) Joker and Klue Corporations
Answer: C
Explanation: JKL form a controlled group. Joker owns 80% of Klue. Joker owns 45% of Lion
direct and Klue owning 40% of Lion. Example C:3-28.
Page Ref.: C:3-21 through C:3-27, Example C:3-28
Objective: 3

2) Identify which of the following statements is false.

A) Brown Corporation owns 60% of Clark Corporation and 65% of Davis Corporation. Davis
Corporation owns 10% of Clark Corporation, and Clark Corporation owns 10% of Davis
Corporation. The remaining stock is owned by an individual shareholder. Brown, Davis, and
Clark Corporations are a parent-subsidiary controlled group.
B) There are three categories of control groups: parent-subsidiary, brother-sister, and combined.
C) The controlled group test is applied on December 31.
D) A controlled group must apportion certain tax benefits among its members.
Answer: A
Explanation: No one entity owns at least 80% in another entity to qualify for a controlled group.
Page Ref.: C:3-21 through C:3-27, Example C:3-28
Objective: 3

3) Andy owns 20% of North Corporation and 60% of Tent Corporation. North and Tent have
only one class of stock outstanding. Barbara owns 50% of North Corporation and 20% of Tent
Corporation. North and Tent Corporations will be brother-sister corporations if
A) no stock ownership change occurs.
B) Barbara acquires an additional 10% of North stock.
C) Andy acquires an additional 10% of North stock and Barbara acquires an additional 10% of
Tent stock.
D) Barbara acquires an additional 10% of North stock and an additional 10% of Tent stock.
Answer: C
Explanation: By increasing ownership by 10%, Andy and Barbara meet the 50% common
ownership test threshold.
Page Ref.: C:3-25 through C:3-28
Objective: 3

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

Shareholder Sun Corporation Moon Corporation

Arthur 50% 60%
Brenda 20% 40%
Charles 30% 0%
David 0% 0%

Which of the four stock ownership changes that are illustrated is the minimum change that is
needed if Sun and Moon Corporations are to be brother-sister corporations under the 50%
requirements? (Assume the two corporations are equally valued.)
A) No stock ownership change is required.
B) Arthur sells 4/5ths of his shares in Sun to David.
C) Arthur sells his 2/3rds of his shares to David.
D) Arthur must acquire an additional 30% of Moon Corporation.
Answer: A
Explanation: Thresholds have been met
Page Ref.: C:3-21 through C:3-27, Example C:3-28
Objective: 3

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

Shareholder Sun Corporation Moon Corporation

Arthur 50% 60%
Brenda 20% 40%
Charles 30% 0%
David 0% 0%

Which of the four stock ownership changes that are illustrated is the minimum change that is
needed if Sun and Moon Corporations are to be brother-sister corporations under the 50%-80%
requirements? (Assume the two corporations are equally valued.)
A) No stock ownership change is required.
B) Charles must acquire an additional 10% of Moon Corporation.
C) Charles must acquire an additional 5% of Sun Corporation.
D) Arthur must acquire an additional 30% of Moon Corporation.
Answer: B
Explanation: Charles does not own minimum percentage of Moon
Page Ref.: C:3-21 through C:3-27, Example C:3-28
Objective: 3

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6) Woods and Tiger Corporations have only one class of stock outstanding, owned by the
following individuals:
Stock Ownership Percentages
Shareholder Woods Corp. Tiger Corp.
John 80% 25%
Sarah 20% 75%

Are Woods and Tiger members of a brother-sister controlled group? Why or why not?
Answer: Five or fewer individuals own at least 80% (they own 100%) of each corporation's
stock. However, those same individuals own only 45% of each corporation's stock, taking into
account only their common ownership. The common ownership is 25% for John and 20% for
Sarah for a total of 45%. Because the more-than-50% test is not met, Woods and Tiger are not
members of a brother-sister controlled group.
Page Ref.: C:3-21 through C:3-27, Example C:3-28
Objective: 3

7) What is probably the most common reason for making a consolidated return election?
Answer: Filing consolidated returns allows the group to offset losses of one corporation against
the profits of other members of the group.
Page Ref.: C:3-26 and C:3-27
Objective: 3

8) What are some of the advantages and disadvantages of filing a consolidated return?
Answer: Advantages include:
1) profits of one member of the group can be offset against losses of another member of the
group;
2) capital gains of one member of the group can be offset against capital losses of another
member of the group; and
3) profits or gains reported on intercompany transactions are deferred until a sale outside the
group takes place.

