Taxation Test Bank

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1. Chapter 1 - Introduction To Taxation Question TF #1 The FICA tax (Medicare component) on wages is progressive since the tax due increases as wages increase. a. True *b. False 2. Chapter 1 - Introduction To Taxation Question TF #2 The Federal estate and gift taxes are examples of progressive taxes. *a. True b. False 3. Chapter 1 - Introduction To Taxation Question TF #3 The Federal excise tax on cigarettes is an example of a proportional tax. *a. True b. False 4. Chapter 1 - Introduction To Taxation Question TF #4 Currently, the Federal income tax is more progressive than it ever has been in the past. a. True *b. False 5. Chapter 1 - Introduction To Taxation Question TF #5 Federal excise tax is no longer imposed on jewelry. *a. True b. False 6. Chapter 1 - Introduction To Taxation Question TF #6 The tax on hotel occupancy is subject to both Federal and state excise taxes.

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Transcript of Taxation Test Bank

1. Chapter 1 - Introduction To Taxation Question TF #1 The FICA tax (Medicare component) on wages is progressive since the tax due increases as wages increase.

a. True*b. False

2. Chapter 1 - Introduction To Taxation Question TF #2 The Federal estate and gift taxes are examples of progressive taxes.

*a. Trueb. False

3. Chapter 1 - Introduction To Taxation Question TF #3

The Federal excise tax on cigarettes is an example of a proportional tax.

*a. Trueb. False

4. Chapter 1 - Introduction To Taxation Question TF #4 Currently, the Federal income tax is more progressive than it ever has been in the past.

a. True*b. False

5. Chapter 1 - Introduction To Taxation Question TF #5 Federal excise tax is no longer imposed on jewelry.

*a. Trueb. False

6. Chapter 1 - Introduction To Taxation Question TF #6 The tax on hotel occupancy is subject to both Federal and state excise taxes.

a. True*b. False

7. Chapter 1 - Introduction To Taxation Question TF #7 The Federal gas-guzzler tax applies only to automobiles manufactured overseas and imported into the U.S.

a. True*b. False

8. Chapter 1 - Introduction To Taxation Question TF #8 Like the Federal counterpart, the amount of the state excise taxes on gasoline do not vary from state to state.

a. True*b. False

9. Chapter 1 - Introduction To Taxation Question TF #9 The states that impose a general sales tax also have a use tax.

*a. Trueb. False

10. Chapter 1 - Introduction To Taxation Question TF #10 Sales made by mail order are not exempt from the application of a general sales (or use) tax.

*a. Trueb. False

11. Chapter 1 - Introduction To Taxation Question TF #11 Two persons who live in the same state but in different counties may not be subject to the same general sales tax rate.

*a. Trueb. False

12. Chapter 1 - Introduction To Taxation Question TF #12 States impose either a state income tax or a general sales tax, but not both types of taxes.

a. True*b. False

13. Chapter 1 - Introduction To Taxation Question TF #13 A safe and easy way for a taxpayer to avoid local and state sales taxes is to have the purchase sent to an address in another state that levies no such taxes.

a. True*b. False

14. Chapter 1 - Introduction To Taxation Question TF #14 The principal objective of the FICA tax is to provide some measure of

retirement security.

*a. Trueb. False

15. Chapter 1 - Introduction To Taxation Question TF #15 Currently, the tax base for the Medicare component of the FICA is not limited to a dollar amount.

*a. Trueb. False

16. Chapter 1 - Introduction To Taxation Question TF #16 A parent employs his twin daughters, age 19, in his sole proprietorship. The daughters are not subject to FICA coverage.

a. True*b. False

17. Chapter 1 - Introduction To Taxation Question TF #17 Unlike FICA, FUTA requires that employers comply with state as well as Federal rules.

*a. Trueb. False

18. Chapter 1 - Introduction To Taxation Question TF #18 On transfers by death, the Federal government relies on an estate tax, while states use only an inheritance tax.

a. True*b. False

19. Chapter 1 - Introduction To Taxation Question TF #19 An inheritance tax is a tax on a decedent’s right to pass property at death.

a. True*b. False

20. Chapter 1 - Introduction To Taxation Question TF #20 One of the major reasons for the enactment of the Federal estate tax was to prevent large amounts of wealth from being accumulated within the family unit.

*a. Trueb. False

21. Chapter 1 - Introduction To Taxation Question TF #21 Under Clint’s will, all of his property passes to either the Lutheran Church or to his wife. No Federal estate tax will be due on Clint’s death in 2011.

*a. Trueb. False

22. Chapter 1 - Introduction To Taxation Question TF #22 Under a state inheritance tax, two heirs, a cousin and a son of the deceased, would be taxed at the same rate.

a. True*b. False

23. Chapter 1 - Introduction To Taxation Question TF #23 The annual exclusion, currently $13,000, is available for gift but not estate tax purposes.

*a. Trueb. False

24. Chapter 1 - Introduction To Taxation Question TF #24 In 2011, José, a widower, sells land (fair market value of $100,000) to his daughter, Linda, for $50,000. José has made a taxable gift of $37,000.

*a. Trueb. False

25. Chapter 1 - Introduction To Taxation Question TF #25 Julius, a married taxpayer, makes gifts to each of his six children. A maximum of six annual exclusions could be allowed as to these gifts.

a. True*b. False

26. Chapter 1 - Introduction To Taxation Question TF #26 One of the motivations for making a gift is to save on income taxes.

*a. Trueb. False

27. Chapter 1 - Introduction To Taxation Question TF #27 Mona inherits her mother’s personal residence, which she converts to a furnished rent house. These changes should affect the amount of ad valorem property taxes levied on the properties.

*a. Trueb. False

28. Chapter 1 - Introduction To Taxation Question TF #28 A fixture will be subject to the ad valorem tax on personalty rather than the ad valorem tax on realty.

a. True*b. False

29. Chapter 1 - Introduction To Taxation Question TF #29 Even if property tax rates are not changed, the ad valorem taxes imposed on realty may not remain the same.

*a. Trueb. False

30. Chapter 1 - Introduction To Taxation Question TF #30 The ad valorem tax on business use personalty is more often avoided by taxpayers than the ad valorem tax on personal use personalty.

a. True*b. False

31. Chapter 1 - Introduction To Taxation Question TF #31 The formula for the Federal income tax on corporations is not the same as that applicable to individuals.

*a. Trueb. False

32. Chapter 1 - Introduction To Taxation Question TF #32 Olga’s proprietorship earned a net profit of $95,000 during the year and she withdrew $70,000 of this profit. Olga must report $70,000 net income from the proprietorship on her individual income tax return (Form 1040).

a. True*b. False

33. Chapter 1 - Introduction To Taxation Question TF #33 Rose is a 50% partner in Wren Partnership. During the year, Wren earned net profit of $100,000 ($210,000 gross income – $110,000 operating expenses) and distributed $20,000 to each partner. Rose must report Wren Partnership profit of $20,000 on her Federal income tax return.

a. True*b. False

34. Chapter 1 - Introduction To Taxation Question TF #34 Rajib is the sole shareholder of Robin Corporation, a calendar year S corporation. Robin earned net profit of $350,000 ($520,000 gross income – $170,000 operating expenses) and distributed $80,000 to Rajib. Rajib must report Robin Corporation profit of $350,000 on his Federal income tax return.

*a. Trueb. False

35. Chapter 1 - Introduction To Taxation Question TF #35 Donald owns a 60% interest in a partnership that earned $230,000 in the current year. He also owns 60% of the stock in a C corporation that earned $230,000 during the year. Donald received $50,000 in distributions from each of the two entities during the year. With respect to this information, Donald must report $188,000 of income on his individual income tax return for the year.

*a. Trueb. False

36. Chapter 1 - Introduction To Taxation Question TF #36 Quail Corporation is a C corporation with net income of $300,000 during 2011. If Quail paid dividends of $50,000 to its shareholders, the corporation must pay tax on $300,000 of net income. Shareholders must report the $50,000 of dividends as income.

*a. Trueb. False

37. Chapter 1 - Introduction To Taxation Question TF #37 Eagle Company, a partnership, had a short-term capital loss of $10,000 during the year. Aaron, who owns 25% of Eagle, will report $2,500 of Eagle’s short-term capital loss on his individual tax return.

*a. Trueb. False

38. Chapter 1 - Introduction To Taxation Question TF #38 Katherine, the sole shareholder of Purple Corporation, a calendar year C corporation, has the corporation pay her a salary of $450,000 in the current year. The Tax Court has held that $150,000 represents unreasonable compensation. Purple Corporation’s taxable income is unaffected by the Tax Court’s determination.

a. True*b. False

39. Chapter 1 - Introduction To Taxation Question TF #39 Double taxation of corporate income results because dividend distributions are included in a shareholder’s gross income but are not deductible by the corporation.

*a. Trueb. False

40. Chapter 1 - Introduction To Taxation Question TF #40 Jake, the sole shareholder of Peach Corporation, a C corporation, has the corporation pay him $100,000. For tax purposes, Jake would prefer to have the payment treated as salary instead of dividend.

a. True*b. False

41. Chapter 1 - Introduction To Taxation Question TF #41 When Congress enacts a tax cut that is phased in over a period of years, revenue neutrality is achieved.

a. True*b. False

42. Chapter 1 - Introduction To Taxation Question TF #42 A tax cut enacted by Congress that contains a sunset provision will make the tax cut permanent.

a. True*b. False

43. Chapter 1 - Introduction To Taxation Question TF #43 The tax law provides various tax credits, deductions, and exclusions that are designed to encourage taxpayers to obtain additional education. These provisions can be justified on both economic and social grounds.

*a. Trueb. False

44. Chapter 1 - Introduction To Taxation Question TF #44 Various tax provisions encourage the creation of certain types of retirement plans. Such provisions can be justified on both economic and equity grounds.

a. True*b. False

45. Chapter 1 - Introduction To Taxation Question TF #45 To lessen, or eliminate, the effect of multiple taxation, a taxpayer who is subject to both foreign and U.S. income taxes on the same income is allowed either a deduction or a credit for the foreign tax paid.

*a. Trueb. False

46. Chapter 1 - Introduction To Taxation Question TF #46

To mitigate the effect of the annual accounting period concept, the tax law permits the carryback and carryforward to other years of the net operating loss of a particular year.

*a. Trueb. False

47. Chapter 1 - Introduction To Taxation Question TF #47 Jason’s business warehouse is destroyed by fire. As the insurance proceeds exceed the basis of the property, a gain results. If Jason shortly reinvests the proceeds in a new warehouse, no gain is recognized due to the application of the wherewithal to pay concept.

*a. Trueb. False

48. Chapter 1 - Introduction To Taxation Question TF #48 Congress has enacted a provision to allow a deduction for state and local sales taxes. Such a provision can be justified on social grounds.

a. True*b. False

49. Chapter 1 - Introduction To Taxation Question TF #49 As it is consistent with the wherewithal to pay concept, the tax law requires a seller to recognize gain in the year the installment sale took place.

a. True*b. False

50. Chapter 1 - Introduction To Taxation Question TF #50 A provision in the law that compels accrual basis taxpayers to pay a tax on prepaid income in the year received and not when earned is

consistent with generally accepted accounting principles.

a. True*b. False

51. Chapter 1 - Introduction To Taxation Question TF #51 As a matter of administrative convenience, the IRS would prefer to have Congress increase (rather than decrease) the amount of the standard deduction allowed to individual taxpayers.

*a. Trueb. False

52. Chapter 1 - Introduction To Taxation Question MC #1 Federal excise taxes that are no longer imposed include:

a. Tax on air travel.b. Tax on wagering.c. Tax on the manufacture of sporting equipment.*d. Tax on jewelry.e. None of the above.

53. Chapter 1 - Introduction To Taxation Question MC #2 Taxes not imposed by the Federal government include:

a. Tobacco excise tax.*b. Car rental tax.c. Customs duties (tariffs on imports).d. Gas guzzler tax.e. None of the above.

54. Chapter 1 - Introduction To Taxation Question MC #3 Taxes levied by both states and the Federal government include:

a. General sales tax.b. Custom duties.c. Hotel occupancy tax.d. Franchise tax.*e. None of the above.

55. Chapter 1 - Introduction To Taxation Question MC #4 Taxes levied by all states include:

*a. Liquor excise tax.b. Individual income tax.c. Inheritance tax.d. General sales tax.e. None of the above.

56. Chapter 1 - Introduction To Taxation Question MC #5 A use tax is imposed by:

a. The Federal government and all states.b. The Federal government and a majority of the states.c. All states and not the Federal government.*d. Most of the states and not the Federal government. e. None of the above.

57. Chapter 1 - Introduction To Taxation Question MC #6 A characteristic of FICA is that:

*a. It applies when one spouse works for the other spouse.b. It is imposed only on the employer. c. It provides a modest source of income in the event of loss of employment.d. It is administered by both state and Federal governments.e. None of the above.

58. Chapter 1 - Introduction To Taxation Question MC #7 A characteristic of FUTA is that:

a. It is imposed on both employer and employee.b. It is imposed solely on the employee.*c. Compliance requires following guidelines issued by both state and Federal regulatory authorities.d. It is applicable to spouses of employees but not to any children under age 18.e. None of the above.

59. Chapter 1 - Introduction To Taxation Question MC #8 Burt and Lisa are married and live in a common law state. Burt wants to make gifts to their five children in 2011. What is the maximum amount of the annual exclusion they will be allowed for these gifts?

a. $0.b. $13,000.c. $26,000.d. $65,000.*e. $130,000.

60. Chapter 1 - Introduction To Taxation Question MC #9 Property can be transferred within the family group by gift or at death. One motivation for preferring the gift approach is:

*a. To take advantage of the per donee annual exclusion.b. To avoid a future decline in value of the property transferred.c. To take advantage of the higher unified transfer tax credit available under the gift tax.

d. To shift income to higher bracket donees.e. None of the above.

61. Chapter 1 - Introduction To Taxation Question MC #10 Which, if any, of the following transactions will increase a taxing jurisdiction’s revenue from the ad valorem tax imposed on real estate?

a. A resident dies and leaves his farm to his church.b. A large property owner issues a conservation easement as to some of her land.*c. A tax holiday issued 10 years ago has expired.d. A bankrupt motel is acquired by the Red Cross and is to be used to provide housing for homeless persons.e. None of the above.

62. Chapter 1 - Introduction To Taxation Question MC #11

Which, if any, of the following transactions will decrease a taxing jurisdiction’s ad valorem tax revenue imposed on real estate?

a. A tax holiday is denied to an out-of-state business that is searching for a new factory site.b. An abandoned church is converted to a restaurant.c. A public school is razed and turned into a city park.*d. A local university buys an apartment building for use as a student dormitory.e. None of the above.

63. Chapter 1 - Introduction To Taxation Question MC #12 Which, if any, of the following is a typical characteristic of an ad valorem tax on personalty?

a. Taxpayer compliance is greater for personal use property than for business use property.*b. The tax on automobiles sometimes considers the age of the vehicle.c. Most states impose a tax on intangibles.d. The tax on intangibles generates considerable revenue since it is difficult for taxpayers to avoid.e. None of the above.

64. Chapter 1 - Introduction To Taxation Question MC #13 Indicate which, if any, statement is incorrect. State income taxes:

a. Can piggyback to the Federal version.b. Can decouple from the Federal version.c. Can apply to visiting nonresidents.d. Can provide occasional amnesty programs.*e. None of the above.

65. Chapter 1 - Introduction To Taxation Question MC #14 State income taxes generally can be characterized by:

a. A different date for filing than the Federal income tax.*b. Provision for withholding procedures. c. Allowance of a deduction for Federal income taxes paid.d. Applying only to individuals and not applying to corporations.e. None of the above.

66. Chapter 1 - Introduction To Taxation Question MC #15 Juanita owns 45% of the stock in a C corporation that had a profit of $120,000 in 2011. Carlos owns a 45% interest in a partnership that had a profit of $120,000 during the year. The corporation distributed $20,000 to Juanita, and the partnership distributed $20,000 to Carlos. Which of the following statements relating to 2011 is incorrect?

a. Juanita must report $20,000 of income from the corporation.b. The corporation must pay corporate tax on $120,000 of income.*c. Carlos must report $20,000 of income from the partnership.d. The partnership is not subject to a Federal entity-level income tax.e. None of the above.

67. Chapter 1 - Introduction To Taxation Question MC #16 Bjorn owns a 60% interest in an S corporation that earned $150,000 in 2011. He also owns 60% of the stock in a C corporation that earned $150,000 during the year. The S corporation distributed $30,000 to Bjorn and the C corporation paid dividends of $30,000 to Bjorn. How much income must Bjorn report from these businesses?

a. $0 income from the S corporation and $30,000 income from the C corporation. *b. $90,000 income from the S corporation and $30,000 income from the C corporation.c. $90,000 income from the S corporation and $0 income from the C corporation.d. $30,000 income from the S corporation and $30,000 of dividend income from the C corporation.e. None of the above.

68. Chapter 1 - Introduction To Taxation Question MC #17 Luis is the sole shareholder of a C corporation, and Eduardo owns a sole proprietorship. Both businesses were started in 2011, and each business has a long-term capital gain of $20,000 for the year. Neither business made any distributions during the year. With respect to this information, which of the following statements is incorrect?

a. Eduardo must report a $20,000 long-term capital gain on his 2011 tax return.b. Louis’s corporation does not receive a preferential tax rate on the $20,000 long-term capital gain.

*c. Luis must report a $20,000 long-term capital gain on his 2011 tax return.d. Eduardo receives a preferential tax rate on a long-term capital gain of $20,000.e. None of the above.

69. Chapter 1 - Introduction To Taxation Question MC #18 Norma formed Hyacinth Enterprises, a proprietorship, in 2011. In its first year, Hyacinth had operating income of $400,000 and operating expenses of $240,000. In addition, Hyacinth had a long-term capital loss of $10,000. Norma, the proprietor of Hyacinth Enterprises, withdrew $75,000 from Hyacinth during the year. Assuming Norma has no other capital gains or losses, how does this information affect her taxable income for 2011?

a. Increases Norma’s taxable income by $75,000.b. Increases Norma’s taxable income by $160,000.c. Increases Norma’s taxable income by $150,000 ($160,000 ordinary business income – $10,000 long-term capital loss). *d. Increases Norma’s taxable income by $157,000 ($160,000 ordinary business income – $3,000 long-term capital loss). e. None of the above.

70. Chapter 1 - Introduction To Taxation Question MC #19 Francisco is the sole owner of Rose Company. For 2011, the only income of Rose was a long-term capital gain of $25,000. The business made no distributions during the year to Francisco. Irrespective of Rose Company, Francisco’s marginal tax rate is 35% and he has no capital asset transactions. Which of the following statements is incorrect?

a. If Rose Company is a sole proprietorship or S corporation, Francisco must report the $25,000 long-term capital gain on his personal income tax return.b. If Rose Company is a C corporation, Francisco will report none of the $25,000 long-term capital gain on his personal income tax return.c. If Rose Company is a sole proprietorship or S corporation, a preferential tax rate applies to the $25,000 long-term capital gain.d. If Rose Company is a C corporation, a preferential tax rate does not apply to the $25,000 long-term capital gain.*e. None of the above.

71. Chapter 1 - Introduction To Taxation Question MC #20 Glen and Michael are equal partners in Trout Enterprises, a calendar year partnership. During the year, Trout Enterprises had gross income of $400,000 and operating expenses of $220,000. In addition, the partnership sold land that had been held for investment purposes for a long-term capital gain of $100,000. During the year, Glen withdrew $60,000 from the partnership, and Michael withdrew $60,000. Discuss the impact of this information on the taxable income of Trout, Glen, and

Michael.

a. Trout pays tax on $0 income, Glen’s taxable income increases by $60,000, and Michael’s taxable income increases by $60,000.b. Trout pays tax on $280,000 income, Glen’s taxable income increases by $60,000, and Michael’s taxable income increases by $60,000.c. Trout pays tax on $0 income, Glen’s taxable income increases by $200,000, and Michael’s taxable income increases by $200,000.*d. Trout pays tax on $0 income, Glen’s taxable income increases by $140,000, and Michael’s taxable income increases by $140,000.e. None of the above.

72. Chapter 1 - Introduction To Taxation Question MC #21 Elk, a C corporation, has $370,000 operating income and $290,000 operating expenses during the year. In addition, Elk has a $10,000 long-term capital gain and a $17,000 short-term capital loss. Elk’s taxable income is:

a. $90,000.*b. $80,000.c. $73,000. d. $63,000. e. None of the above.

73. Chapter 1 - Introduction To Taxation Question MC #22 Flycatcher Corporation, a C corporation, has two equal individual shareholders, Nancy and Pasqual. In the current year, Flycatcher earned $200,000 net profit and paid a dividend of $40,000 to each shareholder. Regardless of any tax consequences resulting from their interests in Flycatcher, Nancy is in the 28% marginal tax bracket and Pasqual is in the 35% marginal tax bracket. With respect to the current year, which of the following statements is incorrect?

*a. Flycatcher can avoid the corporate tax altogether by paying out all $200,000 of net profit as dividends to the shareholders. b. Nancy incurs income tax of $6,000 on her dividend income.c. Pasqual incurs income tax of $6,000 on his dividend income.d. Flycatcher pays corporate tax on $200,000.e. None of the above.

74. Chapter 1 - Introduction To Taxation Question MC #23 Which of the following statements is incorrect about LLCs and the check-the-box Regulations?

a. A limited liability company with one owner can elect to be taxed as a corporation.b. All 50 states have passed laws that allow LLCs.c. An entity with more than one owner and formed as a corporation cannot elect to be taxed as a partnership.d. If a limited liability company with one owner does not make an election, the entity is taxed as a sole proprietorship.

*e. If a limited liability company with more than one owner does not make an election, the entity is taxed as a corporation.

75. Chapter 1 - Introduction To Taxation Question MC #24 Both economic and social considerations can be used to justify:

*a. Various tax credits, deductions, and exclusions that are designed to encourage taxpayers to obtain additional education.b. Disallowance of any deduction for expenditures deemed to be contrary to public policy (e.g., fines, penalties, illegal kickbacks, bribes to government officials).c. Favorable tax treatment for accident and health plans provided for employees and financed by employers.d. Allowance of a deduction for state and local income taxes paid.e. None of the above.

76. Chapter 1 - Introduction To Taxation Question MC #25 Social considerations can be used to justify:

a. Allowing a Federal income tax deduction for state and local sales taxes.b. Allowing excess capital losses to be carried over to other years.c. Allowing accelerated amortization for the cost of installing pollution control facilities.*d. Allowance of a credit for child care expenses.e. None of the above.

77. Chapter 1 - Introduction To Taxation Question MC #26 Allowing a domestic production activities deduction for certain manufacturing income can be justified:

a. As mitigating the effect of the annual accounting period concept.b. As promoting administrative feasibility.*c. By economic considerations. d. Based on the wherewithal to pay concept.e. None of the above.

78. Chapter 1 - Introduction To Taxation Question MC #27 Provisions in the tax law that promote energy conservation and more use of alternative (non-fossil) fuels can be justified by:

a. Political considerations.*b. Economic and social considerations.c. Promoting administrative feasibility. d. Encouragement of small business. e. None of the above.

79. Chapter 1 - Introduction To Taxation Question MC #28 Which, if any, of the following provisions cannot be justified as mitigating the effect of the annual accounting period concept?

*a. Nonrecognition of gain allowed for involuntary conversions.b. Net operating loss carryback and carryover provisions.c. Carry over of excess charitable contributions.d. Use of the installment method to recognize gain.e. Carry over of excess capital losses.

80. Chapter 1 - Introduction To Taxation Question MC #29 Which, if any, of the following provisions of the tax law cannot be justified as promoting administrative feasibility (simplifying the task of the IRS)?

a. Penalties are imposed for failure to file a return or pay a tax on time.b. Prepaid income is taxed in the year received and not in the year earned.c. Annual adjustments for indexation increases the amount of the standard deduction allowed.d. Casualty losses must exceed 10% of AGI to be deductible.*e. A deduction is allowed for charitable contributions.

81. Chapter 1 - Introduction To Taxation Question MC #30 A landlord leases property upon which the tenant makes improvements. The improvements are significant and are not made in lieu of rent. At the end of the lease, the value of the improvements are not income to the landlord. This rule is an example of:

a. A clear reflection of income result.b. The tax benefit rule.c. The arm’s length concept.*d. The wherewithal to pay concept.e. None of the above.

82. Chapter 1 - Introduction To Taxation Question MA #1-15 Using the choices provided below, show the justification for each provision of the tax law listed. Note: In some cases, more than one answer is appropriate.A tax credit for amounts spent to furnish care for children while the parent is at work.Additional depreciation deduction allowed for the year the asset is acquired.Tax brackets are increased for inflation.A small business corporation can elect to avoid the corporate income tax.A deduction for contributions by an employee to certain retirement plans.A deduction for qualified tuition paid to obtain higher education.A deduction for certain expenses (interest and taxes) incident to home ownership.A Federal deduction for state and local income taxes paid.A deduction for certain income from manufacturing activities.A bribe to the local sheriff, although business related, is not deductible.Contributions to charitable organizations are deductible.A Federal deduction for state and local sales taxes paid.Tax credits available for the purchase of a vehicle

that uses alternative (non-fossil) fuels.Tax credits for home improvements that conserve energy.More rapid expensing for tax purposes of the costs of installing pollution control devicesSocial considerations Economic considerations Equity considerations Economic considerations Economic considerations Economic considerations Economic considerations Equity considerations Economic considerations Social considerations Social considerations Equity considerations Economic considerations Economic considerations Economic considerations

[a] 1. A tax credit for amounts spent to furnish care for children while the parent is at work.

[b] 2. Additional depreciation deduction allowed for the year the asset is acquired.

[c] 3. Tax brackets are increased for inflation.[d] 4. A small business corporation can elect to avoid the

corporate income tax.[e] 5. A deduction for contributions by an employee to certain

retirement plans.[f] 6. A deduction for qualified tuition paid to obtain higher

education.[g] 7. A deduction for certain expenses (interest and taxes)

incident to home ownership.[h] 8. A Federal deduction for state and local income taxes

paid.[i] 9. A deduction for certain income from manufacturing

activities.[j] 10. A bribe to the local sheriff, although business

related, is not deductible.[k] 11. Contributions to charitable organizations are

deductible.[l] 12. A Federal deduction for state and local sales taxes

paid.[m] 13. Tax credits available for the purchase of a vehicle

that uses alternative (non-fossil) fuels.[n] 14. Tax credits for home improvements that conserve

energy.[o] 15. More rapid expensing for tax purposes of the costs of

installing pollution control devices

a. Social considerationsb. Economic considerationsc. Equity considerationsd. Economic considerationse. Economic considerationsf. Economic considerationsg. Economic considerationsh. Equity considerationsi. Economic considerationsj. Social considerationsk. Social considerationsl. Equity considerationsm. Economic considerationsn. Economic considerationso. Economic considerations

83. Chapter 1 - Introduction To Taxation Question PR #1 Molly, a widow, makes cash gifts to her five married children (including their spouses) and to her eight grandchildren.

a. What is the maximum amount Molly can give for calendar year 2011 without using her unified transfer tax credit?

b. What is the maximum amount Molly can give for calendar year 2011

also using her unified transfer tax credit? [Note: Molly has never made any prior taxable gifts.]

Correct Answer:a. $234,000. $13,000 (annual exclusion) ´ 18 donees = $234,000. b. $5,234,000. $13,000 (annual exclusion) ´ 18 donees = $234,000 + $5,000,000 (the

exemption equivalent of a $1,730,800 credit) = $5,234,000.

84. Chapter 1 - Introduction To Taxation Question PR #2 Several years ago, Ted purchased extra grazing land for his ranch at a cost of $40,000. In 2011, the land is condemned by the state for development as a highway maintenance depot. Under the condemnation award, Ted receives $100,000 for the land. Within the same year, he replaces the property with other grazing land. What is Ted’s tax situation if the replacement land cost:

a. $35,000?

b. $60,000?

c. $105,000?

d. Why?

Correct Answer:a. The full realized gain of $60,000 [$100,000 (condemnation proceeds) – $40,000 (cost of

land)] must be recognized, as only $35,000 was reinvested. The condemnation proceeds of $100,000 exceed the amount reinvested by more than $60,000.

b. As only $60,000 was reinvested in replacement property, $40,000 ($100,000 – $60,000) of the gain must be recognized.

c. As the full $100,000 was reinvested, no realized gain need be recognized.

d. If some of the gain is not reinvested, consistent with the wherewithal to pay concept there exists the ability to pay the tax.

85. Chapter 1 - Introduction To Taxation Question PR #3 Paige is the sole shareholder of Citron Corporation. During the year, Paige leases a building to Citron for a monthly rental of $80,000. If the fair rental value of the building is $60,000, what are the income tax consequences to the parties involved?

Correct Answer:The rent charged by Paige is not “arms length”; as such, Citron Corporation’s rent deduction is $60,000 (not $80,000). The $20,000 difference is a nondeductible dividend distribution. For Paige, the change merely requires reclassification. Instead of $80,000 of rent income, she has $60,000 of rent income and $20,000 of dividend income.

86. Chapter 1 - Introduction To Taxation Question PR #4 In 1985, Roy leased real estate to Drab Corporation for 20 years. Drab Corporation made significant capital improvements to the property. In 2005, Roy decides not to renew the lease and vacates the property. At that time, the value of the improvements is $800,000. Roy sells the real estate in 2011 for $1,200,000 of which $900,000 is attributable to the improvements. How and when is Roy taxed on the improvements made by Drab Corporation?

Correct Answer:Roy is not subject to taxation on the improvements until he disposes of the property (i.e., 2011). After a controversial Supreme Court decision years ago, Congress clarified the tax law to make it more consistent with the wherewithal to pay concept.

87. Chapter 1 - Introduction To Taxation Question PR #5 During the current year, Waterthrush Company had operating income of $510,000 and operating expenses of $400,000. In addition, Waterthrush had a long-term capital gain of $30,000. How does Lucinda, the sole owner of Waterthrush Company, report this information on her individual income tax return under following assumptions?

a. Waterthrush is a proprietorship, and Lucinda does not withdraw any funds from the company during the year.

b. Waterthrush is an LLC, and Lucinda does not withdraw any funds from

the company during the year. c. Waterthrush is an S corporation, and Lucinda does not withdraw any

funds from the company during the year. d. Waterthrush is a regular corporation, and Lucinda does not withdraw

any funds from the company during the year.

Correct Answer:

a. Revenues, expenses, gains, and losses of a proprietorship flow through to the proprietor. Consequently, Lucinda reports the $110,000 operating profit and $30,000 long-term capital gain on her individual return. The preferential tax rate on LTCG applies with respect to the $30,000 gain.

b. A single-member LLC is taxed as a proprietorship. Consequently, Lucinda reports the $110,000 operating profit and $30,000 long-term capital gain on her individual return. The preferential tax rate on LTCG applies with respect to the $30,000 gain.

c. Revenues, expenses, gains, and losses of an S corporation flow through to the shareholders. Separately stated items (e.g., capital gains and losses), retain their character at the shareholder level. Consequently, Lucinda reports the $110,000 operating profit and $30,000 long-term capital gain on her individual return. The preferential tax rate on LTCG applies with respect to the $30,000 gain.

d. Shareholders of a regular (C) corporation report income from the corporation to the extent of dividends received. Therefore, Lucinda does not report any of Waterthrush’s operating profit or capital gain on her individual return. [Waterthrush Company would report taxable income of $140,000 ($110,000 operating profit + $30,000 long-term capital gain) on its corporate return (Form 1120). C corporations do not receive preferential tax rate treatment with respect to LTCGs.]

88. Chapter 1 - Introduction To Taxation Question PR #6 Beige Company has approximately $250,000 in net income in 2011 before deducting any compensation or other payment to its sole owner, Janet (who is single). Assume that Janet is in the 35% marginal tax bracket. Discuss the tax aspects of each of the following arrangements. (Ignore any employment tax considerations.)

a. Janet operates Beige Company as a proprietorship. b. Janet incorporates Beige Company and pays herself a salary of

$150,000 and no dividend. c. Janet incorporates the company and pays herself a $150,000 salary

and a dividend of $77,750 ($100,000 – $22,250 corporate income tax).

d. Janet incorporates the company and pays herself a salary of $250,000.

Correct Answer:a. Janet’s tax on $250,000 at 35% $87,500

b. Janet’s tax on $150,000 at 35% $52,500 Beige’s tax on $100,000 at corporate rates 22,250 Total tax $74,750

c. Beige’s tax on $100,000 at corporate rates $22,250 Janet’s tax on $77,750 dividend distributed at 15% 11,663 Janet’s tax on $150,000 salary at 35% 52,500 Total tax $86,413

d. Janet’s tax on $250,000 at 35% $87,500

89. Chapter 1 - Introduction To Taxation Question PR #7 During the current year, Shrike Company had $220,000 net profit from operations. Carlos, the sole owner of Shrike, is in the 35% marginal tax bracket. Determine the combined tax burden for Shrike and Carlos under the following two independent situations. (Ignore any employment taxes.)

a. Shrike Company is a C corporation and all of its after-tax income is distributed to Carlos.

b. Shrike Company is a proprietorship and all of its after-tax income

is withdrawn by Carlos.

Correct Answer:a. If Shrike Company is a C corporation, the $220,000 is taxable at the corporate level,

resulting in corporate tax of $69,050. The after-tax dividend distribution of $150,950 ($220,000 – $69,050) to Carlos will result in tax of $22,642.50 ($150,950 ´ 15%). Total taxes amount to $91,692.5 ($69,050 + $22,642.50).

b. If Shrike Company is a proprietorship, there is no entity level Federal income tax. Instead,

the income of the proprietorship is reported on Carlos’s personal tax return, resulting in tax of $77,000 ($220,000 ´ 35%). Carlos’s withdrawal of the after-tax income has no income tax consequences.

90. Chapter 1 - Introduction To Taxation Question ES #1 Timothy recently converted a warehouse into apartment lofts, which he is renting to single professionals. In making the conversion, he emphasized improvements that were portable in nature. Thus, the sprinkler system, heating and cooling units, and room dividers are all removable from the building. In terms of ad valorem property taxes, what was Timothy trying to accomplish?

Correct Answer:When personalty is permanently attached to real estate so that its removal will cause irreparable damage, it becomes a fixture. Consequently, it ceases to be personalty and is now regarded as realty. The classification of an asset is important because different ad valorem taxes apply to realty than to personalty. For one thing, the ad valorem tax on realty is less easily avoided. Also to be considered is the possibility that the ad valorem tax on personalty (even if it cannot be avoided) could be lower than that applicable to realty.

91. Chapter 1 - Introduction To Taxation Question ES #2 Due to the population change, the Goose Creek School District has decided to close one of its high schools. Since it has no further need of the property, the school is listed for sale. The two bids it receives are as follows:

United Methodist Church $1,700,000Planet Motors 1,600,000

The United Methodist Church would use the property to establish a sectarian middle school. Planet, a well-known car dealership, would revamp the property and operate it as a branch location.

If you were a member of the School District board, what factors would you consider in evaluating the two bids?

Correct Answer:Although the bid from the United Methodist Church is higher, several other factors need to be considered. Does, for example, Goose Creek School district exempt property owned by churches from its ad valorem taxes? If so, losing this property from the tax base could prove very costly over the long run. Also, it is probable that income-producing property (such as a car dealership) would be taxed at a higher rate than that owned by a nonprofit organization (a school operated by a church). This assumes, of course, that the school would not be taxed at all. The auto dealership also would generate sales tax.

92. Chapter 1 - Introduction To Taxation Question ES #3 Morgan inherits her father’s personal residence including all of the furnishings. She plans to add a swimming pool and sauna to the property and rent it as a furnished house. What are some of the ad valorem

property tax problems Morgan can anticipate?

Correct Answer:The real estate taxes probably will increase for several reasons. The capital improvements and the conversion from residential to rental will trigger the increase. Furthermore, the furnishings may generate an ad valorem tax on personalty. (Depending on applicable law, furniture might not be subject to tax unless used for business purposes—such as in this case.)

93. Chapter 1 - Introduction To Taxation Question ES #4

In 2009, Deborah became 65 years old. In 2010 she added a swimming pool, and in 2011 she converted the residence to rental property and moved into an assisted living facility. Since 2008, Deborah’s ad valorem property taxes have decreased once and increased twice. Explain.

Correct Answer:The decrease probably came in 2009 when Deborah reached age 65. The increases probably occurred in 2010 when she added the pool and in 2011 when the residence was converted to rental property.

94. Chapter 1 - Introduction To Taxation Question ES #5 A lack of compliance in the payment of use taxes can be eased by several means. In this regard, comment on the following:

a. Registration of automobiles.

b. Reporting of Internet purchases on state income tax returns.

Correct Answer:a. As reflected in Example 4 in the text, re-registration of a car purchased out-of-state is the

occasion for the owner’s home state to collect the use tax.

b. Completing the state income tax return reminds (or forces) the taxpayer to pay use tax on out-of-state-purchases.

95. Chapter 1 - Introduction To Taxation Question ES #6 State and local governments are sometimes forced to find ways to generate additional revenue. Comment on the pros and cons of the following procedures:

a. Decouple what would be part of the piggyback format of the state income tax.

b. Tax amnesty provisions. c. Internet shaming.

Correct Answer:a. The decoupling process is easily accomplished as to new Federal tax changes that have

never taken effect at the state level. Taxpayers are not apt to miss what they never have enjoyed.

b. Tax amnesty provisions generate considerable revenue. It also unmasks many taxpayers who have not previously paid taxes. Now that the taxing jurisdiction is aware of their existence, they will tend to pay taxes in the future.

c. By use of a public Web site, the taxing authority posts the names of those taxpayers that are delinquent as to various taxes (e.g., sales, income). This public humiliation (or threat of) very often results in compliance.

96. Chapter 1 - Introduction To Taxation Question ES #7 In terms of revenue neutrality, comment on a tax cut enacted by Congress that:

a. contains revenue offsets.

b. is phased in over a period of years.

c. contains a sunset provision.

Correct Answer:a. Ideally, to achieve revenue neutrality all tax cuts should be accompanied by revenue

offsets. b. The phase-in approach to a tax cut was taken by Congress in the Tax Relief

Reconciliation Act of 2001 (e.g., the phase-in of the repeal of the Federal estate tax) and reduces the short-run revenue loss.

c. A sunset provision does not account for the immediate revenue losses generated by a

tax cut. It merely provides that such losses will not continue beyond a specified date when the tax cut expires and the former tax law is reinstated.

97. Chapter 1 - Introduction To Taxation Question ES #8

The tax law contains various tax credits, deductions, and exclusions that are designed to encourage taxpayers to obtain additional education. On what grounds can these provisions be justified?

Correct Answer:Social and economic considerations. As to the latter, a better educated workforce carries a positive economic impact.

98. Chapter 1 - Introduction To Taxation Question ES #9 The tax law contains various provisions that encourage home ownership.

a. On what basis can this objective be justified?

b. Are there any negative considerations? Explain.

Correct Answer:a. Home ownership can be justified on economic and social grounds. b. Granting tax advantages to persons who are purchasing their homes places the

taxpayers who rent at a disadvantage. The result is inequality in treatment.

99. Chapter 1 - Introduction To Taxation Question ES #10 The tax law allows an income tax deduction for state and local income taxes or state and local sales taxes paid. Explain the justification for each.

Correct Answer:The deduction for state and local income taxes can be justified on the grounds that it mitigates the double tax imposed on the same income. The deduction for sales taxes paid cannot be similarly justified. Here, the rationale was to place those states that rely on a general sales tax on a parity with those that emphasize an income tax. Thus, if a resident of Montana (which imposes an income tax but no sales tax) can deduct the state income tax, should not a resident of Wyoming (which imposes a general sales tax but no income tax) be able to deduct the sales tax?

100. Chapter 1 - Introduction To Taxation Question ES #11 The tax law allows, under certain conditions, deferral of gain recognition for involuntary conversions.

a. What is the justification for this relief measure?

b. What happens if the proceeds are not entirely reinvested?

Correct Answer:

a. By recognizing that the taxpayer’s relative economic situation has not changed and that he or she lacks the wherewithal to pay a tax, any recognition of realized gain is deferred.

b. If the proceeds from an involuntary conversion are not fully reinvested in property that is similar or related in service or use, recognized gain results. Such recognized gain cannot exceed realized gain and will be limited to the amount of the proceeds not reinvested. Recognition is based on the notion that the taxpayer now has the wherewithal to pay the tax that results.

101. Chapter 2 - Working With The Tax Law Question TF #1 A professional must understand the relative weight of authority within the sources of tax law.

*a. Trueb. False

102. Chapter 2 - Working With The Tax Law Question TF #2 The Internal Revenue Code of 1986 was substantially a re-codification of the existing Code.

a. True*b. False

103. Chapter 2 - Working With The Tax Law Question TF #3 Federal tax legislation generally originates in the House Ways and Means Committee.

*a. Trueb. False

104. Chapter 2 - Working With The Tax Law Question TF #4 House members have considerable latitude to make amendments on the House floor.

a. True*b. False

105. Chapter 2 - Working With The Tax Law Question TF #5 Before a tax bill can become law, it must be approved by the President.

a. True*b. False

106. Chapter 2 - Working With The Tax Law Question TF #6 Subchapter P refers to the “Partners and Partnerships” section of the Internal Revenue Code.

a. True*b. False

107. Chapter 2 - Working With The Tax Law Question TF #7 Regulations are arranged in the same sequence as the Internal Revenue Code.

*a. Trueb. False

108. Chapter 2 - Working With The Tax Law Question TF #8 A Temporary Regulation under § 173 of the Code would be cited as follows: Temp. Reg. § 173.

a. True*b. False

109. Chapter 2 - Working With The Tax Law Question TF #9 Temporary Regulations are first published in the Internal Revenue Bulletin.

a. True*b. False

110. Chapter 2 - Working With The Tax Law Question TF #10 Revenue Rulings issued by the National Office of the IRS carry the same legal force and effect as Regulations.

a. True*b. False

111. Chapter 2 - Working With The Tax Law Question TF #11 A Revenue Ruling is a judicial source of Federal tax law.

a. True*b. False

112. Chapter 2 - Working With The Tax Law Question TF #12 The following citation can be a correct citation: Rev. Rul. 95-271, I.R.B. No. 54, 18.

a. True*b. False

113. Chapter 2 - Working With The Tax Law Question TF #13 Revenue Rulings deal with the internal management practices and procedures of the IRS.

a. True*b. False

114. Chapter 2 - Working With The Tax Law Question TF #14 Post-1984 letter rulings may be substantial authority for purposes of the accuracy-related penalty in § 6662.

*a. Trueb. False

115. Chapter 2 - Working With The Tax Law Question TF #15 A letter ruling applies only to the taxpayer who asks for and obtains a letter ruling.

*a. Trueb. False

116. Chapter 2 - Working With The Tax Law Question TF #16 The IRS is not required to make a letter ruling public.

a. True*b. False

117. Chapter 2 - Working With The Tax Law Question TF #17 Determination letters usually involve completed transactions.

*a. Trueb. False

118. Chapter 2 - Working With The Tax Law Question TF #18 Technical Advice Memoranda deal with proposed transactions.

a. True*b. False

119. Chapter 2 - Working With The Tax Law Question TF #19 Technical Advice Memoranda may not be cited as precedents by taxpayers.

*a. Trueb. False

120. Chapter 2 - Working With The Tax Law Question TF #20 A taxpayer must pay any tax deficiency assessed by the IRS and sue for a refund to bring suit in the U.S. Court of Federal Claims. Only in the Tax Court can jurisdiction be obtained without first paying the assessed tax deficiency.