Disadvantages include:
1) the election is binding on all subsequent tax years unless the IRS grants permission to
discontinue filing consolidated returns or the affiliated group is terminated;
2) losses on intercompany transactions are deferred until a sale outside the group takes place;
3) Sec. 1231 losses are offset by Sec. 1231 gains instead of being reported as an ordinary loss;
4) losses of an unprofitable member may reduce the deduction or credit limits of the group
below what would be available if separate tax returns were filed, and additional administrative
costs may be incurred in maintaining records needed to file a consolidated return.
Page Ref.: C:3-25 and C:3-26
Objective: 3

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9) You are the CPA who prepares the tax returns for Dudley, his wife Margo, and their two
corporations. Dave owns 100% of Duright Corporation's stock. Duright's current-year taxable
income is $100,000. Margo owns 100% of Northwest Corporation's stock. Northwest's current-
year taxable income is $150,000. Dudley and Margo file a joint federal income tax return. What
issues should be considered with respect to the calculation of the three tax return liabilities?
Answer:
• What is the tax liability for Duright Corporation? For Northwest Corporation?
• Are Duright and Northwest Corporations C corporations? S corporations?
• Are Duright and Northwest Corporations members of a controlled group?
• Are Margo and Dudley related parties for purposes of the controlled group stock ownership
tests?
• What effect does being a member of the controlled group have on the reduced tax rate
benefits of each corporation?
• Are Duright and Northwest Corporations personal service corporations?
• What amounts (if any) are Duright and Northwest Corporations paying to Dudley and
Margo?
• Have the taxpayers divided up the payments among the three entities (Duright, Northwest,
and the joint return) to minimize their tax liabilities?
• Can the taxpayers adjust their salaries and/or fringe benefits to reduce their total tax costs?
• If Duright and/or Northwest Corporations are C corporations, would an S election be
advisable?

The primary issue is the appropriate corporation classification for Duright and Northwest
Corporations. If both corporations are C corporations, they constitute a controlled group and
must share the tax benefits of the reduced 15, 25%, and 34% tax brackets. Two other important
issues are: (1) can either one of the corporations benefit from an S election? and (2) what amount
of salaries and fringe benefits should be withdrawn from each of the two corporations to
maximize the corporate and shareholder benefits? The last two points are too complicated to
arrive at a definitive answer with the limited facts given here.
Page Ref.: C:3-21 through C:3-27, Example C:3-28
Objective: 3

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10) Beta Corporation recently purchased 100% of XYZ Corporation stock. You are their CPA.
What tax issues need to be addressed before determining whether or not to file a consolidated tax
return?
Answer:
• Does either Beta or XYZ have losses?
• Does one corporation have capital gains and the other capital losses?
• Have there been transactions between the two companies?
• Would the two companies want to file a consolidated return in future years?
• Does one corporation have Sec. 1231 losses and the other Sec. 1231 gains?
• Will any deductions or credits be reduced if a consolidated return is filed?

If the group members file separate returns, members with NOLs or capital losses must either
carry back these losses to earlier years or carry them forward to future years. Although the losses
of one group member can offset the profits of another group member when the group files a
consolidated return, some important limitations apply to the use of a member corporation's NOL.
These limitations prevent one corporation from purchasing another corporation's NOL
carryovers to offset its own taxable income or purchasing a profitable corporation to facilitate the
use of its own NOL carryovers. If an election is made to file a consolidated return, it is binding
on all subsequent tax years unless IRS permission is granted to discontinue the filing or the
affiliated group is terminated. Profits and losses on intercompany transactions are deferred until a
sale outside the group takes place. One member's Sec. 1231 losses are offset by another
member's Sec. 1231 gains instead of being reported as ordinary losses.
Page Ref.: C:3-21 through C:3-27, Example C:3-28
Objective: 3