*a. Trueb. False

121. Chapter 2 - Working With The Tax Law Question TF #21 In a U.S. District Court, a jury can decide both questions of fact and questions of law.

a. True*b. False

122. Chapter 2 - Working With The Tax Law Question TF #22 Three judges will normally hear each U.S. Tax Court case.

a. True*b. False

123. Chapter 2 - Working With The Tax Law Question TF #23 A taxpayer can obtain a jury trial in the U.S. Tax Court.

a. True*b. False

124. Chapter 2 - Working With The Tax Law Question TF #24 A taxpayer must pay any tax deficiency assessed by the IRS and sue for a refund to bring suit in the U.S. Court of Federal Claims.

*a. Trueb. False

125. Chapter 2 - Working With The Tax Law Question TF #25 Arizona is in the jurisdiction of the Second Circuit Court of Appeals.

a. True*b. False

126. Chapter 2 - Working With The Tax Law Question TF #26 Texas is in the jurisdiction of the Sixth Circuit Court of Appeals.

a. True*b. False

127. Chapter 2 - Working With The Tax Law Question TF #27 The Golsen rule has not been overturned by the U.S. Supreme Court.

*a. Trueb. False

128. Chapter 2 - Working With The Tax Law Question TF #28 The granting of a Writ of Certiorari indicates that at least four members of the Supreme Court believe that an issue is of sufficient importance to be heard by the full court.

*a. Trueb. False

129. Chapter 2 - Working With The Tax Law Question TF #29 The “respondent” refers to the party against whom a suit is brought.

*a. Trueb. False

130. Chapter 2 - Working With The Tax Law Question TF #30 The term “respondent” is a synonym for plaintiff.

a. True*b. False

131. Chapter 2 - Working With The Tax Law Question TF #31 Before 1943, the U.S. Tax Court was called the Board of Tax Appeals.

*a. Trueb. False

132. Chapter 2 - Working With The Tax Law Question TF #32 The following citation is correct: James E. Wiese, T.C. Summary Opinion, 2005-91.

*a. Trueb. False

133. Chapter 2 - Working With The Tax Law Question TF #33 An easy way to locate a journal article pertinent to a tax problem is through Commerce Clearing House’s Federal Tax Articles.

*a. Trueb. False

134. Chapter 2 - Working With The Tax Law Question TF #34 Accessing tax documents through electronic means offers limited advantages over a strictly paper-based approach.

a. True*b. False

135. Chapter 2 - Working With The Tax Law Question TF #35 Most major tax services are available in electronic format.

*a. Trueb. False

136. Chapter 2 - Working With The Tax Law Question TF #36 Among the approaches available for online tax research are a keyword approach, a table of contents approach, an index approach, and a citation approach.

*a. Trueb. False

137. Chapter 2 - Working With The Tax Law Question TF #37 The Internet provides a wealth of tax information in several popular forms, sometimes at no direct cost to the researcher.

*a. Trueb. False

138. Chapter 2 - Working With The Tax Law Question TF #38 When dealing with proposed transactions, the tax research process is directed toward the determination of possible alternative consequences.

*a. Trueb. False

139. Chapter 2 - Working With The Tax Law Question TF #39 A court will never invalidate a Regulation or portion thereof on the grounds that the Regulation is contrary to the intent of Congress.

a. True*b. False

140. Chapter 2 - Working With The Tax Law Question TF #40 IRS agents must give the Code and Regulations issued thereunder equal weight when dealing with taxpayers and their representatives.

*a. Trueb. False

141. Chapter 2 - Working With The Tax Law Question TF #41 Proposed Regulations are often cited by the various courts.

a. True*b. False

142. Chapter 2 - Working With The Tax Law Question TF #42 Interpretive Regulations do not have the force and effect of law.

*a. Trueb. False

143. Chapter 2 - Working With The Tax Law Question TF #43 A U. S. Tax Court decision carries less weight than a decision issued by the Fifth Circuit Court of Appeals.

*a. Trueb. False

144. Chapter 2 - Working With The Tax Law Question TF #44 The computer-based CPA examination has four sections with true-false, multiple-choice, and case studies (called simulations).

a. True*b. False

145. Chapter 2 - Working With The Tax Law Question MC #1 The Internal Revenue Code was codified in which of the following years?

a. 1913.b. 1933.*c. 1954.d. 1957.e. None of the above.

146. Chapter 2 - Working With The Tax Law Question MC #2 Tax bills are handled by which committee in the U.S. Senate?

a. Taxation Committee.b. Ways and Means Committee.*c. Finance Committee.d. Budget Committee.e. None of the above.

147. Chapter 2 - Working With The Tax Law Question MC #3 Which committee reconciles the tax bills between the Senate and the House?

a. Joint Committee on Taxation.*b. Joint Conference Committee.c. Joint Reconciliation Committee.d. Joint Resolving Committee.e. None of the above.

148. Chapter 2 - Working With The Tax Law Question MC #4 Subchapter S covers which specific area of tax law?

a. Simplification.b. Deductions.c. Capital gains and losses.d. Tax rates.*e. None of the above.

149. Chapter 2 - Working With The Tax Law Question MC #5 Which is not a Code section number?

a. § 212(1).b. § 2(a)(1).c. § 280B.*d. § 6(a).e. All are current Code sections.

150. Chapter 2 - Working With The Tax Law Question MC #6 Which statement is false with respect to tax treaties?

a. There is a $1,000 penalty per failure to disclose on the tax return where there is a direct treaty conflict for an individual.b. There is a $10,000 penalty per failure to disclose on the tax return where there is a direct treaty conflict for a corporation.*c. Treaties override the Code when in conflict.d. Treaties may override a Code section when in conflict.e. None of the above.

151. Chapter 2 - Working With The Tax Law Question MC #7 Which of the following is not an administrative source of the tax law?

a. General Counsel Memoranda.b. Revenue Procedures.c. Technical Advice Memoranda.d. Actions on Decisions.*e. All of the above are administrative sources.

152. Chapter 2 - Working With The Tax Law Question MC #8 Which of the following sources has the highest tax validity?

a. Revenue Ruling.b. Letter ruling.c. Regulations.*d. Internal Revenue Code section.e. None of the above.

153. Chapter 2 - Working With The Tax Law Question MC #9 Which of the following types of Regulations has the highest tax

validity?

a. Temporary.*b. Legislative.c. Interpretative.d. Procedural.e. None of the above.

154. Chapter 2 - Working With The Tax Law Question MC #10 What statement is not true with respect to a regulation which interprets the tax law?

*a. Issued by the U.S. Congress.b. Issued by the U.S. Treasury Department.c. Designed to provide an interpretation of the tax law.d. Carries more legal force than a Revenue Ruling.e. All of the above statements are true.

155. Chapter 2 - Working With The Tax Law Question MC #11 In assessing the importance of a regulation, an IRS agent must:

*a. Give equal weight to the Code and regulations.b. Give more weight to the Code rather than to a regulation.c. Give more weight to the regulation rather than to the Code.d. Give less weight to the Code rather than to a regulation.e. None of the above.

156. Chapter 2 - Working With The Tax Law Question MC #12 Which item may not be cited as a precedent?

a. Regulations.b. Temporary Regulations.*c. Technical Advice Memoranda.d. U.S. District Court decision.e. None of the above.

157. Chapter 2 - Working With The Tax Law Question MC #13 What statement is not true with respect to Temporary Regulations?

*a. May not be cited as precedent.b. Issued as Proposed Regulations.c. Automatically expire within three years after the date of issuance.d. Found in the Federal Register.e. All of the above statements are true.

158. Chapter 2 - Working With The Tax Law Question MC #14 What administrative release deals with a proposed transaction rather

than a completed transaction?

*a. Letter Ruling.b. Technical Advice Memorandum.c. Determination Letter.d. Field Service Advice.e. None of the above.

159. Chapter 2 - Working With The Tax Law Question MC #15 Which court decisions are published in paper format by the U.S. government?

a. U.S. Tax Court Memorandum decision.*b. U.S. Tax Court regular decision.c. Fifth Circuit U.S. Court of Appeals decision.d. Court of Federal Claims decision.e. All of the above.

160. Chapter 2 - Working With The Tax Law Question MC #16 Which would not be a citation to a District Court case?

a. 2004-1 USTC ¶ 60,478.b. 93 AFTR 2d 2004-668.c. 306 F. Supp. 2d 668.*d. 97 TCM 1488.e. All of the above are District Court cites.

161. Chapter 2 - Working With The Tax Law Question MC #17 Which tax source may override a Regulation section?

a. Revenue Ruling.b. Revenue Procedure.*c. U.S. tax treaty.d. Technical Advice Memoranda.e. None of the above.

162. Chapter 2 - Working With The Tax Law Question MC #18 Which of the following journals is published by the American Institute of CPAs?

a. Journal of Taxation.b. Corporate Taxation.c. Tax Law Review.*d. The Tax Advisor.e. All of the above.

163. Chapter 2 - Working With The Tax Law Question MC #19 Where can a researcher not find a U.S. Court of Appeals decision?

a. Federal 3d (West).*b. F. Supp. 2d Series (West).c. AFTR (RIA).d. USTC (CCH).e. None of the above.

164. Chapter 2 - Working With The Tax Law Question MC #20 Which publisher offers Tax Center that provides the Code, Regulations, and material from Matthew Bender, CCH, Kleinrock, and the Bureau of National Affairs?

a. Research Institute of America.b. Commerce Clearing House.*c. LexisNexis.d. Prentice-Hall.e. None of the above.

165. Chapter 2 - Working With The Tax Law Question MC #21 Which publisher offers the Standard Federal Tax Reporter?

a. Research Institute of America.*b. Commerce Clearing House.c. Prentice-Hall.d. LexisNexis.e. None of the above.

166. Chapter 2 - Working With The Tax Law Question MC #22 Which is presently not a major tax service?

a. Standard Federal Tax Reporter.*b. Federal Taxes.c. United States Tax Reporter.d. Tax Management Portfolios.e. All of the above are major tax services.

167. Chapter 2 - Working With The Tax Law Question MC #23 Which publisher offers the United States Tax Reporter?

*a. Research Institute of America.b. Commerce Clearing House.c. LexisNexis.d. Tax Analysts.e. None of the above.

168. Chapter 2 - Working With The Tax Law Question MC #24 When searching on an online tax service, which approach is more frequently used?

a. Code section approach.*b. Keyword approach.c. Table of contents approach.d. Index.e. All are about the same.

169. Chapter 2 - Working With The Tax Law Question MC #25 A researcher can find tax information on home page sites of:

a. Governmental bodies.b. Tax academics.c. Publishers.d. CPA firms.*e. All of the above.

170. Chapter 2 - Working With The Tax Law Question MC #26 Tax research involves which of the following procedures:

a. Identifying and refining the problem.b. Locating the appropriate tax law sources.c. Assessing the validity of the tax law sources.d. Follow-up.*e. All of the above.

171. Chapter 2 - Working With The Tax Law Question MC #27 Which tax-related website probably gives the best policy-orientation results?

a. taxalmanac.org.b. irs.gov.c. taxsites.com.*d. taxanalyst.com.e. ustaxcourt.gov.

172. Chapter 2 - Working With The Tax Law Question MC #28 Which court decision would probably carry more weight?

a. Regular U.S. Tax Court decision.*b. Reviewed U.S. Tax Court decision.c. U.S. District Court decision.d. Memorandum Tax Court decision.e. U.S. Court of Federal Claims.

173. Chapter 2 - Working With The Tax Law Question MC #29 Which Regulations have the force and effect of law?

a. Procedural Regulations.b. Finalized Regulations.*c. Legislative Regulations.

d. Interpretive Regulations.e. All of the above.

174. Chapter 2 - Working With The Tax Law Question MC #30 Which items tell taxpayers the IRS’s reaction to certain court decisions?

a. Notices.b. Revenue Procedures.c. Revenue Rulings.*d. Actions on Decisions.e. Procedural Regulations.

175. Chapter 2 - Working With The Tax Law Question MC #31 Which court decision carries less weight?

a. Federal District Court.b. Fifth Circuit Court of Appeals.c. Memorandum U.S. Tax Court decision.*d. Small Cases Division of U.S. Tax Court.e. U.S. Court of Federal Claims.

176. Chapter 2 - Working With The Tax Law Question MC #32 Which company does not publish citators for tax purposes?

*a. McGraw-Hill.b. Commerce Clearing House.c. Research Institute of America.d. Westlaw.e. Shepard’s.

177. Chapter 2 - Working With The Tax Law Question MC #33 Which is not a primary source of tax law?

a. Notice 89-99, 1989-2 C.B. 422.b. Estate of Harry Holmes v. Comm., 326 U.S. 480 (1946).c. Rev. Rul. 79-353, 1979-2 C.B. 325.d. Temp. Reg. § 1.752-4T(f).*e. All of the above are primary sources.

178. Chapter 2 - Working With The Tax Law Question MC #34 Which statement is incorrect with respect to taxation on the CPA exam?

a. The CPA exam now has only four parts.*b. There are no longer case studies on the exam.c. A candidate may not go back after exiting a testlet.d. Simulations include a four-function pop-up calculator.e. None of the above are incorrect.

179. Chapter 2 - Working With The Tax Law Question ES #1 What is the role of the Joint Conference Committee in the legislative process?

Correct Answer:When the Senate version of a bill differs from that passed by the House, the Joint Conference Committee, which includes members of both the House Ways and Means Committee and the Senate Finance Committee, is called upon to resolve the differences. The deliberations of the Joint Conference Committee usually produce a compromise between the two versions, which is then voted on by both the House and the Senate. If both bodies accept the bill, it is referred to the President for approval or veto.

180. Chapter 2 - Working With The Tax Law Question ES #2 What are Treasury Department Regulations?

Correct Answer:Regulations are issued by the U.S. Treasury Department under authority granted by Congress. Interpretive by nature, they provide taxpayers with considerable guidance on the meaning and application of the Code. Regulations may be issued in proposed, temporary, or final form. Regulations carry considerable authority as the official interpretation of tax statutes. They are an important factor to consider in complying with the tax law. Courts generally ignore Proposed Regulations.

181. Chapter 2 - Working With The Tax Law Question ES #3 Compare Revenue Rulings with Revenue Procedures.

Correct Answer:Revenue Rulings are official pronouncements of the National Office of the IRS. They typically provide one or more examples of how the IRS would apply a law to specific fact situations. Like Regulations, Revenue Rulings are designed to provide interpretation of the tax law. However, they do not carry the same legal force and effect as Regulations and usually deal with more restricted problems. Regulations are approved by the Secretary of the Treasury, whereas Revenue Rulings generally are not.

Revenue Procedures are issued in the same manner as Revenue Rulings, but deal with the internal management practices and procedures of the IRS. Familiarity with these procedures can increase taxpayer compliance and help the IRS administer the tax laws more efficiently. A taxpayer’s failure to follow a Revenue Procedure can result in unnecessary delay or, in a discretionary situation, can cause the IRS to decline to act on behalf of the taxpayer.

182. Chapter 2 - Working With The Tax Law Question ES #4 Compare a determination letter with a letter ruling.

Correct Answer:Like letter rulings, determination letters are issued at the request of taxpayers and provide guidance on the tax law. Determination letters differ from letter rulings in that the issuing source of a determination letter is the Area Director rather than the National Office of the IRS. Also, determination letters usually involve completed (as opposed to proposed) transactions. Determination letters are not published and are made known only to the party making the request.

183. Chapter 2 - Working With The Tax Law Question ES #5 Discuss the advantages and disadvantages of the Small Cases Division of the U.S. Tax Court.

Correct Answer:There is no appeal from the Small Cases Division. The jurisdiction of the Small Cases Division is limited to cases involving amounts of $50,000 or less. The proceedings of the Small Cases Division are informal (e.g., no necessity for the taxpayer to be represented by a lawyer or other tax adviser). Special trial judges rather than Tax Court judges preside over these proceedings. The decisions of the Small Cases Division are not precedents for any other court decision and are not reviewable by any higher court. Proceedings can be more timely and less expensive in the Small Cases Division. Some of these cases can now be found on the U.S. Tax Court Internet Website.

184. Chapter 2 - Working With The Tax Law Question ES #6 Explain the tax appeals process from trial courts.

Correct Answer:Appeals from a District Court or a Tax Court decision are to the U. S. Court of Appeals for the circuit in which the taxpayer resides. Appeals from the Court of Federal Claims go to the U. S. Court of Appeals for the Federal Circuit. Few Tax Court cases are appealed, and when appeals are made, most are filed by the taxpayer rather than the IRS. There is no appeal from the Small Cases Division.

185. Chapter 3 - Taxes On The Financial Statements Question TF #1 If a corporation has no subsidiaries outside the U.S., its book and taxable income are identical.

a. True*b. False

186. Chapter 3 - Taxes On The Financial Statements Question TF #2 Only U.S. corporations are included in a combined GAAP financial statement.

a. True*b. False

187. Chapter 3 - Taxes On The Financial Statements Question TF #3 Domestic and foreign entities owned more than 80% are included in a consolidated group’s U.S. tax return.

a. True*b. False

188. Chapter 3 - Taxes On The Financial Statements Question TF #4 Giant uses the “equity method” to account for the operations of its 40% owned subsidiary Little. A portion of Little’s profits for the year are included in Giant’s GAAP book income.

*a. Trueb. False

189. Chapter 3 - Taxes On The Financial Statements Question TF #5 The operations of an 80% or more owned domestic subsidiaries must be included in the parent corporation’s consolidated tax return.

a. True*b. False

190. Chapter 3 - Taxes On The Financial Statements Question TF #6 Yahr, Inc., is a domestic corporation with no subsidiaries. It operates in almost every U.S. state. Yahr records no permanent or temporary book-tax differences this year. Yahr’s tax expense on its GAAP financial statements and its tax liability reported on its Federal income tax return are identical.

a. True*b. False

191. Chapter 3 - Taxes On The Financial Statements Question TF #7 “Temporary differences” are book-tax income differences that eventually appear in both the financial statements and the income tax return, but not in the same reporting period.

*a. Trueb. False

192. Chapter 3 - Taxes On The Financial Statements Question TF #8 Schedule M-3 of the tax return Form 1120 reconciles financial statement net income after tax with a large corporation’s taxable income.

*a. Trueb. False

193. Chapter 3 - Taxes On The Financial Statements Question TF #9 “Permanent differences” include items that appear in the Federal income tax return as income or deduction, and in the GAAP financial statements as revenue or expense, but in different reporting periods.

a. True*b. False

194. Chapter 3 - Taxes On The Financial Statements Question TF #10 In general, the purpose of ASC 740 (SFAS 109) is to compute and disclose the actual taxes paid by a business entity to state, local, Federal, and foreign governments for the current year.

a. True*b. False

195. Chapter 3 - Taxes On The Financial Statements Question TF #11 The current tax expense reported on the GAAP financial statement generally represents the taxes actually payable to domestic or foreign governmental authorities.

*a. Trueb. False

196. Chapter 3 - Taxes On The Financial Statements Question TF #12 A deferred tax liability represents a potential future tax benefit associated with income reported in the current year GAAP financial statements.

a. True*b. False

197. Chapter 3 - Taxes On The Financial Statements Question TF #13 A deferred tax liability represents a current tax liability associated with income or expense to be reported in future year GAAP financial statements.

a. True*b. False

198. Chapter 3 - Taxes On The Financial Statements Question TF #14 A deferred tax asset is the expected future tax benefit (savings) associated with income reported in the current year GAAP financial statements.

*a. Trueb. False

199. Chapter 3 - Taxes On The Financial Statements Question TF #15 A deferred tax asset is the current tax benefit (savings) associated with income or expense to be reported in future year GAAP financial statements.

a. True*b. False

200. Chapter 3 - Taxes On The Financial Statements Question TF #16 The valuation allowance can reduce either a deferred tax asset or a deferred tax liability.

a. True*b. False

201. Chapter 3 - Taxes On The Financial Statements Question TF #17 If a valuation allowance is increased in the current year, the corporation’s effective tax rate is higher than if the valuation allowance had not increased.

*a. Trueb. False

202. Chapter 3 - Taxes On The Financial Statements Question TF #18 If a valuation allowance is decreased (released) in the current year, the corporation’s effective tax rate is higher than if the valuation allowance had not increased.

a. True*b. False

203. Chapter 3 - Taxes On The Financial Statements Question TF #19 Under GAAP, a corporation can defer a disclosure of the future U.S. tax expense related to the earnings of foreign subsidiaries, by taking into account its repatriation plans for these earnings.

*a. Trueb. False

204. Chapter 3 - Taxes On The Financial Statements Question TF #20 One can describe the benefits of ASC 740-30 (APB 23) as “all or nothing.” If it is elected, APB 23 applies to the earnings from all foreign subsidiaries, in the current year and thereafter.

a. True*b. False

205. Chapter 3 - Taxes On The Financial Statements Question TF #21 Repatriating prior year earnings from a foreign subsidiary located in a

low-tax country where ASC 740-30 (APB 23) benefits were previously adopted will cause an increase in a corporation’s current year effective tax rate.

*a. Trueb. False

206. Chapter 3 - Taxes On The Financial Statements Question TF #22 The taxpayer should use the technique of ASC 740-30 (APB 23) income deferral only when the tax rates that apply to the subsidiary are less than those of the applicable U.S. income tax rate.

*a. Trueb. False

207. Chapter 3 - Taxes On The Financial Statements Question TF #23 The income tax note to the GAAP financial statements includes a reconciliation of a corporation’s hypothetical tax on book income to its book tax expense as if it were taxed at the applicable U.S. income tax rates.

*a. Trueb. False

208. Chapter 3 - Taxes On The Financial Statements Question TF #24 In the “rate reconciliation” of GAAP tax footnotes, temporary book-tax differences are reconciled between book income as if taxed at U.S. tax rates and the actual book income tax expense.

a. True*b. False

209. Chapter 3 - Taxes On The Financial Statements Question TF #25 A $50,000 cash tax savings that is temporary has the same effect on a corporation’s current year effective tax rate as a $50,000 cash tax savings that is a permanent difference.

a. True*b. False

210. Chapter 3 - Taxes On The Financial Statements Question TF #26 ASC 740 (FIN 48) allows companies to choose their own level of certainty in reporting uncertain tax positions in their financial statements.

*a. Trueb. False

211. Chapter 3 - Taxes On The Financial Statements Question TF #27 ASC 740 (FIN 48) replaced FAS 5, Accounting for Contingencies, with regard to accounting for uncertain tax positions.

*a. Trueb. False

212. Chapter 3 - Taxes On The Financial Statements Question TF #28 The major purpose of ASC 740 (SFAS 109) is to build a cushion into currently reported income tax expense in order to insure that the financial statements are conservative.

a. True*b. False

213. Chapter 3 - Taxes On The Financial Statements Question TF #29 Current tax expense always totals the amount a taxpayer actually paid all Federal, state, and foreign tax authorities in a particular year.

a. True*b. False

214. Chapter 3 - Taxes On The Financial Statements Question MC #1 Purple, Inc., a domestic corporation, owns 100% of Blue, Ltd., a foreign corporation and Yellow, Inc., a domestic corporation. Purple also owns 40% of Green, Inc., a domestic corporation. Purple receives no distributions from any of these corporations. Which of these entities’ net income are included in Purple’s GAAP income statement for current year financial reporting purposes?

*a. Purple, Blue, Yellow, and Green.b. Purple, Blue, and Yellow.c. Purple, Blue, and Green.d. Purple, Yellow, and Green.

215. Chapter 3 - Taxes On The Financial Statements Question MC #2 Create, Inc., a domestic corporation, owns 100% of Vinyl, Ltd., a foreign corporation and Digital, Inc., a domestic corporation. Create also owns 12% of Record, Inc., a domestic corporation. Create receives no distributions from any of these corporations. Which of these entities’ net income are included in Create’s income statement for current year financial reporting purposes?

a. Create, Vinyl, Digital, and Record.b. Create, Vinyl, and Record.*c. Create, Vinyl, and Digital.d. Create, Digital, and Record.e. None of the above.

216. Chapter 3 - Taxes On The Financial Statements Question MC #3 Purple, Inc., a domestic corporation, owns 80% of Blue, Ltd., a foreign corporation and Yellow, Inc., a domestic corporation. Purple also owns 50% of Green, Inc., a domestic corporation. Purple receives no distributions from any of these corporations. Which of these entities’ net income are included in Purple’s Federal tax return for the current year assuming Purple elects to include all eligible entities in its consolidated Federal income tax return?

a. Purple, Blue, Yellow, and Green.b. Purple, Blue, and Yellow.c. Purple, Blue, and Green.*d. Purple and Yellow.

217. Chapter 3 - Taxes On The Financial Statements Question MC #4 Create, Inc., a domestic corporation, owns 90% of Vinyl, Ltd., a foreign corporation and Digital, Inc., a domestic corporation. Create also owns 60% of Record, Inc., a domestic corporation. Create receives no distributions from any of these corporations. Which of these entities’ net income are included in Create’s Federal tax return for the current year assuming Create elects to include all eligible entities in its consolidated Federal income tax return?

*a. Create and Digital.b. Create, Vinyl, and Digital.c. Create, Vinyl, and Record.d. Create, Vinyl, Digital, and Record.

218. Chapter 3 - Taxes On The Financial Statements Question MC #5 Which of the following taxes are included in the total income tax expense of a corporation as reported on its financial statements?

a. State income taxes.b. Local income taxes.c. Foreign income taxes.d. Federal income taxes.*e. All the above taxes are included.

219. Chapter 3 - Taxes On The Financial Statements Question MC #6 Which of the following taxes are included in the total income tax expense of a corporation reported on its Federal tax return?

a. State income taxes.b. Local income taxes.c. Foreign income taxes.*d. Federal income taxes.e. All the above taxes are included

220. Chapter 3 - Taxes On The Financial Statements Question MC #7 Which of the following items represents a temporary book-tax

difference?

a. Municipal bond interest.*b. Compensation-related expenses.c. Meals and entertainment expense deduction.d. Nondeductible penalties.

221. Chapter 3 - Taxes On The Financial Statements Question MC #8 Phyllis, Inc., earns book net income before tax of $600,000. Phyllis puts into service a depreciable asset this year, and first year tax depreciation exceeds book depreciation by $120,000. Phyllis has recorded no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is Phyllis’s total income tax expense reported on its GAAP financial statements?

a. $252,000.*b. $210,000.c. $168,000.d. $42,000.

222. Chapter 3 - Taxes On The Financial Statements Question MC #9 Gravel, Inc., earns book net income before tax of $600,000. Gravel puts into service a depreciable asset this year, and first year tax depreciation exceeds book depreciation by $120,000. Gravel has recorded no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is Gravel’s current income tax expense reported on its GAAP financial statements?

a. $252,000.b. $210,000.*c. $168,000.d. $42,000.

223. Chapter 3 - Taxes On The Financial Statements Question MC #10 Clipp, Inc., earns book net income before tax of $600,000. Clipp puts into service a depreciable asset this year, and first year tax depreciation exceeds book depreciation by $120,000. Clipp has recorded no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is Clipp’s deferred income tax liability reported on its GAAP financial statements?

a. $252,000.b. $210,000.c. $168,000.*d. $42,000.

224. Chapter 3 - Taxes On The Financial Statements Question MC #11 Jogg, Inc., earns book net income before tax of $600,000. Jogg puts into service a depreciable asset this year, and first year tax depreciation exceeds book depreciation by $120,000. Jogg has recorded no other temporary or permanent book-tax differences. Assuming that the

U.S. tax rate is 35%, and that this is Jogg’s first year of operations, what is Jogg’s balance in its deferred tax asset and deferred tax liability accounts at year end?

a. $42,000 and $0.*b. $0 and $42,000.c. $42,000 and $42,000.d. $0 and $0.

225. Chapter 3 - Taxes On The Financial Statements Question MC #12 Qute, Inc., earns book net income before tax of $500,000. In computing its book income, Qute deducts $50,000 more in warranty expense for book purposes than is allowed for tax purposes. Qute records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35% and no valuation allowance is required, what is Qute’s total income tax expense reported on its GAAP financial statements?

a. $192,500.*b. $175,000.c. $157,500.d. $17,500.

226. Chapter 3 - Taxes On The Financial Statements Question MC #13 Morrisson, Inc., earns book net income before tax of $500,000. In computing its book income, Morrisson deducts $50,000 more in warranty expense for book purposes than is allowed for tax purposes. Morrisson records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35% and no valuation allowance is required, what is Morrisson’s current income tax expense reported on its GAAP financial statements?

*a. $192,500.b. $175,000.c. $157,500.d. $17,500.

227. Chapter 3 - Taxes On The Financial Statements Question MC #14 Never, Inc., earns book net income before tax of $500,000. In computing its book income, Never deducts $50,000 more in warranty expense for book purposes than is allowed for tax purposes. Never records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35% and no valuation allowance is required, what is Never’s deferred income tax asset reported on its GAAP financial statements?

a. $192,500.b. $175,000.c. $157,500.*d. $17,500.

228. Chapter 3 - Taxes On The Financial Statements Question MC #15 South, Inc., earns book net income before tax of $400,000 in 2010.

South acquires a depreciable asset in 2010, and first year tax depreciation exceeds book depreciation by $50,000. At the end of 2010, South’s deferred tax liability account balance is $17,500. In 2011, South earns $500,000 book net income before tax, and its book depreciation exceeds tax depreciation by $20,000. South records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is South’s total income tax expense reported on its GAAP financial statements for 2011?

a. $182,000.*b. $175,000.c. $168,000.d. $7,000.

229. Chapter 3 - Taxes On The Financial Statements Question MC #16 South, Inc., earns book net income before tax of $400,000 in 2010. South acquires a depreciable asset in 2010, and first year tax depreciation exceeds book depreciation by $50,000. At the end of 2010, South’s deferred tax liability account balance is $17,500. In 2011, South earns $500,000 book net income before tax, and its book depreciation exceeds tax depreciation by $20,000. South records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is South’s current income tax expense reported on its GAAP financial statements for 2011?

*a. $182,000.b. $175,000.c. $168,000.d. $7,000.

230. Chapter 3 - Taxes On The Financial Statements Question MC #17 South, Inc., earns book net income before tax of $400,000 in 2010. South acquires a depreciable asset in 2010, and first year tax depreciation exceeds book depreciation by $50,000. At the end of 2010, South’s deferred tax liability account balance is $17,500. In 2011, South earns $500,000 book net income before tax, and its book depreciation exceeds tax depreciation by $20,000. South records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 35%, what is South’s balance in its deferred tax liability account at the end of 2011?

a. $17,500.*b. $10,500.c. $7,000.d. $0.

231. Chapter 3 - Taxes On The Financial Statements Question MC #18 Larson, Inc., hopes to report a total book tax expense of $160,000 in the current year. This $160,000 expense consists of $240,000 in current tax expense and an $80,000 tax benefit related to the expected future use of an NOL by Larson. If the auditors determine that a valuation allowance of $30,000 must be placed against Larson’s deferred tax

assets, what is Larson’s total book tax expense?

a. $160,000.b. $130,000.*c. $190,000.d. $240,000.

232. Chapter 3 - Taxes On The Financial Statements Question MC #19 Cold, Inc., reported a $100,000 total tax expense for financial statement purposes in 2010. This total expense consisted of $150,000 in current tax expense and a deferred tax benefit of $50,000. The deferred tax benefit consisted of $90,000 in deferred tax assets reduced by a valuation allowance of $40,000. In 2011, Cold reports $600,000 in book net income before tax. Cold records no other permanent or temporary book-tax differences for 2011. At the end of 2011, Cold’s auditors determine that the existing valuation allowance of $40,000 should be reduced to zero. What is Cold’s total tax expense for 2011?

a. $210,000.*b. $170,000.c. $250,000.d. $40,000.

233. Chapter 3 - Taxes On The Financial Statements Question MC #20 Beach, Inc., a domestic corporation, owns 100% of Mountain, Ltd., a manufacturing facility in Ireland. Mountain has no operations or activities in the United States. The U.S. tax rate is 35% and the Irish tax rate is 10%. For the current year, Beach earns $500,000 in taxable income. Mountain earns $300,000 in taxable income from its operations, pays $30,000 in taxes to Ireland, and makes no distributions to Beach. What is Beach’s effective tax rate for GAAP book purposes, assuming that Beach does not make the permanent reinvestment assumption of ASC 740-30 (APB 23)?

a. 38.75%.b. 31.25%.*c. 35%.d. 25.63%.

234. Chapter 3 - Taxes On The Financial Statements Question MC #21 Beach, Inc., a domestic corporation, owns 100% of Mountain, Ltd., a manufacturing facility in Ireland. Mountain has no operations or activities in the United States. The U.S. tax rate is 35% and the Irish tax rate is 10%. For the current year, Beach earns $500,000 in taxable income. Mountain earns $300,000 in taxable income from its operations, pays $30,000 in taxes to Ireland, and makes no distributions to Beach. What is Beach’s effective tax rate for GAAP book purposes, assuming that Beach makes the permanent reinvestment assumption of ASC 740-30 (APB 23)?

a. 38.75%.b. 31.25%.

c. 35%.*d. 25.63%.

235. Chapter 3 - Taxes On The Financial Statements Question MC #22 Which of the following items are not included in the GAAP financial statement income tax note’s effective tax rate reconciliation?

a. Hypothetical tax on book income at U.S. Federal corporate tax rate.b. Tax effect of permanent differences.*c. Tax effect of temporary differences.d. Total tax expense per financial statements.e. None of the above is included in the note.

236. Chapter 3 - Taxes On The Financial Statements Question MC #23 Which of the following items are not included in the income tax note for a publicly traded company?

a. Breakdown of income between foreign and domestic.b. Analysis of deferred tax assets and liabilities.*c. Breakdown of income among States.d. Rate reconciliation.e. Analysis of total tax expense components.

237. Chapter 3 - Taxes On The Financial Statements Question MC #24 How are deferred tax liabilities and assets categorized on the balance sheet?

a. Capital and ordinary.b. Domestic and foreign.*c. Current and non-current.d. Positive and negative.

238. Chapter 3 - Taxes On The Financial Statements Question MC #25 Hot, Inc.’s primary competitor is Cold, Inc. When comparing relative deferred tax asset and liability accounts with Cold, which of the following benchmarking activities should Hot undertake?

*a. Scale the deferred tax assets and liabilities by total sales or total assets.b. Compare raw dollar amounts of deferred tax assets and liabilities.c. Ignore deferred tax assets and liabilities and focus on overall effective tax rate.d. Ignore all tax information other than the current tax expense.

239. Chapter 3 - Taxes On The Financial Statements Question MC #26 Collins, Inc., reports an effective tax rate in its income tax footnote of 14%. The only reconciling item with regard to the hypothetical tax at 35% is a valuation allowance reversal of negative 21%. Which of the

following statements is true concerning comparing Collins, Inc.’s effective tax rate with its competitors, all of whom have an effective tax rate between 32 and 36%?

a. Collins Inc. is managing its tax burden in a more efficient manner than its competitors.b. Collins Inc. earned more cash profits because of its lower effective tax rate.*c. Collins Inc.’s structural effective tax rate is actually quite close to its competitors.d. Collins Inc. is likely to be engaged in tax shelter activities.

240. Chapter 3 - Taxes On The Financial Statements Question MC #27 Which of the following statements best describes considerations regarding a company’s tax expense that may be made by users of GAAP financial statements?

a. The breakdown of tax expense between current and deferred may provide useful information regarding the comparison of tax burdens between companies.b. An analysis of earnings before interest, taxes, depreciation, and amortization (EBITDA) is often a better approach to comparing operating results of two companies.c. One-time effects within a company’s effective tax rate should be removed before comparing effective tax rates across companies (or across years for the same company).*d. All the above observations are correct.

241. Chapter 3 - Taxes On The Financial Statements Question PR #1 Kooler, Inc., is a domestic corporation. It owns 100% of Texas, Inc., a domestic corporation, 100% of Paris, a foreign corporation, and 45% of Iowa, Inc., a domestic corporation.

a. Which entities’ incomes are included in Kooler’s combined GAAP financial statements?

b. How would your answer change if Kooler instead owned 15% of Iowa?

Correct Answer:a. Kooler includes its own net income and the net income of both Texas and Paris. In

addition, Kooler’s financial statements includes its 45% share of Iowa’s net income. Kooler’s financial statement includes the income of these subsidiaries without regard to whether Kooler receives any actual profit distributions from its subsidiaries.

b. If Kooler instead owns 15% of Iowa, none of Iowa’s income is included in Kooler’s

financial statements until Iowa makes an actual dividend distribution to Kooler.

242. Chapter 3 - Taxes On The Financial Statements Question PR #2 Bunker, Inc., is a domestic corporation. It owns 100% of Texas, Inc., a domestic corporation, 100% of Paris, a foreign corporation, and 35% of Iowa, Inc., a domestic corporation.

a. Which entities’ incomes are included in Bunker’s Federal consolidated income tax return?

b. How would your answer change if Bunker instead owned 15% of Iowa?

Correct Answer:Bunker includes its own taxable income and the taxable income of Texas if Bunker elects to include Texas in its consolidated group. Paris is not included because foreign corporations are not eligible to be included. Iowa’s income is not included because, although domestic, Bunker’s ownership percentage does not meet the 80% required level for tax consolidation.

If Bunker instead owns 15% of Iowa, the answer remains the same. None of Iowa’s income is included in Bunker’s consolidated Federal income tax return until Iowa makes an actual dividend distribution to Bunker.

243. Chapter 3 - Taxes On The Financial Statements Question PR #3 Rochelle, Inc., reported the following results for the current year.

Book income (before tax) $500,000Tax depreciation in excess of book 25,000Non-tax-deductible warranty expense 17,500Municipal bond interest income 20,000

Determine Rochelle’s taxable income for the current year. Identify any temporary or permanent book-tax differences.

Correct Answer:

Rochelle reports net income before tax of $425,000 on its GAAP financial statement, but it must adjust this amount for book-tax differences . Tax depreciation in excess of book is a tax deduction not deducted for book purposes, and warranty expense is deductible for book purposes but not yet deductible for tax. Both these items are temporary differences because they eventually reverse (with book depreciation eventually exceeding tax depreciation and the warranty expense ultimately deducted for tax when incurred). The municipal bond adjustment is a permanent difference because this income never is subject to Federal income tax.

Book income (before tax) $500,000 Tax depreciation in excess of book (25,000)

Non-deductible warranty expense 17,500 Municipal bond interest income (20,000) Taxable income (Form 1120) $472,500

244. Chapter 3 - Taxes On The Financial Statements Question PR #4 PaintCo Inc., a domestic corporation, owns 100% of BrushCo Ltd., an Irish corporation. Assume that the U.S. corporate tax rate is 35% and the Irish rate is 10%. PaintCo is permanently reinvesting BrushCo’s earnings outside the United States under ASC 740-30 (APB 23). The corporations’ book income, permanent and temporary book-tax differences, and current tax expense are as follows. Determine PaintCo’s total tax expense reported on its financial statements, its current tax expense (benefit), and its deferred tax expense (benefit).

PaintCo BrushCo Book income before tax $600,000 $400,000Permanent differences Meals & entertainment expense 40,000 –0– Municipal bond interest income (100,000) –0–Temporary differences Tax > book depreciation (100,000) –0– Book > tax bad debt expense 20,000 –0–

Correct Answer: PaintCo BrushCo Book income before tax $600,000 $400,000Permanent differences Meals & entertainment expense 40,000 –0– Municipal bond interest income (100,000) –0– Book income after permanent differences $540,000 $400,000Temporary differences Tax > book depreciation (100,000) –0– Book > tax bad debt expense 20,000 –0– Taxable income $460,000 $400,000 ´ 35% ´ 10% Current tax expense $161,000 $ 40,000

The total tax expense is based on book income after permanent differences taking into account the APB 23 treatment of the foreign earnings [$229,000 = ($540,000 ´ 35%) + ($400,000 ´ 10%)]. The deferred tax liability is increased by $28,000 for the year ($80,000 net temporary differences at 35%).

Current tax expense Domestic $161,000 Foreign 40,000Deferred tax expense Domestic 28,000

Foreign –0– Total tax expense $229,000

245. Chapter 3 - Taxes On The Financial Statements Question PR #5 PaintCo Inc., a domestic corporation, owns 100% of BrushCo Ltd., an Irish corporation. Assume that the U.S. corporate tax rate is 35% and the Irish rate is 10%. PaintCo is permanently reinvesting BrushCo’s earnings outside the United States under ASC 740-30 (APB 23). The corporations’ book income, permanent and temporary book-tax differences, and current tax expense are as follows. Provide the income tax footnote rate reconciliation for PaintCo using both dollar amounts and percentages.

PaintCo BrushCo Book income before tax $600,000 $400,000Permanent differences Meals & entertainment expense 40,000 –0– Municipal bond interest income (100,000) –0–Temporary differences Tax > book depreciation (100,000) –0– Book > tax bad debt expense 20,000 –0–

Correct Answer:

PaintCo’s book income is $1,000,000 (the combined book income of both PaintCo and BrushCo). The effective tax rate reconciliation is based on this book income, with the dollar amounts in the table representing the tax expense (benefit) related to the item and the percentage representing the tax expense (benefit) as a percentage of book income.

Effective tax rate reconciliation $ % Hypothetical tax at U.S. rate $350,000 35.0 Disallowed meals and entertainment expense 14,000 1.4 Municipal bond interest (35,000) (3.5)Foreign income taxed at less than U.S. rate (100,000) (10.0)Income tax expense (provision) $229,000 22.9

Note that only permanent differences appear in the rate reconciliation. Temporary differences do not affect the total book income tax expense, they simply affect the amount of the tax expense that is current versus deferred.

246. Chapter 3 - Taxes On The Financial Statements Question PR #6 Gator, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000)Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000)Total Assets $174,300 $250,300

Liabilities Accrued Litigation Expense

$ –0– ($ 27,000)

Note Payable (116,000) (116,000)Total Liabilities ($116,000) ($143,000)

Stockholder Equity Paid in Capital ($ 1,000) ($ 1,000)Retained Earnings (57,300) (106,300)Total Liabilities and

Stockholders Equity($174,300)

($250,300)

Gator Inc.’s gross deferred tax assets and liabilities at the beginning of Gator’s year are listed below.

Beginning of YearAccrued Litigation Expense $21,000 Subtotal $21,000 Applicable Tax Rate ´ 34% Gross Deferred Tax Asset $ 7,140

Building – Acc. Depreciation ($61,000)Furniture & fixtures – Acc. Depreciation

(3,200)

Subtotal ($64,200)Applicable tax rate ´ 34% Gross deferred tax liability ($21,828)

Gator Inc.’s book income before tax is $6,300. Gator records two permanent book-tax differences. It earned $250 in tax exempt municipal bond interest and $460 in nondeductible meals and entertainment expense. Determine the change in Gator’s deferred tax assets for the current year.

Correct Answer: Beginning of

Year

Current Year Difference

End of YearAccrued Litigation Expense $21,000 $6,000 $27,000Subtotal $21,000 $6,000 $27,000Applicable Tax Rate ´ 34% ´ 34% Gross Deferred Tax Asset $ 7,140 $ 9,180Change in Deferred Tax Asset $2,040

247. Chapter 3 - Taxes On The Financial Statements Question PR #7 Gator, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000)Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000)Total Assets $174,300 $250,300

Liabilities Accrued Litigation Expense

$ –0– ($ 27,000)

Note Payable (116,000) (116,000)Total Liabilities ($116,000) ($143,000)

Stockholder Equity Paid in Capital ($ 1,000) ($ 1,000)Retained Earnings (57,300) (106,300)Total Liabilities and

Stockholders Equity($174,300)

($250,300)

Gator Inc.’s gross deferred tax assets and liabilities at the beginning of Gator’s year are listed below.

Beginning of YearAccrued Litigation Expense $21,000 Subtotal $21,000 Applicable Tax Rate ´ 34%

Gross Deferred Tax Asset $ 7,140

Building – Acc. Depreciation ($61,000)Furniture & fixtures – Acc. Depreciation

(3,200)

Subtotal ($64,200)Applicable tax rate ´ 34% Gross deferred tax liability ($21,828)

Gator Inc.’s book income before tax is $6,300. Gator records two permanent book-tax differences. It earned $250 in tax exempt municipal bond interest and $460 in nondeductible meals and entertainment expense. Determine the net deferred tax asset or net deferred tax liability at year end.

Correct Answer: Tax Debit/(Credit) Book Debit/(Credit) DifferenceAssets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000) ($70,000)Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000) (6,000) Total Assets $174,300 $250,300 ($76,000)

Liabilities Accrued Litigation Expense

$ –0– ($ 27,000) $27,000

Note Payable (116,000) (116,000) Total Liabilities ($116,000) ($143,000) $27,000

Stockholder Equity Paid in Capital ($ 1,000) ($ 1,000) Retained Earnings (57,300) (106,300) Total Liabilities & Stockholders Equity

($174,300) ($250,300)

Given these basis differences, the gross DTA and gross DTL are calculated as follows, with the net result a DTL of $16,660.

Gross Deferred Tax Asset ($27,000 ´ 34%) $ 9,180Gross Deferred Tax Liability ($76,000 ´ 34%) (25,840) Net Deferred Tax Liability ($16,660)

248. Chapter 3 - Taxes On The Financial Statements Question PR #8 Gator, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000)Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000)Total Assets $174,300 $250,300

Liabilities Accrued Litigation Expense

$ –0– ($ 27,000)

Note Payable (116,000) (116,000)Total Liabilities ($116,000) ($143,000)

Stockholder Equity Paid in Capital ($ 1,000) ($ 1,000)Retained Earnings (57,300) (106,300)Total Liabilities and

Stockholders Equity($174,300)

($250,300)

Gator Inc.’s gross deferred tax assets and liabilities at the beginning of Gator’s year are listed below.

Beginning of YearAccrued Litigation Expense $21,000 Subtotal $21,000 Applicable Tax Rate ´ 34% Gross Deferred Tax Asset $ 7,140

Building – Acc. Depreciation ($61,000)Furniture & fixtures – Acc. Depreciation

(3,200)

Subtotal ($64,200)Applicable tax rate ´ 34% Gross deferred tax liability ($21,828)

Gator Inc.’s book income before tax is $6,300. Gator records two permanent book-tax differences. It earned $250 in tax exempt municipal bond interest and $460 in nondeductible meals and entertainment expense. Determine the change in Gator’s deferred tax liabilities for the current year.

Correct Answer: Beginning of Year Current Year

DifferenceEnd of Year

Building – Acc. Depreciation ($61,000) ($ 9,000) ($70,000)Furniture & fixtures – Acc. Deprec (3,200) (2,800) (6,000) Subtotal ($64,200) ($11,800) ($76,000)Applicable tax rate ´ 34% ´ 34% Gross Deferred Tax liability ($21,828) ($25,840)Change in Deferred Tax Liability ($ 4,012)

249. Chapter 3 - Taxes On The Financial Statements Question PR #9 Gator, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000)Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000)Total Assets $174,300 $250,300

Liabilities Accrued Litigation Expense

$ –0– ($ 27,000)

Note Payable (116,000) (116,000)Total Liabilities ($116,000) ($143,000)

Stockholder Equity Paid in Capital ($ 1,000) ($ 1,000)Retained Earnings (57,300) (106,300)Total Liabilities and

Stockholders Equity($174,300)

($250,300)

Gator Inc.’s gross deferred tax assets and liabilities at the beginning of Gator’s year are listed below.

Beginning of YearAccrued Litigation Expense $21,000 Subtotal $21,000 Applicable Tax Rate ´ 34% Gross Deferred Tax Asset $ 7,140

Building – Acc. Depreciation ($61,000)Furniture & fixtures – Acc. Depreciation

(3,200)

Subtotal ($64,200)Applicable tax rate ´ 34% Gross deferred tax liability ($21,828)

Gator Inc.’s book income before tax is $6,300. Gator records two permanent book-tax differences. It earned $250 in tax exempt municipal bond interest and $460 in nondeductible meals and entertainment expense. Determine Gator’s change in net deferred tax asset or net deferred tax liability for the current year and provide the journal entry to record this amount.

Correct Answer: Beginning of Year Current Year

Difference End of YearGross Deferred Tax Asset $ 7,140 $ 9,180Change in Deferred Tax Asset $2,040 Gross deferred tax liability ($21,828) ($25,840)Change in Deferred tax liability ($4,012) Net Deferred Tax Asset/ (Deferred Tax Liability)

($14,688) ($1,972) ($16,660)

The journal entry to record the deferred tax liability is as follows.

Income Tax Expense $1,972 Deferred Tax Liability $1,972

250. Chapter 3 - Taxes On The Financial Statements Question PR #10 Gator, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000)Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000)Total Assets $174,300 $250,300

Liabilities Accrued Litigation Expense

$ –0– ($ 27,000)

Note Payable (116,000) (116,000)Total Liabilities ($116,000) ($143,000)

Stockholder Equity Paid in Capital ($ 1,000) ($ 1,000)Retained Earnings (57,300) (106,300)Total Liabilities and

Stockholders Equity($174,300)

($250,300)

Gator Inc.’s gross deferred tax assets and liabilities at the beginning of Gator’s year are listed below.

Beginning of YearAccrued Litigation Expense $21,000Subtotal $21,000Applicable Tax Rate ´ 34%Gross Deferred Tax Asset $ 7,140

Building – Acc. Depreciation ($61,000)Furniture & fixtures – Acc. Depreciation

(3,200)

Subtotal ($64,200)Applicable tax rate ´ 34% Gross deferred tax liability ($21,828)

Gator Inc.’s book income before tax is $6,300. Gator records two permanent book-tax differences. It earned $250 in tax exempt municipal bond interest and $460 in nondeductible meals and entertainment expense. Calculate Gator’s current tax expense.

Correct Answer:Pre-tax Book Income $6,300

Book-Tax Adjustments

Permanent Items

Tax Exempt Income (250)Nondeductible M&E 460

Temporary Differences

Building Depreciation (9,000)Furniture & Fixtures Depreciation (2,800)Accrued Litigation Expenses 6,000 Taxable Income $ 710 Current Tax Expense $ 241

251. Chapter 3 - Taxes On The Financial Statements Question PR #11 Gator, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000)Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000)Total Assets $174,300 $250,300

Liabilities Accrued Litigation Expense

$ –0– ($ 27,000)

Note Payable (116,000) (116,000)Total Liabilities ($116,000) ($143,000)

Stockholder Equity Paid in Capital ($ 1,000) ($ 1,000)Retained Earnings (57,300) (106,300)Total Liabilities and

Stockholders Equity($174,300)

($250,300)

Gator Inc.’s gross deferred tax assets and liabilities at the beginning of Gator’s year are listed below.

Beginning of YearAccrued Litigation Expense $21,000 Subtotal $21,000

Applicable Tax Rate ´ 34% Gross Deferred Tax Asset $ 7,140

Building – Acc. Depreciation ($61,000)Furniture & fixtures – Acc. Depreciation

(3,200)

Subtotal ($64,200)Applicable tax rate ´ 34% Gross deferred tax liability ($21,828)

Gator Inc.’s book income before tax is $6,300. Gator records two permanent book-tax differences. It earned $250 in tax exempt municipal bond interest and $460 in nondeductible meals and entertainment expense. Provide the journal entry to record Gator’s current tax expense.

Correct Answer:Income Tax Expense $241Current Income Tax Payable $241

252. Chapter 3 - Taxes On The Financial Statements Question PR #12 Gator, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000)Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000)Total Assets $174,300 $250,300

Liabilities Accrued Litigation Expense

$ –0– ($ 27,000)

Note Payable (116,000) (116,000)Total Liabilities ($116,000) ($143,000)

Stockholder Equity Paid in Capital ($

1,000)($ 1,000)

Retained Earnings (57,300)

(106,300)

Total Liabilities and Stockholders Equity ($174,300)

($250,300)

Gator Inc.’s gross deferred tax assets and liabilities at the beginning of Gator’s year are listed below.

Beginning of YearAccrued Litigation Expense $21,000 Subtotal $21,000 Applicable Tax Rate ´ 34% Gross Deferred Tax Asset $ 7,140

Building – Acc. Depreciation ($61,000)Furniture & fixtures – Acc. Depreciation

(3,200)

Subtotal ($64,200)Applicable tax rate ´ 34% Gross deferred tax liability ($21,828)

Gator Inc.’s book income before tax is $6,300. Gator records two permanent book-tax differences. It earned $250 in tax exempt municipal bond interest and $460 in nondeductible meals and entertainment expense. What is Gator’s total provision for income tax expense reported on its GAAP financial statement and its book net income after tax?

Correct Answer:Book Net Income Before Tax $6,300 Provision for Income Tax Expense* (2,213)Net Income After Tax* $241 + $1,972 = $2,213

$4,087

253. Chapter 3 - Taxes On The Financial Statements Question PR #13 Gator, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 300 $ 300 Accounts Receivable 5,000 5,000 Buildings 300,000 300,000 Acc. Depreciation (150,000) (80,000)Furniture & Fixtures 40,000 40,000 Acc. Depreciation (21,000) (15,000)Total Assets $174,300 $250,300

Liabilities Accrued Litigation Expense

$ –0– ($ 27,000)

Note Payable (116,000) (116,000)Total Liabilities ($116,000) ($143,000)

Stockholder Equity Paid in Capital ($

1,000)($ 1,000)

Retained Earnings (57,300)

(106,300)

Total Liabilities and Stockholders Equity ($174,300)

($250,300)

Gator Inc.’s gross deferred tax assets and liabilities at the beginning of Gator’s year are listed below.

Beginning of YearAccrued Litigation Expense $21,000 Subtotal $21,000 Applicable Tax Rate ´ 34% Gross Deferred Tax Asset $ 7,140

Building – Acc. Depreciation ($61,000)Furniture & fixtures – Acc. Depreciation

(3,200)

Subtotal ($64,200)Applicable tax rate ´ 34% Gross deferred tax liability ($21,828)

Gator Inc.’s book income before tax is $6,300. Gator records two permanent book-tax differences. It earned $250 in tax exempt municipal bond interest and $460 in nondeductible meals and entertainment expense. Provide the income tax footnote rate reconciliation for Gator.

Correct Answer: $ %Tax on Book Income at Statutory Rate 2,142 34.00 Tax Exempt Income (85) (1.35)Non-deductible Meals & Entertainment 156 2.48 Provision for Income Tax Expense 2,213 35.13

254. Chapter 3 - Taxes On The Financial Statements Question PR #14 Amelia, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000)Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000)Total Assets $ 697,200 $1,001,200

Liabilities Accrued Vacation Pay $ –0– ($108,000)Note Payable (464,000) (464,000)Total Liabilities ($464,000) ($572,000)

Stockholder Equity Paid in Capital ($ 4,000) ($ 4,000)Retained Earnings (229,200) (425,200)Total Liabilities and

Stockholders Equity($697,200) ($1,001,200)

Amelia Inc.’s gross deferred tax assets and liabilities at the beginning of Amelia’s year are listed below.

Beginning of YearAccrued Vacation Pay $84,000Subtotal $84,000Applicable Tax Rate ´ 34%Gross Deferred Tax Asset $28,560

Building – Acc. Depreciation ($244,000)Furniture & fixtures – Acc. Depreciation

(12,800)

Subtotal ($256,800)Applicable tax rate ´ 34% Gross deferred tax liability ($ 87,312)

Amelia Inc.’s book income before tax is $25,200. Amelia records two permanent book-tax differences. It earned $1,000 in tax exempt

municipal bond interest and $1,840 in nondeductible meals and entertainment expense. Determine the change in Amelia’s deferred tax assets for the current year.

Correct Answer: Beginning of

Year

Current Year Difference

End of YearAccrued Vacation Pay $84,000 $24,000 $108,000Subtotal $84,000 $24,000 $108,000Applicable Tax Rate ´ 34% ´ 34% Gross Deferred Tax Asset $28,560 $ 36,720Change in Deferred Tax Asset $ 8,160

255. Chapter 3 - Taxes On The Financial Statements Question PR #15 Amelia, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000)Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000)Total Assets $ 697,200 $1,001,200

Liabilities Accrued Vacation Pay $ –0– ($108,000)Note Payable (464,000) (464,000)Total Liabilities ($464,000) ($572,000)

Stockholder Equity Paid in Capital ($ 4,000) ($ 4,000)Retained Earnings (229,200) (425,200)Total Liabilities and

Stockholders Equity($697,200) ($1,001,200)

Amelia Inc.’s gross deferred tax assets and liabilities at the beginning of Amelia’s year are listed below.

Beginning of YearAccrued Vacation Pay $84,000Subtotal $84,000Applicable Tax Rate ´ 34%Gross Deferred Tax Asset $28,560

Building – Acc. Depreciation ($244,000)Furniture & fixtures – Acc. Depreciation

(12,800)

Subtotal ($256,800)Applicable tax rate ´ 34% Gross deferred tax liability ($ 87,312)

Amelia Inc.’s book income before tax is $25,200. Amelia records two permanent book-tax differences. It earned $1,000 in tax exempt municipal bond interest and $1,840 in nondeductible meals and entertainment expense. Determine the net deferred tax asset or net deferred tax liability at year end.

Correct Answer: Tax Debit/(Credit) Book Debit/(Credit) DifferenceAssets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000) ($280,000) Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000) (24,000) Total Assets $ 697,200 $1,001,200 ($304,000)

Liabilities Accrued Vacation Pay $ –0– ($108,000) $108,000Note Payable (464,000) (464,000) Total Liabilities ($464,000) ($572,000) $108,000

Stockholder Equity Paid in Capital ($ 4,000) ($ 4,000)Retained Earnings (229,200) (425,200) Total Liabilities & Stockholders Equity

($697,200) ($1,001,200)

Given these basis differences, the gross DTA and gross DTL are calculated as follows, with the net result a DTL of $66,640.

Gross Deferred Tax Asset ($108,000 ´ 34%) $ 36,720 Gross Deferred Tax Liability ($304,000 ´ 34%) (103,360)Net Deferred Tax Liability ($ 66,640)

256. Chapter 3 - Taxes On The Financial Statements Question PR #16 Amelia, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000)Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000)Total Assets $ 697,200 $1,001,200

Liabilities Accrued Vacation Pay $ –0– ($108,000)Note Payable (464,000) (464,000)Total Liabilities ($464,000) ($572,000)

Stockholder Equity Paid in Capital ($ 4,000) ($ 4,000)Retained Earnings (229,200) (425,200)Total Liabilities and

Stockholders Equity($697,200) ($1,001,200)

Amelia Inc.’s gross deferred tax assets and liabilities at the beginning of Amelia’s year are listed below.

Beginning of YearAccrued Vacation Pay $84,000Subtotal $84,000Applicable Tax Rate ´ 34%Gross Deferred Tax Asset $28,560

Building – Acc. Depreciation ($244,000)Furniture & fixtures – Acc. Depreciation

(12,800)

Subtotal ($256,800)Applicable tax rate ´ 34% Gross deferred tax liability ($ 87,312)

Amelia Inc.’s book income before tax is $25,200. Amelia records two permanent book-tax differences. It earned $1,000 in tax exempt municipal bond interest and $1,840 in nondeductible meals and entertainment expense. Determine the change in Amelia’s deferred tax liabilities for the current year.

Correct Answer: Beginning of Year Current Year

DifferenceEnd of Year

Building – Acc. Depreciation ($244,000) ($36,000) ($280,000)Furniture & fixtures – Acc. Deprec (12,800) (11,200) (24,000) Subtotal ($256,800) ($47,200) ($304,000)Applicable tax rate ´ 34% ´ 34% Gross Deferred Tax liability ($ 87,312) ($103,360)Change in Deferred Tax Liability ($16,048)

257. Chapter 3 - Taxes On The Financial Statements Question PR #17 Amelia, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000)Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000)Total Assets $ 697,200 $1,001,200

Liabilities Accrued Vacation Pay $ –0– ($108,000)Note Payable (464,000) (464,000)Total Liabilities ($464,000) ($572,000)

Stockholder Equity Paid in Capital ($ 4,000) ($ 4,000)Retained Earnings (229,200) (425,200)Total Liabilities and

Stockholders Equity($697,200) ($1,001,200)

Amelia Inc.’s gross deferred tax assets and liabilities at the beginning of Amelia’s year are listed below.

Beginning of YearAccrued Vacation Pay $84,000 Subtotal $84,000 Applicable Tax Rate ´ 34% Gross Deferred Tax Asset $28,560

Building – Acc. Depreciation ($244,000)Furniture & fixtures – Acc. Depreciation

(12,800)

Subtotal ($256,800)Applicable tax rate ´ 34% Gross deferred tax liability ($ 87,312)

Amelia Inc.’s book income before tax is $25,200. Amelia records two permanent book-tax differences. It earned $1,000 in tax exempt municipal bond interest and $1,840 in nondeductible meals and entertainment expense. Determine Amelia’s change in net deferred tax asset or net deferred tax liability for the current year and provide the journal entry to record this amount.

Correct Answer: Beginning of

YearCurrent Year Difference End of Year

Gross Deferred Tax Asset $28,560 $ 36,720 Change in Deferred Tax Asset $ 8,160 Gross deferred tax liability ($87,312) ($103,360)Change in Deferred tax liability ($16,048) Net Deferred Tax Asset/ (Deferred Tax Liability)

($58,752) ($ 7,888) ($ 66,640)

The journal entry to record the deferred tax liability is as follows.

Income Tax Expense $7,888 Deferred Tax Liability $7,888

258. Chapter 3 - Taxes On The Financial Statements Question PR #18 Amelia, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Book

Debit/(Credit) Debit/(Credit)Assets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000)Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000)Total Assets $ 697,200 $1,001,200

Liabilities Accrued Vacation Pay $ –0– ($108,000)Note Payable (464,000) (464,000)Total Liabilities ($464,000) ($572,000)

Stockholder Equity Paid in Capital ($ 4,000) ($ 4,000)Retained Earnings (229,200) (425,200)Total Liabilities and

Stockholders Equity($697,200) ($1,001,200)

Amelia Inc.’s gross deferred tax assets and liabilities at the beginning of Amelia’s year are listed below.

Beginning of YearAccrued Vacation Pay $84,000Subtotal $84,000Applicable Tax Rate ´ 34%Gross Deferred Tax Asset $28,560

Building – Acc. Depreciation ($244,000)Furniture & fixtures – Acc. Depreciation

(12,800)

Subtotal ($256,800)Applicable tax rate ´ 34% Gross deferred tax liability ($ 87,312)

Amelia Inc.’s book income before tax is $25,200. Amelia records two permanent book-tax differences. It earned $1,000 in tax exempt municipal bond interest and $1,840 in nondeductible meals and entertainment expense. Calculate Amelia’s current tax expense.

Correct Answer:Pre-tax Book Income $25,200

Book-Tax AdjustmentsPermanent Items Tax Exempt Income (1,000)Nondeductible M&E 1,840

Temporary Differences

Building Depreciation (36,000)Furniture & Fixtures Depreciation (11,200)Accrued Litigation Expenses 24,000 Taxable Income $ 2,840 Current Tax Expense $ 966

259. Chapter 3 - Taxes On The Financial Statements Question PR #19 Amelia, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000)Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000)Total Assets $ 697,200 $1,001,200

Liabilities Accrued Vacation Pay $ –0– ($108,000)Note Payable (464,000) (464,000)Total Liabilities ($464,000) ($572,000)

Stockholder Equity Paid in Capital ($ 4,000) ($ 4,000)Retained Earnings (229,200) (425,200)Total Liabilities and

Stockholders Equity($697,200) ($1,001,200)

Amelia Inc.’s gross deferred tax assets and liabilities at the beginning of Amelia’s year are listed below.

Beginning of YearAccrued Vacation Pay $84,000 Subtotal $84,000

Applicable Tax Rate ´ 34% Gross Deferred Tax Asset $28,560

Building – Acc. Depreciation ($244,000)Furniture & fixtures – Acc. Depreciation

(12,800)

Subtotal ($256,800)Applicable tax rate ´ 34% Gross deferred tax liability ($ 87,312)

Amelia Inc.’s book income before tax is $25,200. Amelia records two permanent book-tax differences. It earned $1,000 in tax exempt municipal bond interest and $1,840 in nondeductible meals and entertainment expense. Provide the journal entry to record Amelia’s current tax expense.

Correct Answer:Income Tax Expense $966Current Income Tax Payable $966

260. Chapter 3 - Taxes On The Financial Statements Question PR #20 Amelia, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000)Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000)Total Assets $ 697,200 $1,001,200

Liabilities Accrued Vacation Pay $ –0– ($108,000)Note Payable (464,000) (464,000)Total Liabilities ($464,000) ($572,000)

Stockholder Equity Paid in Capital ($ 4,000) ($ 4,000)Retained Earnings (229,200) (425,200)Total Liabilities and

Stockholders Equity($697,200) ($1,001,200)

Amelia Inc.’s gross deferred tax assets and liabilities at the beginning of Amelia’s year are listed below.

Beginning of YearAccrued Vacation Pay $84,000Subtotal $84,000Applicable Tax Rate ´ 34%Gross Deferred Tax Asset $28,560

Building – Acc. Depreciation ($244,000)Furniture & fixtures – Acc. Depreciation

(12,800)

Subtotal ($256,800)Applicable tax rate ´ 34% Gross deferred tax liability ($ 87,312)

Amelia Inc.’s book income before tax is $25,200. Amelia records two permanent book-tax differences. It earned $1,000 in tax exempt municipal bond interest and $1,840 in nondeductible meals and entertainment expense. What is Amelia’s total provision for income tax expense reported on its financial statement and its book net income after tax?

Correct Answer:Book Net Income Before Tax $25,200 Provision for Income Tax Expense* (8,854) Net Income After Tax $16,346 * $966 + $7,888 = $8,854

261. Chapter 3 - Taxes On The Financial Statements Question PR #21 Amelia, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 34% corporate tax rate and no valuation allowance.

Tax Debit/(Credit)

Book Debit/(Credit)

Assets Cash $ 1,200 $ 1,200 Accounts Receivable 20,000 20,000 Buildings 1,200,000 1,200,000 Acc. Depreciation (600,000) (320,000)Furniture & Fixtures 160,000 160,000 Acc. Depreciation (84,000) (60,000)Total Assets $ 697,200 $1,001,200

Liabilities Accrued Vacation Pay $ –0– ($108,000)Note Payable (464,000) (464,000)Total Liabilities ($464,000) ($572,000)

Stockholder Equity Paid in Capital ($ 4,000) ($ 4,000)Retained Earnings (229,200) (425,200)Total Liabilities and

Stockholders Equity($697,200) ($1,001,200)

Amelia Inc.’s gross deferred tax assets and liabilities at the beginning of Amelia’s year are listed below.

Beginning of YearAccrued Vacation Pay $84,000 Subtotal $84,000 Applicable Tax Rate ´ 34% Gross Deferred Tax Asset $28,560

Building – Acc. Depreciation ($244,000)Furniture & fixtures – Acc. Depreciation

(12,800)

Subtotal ($256,800)Applicable tax rate ´ 34% Gross deferred tax liability ($ 87,312)

Amelia Inc.’s book income before tax is $25,200. Amelia records two permanent book-tax differences. It earned $1,000 in tax exempt municipal bond interest and $1,840 in nondeductible meals and entertainment expense. Provide the income tax footnote rate reconciliation for Amelia.

Correct Answer: $ %Tax on Book Income at Statutory Rate 8,568 34.00 Tax Exempt Income (340) (1.35) Non-deductible Meals & Entertainment 626 2.48 Provision for Income Tax Expense 8,854 35.13

262. Chapter 3 - Taxes On The Financial Statements Question PR #22 At the beginning of the year, Jensen Inc., holds a net operating loss carryforward, and its balance sheet shows a related deferred tax asset of $500,000. At the end of the year, the balance in the deferred tax asset account has not changed, but Jensen’s auditors want to record a

$100,000 valuation allowance against this amount, because of a persistent downturn in Jensen’s profitability. Develop the journal entry to record the valuation allowance.

Correct Answer:Income tax expense (provision), current year $100,000 Valuation allowance $100,000

263. Chapter 3 - Taxes On The Financial Statements Question PR #23 At the beginning of the year, the balance sheet of Jensen Inc., shows a $500,000 deferred tax asset relating to a net operating loss carryforward, offset by a $100,000 valuation allowance. At the end of the year, Jensen’s auditors agree to release $40,000 of the allowance. Develop the journal entry to record this change in the valuation allowance.

Correct Answer:Valuation allowance $40,000 Income tax expense (provision), current year $40,000

264. Chapter 3 - Taxes On The Financial Statements Question PR #24 After applying the balance sheet method to determine the GAAP income tax expense of Cutter Inc., the following account balances are found. Determine the balance sheet presentation of these amounts. Hint: Which of the accounts should you combine for the final balance sheet disclosure?

Deferred tax assets, current $100,000Deferred tax liabilities, current

115,000

Deferred tax assets, noncurrent 80,000Deferred tax liabilities, noncurrent

30,000

Correct Answer:On its balance sheet, Cutter reports the following.

Deferred tax liabilities, current $15,000Deferred tax assets, noncurrent $50,000

265. Chapter 3 - Taxes On The Financial Statements Question PR #25 After applying the balance sheet method to determine the GAAP income tax expense of Poppert Inc., the following account balances are found. Determine the balance sheet presentation of these amounts. Hint: Which of the accounts should you combine for the final balance sheet disclosure?

Deferred tax assets, current $200,000

Deferred tax assets, noncurrent 145,000Deferred tax liabilities, current

80,000

Deferred tax liabilities, noncurrent

230,000

Correct Answer:On its balance sheet, Poppert reports the following.

Deferred tax assets, current $120,000Deferred tax liabilities, noncurrent $ 85,000

266. Chapter 3 - Taxes On The Financial Statements Question PR #26 You are assisting LipidCo, a U.S. corporation subject to GAAP, to determine its current-year book expense for income taxes. The following represent the steps that you will take in making this computation. Put the steps into the correct order.

A. Compute the deferred tax provision.B. Decide whether a valuation allowance is required, and apply or

release it.C. Determine book income before tax effects.D. Determine the current tax provision.E. Identify and measure temporary book-tax differences.F. Prepare the disclosures for the financial statement footnotes.G. Subtract permanent book-tax difference.

Correct Answer:C. – G. – E. – D. – A. – B. - F.

267. Chapter 3 - Taxes On The Financial Statements Question ES #1 A corporation’s taxable income almost never is the same as its GAAP financial accounting income. Explain why this occurs. Use the terms permanent and temporary book-tax differences in your answer. Give examples of each.

Correct Answer:

Temporary differences are caused by income and expenses appearing in both the financial statement and tax return, but in different periods (i.e., a timing difference). Permanent differences are caused by items appearing in the financial statement or the tax return, but not both. Temporary differences do not affect the book total tax expense. Temporary differences merely shift tax expense (benefit) between the current and deferred accounts. Permanent differences do affect the total book tax expense and are identified in the tax footnote rate reconciliation.

Examples of temporary differences include the following.

· Depreciation on fixed assets. · Compensation related expenses where under GAAP, corporations must accrue the

future expenses related to providing postretirement benefits other than pensions (e.g., health insurance coverage) but these expenses are deductible for tax purposes only when paid.

· Warranty expenses accrued for book purposes but not deductible for tax purposes until

incurred. · Inventory write-offs accrued for book but not deductible for tax until incurred. · Net operating losses where operating losses from one tax year may be used to offset

taxable income in another tax year. · Goodwill is not amortizable for book purposes unless and until impaired.

Examples of permanent differences include the following.

· Municipal bond interest income. · The disallowed portion of meals and entertainment expense. · Certain penalties. · Tax credits.

268. Chapter 3 - Taxes On The Financial Statements Question ES #2 Book-tax differences can be explained in part by examining the objectives underlying financial accounting and taxable income computations. Evaluate this statement.

Correct Answer:The purpose of the Federal tax return is to report the taxable income of an entity (or consolidated group) for the tax year following U.S. tax law. A corporation’s financial statements are prepared in accordance with GAAP. The ASC 740 (SFAS 109) approach produces a total income tax expense (also referred to as the income tax provision) for the income currently reported on a corporation’s combined financial statement. This approach follows the matching principle, where all the expenses related to earning income are reported in the same period as the income without regard to when the expenses are actually paid.

The total book tax expense under ASC 740 (SFAS 109) is made up of both current and deferred components. The current tax expense theoretically represents the taxes actually payable to (or refund receivable from) the governmental authorities for the current period. The deferred component of the book tax expense is called the deferred tax expense or

deferred tax benefit. This component represents the future tax cost (or savings) connected with income reported in the current period financial statement. Deferred tax expense or benefit is created as a result of temporary differences.

269. Chapter 3 - Taxes On The Financial Statements Question ES #3 How does an auditor determine whether a valuation allowance is needed against an entity’s deferred tax asset? List some of the factors than an auditor will consider in this regard.

Correct Answer:

To determine whether a valuation allowance is required, both positive and negative evidence must be evaluated. The key issue is whether the taxpayer will generate sufficient income (and tax liability) in the future to use the deferred tax asset before any benefits expire. Examples of negative evidence (i.e., evidence suggesting that the deferred tax asset will not be realized) include the following.

· History of losses. · Expected future losses. · Short carryback/carryforward periods. · History of tax credits expiring unused.

Positive evidence (i.e., support for realizing the current benefit of future tax savings) include:

· Strong earnings history. · Existing contracts. · Unrealized appreciation in assets. · Sales backlog of profitable orders. · Turnaround of temporary differences that produce future taxable income.

270. Chapter 3 - Taxes On The Financial Statements Question ES #4 Grant, a multinational corporation based in the U.S., has used ASC 740-30 (APB 23) to avoid reporting any U.S. deferred tax expense on $70 million of the earnings of its foreign subsidiaries. All of these subsidiaries operate in countries with lower tax rates than those of the U.S. When the profits eventually are repatriated, how is Grant’s effective tax rate affected on its GAAP financial statements?

Correct Answer:Because Grant used ASC 740-30 (APB 23) to avoid reporting any U.S. deferred tax liability for the $50 million of foreign subsidiary earnings, any repatriation of these profits back to the U.S. causes a spike (increase) in the company’s book effective tax rate. The U.S. tax on these dividends (after any allowable foreign tax credit) produces a current tax expense, but the book income will not include the dividends (as the underlying profits were reported as book income in a prior year). With the numerator of the effective tax rate fraction increasing and the denominator staying the same, the effective tax rate increases.

271. Chapter 3 - Taxes On The Financial Statements Question ES #5 You are the tax adviser to a publicly traded U.S. corporation. How might you use a “benchmarking” analysis to begin your review of the entity’s tax situation and planning opportunities?

Correct Answer:Companies may benchmark their tax situation to other years’ results or to other companies within the same industry. The starting point for a benchmarking exercise is the data from the income tax note rate reconciliation. When comparing effective tax rates it is important to consider which components of the effective rate produce one-time effects and which components represent structural (long-lasting) effects. In addition to comparing effective tax rates, companies can compare levels of deferred tax assets and liabilities.

272. Chapter 4 - Gross Income Question TF #1 The realization requirement gives an incentive to sell assets that have increased in value and to retain assets whose value has decreased.

a. True*b. False

273. Chapter 4 - Gross Income Question TF #2 The realization requirement applies to taxable income but not to the economist’s concept of income.

*a. Trueb. False

274. Chapter 4 - Gross Income Question TF #3 Judy is a cash basis attorney. In 2011, she performed services in connection with the formation of a corporation and received stock with a value of $4,000 for her services. By the end of the year, the value of the stock had decreased to $2,000. She continued to hold the stock. Judy must recognize $4,000 of gross income from the stock for 2011.

*a. Trueb. False

275. Chapter 4 - Gross Income Question TF #4 Barney painted his house which saved him $3,000. According to the realization requirement, Barney must recognize $3,000 of income.

a. True*b. False

276. Chapter 4 - Gross Income Question TF #5 Nicholas owned stock that decreased in value by $20,000 during the year, but he did not sell the stock. He earned $45,000 salary, but received only $34,000 because $11,000 in taxes were withheld. Nicholas saved $10,000 of his salary and used the remainder for personal living expenses. Nicholas’s economic income for the year exceeded his gross income for tax purposes.

a. True*b. False

277. Chapter 4 - Gross Income Question TF #6 If the taxpayer’s method of measuring income is consistent with GAAP, it will be acceptable for tax purposes.

a. True*b. False

278. Chapter 4 - Gross Income Question TF #7 The financial accounting principle of conservatism is not well-suited to the task of measuring taxable income.

*a. Trueb. False

279. Chapter 4 - Gross Income Question TF #8 A cash basis taxpayer purchased a certificate of deposit for $1,000 on July 1, 2011 that will pay $1,100 upon its maturity on June 30, 2013. The taxpayer must recognize a portion of the income in 2011.

*a. Trueb. False

280. Chapter 4 - Gross Income Question TF #9 Ralph purchased his first Series EE bond during the year. He paid $709 for a 10-year bond with a $1,000 maturity value. The yield to maturity on the bonds was 3.5%. Ralph is not required to recognize the $291 ($1,000 – $709) original issue discount until the bond matures.

*a. Trueb. False

281. Chapter 4 - Gross Income Question TF #10 At the beginning of 2011, Mary purchased a 3-year certificate of deposit (CD) for $8,760. The maturity value of the certificate was $10,000 and it was to yield 4.5%. She also purchased a Series EE bond for $6,400 with a maturity value in 10 years of $10,000. Mary must recognize income from the certificate of deposit each year, 2011-2013, and $3,600 from the Series EE bonds in 2020.

*a. Trueb. False

282. Chapter 4 - Gross Income Question TF #11 In 2003, Terry purchased land for $150,000. In 2011, Terry received $10,000 from a local cable television company in exchange for Terry allowing the company to run an underground cable across Terry’s property. Terry is not required to recognize income from receiving the $10,000 because it was a return of his capital invested in the land.

*a. Trueb. False

283. Chapter 4 - Gross Income Question TF #12 In December 2011, Mary collected the December 2011 and January 2012 rent from a tenant. Mary is a cash basis taxpayer. The amount collected in December 2011 for the 2012 rent should be included in her 2012 gross income.

a. True*b. False

284. Chapter 4 - Gross Income Question TF #13 Daniel, an accrual basis taxpayer, collects the rent for December 2011 and January 2012 on December 1, 2011. Daniel must include the December 2011 rent but not the January 2012 rent in his 2011 gross income.

a. True*b. False

285. Chapter 4 - Gross Income Question TF #14 On January 1, 2011, an accrual basis taxpayer entered into a contract to provide termite inspection service each month for 36 months. The amount received for the contract was $2,400. The taxpayer should report $1,600 of income in 2012.

*a. Trueb. False

286. Chapter 4 - Gross Income Question TF #15 An accrual basis taxpayer can defer all advance payments for services until the services are performed if the method of accounting for the

services is the same for tax and financial reporting purposes.

a. True*b. False

287. Chapter 4 - Gross Income Question TF #16 An accrual basis taxpayer who owns and operates a professional basketball team is allowed to allocate income from season ticket sales on the basis of the number of games played during the year.

*a. Trueb. False

288. Chapter 4 - Gross Income Question TF #17 In 2011, Jimmy, a cash basis taxpayer, was offered $3,000,000 for signing a professional baseball contract. He rejected the offer in favor of $900,000 per year for 4 years beginning in 2011. He collected $900,000 in 2011. Jimmy did not constructively receive $3,000,000 in 2011.

*a. Trueb. False

289. Chapter 4 - Gross Income Question TF #18 The constructive receipt doctrine requires that income must be recognized when it is made available to the cash basis taxpayer, although it has not been actually received. The constructive receipt doctrine does not apply to accrual basis taxpayers.

*a. Trueb. False

290. Chapter 4 - Gross Income Question TF #19 Mabel is age 65 and lives on her Social Security benefits and gifts from her son, Fred. Fred is a full-time teacher. He has written a book and receives royalties from it. This year Fred directed the publisher to make the royalty check payable to Mabel because she needs the money for support. Mabel must include the amount of the royalty check in her gross income.

a. True*b. False

291. Chapter 4 - Gross Income Question TF #20 Jessica is a cash basis taxpayer. When Jessica failed to repay a loan, the bank garnished her salary. Each week $60 was withheld from Jessica’s salary and paid to the bank. Jessica is required to include the $60 each week in her gross income even though it is the creditor that benefits from the income.

*a. Trueb. False

292. Chapter 4 - Gross Income Question TF #21 ABC Corporation mails out its annual Christmas bonuses to employees on December 24th. Ed, a cash basis taxpayer, is an employee who is on a ski trip until January 7th of the new year, but is aware that his annual Christmas bonus arrives on the 28th of December. Ed cannot delay reporting the income from the bonus until the new year.

*a. Trueb. False

293. Chapter 4 - Gross Income Question TF #22 Tom purchased a bond on March 31 for $10,000, plus $100 accrued interest. In December, Tom collected $500 interest from the bond. Tom’s interest income from the bond for the year is $500.

a. True*b. False

294. Chapter 4 - Gross Income Question TF #23 When stock is sold after the dividend is declared but prior to the record date, the buyer must recognize as income the dividend received, rather than a recovery of the amount of the dividend that is included in the price of the stock.

*a. Trueb. False

295. Chapter 4 - Gross Income Question TF #24 Linda delivers pizzas for a pizza shop. On Wednesday, December 31, 2011, Linda made several deliveries and collected $400 from customers. However, Linda forgot to turn in the proceeds for the day to her employer until the following Friday, January 2, 2012. The pizza shop owner recognizes the income of $400 when he receives it from Linda in 2012.

a. True*b. False

296. Chapter 4 - Gross Income Question TF #25 Father made an interest-free loan of $25,000 to Son who used the money to buy an SUV. If Son’s investment income for the year is less than $1,000, Father is not required to impute interest income.

*a. Trueb. False

297. Chapter 4 - Gross Income Question TF #26 In the case of a below-market gift loan for which there is no exception to the imputed interest rules, the lender is deemed to have received interest income even though no interest is charged and collected.

*a. Trueb. False

298. Chapter 4 - Gross Income Question TF #27 In the case of a gift loan of less than $100,000, the imputed interest rules apply if the donee has net investment income of over $1,000.

*a. Trueb. False

299. Chapter 4 - Gross Income Question TF #28 Mel was the beneficiary of a $45,000 group term life insurance policy on his wife. His wife’s employer paid all of the premiums on the policy. Mel used the life insurance proceeds to purchase a United States Government bond, which paid him $2,500 interest during the current year. Mel’s Federal gross income from the above is $2,500.

*a. Trueb. False

300. Chapter 4 - Gross Income Question TF #29 Zack was the beneficiary of a life insurance policy on his wife. Zack had paid $20,000 in premiums on the policy. He collected $50,000 on the policy when his wife died from a terminal illness. Because it took several months to process the claim, the insurance company paid Zack $53,000, the face amount of the policy plus $3,000 interest. Zack must include $53,000 in his gross income.

a. True*b. False

301. Chapter 4 - Gross Income Question TF #30 Calvin’s property was taken by the State of Louisiana to build a highway overpass. He disputed the amount of the condemnation award he was to receive and ultimately collected an amount for the property plus $15,000 interest on the award. Calvin can exclude from gross income the $15,000 interest he received from the State of Louisiana associated with the condemnation award.

a. True*b. False

302. Chapter 4 - Gross Income Question TF #31 The taxpayer incorrectly took a $5,000 deduction (e.g., incorrectly calculated depreciation) in 2011 and as a result his taxable income was

reduced by $5,000. The taxpayer discovered his error in 2012. The taxpayer must add $5,000 to his 2012 gross income in accordance with the tax benefit rule to correct for the 2011 error.

a. True*b. False

303. Chapter 4 - Gross Income Question TF #32 Benny loaned $100,000 to his controlled corporation. When it became apparent the corporation would not be able to repay the loan in the near future, Benny canceled the debt. The corporation should treat the cancellation as a nontaxable contribution to capital.

*a. Trueb. False

304. Chapter 4 - Gross Income Question TF #33 A debtor undergoing a Chapter 11 reorganization under the bankruptcy laws who receives a discharge of his or her liabilities has realized income but can exclude the debt reduction from gross income.

*a. Trueb. False

305. Chapter 4 - Gross Income Question TF #34 Amber Machinery Company purchased a building from Ted for $250,000 cash and a mortgage of $750,000. One year after the transaction, the mortgage had been reduced to $725,000 by principal payments by Amber, but it was apparent that Amber would not be able to continue to make the monthly payments on the mortgage. Ted reduced the amount owed by Amber to $600,000. This reduced the monthly payments to a level that Amber could pay. Amber must recognize $125,000 income from the reduction in the debt by Ted.

a. True*b. False

306. Chapter 4 - Gross Income Question TF #35 In 2011, Warren sold his personal use automobile for a loss of $9,000. He also sold a personal coin collection for a gain of $10,000. As a result of these sales, $1,000 is subject to income tax.

a. True*b. False

307. Chapter 4 - Gross Income Question MC #1 On a particular Saturday, Tom had planned to paint a room in his house, but his employer gave him the opportunity to work that day. If Tom works, he must hire a painter for $100. For Tom to have a positive cash

flow from working and hiring the painter:

a. Tom must earn at least $125 if Tom is in the 25% marginal tax bracket.*b. Tom must earn at least $150 if Tom is in the 33% marginal tax bracket.c. Tom must earn at least $150 if he is in the 25% marginal tax bracket.d. Tom must earn at least $115 if he is in the 15% marginal tax bracket.e. None of the above.

308. Chapter 4 - Gross Income Question MC #2 The tax concept and economic concept of income are in agreement on which of the following:

a. The fair rental value of an owner-occupied home should be included in income.b. The increase in value of assets held for the entire year should be included in income for the year.c. The decrease in value of assets held for the entire year should reduce income for the year.d. All of the above.*e. None of the above.

309. Chapter 4 - Gross Income Question MC #3 The Blue Utilities Company paid Sue $2,000 for the right to lay an underground electric cable across her property anytime in the future.

a. Sue must recognize $2,000 gross income in the current year if the company did not install the cable during the year.*b. Sue is not required to recognize gross income from the receipt of the funds, but she must reduce her cost basis in the land by $2,000.c. Sue must recognize $2,000 gross income in the current year regardless of whether the company installed the cable during the year.d. Sue must recognize $2,000 gross income in the current year, and when the cable is installed, she must reduce her cost basis in the land by $2,000.e. None of the above.

310. Chapter 4 - Gross Income Question MC #4 For purposes of determining gross income, which of the following is true?

a. A taxpayer who finds a wallet full of money is not required to recognize income because someone will eventually ask for the return of the money.*b. A mechanic completed repairs on an automobile during the year and collects money from the customer. The customer was not satisfied with the repairs and sued the mechanic for a refund.

The mechanic cannot defer recognition of the income until the suit has been settled.c. Embezzlement proceeds are not included in the embezzler’s gross income because the embezzler has an obligation to repay the owner.d. All of the above are true.e. None of the above is true.

311. Chapter 4 - Gross Income Question MC #5 Detroit Corporation sued Chicago Corporation for intentional damage to Detroit’s goodwill. Detroit had created its goodwill through providing high-quality services to its customers. Thus, no basis for the goodwill appeared on Detroit’s balance sheet. The suit was settled and Detroit received $1,500,000 for the damages to its goodwill.

a. The $1,500,000 is not taxable because it represents a recovery of capital.*b. The $1,500,000 is taxable because Detroit has no basis in the goodwill.c. The $1,500,000 is not taxable because Detroit did nothing to earn the money.d. The $1,500,000 is not taxable because Detroit settled the case.e. None of the above.