LO4: Tax Planning Considerations

1) Closely held corporations retain C corporation status to benefit from nontaxable fringe
benefits such
as health and accident insurance. These fringe benefits are nontaxable to the employee
and deductible by the corporation.
Answer: TRUE
Explanation: Fringe benefits are nontaxable to the employee and deductible by the corporation.
Page Ref.: C:3-28
Objective: 4

2) If a corporation distributes all its profits as deductible reasonable salary and fringe benefit
payments, it will eliminate double taxation.
Answer: TRUE
Explanation: A corporation can distribute all its profits as deductible reasonable salary and
fringe benefits.
Page Ref.: C:3-29
Objective: 4

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LO5: Compliance and Procedural Considerations

1) Corporate estimated tax payments are due April 15, June 15, September 15, and January 15.
Answer: FALSE
Explanation: 4/15, 6/15, 9/15, 12/15
Page Ref.: C:3-30
Objective: 5

2) Grant Corporation is not a large corporation for estimated tax purposes and reports on a
calendar-year basis. Grant expects the following results:

Regular tax $248,000

Alternative minimum tax 40,000
Total tax due $288,000

Grant's tax liability for last year was $240,000. Grant's minimum total estimated tax payment for
this year to avoid a penalty is
A) $240,000.
B) $248,000.
C) $288,000.
D) $280,000.
Answer: A
Explanation: The estimated tax liability for a small corporation is the lesser of 100% of the
current year's tax liability (regular tax and alternative minimum tax), or 100% of last year's tax
liability, or $240,000.
Page Ref.: C:3-30
Objective: 5

3) Identify which of the following statements is true.

A) A corporate tax return must be filed by the fifteenth day of the fourth month following the
close of the corporation's tax year.
B) A corporation is required to file a tax return even if it has no taxable income.
C) A corporation with gross receipts, total income, and total assets of $1,000,000 or less is
permitted to file Form 1120-A.
D) All of the above are false.
Answer: B
Explanation: Corporations are required to file a tax return annually.
Page Ref.: C:3-33
Objective: 5

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4) Identify which of the following statements is false.
A) A corporation must file a tax return annually.
B) A corporation can obtain an automatic six-month extension of time to file its tax return.
C) The IRS will permit an extension of time to file a corporate return beyond the original due
date only when the corporation's delay is reasonable.
D) The IRS can rescind the extension period.
Answer: C
Explanation: Corporations are allowed an automatic extension if filed for properly
Page Ref.: C:3-33
Objective: 5

5) Identify which of the following statements is true.

A) Form 1120 Schedule L contains the corporation's income statement.
B) Schedule M-1 (Form 1120) is an analysis of the corporation's retained earnings.
C) Organizational expense amortized over fifteen years for purposes of determining taxable
income results in an upper adjustment in the initial years to book income on the Schedule M-1
when the expense is being amortized over ten years for book income purposes.
D) All of the above are false.
Answer: C
Explanation: Organizational expense amortized over fifteen years for purposes of determining
taxable income results in an upper adjustment in the initial years to book income on the Schedule
M-1 when the expense is being amortized over ten years for book income purposes.
Page Ref.: C:3-35
Objective: 5

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6) Bishop Corporation reports taxable income of $700,000 on its tax return. Given the following
information from the corporation's records, determine Bishop's net income per its financial
accounting records.

Deduction for federal income taxes per books $240,000

Depreciation claimed on the tax return 135,000
Depreciation reported on the financial accounting
books 75,000
Life insurance proceeds on death of a corporate officer 100,000

A) $520,000
B) $620,000
C) $660,000
D) $560,000
Answer: B
Explanation:
Taxable income $700,000
Plus: excess of tax depreciation over book
depreciation 60,000
Plus: nontaxable life insurance proceeds 100,000
Minus: federal income taxes (240,000)
Net income $620,000

Page Ref.: C:3-35 and C:3-36

Objective: 5

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7) Dreyfuss Corporation reports the following items:

Unappropriated retained earnings, beginning of year: $800,000

Net income: 700,000
Federal income tax refund for last year taken directly
to retained earnings: 50,000
Cash dividends paid this year: 500,000