312. Chapter 4 - Gross Income Question MC #6 The annual increase in the cash surrender value of a life insurance policy:

a. Is taxed when the individual dies and the heirs collect the insurance proceeds.b. Must be included in gross income each year under the original issue discount rules.c. Reduces the deduction for life insurance expense.*d. Is not included in gross income each year because of the substantial restrictions on gaining access to the policy’s value.e. None of the above.

313. Chapter 4 - Gross Income Question MC #7 Turner, a successful executive, is negotiating a compensation plan with his potential employer. The employer has offered to pay Turner a $600,000 annual salary, payable at the rate of $50,000 per month. Turner counteroffers to receive a monthly salary of $40,000 ($480,000 annually) and a $180,000 bonus in 5 years when Turner will be age 65.

a. If the employer accepts Turner’s counteroffer, Turner will recognize $55,000 ($660,000 ÷ 12) each month.*b. If the employer accepts Turner’s counteroffer, Turner will recognize as gross income $40,000 per month and $180,000 in year 5.c. If the employer accepts Turner’s counteroffer, Turner will be in constructive receipt of $50,000 per month.

d. If the employer accepts Turner’s counteroffer, Turner will be in constructive receipt of $50,000 per month and the $180,000 bonus.e. None of the above.

314. Chapter 4 - Gross Income Question MC #8 Maroon Corporation is considering deferred compensation plans for its executive employees over age 55. All of the employees use the cash method of accounting. One plan is to allow the employee to make an election at the beginning of the year to defer 10% of his or her salary until retirement, at which time the executive would receive the deferred pay plus 6% interest.

a. The 10% of salary and the interest must be included in gross income before retirement.b. The employee cannot defer the income (both the salary and the interest) for tax purposes because it is constructively received each year.c. The employee must recognize the salary each year, but can defer the interest.*d. The salary and the related interest can be deferred from inclusion in gross income until they are received.e. None of the above is correct.

315. Chapter 4 - Gross Income Question MC #9 The annual increase in the cash surrender value of a life insurance policy:

a. Is taxed according to the original issue discount rules.*b. Is not included in gross income because the policy must be surrendered to receive the cash surrender value.c. Reduces the deduction for life insurance expense.d. Is exempt because it is life insurance proceeds.e. None of the above.

316. Chapter 4 - Gross Income Question MC #10 Under the original issue discount (OID) rules as applied to a three-year certificate of deposit:

a. All of the income must be recognized in the year of purchase.b. The OID will not be included in gross income until the end of the third year.c. The interest income for the first year will be greater than the interest income for the second year.*d. The original issue discount must be amortized using the effective interest method.e. None of the above is correct.

317. Chapter 4 - Gross Income Question MC #11 Freddy purchased a certificate of deposit for $20,000 on January 1, 2011. The certificate’s maturity value in two years (December 31, 2012)

is $22,050, yielding 5% before-tax interest.

a. Freddy must recognize $2,050 gross income in 2012.b. Freddy must recognize $2,050 gross income in 2011.*c. Freddy must recognize $1,000 (.05 ´ $20,000) gross income in 2011.d. Freddy must recognize $1,025 ($2,050/2) gross income in 2011 and 2012.e. None of the above.

318. Chapter 4 - Gross Income Question MC #12 Jerry purchased a U.S. Series EE savings bond for $279. The bond has a maturity value in 10 years of $500 and yields 6% interest. This is the first Series EE bond that Jerry has ever owned.

a. Jerry must report the interest income each year using the original issue discount rules.*b. Jerry can report all of the $221 interest income in the year the bond matures.c. The interest on the bonds is exempt from Federal income tax.d. Jerry must report ($500 – $279)/10 = $22.10 interest income each year he owns the bond.e. None of the above.

319. Chapter 4 - Gross Income Question MC #13 Office Palace, Inc., leased an all-in-one printer to a new customer, Ashley, on December 27, 2011. The printer was to rent for $600 per month for a period of 36 months beginning January 1, 2012. Ashley was required to pay the first and last month’s rent at the time the lease was signed. Ashley was also required to pay a $1,500 damage deposit. Office Palace must recognize as income for the lease:

a. $0 in 2011, if Office Palace is an accrual basis taxpayer.b. $7,800 in 2012, if Office Palace is a cash basis taxpayer.c. $2,700 in 2011, if Office Palace is a cash basis taxpayer.*d. $1,200 in 2011, if Office Palace is an accrual basis taxpayer.e. None of the above.

320. Chapter 4 - Gross Income Question MC #14 Kathy operates a gym. She sells memberships that entitle the member to use the facilities at any time. A one-year membership costs $360 ($360/12 = $30 per month); a two-year membership costs $600 ($600/24 = $25 per month). Cash payment is required at the beginning of the membership period. On July 1, 2011, Kathy sold a one-year membership and a two-year membership.

I. If Kathy is a cash basis taxpayer, her 2011 gross income from the contracts is $960 ($360 + $600).

II. If Kathy is an accrual basis taxpayer, her 2011 gross income from the contracts is $330 [(6/12 ´ $360) + (6/24 ´ $600)].

III. If Kathy is an accrual basis taxpayer, her 2012 gross income from the contracts is

$630 [(6/12)($360) + $450].

a. Only I is true.b. Only I and II are true.c. Only II and III are true.*d. I, II, and III are true.e. None of the above.

321. Chapter 4 - Gross Income Question MC #15 Orange Cable TV Company, an accrual basis taxpayer, allows its customers to pay by the year in advance ($500 per year), or two years in advance ($950). In September 2011, the company collected the following amounts applicable to future services:

October 2011-September 2013 services (two-year contracts) $144,000October 2011-September 2012 services (one-year contracts) 128,000 Total $272,000

As a result of the above, Orange Cable should report as gross income:

a. $272,000 in 2011.b. $128,000 in 2011.c. $168,000 in 2012.*d. $222,000 in 2012.e. None of the above.

322. Chapter 4 - Gross Income Question MC #16 With respect to the prepaid income from services, which of the following is true?

a. The treatment of prepaid income is the same for tax and financial accounting.b. A cash basis taxpayer can spread the income over the period services are to be provided if all of the services will be completed by the end of the tax year following the year of receipt.*c. An accrual basis taxpayer can spread the income over the period services are to be provided if all of the services will be completed by the end of the tax year following the year of receipt.d. An accrual basis taxpayer can spread the income over the period services are to be provided on a contract for three years or less.e. None of the above.

323. Chapter 4 - Gross Income Question MC #17 With respect to income from services, which of the following is true?

a. The income is always amortized over the period the services will be rendered by an accrual basis taxpayer.b. A cash basis taxpayer can spread the income from a 12-month service contract over the contract period.*c. If an accrual basis taxpayer sells a 24-month service contract on July 1, 2011, for $2,400, the taxpayer’s 2012 gross income from the contract is $1,800.d. If the accrual basis taxpayer sells a 12-month service contract on July 1, 2011, all of the income is recognized in 2012.e. None of the above.

324. Chapter 4 - Gross Income Question MC #18 The Green Company, an accrual basis taxpayer, provides business-consulting services. Clients generally pay a retainer at the beginning of a 12-month period. This entitles the client to no more than 40 hours of services. Once the client has received 40 hours of services, Green charges $500 per hour. Green Company allocates the retainer to income based on the number of hours worked on the contract. At the end of the tax year, the company had $50,000 of unearned revenues from these contracts. The company also had $10,000 in unearned rent income received from excess office space leased to other companies. Based on the above, Green must include in gross income for the current year:

a. $60,000.b. $50,000.*c. $10,000.d. $0.e. None of the above.

325. Chapter 4 - Gross Income Question MC #19 Teal company is an accrual basis taxpayer. On December 1, 2011, a customer paid for an item that was on hand, but the customer wanted the item delivered in early January 2012. Teal delivered the item on January 4, 2012. Teal included the sale in its 2011 income for financial accounting purposes.

*a. Teal must recognize the income in 2011.b. Teal must recognize the income in the year title to the goods passed to the customer, as determined under the state laws in which the store is located.c. Teal can elect to recognize the income in either 2011 or 2012.d. Teal must recognize the income in 2012.e. None of the above.

326. Chapter 4 - Gross Income Question MC #20 On January 1, 2011, Jane purchased a bond paying interest at 6% for $30,000. On September 30, 2011, she gave the bond to Tim. The bond pays $1,800 interest on December 31. Jane and Tim are cash basis

taxpayers. When Tim collects the interest in December 2011:

a. Jane must include all of the interest in her gross income.b. Tim must include all of the interest in his gross income.c. Jane reports $450 of interest income in 2011, and Tim reports $1,350 of interest income in 2011.*d. Jane reports $1,350 of interest income in 2011, and Tim reports $450 of interest income in 2011.e. None of the above is correct.

327. Chapter 4 - Gross Income Question MC #21 Mike contracted with Kram Company, Mike’s controlled corporation. Mike was a medical doctor and the contract provided that he would work exclusively for the corporation. No other doctor worked for the corporation. The corporation contracted to perform an operation for Rosa for $8,000. The corporation paid Mike $6,500 to perform the operation under the terms of his employment contract.

*a. Mike’s gross income is $6,500.b. Mike must recognize the $8,000 gross income because he provided the service.c. Mike must recognize $8,000 gross income since the patient obviously wanted him to perform the operation.d. The Kram Company corporation’s gross income is $1,500.e. None of the above.

328. Chapter 4 - Gross Income Question MC #22 As a general rule:

I. Income from property is taxed to the person who owns the property.II. Income from services is taxed to the person who earns the income.III. The assignee of income from property must pay tax on the income.IV. The person who receives the benefit of the income must pay the tax on the income.

*a. Only I and II are true.b. Only III and IV are true.c. I, II, and III are true, but IV is false.d. I, II, III, and IV are true.e. None of the above is true.

329. Chapter 4 - Gross Income Question MC #23 On October 1, 2011, Bob, a cash basis taxpayer, gave Dave common stock that paid a dividend of $1,000 on December 15, 2011. On November 15, 2011, the corporation declared the dividend payable to shareholders of record as of November 22, 2011. The corporation has paid the $1,000 dividend once each year for the past ten years, during which Bob owned the stock. When Dave collected the dividend on December 15, 2011:

a. Bob must include all of the dividend in his gross income.*b. Dave must include all of the dividend in his gross income.

c. Bob must report $750 of dividend income, and Dave must report $250 of dividend income.d. Bob must report $250 of dividend income, and Dave must report $750 of dividend income.e. None of the above is correct.

330. Chapter 4 - Gross Income Question MC #24 Daniel purchased a bond on July 1, 2011, at par of $10,000 plus accrued interest of $300. On December 31, 2011, Daniel collected the $600 interest for the year. On January 1, 2012, Daniel sold the bond for $10,200.

*a. Daniel must recognize $300 interest income for 2011 and a $200 gain on the sale of the bond in 2012.b. Daniel must recognize $600 interest income for 2011 and a $200 gain on the sale of the bond in 2012.c. Daniel must recognize $600 interest income for 2011 and a $100 loss on the sale of the bond in 2012.d. Daniel must recognize $300 interest income for 2011 and a $100 loss on the sale of the bond in 2012.e. None of the above.

331. Chapter 4 - Gross Income Question MC #25 Theresa, a cash basis taxpayer, purchased a bond on July 1, 2008, for $10,000, plus $400 of accrued interest. The bond paid $800 of interest each December 31. On March 31, 2011, she sold the bond for $10,150, which included $200 of accrued interest.

a. Theresa’s 2011 interest income from the bond is $150.b. Theresa’s gain on the sale of the bond is $150.c. Theresa has a $250 loss from the sale of the bond.*d. Theresa has $200 of interest income and a $50 loss from the bond in 2011.e. None of the above.

332. Chapter 4 - Gross Income Question MC #26 Darryl, a cash basis taxpayer, gave 1,000 shares of Copper Company common stock to his daughter on September 29, 2011. Copper Company is a publicly held company that has declared a $2.00 per share dividend on September 30th every year for the last 20 years. Just as Darryl had expected, Copper Company declared a $2.00 per share dividend on September 30th, payable on October 15th, to stockholders of record as of October 10th. The daughter received the $2,000 dividend on October 18, 2011.

a. Darryl must recognize the $2,000 dividend as his income because he knew the dividend would be paid.b. Darryl must recognize the income of $2,000 because he constructively received the $2,000.c. Darryl must recognize $1,500 of the dividend because he owned the stock for three-fourths of the year.*d. The daughter must recognize the income because she owned the

stock when the dividend was declared and she received the $2,000.e. None of the above.

333. Chapter 4 - Gross Income Question MC #27 In the case of a below-market loan between family members, if the imputed interest rules apply:

I. The borrower must recognize interest income.II. The lender has interest income.III. The lender is deemed to have made a gift.IV. The borrower has interest expense.

a. Only I is true.*b. II, III, and IV are true but I is false.c. I and II are false but III and IV are true.d. All of the above are true.e. None of the above is true.

334. Chapter 4 - Gross Income Question MC #28 On January 1, Father (Dave) loaned Daughter (Debra) $100,000 to purchase a new car and to pay off college loans. There were no other loans outstanding between Dave and Debra. The relevant Federal rate on interest was 6 percent. The loan was outstanding for the entire year.

*a. If Debra has $15,000 of investment income, Dave must recognize $6,090 of imputed interest income.b. Dave must recognize $6,090 of imputed interest income regardless of the amount of Debra’s investment income.c. Debra must recognize $6,090 of imputed interest income.d. Debra must recognize $6,090 of imputed interest income if Dave has at least $6,090 of investment income.e. None of the above.

335. Chapter 4 - Gross Income Question MC #29 The effects of a below-market loan for $450,000 made by a corporation to its chief executive officer as an enticement to get him to remain with the company are:

a. The corporation has imputed interest income and dividends paid.*b. The employee has imputed compensation income and interest expense.c. The employee has no income unless the funds are invested and produce investment income for the year.d. The corporation has imputed interest expense.e. None of the above.

336. Chapter 4 - Gross Income Question MC #30 Sarah, a majority shareholder in Teal, Inc., made a $200,000 interest-free loan to the corporation. Sarah is not an employee of the corporation.

*a. Sarah must recognize imputed interest income and the corporation must recognize imputed interest expense.b. Sarah must recognize imputed interest expense and the corporation must recognize imputed interest income.c. Sarah must recognize imputed dividend income and the corporation may recognize imputed interest expense.d. Neither Sarah’s nor the corporation’s gross income is affected by the loans because no interest was charged.e. None of the above.

337. Chapter 4 - Gross Income Question MC #31 Sharon made a $60,000 interest-free loan to her son, Todd, who used the money to start a new business. Todd’s only sources of income were $25,000 from the business and $490 of interest on his checking account. The relevant Federal interest rate was 5%. Based on the above information:

a. Todd’s business net profit will be reduced by $3,000 (.05 ´ $60,000) of interest expense.b. Sharon must recognize $3,000 (.05 ´ $60,000) of imputed interest income on the below- market loan.c. Todd’s gross income must be increased by the $3,000 (.05 ´ $60,000) imputed interest income on the below market loan.*d. Sharon does not recognize any imputed interest income and Todd does not recognize any imputed interest expense.e. None of the above is correct.

338. Chapter 4 - Gross Income Question MC #32 Our tax laws encourage taxpayers to ____ assets that have appreciated in value and ____ assets that have declined in value.

a. sell, keep.b. sell, sell.*c. keep, sell.d. keep, keep.e. None of the above.

339. Chapter 4 - Gross Income Question MC #33 Carin, a widow, elected to receive the proceeds of a $150,000 life insurance policy on the life of her deceased husband in 10 installments of $17,500 each. Her husband had paid premiums of $60,000 on the policy. In the first year, Carin collected $17,500 from the insurance company. She must include in gross income:

a. $0.*b. $2,500.c. $10,000.

d. $25,000.e. None of the above.

340. Chapter 4 - Gross Income Question MC #34 Iris collected $100,000 on her deceased husband’s life insurance policy. The policy was purchased by the husband’s employer under a group policy. Iris’s husband had included $5,000 in gross income from the group term life insurance premiums during the years he worked for the employer. She elected to collect the policy in 10 equal annual payments of $12,500 each.

a. None of the payments must be included in Iris’s gross income.b. The first 8 payments are a return of her capital and thus Iris is not required to recognize any income from the policy until she receives the ninth payment.*c. For each $12,500 payment that Iris receives, she can exclude $10,000 ($100,000/$125,000 ´ $12,500) from gross income.d. For each $12,500 that Iris receives, she can exclude from gross income $500 ($5,000/$125,000 ´ $12,500).e. None of the above.

341. Chapter 4 - Gross Income Question MC #35 Turquoise Company purchased a life insurance policy on the company’s chief executive officer, Joe. After the company had paid $400,000 in premiums, Joe died and the company collected the $1.5 million face amount of the policy. The company also purchased group term life insurance on all its employees. Joe had included $16,000 in gross income for the group term life insurance premiums. Joe’s widow, Rebecca, received the $100,000 proceeds from the group term life insurance policy.

a. Rebecca can exclude the life insurance proceeds of $100,000, but Turquoise Company must include $1,100,000 ($1,500,000 – $400,000) in gross income.*b. Turquoise Company and Rebecca can exclude the life insurance proceeds of $1,500,000 and $100,000, respectively, from gross income.c. Turquoise Company can exclude $1,100,000 ($1,500,000 – $400,000) from gross income, but Rebecca must include $84,000 in gross income.d. Turquoise Company must include $1,100,000 ($1,500,000 – $400,000) in gross income and Rebecca must include $100,000 in gross income.e. None of the above.

342. Chapter 4 - Gross Income Question MC #36 Swan Finance Company, an accrual method taxpayer, requires all of its customers to carry credit life insurance. If a customer dies, the company receives from the insurance company the balance due on the customer’s loan. Ali, a customer, died owing Swan $1,500. The balance due included $200 accrued interest that Swan has included in income.

When Swan collects $1,500 from the insurance company, Swan:

a. Must recognize $1,500 income from the life insurance proceeds.b. Must recognize $1,300 income from the life insurance proceeds.c. Does not recognize income because life insurance proceeds are tax-exempt.*d. Does not recognize income from the life insurance because the entire amount is a recovery of capital.e. None of the above.

343. Chapter 4 - Gross Income Question MC #37 In the case of interest income from state and Federal bonds:

I. Interest on United States government bonds received by a state resident cannot be subject to that state’s income tax.

II. Interest on United States government bonds are not subject to Federal income tax.III. Interest received on bonds issued by State A received by a resident of State B cannot

be subject to income tax in State B.

*a. I is true, II and III are false.b. I and II are true, and III is false.c. II and III are true, and I is false.d. I, II, and III are true.e. None of the above.

344. Chapter 4 - Gross Income Question MC #38 Heather’s interest and gains on investments for 2011 were as follows:

Interest on Bland County school bonds $600Interest on U.S. government bonds 700Interest on a Federal income tax refund 200Gain on the sale of Bland County school bonds 500

Heather’s gross income from the above is:

a. $2,000.b. $1,800.*c. $1,400.d. $1,300.e. None of the above.

345. Chapter 4 - Gross Income Question MC #39 Emily is in the 35% marginal tax bracket. She can purchase a York County school bond yielding 5% interest, but she is interested in earning a higher return for comparable risk.

a. If she buys a corporate bond that pays 8% interest, her after-tax rate of return will be greater than if she purchased the York County school bond.b. If she buys a U.S. government bond paying 6%, her after-tax rate of return will be less than if she purchased the York County school bond.c. If she buys a common stock paying 6% dividend, her after-tax rate of return will be higher than if she purchased the York County school bond.*d. All of the above are correct.e. None of the above are correct.

346. Chapter 4 - Gross Income Question MC #40 Doug and Pattie received the following interest income in the current year:

Savings account at Greenbacks Bank $4,000United States Treasury bonds 250Interest on State of Virginia bonds 200Interest on Federal tax refund 150Interest on state income tax refund 75

Greenbacks Bank also gave Doug and Pattie a cellular phone (worth $100) for opening the savings account. What amount of interest income should they report on their joint income tax return?

a. $4,775.b. $4,675.*c. $4,575.d. $4,300.e. None of the above.

347. Chapter 4 - Gross Income Question MC #41 George, an unmarried cash basis taxpayer, received the following amounts during 2011:

Interest on savings accounts $3,000Original issue discount on a certificate of deposit purchased on July 1, 2010, and matured on June 30, 2011 1,500Dividends on USG common stock 300Interest on United States government bonds 450Interest on City of Radford school bonds 700

What amount should George report as gross income from dividends and interest for 2011?

a. $4,500.b. $4,800.*c. $5,250.

d. $5,950.e. None of the above.

348. Chapter 4 - Gross Income Question MC #42 In December 2011, Todd, a cash basis taxpayer, paid $1,200 fire insurance for the calendar year 2012 on a building he held for rental income. Todd deducted the $1,200 insurance premiums on his 2011 tax return. He had $150,000 of taxable income that year. On June 30, 2012, he sold the building and, as a result, received a $500 refund on his fire insurance premiums. As a result of the above:

a. Todd should amend his 2011 return and claim $500 less insurance expense.b. Todd should add the $500 to his sales proceeds from the building.*c. Todd should include the $500 in 2012 gross income in accordance with the tax benefit rule.d. Todd should include the $500 in 2012 gross income in accordance with the claim of right doctrine.e. None of the above.

349. Chapter 4 - Gross Income Question MC #43 Tonya is a cash basis taxpayer. In 2011, she paid state income taxes of $6,000. In early 2012, she filed her 2011 state income tax return and received a $600 refund.

a. If Tonya itemized her deductions in 2011 on her Federal income tax return and her itemized deductions exceeded the standard deduction by at least $600, she must amend her 2011 return to reduce her itemized deductions.*b. If Tonya itemized her deductions in 2011 on her Federal income tax return and her itemized deductions exceeded the standard deduction by at least $600, she must include the $600 in her 2012 gross income.c. If Tonya itemized her deductions in 2011, she must amend her 2011 Federal income tax return and use the standard deduction.d. Tonya must recognize $600 as income from discharge of indebtedness.e. None of the above.

350. Chapter 4 - Gross Income Question MC #44 Harold bought land from Jewel for $150,000. Harold paid $50,000 cash and gave Jewel an 8% note for $100,000. The note was to be paid over a five-year period. When the balance on the note was $80,000, Jewel began having financial difficulties. To accelerate her cash inflows, Jewel agreed to accept $60,000 cash from Harold in final payment of the note principal.

a. Harold must recognize $20,000 ($80,000 – $60,000) of gross income.*b. Harold is not required to recognize gross income, but must reduce his cost basis in the land to $130,000.

c. Harold is not required to recognize gross income, since he paid the debt before it was due.d. Jewel must recognize gross income of $20,000 ($80,000 – $60,000) from discharge of the debt.e. None of the above.

351. Chapter 4 - Gross Income Question MC #45 Hazel, a solvent individual but a recovering alcoholic, embezzled $6,000 from her employer. In the same year that she embezzled the funds, her employer discovered the theft. Her employer did not fire her and told her she did not have to repay the $6,000 if she would attend Alcoholics Anonymous. Hazel met the conditions and her employer canceled the debt.

a. Hazel did not realize any income because she obtained the funds illegally.b. Hazel is not required to include the $6,000 in gross income because her employer made a gift to her.*c. Hazel must include $6,000 in gross income from discharge of indebtedness.d. Hazel may exclude the $6,000 from gross income because the debt never existed.e. None of the above.

352. Chapter 4 - Gross Income Question MC #46 Gold Company was experiencing financial difficulties, but was not bankrupt or insolvent. The National Bank, which held a mortgage on other real estate owned by Gold, reduced the principal from $110,000 to $85,000. The bank had made the loan to Gold when it purchased the real estate from Silver, Inc. Pink, Inc., the holder of a mortgage on Gold’s building, agreed to accept $40,000 in full payment of the $55,000 due. Pink had sold the building to Gold for $150,000 that was to be paid in installments over 8 years. As a result of the above, Gold must:

a. Include $40,000 in gross income.b. Reduce the basis in its assets by $40,000.*c. Include $25,000 in gross income and reduce its basis in its assets by $15,000.d. Include $15,000 in gross income and reduce its basis in the building by $25,000.e. None of the above.

353. Chapter 4 - Gross Income Question MC #47 On January 1, 2001, Cardinal Corporation issued 5% 25-year bonds at par and used the $12,000,000 proceeds to finance the construction of a new plant. On January 1, 2011, the company acquired the bonds on the open market for $11,500,000. Assuming that Cardinal Corporation is neither bankrupt nor insolvent, the acquisition and retirement of the bonds results in which of the following:

*a. The company must recognize a $500,000 gain.b. The company can make an election to recognize a $500,000 gain

or reduce the company’s basis in the plant by $500,000.c. The company must recognize a $500,000 gain and increase the company’s basis in the plant by $500,000.d. The company can amortize the $500,000 gain, recognizing income over the remaining life of the bonds.e. None of the above.

354. Chapter 4 - Gross Income Question MC #48 Denny was neither bankrupt nor insolvent but was short of cash and could not make the mortgage payments on his personal residence in 2011. The bank that held the mortgage agreed to reduce the principal on the debt from $100,000 to $80,000 so that Denny’s monthly mortgage payments could be reduced to a manageable amount. Denny also had a vacation home with a mortgage whose payments were beyond his means. The mortgage holder on the vacation home agreed to reduce the mortgage from $60,000 to $50,000. The value of the personal residence was $80,000 and the value of the vacation home was $45,000 at the dates of the debt reduction.

a. Denny is not required to recognize any income as a result of the reduction in the principal of the mortgages.b. Denny is required to recognize $5,000 income from the reduction in the mortgage on the vacation home, but has no gross income from the reduction in the mortgage principal on his personal residence.*c. Denny is required to recognize $10,000 income from the reduction in the mortgage on the vacation home, but nothing for the reduction in the mortgage on his personal residence.d. Denny is required to recognize $10,000 income from the reduction in the mortgage on the vacation home and $20,000 income for the reduction in the mortgage on his personal residence.e. None of the above.

355. Chapter 4 - Gross Income Question MC #49 Flora Company owed $95,000 to the National Bank. Flora borrowed the funds to purchase land from another party. The land serves as security for the loan.

a. If the bank accepts $90,000 in full payment of the debt, and Flora is solvent after the transfer, Flora must reduce the cost of the land by $5,000.b. If the bank forecloses on the land (takes the land and cancels the debt) with a basis of $115,000 and fair market value of $90,000, when Flora is solvent, Flora must recognize a $5,000 gain.c. If Flora transfers to the bank other property, with a basis of $90,000 and a fair market value of $95,000, in full payment of the debt, Flora must reduce its basis in the land by $5,000.*d. If the bank accepts the land in full payment of the debt, and Flora is solvent after the transfer, when the basis in the land is $90,000 and the amount of the debt is $95,000, Flora must recognize $5,000 gain.

e. None of the above.

356. Chapter 4 - Gross Income Question MC #50 During the year, Kim sold the following assets: business auto for a $1,000 loss, stock investment for a $1,000 loss, and pleasure yacht for a $1,000 loss. Presuming adequate income, how much of these losses may Kim claim?

a. $0.b. $1,000.*c. $2,000.d. $3,000.e. None of the above.

357. Chapter 4 - Gross Income Question MC #51 For the current year, David has salary income of $80,000 and the following property transactions:

Stock investment sales— Long-term capital gain $ 9,000 Short-term capital loss (11,000)Loss on sale of camper (purchased 4 years ago and used for family vacations) (2,000)

What is David’s AGI for the current year?

a. $76,000.b. $77,000.*c. $78,000.d. $89,000.e. None of the above.

358. Chapter 4 - Gross Income Question PR #1 Ted was shopping for a new automobile. He found one that met his needs and agreed to purchase it for $23,000. He had shopped around and concluded that he could not get a better price from another dealer. After he had paid for the automobile, the dealer called to notify Ted that he was entitled to a manufacturer’s rebate of $1,500. The next week he received a $1,500 check from the manufacturer. How much should Ted include in gross income?

Correct Answer:Perhaps in Ted’s mind he is $1,500 richer as a result of the rebate, since he was willing to pay $23,000 for the automobile without any knowledge of the fact that he was entitled to the rebate. However, from the point of view of measuring gross income, one could reason that he purchased an automobile for a net cost of $21,500 ($23,000 – $1,500). The fact that the net cost is less than the amount Ted was willing to pay should not affect the determination of gross income.

359. Chapter 4 - Gross Income Question PR #2 Determine the proper tax year for gross income inclusion in each of the following cases.

a. An automobile dealer has several new cars in inventory, but often does not have the right combination of body style, color, and accessories. In some cases the dealer makes an offer to sell a car at a certain price, accepts a deposit, and then orders the car from the manufacturer. When the car is received from the manufacturer, the sale is closed, and the dealer receives the balance of the sales price. At the end of the current year, the dealer has deposits totaling $8,200 for cars that have not been received from the manufacturer. When is the $8,200 subject to tax?

b. Purple Corporation, an exterminating company, is a calendar year taxpayer. It contracts to provide service to homeowners once a month under a one-, two-, or three-year contract. On April 1 of the current year, the company sold a customer a one-year contract for $120. How much of the $120 is taxable in the current year if the company is an accrual basis taxpayer. If the $120 is payment on a two-year contract, how much is taxed in the year the contract is sold and in the following year? If the $120 is payment on a three-year contract, how much is taxed in the year the contract is sold and in the following year?

c. Pink, Inc., an accrual basis taxpayer, owns an amusement park whose fiscal year ends September 30. To increase business during the fall and winter months, Pink sold passes that would allow the holder to ride “free” during the months of October through March. During the month of September, $6,000 was collected from the sale of passes for the upcoming fall and winter. When will the $6,000 be taxable to Pink?

d. The taxpayer is in the office equipment rental business and uses the accrual basis of accounting. In December he collected $5,000 in rents for the following January. When is the $5,000 taxable?

Correct Answer:a. Reg. § 1.451-5 specifies that accrual basis taxpayers may defer the recognition of income

from advance payments for the future sale of inventories that are not on hand the last day of the year and the amount collected is less than the seller’s cost of the goods. The $8,200 would not be includible in the gross income of the dealer for the current year and would be includible in gross income at the time the sale is consummated upon delivery of the car.

b. Revenue Procedure 2004-34 permits the accrual basis taxpayer to amortize the prepaid income for the first year under the contract. However, the balance of the unearned income must be recognized in the tax year following the year of receipt. In the case of a contract sold on April 1 that was for services over the twelve-month period beginning on that date, the taxpayer would recognize 9/12 of the income in the year of sale, and the remaining balance (3/12) in the following year. In the case of a contract sold on April 1 that was for services over the 24-month period beginning on that date, the taxpayer would recognize 9/24 of the income in the year of sale and the remaining balance (15/24) in the following year. In the case of a contract sold on April 1 that was for services over the 36-month period beginning

on that date, the taxpayer would recognize 9/36 of the income in the year of sale and the remaining balance (27/36) in the following year.

c. Revenue Procedure 2004-34 would permit deferral of $6,000 from income until the following tax year since all services will be performed by the end of the tax year following the year of receipt.

d. Prepaid rent is taxable in the year of receipt to both the accrual and cash basis taxpayers. Revenue Procedure 2004-34 is not applicable to prepaid rent income.

360. Chapter 4 - Gross Income Question PR #3 On January 1, 2011, Faye gave Todd, her son, a 36-month certificate of deposit she purchased December 31, 2009, for $8,638. Faye gave Todd 1,000 shares of ABC, Inc., on December 2, 2011. The certificate had a maturity value of $10,000 and the yield to maturity was 5%. On November 30, 2011, ABC, Inc., had declared a dividend of $1.00 payable to stockholders of record on December 5th. How much interest and dividends should Todd include in his gross income for 2011?

Correct Answer:Todd must report $454 of interest income and no dividends. The certificate of deposit is an original issue discount instrument. Therefore, Faye should have reported $432 (.05 ´ $8,638) of interest income in 2010, and thus the adjusted basis of the CD is $9,070 ($8,638 + $432). Todd must report interest income for 2011 calculated as follows: $454 (.05 ´ $9,070). The dividends had been declared before Todd received the stock. According to the IRS in this case, the income belongs to Faye since she was the owner of the stock when the dividend was declared and she assigned to Todd the right to receive it.

361. Chapter 4 - Gross Income Question PR #4 Margaret made a $90,000 interest-free loan to her son, Adam, who used the money to retire a mortgage on his personal residence and to buy a certificate of deposit. Adam’s only income for the year is his salary of $35,000 and $1,400 interest income on the certificate of deposit. The relevant Federal interest rate is 8% compounded semiannually. The loan is outstanding for the entire year.

a. Based on the above information, what is the effect of the loan on Margaret’s gross income for the year?

b. The facts are the same as above, except you discovered that Margaret had made an additional loan of $15,000 to Adam in the previous year. Adam used the funds to pay his child’s private school tuition. What are the effects of the loans on Margaret’s gross income?

Correct Answer:a. Margaret’s interest income from the loan is $1,400, which is equal to Adam’s net investment

income for the year. Thus, Margaret’s imputed interest income for the year is $1,400, which

is the lesser of the imputed interest at the Federal rate of $7,344 [($90,000 ´ 8% ´ 1/2) + ($93,600 ´ 8% ´ 1/2)] or Adam’s net investment income of $1,400.

b. Margaret’s loans to Adam exceed $100,000 ($90,000 + $15,000). Therefore, Margaret must recognize interest income equal to the Federal rate times the outstanding loans.

(.08 ´ $105,000 ´ 1/2) = $4,200; (.08 ´ $109,200 ´ 1/2) = $4,368

Total = $8,568

362. Chapter 4 - Gross Income Question PR #5 Roy is considering purchasing land for $10,000. He expects the land to appreciate in value 8% each year (compounded) and he will sell it at the end of 10 years. He also is considering purchasing a bond for $10,000. The bond does not pay any annual interest, but will pay $21,589 at maturity in 10 years. The before-tax rate of return on the bond is 8%. Roy is in the 40% (combined Federal and State) marginal tax bracket. Roy has other investments that earn a 8% before-tax rate of return. Given that the compound interest factor at 8% is 2.1589, and at 4.8% the factor is 1.5981, which alternative should Roy choose?

Correct Answer:Roy should select the investment in the land. The investment in the bond earns a 4.8% after-tax rate of return. The tax on the original issue discount must be paid each year; therefore, owning the bond is equivalent to owning an investment that appreciates at an after-tax rate of 4.8%. At the end of 10 years, Roy will have accumulated $15,981 (1.5981 ´ $10,000). With the land, Roy’s investment will appreciate to $21,589 (2.1589 ´ $10,000) which exceeds the $15,981 amount accumulated with the bond.

363. Chapter 4 - Gross Income Question PR #6 In January 2011, Tammy purchased a bond due in 24 months. The cost of the bond is $857 and its maturity value is $1,000. No interest is paid each year, but the compound interest rate on the bond is 8%. Tammy also purchased a Series EE United States Government bond for $558, with a maturity value in 10 years of $1,000. This is the only Series EE bond she has ever owned. The Series EE bond is sold to yield 6% interest. Tammy is 13 years old and has no other source of income. She is claimed as a dependent by her parents. Compute Tammy’s gross income from the bond and Series EE bond for 2011.

Correct Answer:Tammy’s only recognized income is from the original issue discount of $69 ($857 ´ 8%) on the bond. The Series EE bonds are exempt from the original issue discount rules. However, Tammy could elect to include the original issue discount on the Series EE bond each year, and it appears that the election should be made. Because Tammy has no other sources of income, the effective tax rate on the accrued Series EE bond interest is zero because of the available standard deduction of $900. The interest reported will increase Tammy’s basis in the Series EE bond and, therefore, she will not have to recognize any income at maturity. The interest on the Series EE bond for 2011, if the election is made,

is $33 ($558 ´ 6%).

364. Chapter 4 - Gross Income Question PR #7 Juan, was considering purchasing an interest in a tax-exempt bond fund for $100,000, when he discovered that the interest must be included on his state income tax return. The interest rate is 5%. His marginal Federal tax rate is 35%, and his marginal state income tax rate is 10%. Juan itemizes his deductions on his Federal income tax return. As an alternative, Juan can purchase a state bond (a “double-exempt bond”) yielding 4.9% interest that is exempt from both Federal and state income tax. Which investment would yield the greater after-tax return?

Correct Answer:Juan will receive $5,000 before-tax from the bond fund. The state income tax is $500 [(.10)($5,000)]. The state income tax will be deductible on the Federal return; thus, the state taxes will reduce Juan’s after-tax income by only $325 [(1 – .35)($500]. Therefore, the annual after-tax return is $4,675 ($5,000 – $325), or 4.675%. The double-exempt bonds will yield 4.9% after tax; therefore, it is the preferred investment, assuming equal risks.

365. Chapter 4 - Gross Income Question PR #8 Gull Corporation was undergoing reorganization under the bankruptcy laws. The shareholders, who had made loans of $250,000 to the corporation, agreed to accept additional stock with a value of $200,000 instead of repayment on the debt. The Old Line Insurance Company, which had a $350,000 mortgage on the building, agreed to reduce the principal to $300,000. A trade creditor with a receivable of $150,000 from the company agreed to accept $70,000 in full payment for the debt incurred to purchase goods that were still on hand. Finally, the company transferred some equipment with an adjusted basis of $60,000 in satisfaction of a liability for $70,000. Compute the corporation’s gross income and other adjustments necessary as a result of the above transactions.

Correct Answer:Gull is not required to recognize income from the shareholders exchanging the debt for stock (a nontaxable contribution to capital). The $80,000 reduction in debt ($150,000 – $70,000) to trade creditors can be used to reduce the basis in the goods purchased. However, Gull is required to recognize $50,000 of gross income from the reduction in the mortgage held by Old Line, and must recognize $10,000 gain ($70,000 – $60,000) from transferring the equipment in satisfaction of the debt.

366. Chapter 4 - Gross Income Question PR #9 During the year, Herb had the following transactions:

Long-term loss on the sale of business use equipment $6,000Long-term loss on the sale of personal use boat 5,000Long-term gain on the sale of personal use camper 2,000Short-term loss on the sale of stock investment 3,000Long-term loss on the sale of land investment 4,000

How are these transactions handled for income tax purposes?

Correct Answer:Ordinary loss of $6,000 on the business equipment. The $5,000 loss on the boat is personal and not deductible. However, the $2,000 gain on the camper is taxable and is applied against the long-term capital loss on the land, reducing it to $2,000. The $3,000 short-term capital loss on the stock offsets ordinary income. The unused remaining $2,000 long-term capital loss from the land sale is carried over to future years.

367. Chapter 4 - Gross Income Question PR #10 During 2011, Lana has the following gains and losses:

LTCG $8,000LTCL 2,000STCG 1,000STCL 6,000

a. How much is Lana’s tax liability if she is in the 15% tax bracket?

b. If her tax bracket is 33% (not 15%)?

Correct Answer:a. $0. After the initial netting process, there is a LTCG of $6,000, and a STCL of $5,000.

The $5,000 of STCL is applied to the LTCG of $6,000. The final result is a net LTCG of $1,000 taxed at 0% for a tax liability of $0.

b. $150. See part a. for the netting process. Now the $1,000 is taxed at 15% for a tax

liability of $150.

368. Chapter 4 - Gross Income Question PR #11 During 2011, Dena had salary income of $90,000 and the following capital transactions:

LTCG $12,000 LTCL 15,000 STCG 12,000 STCL 6,000

How are these transactions handled for income tax purposes?

Correct Answer:

Combining the long-term transactions yields a net LTCL of $3,000 ($12,000 – $15,000), while the short-term process results in a net STCG of $6,000 ($12,000 – $6,000). A further combination leaves a net STCG of $3,000 ($6,000 – $3,000) which is taxed as ordinary income. Only net LTCG results in preferential tax treatment.

369. Chapter 4 - Gross Income Question ES #1 In some foreign countries, the tax law specifically designates the types of income items that are includible in gross income. How does this approach compare with the U.S. Internal Revenue Code (§ 61)? What is a major advantage to the approach used in the U.S. tax law?

Correct Answer:The Internal Revenue Code defines gross income as all income unless specifically excluded. The advantage of the U.S. system is that an all-inclusive list of types of income does not have to be developed.

370. Chapter 4 - Gross Income Question ES #2 Melissa is a compulsive coupon clipper. She often brags about the time she purchased a cart full of groceries for $5.00, when the cost without coupons would have been $50. Discuss whether Melissa realizes gross income from her coupon clipping.

Correct Answer:Under the all-inclusive concept of gross income, one could reason that Melissa realizes income from her coupon collecting activities. She clearly increases her wealth, as she acquires food at 1/10th of the amount paid by those who do not spend their time and effort saving coupons. In some cases, the coupons may have been obtained when other goods were purchased. One could reason that the price paid included a cost of the coupon; thus, the price paid would be allocated between the goods received and the cost of the coupon. Then, when the coupon was utilized, the difference between Melissa’s cost and the redemption value would be income.

However, it seems unlikely that the IRS would attempt to tax the earnings from coupon clipping because of the time and effort required to collect small amounts of taxes.

371. Chapter 4 - Gross Income Question ES #3 Katherine is 60 years old and is bargaining with her employer over deferred compensation. In exchange for reducing her current year’s salary by $50,000, she can receive a lump-sum amount in 5 years, when she will retire. If she receives the $50,000 in the current year, she will invest in certificates of deposit that yield 5%. Katherine in the 28% marginal tax bracket in all relevant years. What is the minimum amount Katherine should accept as a deferred pay option? [Hint: the compound interest factor is 1.1934.]

Correct Answer:$59,669

The $50,000 salary will be $36,000 [(1 – .28)($50,000)] after-tax. When this is invested in a CD that yields 3.6% [(1 – .28)(.05)] after-tax for five years, the compounded amount will be $42,962 ($36,000 ´ 1.1934). If a lump-sum is received in five years, it will be subject to tax. Therefore, Katherine should receive at least $59,669 [$42,962/(1 – .28)].

372. Chapter 4 - Gross Income Question ES #4 Rachel owns rental properties. When Rachel rents to a new tenant, she usually requires the tenant to pay an amount in addition to the first month’s rent. The additional amount serves as security for damages to the property and the tenant’s failure to pay future rents. How should the payments be characterized (e.g., on lease documents) to minimize Rachel’s current tax liability?

Correct Answer:The payments should be characterized as damage deposits. This will ensure that the IRS will not tax the payments as prepaid income. A payment to secure future rents would probably be treated as prepaid rent income.

373. Chapter 4 - Gross Income Question ES #5 In the case of a zero interest below-market loan by a corporation to a shareholder-employee, what difference does it make to the corporation and the shareholder whether the loan is characterized as a corporation’s loan to its shareholder or a corporation’s loan to its employee?

Correct Answer:Imputed interest on the loan to an employee would create compensation expense equal to the amount of imputed interest that is not charged the employee. The compensation expense would be deductible by the corporation. On the other hand, the imputed interest on the shareholder loan creates a non-deductible dividend paid by the corporation. From the shareholder-employee’s perspective, dividend treatment might be preferable because the dividends are not subject to 1.45% Medicare tax and the beneficial tax rate for qualified dividends.

374. Chapter 4 - Gross Income Question ES #6 Sally and Ed each own property with a fair market value less than the amount of the outstanding mortgage on the property and also less than the original cost basis. They each were able to convince the mortgage holder to reduce the principal amount on the mortgage. Sally’s mortgage is on her personal residence and Ed’s mortgage is on rental property he owns.

a. Explain whether each of these individuals has realized income from the reduction in the debt.

b. Assume that under the current system of measuring income, each of these taxpayers realized income from the reductions in the mortgages. Should either of these taxpayers be permitted to exclude

any of the debt reduction income?

Correct Answer:a. Each taxpayer’s liabilities were reduced. Therefore, their net worth has increased as

measured using the cost basis in the assets. Each taxpayer also experienced a loss in the value of their assets. However, the losses were not realized (because each taxpayer still owns the property). Thus, each taxpayer had income from the reduction in debt, but no recognized loss. Fortunately, recent legislation permits the taxpayer whose property is a personal residence to exclude the amount of the debt reduction from gross income. The taxpayer who owns the rental home is not eligible for the debt reduction exclusion.

b. Allowing the exclusion from income for the homeowner but not for the investor can only

be justified on the basis of a value system that says we should bend the otherwise equitable rules to favor home ownership.

375. Chapter 4 - Gross Income Question ES #7 If a tax-exempt bond will yield approximately .65 (1 – .35) times the yield on a taxable bond of equal risk, who benefits from the tax exemption: the Federal government, the state and local governments who issue the bonds, or the investors?

Correct Answer:The state and local governments benefit from the exemption because they are required to pay less interest. The exemption costs the Federal government, and thus the exemption shifts resources from the Federal to the state and local governments. The investors do not derive any benefit from the exemption, in this example, because the market drives the price of the exempt bonds upward so that the after-tax yields on the bonds are equal for investors in the highest marginal tax bracket (35%).

376. Chapter 4 - Gross Income Question ES #8 In early 2011, Ben sold a yacht, held for 9 months and for pleasure, for a $5,000 gain. Concerned about offsetting the gain before year-end, Ben is considering selling one of the following—each of which would yield a $5,000 loss:

· Houseboat used for recreation.

· Truck used in business.

· Stock investment held for 13 months.

Evaluate each choice.

Correct Answer:The sale of the houseboat produces no benefit since losses on personal use property are not deductible. The sale of the truck yields an ordinary loss of $5,000. The ordinary loss result offsets the ordinary income caused by a short-term capital gain. The best choice, however,

is the stock investment. A net long-term capital loss can neutralize a net short-term capital gain and prevent ordinary income from materializing. By itself, a net long-term capital loss can only be offset against regular income to the extent of $3,000. Also, it might obviate long-term capital gains which are taxed at preferential tax rates.

377. Chapter 5 - Business Deductions Question TF #1 For an expense to be deducted as ordinary, it must be recurring in nature.

a. True*b. False

378. Chapter 5 - Business Deductions Question TF #2 Rob, a shareholder-employee of Falcon, Inc., receives a $300,000 salary. The IRS classifies $100,000 of this amount as unreasonable compensation. The effect of this reclassification is to decrease Rob’s gross income by $100,000 and increase Falcon’s gross income by $100,000.

a. True*b. False

379. Chapter 5 - Business Deductions Question TF #3 A salary that is classified as unreasonable by the IRS is disallowed as a deduction to the corporation.

*a. Trueb. False

380. Chapter 5 - Business Deductions Question TF #4 Generally, a closely-held family corporation is not permitted to take a deduction for a salary paid to a family member in calculating corporate taxable income.

a. True*b. False

381. Chapter 5 - Business Deductions Question TF #5 For an expense to be deducted, the amount must be paid by the taxpayer.

a. True*b. False

382. Chapter 5 - Business Deductions Question TF #6 Under certain circumstances, a cash method taxpayer must treat prepayments the same as an accrual method taxpayer.

*a. Trueb. False

383. Chapter 5 - Business Deductions Question TF #7 A cash basis taxpayer who charges an expense on a bank credit card is allowed to claim a deduction currently, whereas a cash basis taxpayer who charges an expense on a department store credit card is not allowed to claim a deduction until payment is made.

a. True*b. False

384. Chapter 5 - Business Deductions Question TF #8 None of the prepaid rent paid on October 1 by a calendar year cash basis taxpayer for the next 18 months is deductible in the current period.

a. True*b. False

385. Chapter 5 - Business Deductions Question TF #9 The period in which an accrual basis taxpayer can deduct an expense is determined by applying the economic performance and all events tests.

*a. Trueb. False

386. Chapter 5 - Business Deductions Question TF #10 The amount of the addition to the reserve for bad debts for an accrual method taxpayer is allowed as a deduction for tax purposes.

a. True*b. False

387. Chapter 5 - Business Deductions Question TF #11 Fines and penalties paid for violations of the law (e.g., illegal dumping of hazardous waste) are deductible only if they relate to a trade or business.

a. True*b. False

388. Chapter 5 - Business Deductions Question TF #12 Two-thirds of treble damage payments under the antitrust law are deductible.

a. True*b. False

389. Chapter 5 - Business Deductions Question TF #13 Legal fees incurred in connection with a criminal defense are not deductible even if the crime is associated with a trade or business.

a. True*b. False

390. Chapter 5 - Business Deductions Question TF #14 The ordinary and necessary expenses for operating an illegal gambling operation (excluding such items as fines, bribes, and other illegal payments) are deductible.

*a. Trueb. False

391. Chapter 5 - Business Deductions Question TF #15 Ordinary and necessary business expenses, other than cost of goods sold, of an illegal drug trafficking business do not reduce taxable income.

*a. Trueb. False

392. Chapter 5 - Business Deductions Question TF #16 A political contribution to the Democratic Party or the Republican Party is not deductible, but a contribution to the Presidential Election Campaign Fund is deductible.

a. True*b. False

393. Chapter 5 - Business Deductions Question TF #17 A baseball team that pays a star player an annual salary of $25 million can deduct the entire $25 million as salary expense. If the same amount is paid to the CEO of IBM, only $1 million is deductible.

*a. Trueb. False

394. Chapter 5 - Business Deductions Question TF #18 Hollis operates a lawn care service in southeastern Missouri. He incurs $63,000 of expenses determining the feasibility of expanding the business to southwestern Missouri. If he expands the business, the $63,000 is deductible in the current year. If he does not do so, then he must amortize the $63,000 over a 180-month period.

a. True*b. False

395. Chapter 5 - Business Deductions Question TF #19 Investigation of a business unrelated to one’s present business never results in a current period deduction of the entire amount if the amount of the investigation expenses exceeds $5,000.

*a. Trueb. False

396. Chapter 5 - Business Deductions Question TF #20 LD Partnership, a cash basis taxpayer, purchases land and a building for $200,000 with $150,000 of the cost being allocated to the building. The gross receipts of the partnership are less than $100,000. LD must capitalize the $50,000 paid for the land, but can deduct the $150,000 paid for the building in the current tax year.

a. True*b. False

397. Chapter 5 - Business Deductions Question TF #21 Landscaping expenditures on new rental property are deductible in the year they are paid or incurred.

a. True*b. False

398. Chapter 5 - Business Deductions Question TF #22 Marge sells land to her adult son, Jason, for its $20,000 appraised value. Her adjusted basis for the land is $25,000. Marge’s recognized loss is $0 and Jason’s adjusted basis for the land is $25,000 ($20,000 cost + $5,000 disallowed loss of Marge).

a. True*b. False

399. Chapter 5 - Business Deductions Question TF #23 For purposes of the § 267 loss disallowance provision, a taxpayer’s aunt is a related party.

a. True*b. False

400. Chapter 5 - Business Deductions Question TF #24 On December 20, 2011, the directors of Quail Corporation (an accrual basis, calendar year taxpayer) authorized a cash donation of $5,000 to the American Cancer Society, a qualified charity. The payment, which is made on March 15, 2012, may be claimed as a deduction for tax year 2011.

*a. Trueb. False

401. Chapter 5 - Business Deductions Question TF #25 In the current year, Oriole Corporation donated a painting worth $75,000 to the Texas Art Museum, a qualified public charity. The museum included the painting in its permanent collection. Oriole Corporation purchased the painting 5 years ago for $25,000. Oriole’s charitable contribution deduction is $25,000 (ignoring the taxable income limitation).

a. True*b. False

402. Chapter 5 - Business Deductions Question TF #26 In the current year, Zircon Corporation donated scientific property worth $300,000 to City University (a qualified charitable organization) to be used in research. The basis of the property was $140,000, and Zircon had held it for ten months as inventory. Zircon Corporation may deduct $220,000 as a charitable contribution (ignoring the taxable income limitation).

*a. Trueb. False

403. Chapter 5 - Business Deductions Question TF #27 Heron Corporation, a calendar year C corporation, had an excess charitable contribution for 2010 of $5,000. In 2011, Heron made a further charitable contribution of $20,000. Heron’s 2011 deduction is limited to $15,000 (10% of taxable income). The current year’s contribution must be applied first against the $15,000 limitation.

*a. Trueb. False

404. Chapter 5 - Business Deductions Question TF #28 Research and experimental expenditures do not include expenditures for ordinary testing of materials for quality control.

*a. Trueb. False

405. Chapter 5 - Business Deductions Question TF #29 Depreciation on a building used for research may be a research and experimental expense.

*a. Trueb. False

406. Chapter 5 - Business Deductions Question TF #30 If an election is made to defer deduction of research expenditures, the amortization period is based on the expected life of the research project if less than 60 months.

a. True*b. False

407. Chapter 5 - Business Deductions Question TF #31 For tax years beginning in 2011, the domestic production activities deduction (DPAD) for a sole proprietor is calculated by multiplying 9% times the lesser of (1) qualified production activities income (QPAI) or (2) taxable income or alternative minimum taxable income.

a. True*b. False

408. Chapter 5 - Business Deductions Question TF #32 If qualified production activities income (QPAI) cannot be used in the calculation of the domestic production activities deduction in 2011 because of the taxable income limitation, the product of the amount not allowed multiplied by 9% can be carried over for 5 years.

a. True*b. False

409. Chapter 5 - Business Deductions Question TF #33 The domestic production activities deduction (DPAD) for 2011 cannot exceed 50% of all W-2 wages paid to employees by the taxpayer during the tax year.

a. True*b. False

410. Chapter 5 - Business Deductions Question TF #34 The basis of cost recovery property must be reduced by the cost recovery allowed.

a. True*b. False

411. Chapter 5 - Business Deductions Question TF #35 The cost recovery basis for property converted from personal use to business use is the fair market value of the property at the time of the conversion.

a. True*b. False

412. Chapter 5 - Business Deductions Question TF #36 If more than 40% of the value of property, other than real property, is placed in service during the last quarter, all of the property will be allowed 1.5 months of cost recovery.

a. True*b. False

413. Chapter 5 - Business Deductions Question TF #37 Under MACRS, if the mid-quarter convention is applicable, all property sold is treated as being sold at the mid-point of the quarter in which it is placed in service.

a. True*b. False

414. Chapter 5 - Business Deductions Question TF #38 Residential rental real estate includes property where 80% or more of the net rental revenues are from nontransient dwelling units.

a. True*b. False

415. Chapter 5 - Business Deductions Question TF #39 In a farming business, if the uniform capitalization rules apply, cost is recovered using the ADS straight-line method.

a. True*b. False

416. Chapter 5 - Business Deductions Question TF #40 When lessor owned leasehold improvements are abandoned because of the termination of the lease, a loss can be taken for the unrecovered basis.

*a. Trueb. False

417. Chapter 5 - Business Deductions Question TF #41 The § 179 deduction can exceed $500,000 in 2011 if the taxpayer had a § 179 amount which exceeded the taxable income limitation in the prior year.

a. True*b. False

418. Chapter 5 - Business Deductions Question TF #42 The § 179 limit of $250,000 for qualified leasehold improvement property is in addition to the $500,000 limit for tangible personal

property.

a. True*b. False

419. Chapter 5 - Business Deductions Question TF #43 If a new car that is used predominantly in business is placed in service in 2011, the statutory dollar cost recovery limit under § 280F will depend on whether the taxpayer takes MARCS or straight-line depreciation.

a. True*b. False

420. Chapter 5 - Business Deductions Question TF #44 If a used $15,000 automobile used 100% for business in the first year (2011) fails the 50% business usage test in the second year, no cost recovery will be recaptured.

a. True*b. False

421. Chapter 5 - Business Deductions Question TF #45 The inclusion amount for a leased automobile is adjusted by a business usage percentage.

*a. Trueb. False

422. Chapter 5 - Business Deductions Question TF #46 Under the alternative depreciation system (ADS), the half-year and mid-quarter conventions are applicable for personalty.

*a. Trueb. False

423. Chapter 5 - Business Deductions Question TF #47 The cost of a covenant not to complete for five years incurred in connection with the acquisition of a business is amortized over 5 years.

a. True*b. False

424. Chapter 5 - Business Deductions Question TF #48 Goodwill associated with the acquisition of a business cannot be amortized.

a. True*b. False

425. Chapter 5 - Business Deductions Question TF #49 Cost depletion is determined by multiplying the depletion cost per unit by the number of units produced.

a. True*b. False

426. Chapter 5 - Business Deductions Question TF #50 Percentage depletion enables the taxpayer to recover only the cost of an asset.

a. True*b. False

427. Chapter 5 - Business Deductions Question MC #1 Which of the following is not a deductible “trade or business” expense?

a. Interest on business indebtedness.b. Property taxes on business property.*c. Parking ticket paid on business auto.d. Depreciation on business property.e. All of the above are “trade or business” expenses.

428. Chapter 5 - Business Deductions Question MC #2 Agnes is the sole shareholder of Violet, Inc. For 2011, she receives from Violet a salary of $200,000 and dividends of $100,000. Violet’s taxable income for 2011 is $500,000. On audit, the IRS treats $50,000 of Agnes’s salary as unreasonable. Which of the following statements is correct?

a. Agnes’s gross income will increase by $50,000 as a result of the IRS adjustment.b. Violet’s taxable income will not be affected by the IRS adjustment.c. Agnes’s gross income will decrease by $50,000 as a result of the IRS adjustment.*d. Violet’s taxable income will increase by $50,000 as a result of the IRS adjustment.e. None of the above is correct.

429. Chapter 5 - Business Deductions Question MC #3 Which of the following is incorrect?

*a. All salaries of a business are deductible.b. To be deductible, a business expense must be both ordinary and necessary.c. The income and expenses of a sole proprietorship business are

reported on Schedule C.d. The purchase of a building must be capitalized.e. All of the above are incorrect.

430. Chapter 5 - Business Deductions Question MC #4 Benita incurred a business expense on December 10, 2011, which she charged on her bank credit card. She paid the credit card statement which included the charge on January 5, 2012. Which of the following is correct?

a. If Benita is a cash method taxpayer, she cannot deduct the expense until 2012.*b. If Benita is an accrual method taxpayer, she can deduct the expense in 2011.c. If Benita uses the accrual method, she can choose to deduct the expense in either 2011 or 2012.d. Only b. and c. are correct.e. a., b., and c. are correct.

431. Chapter 5 - Business Deductions Question MC #5 Payments by a cash basis taxpayer of capital expenditures:

a. Must be expensed at the time of payment.b. Must be expensed by the end of the first year after the asset is acquired.*c. Must be deducted over the actual or statutory life of the asset.d. Can be deducted in the year the taxpayer chooses.e. None of the above.

432. Chapter 5 - Business Deductions Question MC #6 Petal, Inc. is an accrual basis taxpayer. Petal uses the aging approach to calculate the reserve for bad debts. During 2011, the following occur associated with bad debts.

Credit sales $325,000Collections on credit sales 290,000Amount added to the reserve 15,000Beginning balance in the reserve –0–Identifiable bad debts during 2011 12,000

The amount of the deduction for bad debt expense for Petal for 2011 is:

*a. $12,000.b. $15,000.c. $27,000.d. $35,000.e. None of the above.

433. Chapter 5 - Business Deductions Question MC #7 Which of the following is deductible as a trade or business expense?

a. A city coroner contributes to the mayor’s reelection campaign fund.b. Illegal bribes and kickbacks paid to a Federal government employee by a corporate executive.c. Two-thirds of treble damage payments.d. Fines and penalties paid by a trucking firm for excessive weight and speeding.*e. None of the above.

434. Chapter 5 - Business Deductions Question MC #8 Rex, a cash basis calendar year taxpayer, runs a bingo operation which is illegal under state law. During 2011, a bill designated H.R. 9 is introduced into the state legislature which, if enacted, would legitimize bingo games. In 2011, Rex had the following expenses:

Operating expenses in conducting bingo games $247,000Payoff money to state and local police 24,000Newspaper ads supporting H.R. 9 3,000Political contributions to legislators who support H.R. 9 8,000

Of these expenditures, Rex may deduct:

*a. $247,000.b. $250,000.c. $258,000.d. $282,000.e. None of the above.

435. Chapter 5 - Business Deductions Question MC #9 Angela, a real estate broker, had the following income and expenses in her business:

Commissions income $100,000Expenses: Commissions paid to non-brokers for referrals (illegal under state law and subject to criminal penalties) 20,000 Commissions paid to other real estate brokers for referrals (not illegal under state law) 10,000 Travel and transportation 12,000 Supplies 4,000 Office and phone 5,000 Parking tickets 500

How much net income must Angela report from this business?

a. $48,500.b. $49,000.c. $60,000.d. $68,500.*e. $69,000.

436. Chapter 5 - Business Deductions Question MC #10 Gerald owns an illegal casino. Which of the following expenses incurred in connection with this activity are deductible?

*a. Rent.b. Illegal kickbacks to government officials to stay in business.c. Fines.d. Purchase of land for a new building.e. None of the above.

437. Chapter 5 - Business Deductions Question MC #11 Terry and Jim are both involved in operating illegal businesses. Terry operates a gambling business and Jim operates a drug running business. Both businesses have gross revenues of $500,000. The businesses incur the following expenses.

Terry Jim Employee salaries $200,000 $200,000 Bribes to police 25,000 25,000 Rent and utilities 50,000 50,000 Cost of goods sold –0– 125,000

Which of the following statements is correct?

a. Neither Terry nor Jim can deduct any of the above items in calculating the business profit.*b. Terry should report profit from his business of $250,000.c. Jim should report profit from his business of $500,000.d. Jim should report profit from his business of $250,000.e. None of the above.

438. Chapter 5 - Business Deductions Question MC #12 Tom operates an illegal drug-running operation and incurred the following expenses:

Salaries $ 75,000Illegal kickbacks 20,000Bribes to border guards 25,000Cost of goods sold 160,000

Rent 8,000Interest 10,000Insurance on furniture and fixtures 6,000Utilities and telephone 20,000

Which of the above amounts reduces his taxable income?

a. $0.*b. $160,000.c. $279,000.d. $324,000.e. None of the above.

439. Chapter 5 - Business Deductions Question MC #13 Vera is the CEO of Brunettes, a publicly held corporation. For the year, she receives a salary of $900,000, a bonus of $500,000, and contributions to her retirement plan of $42,000. The bonus was awarded at the December board meeting based on Vera’s threat to accept a better paying job with a competitor. What amount may Brunettes deduct?

a. $942,000.*b. $1,042,000.c. $1,400,000.d. $1,442,000.e. None of the above.

440. Chapter 5 - Business Deductions Question MC #14 Tommy, an automobile mechanic employed by an auto dealership, is considering opening a fast food franchise. If Tommy decides not to acquire the fast food franchise, any investigation expenses are:

a. A deduction for AGI.b. A deduction from AGI, subject to the 2 percent floor.c. A deduction from AGI, not subject to the 2 percent floor.d. Deductible up to $5,000 in the current year with the balance being amortized over a 180-month period.*e. Not deductible.

441. Chapter 5 - Business Deductions Question MC #15 Iris, a calendar year cash basis taxpayer, owns and operates several TV rental outlets in Florida, and wants to expand to other states. During 2011, she spends $14,000 to investigate TV rental stores in South Carolina and $9,000 to investigate TV rental stores in Georgia. She acquires the South Carolina operations, but not the outlets in Georgia. As to these expenses, Iris should:

a. Capitalize $14,000 and not deduct $9,000.*b. Expense $23,000 for 2011.c. Expense $9,000 for 2011 and capitalize $14,000.d. Capitalize $23,000.

e. None of the above.

442. Chapter 5 - Business Deductions Question MC #16 Which of the following statements is correct in connection with the investigation of a business?

a. If the taxpayer is not already engaged in the trade or business, the expenses incurred are deductible if the project is abandoned.*b. If the business is acquired, the expenses may be deducted immediately by a taxpayer engaged in a similar trade or business.c. That business must be related to the taxpayer’s present business for any expense ever to be deductible.d. Regardless of whether the taxpayer is already engaged in the trade or business, the expenses must be capitalized and amortized.e. None of the above.

443. Chapter 5 - Business Deductions Question MC #17 Which of the following must be capitalized by a business?

a. Replacement of a windshield of a business truck which was broken in an accident.b. Replacement of a roof of a building used in business.c. Amount paid for a covenant not to compete.*d. Only b. and c. must be capitalized.e. a., b., and c. can be expensed rather than capitalized.

444. Chapter 5 - Business Deductions Question MC #18 On January 2, 2011, Fran acquires a business from Chuck. Among the assets purchased are the following intangibles: patent with a 7-year remaining life, a covenant not to compete for 10 years, and goodwill.

Of the purchase price, $140,000 was paid for the patent and $60,000 for the covenant. The amount of the excess of the purchase price over the identifiable assets was $100,000. What is the amount of the amortization deduction for 2011?

a. $10,667.b. $16,000.*c. $20,000.d. $32,667.e. None of the above.

445. Chapter 5 - Business Deductions Question MC #19 In January, Lance sold stock with a cost basis of $26,000 to his brother, James, for $24,000, the fair market value of the stock on the date of sale. Five months later, James sold the same stock through his broker for $27,000. What is the tax effect of these transactions?

a. Disallowed loss to James of $2,000; gain to Lance of $1,000.b. Disallowed loss to Lance of $2,000; gain to James of $3,000.c. Deductible loss to Lance of $2,000; gain to James of $3,000.*d. Disallowed loss to Lance of $2,000; gain to James of $1,000.e. None of the above.

446. Chapter 5 - Business Deductions Question MC #20 Nikeya sells land (adjusted basis of $120,000) to her adult son, Shamed, for its appraised value of $95,000. Which of the following statements is correct?

a. Nikeya’s recognized loss is $25,000 ($95,000 amount realized – $120,000 adjusted basis).b. Shamed’s adjusted basis for the land is $120,000 ($95,000 cost + $25,000 disallowed loss for Nikeya).*c. If Shamed subsequently sells the land for $112,000, he has no recognized gain or loss.d. Only a. and b. are correct.e. a., b., and c. are correct.

447. Chapter 5 - Business Deductions Question MC #21 Which of the following is not a related party for constructive ownership purposes under § 267?

*a. The taxpayer’s cousin.b. The taxpayer’s brother.c. The taxpayer’s grandmother.d. A corporation owned more than 50% by the taxpayer.e. None of the above.

448. Chapter 5 - Business Deductions Question MC #22 Grocer Services Corporation (a calendar year taxpayer), a wholesale distributor of food, made the following donations to qualified charitable organizations during the year:

Adjusted Basis Fair Market ValueFood (held as inventory) donated to the Ohio Children’s Shelter

$3,500 $8,000

Passenger van to Ohio Children’s Shelter, to be used to transport children to school

7,500 7,100

Stock in Acme Corporation acquired 7 months ago and held as an investment, donated to Southwest University

4,000 6,200

How much qualifies for the charitable contribution deduction?

a. $15,000.*b. $16,850.

c. $17,250.d. $19,450.e. None of the above.

449. Chapter 5 - Business Deductions Question MC #23 In the current year, Plum Corporation, a computer manufacturer, donated 100 laptop computers to a local school district (a qualified educational organization). The computers were constructed by Plum earlier this year, and the school district allocated the computers among its various schools where they will be used for educational purposes. Plum’s basis in the computers is $50,000, and their fair market value is $120,000. What is Plum’s deduction for the contribution of the computers (ignoring the taxable income limitation)?

a. $0.b. $50,000.*c. $85,000. d. $100,000. e. $120,000.

450. Chapter 5 - Business Deductions Question MC #24 During the current year, Kingbird Corporation (a calendar year C corporation) had the following income and expenses:

Income from operations $135,000Expenses from operations 99,000Dividends received (40% ownership) 9,000Domestic production activities deduction 2,700

On October 1, Kingbird Corporation made a contribution to a qualified charitable organization of $6,300 in cash (not included in any of the above items). Determine Kingbird’s charitable contribution deduction for the current year.

a. $0.b. $4,230.*c. $4,500.d. $6,300.e. None of the above.

451. Chapter 5 - Business Deductions Question MC #25 Regarding research and experimental expenditures, which of the following are not qualified expenditures?

a. Costs of improving an existing pilot model.b. Costs to develop a plant process.c. Costs of developing a formula.d. Depreciation on a building used for research.

*e. All of the above are qualified expenditures.

452. Chapter 5 - Business Deductions Question MC #26 Blue Corporation incurred the following expenses in connection with the development of a new product:

Salaries $100,000Utilities 18,000Materials 25,000Advertising 5,000Market survey 3,000Depreciation on machine 9,000

Blue expects to begin selling the product next year. If Blue elects to amortize research and experimental expenditures over 60 months, determine the amount of the deduction for research and experimental expenditures for the current year.

*a. $0.b. $118,000.c. $143,000.d. $152,000.e. $160,000.

453. Chapter 5 - Business Deductions Question MC #27 Last year, Green Corporation incurred the following expenditures in the development of a new plant process:

Salaries $200,000Materials 80,000Utilities 10,000Quality control testing costs 30,000Management study costs 5,000Depreciation of equipment 15,000

During the current year, benefits from the project began being realized in March. If Green Corporation elects a 60 month deferral and amortization period, determine the amount of the deduction for the current year.

*a. $50,833.b. $55,833.c. $56,667.d. $61,000.e. None of the above.

454. Chapter 5 - Business Deductions Question MC #28 Ivory, Inc., has taxable income of $600,000 and qualified production activities income (QPAI) of $400,000 in 2011. Ivory’s domestic production activities deduction is:

a. $24,000.*b. $36,000.c. $40,000.d. $54,000.e. None of the above.

455. Chapter 5 - Business Deductions Question MC #29 For the year 2011, Amber Corporation has taxable income of $880,000, alternative minimum taxable income of $600,000, and qualified production activities income (QPAI) of $640,000. The total W-2 wages paid to employees engaged in qualified domestic production activities are $116,000. Amber’s DPAD for 2011 is:

*a. $54,000.b. $57,600.c. $58,000.d. $79,200.e. None of the above.

456. Chapter 5 - Business Deductions Question MC #30 Cream, Inc.’s taxable income for 2011 before any deduction for an NOL carryforward of $30,000 is $70,000. Cream’s qualified production activities income (QPAI) is $60,000. What is the amount of Cream’s domestic production activities deduction (DPAD) for 2011?

a. $1,200.b. $1,800.c. $2,400.*d. $3,600.e. None of the above.

457. Chapter 5 - Business Deductions Question MC #31 In Shelby County, the real property tax year is the calendar year. The real property tax becomes a personal liability of the owner of real property on January 1 in the current real property tax year, 2011. The tax is payable on June 1, 2011. On April 30, 2011, Julio sells his house to Anita for $230,000. On June 1, 2011, Anita pays the entire real estate tax of $7,300 for the year ending December 31, 2011. How much of the property taxes may Julio deduct?

a. $0.*b. $2,380.c. $2,400.d. $4,920e. None of the above.

458. Chapter 5 - Business Deductions Question MC #32 On June 1 of the current year, Tab converted a machine from personal use to rental property. At the time of the conversion, the machine was worth $90,000. Five years ago Tab purchased the machine for $70,000. The machine is still encumbered by a $50,000 mortgage. What is the basis of the machine for cost recovery?

*a. $70,000.b. $90,000.c. $120,000.d. $140,000.e. None of the above.

459. Chapter 5 - Business Deductions Question MC #33 Tara purchased a machine for $40,000 to be used in her business. The cost recovery allowed and allowable for the three years the machine was used are as follows:

Cost Recovery Allowed Cost Recovery AllowableYear 1 $16,000 $ 8,000Year 2 9,600 12,800Year 3 5,760 7,680

If Tara sells the machine after three years for $15,000, how much gain should she recognize?

a. $3,480.b. $6,360.c. $9,240.*d. $11,480.e. None of the above.

460. Chapter 5 - Business Deductions Question MC #34 Hazel purchased a new business asset (five-year asset) on September 30, 2011, at a cost of $100,000. On October 4, 2011, Hazel placed the asset in service. This was the only asset Hazel placed in service in 2011. The only election with respect to the asset was not to take additional first-year depreciation. On August 20, 2012, Hazel sold the asset. Determine the cost recovery for 2012 for the asset.

a. $9,600.b. $16,000.c. $26,000.d. $38,000.*e. None of the above.

461. Chapter 5 - Business Deductions Question MC #35 Tan Company acquires a new machine (ten-year property) on January 15, 2011, at a cost of $200,000. Tan also acquires another new machine

(seven-year property) on November 5, 2011, at a cost of $40,000. No election is made to use the straight-line method. The company does not make the § 179 election. Tan elects not to take additional first-year depreciation. Determine the total deductions in calculating taxable income related to the machines for 2011.

a. $24,000.*b. $25,716.c. $102,000.d. $132,858.e. None of the above.

462. Chapter 5 - Business Deductions Question MC #36 James purchased a new business asset (three-year personalty) on July 23, 2011, at a cost of $40,000. He did not elect to expense any of the asset under § 179, nor did he elect straight-line cost recovery. James elects not to take additional first-year depreciation. Determine the cost recovery deduction for 2011.

a. $8,333.b. $16,665.c. $33,333.d. $41,665.*e. None of the above.

463. Chapter 5 - Business Deductions Question MC #37 Alice purchased office furniture on September 20, 2011, for $100,000. On October 10, she purchased business computers for $80,000. Alice did not elect to expense any of the assets under § 179, nor did she elect straight-line cost recovery. She elects not to take additional first-year depreciation. Determine the cost recovery deduction for the business assets for 2011.

a. $6,426.*b. $14,710.c. $25,722.d. $30,290.e. None of the above.

464. Chapter 5 - Business Deductions Question MC #38 Barry purchased a used business asset (seven-year property) on September 30, 2011, at a cost of $200,000. This is the only asset he purchased during the year. Barry did not elect to expense any of the asset under § 179, nor did he elect straight-line cost recovery. Barry sold the asset on July 17, 2012. Determine the cost recovery deduction for 2012.

a. $19,133.*b. $24,490.c. $34,438.d. $55,100.

e. None of the above.

465. Chapter 5 - Business Deductions Question MC #39 Bonnie purchased a new business asset (five-year property) on March 10, 2011, at a cost of $20,000. She also purchased a new business asset (seven-year property) on November 20, 2011, at a cost of $13,000. Bonnie did not elect to expense either of the assets under § 179, nor did she elect straight-line cost recovery. Bonnie elects not to take additional first-year depreciation. Determine the cost recovery deduction for 2011 for these assets.

*a. $5,858.b. $7,464.c. $9,586.d. $19,429.e. None of the above.

466. Chapter 5 - Business Deductions Question MC #40 Doug purchased a new factory building on January 15, 1988, for $400,000. On March 1, 2011, the building was sold. Determine the cost recovery deduction for the year of the sale assuming he did not use the MACRS straight-line method.

a. $0.b. $1,587.*c. $2,645.d. $12,696.e. None of the above.

467. Chapter 5 - Business Deductions Question MC #41 Cora purchased a hotel building on May 17, 2011, for $6,000,000. Determine the cost recovery deduction for 2012.

a. $96,300.b. $119,040.c. $138,000.*d. $153,840.e. None of the above.

468. Chapter 5 - Business Deductions Question MC #42 Carlos purchased an apartment building on November 16, 2011, for $1,000,000. Determine the cost recovery for 2011.

a. $3,210.b. $3,970.*c. $4,550.d. $7,580.e. None of the above.

469. Chapter 5 - Business Deductions Question MC #43 Diane purchased a factory building on November 15, 1993, for $5,000,000. She sells the factory building on February 2, 2011. Determine the cost recovery deduction for the year of the sale.

*a. $16,025.b. $19,844.c. $26,458.d. $158,750.e. None of the above.

470. Chapter 5 - Business Deductions Question MC #44 Howard’s business is raising and harvesting peaches. On March 10, 2011, Howard purchased 10,000 new peach trees at a cost of $60,000. Howard does not elect to expense assets under § 179. Determine the cost recovery deduction for 2011.

a. $0.b. $2,500.c. $10,000.*d. $60,000.e. None of the above.

471. Chapter 5 - Business Deductions Question MC #45 On May 15, 2011, Brent purchased new farm equipment for $120,000. Brent used the equipment in connection with his farming business. Brent does not elect to expense assets under § 179. Brent does elect not to take additional first-year depreciation. Determine the cost recovery deduction for 2011.

*a. $12,852.b. $18,000.c. $24,000.d. $30,000.e. None of the above.

472. Chapter 5 - Business Deductions Question MC #46 On June 1, 2011, Sam purchased new farm machinery for $150,000. Sam used the machinery in connection with his farming business. Sam does not elect to expense assets under § 179. Sam has, however, made an election to not have the uniform capitalization rules apply to the farming business. Sam does elect not to take additional first-year depreciation. Determine the cost recovery deduction for 2011.

a. $5,000.*b. $7,500.c. $10,000.d. $12,500.e. None of the above.

473. Chapter 5 - Business Deductions Question MC #47 On May 30, 2011, Jane signed a 20-year lease on a factory building to use for her business. The lease begins on June 1, 2011. In August 2011, Jane paid $300,000 for qualified leasehold improvements to the building. Jane elected to treat the qualified leasehold improvements as § 179 property. Determine Jane’s total deduction with respect to the leasehold improvements for 2011.

a. $2,889.b. $250,000.c. $250,482.*d. $300,000.e. None of the above.

474. Chapter 5 - Business Deductions Question MC #48 On February 20, 2011, Susan paid $200,000 for a qualified leasehold improvement to an office building that she is going to lease to John. The lease will begin on June 1, 2011, and terminate on May 31, 2021. At the termination of the lease, the improvement will be worthless. Susan did not elect to treat the leasehold improvement property as § 179 property; however, she did elect not to take additional first-year depreciation. Determine Susan’s deductible loss as a result of the termination of the lease.

a. $0.b. $123,503.c. $127,990.d. $128,631.*e. None of the above.

475. Chapter 5 - Business Deductions Question MC #49 White Company acquires a new machine (seven-year property) on January 10, 2011, at a cost of $900,000. White makes the election to expense the maximum amount under § 179. No election is made to use the straight-line method. White does elect not to take additional first-year depreciation. Determine the total deductions in calculating taxable income related to the machine for 2011 assuming White has taxable income of $800,000.

a. $64,000.b. $128,610.c. $257,175.d. $500,000.*e. None of the above.

476. Chapter 5 - Business Deductions Question MC #50 Augie purchased one used asset during the year (five-year property) on November 10, 2011, at a cost of $650,000. She made the § 179 election. The income from the business before the cost recovery deduction and the § 179 deduction was $400,000. Determine the total cost recovery deduction with respect to the asset for 2011.

a. $7,500.b. $92,500.c. $392,500.d. $500,000.*e. None of the above.

477. Chapter 5 - Business Deductions Question MC #51 In 2010, Gail had a § 179 deduction carryover of $15,000. In 2011, she elected § 179 for an asset acquired at a cost of $115,000. Gail’s § 179 business income limitation for 2011 is $127,000. Determine Gail’s § 179 deduction for 2011.

a. $15,000.b. $115,000.*c. $127,000.d. $130,000.e. None of the above.

478. Chapter 5 - Business Deductions Question MC #52 The only asset Bill purchased during 2011 was a new seven-year class asset. The asset, which was listed property, was acquired on June 17 at a cost of $50,000. The asset was used 40% for business, 30% for the production of income, and the rest of the time for personal use. Bill always elects to expense the maximum amount under § 179 whenever it is applicable. The net income from the business before the § 179 deduction is $100,000. Determine Bill’s maximum deduction with respect to the property for 2011.

a. $1,428.*b. $2,499.c. $26,749.d. $33,375.e. None of the above.

479. Chapter 5 - Business Deductions Question MC #53 Mary purchased a new five-year class asset on March 7, 2011. The asset was listed property (not an automobile). It was used 60% for business and the rest of the time for personal use. The asset cost $600,000. Mary made the § 179 election. The income from the business before the § 179 deduction was $400,000. Mary does elect not to take additional first-year depreciation. Determine the total deductions with respect to the asset for 2011.

a. $72,000.b. $250,000.c. $272,000.*d. $360,000.e. None of the above.

480. Chapter 5 - Business Deductions Question MC #54 Hans purchased a new passenger automobile on August 17, 2011, for

$30,000. During the year the car was used 40% for business and 60% for personal use. Determine his cost recovery deduction for the car for 2011.

a. $500.b. $1,000.c. $1,224.d. $1,500.*e. None of the above.

481. Chapter 5 - Business Deductions Question MC #55 On June 1, 2011, Irene places in service a new automobile that cost $21,000. The car is used 70% for business and 30% for personal use. (Assume this percentage is maintained for the life of the car.) She does elect not to take additional first-year depreciation. Determine the cost recovery deduction for 2012.

a. $3,060.b. $3,290.*c. $3,430.d. $6,720.e. None of the above.

482. Chapter 5 - Business Deductions Question MC #56 On June 1, 2011, James places in service a new automobile that cost $40,000. The car is used 60% for business and 40% for personal use. (Assume this percentage is maintained for the life of the car.) James does elect not to take additional first-year depreciation. Determine the cost recovery deduction for 2011.

a. $1,776.*b. $1,836.c. $6,576.d. $8,000.e. None of the above.

483. Chapter 5 - Business Deductions Question MC #57 On May 2, 2011, Karen placed in service a used sports utility vehicle that cost $60,000 and has a gross vehicle weight of 6,300 lbs. The vehicle is used 60% for business and 40% for personal use. Determine the cost recovery for 2011.

a. $2,200.b. $3,060.c. $25,000.*d. $27,200.e. None of the above.

484. Chapter 5 - Business Deductions Question MC #58 On July 17, 2011, Kevin places in service a used automobile that cost $25,000. The car is used 80% for business and 20% for personal use. In

2012, he used the automobile 40% for business and 60% for personal use. Determine the cost recovery recapture for 2012.

a. $0.*b. $448.c. $2,000.d. $2,500.e. None of the above.

485. Chapter 5 - Business Deductions Question MC #59 Janet purchased a new car on June 5, 2011, at a cost of $18,000. She used the car 80% for business and 20% for personal use in 2011. She used the automobile 40% for business and 60% for personal use in 2012. Janet elects not to take additional first-year depreciation. Determine Janet’s cost recovery recapture for 2012.

a. $0.b. $928.*c. $1,008.d. $1,440.e. None of the above.

486. Chapter 5 - Business Deductions Question MC #60 On July 10, 2011, Ariff places in service a new sports utility vehicle that cost $70,000 and weighed 6,300 pounds. The SUV is used 100% for business. Determine Ariff’s maximum deduction for 2011, assuming Ariff’s § 179 business income is $110,000. Ariff elects not to take additional first-year depreciation.

a. $2,960.b. $25,000.*c. $34,000.d. $70,000.e. None of the above.

487. Chapter 5 - Business Deductions Question MC #61 On March 1, 2011, Lana leases and places in service a passenger automobile. The lease will run for five years and the payments are $500 per month. During 2011, she uses her car 40% for business and 60% for personal activities. Assuming the dollar amount from the IRS table is $110, determine Lana’s deduction for the lease payments.

a. $0.b. $1,800.*c. $2,000.d. $2,330.e. None of the above.

488. Chapter 5 - Business Deductions Question MC #62 On June 1, 2011, Norm leases a taxi and places it in service. The lease payments are $1,000 per month. Assuming the dollar amount from the IRS

table is $241, determine Norm’s inclusion amount.

*a. $0.b. $241.c. $907.d. $1,687.e. None of the above.

489. Chapter 5 - Business Deductions Question MC #63 Bhaskar purchased a new factory building on September 2, 2011, for $2,000,000. He elected the alternative depreciation system (ADS). Determine the cost recovery deduction for 2012.

a. $15,000.b. $18,000.c. $22,000.*d. $50,000.e. None of the above.

490. Chapter 5 - Business Deductions Question MC #64 Pat purchased a used five-year class asset on March 15, 2011, for $60,000. He did not elect § 179 expensing. Determine the cost recovery deduction for 2011 for earnings and profits purposes.

a. $2,000.b. $3,000.*c. $6,000.d. $12,000.e. None of the above.

491. Chapter 5 - Business Deductions Question MC #65 George purchases used seven-year class property at a cost of $200,000 on April 20, 2011. Determine George’s cost recovery deduction for 2011 for alternative minimum tax purposes, assuming George does not elect § 179 and the maximum cost recovery deduction is taken for regular income tax purposes.

a. $2,500.b. $10,000.c. $14,280.d. $28,580.*e. None of the above.

492. Chapter 5 - Business Deductions Question MC #66 During the past two years, through extensive advertising and improved customer relations, Orange Corporation estimated that it had developed customer goodwill worth $500,000. For the current year, determine the amount of goodwill Orange Corporation may amortize.

a. $16,667.b. $26,667.

c. $33,333.d. $100,000.*e. None of the above.

493. Chapter 5 - Business Deductions Question MC #67 On June 1, 2011, Red Corporation purchased an existing business. With respect to the acquired assets of the business, Red allocated $300,000 of the purchase price to a patent. The patent will expire in five years. Determine the total amount that Red may amortize for 2011 for the patent.

a. $0.b. $1,667.*c. $11,667.d. $35,000.e. None of the above.

494. Chapter 5 - Business Deductions Question MC #68 On January 15, 2011, Vern purchased the rights to a mineral interest for $3,500,000. At that time it was estimated that the recoverable units would be 500,000. During the year, 40,000 units were mined and 25,000 units were sold for $800,000. Vern incurred expenses during 2011 of $500,000. The percentage depletion rate is 22%. Determine Vern’s depletion deduction for 2011.

a. $150,000.*b. $175,000.c. $176,000.d. $200,000.e. $250,000.

495. Chapter 5 - Business Deductions Question PR #1 Sandra owns an insurance agency. The following selected data are taken from the agency balance sheet and income statement prepared using the accrual method.

Revenue $250,000Salaries and commissions 100,000Rent 10,000Insurance 5,000Utilities 6,000Accounts receivable, 1/1/2011 40,000Accounts receivable, 12/31/2011 38,000Accounts payable, 1/1/2011 12,000Accounts payable, 12/31/2011 11,000

Calculate Sandra’s net profit using the cash method for 2011.

Correct Answer:

Sandra’s accrual method net profit is calculated as follows:

Revenue $250,000 Less: Expenses Salaries and commissions $100,000 Rent 10,000 Insurance 5,000 Utilities 6,000 (121,000)Net profit $129,000

To convert to cash method net profit, the following adjustments must be made.

Net profit—accrual method $129,000 Deduct: Decrease in accounts payable ($11,000 – $12,000) (1,000)Add: Decrease in accounts receivable ($38,000 – $40,000) 2,000 Net profit—cash method $130,000

496. Chapter 5 - Business Deductions Question PR #2 Woody owns a barber shop. The following selected data are taken from the barber shop balance sheet and income statement prepared for 2010 using the cash method.

Revenue $242,000Salaries and commissions 97,000Rent 10,000Insurance 5,000Utilities 6,000

The following supplemental data also is provided.

Accounts receivable, 1/1/2011 $40,000Accounts receivable, 12/31/2011 48,000Accounts payable, 1/1/20101 12,000Accounts payable, 12/31/2011 15,000

Calculate Woody’s net profit using the accrual method for 2011.

Correct Answer:

Woody’s cash method net profit is calculated as follows:

Revenue $242,000 Less: Expenses Salaries and commissions $97,000

Rent 10,000 Insurance 5,000 Utilities 6,000 (118,000)Net profit $124,000

To convert to accrual method net profit, the following adjustments must be made.