The unappropriated retained earnings at year-end are

A) $1,000,000.
B) $1,050,000.
C) $1,500,000.
D) $2,050,030.
Answer: B
Explanation:
Beginning balance $ 800,000
Plus: net income 700,000
Plus: tax refund 50,000
Minus: dividends paid ( 500,000)
Ending balance $1,050,000

Page Ref.: C:3-35 and C:3-36

Objective: 5

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8) Winter Corporation's taxable income is $500,000. In addition, Winter has the following items:

Depreciation for tax purposes $60,000

Depreciation for financial accounting
purposes 40,000
Net capital loss (2,000)
Interest on loan to acquire tax-exempt
securities 7,000

What is Winter's financial accounting income?

A) $511,000
B) $513,000
C) $518,000
D) $520,000
Answer: A
Explanation:
Taxable income 500,000
Plus: difference between book and tax depreciation 20,000
Minus: net capital loss ( 2,000)
Minus: interest on loan to acquire tax-exempt
securities ( 7,000)
Financial accounting income $511,000

Page Ref.: C:3-35 and C:3-36

Objective: 5

9) Exam Corporation reports taxable income of $800,000 on its federal income tax return. Given
the following information from the corporation's records, determine its book income.

Deduction for federal income taxes per

financial accounting records $272,000
Depreciation claimed on the tax return 140,000
Depreciation recorded on the financial accounting records 80,000
Dividends-received deduction 48,000
Life insurance proceeds on death of corporate officer 90,000
Answer: $800,000 - $272,000 + ($140,000 - $80,000) + $48,000 + $90,000 = $726,000

The reconciling number on the Schedule M-1 is taxable income before special deductions. Thus,
the dividends-received deduction amount would not regularly be included in the Schedule M-1
reconciliation but must be included here since the starting point for the calculation is taxable
income.
Page Ref.: C:3-35 and C:3-36
Objective: 5

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10) Discuss the estimated tax filing requirements for a C corporation.
Answer: Every corporation that expects to owe more than $500 tax for the current year must pay
four installments of estimated tax, each equal to 25% of its required annual payment. If a
corporation is not a large one, its required annual payment is the lesser of 100% of the tax shown
on the current year's return or 100% of the tax shown on the preceding year's return. If a
corporation is a large one, its required annual payment is 100% of the tax shown on the current
year's return. Its first estimated tax payment may be based on the preceding year's tax liability,
but any shortfall must be made up when the second installment is due. Special rules apply if the
corporation bases its estimated tax payments on the annualized income or adjusted seasonal
income methods.
Page Ref.: C:3-30 and C:3-31
Objective: 5

11) Jeffrey Corporation has asked you to prepare its corporate federal income tax return. What
issue do you need to address in considering whether Schedule M-3 is required?
Answer: Whether total assets are under $10 million.
Page Ref.: C:3-35
Objective: 5

12) Junod Corporation's book income is $500,000. What tax issues must be addressed in
determining taxable income?
Answer:
• What is the amount of federal income tax expense?
• Is there an excess of capital losses over capital gains?
• Is there any income subject to tax but not recorded on the books this year?
• Are there any expenses recorded on the books that are not deductible for tax purposes this
year?
• Is there any income recorded on the books this year that is not taxable in the current year?
• Are there any items of deduction or loss that can be claimed on the tax return that do not
reduce book income in the current year?

Some book income is not taxable (e.g., tax-exempt interest). Some gross income is not reflected
in book income for the current period (e.g., prepaid rent). Some financial accounting expenses
are not deductible for tax purposes (e.g., federal income taxes). Some deductions allowed for tax
purposes are not expenses in determining book income for the current period (e.g., asset costs
expensed under Sec. 179).
Page Ref.: C:3-35 and C:3-36
Objective: 5

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LO6: Financial Statement Implications

1) A deferred tax asset indicates that a firm will realize the tax benefit of an event sometime in
the future.
Answer: TRUE
Explanation: A deferred tax asset indicates that a firm will realize the tax benefit of an event
sometime in the future.
Page Ref.: C:3-38 and C:3-39
Objective: 6

2) Deferred tax liabilities occur when expenses are deductible for book purposes before tax
purposes.
Answer: FALSE
Explanation: Deferred tax liabilities occur when expenses are deductible for tax purposes before
book purposes.
Page Ref.: C:3-38 and C:3-39
Objective: 6