Net profit—cash method $124,000 Add: Increase in accounts receivable ($48,000 – $40,000) 8,000 Deduct: Increase in accounts payable ($15,000 – $12,000) (3,000) Net profit—accrual method $129,000

497. Chapter 5 - Business Deductions Question PR #3 Taylor, a cash basis architect, rents the building in which his office is located for $5,000 per month. He commenced his practice on February 1, 2011. In order to guarantee no rent increases during an 18-month period, he signed an 18-month lease and prepaid the $90,000 on February 1, 2011. How much can Taylor deduct as rent expense for 2011?

Correct Answer:Taylor is a cash basis taxpayer. Thus, he is eligible to use the “one-year rule” on prepayments. Since his prepayments of 18-months rent does not extend beyond the end of 2012, he can deduct the $90,000 paid in 2011.

498. Chapter 5 - Business Deductions Question PR #4 In order to protect against rent increases on the building in which she operates a dance studio, Mella signs an 18-month lease for $18,000. The lease commences on November 1, 2011. How much of the $18,000 payment can she deduct in 2011 and 2012?

a. If Mella is an accrual basis taxpayer?

b. If Mella is a cash basis taxpayer?

Correct Answer:a. As an accrual basis taxpayer, Mella can deduct the amount of the rent expenses incurred in 2011 of $2,000 ($1,000 ´ 2 months) for 2011 and the $12,000 ($1,000 ´ 12 months) incurred in 2012.

b. Since Mella is a cash basis taxpayer, she can deduct the entire $18,000 prepayment in 2011 if she can satisfy the one-year rule. However, since the rental period of 18 months extends beyond the end of 2012, she fails the requirement for the one-year rule. Consequently, she can deduct only $2,000 in 2011 and $12,000 in 2012.

499. Chapter 5 - Business Deductions Question PR #5 Rose’s business sells air conditioners which have a one-year warranty.

Based on historical data, the warranty costs amount to 14% of sales. During 2011, air conditioner sales are $300,000. Actual warranty expenses paid in 2011 are $37,000.

a. Determine the amount of the warranty expense deduction for 2011 if Rose’s business uses the accrual method.

b. How would your answer change if Rose used the cash method for

extended warranties and the purchasers paid $20,000 for the warranties which covered the second and third years of ownership?

Correct Answer:a. Even though Rose’s business uses the accrual method, reserves for estimated warranty

expenses are not permitted. Therefore, the deduction for warranty expenses is the amount paid of $37,000.

b. Rose would record gross income in 2011 of $320,000 ($300,000 + $20,000). The

deduction for warranty expense would still be $37,000.

500. Chapter 5 - Business Deductions Question PR #6 Edward operates an illegal drug-running business and has the following items of income and expense. What is Edward’s adjusted gross income from this operation?

Income $750,000Expenses: Rent 24,000 Utilities 8,000 Bribes to police 40,000 Medical expense 5,000 Legal fees 20,000 Depreciation 30,000 Illegal kickbacks 35,000 Cost of goods sold 300,000

Correct Answer:He is allowed to deduct only the cost of goods sold; thus, his AGI is $450,000 ($750,000 – $300,000). Note that the cost of goods sold is treated as a negative item in calculating gross income.

501. Chapter 5 - Business Deductions Question PR #7 Kitty runs a brothel (illegal under state law) and has the following items of income and expense. What is the amount that she must include in taxable income from her operation?

Income $200,000 Expenses: Rent 8,000 Utilities 2,000 Bribes to police 10,000 Medical expense 5,000 Legal fees 20,000 Depreciation 14,000 Illegal kickbacks 15,000

Correct Answer:Income $200,000 Expenses: Rent $ 8,000 Utilities 2,000 Medical expense 5,000 Legal fees 20,000 Depreciation 14,000 (49,000) $151,000

The bribes to police of $10,000 and illegal kickbacks of $15,000 are not deductible.

502. Chapter 5 - Business Deductions Question PR #8 The salaries of the top eight executives of Lemon, Inc. are as follows:

No. 1 $9.0 millionNo. 2 6.5 millionNo. 3 2.0 millionNo. 4 1.3 millionNo. 5 .7 millionNo. 6 .4 millionNo. 7 .3 millionNo. 8 .25 million

a. Determine the amount Lemon may deduct for the salaries if it is a publicly traded corporation.

b. Determine the amount Lemon may deduct for the salaries if it is

a closely held corporation.

Correct Answer:a. The salary deduction for the top five executives is limited to $1 million per executive.

Thus, Lemon’s deduction is limited to $4.7 million ($1 million + $1 million + $1 million + $1 million + $0.7 million) for these five executives. In addition, Lemon can deduct the $950,000 ($400,000 + $300,000 + $250,000) paid to the other two executives.

b. Assuming the salaries paid by Lemon are reasonable, the entire $20.45 million ($9.0 million + $6.5 million + $2.0 million + $1.3 million + $0.7 million + $0.4 million + $0.3 million + $0.25 million) paid may be deducted.

503. Chapter 5 - Business Deductions Question PR #9 Gladys owns a retail hardware store in Tangipahoa. She is considering opening a business in Hammond, a community located 25 miles away. She incurs expenses of $60,000 in 2011 in investigating the feasibility and desirability of doing so. What amount can Gladys deduct in 2011 if the business is:

a. Another retail hardware store which she opens in December 2011?

b. Another retail hardware store which she decides against opening?

c. A video rental store which she opens in December 2011?

d. A video rental store which she decides against opening?

Correct Answer:a. The $60,000 of investigation expense can be deducted by Gladys in 2011. b. Even though Gladys decided not to open another store, she can deduct the $60,000 of

investigation expenses in 2011 since she already is in the retail hardware business. c. Because Gladys was not in the video rental business, the $60,000 of investigation

expenses must be capitalized. The $5,000 expense allowance is completely phased out; thus, the entire $60,000 is amortized over a 180-month period beginning with the month in which the business is started (i.e., December). Thus, Gladys can deduct $333 in 2011 ($60,000 ¸ 180 ´ 1 month).

d. Since Gladys was not in the video rental business and she did not open the store, none

of the $60,000 can be deducted.

504. Chapter 5 - Business Deductions Question PR #10 While she was a college student, Juliet worked in a bookstore located near campus. She thinks a bookstore located on the other side of campus would be successful. She incurs expenses of $41,000 (accounting fees, marketing survey, etc.) in exploring its business potential. Her parents have agreed to loan her the money required to start the business. What amount of these investigation costs can Juliet deduct if:

a. She opens the business in March 2011.

b. She decides not to open the bookstore.

Correct Answer:

a. If Juliet opens the bookstore in March 2011, she can deduct the following investigation expenses in 2011.

Allowed expense deduction in first year $5,000Amortization ($36,000/180 months ´ 10 months) 2,000 Deductible investigation expenses $7,000

b. If Juliet does not open the bookstore, she cannot deduct any of the $41,000 of expenses she incurred.

505. Chapter 5 - Business Deductions Question PR #11 Alton sells land with an adjusted basis of $150,000 and a fair market value of $140,000 to his mother, Shirley, for $140,000. Alton reinvests the proceeds in the stock market. Shirley holds the land for one year and a day and sells it in the marketplace for $148,000.

a. Determine the tax consequences to Alton.

b. Determine the tax consequences to Shirley.

Correct Answer:a. Amount realized $140,000 Adjusted basis (150,000) Realized loss ($10,000) Alton’s realized loss of $10,000 is disallowed because Alton and Shirley are related

parties. b. Amount realized $148,000 Adjusted basis (140,000) Realized gain $ 8,000 Alton’s disallowed loss needed to reduce Shirley’s gain to zero (8,000) Recognized gain $ –0– Shirley may use as much of Alton’s disallowed loss as she needs to reduce her realized

gain (i.e., $8,000) to $0. Thus, Shirley’s recognized gain is $0 and the $2,000 ($10,000 – $8,000) of Alton’s disallowed loss that is not used by Shirley is permanently lost.

506. Chapter 5 - Business Deductions Question PR #12 Peter sells land held as an investment (adjusted basis of $400,000; fair market value of $300,000) to his Aunt Martha for $300,000. Three years later, Aunt Martha sells the land for $425,000 to a partnership whose business is real estate development.

a. Determine the tax consequences to Peter.

b. Determine the tax consequences to Aunt Martha.

Correct Answer:a. Amount realized $300,000 Adjusted basis (400,000) Realized loss ($100,000)

Recognized loss ($100,000) Since Peter and Aunt Martha are not related parties, the realized loss of $100,000 is

recognized. b. Amount realized $425,000 Adjusted basis (300,000) Realized gain $125,000

Recognized gain $125,000 Aunt Martha’s basis in the land is her cost of $300,000.

507. Chapter 5 - Business Deductions Question PR #13 The stock of Eagle, Inc. is owned as follows:

Tom 23%Tom’s uncle 22%Tom’s daughter 7%Tom’s sister 15%Tom’s spouse 15%Tom’s nephew 8%Tom’s CPA, unrelated 10%

Tom sells land and a building to Eagle, Inc. for $212,000. His adjusted basis for these assets is $225,000. Calculate Tom’s realized and recognized loss associated with the sale.

Correct Answer:

Tom’s realized loss is $13,000.

Amount realized $212,000 Adjusted basis (225,000) Realized loss ($ 13,000)

However, his recognized loss is $0 because the loss is disallowed as a § 267 related party transaction.

A related party includes a corporation more than 50% (directly or indirectly) owned by the taxpayer. Tom’s total ownership (i.e., both direct and constructive) of Eagle, Inc. is 60%.

Tom 23%Tom’s daughter 7%Tom’s sister 15%Tom’s spouse 15% 60%

Tom’s uncle, nephew, and the CPA are not related parties for § 267 purposes.

508. Chapter 5 - Business Deductions Question PR #14 Brenda invested in the following stocks and bonds during 2011.

Green, Inc. $20,000City of Falcon bonds 80,000

To finance the investments, she borrowed $100,000 from Swan Bank. Interest expense paid on the loan during 2011 was $6,000. During 2011, Brenda received $2,400 of dividend income from Green, Inc. and $3,200 of interest income on the municipal bonds.

a. Determine the amount of Brenda’s gross income.

b. Determine the maximum amount of Brenda’s deductible interest expense.

Correct Answer:a. Brenda must include the $2,400 of dividend income in her gross income. The interest on

the municipal bonds of $3,200 is tax-exempt. b. Brenda can deduct the interest paid of $1,200 ($6,000 ´ 1/5) on the portion of the loan

that relates to the Green, Inc. stock. The interest paid of $4,800 on the portion of the loan that relates to the municipal bonds is disallowed because the interest income from the bonds is tax-exempt.

509. Chapter 5 - Business Deductions Question PR #15 During the current year, Lavender Corporation, a C corporation in the business of manufacturing tangible research equipment, made charitable contributions to qualified organizations as follows:

· Research equipment (basis of $70,000, fair market value of $110,000), held as inventory, to a qualified educational organization that uses the property for research training. The inventory was produced by Lavender earlier in the current year.

· Stock (basis of $30,000, fair market value of $65,000) in Olive

Corporation, held for seventeen months as an investment, to United Way. (United Way plans on selling the stock.)

· Land (basis of $180,000, fair market value of $220,000), held

for three years as an investment, to State University. (State University plans on using the land for new dormitories.)

Lavender Corporation’s taxable income (before any charitable contribution deduction) is $2.5 million.

a. What is the total amount of Lavender’s charitable contributions for the year?

b. What is the amount of Lavender’s charitable contribution

deduction in the current year, and what happens to any excess charitable contribution, if any?

Correct Answer:a. Lavender’s total amount of charitable contributions is $375,000 [$90,000 (inventory) +

$65,000 (stock) + $220,000 (land)], computed as follows:

Inventory: this qualifies for the enhanced contribution amount available with respect to certain inventory, since it consists of tangible research property contributed to a qualified educational organization that uses the property for research training. The contribution amount is equal to the lesser of (1) the sum of the property’s basis plus 50% of the appreciation on the property [$90,000 = $70,000 basis + 50%($110,000 fair market value – $70,000 basis)] or (2) twice the property’s basis ($140,000 = 2 ´ $70,000 basis). Thus, the amount of the contribution is $90,000.

Stock: this is capital gain property, since a sale of the stock would result in long-term capital gain for Lavender. Thus, the amount of the contribution is the stock’s fair market value, or $65,000.

Land: this is capital gain property, since a sale of the land would result in a long-term capital gain for Lavender. Thus, the amount of the contribution is the land’s fair market value, or $220,000.

b. Lavender’s current year charitable deduction is limited to $250,000 [10% ´ $2.5 million (taxable income before charitable deduction)], and the excess charitable contribution of $125,000 ($375,000 – $250,000) is carried forward to the five succeeding tax years.

510. Chapter 5 - Business Deductions Question PR #16 On December 30, 2011, the board of directors of Gull Corporation, a calendar year, accrual method C corporation, authorized a contribution of $50,000 to a qualified charitable organization. For purposes of the taxable income limitation applicable to charitable deductions, Gull has taxable income of $420,000 and $370,000 for 2011 and 2012, respectively. Describe the tax consequences to Gull Corporation under the following independent situations.

a. The $50,000 donation is made on February 21, 2012, by Gull Corporation.

b. The $50,000 donation is made on April 15, 2012, by Gull

Corporation.

Correct Answer:

In general, charitable contributions are deductible in the year made. However, in the case of an accrual method corporation, a deduction can be claimed in the current year for a charitable contribution made in the subsequent year if (1) the contribution is approved by the board of directors of the corporation in the current year, and (2) the contribution is made on or before the fifteenth day of the third month of the subsequent year.

a. The requirements for an accrual of the charitable deduction are satisfied; thus, the $50,000 contribution is deductible by Gull in 2011, subject to the taxable income limitation. For 2011, the taxable income limitation for charitable deductions is $42,000 (10% ´ $420,000). The excess contribution amount of $8,000 carries forward to 2012 (five-year carryover limit).

b. The requirements for an accrual of the charitable deduction are not satisfied; thus, the

$50,000 contribution is deductible by Gull in 2012 (the year the contribution is made), subject to the taxable income limitation. For 2012, the taxable income limitation for charitable deductions is $37,000 (10% ´ $370,000). The excess contribution amount of $13,000 carries forward to 2013 (five-year carryover limit).

511. Chapter 5 - Business Deductions Question PR #17 In 2010, Robin Corporation incurred the following expenditures in connection with the development of a new product:

Salaries $50,000Supplies 20,000Market survey 10,000Depreciation 15,000

In 2011, Robin incurred the following additional expenditures in connection with the development of the product:

Salaries $75,000Supplies 15,000Depreciation 17,000Advertising 8,000

In October 2011, Robin began receiving benefits from the project. If Robin elects to expense research and experimental expenditures, determine the amount and year of the deduction.

Correct Answer:Deductibility of research and experimental expenditures is permitted in the year of incurrence.

2010

Salaries $50,000Supplies 20,000Depreciation 15,000 Deductible expenses $85,000

The market survey is not a research and experimental expenditure.

2011

Salaries $ 75,000Supplies 15,000Depreciation 17,000 Deductible expenses $107,000

The advertising is not a research and experimental expenditure

512. Chapter 5 - Business Deductions Question PR #18 In 2010, Tan Corporation incurred the following expenditures in connection with the development of a new product:

Salaries $ 60,000 Supplies 20,000 Depreciation on research equipment 10,000 Testing for quality control 5,000 Advertising 8,000 Overhead allocated to research 2,000

Tan began selling the product in November, 2010. If Tax elects to amortize research and experimental expenditures, determine Tan’s

deduction for 2011.

Correct Answer:Salaries $60,000 Supplies 20,000 Depreciation 10,000 Overhead allocated to research 2,000 Total qualifying research expenditures $92,000

[($92,000/60 months) ´12 months] = $18,400

513. Chapter 5 - Business Deductions Question PR #19 Green, Inc., manufactures and sells widgets. During 2011, an examination of the company records showed the following items:

Domestic production gross receipts $3,000,000 Cost of goods sold for domestic products 750,000 Expenses directly related to domestic production gross receipts (other than wages)

300,000

W-2 wages paid to employees engaged in qualified domestic production activities

300,000

Ratable portion of other expenses 100,000 Total W-2 wages 325,000 Taxable income 1,600,000

Determine Green’s domestic production activities deduction for 2011.

Correct Answer:Domestic production gross receipts $3,000,000 Less: Cost of goods sold (750,000) Direct expenses (300,000) W-2 wages directly related (300,000) Allocated expenses (100,000) Qualified production activities income (QPAI) $1,550,000 Domestic production activities deduction Lesser of: QPAI ´ 9% ($1,550,000 ´ 9%)

Taxable income ´ 9% ($1,600,000 ´ 9%) $ 139,500

Limited to 50% of related W-2 wages (50% ´ $300,000) [no limit] $ 150,000

514. Chapter 5 - Business Deductions Question PR #20 In 2011, Linda sold her personal residence to Tom for $300,000. Before the sale, Linda paid the real estate taxes of $8,030 for the calendar year. For income tax purposes, the deduction is apportioned as follows: $4,400 to Linda and $3,630 to Tom.

a. What is Tom’s basis in the residence?

b. What is Linda’s amount realized from the sale of the residence?

c. What amount of real estate taxes can Tom deduct?

d. What amount of real estate taxes can Linda deduct?

Correct Answer:General discussion. For Federal income tax purposes, real estate taxes must be apportioned between the buyer and the seller. The taxes paid by the seller that are apportioned to the buyer affect both the basis of the buyer’s property and the amount realized by the seller.

a. Tom’s basis in the residence is $296,370 [$300,000 (purchase price) – $3,630 (property taxes allocated to Tom but paid by Linda)].

b. Linda’s amount realized is $296,370 [$300,000 (sales price) – $3,630 (property taxes allocated to Tom but paid by Linda)].

c. Tom can deduct the $3,630 apportioned to him, even though the tax was paid by Linda.d. Linda can deduct only the tax apportioned to her of $4,400, even though she paid the entire amount of $8,030.

515. Chapter 5 - Business Deductions Question PR #21 Sid bought a new $700,000 seven-year class asset on August 2, 2011. On December 2, 2011, he purchased $160,000 of used five-year class assets. Sid elects not to take additional first-year depreciation. If Sid elects § 179, what is the maximum write-off for these purchases for 2011?

Correct Answer:

Seven-year property:

§ 179 deduction $500,000Regular MACRS [($700,000 – $500,000) ´ .1429 (Table 5.1)] 28,580 Five-year property: Regular MACRS [$160,000 ´ .20 (Table 5.1)] 32,000 Total deduction $560,580

Using the § 179 deduction for the longer lived asset produces a greater total deduction in 2011.

516. Chapter 5 - Business Deductions Question PR #22 Polly purchased a new hotel on July 20, 2011, for $6,000,000. On January 20, 2018, the building was sold. Determine the cost recovery deduction for the year of the sale.

Correct Answer:$6,000,000 ´ .02564 ´ .5/12 = $6,410.

517. Chapter 5 - Business Deductions Question PR #23 Rustin bought used 7-year class property on May 15, 2011, for $800,000. Rustin elects § 179 and straight-line cost recovery. Rustin’s taxable income would not create a limitation for purposes of the § 179 deduction. Rustin elects not to take additional first-year depreciation. Determine the write-off Rustin can take in 2011.

Correct Answer:§ 179 expense election $500,000Cost recovery [($800,000 – $500,000) ´ .0714 (Table 5.4)] 21,420 Total deduction $521,420

518. Chapter 5 - Business Deductions Question PR #24 Audra acquires the following new five-year class property in 2011:

Asset Acquisition Date CostA January 10 $106,000B July 5 70,000C November

15 450,000

Total $626,000

Audra elects § 179 for Asset B and Asset C. Audra’s taxable income from her business would not create a limitation for purposes of the § 179 deduction. Audra elects not to take additional first-year depreciation. Determine her total cost recovery deduction (including the § 179 deduction) for the year.

Correct Answer:

$450,000/$626,000 = 71.9%. Therefore, Audra must use the mid-quarter convention.

Asset A: Regular MACRS ($106,000 ´ .35) $

37,100 Asset B: § 179 expense 50,000 Regular MACRS [($70,000 – $50,000) 3,000 53,000

´ .15] Asset C: § 179 expense 450,00

0 Total deduction $540,1

00

519. Chapter 5 - Business Deductions Question PR #25 Nora purchased a new automobile on July 20, 2011, for $29,000. The car was used 60% for business and 40% for personal use. In 2012, the car was used 30% for business and 70% for personal use. Nora elects not to take additional first-year depreciation. Determine the cost recovery recapture and the cost recovery deduction for 2012.

Correct Answer:

Cost recovery in 2011:

MACRS ($29,000 ´ .20) = $5,800 (limited to $3,060*); $3,060 ´ 60% $1,836 Straight-line ($29,000 ´ .10) = $2,900 (limited to $3,060*); $2,900 ´ 60% (1,740)Cost recovery recapture in 2012 $ 96

Cost recovery in 2012: Straight-line ($29,000 ´ .20) = $5,800 (limited to $4,900*); $4,900 ´ .30 $1,470

*These depreciation limits are indexed annually.

520. Chapter 5 - Business Deductions Question PR #26 Norm purchases a new sports utility vehicle (SUV) on October 12, 2011, for $50,000. The SUV has a gross vehicle weight of 6,200 lbs. It is used 100% of the time for business and it is the only business asset acquired by Norm during 2011. Compute the maximum deduction with respect to the SUV for 2011. Norm elects not to take additional first-year depreciation.

Correct Answer:

The SUV is not classified as a passenger automobile because of its GVW exceeding 6,000 lbs. Therefore, it is not subject to the cost recovery limits of § 280F.

Section 179 expense (limited to $25,000) $25,000MACRS [($50,000 – $25,000) ´ .05] 1,250 Total deduction $26,250

521. Chapter 5 - Business Deductions Question PR #27 Rick purchased a cobalt interest for $10,000,000 on January 3, 2011, when recoverable reserves were estimated at 200,000 units. A total of 10,000 units were extracted in 2011 and 7,000 units were sold in 2011. Gross income from the property was $2,800,000 and taxable income without the allowance for depletion was $1,000,000. Determine the depletion deduction for 2011.

Correct Answer:Cost depletion

pr027-1.jpg

Percentage depletion

Lesser of: 22% ´ $2,800,000 = $616,000 50% ´ $1,000,000 = $500,000

Therefore the depletion deduction would be $500,000.

522. Chapter 5 - Business Deductions Question ES #1 Can a trade or business expense be deductible if it is necessary but not ordinary?

Correct Answer:No. To be deductible as a trade or business expense, the expense must be both ordinary and necessary.

523. Chapter 5 - Business Deductions Question ES #2 Salaries are considered an ordinary and necessary expense of a trade or business if they meet what other requirement? What are the tax consequences if this requirement is not met?

Correct Answer:“Reasonableness” is an additional requirement that applies to salaries. Generally, the unreasonable expense is disallowed as a deduction to the corporation and taxable as a dividend, rather than as salary, to the shareholder.

524. Chapter 5 - Business Deductions Question ES #3 If part of a shareholder/employee’s salary is classified as unreasonable, determine the effect on the:

a. Shareholder/employee’s gross income.

b. Corporation’s taxable income.

Correct Answer:

a. The reclassification of part of a shareholder/employee’s salary as unreasonable will have no effect on the shareholder/employee’s gross income. That is, the shareholder/employee’s salary income will decrease by the same amount as his dividend income increases. Note that if the dividends are qualified dividends, they are eligible for the same preferential tax rate of 15%/0% applicable to long-term capital gains.

b. Salaries are deductible in calculating corporate taxable income, whereas dividends are

not. So, the taxable income of the corporation will increase due to a reduced salary deduction.

525. Chapter 5 - Business Deductions Question ES #4 Bruce owns several sole proprietorships. Must Bruce use the same accounting method for each of these businesses?

Correct Answer:No. If a taxpayer owns multiple businesses, it may be possible to use the cash method for some and the accrual method for others.

526. Chapter 5 - Business Deductions Question ES #5 Calvin opened his dental practice (a sole proprietorship) in May 2011. At the end of the year, he has unpaid accounts receivable of $36,000 and no unpaid accounts payable. Should Calvin use the accrual method or the cash method for his dental practice?

Correct Answer:A service provider generally should use the cash method. Under the cash method, Calvin records income from his dental practice only as he collects from his patients and/or their insurance companies. Calvin has income from the uncollected accounts receivable only as he receives payment.

527. Chapter 5 - Business Deductions Question ES #6 Discuss the application of the “one-year rule” on prepayments by a cash basis taxpayer.

Correct Answer:The Regulations set forth the general rule that an expenditure that creates an asset having a useful life that extends substantially beyond the end of the tax year must be capitalized. However, under the “one-year rule” on prepayments for cash basis taxpayers, the prepayment can be expensed in the current tax year if the asset will expire or be consumed by the end of the tax year following the year of payment. Otherwise, the taxpayer must capitalize the prepayment and deduct it over the benefit period.

528. Chapter 5 - Business Deductions Question ES #7 Briefly discuss the two tests that an accrual basis taxpayer must apply before an expense can be deducted.

Correct Answer:

The two tests that an accrual basis taxpayer must apply before an expense can be deducted are (1) the all events test and (2) the economic performance test. The all events test provides that a deduction cannot be claimed until all the events that create the taxpayers liability have occurred and that the amount of the liability can be determined with reasonable accuracy. The economic performance test provides that the service, property, or use of property giving rise to the liability must have been performed for, provided to, or used by the taxpayer.

529. Chapter 5 - Business Deductions Question ES #8 Graham, a CPA, has submitted a proposal to do the annual audit for a municipality. Owen, the city treasurer, tells Graham that for a $1,000 fee, he will use his influence to have the audit awarded to Graham. What factors are relevant in determining if Graham can deduct the $1,000 payment assuming he pays the fee to Owen?

Correct Answer:The payment from Graham to Owen appears to be a bribe. To be disallowed, the bribe must be illegal under either Federal or state law and also must subject the payer to a criminal penalty or the loss of license or privilege to engage in a trade or business. For a bribe that is illegal under state law, a deduction is denied only if the state law is generally enforced.

530. Chapter 5 - Business Deductions Question ES #9 If a taxpayer operated an illegal business (not drug trafficking), what expenses can be deducted and what expenses are disallowed?

Correct Answer:The usual expenses of operating a business are deductible. However, the following expenses are disallowed.

· Fines.

· Bribes to public officials.

· Illegal kickbacks.

· Other illegal payments.

531. Chapter 5 - Business Deductions Question ES #10 Bobby operates a drug trafficking business. Because he has an accounting background, he keeps detailed financial records. What expenses can Bobby deduct on his Federal income tax return?

Correct Answer:Bobby cannot deduct any of the expenses associated with operating his illegal drug trafficking business. However, gross income for tax purposes is defined as sales minus cost of goods sold. So in calculating the net income of the business for tax purposes, cost of goods sold is treated as a negative income item rather than as an

expense.

532. Chapter 5 - Business Deductions Question ES #11 Abner contributes $1,000 to the campaign of the Tea Party candidate for governor. Can Abner deduct this political contribution?

Correct Answer:No. Political contributions cannot be deducted.

533. Chapter 5 - Business Deductions Question ES #12 Are there any circumstances under which lobbying expenditures are deductible?

Correct Answer:Yes. Lobbying expenditures are deductible under the following three circumstances.

· Influencing local legislation.

· Activities devoted solely to monitoring legislation.

· De minimis provision for annual in-house expenditures (lobbying expenses other than those paid to professional lobbyists) if such expenditures do not exceed $2,000.

534. Chapter 5 - Business Deductions Question ES #13 In applying the $1 million limit on deducting executive compensation, what corporations are subject to the deduction limit? What executives are covered?

Correct Answer:The $1 million limit on deducting the compensation of a covered executive applies to corporations that have at least one class of stock registered under the Securities Exchange Act of 1934. Covered employees include the chief executive officer and the four other most highly compensated officers.

535. Chapter 5 - Business Deductions Question ES #14 Under what circumstances may a taxpayer deduct the expenses of investigating a possible business acquisition, if (1) the business is not acquired; and (2) the business is acquired?

Correct Answer:(1) The expenses of investigation may be deducted if the taxpayer is in the same or similar

business to that being investigated, even if the business is not acquired. If the taxpayer is not in the same or similar trade or business to the one being investigated, the investigation expenses are nondeductible if the business is not acquired.

(2) The expenses of investigation must be capitalized by a taxpayer not in a similar

business when the business is acquired. Such expenses may be immediately expensed (up to $5,000) and the balance amortized over a 180-month minimum

period. If the taxpayer is in the same or similar trade or business as that acquired, investigation expenses are currently deductible.

536. Chapter 5 - Business Deductions Question ES #15 Briefly discuss the disallowance of deductions for capital expenditures.

Correct Answer:Any expenditures that add to the value or prolong the life of property or adapt the property to a new or different use are capital expenditures which must be capitalized and depreciated or amortized.

537. Chapter 5 - Business Deductions Question ES #16 Why are there restrictions on the recognition of gains and losses resulting from transactions between related parties?

Correct Answer:Sham transactions can be structured between related parties such that no real economic change occurs in the status of the parties, but a tax savings results. This is an abuse of the tax law which has resulted in restrictions on the recognition of such transactions.

538. Chapter 5 - Business Deductions Question ES #17 In a related party transaction where realized loss is disallowed, when can the disallowed loss be used by the buyer on the subsequent sale of the property?

Correct Answer:The related party buyer is permitted to use as much of the disallowed loss of the seller as is needed to reduce any realized gain on the subsequent sale of the property. If the property in the hands of the buyer appreciates to at least the amount of the seller’s adjusted basis at the date of the original sale, all of the disallowed loss can be used by the buyer on the subsequent sale.

539. Chapter 5 - Business Deductions Question ES #18 Olive, Inc., an accrual method taxpayer, is a corporation that is equally owned by Maurice and Alex, who are brothers. The corporation uses the accrual method of accounting and the shareholders use the cash method. To provide Olive with funds to acquire additional working capital, the shareholders each loan Olive $100,000 with a 6% interest rate. At the end of the tax year, there is unpaid accrued interest of $3,000 due to each shareholder. From a timing perspective, when should Olive deduct this $6,000 and when should Maurice and Alex include the $3,000 in gross income? Olive pays the $3,000 to each shareholder early next year.

Correct Answer:Maurice and Alex are related parties with Olive. So Olive (accrual method) must claim the deduction of $6,000 in the same tax year that

the cash method shareholders include the $3,000 each in gross income (next year). Note that this matching provision applies only if the payor uses the accrual method and the payee uses the cash method.

540. Chapter 5 - Business Deductions Question ES #19 Briefly explain why interest on money borrowed to buy tax-exempt municipal bonds is disallowed as a deduction.

Correct Answer:Because the interest income on municipal bonds is excludible from gross income, the related expense should not be deductible. Otherwise, a taxpayer could borrow money, at say 10%, invest the funds in tax-exempt securities, at say 8%, and realize a profit if the interest expense were deductible. The entire profit would be derived from the tax treatment.

541. Chapter 5 - Business Deductions Question ES #20 Briefly describe the charitable contribution deduction rules applicable to C corporations.

Correct Answer:Tax year of deduction: In general, a charitable contribution is deductible only in the year the gift is made. For an accrual basis corporation, however, a charitable contribution can be deducted in the current year for a contribution that is (1) approved by the corporation’s board of directors by the end of such year and (2) paid on or before the fifteenth day of the third month of the next year.

Amount of contribution: In addition to cash gifts, property contributions to qualified charitable organizations are also deductible. For property that is depreciated (fair market value less than basis), the amount of the contribution is the property’s fair market value. For property that is appreciated (fair market value greater than basis), the amount of the contribution depends on whether the property is “capital gain property” or “ordinary income property.” Capital gain property is property that, if sold, would result in a long-term capital gain or § 1231 gain. A contribution of capital gain property generally results in a deductible amount equal to the property’s fair market value. If the capital gain property is tangible personal property and the charitable organization’s use of the property is unrelated to its exempt function, the amount of the contribution is equal to the property’s basis. (Contributions of capital gain property to certain private foundations are similarly limited to the property’s basis.) Ordinary income property is property that, if sold, would not result in a long-term capital gain or § 1231 gain. Typically, the deduction for a contribution of ordinary income property is equal to the property’s basis. However, charitable contributions of certain inventory property by corporations can result in an enhanced deduction amount. For such inventory property, the deductible amount is equal to the lesser of (1) the sum of the property’s basis plus 50% of the appreciation on the property or (2) twice the property’s basis.

Annual limitation on deduction: A corporate taxpayer’s charitable deduction is limited to 10% of taxable income (determined without regard to the charitable contribution deduction, any net operating loss carryback or capital loss carryback, dividends received deduction, and domestic production activities deduction). Any contributions in excess of the 10% limitation may be carried forward for five years. In any tax year for which there is a charitable contribution carryover, current year’s gifts are applied against the 10% limitation first, with carryover amounts deducted in order of time.

542. Chapter 5 - Business Deductions Question ES #21 What are the three methods of handling research and experimental expenditures incurred in a trade or business? Under what circumstances would you choose each?

Correct Answer:

The following methods are permitted:

· The expense method, where the expenditures are written off immediately, is attractive where the taxpayer is currently in a high tax bracket and has sufficient other income to offset the deductions.

· Deferral and amortization of expenditures over a period of not less than 60 months is

generally chosen when the total deduction is not wanted immediately because future income is expected to be available to offset the deduction.

· The capitalization method allows no deduction until the project is abandoned or becomes

worthless. Usually taxpayers do not choose this method, since the tax benefit is deferred for an indefinite period.

543. Chapter 5 - Business Deductions Question ES #22 Why was the domestic production activities deduction (DPAD) enacted by Congress?

Correct Answer:The American Jobs Creation Act of 2004 provision creating DPADs was enacted to replace certain tax provisions that our world trading partners regarded as allowing unfair advantage to U.S. exports. Note, however, in no way is the DPAD limited to exports.

544. Chapter 5 - Business Deductions Question ES #23 Antonio sold his personal residence to Mina on July 1, 2011. He had paid real property taxes on March 1, 2011, the due date for property taxes for 2011. How will Antonio’s payment affect his deduction for property taxes in 2011? Will Antonio’s payment of the taxes have any effect on Mina’s itemized deductions for 2011? What other tax or financial effects will Antonio’s payment of the taxes have on either

party?

Correct Answer:Even though Antonio paid all the real property taxes for 2011, they must be prorated for deduction purposes. Antonio can deduct property taxes for the period he owned the property (January 1 through June 30). Mina can deduct property taxes related to the period she owned the property (July 1 through December 31), even though she did not actually pay the taxes. Antonio will treat the taxes he paid on Mina’s behalf as a reduction of the amount realized on the sale, and Mina must treat this amount as a reduction in her basis for the property.

545. Chapter 5 - Business Deductions Question ES #24 Discuss the difference between the half-year convention and the mid-quarter convention.

Correct Answer:The half-year convention assumes property is placed in service at mid-year and thus provides for a half-year’s cost recovery for that year. The mid-quarter convention assumes property placed in service during the year is placed in service at the middle of the quarter in which it is actually placed in service.

546. Chapter 5 - Business Deductions Question ES #25 Discuss the criteria used to determine whether a building is residential or nonresidential realty. Also explain the tax consequences resulting from this determination if the property is placed in service in 2011.

Correct Answer:Residential realty is property for which 80% or more of the gross rental revenues are from nontransient dwelling units. Residential realty has a recovery period of 27.5 years. Nonresidential realty has a recovery period of 39 years.

547. Chapter 5 - Business Deductions Question ES #26 Discuss the tax consequences of listed property being used for the production of income compared to being used in a trade or business.

Correct Answer:Section 179 expensing cannot be taken associated with the property’s use for the production of income.

548. Chapter 5 - Business Deductions Question ES #27 Discuss the beneficial tax consequences of an SUV not being classified as a passenger automobile.

Correct Answer:If an automobile is not classified as a passenger automobile, it is not subject to the statutory dollar cost recovery limits under § 280F. In addition to a larger cost recovery deduction each year, it also results

in the total recovery of the cost over a six-year period. While the automobile is still listed property, if it passes the more-than-50% business use test, MACRS cost recovery can be used as well as an election under § 179. However, the § 179 limit for SUVs is $25,000 rather than $500,000 in 2011. The automobile also is eligible for additional first-year depreciation.

549. Chapter 5 - Business Deductions Question ES #28 Discuss the reason for the inclusion amount with respect to leased automobiles.

Correct Answer:The purpose of the inclusion amount is to prevent taxpayers from circumventing the cost recovery dollar limitations by leasing, instead of purchasing, an automobile.

550. Chapter 6 - Losses and Loss Limitations Question TF #1 James is in the business of debt collection. He purchased a $20,000 account receivable from Green Corporation for $15,000. During the year, James collected $12,000 in final settlement of the account. James can take a $3,000 bad debt deduction in the current year.

*a. Trueb. False

551. Chapter 6 - Losses and Loss Limitations Question TF #2 If a business debt previously deducted as partially worthless becomes totally worthless this year, only the amount not previously deducted can be deducted this year.

*a. Trueb. False

552. Chapter 6 - Losses and Loss Limitations Question TF #3 Last year, taxpayer had a $10,000 business loan that was written off. Last year, taxpayer also had an NOL which taxpayer carried back two years and used in its entirety. If taxpayer collects the entire $10,000 during the current year, $10,000 needs to be included in gross income.

*a. Trueb. False

553. Chapter 6 - Losses and Loss Limitations Question TF #4 A cash basis taxpayer can deduct the cost of a product sold even though the purchaser of the product ultimately does not pay the purchase price.

*a. Trueb. False

554. Chapter 6 - Losses and Loss Limitations Question TF #5 If an account receivable written off during the current year is subsequently collected during the current year, the write-off entry is reversed.

*a. Trueb. False

555. Chapter 6 - Losses and Loss Limitations Question TF #6 A nonbusiness bad debt deduction can be taken any year after the debt becomes totally worthless.

a. True*b. False

556. Chapter 6 - Losses and Loss Limitations Question TF #7 A nonbusiness bad debt is a debt unrelated to the taxpayer’s trade or business either when it was created or when it became worthless.

*a. Trueb. False

557. Chapter 6 - Losses and Loss Limitations Question TF #8 In determining whether a debt is a business or nonbusiness bad debt, the debtor’s use of the borrowed funds is not important.

*a. Trueb. False

558. Chapter 6 - Losses and Loss Limitations Question TF #9 A corporation which makes a loan to a shareholder cannot have a nonbusiness bad debt deduction.

*a. Trueb. False

559. Chapter 6 - Losses and Loss Limitations Question TF #10 A business bad debt can offset an unlimited amount of ordinary income.

*a. Trueb. False

560. Chapter 6 - Losses and Loss Limitations Question TF #11 The amount of complete worthlessness on a nonbusiness bad debt is deducted at final settlement.

*a. Trueb. False

561. Chapter 6 - Losses and Loss Limitations Question TF #12 A bona fide debt cannot arise on a loan between father and son.

a. True*b. False

562. Chapter 6 - Losses and Loss Limitations Question TF #13 A bond held by an investor that is uncollectible will be treated as a worthless security and hence, produce a bad debt.

a. True*b. False

563. Chapter 6 - Losses and Loss Limitations Question TF #14 A loss from a worthless security is always treated as a long-term capital loss.

a. True*b. False

564. Chapter 6 - Losses and Loss Limitations Question TF #15 A loss is not allowed for a security that declines in value.

*a. Trueb. False

565. Chapter 6 - Losses and Loss Limitations Question TF #16 Several years ago, John purchased 2,000 shares of § 1244 stock from Red Corporation for $40,000. Last year, John sold one-half of his Red Corporation stock to Mike for $12,000. During the current year, John sold the remaining Red Corporation stock for $3,000. John has a $17,000 ($3,000 – $20,000) ordinary loss for the current year.

*a. Trueb. False

566. Chapter 6 - Losses and Loss Limitations Question TF #17 Taxpayers must sell or exchange their § 1244 stock in order to recognize an ordinary loss (does not apply to stock becoming worthless).

a. True*b. False

567. Chapter 6 - Losses and Loss Limitations Question TF #18 Al, who is single, has a gain of $40,000 on the sale of §1244 stock (small business stock) and a loss of $80,000 on the sale of § 1244 stock. As a result, Al has a $40,000 ordinary loss.

a. True*b. False

568. Chapter 6 - Losses and Loss Limitations Question TF #19 An individual may deduct a loss on rental property even if it does not meet the definition of a casualty loss.

*a. Trueb. False

569. Chapter 6 - Losses and Loss Limitations Question TF #20 “Other casualty” means casualties similar to those associated with fires, storms, or shipwrecks.

*a. Trueb. False

570. Chapter 6 - Losses and Loss Limitations Question TF #21 A casualty loss deduction is not allowed for losses resulting from a decline in value rather than an actual loss of property.

*a. Trueb. False

571. Chapter 6 - Losses and Loss Limitations Question TF #22 If the amount of the insurance recovery for a theft of business property is greater than the asset’s fair market value but less than it’s adjusted basis, a gain is recognized.

a. True*b. False

572. Chapter 6 - Losses and Loss Limitations Question TF #23 A theft loss is taken in the year the theft is discovered.

*a. Trueb. False

573. Chapter 6 - Losses and Loss Limitations Question TF #24 Last year, Amos had AGI of $50,000. Amos also had a diamond ring stolen which cost $20,000 and was worth $17,000 at the time of the theft. He itemized deductions on last year’s tax return. In the current year, Amos recovered $17,000 from the insurance company. Therefore, he must

include $11,900 in gross income on the tax return for the current year.

*a. Trueb. False

574. Chapter 6 - Losses and Loss Limitations Question TF #25 If rental property is completely destroyed, the amount of the loss is the adjusted basis of the property at the time of the destruction reduced by $100 and 10% of AGI.

a. True*b. False

575. Chapter 6 - Losses and Loss Limitations Question TF #26 The cost of repairs to damaged property may be acceptable as a measure of the loss in value of the property.

*a. Trueb. False

576. Chapter 6 - Losses and Loss Limitations Question TF #27 Taxpayer’s home was destroyed by a storm in the current year and the area was declared a disaster area. If the taxpayer elects to treat the loss as having occurred in the prior year, it will be subject to the 10%-of-AGI reduction based on the AGI of the prior year.

*a. Trueb. False

577. Chapter 6 - Losses and Loss Limitations Question TF #28 The amount of loss for partial destruction of business property is the lesser of the adjusted basis or the decline in fair market value.

*a. Trueb. False

578. Chapter 6 - Losses and Loss Limitations Question TF #29 The amount of a loss on insured business use property is reduced by the insurance coverage if no claim is made against the insurer.

a. True*b. False

579. Chapter 6 - Losses and Loss Limitations Question TF #30 Losses on rental property are classified as deductions from AGI (itemized deductions).

a. True*b. False

580. Chapter 6 - Losses and Loss Limitations Question TF #31 A theft loss of investment property is an itemized deduction not subject to the 2%-of-AGI floor.