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

A) Revenue or gains are recognized earlier for book purposes than for tax purposes.
B) Operating loss or tax credit carryforwards exist.
C) Tax basis of an asset is less than its book.
D) Expenses are deductible earlier for tax purposes than for book purposes.
Answer: B
Explanation: Operating loss or tax credit carryforwards exist create a DTA.
Page Ref.: C:3-39 and C:3-40
Objective: 6

4) Which of the following items will not create a deferred tax liability?
A) Revenues or gains are recognized earlier for book purposes than for tax purposes.
B) Expenses or losses are deductible earlier for tax purposes than for book purposes.
C) Tax basis of an asset is less than its book basis.
D) Operating loss or tax credit carryforwards exist.
Answer: D
Explanation: Operating loss or tax credit carryforwards create a DTA.
Page Ref.: C:3-39 and C:3-40
Objective: 6

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5) Which of the following types of evidence indicate that a valuation allowance is needed to
reduce the deferred tax asset?
A) history of profits
B) excess of appreciated asset values over basis
C) existing contracts or sales backlogs, which will generate significant future income
D) short carryback or carryover periods
Answer: D
Explanation: Valuation allowance is needed to reduce short carryback or carryover periods.
Page Ref.: C:3-39 and C:3-40
Objective: 6

6) Which of the following items is a permanent difference between taxable and financial
accounting income?
A) depreciation
B) dividends-received deduction
C) bad debts
D) net capital loss
Answer: B
Explanation: DRD is a permanent tax difference.
Page Ref.: C:3-39 and C:3-40
Objective: 6

7) Which of the following items is a temporary difference between tax income and financial
accounting income?
A) production activities deduction
B) proceeds on life insurance on a key executive
C) dividends-received deduction
D) depreciation
Answer: D
Explanation: Depreciation is temporary tax difference.
Page Ref.: C:3-39 and C:3-40
Objective: 6

8) Which of the following items indicate that a company does not need a valuation allowance?
A) existing sales contracts that will produce sufficient income to realize the deferred tax asset
B) excess of appreciated asset value over tax basis sufficient to realize the deferred tax asset
C) a strong history of earnings without considering the deferred tax asset
D) All of the above are correct.
Answer: D
Explanation: See C3-40 provides a list of items that indicate a need for a valuation allowance.
Page Ref.: C:3-39 and C:3-40
Objective: 6

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9) Which of the following statements is correct?
A) Deferred tax assets/liabilities are always classified as current on the balance sheet.
B) The classification of deferred tax assets/liabilities depends on whether the related asset is
current or noncurrent.
C) Deferred tax assets are classified based on their expected reversal dates.
D) Deferred tax assets/liabilities are classified as noncurrent on the balance sheet.
Answer: B
Explanation: The classification of deferred tax assets/liabilities depends on whether the related
asset is current or noncurrent.
Page Ref.: C:3-39 and C:3-40
Objective: 6

10) Continental Corporation anticipates a 34% tax rate for the next several years and has a
$500,000 NOL carryover.
a) What is the journal entry to record the NOL carryover's tax benefits, assuming that no
valuation is needed?
b) What is the journal entry if Continental Corporation estimates that one-half of the NOL will
not be realized?
Answer:
a) Deferred tax asset 170,000
Federal income tax expense (benefit) 170,000

b) Deferred tax asset 170,000

Liability for unrecognized tax benefit 85,000
Federal income tax expense (benefit) 85,000
Page Ref.: C:3-40 and C:3-41
Objective: 6

11) What are the four principles underlying ASC 740?

Answer:
1) Recognize a current-year tax liability or asset for taxes payable or refundable on current year
tax returns.
2) Recognize a deferred tax liability or asset for future tax effects attributable to temporary
differences and carryforwards.
3) Measure current and deferred tax liabilities and assets using only enacted tax law, not
anticipated future changes.
4) Reduce deferred tax assets by the amount of tax benefits the firm does not expect to realize,
based on available evidence and adjusted via a valuation allowance.
Page Ref.: C:3-38 and C:3-39
Objective: 6

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