*a. Trueb. False

581. Chapter 6 - Losses and Loss Limitations Question TF #32 A taxpayer may carry any NOL incurred back two years.

*a. Trueb. False

582. Chapter 6 - Losses and Loss Limitations Question TF #33 Stuart is the sole owner and a material participant in a business in which he has $50,000 at risk. If the business incurs a loss of $80,000 from operations, Stuart can deduct the full amount.

a. True*b. False

583. Chapter 6 - Losses and Loss Limitations Question TF #34 Stan owns a 20% interest in a partnership (not real estate) in which his at-risk amount was $38,000 at the beginning of the year. During the year, the partnership borrows $80,000 on a nonrecourse note and incurs a loss of $50,000 from operations. Stan’s at-risk amount at the end of the year is $44,000.

a. True*b. False

584. Chapter 6 - Losses and Loss Limitations Question TF #35 In the current year, Rich has a $40,000 loss from a business he owns. His at-risk amount at the end of the year, prior to considering the current year loss, is $24,000. He will be allowed to deduct the $40,000 loss this year if he is a material participant in the business.

a. True*b. False

585. Chapter 6 - Losses and Loss Limitations Question TF #36 Judy owns a 20% interest in a partnership (not real estate) in which her at-risk amount was $35,000 at the beginning of the year. The partnership borrowed $50,000 on a recourse note and made a $40,000 profit during the year. Her at-risk amount at the end of the year is

$43,000.

a. True*b. False

586. Chapter 6 - Losses and Loss Limitations Question TF #37 Tonya owns an interest in an activity (not real estate) that converted recourse financing to nonrecourse financing. Recapture of previously allowed losses is required if Tonya’s at-risk amount is reduced below zero as a result of the debt restructuring.

*a. Trueb. False

587. Chapter 6 - Losses and Loss Limitations Question TF #38 Kelly, who earns a yearly salary of $120,000, sold an activity with a suspended passive loss of $44,000. The activity was sold at a loss and Kelly has no other passive activities. The suspended loss is not deductible.

a. True*b. False

588. Chapter 6 - Losses and Loss Limitations Question TF #39 All of a taxpayer’s tax credits relating to a passive activity can be utilized when the activity is sold at a loss.

a. True*b. False

589. Chapter 6 - Losses and Loss Limitations Question TF #40 During the year, Lion Company incurs a $25,000 loss on a passive activity, has active income of $17,000, and portfolio income of $12,000. If Lion is a personal service corporation, it may deduct $17,000 of the $25,000 passive loss.

a. True*b. False

590. Chapter 6 - Losses and Loss Limitations Question TF #41 Coyote Corporation has active income of $45,000 and a passive loss of $23,000 in the current year. Coyote cannot deduct the $23,000 loss if it is a personal service corporation.

*a. Trueb. False

591. Chapter 6 - Losses and Loss Limitations Question TF #42 Peach Company, a closely held C corporation, incurs a $58,000 loss on a

passive activity during the year. The company has active income of $34,000 and portfolio income of $24,000. If Peach is a not a personal service corporation, it may deduct the entire $58,000 passive loss.

a. True*b. False

592. Chapter 6 - Losses and Loss Limitations Question TF #43 Wolf Corporation has active income of $55,000 and a passive loss of $33,000 in the current year. Wolf cannot deduct the $33,000 loss if it is a closely held C corporation that is not a personal service corporation.

a. True*b. False

593. Chapter 6 - Losses and Loss Limitations Question TF #44 Nathan owns Activity A, which produces income, and Activity B, which produces passive losses. From a tax planning perspective, Nathan will be better off if Activity A is passive.

*a. Trueb. False

594. Chapter 6 - Losses and Loss Limitations Question TF #45 Anita owns Activity A which produces active income and Activity B which produces losses. From a tax planning perspective, Anita will be better off if Activity B is a passive activity.

a. True*b. False

595. Chapter 6 - Losses and Loss Limitations Question TF #46 David participates 580 hours in an activity during the year; others participate for 1,400 hours. David is a material participant in the activity.

*a. Trueb. False

596. Chapter 6 - Losses and Loss Limitations Question TF #47 Joe participates 95 hours in an activity, while an employee participates 5 hours. Joe has materially participated in the activity.

*a. Trueb. False

597. Chapter 6 - Losses and Loss Limitations Question TF #48 Mary Jane participates for 100 hours during the year in an activity she

owns. She has no employees and is the only participant in the activity. The activity is a significant participation activity.

a. True*b. False

598. Chapter 6 - Losses and Loss Limitations Question TF #49 A taxpayer is considered to be a material participant in a significant participation activity if he or she spends at least 400 hours in the activity.

a. True*b. False

599. Chapter 6 - Losses and Loss Limitations Question TF #50 Rachel participates 150 hours in Activity A and 400 hours in Activity B, both of which are nonrental businesses. Both activities are passive.

a. True*b. False

600. Chapter 6 - Losses and Loss Limitations Question TF #51 Lucy participates for 405 hours in Activity A and 101 hours in Activity B, both of which are nonrental businesses. Both activities are passive.

a. True*b. False

601. Chapter 6 - Losses and Loss Limitations Question TF #52 From January through November, Vern participated for 420 hours as a salesman in a partnership in which he owns a 50% interest. The partnership has four full-time employees. During December, Vern spends 110 hours cleaning the store and painting the walls in order to meet the material participation standards. Vern qualifies as a material participant.

a. True*b. False

602. Chapter 6 - Losses and Loss Limitations Question TF #53 Joyce owns an activity (not real estate) in which she participates for 100 hours a year; her husband participates for 450 hours. Joyce qualifies as a material participant.

*a. Trueb. False

603. Chapter 6 - Losses and Loss Limitations Question TF #54 When determining whether an individual is a material participant,

participation by an owner’s spouse generally counts.

*a. Trueb. False

604. Chapter 6 - Losses and Loss Limitations Question TF #55 Kathy is a full-time educator, but she owns an apartment building and devotes 550 hours to managing the activity. All losses from the rental activity will be considered nonpassive and deductible against active income because she is a real estate professional.

a. True*b. False

605. Chapter 6 - Losses and Loss Limitations Question TF #56 Bruce owns a small apartment building that produces a $25,000 loss during the year. His AGI before considering the rental loss is $85,000. Bruce must be an active participant with respect to the rental activity in order to deduct the $25,000 loss under the real estate rental exception.

*a. Trueb. False

606. Chapter 6 - Losses and Loss Limitations Question TF #57 In the current year, Kenny has a $35,000 loss from a real estate rental activity. Kenny provides 1,000 hours of service to that activity, which is more than half of his working hours for the year. Kenny can deduct the $35,000 loss.

*a. Trueb. False

607. Chapter 6 - Losses and Loss Limitations Question TF #58 Services performed by an employee are treated as being related to a real estate trade or business if the employee performing the services has more than a 5% ownership interest in the employer.

*a. Trueb. False

608. Chapter 6 - Losses and Loss Limitations Question TF #59 In the current year, Abby has AGI of $95,000 and a $40,000 loss from a real estate rental activity in which she is a 15% owner. If she is an active participant, she can deduct $25,000 of the loss.

*a. Trueb. False

609. Chapter 6 - Losses and Loss Limitations Question TF #60 Individuals can deduct from active or portfolio income losses of up to $25,000 from real estate rental activities in which they actively participate.

*a. Trueb. False

610. Chapter 6 - Losses and Loss Limitations Question TF #61 Individuals with modified AGI of $100,000 can deduct against active or portfolio income losses of up to $25,000 from real estate rental activities in which they actively participate.

*a. Trueb. False

611. Chapter 6 - Losses and Loss Limitations Question TF #62 Roger owns and actively participates in the operations of an apartment building which produces a $40,000 loss during the year. He has AGI of $150,000 from an active business. He may deduct $25,000 of the loss.

a. True*b. False

612. Chapter 6 - Losses and Loss Limitations Question TF #63 Bonnie owns and actively participates in the operations of an apartment building that produces a $40,000 loss during the year. In addition, she has AGI of $100,000 from an active business. Her at-risk amount in the apartment building is $200,000. She may deduct $25,000 of the loss in the current year, while the remaining $15,000 is a suspended passive loss.

*a. Trueb. False

613. Chapter 6 - Losses and Loss Limitations Question TF #64 Susan dies owning a passive activity with a basis of $75,000, a fair market value of $140,000, and suspended losses of $80,000. A $15,000 passive loss can be deducted on Susan’s final income tax return.

*a. Trueb. False

614. Chapter 6 - Losses and Loss Limitations Question TF #65 Chris receives a gift of a passive activity from his father whose basis was $60,000. Suspended losses related to the activity are $18,000. Chris will be allowed to offset the $18,000 suspended losses against future passive income.

a. True*b. False

615. Chapter 6 - Losses and Loss Limitations Question MC #1 Peggy is in the business of factoring accounts receivable. Last year, she purchased a $30,000 account receivable for $25,000. This year, the account was settled for $18,000. How much loss can Peggy deduct and in which year?

a. $5,000 for the current year.b. $5,000 for the prior year and $7,000 for the current year.*c. $7,000 for the current year.d. $12,000 for the current year.e. None of the above.

616. Chapter 6 - Losses and Loss Limitations Question MC #2 Jed is an electrician. Jed and his wife are accrual basis taxpayers and file a joint return. Jed wired a new house for Alison and billed her $15,000. Alison paid Jed $10,000 and refused to pay the remainder of the bill, claiming the fee to be exorbitant. Jed took Alison to Small Claims Court for the unpaid amount and was awarded a $2,000 judgement. Jed was never able to collect the judgement nor the remainder of the bill from Alison. What amount of loss may Jed deduct in the current year?

a. $0.b. $2,000.c. $3,000.*d. $5,000.e. None of the above.

617. Chapter 6 - Losses and Loss Limitations Question MC #3 On June 2, 2010, Fred’s TV Sales sold Mark a large HD TV, on account, for $12,000. Fred’s TV Sales uses the accrual method. In 2011, when the balance on the account was $8,000, Mark filed for bankruptcy. Fred was notified that he could not expect to receive any of the amount owed to him. In 2012, final settlement was made and Fred received $1,000. How much bad debt loss can Fred deduct in 2012?

*a. $0.b. $7,000.c. $8,000.d. $12,000.e. None of the above.

618. Chapter 6 - Losses and Loss Limitations Question MC #4 Red Corporation incurred a $15,000 bad debt last year. Red Corporation also had an $9,000 long-term capital gain last year. Red’s taxable income for last year was $100,000. During the current year, Red Corporation, unexpectedly, collected $7,000 on the debt. How should Red

Corporation account for the $7,000 collection?

a. $0 income.b. $3,000 income.c. $4,000 income.*d. $7,000 income.e. None of the above.

619. Chapter 6 - Losses and Loss Limitations Question MC #5 Last year, Lucy purchased a $100,000 account receivable for $90,000. During the current year, Lucy collected $87,000 on the account. What are the tax consequences to Lucy associated with the collection of the account receivable? No subsequent collections are expected.

a. $0.b. $2,000 gain.*c. $3,000 loss.d. $13,000 loss.e. None of the above.

620. Chapter 6 - Losses and Loss Limitations Question MC #6 Two years ago, Gina loaned Tom $50,000. Tom signed a note the terms of which called for monthly payments of $2,000 plus 6% interest on the outstanding balance. Last year, when the balance owing on the loan was $18,000, Tom defaulted on the note. As of the end of last year, there appeared to be no reasonable prospect of Gina recovering the $18,000. As a consequence, Gina claimed the $18,000 as a nonbusiness bad debt. Last year, Gina had AGI of $60,000 which included $5,000 net long-term capital gains and $4,000 of qualified dividends. Gina did not itemize her deductions. During the current year, Tom paid Gina $13,000 in final settlement of the loan. How should Gina account for the payment in the current year?

a. File an amended tax return for last year.b. Report no income for the current year.*c. Report $8,000 of income for the current year.d. Report $12,000 of income for the current year.e. Report $13,000 of income for the current year.

621. Chapter 6 - Losses and Loss Limitations Question MC #7 Five years ago, Tom loaned his son John $20,000 to start a business. A note was executed with an interest rate of 8%, which is the Federal rate. The note required monthly payments of the interest with the $20,000 due at the end of ten years. John always made the interest payments until last year. During the current year, John notified his father that he was bankrupt and would not be able to repay the $20,000 or the accrued interest of $1,800. Tom is a cash basis taxpayer whose only income is salary and interest income. The proper treatment for the nonpayment of the note is:

a. No deduction.*b. $3,000 deduction.

c. $20,000 deduction.d. $21,800 deduction.e. None of the above.

622. Chapter 6 - Losses and Loss Limitations Question MC #8 Three years ago, Sharon loaned her sister $30,000 to buy a car. A note was issued for the loan with the provision for monthly payments of principal and interest. Last year, Sharon purchased a car from the same dealer, Hank’s Auto. As partial payment for the car, the dealer accepted the note from Sharon’s sister. At the time Sharon purchased the car, the note had a balance of $18,000. During the current year, Sharon’s sister died. Hank’s Auto was notified that no further payments on the note would be received. At the time of the notification, the note had a balance due of $15,500. What is the amount of loss, with respect to the note, that Hank’s Auto may claim on the current year tax return?

a. $0.b. $3,000.*c. $15,500.d. $18,000.e. None of the above.

623. Chapter 6 - Losses and Loss Limitations Question MC #9 On September 3, 2010, Able, a single individual, purchased § 1244 stock in Red Corporation for $60,000. On December 31, 2010, the stock was worth $85,000. On August 15, 2011, Able was notified that the stock was worthless. How should Able report this item on his 2011 tax return?

a. $85,000 capital loss.b. $85,000 ordinary loss.c. $50,000 ordinary loss and $35,000 capital loss.d. $60,000 ordinary loss.*e. None of the above.

624. Chapter 6 - Losses and Loss Limitations Question MC #10 On February 20, 2010, Bill purchased stock in Pink Corporation (the stock is not small business stock) for $1,000. On May 1, 2011, the stock became worthless. During 2011, Bill also had an $8,000 loss on § 1244 small business stock purchased two years ago, a $9,000 loss on a nonbusiness bad debt, and a $5,000 long-term capital gain. How should Bill treat these items on his 2011 tax return?

a. $4,000 long-term capital loss and $9,000 short-term capital loss.b. $4,000 long-term capital loss and $3,000 short-term capital loss.*c. $8,000 ordinary loss and $3,000 short-term capital loss.d. $8,000 ordinary loss and $5,000 short-term capital loss.e. $8,000 long-term capital loss and $6,000 short-term capital loss.

625. Chapter 6 - Losses and Loss Limitations Question MC #11 John files a return as a single taxpayer. In 2011, he had the following items:

· Salary of $45,000.· Loss of $65,000 on the sale of § 1244 stock acquired two years ago.· Interest income of $6,000.

Determine John’s AGI for 2011.

a. ($5,000).*b. $0.c. $45,000.d. $51,000.e. None of the above.

626. Chapter 6 - Losses and Loss Limitations Question MC #12 Bruce, who is single, had the following items for the current year:

· Salary of $90,000.· Gain of $30,000 on the sale of § 1244 stock acquired two years earlier.· Loss of $75,000 on the sale of § 1244 stock acquired three years earlier.· Worthless stock of $7,000. The stock was acquired on February 1 of the prior year and

became worthless on January 15 of the current year.

Determine Bruce’s AGI for the current year.

a. $37,000.*b. $38,000.c. $42,000.d. $47,000.e. None of the above.

627. Chapter 6 - Losses and Loss Limitations Question MC #13 On July 20, 2009, Matt (who files a joint return) purchased 3,000 shares of Orange Corporation stock (the stock is § 1244 small business stock) for $24,000. On November 10, 2010, Matt purchased an additional 1,000 shares of Orange Corporation stock from a friend for $150,000. On September 15, 2011, Matt sold the 4,000 shares of stock for $120,000. How should Matt treat the sale of the stock on his 2011 return?

a. $54,000 ordinary loss.b. $100,000 ordinary loss; $46,000 net capital gain.c. $100,000 ordinary loss; $20,000 STCL.d. $130,000 ordinary loss; $66,000 LTCG.*e. None of the above.

628. Chapter 6 - Losses and Loss Limitations Question MC #14 Which of the following events would produce a deductible loss?

a. Erosion of personal use land due to rain or wind.b. Termite infestation of a personal residence over a several year period.c. Damages to personal automobile resulting from a taxpayer’s willful negligence.d. A misplaced diamond ring.*e. None of the above.

629. Chapter 6 - Losses and Loss Limitations Question MC #15 In 2011, Wally had the following insured business property casualty losses (arising from one casualty). Wally also had $48,000 AGI for the year.

Fair Market Value InsuranceAsset Adjusted Basis Before After RecoveryA $9,200 $8,000 $1,000 $2,000B 3,000 4,000 –0– 500C 3,700 1,900 –0– 800

Wally’s casualty loss deduction is:

a. $3,700.b. $4,500.*c. $8,600.d. $9,500.e. None of the above.

630. Chapter 6 - Losses and Loss Limitations Question MC #16 Jim had a car accident in 2011 in which his car was completely destroyed. At the time of the accident, the car had a fair market value of $30,000 and an adjusted basis of $40,000. Jim used the car 100% of the time for business use. Jim received an insurance recovery of 70% of the value of the car at the time of the accident. If Jim’s AGI for the year is $60,000, determine his deductible loss on the car.

a. $900.b. $2,900.c. $9,000.*d. $19,000.e. None of the above.

631. Chapter 6 - Losses and Loss Limitations Question MC #17 Norm’s car, which he uses 100% for personal purposes, was completely destroyed in an accident in 2011. The car’s adjusted basis at the time of the accident was $13,000. Its fair market value was $10,000. The car was covered by a $2,000 deductible insurance policy. Norm did not file

a claim against the insurance policy because of a fear that reporting the accident would result in a substantial increase in his insurance rates. His adjusted gross income was $14,000 (before considering the loss). What is Norm’s deductible loss?

a. $0.b. $100.*c. $500.d. $9,500.e. None of the above.

632. Chapter 6 - Losses and Loss Limitations Question MC #18 In 2011, Grant’s personal residence was damaged by fire. Grant was insured for 90% of his actual loss, and he received the insurance settlement. Grant had adjusted gross income, before considering the casualty item, of $30,000. Pertinent data with respect to the residence follows:

Cost basis $170,000Value before casualty 250,000Value after casualty 60,000

What is Grant’s allowable casualty loss deduction?

*a. $0.b. $6,500.c. $6,900.d. $10,000.e. $80,000.

633. Chapter 6 - Losses and Loss Limitations Question MC #19 Alma is in the business of dairy farming. During the year, one of her barns was completely destroyed by fire. The adjusted basis of the barn was $90,000. The fair market value of the barn before the fire was $75,000. The barn was insured for 95% of its fair market value, and Alma recovered this amount under the insurance policy. Alma has adjusted gross income for the year of $40,000 (before considering the casualty). Determine the amount of loss she can deduct on her tax return for the current year.

a. $3,750.b. $14,650.c. $14,750.*d. $18,750.e. None of the above.

634. Chapter 6 - Losses and Loss Limitations Question MC #20 If a taxpayer has an NOL in 2011 of $20,000, of which $8,000 is

attributable to a theft of personal use property, the taxpayer may:

a. Carry all of the NOL of $20,000 back 5 years.b. Carry all of the NOL of $20,000 back 3 years.*c. Carry $8,000 of the NOL back 3 years and the remainder of the NOL of $12,000 back 2 years.d. All of the above.e. None of the above.

635. Chapter 6 - Losses and Loss Limitations Question MC #21 In 2011, Judy invested $200,000 for a 25% interest in a limited liability company (LLC) involved in an activity in which she is a material participant. The LLC reported losses of $680,000 in 2011 and $360,000 in 2012 with Judy’s share being $170,000 in 2011 and $90,000 in 2012. How much of the losses can Judy deduct?

a. $0 in 2011; $0 in 2012.b. $170,000 in 2011; $0 in 2012.*c. $170,000 in 2011; $30,000 in 2012.d. $170,000 in 2011; $90,000 in 2012.e. None of the above.

636. Chapter 6 - Losses and Loss Limitations Question MC #22 Which of the following decreases a taxpayer’s at-risk amount?

a. Cash and the adjusted basis of property contributed to the activity.b. Amounts borrowed for use in the activity for which the taxpayer is personally liable or has pledged as security property not used in the activity.c. Taxpayer’s share of amounts borrowed for use in the activity that is qualified nonrecourse financing.d. Taxpayer’s share of the activity’s income.*e. None of the above.

637. Chapter 6 - Losses and Loss Limitations Question MC #23 In 2011, Pearl invests $80,000 for a 10% partnership interest in an activity in which she is a material participant. The partnership reports losses of $500,000 in 2011 and $450,000 in 2012. Pearl’s share of the partnership’s losses is $50,000 in 2011 and $45,000 in 2012. How much of the losses can Pearl deduct?

*a. $50,000 in 2011 and $30,000 in 2012.b. $50,000 in 2011 and $45,000 in 2012.c. $0 in 2011 and $0 in 2012.d. $50,000 in 2011 and $0 in 2012.e. None of the above.

638. Chapter 6 - Losses and Loss Limitations Question MC #24 In 2011, Kipp invested $65,000 for a 30% interest in a partnership conducting a passive activity. The partnership reported losses of

$200,000 in 2011 and $100,000 in 2012, Kipp’s share being $60,000 in 2011 and $30,000 in 2012. How much of the losses from the partnership can Kipp deduct assuming he owns no other investments and does not participate in the partnership’s operations?

a. $0 in 2011; $30,000 in 2012.b. $60,000 in 2011; $30,000 in 2012.c. $60,000 in 2011; $5,000 in 2012.d. $60,000 in 2011; $0 in 2012.*e. None of the above.

639. Chapter 6 - Losses and Loss Limitations Question MC #25 Nora acquired passive activity A several years ago that until 2010 was profitable. However, the activity produced losses of $100,000 in 2010 and $50,000 in 2011. Nora had passive income from activity B of $40,000 in 2010 and $0 in 2011. How much loss is suspended from activity A in each year?

*a. $60,000 in 2010 and $50,000 in 2011.b. $100,000 in 2010 and $50,000 in 2011.c. $0 in 2010 and $0 in 2011.d. None of the above.

640. Chapter 6 - Losses and Loss Limitations Question MC #26 Carl, a physician, earns $200,000 from his medical practice in the current year. He receives $45,000 in dividends and interest during the year as well as $5,000 of income from a passive activity. In addition, he incurs a loss of $50,000 from an investment in a passive activity. What is Carl’s AGI for the current year after considering the passive investment?

a. $195,000.b. $200,000.c. $240,000.*d. $245,000.e. None of the above.

641. Chapter 6 - Losses and Loss Limitations Question MC #27 Samantha sells a passive activity (adjusted basis of $50,000) for $90,000. Suspended losses attributable to this property total $30,000. The realized gain and the taxable gain are:

a. $40,000 realized gain; $70,000 taxable gain.b. $10,000 realized gain; $10,000 taxable gain.c. $40,000 realized gain; $0 taxable gain.*d. $40,000 realized gain; $10,000 taxable gain.e. None of the above.

642. Chapter 6 - Losses and Loss Limitations Question MC #28 Alex has three passive activities with at-risk amounts in excess of $100,000 for

each. During the year, the activities produced the following income (losses).

Activity A ($75,000)Activity B (25,000)Activity C 25,000 Net passive loss ($75,000)

Alex’s suspended losses are as follows:

a. $75,000 is allocated to C; $0 to A and B.b. $37,500 is allocated to A; $37,500 to B.*c. $56,250 is allocated to A; $18,750 to B.d. $25,000 is allocated to A, B, and C.e. None of the above.

643. Chapter 6 - Losses and Loss Limitations Question MC #29 In the current year, Crow Corporation, a closely held C corporation that is not a personal service corporation, has $100,000 of passive losses, $80,000 of active business income, and $20,000 of portfolio income. How much of the passive loss may Crow deduct in the current year?

a. $0.b. $20,000.*c. $80,000.d. $100,000.e. None of the above

644. Chapter 6 - Losses and Loss Limitations Question MC #30 In the current year, Spring Corporation, a closely held personal service corporation, has $120,000 of passive losses, $70,000 of active business income, and $50,000 of portfolio income. How much of the passive loss may Spring deduct in the current year?

a. $120,000.b. $70,000.c. $50,000.*d. $0.e. None of the above.

645. Chapter 6 - Losses and Loss Limitations Question MC #31 Tara owns a shoe store and a bookstore. Both businesses are operated in a mall. She also owns a restaurant across the street and a jewelry store several blocks away.

*a. All four businesses can be treated as a single activity if Tara elects to do so.b. Only the shoe store and bookstore can be treated as a single activity, the restaurant must be treated as a separate activity,

and the jewelry store must be treated as a separate activity.c. The shoe store, bookstore, and restaurant can be treated as a single activity, and the jewelry store must be treated as a separate activity.d. All four businesses must be treated as separate activities.e. None of the above.

646. Chapter 6 - Losses and Loss Limitations Question MC #32 Rick, a computer consultant, owns a separate business (not real estate) in which he participates. He has one employee who works part-time in the business.

a. If Rick participates for 500 hours and the employee participates for 620 hours during the year, Rick qualifies as a material participant.*b. If Rick participates for 550 hours and the employee participates for 2,000 hours during the year, Rick qualifies as a material participant.c. If Rick participates for 120 hours and the employee participates for 120 hours during the year, Rick does not qualify as a material participant.d. If Rick participates for 95 hours and the employee participates for 5 hours during the year, Rick probably does not qualify as a material participant.e. None of the above.

647. Chapter 6 - Losses and Loss Limitations Question MC #33 Ned, a college professor, owns a separate business (not real estate) in which he participates in the current year. He has one employee who works part-time in the business.

a. If Ned participates for 120 hours and the employee participates for 120 hours during the year, Ned does not qualify as a material participant.b. If Ned participates for 95 hours and the employee participates for 5 hours during the year, Ned probably does not qualify as material participant.c. If Ned participates for 500 hours and the employee participates for 520 hours during the year, Ned qualifies as material participant.*d. If Ned participates for 600 hours and the employee participates for 2,000 hours during the year, Ned qualifies as a material participant.e. None of the above.

648. Chapter 6 - Losses and Loss Limitations Question MC #34 Paula owns four separate activities. She elects not to group them together as a single activity under the “appropriate economic unit” standard. Paula participates for 130 hours in Activity A, 115 hours in Activity B, 260 hours in Activity C, and 100 hours in Activity D. She has one employee, who works 125 hours in Activity D. Which of the

following statements is correct?

a. Activities A, B, C, and D are all significant participation activities.b. Paula is a material participant with respect to Activities A, B, C, and D.c. Paula is not a material participant with respect to Activities A, B, C, and D.d. Losses from all of the activities can be used to offset Paula’s active income.*e. None of the above.

649. Chapter 6 - Losses and Loss Limitations Question MC #35

Tom owns five activities, and he elects not to group them together as a single activity under the “appropriate economic unit” standard. During the year, he participates for 120 hours in Activity A, 150 hours in Activity B, 140 hours in Activity C, 110 hours in Activity D, and 100 hours in Activity E.

a. Activities A, B, C, D, and E are all significant participation activities.b. Tom is a material participant only in Activities A, B, and C.*c. Tom is a material participant in Activities A, B, C, and D.d. Tom is not a material participant in any of the activities.e. None of the above.

650. Chapter 6 - Losses and Loss Limitations Question MC #36 Dena owns interests in five businesses and has full-time employees in each business. She participates for 100 hours in Activity A, 120 hours in Activity B, 130 hours in Activity C, 140 hours in Activity D, and 125 hours in Activity E.

a. All five of Dena’s activities are significant participation activities.b. Dena is a material participant with respect to all five activities.c. Dena is not a material participant in any of the activities.*d. Dena is a material participant with respect to Activities B, C, D, and E.e. None of the above.

651. Chapter 6 - Losses and Loss Limitations Question MC #37 Maria, who owns a 50% interest in a restaurant, has been a material participant in the restaurant activity for the last 20 years. She retired from the restaurant at the end of last year and will not participate in the restaurant activity in the future. However, she continues to be a material participant in a retail store in which she is a 50% partner. The restaurant operations produce a loss for the current year, and Maria’s share of the loss is $80,000. Her share of the income from the retail store is $150,000. She does not own

interests in any other activities.

a. Maria cannot deduct the $80,000 loss from the restaurant because she is not a material participant.*b. Maria can offset the $80,000 loss against the $150,000 of income from the retail store.c. Maria will not be able to deduct any losses from the restaurant until she has been retired for at least three years.d. Assuming Maria continues to hold the interest in the restaurant, she will always treat the losses as active.e. None of the above.

652. Chapter 6 - Losses and Loss Limitations Question MC #38 Sarah, who owns a 50% interest in a grocery store, was a material participant in the activity for the last 25 years. She retired from the grocery store at the end of last year and will not participate in the activity in the future. However, she continues to be a material participant in an office supply store in which she is a 50% partner. The operations of the grocery store resulted in a loss for the current year and Sarah’s share of the loss is $40,000. Sarah’s share of the income from the office supply store is $75,000. She does not own interests in any other activities.

a. Sarah cannot deduct the $40,000 loss from the grocery store because she is not a material participant.b. Sarah will not be able to deduct any losses from the grocery store until future years. *c. Sarah can offset the $40,000 loss from the grocery store against the $75,000 of income from the office supply store.d. Sarah will not be able to deduct any losses from the grocery store until she has been retired for at least four years.e. None of the above.

653. Chapter 6 - Losses and Loss Limitations Question MC #39 Jed spends 32 hours a week, 50 weeks a year, operating a DVD rental store that he owns. He also owns a music store in another city that is operated by a full-time employee. He elects not to group them together as a single activity under the “appropriate economic unit” standard. Jed spends 40 hours per year working at the music store.

a. Neither store is a passive activity.b. Both stores are passive activities.c. Only the DVD rental store is a passive activity.*d. Only the music store is a passive activity.e. None of the above.

654. Chapter 6 - Losses and Loss Limitations Question MC #40 Jenny spends 32 hours a week, 50 weeks a year, operating a DVD rental store that she owns. She also owns a music store in another city that is operated by a full-time employee. Jenny spends 140 hours per year working at the music store. She elects not to group them together as a

single activity under the “appropriate economic unit” standard.

*a. Neither store is a passive activity.b. Both stores are passive activities.c. Only the DVD rental store is a passive activity.d. Only the music store is a passive activity.e. None of the above.

655. Chapter 6 - Losses and Loss Limitations Question MC #41 Kenton has investments in two passive activities. Activity A, acquired three years ago, produces income in the current year of $60,000. Activity B, acquired last year, produces a loss of $110,000 in the current year. At the beginning of this year, Kenton’s at-risk amounts in Activities A and B are $10,000 and $120,000, respectively. What is the amount of Kenton’s suspended passive loss with respect to these activities at the end of the current year?

a. $100,000.*b. $50,000.c. $40,000.d. $0.e. None of the above.

656. Chapter 6 - Losses and Loss Limitations Question MC #42 Rachel acquired a passive activity several years ago. Until 2008, the activity was profitable, and Rachel’s at-risk amount at the beginning of 2008 was $300,000. The activity produced losses for Rachel of $80,000 in 2008, $50,000 in 2009, and $70,000 in 2010. In 2011, the activity produced income of $90,000. How much is Rachel’s suspended passive loss at the beginning of 2012?

a. $150,000.*b. $110,000.c. $60,000.d. $0.e. None of the above.

657. Chapter 6 - Losses and Loss Limitations Question MC #43 Emily earns a salary of $150,000, and invests $60,000 for a 20% interest in a passive activity. Operations of the activity result in a loss of $400,000, of which Emily’s share is $80,000. How is her loss characterized?

*a. $60,000 is suspended under the passive loss rules and $20,000 is suspended under the at-risk rules.b. $60,000 is suspended under the at-risk rules and $20,000 is suspended under the passive loss rules.c. $80,000 is suspended under the passive loss rules.d. $80,000 is suspended under the at-risk rules.e. None of the above.

658. Chapter 6 - Losses and Loss Limitations Question MC #44 Several years ago, Joy acquired a passive activity. Until 2009, the activity was profitable. Joy’s at-risk amount at the beginning of 2009 was $250,000. The activity produced losses of $100,000 in 2009, $80,000 in 2010, and $90,000 in 2011. During the same period, no passive income was recognized. How much is suspended under the at-risk rules and the passive loss rules at the beginning of 2012? At-risk Passive loss

a. $0 $270,000.*b. $20,000 $250,000.c. $30,000 $240,000.d. $260,000 $10,000.e. None of the above.

659. Chapter 6 - Losses and Loss Limitations Question MC #45 Jerry’s at-risk amount in a passive activity is $100,000 at the beginning of the current year. His current loss from the activity is $45,000. Jerry had no passive activity income during the year. At the end of the current year:

*a. Jerry has an at-risk amount in the activity of $55,000 and a suspended passive loss of $45,000.b. Jerry has an at-risk amount in the activity of $100,000 and a suspended passive loss of $45,000.c. Jerry has an at-risk amount in the activity of $55,000 and no suspended passive loss.d. Jerry has an at-risk amount in the activity of $100,000 and no suspended passive loss.e. None of the above.

660. Chapter 6 - Losses and Loss Limitations Question MC #46 Wes’s at-risk amount in a passive activity is $25,000 at the beginning of the current year. His current loss from the activity is $35,000 and he has no passive activity income. At the end of the current year, which of the following statements is incorrect?

a. Wes has a loss of $25,000 suspended under the passive loss rules.b. Wes has an at-risk amount in the activity of $0.c. Wes has a loss of $10,000 suspended under the at-risk rules.*d. Wes has a loss of $35,000 suspended under the passive loss rules.e. None of the above is incorrect.

661. Chapter 6 - Losses and Loss Limitations Question MC #47 Jon owns an apartment building in which he is a material participant and a computer consulting business. Of the 2,000 hours he spends on these activities during the year, 55% of the time is spent operating the apartment building and 45% of the time is spent in the computer consulting business.

a. The computer consulting business is a passive activity but the apartment building is not.b. The apartment building is a passive activity but the computer consulting business is not.c. Both the apartment building and the computer consulting business are passive activities.*d. Neither the apartment building nor the computer consulting business is a passive activity.e. None of the above.

662. Chapter 6 - Losses and Loss Limitations Question MC #48 Consider the following three statements:

(1) Tad invests in vacant land for the purpose of realizing a profit on its appreciation. He leases the land during the period he holds it. The unadjusted basis of the property is $25,000 and its fair market value is $35,000. The lease payments are $400 per year.

(2) A farmer owns land with an unadjusted basis of $25,000 and a fair market value of $35,000. He used it for farming purposes in the two prior years. In the current year, he leases the land to another farmer for $400.

(3) At City Hospital, each inpatient is provided a private room while medical care is provided.

In which of the three cases above could the rental activity automatically be considered a passive activity?

a. Case 1 only.b. Case 2 only.c. Case 3 only.d. Cases 1, 2, and 3.*e. None of the above.

663. Chapter 6 - Losses and Loss Limitations Question MC #49 Andrea, a single taxpayer, has $90,000 in salary, $15,000 in income from a limited partnership, and a $40,000 passive loss from a real estate rental activity in which she actively participates. Her modified adjusted gross income is $90,000. Of the $40,000 loss, Andrea may deduct:

a. $0.b. $15,000.c. $25,000.*d. $40,000.e. Some other amount.

664. Chapter 6 - Losses and Loss Limitations Question MC #50 Roxanne, who is single, has $125,000 of salary, $10,000 of income from a limited partnership, and a $26,000 passive loss from a real estate rental activity in which she actively participates. Her modified

adjusted gross income is $125,000. Of the $26,000 loss, how much is deductible?

a. $0.b. $10,000.c. $25,000.d. $26,000.*e. None of the above.

665. Chapter 6 - Losses and Loss Limitations Question MC #51 Lucy dies owning a passive activity with an adjusted basis of $90,000. Its fair market value at that date is $145,000. Suspended losses relating to the property were $75,000. Which of the following statements is true?

*a. The heir’s adjusted basis is $145,000, and Lucy’s final deduction is $20,000.b. The heir’s adjusted basis is $145,000, and Lucy’s final deduction is $75,000.c. The heir’s adjusted basis is $90,000, and Lucy’s final deduction is $75,000.d. The heir’s adjusted basis is $220,000, and Lucy has no final deduction.e. None of the above.

666. Chapter 6 - Losses and Loss Limitations Question MC #52 Caroyl made a gift to Tim of a passive activity (adjusted basis of $50,000, suspended losses of $20,000, and a fair market value of $80,000). No gift tax resulted from the transfer.

a. Tim’s adjusted basis is $80,000, and Tim can deduct the $20,000 of suspended losses in the future.b. Tim’s adjusted basis is $80,000.c. Tim’s adjusted basis is $50,000, and the suspended losses are lost. d. Tim’s adjusted basis is $50,000, and Tim can deduct the $20,000 of suspended losses in the future. *e. None of the above.

667. Chapter 6 - Losses and Loss Limitations Question PR #1 Tonya had the following items for last year:

Salary $40,000 Short-term capital gain 12,000 Nonbusiness bad debt (10,000)Long-term capital loss (5,000)

For the current year, Tonya had the following items:

Salary $45,000 Collection of last year’s bad debt 10,000

Determine Tonya’s adjusted gross income for the current year.

Correct Answer:Salary $45,000 Income under tax benefit rule 10,000 Long-term capital loss carryover (3,000) AGI $55,000 Income on collection of nonbusiness bad debt (classified as STCL) to the extent of tax benefit in the prior year ($10,000 offset against short-term capital gain).

$10,000

668. Chapter 6 - Losses and Loss Limitations Question PR #2 Maria, who is single, had the following items for 2011:

Salary $80,000 Loss on sale of § 1244 small business stock acquired 3 years ago

(60,000)

Stock acquired 2 years ago became worthless during the year

(5,000)

Long-term capital gain 25,000 Nonbusiness bad debt (8,000)Casualty loss on property held 6 months (4,000)Casualty gain on property held 4 years 4,000

Determine Maria’s adjusted gross income for 2011.

Correct Answer:Salary $80,000 Ordinary loss from § 1244 stock (50,000) Capital gains and losses Long-term capital gain ($25,000 + $4,000) $29,000 Less: Long-term capital loss [($60,000 – $50,000) + $5,000] (15,000) Net long-term capital gain $14,000 Less: Short-term capital loss ($8,000 + $4,000) (12,000) Capital gain net income 2,000 Adjusted gross income $32,000

669. Chapter 6 - Losses and Loss Limitations Question PR #3 Jose, single, had the following items for 2011:

Salary $44,000

§ 1244 loss on stock acquired 3 years ago (70,000)§ 1244 gain on stock acquired 10 months ago 26,000 Worthless security purchased in June of last year

(4,000)

Nonbusiness bad debt (7,000)Interest income 8,000

Compute Jose’s adjusted gross income for 2011.

Correct Answer:Salary $44,000 Ordinary loss from § 1244 stock (50,000)Interest income 8,000 Short-term capital gain $26,000 Short-term capital loss (7,000) Net short-term capital gain $19,000 Long-term loss from § 1244 stock ($70,000 – $50,000) ($20,000) Worthless security (4,000) (24,000) Net long-term capital loss ($ 5,000) Limit (2,000) Adjusted gross income $ –0–

670. Chapter 6 - Losses and Loss Limitations Question PR #4 Sarah purchased for $100,000 a 10% interest in a business venture that is not subject to the passive activity rules. During the first year, her share of the entity’s loss was $120,000. At the beginning of the second year, the entity obtained $800,000 of recourse financing. During the second year, Sarah withdrew cash of $20,000, and her share of the entity’s loss was $25,000. Calculate the amount of loss that Sarah may claim in each of the two years and determine her at-risk amount at the end of each year.

Correct Answer:Initial at-risk amount $100,000 Subtract: Deductible first year loss of $120,000, limited to at-risk amount of $100,000 (100,000)At-risk amount at the end of first year $ –0–

Suspended loss at the end of first year $ 20,000 At-risk amount at the beginning of the second year $ –0– Add: Share of recourse debt 80,000 Subtract: Withdrawal (20,000) Deductible $25,000 second year loss + $20,000 loss suspended from prior year

(45,000) At-risk amount at the end of second year $ 15,000

Suspended loss at the end of second year $ –0–

671. Chapter 6 - Losses and Loss Limitations Question PR #5 In 2011, Emily invests $100,000 in a limited partnership that is not a passive activity. During 2011, her share of the partnership loss is $70,000. In 2012, her share of the partnership loss is $50,000. How much can Emily deduct in 2011 and 2012?

Correct Answer:Although the passive loss rules do not apply, the at-risk rules limit Emily’s deductions. She can deduct $70,000 in 2011 and her at-risk amount will be reduced to $30,000 ($100,000 – $70,000 deducted). She will be limited to a $30,000 deduction in 2012 unless she increases her amount at risk. For example, if Emily invests an additional $20,000 in 2011, her at-risk amount would be $50,000 ($30,000 balance + $20,000 additional investment), and she would be able to deduct the entire $50,000 loss in 2012.

672. Chapter 6 - Losses and Loss Limitations Question PR #6 Sam, who earns a salary of $400,000, invested $160,000 for a 40% working interest in an oil and gas limited partnership (not a passive activity) last year. Through the use of $1,600,000 of nonrecourse financing, the partnership acquired assets worth $2 million. Depreciation, interest, and other deductions related to the activity resulted in a loss in the partnership’s initial year of $300,000, of which Sam’s share was $120,000. Sam’s share of loss from the partnership is $60,000 in the current year. How much of the loss from the partnership can Sam deduct in each year?

Correct Answer:Sam has $160,000 at risk at the end of the partnership’s initial year and can deduct the $120,000 loss in that year. Sam’s at-risk amount is decreased to $40,000 as a result of the $120,000 loss. Because his at-risk amount is $40,000 at the end of the current year, he can deduct only $40,000 of the $60,000 loss in the current year.

673. Chapter 6 - Losses and Loss Limitations Question PR #7 Joyce, an attorney, earns $100,000 from her law practice in the current year. In addition, she receives $35,000 in dividends and interest during the year. Further, she incurs a loss of $35,000 from an investment in a passive activity. What is Joyce’s AGI for the year after considering the passive investment?

Correct Answer:Joyce cannot deduct the passive loss against active or portfolio income. Therefore, her AGI after considering the passive investment is $135,000 ($100,000 active income + $35,000 portfolio income).

674. Chapter 6 - Losses and Loss Limitations Question PR #8 Caroline sells a rental house for $320,000 that has an adjusted basis of $280,000. During the years of her ownership, $75,000 of losses have been incurred that were suspended under the passive activity loss

rules. Determine the tax treatment to Caroline on the disposition of the property.

Correct Answer:

Because Caroline disposes of her entire interest in the passive activity, she is able to recognize fully the losses that had been suspended during the years of her ownership. With the current utilization of the $75,000 suspended loss, a net deductible loss of $35,000 results, which is treated as a loss that is not from a passive activity.

Net sales price $320,000 Less: Adjusted basis (280,000)Total gain $ 40,000 Less: Suspended losses (75,000) Deductible loss ($ 35,000)

675. Chapter 6 - Losses and Loss Limitations Question PR #9 Seth has four passive activities. The following income and losses are generated in the current year.

Activity Gain (Loss)A ($60,000)B (25,000)C (15,000)D 10,000 Total ($90,000)

How much of the $90,000 net passive loss can Seth deduct this year? Calculate the suspended losses (by activity).

Correct Answer:

None. The suspended losses of $90,000 are allocated as follows:

Activity Suspended Loss A $60,000/$100,000 ´ $90,000 $54,000 B $25,000/$100,000 ´ $90,000 22,500 C $15,000/$100,000 ´ $90,000 13,500 Total suspended loss $90,000

676. Chapter 6 - Losses and Loss Limitations Question PR #10 Pat sells a passive activity for $100,000 that has an adjusted basis of $55,000. During the years of her ownership, $60,000 of losses have been incurred that were suspended under the passive activity loss rules. In

addition, the passive activity generated tax credits of $10,000 that were not utilized and suspended. Determine the tax treatment to Pat on the disposition of the property.

Correct Answer:

Because Pat disposes of her entire interest in the passive activity, she is able to recognize fully the losses that had been suspended during the years of her ownership. With the current utilization of the $60,000 suspended loss, a net deductible loss of $15,000 results, which is treated as a loss that is not from a passive activity. However, the suspended credits are lost and may not be used. The tax credits are allowed on dispositions only when there is sufficient tax on the disposition (i.e., due to a gain) to absorb them.

Net sales price $100,000 Less: Adjusted basis (55,000) Total gain $ 45,000 Less: Suspended losses (60,000) Deductible loss ($ 15,000)

677. Chapter 6 - Losses and Loss Limitations Question PR #11 Green, Inc., a closely held personal service corporation, has the following transactions in the current year: $100,000 of passive losses, $80,000 of active business income, and $20,000 of portfolio income. How much of the passive loss may Green use to offset other types of income this year?

Correct Answer:The passive loss limitations apply to personal service corporations. Therefore, the $100,000 of passive losses may not be used to offset any other income and is suspended for use in the future when Green generates passive income or disposes of the passive activity.

678. Chapter 6 - Losses and Loss Limitations Question PR #12 Tangerine Corporation, a closely held (non-personal service) C corporation, earns active income of $400,000 in the current year. The corporation also receives $35,000 in dividends during the year. In addition, Tangerine incurs a loss of $60,000 from an investment in a passive activity. What is Tangerine’s income for the year after considering the passive investment?

Correct Answer:A closely held (non-personal service) C corporation can offset passive losses against active, but not portfolio income. Therefore, Tangerine’s income is $375,000 [($400,000 active income – $60,000 passive loss) + $35,000 portfolio income].

679. Chapter 6 - Losses and Loss Limitations Question PR #13 Lloyd, a life insurance salesman, earns a $400,000 salary in the

current year. As he works only 30 hours per week in this job, he has time to participate in several other businesses. He owns an ice cream parlor and a car repair shop in Tampa. He also owns an ice cream parlor and a car repair shop in Portland and a car repair shop in St. Louis. A preliminary analysis on December 1 of the current year shows projected income and losses for the various businesses as follows:

Income (Loss)Tampa ice cream parlor (95 hours participation)

$56,000

Tampa car repair shop (140 hours participation)

(89,000)

Portland ice cream parlor (90 hours participation)

34,000

Portland car repair shop (170 hours participation)

(41,000)

St. Louis car repair shop (180 hours participation)

(15,000)

Lloyd has full-time employees at each of the five businesses listed above. Review all possible groupings for Lloyd’s activities. Which grouping method and other strategies should Lloyd consider that will provide the greatest tax advantage?

Correct Answer:The basic issue relates to how the car repair shops and ice cream parlors should be grouped under the passive activity rules so as to maximize the tax benefit to Lloyd. The $400,000 salary is active income. If the participation levels stay the same in the ice cream parlor and car repair shop businesses, all profits and losses will be passive, assuming each location is a separate activity. As a result, a net passive loss of $55,000 ($89,000 loss + $41,000 loss + $15,000 loss – $56,000 profit – $34,000 profit) would be suspended and not be available to offset his salary. To mitigate this result, three options should be considered.

Option 1 is based on the significant participation activity rule. If all of the businesses are treated as separate activities, Lloyd would not be considered a material participant, even under the significant participation activity rule. Under the significant participation activity rule, the car repair shops would be considered significant activities, but the ice cream parlors would not. But even with the car repair shops, the total participation is not expected to exceed the more-than-500 hour threshold (140 + 170 + 180 = 490). If Lloyd could participate 11 more hours in any of the car repair shop businesses, they would be treated as active and the net loss from the car repair shops of $145,000 ($89,000 + $41,000 + $15,000) could be offset against his salary. Further, if Lloyd does not participate any more in the other ice cream parlor businesses, their combined $90,000 of income will be reported as passive income. This characterization as passive could be helpful if Lloyd were to acquire additional businesses in the future that produce passive losses.

Under option 2, both the ice cream parlor and car repair shop businesses could be combined as a “single activity” based on common

ownership. Because Lloyd has participated more than 500 hours in the five businesses, the net loss of $55,000 would be considered active and could be used to offset his salary.

Option 3 would combine the car repair shops as one activity based on product while the ice cream parlors would be treated as a separate activity based on product. As with option 1, if Lloyd could participate 11 more hours in any of the car repair shop businesses, they would be treated as active, and the net loss of $145,000 ($89,000 + $41,000 + $15,000) could be offset against his salary. Also, he could treat the ice cream parlors as a single business and the net income would be passive, which could be helpful in the future if other passive ventures would be acquired.

680. Chapter 6 - Losses and Loss Limitations Question PR #14 Samantha invested $75,000 in a passive activity several years ago, and on January 1, 2010, her amount at risk was $15,000. Her shares of the income and losses in the activity for the next three years are as follows:

Year Income (Loss)2010 ($20,000)2011 (15,000)2012 25,000

How much can Samantha deduct in 2010 and 2011? What is her taxable income from the activity in 2012? (Consider both the at-risk rules as well as the passive loss rules.)

Correct Answer:

If losses were limited only by the at-risk rules, Samantha would be able to deduct the following amounts in 2010 and 2011.

Year Loss Allowed* Disallowed2010 $20,000 $15,000 $ 5,0002011 15,000 –0– 15,000 $35,000 $15,000 $20,000

*Allowed under the at-risk rules, then reclassified as passive losses and subject to the passive loss limitations.

However, the losses are limited by the passive loss rules as follows:

Year Passive Deductible* Suspended2010 $15,000 $ –0– $15,0002011 –0– –0– –0– $15,000 $ –0– $15,000

In 2012, the $25,000 income increases Samantha’s at-risk amount to $25,000 so she is now allowed to deduct the $20,000 of disallowed losses. The $25,000 is passive income, which can be offset by $25,000 of suspended losses, leaving a suspended loss of $10,000. At the end of 2012, Samantha has no unused losses under the at-risk rules, $10,000 of suspended passive losses, and a $5,000 at-risk amount ($15,000 at-risk amount on 1/1/10 – $15,000 loss in 2010 – $0 loss in 2011 + $25,000 income in 2012 – $20,000 reclassified passive loss in 2012).

681. Chapter 6 - Losses and Loss Limitations Question PR #15 Ken has a $40,000 loss from an investment in a partnership in which he does not materially participate. He paid $30,000 for his interest. How much of the loss is disallowed by the at-risk rules? How much is disallowed by the passive loss rules?

Correct Answer:The at-risk limits disallow $10,000 of the deduction ($40,000 loss – $30,000 at risk). Ken is not a material participant, so the remaining $30,000 is disallowed by the passive loss rules.

682. Chapter 6 - Losses and Loss Limitations Question PR #16 During the year, James performs the following personal services in three separate activities: 800 hours as a CPA in his tax practice, 400 hours in a real estate development business (in which he is not a material participant), and 600 hours in an apartment leasing operation. He expects that losses will be realized from the two real estate ventures while his tax practice will show a profit. James files a joint return with his wife whose salary is $200,000. What is the character of the income and losses generated by these activities?

Correct Answer:James is a material participant in the tax practice but not in the real estate development business. This causes the real estate development activity to be classified as passive. Further, the apartment leasing operation is a passive activity. It is a rental activity and does not qualify for the real estate rental exception given the taxpayers’ level of income. Therefore, the income from the tax practice may not be offset by either the losses from the real estate development business or the apartment leasing operation.

James does not qualify for the exception for real estate professionals because he has not spent more than half of his personal services in real estate trades or businesses in which he materially participates.

683. Chapter 6 - Losses and Loss Limitations Question PR #17 In the current year, Lucile, who has AGI of $70,000 before considering rental activities, is active in three separate real estate rental activities and is in the 28% tax bracket. She had $15,000 of losses from Activity A, $25,000 of losses from Activity B, and income of $20,000 from Activity C. She also had $3,100 of tax credits from Activity A. Calculate her deductions and credits currently allowed and

the suspended losses and credits.

Correct Answer:

Lucile can utilize $20,000 of losses and $1,400 of credits under the real estate rental activities exception as follows:

Income (Loss): Activity A ($15,000) Activity B (25,000) Activity C 20,000 Net loss ($20,000)Utilized loss 20,000 Suspended loss $ –0–

Utilized credit $ 1,400

Suspended credit $ 1,700

After deducting the $20,000 loss, Lucile has an available deduction equivalent of $5,000 [$25,000 (maximum loss allowed) – $20,000 (utilized loss)]. Then the maximum amount of credits Lucile may claim is $1,400 [$5,000 deduction equivalent ´ .28 (marginal tax bracket)] that is allocated to Activity A.

684. Chapter 6 - Losses and Loss Limitations Question PR #18 Faye dies owning an interest in a passive activity property (adjusted basis of $150,000, suspended losses of $52,000, and a fair market value of $180,000). What, if any, can be deducted on her final income tax return?

Correct Answer:On Faye’s final income tax return, a deduction of $22,000 is allowed, determined as follows:

FMV of property at death $180,000 Adjusted basis of property (150,000)Increase (step-up) in basis $ 30,000

Suspended loss ($ 52,000)Increase in basis 30,000 Suspended loss allowable on Faye’s final income tax return ($ 22,000)

685. Chapter 6 - Losses and Loss Limitations Question ES #1 Identify the factors that should be considered in determining whether a transaction is a bona fide loan or a gift.

Correct Answer:Factors to be considered in determining whether a transaction is a bona

fide loan or gift are as follows:

· Was a note properly executed? · Was there a reasonable rate of interest? · Was collateral provided? · What collection efforts were made? · What was the intent of the parties?

686. Chapter 6 - Losses and Loss Limitations Question ES #2 Identify the factors that should be considered in determining whether a transaction is a business bad debt or a nonbusiness bad debt.

Correct Answer:

Factors to be considered in determining whether a transaction is a business bad debt or a nonbusiness bad debt are as follows:

· Was the debt related to the taxpayer’s business when it was created? · Was the debt related to the taxpayer’s business when it became worthless? · Was the lender engaged in the business of lending money? · Was there a proximate relationship between the creation of the debt and the lender’s

business?

687. Chapter 6 - Losses and Loss Limitations Question ES #3 A taxpayer who sustains a casualty loss in an area designated by the President of the United States as a disaster area may take the loss in the year in which the loss occurred or elect to take the loss in the previous year. Identify factors that should be considered in deciding in which year to take the loss.

Correct Answer:

Factors that should be considered include:

· The marginal tax rates of the two different years. · The adjusted gross incomes of the two different years. · Other casualty losses in the two different years. · The benefits of a faster refund (or reduction of tax).

688. Chapter 6 - Losses and Loss Limitations Question ES #4 Explain how a taxpayer’s at-risk amount in a business venture is adjusted periodically.

Correct Answer:Once a taxpayer’s initial at-risk amount in an investment is established, it must be revised periodically to reflect the impact of various events. The at-risk amount generally is increased each year by the taxpayer’s share of income and decreased by the taxpayer’s share of losses from the activity. In the case of a partnership, the at-risk amounts are increased when the partnership increases its debt and decreased when the partnership reduces its debt. Cash and the adjusted basis of property contributed to the activity increase the at-risk amount, while withdrawals decrease the at-risk amount.

689. Chapter 6 - Losses and Loss Limitations Question ES #5 Identify how the passive loss rules broadly classify various types of income and losses. Provide examples of each category.

Correct Answer:The passive loss rules require income and losses to be classified into one of three categories: active, passive, or portfolio. Active income includes salary and wages, profit from a trade or business in which the taxpayer is a material participant, and gain on the sale of assets used in an active trade or business. Portfolio income includes interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business. The final category, passive income or loss, is generated by a passive activity. The following activities are treated as passive: (1) any trade or business or income-producing activity in which the taxpayer does not materially participate, and (2) subject to exceptions, all rental activities, whether the taxpayer materially participates or not.

690. Chapter 6 - Losses and Loss Limitations Question ES #6 Discuss the treatment given to suspended passive activity losses and credits. What happens to an activity’s unused losses and credits when the activity is sold?

Correct Answer:In general, passive losses are deductible to the extent of passive income from all of the taxpayer’s current-year passive activities. Passive credits can be utilized only against regular tax attributable to passive income. If passive losses or credits are not used in the current year, they are carried over indefinitely for potential use in the succeeding years to offset passive income (or regular tax attributable to passive income) in those years.

An activity’s unused (or suspended) passive losses that exist when a taxpayer sells the passive activity may be used to reduce the gain from the sale, or increase the recognized loss. Thus, the suspended passive

losses are fully utilized in the year of disposition. In contrast, passive credits are allowed on dispositions only when there is sufficient tax on passive income to absorb them.

691. Chapter 6 - Losses and Loss Limitations Question ES #7 List the taxpayers that are subject to the passive loss rules and summarize the general impact of these rules on these taxpayers.

Correct Answer:The passive loss rules apply to individuals, estates, trusts, personal service corporations, and closely held C corporations. Passive income or loss from investments held by S corporations or partnerships flows through to the owners and the passive loss rules apply at the owner level.

For individuals, estates, trusts, and personal service corporations, losses or expenses generated by passive activities can be deducted only to the extent of income from all of the taxpayer’s passive activities. The application of the passive loss rules to closely held (non-personal service) C corporations is slightly different: these taxpayers may use passive losses to offset active income, but not portfolio income. Any unused passive losses are suspended and carried forward to future years to offset passive income generated in those years. Otherwise, suspended losses may be used when a taxpayer disposes of his or her entire interest in an activity.

692. Chapter 6 - Losses and Loss Limitations Question ES #8 What special passive loss treatment is available to real estate activities?

Correct Answer:

The special passive loss rules available to real estate activities allow the deduction of all or part of real estate rental losses against active or portfolio income, even though the activity otherwise is defined as a passive activity. The special rules are available in two situations:

· Losses from real estate rental activities are not treated as passive losses for certain qualifying real estate professionals.

· Qualifying individuals may deduct up to $25,000 of losses from real estate rental

activities against active and portfolio income. The potential annual $25,000 deduction is reduced by 50 percent of the taxpayer’s AGI in excess of $100,000.

693. Chapter 6 - Losses and Loss Limitations Question ES #9 When a taxpayer disposes of a passive activity by death, what happens to any unused passive losses?

Correct Answer:

A transfer of a taxpayer’s interest in an activity by reason of the taxpayer’s death results in suspended losses being allowed to the decedent to the extent they exceed the amount, if any, of the step-up in basis allowed. Suspended losses are lost to the extent of the amount of the basis increase. The losses allowed generally are reported on the deceased taxpayer’s final income tax return.

694. Chapter 7 - Property Transactions: Basis, Gain and Loss, and Non Realized gain or loss is measured by the difference between the amount realized from the sale or other disposition of property and the property’s adjusted basis at the date of disposition.

*a. Trueb. False

695. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N 2 Molanda sells a parcel of land for $18,000 in cash and the buyer assumes Molanda’s mortgage of $12,000 on the land. Molanda’s amount realized is $18,000.

a. True*b. False

696. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N 3 If Wal-Mart stock increases in value during the tax year by $4,500, the amount realized is a positive $4,500.

a. True*b. False

697. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N 4 If the buyer assumes the seller’s liability on the property acquired, the seller’s amount realized is increased by the amount of the liability assumed.

*a. Trueb. False

698. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N 5 The fair market value of property received in a sale or other disposition is the price at which property will change hands between a willing seller and a willing buyer when neither is compelled to sell or buy.

*a. Trueb. False

699. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N 6 If a seller assumes the buyer’s liability on the property acquired, the

buyer’s adjusted basis for the property is decreased by the amount of the liability assumed.

*a. Trueb. False

700. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N 7 Expenditures made for ordinary repairs and maintenance of property are not added to the original basis in the determination of the property’s adjusted basis whereas capital expenditures are added to the original basis.

*a. Trueb. False

701. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N 8 Louis purchases land and an office building for his business for $150,000 with $50,000 being allocated to the land. During the first year, Louis deducts cost recovery of $2,247. Louis’ adjusted basis for the building at the end of the first year is $97,753 ($100,000 – $2,247).

*a. Trueb. False

702. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N 9 The adjusted basis of property that is stolen is reduced by the amount of insurance proceeds received and by any recognized loss.

*a. Trueb. False

703. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N10 Monroe’s delivery truck is damaged in an accident. Monroe’s adjusted basis for the delivery truck prior to the accident is $20,000. If Monroe receives insurance proceeds of $21,000 and recognizes a casualty gain of $1,000, his adjusted basis for the delivery truck after the accident is $21,000.

a. True*b. False

704. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N11 If insurance proceeds are received for property used in a trade or business, a casualty transaction can result in recognized gain or recognized loss.

*a. Trueb. False

705. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N12 If the amount of a corporate distribution is less than the amount of the corporate earnings and profits, the return of capital concept does not apply and the shareholders’ adjusted basis for the stock remains unchanged.

*a. Trueb. False

706. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N13 Ricky owns all the stock of Amethyst, Inc. (adjusted basis of $72,000). If he receives a distribution from Amethyst of $65,000 and corporate earnings and profits are $15,000, Ricky has a capital gain of $7,000 and an adjusted basis for his Amethyst stock of $0.

a. True*b. False

707. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N14 The amount of a corporate distribution qualifying for capital recovery treatment which exceeds the recipient’s stock basis is treated as an ordinary gain.

a. True*b. False

708. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N15 The adjusted basis for a taxable bond purchased at a premium is reduced if the amortization election is made. The amount of the amortized premium is treated as an interest deduction.

*a. Trueb. False

709. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N16 Ginger purchases a $1,000 corporate bond at a premium of $100 and elects to amortize the premium. On the later sale of the bond for $1,090, she has amortized $30 of the premium. Ginger has a recognized gain of $120 ($1,090 amount realized – $970 adjusted basis).

a. True*b. False

710. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N17 The amount received for a utility easement on land is included in the gross income of the taxpayer.

a. True*b. False

711. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N18 A realized gain on the sale or exchange of a personal use asset is recognized, but a realized loss on the sale, exchange, or condemnation of a personal use asset is not recognized.

*a. Trueb. False

712. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N19 As compensation for her services, Leslie purchases real estate from her employer for less than fair market value. Leslie’s basis for the real estate is its fair market value.

*a. Trueb. False

713. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N20 When a taxpayer has purchased several lots of stock on different dates at different purchase prices and cannot identify the lot of stock that is being sold, he should use a weighted approach.

a. True*b. False

714. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N21 Cassie purchases a sole proprietorship for $125,000. The fair market value of the tangible assets is $100,000 and the agreed to value of goodwill is $15,000. Assuming there are no other intangible assets, Cassie’s basis for the tangible assets is $108,696 ($100,000 + $8,696) and her basis for the goodwill is $16,304 ($15,000 + $1,304).

a. True*b. False

715. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N22 Nontaxable stock dividends result in no change to the total basis of the old and new stock, but the basis per share decreases.

*a. Trueb. False

716. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N23 The basis of property received by gift is always a carryover basis.

a. True*b. False

717. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N24 This year, Fran receives a birthday gift of stock worth $75,000 from her aunt. The aunt has owned the stock (adjusted basis $50,000) for 10 years and pays gift tax of $27,000 on the transfer. Fran’s basis in the stock is $75,000—the lesser of $77,000 ($50,000 + $27,000) or $75,000.

a. True*b. False

718. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N25 Todd gives Sam stock (adjusted basis of $90,000; fair market value of $78,000). Sam later sells the stock for $85,000. Sam’s recognized loss is $5,000 ($85,000 amount realized – $90,000 adjusted basis).

a. True*b. False

719. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N26 A donee receives depreciable property worth $85,000 (basis to donor of $150,000) with no gift tax being paid on the transfer. The donee’s basis for depreciation purposes is $85,000.

a. True*b. False

720. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N27 The holding period for property acquired by gift is automatically long term.

a. True*b. False

721. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N28 The basis of property received by inheritance in 2011 is a carryover basis if the property has declined in value while being held by the decedent.

a. True*b. False

722. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N29 The alternate valuation date amount cannot be elected in 2011 if the property in the estate appreciates in value during the six-month period after death.

*a. Trueb. False

723. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N30 If the alternate valuation date is elected by the executor in 2011, the total basis of inherited property will be more than what it would have been if the primary valuation date and amount had been used.

a. True*b. False

724. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N31 If the alternate valuation date is elected by the executor of the estate, the basis of all of the property included in the decedent’s estate becomes the fair market value 6 months after the decedent’s death.

a. True*b. False

725. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N32 Parker bought a brand new Ferrari on January 1, 2011, for $125,000. Parker was fatally injured in an auto accident on June 23, 2011, when the fair market value of the car was $105,000. Parker was driving a loaner car from the Ferrari dealership while his car was being serviced. In his will, Parker left the Ferrari to his best friend, Ryan. Ryan’s holding period for the Ferrari begins on June 23, 2011.

a. True*b. False

726. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N33 Section 267 provides that realized losses and realized gains from related party transactions are not recognized. The basis of the property received by the related party purchaser is a carryover basis.

a. True*b. False

727. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N34 For the loss disallowance provision under § 267, related parties include certain family members, a shareholder and his or her controlled corporation (i.e., greater than 50% in value of the corporation’s outstanding stock), and a partner and his or her controlled partnership (i.e., greater than 50% of the capital interests or profits interest in the partnership).

*a. Trueb. False

728. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N35 A related party purchaser includes in the basis of the property acquired the seller’s disallowed loss.

a. True*b. False

729. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N36 Ben sells stock (adjusted basis of $25,000) to his son, Ray, for its fair market value of $15,000. Ray gives the stock to his daughter, Trish, who subsequently sells it for $26,000. Ben’s recognized loss is $0 and Trish’s recognized gain is $1,000 ($26,000 – $15,000 – $10,000).

a. True*b. False

730. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N37 The basis of property acquired in a wash sale is its cost plus the loss recognized on the wash sale.

a. True*b. False

731. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N38 Realized losses from the sale or exchange of stock are disallowed if within 30 days before or 30 days after the sale or exchange, the taxpayer acquires substantially identical stock.

*a. Trueb. False

732. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N39 Gene purchased an SUV for $42,000 which he uses 100% for personal purposes. When the SUV is worth $29,000, he contributes it to his business. The gain basis is $42,000, the loss basis is $29,000, and the basis for cost recovery is $29,000.

*a. Trueb. False

733. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N40 Property that has been converted from personal use to business or income-producing use will be dual basis property if the adjusted basis exceeds the fair market value at the date of conversion.

*a. Trueb. False

734. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N41 The basis for gain and loss of personal use property converted to business use is the lower of the adjusted basis or the fair market value on the date of conversion.

a. True*b. False

735. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N42 Stuart owns land with an adjusted basis of $190,000 and a fair market value of $500,000. If the property is going to be given to the Stuart’s nephew, Alex, it is preferable for the transfer to be by inheritance rather than by gift.

*a. Trueb. False

736. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N43 The taxpayer owns stock with an adjusted basis of $15,000 and a fair market value of $8,000. If the stock or cash is going to be given to her niece, it is preferable for the taxpayer to sell the stock and give the $8,000 of cash to her niece. The same preference would exist if the recipient were a qualified charitable organization.

*a. Trueb. False

737. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N44 Since wash sales do not apply to gains, it may be desirable to engage in this type of transaction before the end of the tax year.

*a. Trueb. False

738. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N45 Gains and losses on nontaxable exchanges are deferred because the tax law recognizes that nontaxable exchanges result in a change in the substance but not the form of the taxpayer’s relative economic position.

a. True*b. False

739. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N46 Ava exchanges a pick-up truck that she has held for personal use plus $14,000 for a new pick-up truck which she will use exclusively in her sole proprietorship business. This exchange qualifies for nontaxable exchange treatment.

a. True*b. False

740. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N47 In a nontaxable exchange, recognition is postponed. In a tax-free transaction, nonrecognition is permanent.

*a. Trueb. False

741. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N48 In a nontaxable exchange, the replacement property is assigned a carryover basis.

*a. Trueb. False

742. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N49 A taxpayer cannot recognize a realized loss on a § 1031 like-kind exchange.

*a. Trueb. False

743. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N50 Abby exchanges 300 shares of Osprey, Inc., stock for 100 shares of Blue Heron, Inc., stock. Abby’s adjusted basis for the Osprey stock is $14,000 and the fair market value of the Blue Heron stock is $16,000. Abby’s recognized gain is $0 and her adjusted basis for the Blue Heron stock is $14,000.

a. True*b. False

744. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N51 Livestock of different sexes can qualify for like-kind exchange treatment if the livestock has been held for over one year.

a. True*b. False

745. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N52 To qualify as a like-kind exchange, real property must be exchanged either for other real property or for personal property with a statutory life of at least 39 years.

a. True*b. False

746. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N53 The exchange of unimproved real property located in Topeka (KS) for improved real property located in Atlanta (GA) qualifies as a like-kind exchange.

*a. Trueb. False

747. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N54 Jena owns land as an investor. She exchanges the land for a warehouse in which she will store the inventory of her business. The exchange does not qualify for like-kind exchange treatment.

a. True*b. False

748. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N55 A building located in Virginia (used in business) exchanged for a building located in France (used in business) cannot qualify for like-kind exchange treatment.

*a. Trueb. False

749. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N56 Paul owns a 1965 Mustang car which he uses for personal use. He purchased it three years ago for $13,000, and it currently is worth $16,000. He exchanges it for a 1979 Triumph Spitfire convertible worth $16,000. Paul’s recognized gain is $0 and his adjusted basis for the convertible is $13,000.

a. True*b. False

750. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N57 An exchange of business or investment property for like-kind property with a § 267 related party cannot qualify as a § 1031 like-kind exchange.

a. True*b. False

751. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N58 An exchange of two items of personal property (personalty) that belong to different general business asset classes qualifies for nonrecognition under § 1031 as long as both properties are used in the taxpayer’s trade or business.

a. True*b. False

752. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N59 In a like-kind exchange where the boot received exceeds the realized gain, gain is recognized only to the extent of the realized gain.

*a. Trueb. False

753. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N60 Shari exchanges an office building in New Orleans (adjusted basis of $700,000) for an apartment building in Baton Rouge (fair market value of $900,000). In addition, she receives $100,000 of cash. Shari’s recognized gain is $100,000 and her basis for the apartment building is $800,000 ($700,000 adjusted basis + $100,000 recognized gain).

a. True*b. False

754. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N61 If boot in the form of cash is given in a § 1031 like-kind exchange, the realized gain may be recognized.

a. True*b. False

755. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N62 If there is a realized gain on a like-kind exchange, both the receipt of boot and the giving of boot result in part or all of the realized gain being recognized.

a. True*b. False

756. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N63 Pierce exchanges an asset (adjusted basis of $14,000; fair market value of $18,000) for another asset (fair market value of $15,000). In addition, he receives cash of $3,000. If the exchange qualifies as a like-kind exchange, his recognized gain is $3,000 and his adjusted basis for the property received is $17,000 ($14,000 + $3,000 recognized gain).

a. True*b. False

757. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N64 The basis of boot received in a like-kind exchange is its fair market

value, unless the realized gain is a smaller amount.

a. True*b. False

758. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N65 Terry exchanges real estate (acquired on August 25, 2005) held for investment for other real estate to be held for investment on September 1, 2011. None of the realized gain of $10,000 is recognized, and Terry’s adjusted basis for the new real estate is a carryover basis of $80,000. Consequently, Terry’s holding period for the new real estate begins on August 25, 2005.

*a. Trueb. False

759. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N66 If boot is received in a § 1031 like-kind exchange that results in some of the realized gain being recognized, the holding period for both the like-kind property and the boot received begins on the date of the exchange.

a. True*b. False

760. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N67 If a taxpayer exchanges like-kind property under § 1031 and assumes a liability associated with the property received, the taxpayer is considered to have received boot in the transaction.

a. True*b. False

761. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N68 An involuntary conversion results from the destruction (complete or partial), theft, seizure, requisition or condemnation, or the sale or exchange under threat or imminence of requisition or condemnation of the taxpayer’s property.

*a. Trueb. False

762. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N69 Section 1033 (nonrecognition of gain from an involuntary conversion) applies to both gains and losses.

a. True*b. False

763. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N70 The amount realized includes the compensation paid by the public authority acquiring the taxpayer’s property.

*a. Trueb. False

764. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N71 The requirements for replacement property in involuntary conversions are generally less restrictive than the requirements in like-kind exchanges.

a. True*b. False

765. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N72 Milt’s building which houses his retail sporting goods store is destroyed by a flood. Sandra’s warehouse which she is leasing to Milt to store the inventory of his business also is destroyed in the same flood. Both Milt and Sandra receive insurance proceeds that result in a realized gain. Sandra will have less flexibility than Milt in the type of building in which she can invest the proceeds and qualify for postponement treatment under § 1033 (nonrecognition of gain from an involuntary conversion).

a. True*b. False

766. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N73 A condemned office building owned and used in the business by a taxpayer can be replaced by land and qualify for nonrecognition treatment.

*a. Trueb. False

767. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N74 A taxpayer can replace property before its condemnation and still qualify for nonrecognition treatment.

*a. Trueb. False

768. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N75 If a taxpayer reinvests the net proceeds (amount received – related expenses) received in an involuntary conversion in qualifying replacement property within the statutory time period, it is possible to defer the recognition of the realized gain.

*a. Trueb. False

769. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N76 The holding period of replacement property where the election to postpone gain is made includes the holding period of the involuntarily converted property.

*a. Trueb. False

770. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N77 Gabe’s office building (adjusted basis of $200,000; fair market value of $250,000) is destroyed by a hurricane. Due to a 30% co-insurance clause, Gabe receives insurance proceeds of only $175,000. If Gabe purchases an office building for $250,000 one month later, its adjusted basis is $275,000 ($250,000 cost + $25,000 postponed loss).

a. True*b. False

771. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N78 If the recognized gain on an involuntary conversion equals the realized gain because of a reinvestment deficiency, the basis of the replacement property will be more than its cost (cost plus realized gain).

a. True*b. False

772. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N79 To qualify for the § 121 exclusion, the property must have been owned by the taxpayer for the 5 years preceding the date of sale and used by the taxpayer as the principal residence for the last 2 of those years.

a. True*b. False

773. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N80 A taxpayer who sells his or her principal residence at a realized loss can elect to recognize the loss even if a qualified residence is acquired during the statutory time period.

a. True*b. False

774. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N81 Owen and Polly have been married for two years. Owen sells investment property to Polly for a realized loss of $100,000. Owen’s loss of $100,000 is disallowed and Polly’s basis for the property she purchased

is her cost.

a. True*b. False

775. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N82 Albert purchased a tract of land for $140,000 in 2008 when he heard that a new highway was going to be constructed through the property and that the land would soon be worth $200,000. Highway engineers surveyed the property and indicated that he would probably get $180,000. The highway project was abandoned in 2011 and the value of the land fell to $100,000. What is the amount of loss Albert can claim in 2011?

a. $40,000.b. $60,000.c. $80,000.d. $100,000.*e. None of the above.

776. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N83 Ashley sells real property for $280,000. The buyer pays $4,000 in property taxes that had accrued during the year while the property was still legally owned by Ashley. In addition, Ashley pays $14,000 in commissions and $3,000 in legal fees in connection with the sale. How much does Ashley realize (the amount realized) from the sale of her property?

a. $259,000.b. $263,000.*c. $267,000.d. $280,000.e. None of the above.

777. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N84 Alice owns land with an adjusted basis of $610,000, subject to a mortgage of $350,000. Real estate taxes are $9,000 per calendar year and are payable on December 31. On April 1, 2011, Alice sells her land subject to the mortgage for $650,000 in cash, a note for $600,000, and property with a fair market value of $120,000. What is the amount realized?

a. $1,370,000.b. $1,372,219.c. $1,720,000.*d. $1,722,219.e. None of the above.

778. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N85 Pedro borrowed $50,000 to purchase a machine costing $75,000. He later borrowed $20,000 using the machine as collateral. Both notes are nonrecourse. Eight years later, the machine has an adjusted basis of

zero and two outstanding note balances of $40,000 and $14,000. Pedro sells the machine subject to the two liabilities for $25,000. What is his realized gain or loss?

a. $0.b. $25,000.*c. $79,000.d. $95,000.e. None of the above.

779. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N86 Carlton purchases land for $400,000. He incurs legal fees of $8,000 associated with the purchase. He subsequently incurs additional legal fees of $25,000 in having the land rezoned from agricultural to residential. He subdivides the land and installs streets and sewers at a cost of $700,000. What is Carlton’s basis for the land and the improvements?

a. $400,000.b. $433,000.c. $1,100,000.*d. $1,133,000.e. None of the above.

780. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N87 Jamie bought her house in 2006 for $395,000. Since then, she has deducted $70,000 in depreciation associated with her home office and has spent $45,000 replacing all the old pipes and plumbing. She sells the house on July 1, 2011. Her realtor charged $34,700 in commissions. Prior to listing the house with the realtor, she spent $300 advertising in the local newspaper. Sammy buys the house for $500,000 in cash, assumes her mortgage of $194,000, and pays property taxes of $4,200 for the entire year on December 1, 2011. What is Jamie’s adjusted basis at the date of the sale and the amount realized?

a. $370,000 adjusted basis; $661,400 amount realized.*b. $370,000 adjusted basis; $661,100 amount realized.c. $370,000 adjusted basis; $665,200 amount realized.d. $325,000 adjusted basis; $663,200 amount realized.e. $325,000 adjusted basis; $694,000 amount realized.

781. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N88 Alicia buys a beach house for $425,000 which she uses as her personal vacation home. She builds an additional room on the house for $45,000. She sells the property for $510,000 and pays $30,000 in commissions and $4,000 in legal fees in connection with the sale. What is the recognized gain or loss on the sale of the house?

a. $0.*b. $6,000.c. $30,000.d. $40,000.

e. None of the above.

782. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N89 Capital recoveries include:

a. The cost of capital improvements.b. Ordinary repair and maintenance expenditures.c. Payments made on the principal of a mortgage on taxpayer’s building.*d. Amortization of bond premium.e. All of the above.

783. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N90 Steve purchased his home for $500,000. As a sole proprietor, he operates a certified public accounting practice in his home. For this business, he uses one room exclusively and regularly as a home office. In Year 1, $3,042 of depreciation expense on the home office was deducted on his income tax return. In Year 2, Steve sustained losses in his business; therefore, no depreciation was taken on the home office. Had he been allowed to deduct depreciation expense, his depreciation expense would have been $3,175. What is the adjusted basis in the home?

*a. $493,783.b. $496,825.c. $496,958.d. $500,000.e. None of the above.

784. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N91 Sandra’s automobile, which is used exclusively in her trade or business, was damaged in an accident. The adjusted basis prior to the accident was $11,000. The fair market value before the accident was $10,000 and the fair market value after the accident is $6,000. Insurance proceeds of $3,200 are received. What is Sandra’s adjusted basis for the automobile after the casualty?

a. $0.*b. $7,000.c. $7,800.d. $10,200.e. None of the above.

785. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N92 Joyce’s office building was destroyed in a fire (adjusted basis of $350,000; fair market value of $400,000). Of the insurance proceeds of $360,000 she receives, Joyce uses $310,000 to purchase additional inventory and invests the remaining $50,000 in short-term certificates of deposit. She received only $360,000 because of a co-insurance clause in her insurance policy. What is Joyce’s recognized gain or loss?

a. $0.b. $10,000 loss.*c. $10,000 gain.d. $40,000 gain.e. None of the above.

786. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N93 Karen owns City of Richmond bonds with a face value of $10,000. She purchased the bonds on January 1, 2011, for $11,000. The maturity date is December 31, 2020. The annual interest rate is 8%. What is the amount of taxable interest income that Karen should report for 2011, and the adjusted basis for the bonds at the end of 2011, assuming straight-line amortization is appropriate?

a. $0 and $11,000.*b. $0 and $10,900.c. $100 and $11,000.d. $100 and $10,900.e. None of the above.

787. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N94 Milton owns a bond (face value of $25,000) for which he paid $28,000. Which of the following statements is correct?

a. If the bond is taxable, Milton must amortize the $3,000 premium over its remaining life.b. The adjusted basis of the taxable bond remains at $28,000, as the amortized amount is deducted as interest.c. If the bond is tax-exempt, Milton can elect to amortize the $3,000 premium over the remaining life of the bond.d. The adjusted basis of the tax-exempt bond remains at $28,000, as the amortized amount cannot be deducted as interest.*e. None of the above is correct.

788. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N95 Which of the following is correct?

a. Realized gains are always recognized and realized losses are never recognized.b. Realized gains and realized losses on the sale of personal use assets are not recognized.c. Realized gains and realized losses on the sale of personal use assets are recognized.d. Only a. and b. are correct.*e. None of the above.

789. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N96 Joy sells her personal use boat for $18,000. She purchased the boat two years ago for $15,000. What is her recognized gain or loss?

a. $0.*b. $3,000.c. $15,000.d. $18,000.e. None of the above.

790. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N97 Noelle owns an automobile which she uses for personal use. Her adjusted basis is $45,000 (i.e., the original cost). The car is worth $22,000. Which of the following statements is correct?

a. If Noelle sells the car for $22,000, her realized loss of $23,000 is not recognized.b. If Noelle exchanges the car for another car worth $22,000, her realized loss of $23,000 is not recognized.c. If the car is stolen and it is uninsured, Noelle may be able to recognize part of her realized loss of $23,000.d. Only a. and b. are correct.*e. a., b., and c. are correct.

791. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N98 Katie sells her personal use automobile for $15,000. She purchased the car four years ago for $31,000. What is Katie’s recognized gain or loss?

*a. $0.b. $15,000.c. ($16,000).d. ($31,000).e. None of the above.

792. Chapter 7 - Property Transactions: Basis, Gain and Loss, and N99 Alvin is employed by an automobile dealership as its manager. As such, he purchased an SUV for $20,000 (fair market value is $41,000). No other employees are permitted a discount. What is Alvin’s basis in the SUV?

a. $20,000.b. $21,000.*c. $41,000.d. $61,000.e. None of the above.

793. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 100 Over the past 20 years, Alfred has purchased 380 shares of Green, Inc., common stock. His first purchase was in 1990 when he acquired 30 shares for $20 a share. In 1995, Alfred bought 150 shares at $10 a share. In 2010, Alfred acquired 200 shares at $50 a share. Alfred intends to sell 125 shares at $60 per share in the current year. If Alfred’s objective is to minimize gain, what is his recognized gain?

*a. $1,250.b. $3,520.c. $5,950.d. $6,250.e. None of the above.

794. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 101 Mona purchased a business from Judah for $1,000,000. Judah’s records and an appraiser provided her with the following information regarding the assets purchased:

Adjusted Basis FMVLand $195,000 $270,000Building 310,000 450,000Equipment 95,000 180,000

What is Mona’s adjusted basis for the land, building, and equipment?

*a. Land $270,000, building $450,000, equipment $180,000.b. Land $195,000, building $575,000, equipment $230,000.c. Land $195,000, building $310,000, equipment $95,000.d. Land $270,000, building $521,429, equipment $208,571.e. None of the above.

795. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 102 Nontaxable stock dividends result in:

a. A higher cost per share for all shares than before the stock dividend.*b. A lower cost per share for all shares than before the stock dividend.c. An increase in the total cost of the old and new stock combined.d. A decrease in the total cost of the old and new stock combined.e. None of the above.

796. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 103 Kevin purchased 5,000 shares of Purple Corporation stock at $10 per share. Two years later, he receives a 5% common stock dividend. At that time, the common stock of Purple Corporation had a fair market value of $12.50 per share. What is the basis of the Purple Corporation stock, the per share basis, and gain recognized upon receipt of the common stock dividend?

a. $50,000 basis in stock, $10 basis per share for the original stock and $0 basis per share for the dividend shares, $0 recognized gain.*b. $50,000 basis in stock, $9.52 basis per share, $0 recognized

gain.c. $53,125 basis in stock, $10 basis per share for the original stock and $12.50 basis per share for the dividend shares, $3,125 recognized gain.d. $53,125 basis in stock, $10.12 basis per share, $3,125 recognized gain.e. None of the above.

797. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 104 In 2007, Harold purchased a classic car that he planned to restore for $12,000. However, Harold is too busy to work on the car and he gives it to his daughter Julia in 2011. At this time, the fair market value of the car has declined to $10,000. Harold paid no gift tax on the transaction. Julia completes some of the restoration herself with out-of-pocket costs of $5,000. She later sells the car for $30,000. What is Julia’s recognized gain or loss on the sale of the car?

a. $0.*b. $13,000.c. $15,000.d. $18,000.e. None of the above.

798. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 105 Abner gives his daughter, Melissa, stock (basis of $52,000; fair market value of $42,000). No gift tax is paid. If Melissa subsequently sells the stock for $54,000, what is her recognized gain or loss?

a. $0.*b. $2,000.c. $10,000.d. $12,000.e. None of the above.

799. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 106 Gift property (disregarding any adjustment for gift tax paid by the donor):

a. Has no basis to the donee because he or she did not pay anything for the property.*b. Has the same basis to the donee as the donor’s adjusted basis if the donee disposes of the property at a gain.c. Has the same basis to the donee as the donor’s adjusted basis if the donee disposes of the property at a loss, and the fair market value on the date of gift was less than the donor’s adjusted basis.d. Has no basis to the donee if the fair market value on the date of gift is less than the donor’s adjusted basis.e. None of the above.

800. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 107 Shontelle received a gift of income-producing property with an adjusted basis of $75,000 to the donor and fair market value of $69,000 on the date of gift. Gift tax of $7,000 was paid by the donor. Shontelle subsequently sold the property for $72,000. What is the recognized gain or loss?

a. $3,000.b. ($3,000).c. ($4,000).d. ($10,000).*e. None of the above.

801. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 108 Rob was given a residence in 2011. At the time of the gift, the residence had a fair market value of $200,000, and its adjusted basis to the donor was $140,000. The donor paid a gift tax of $10,000 on the taxable gift of $187,000. What is Rob’s basis for gain?

a. $140,000.*b. $143,209.c. $150,000.d. $200,000.e. None of the above.

802. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 109 In addition to other gifts, Megan made a gift of stock to Jeri in 1975. Megan had purchased the stock in 1973 for $7,500. At the time of the gift, the stock was worth $20,000. If Megan paid $850 of gift tax on the transaction in 1975, what is Jeri’s gain basis for the stock?

a. $7,500.*b. $8,350.c. $9,017.d. $20,000.e. None of the above.

803. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 110 Noelle received dining room furniture as a gift from her friend, Jane. Jane’s adjusted basis was $9,200 and the fair market value on the date of the gift was $7,000. Noelle decided she did not need the furniture and sold it to a neighbor six months later for $6,500. What is her recognized gain or loss?

*a. $0.b. ($500).c. ($2,700).d. $6,500.e. None of the above.

804. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 111 The holding period of property acquired by gift may begin on:

a. The date the property was acquired by the donor only.b. The date of gift only.*c. Either the date the property was acquired by the donor or the date of gift.d. The end of the tax year in which the property was originally acquired by the donor.e. None of the above.

805. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 112 Melba gives her niece a drill press to use in her business with a fair market value of $36,000 and a basis in Melba’s hands of $41,000. No gift tax was paid. What is the niece’s basis for depreciation (cost recovery)?

a. $0.b. $5,000.c. $36,000.*d. $41,000.e. None of the above.

806. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 113 Abner, age 80 and in poor health, owns investment land with an adjusted basis of $50,000. He is considering transferring it to Stella, his niece. Regarding Stella’s income tax position, should the transfer to her be by gift or by inheritance? (Assume neither gift tax nor estate tax would be due, and that the property is not expected to change in value.)

a. If the fair market value of the land is $200,000, the transfer should be by inheritance.b. If the fair market value of the land is $10,000, the transfer should be by gift.c. If the fair market value of the land is $50,000, the transfer can be either by gift or by inheritance (i.e., the tax consequences are the same).*d. Only a. and c. are correct.e. a., b., and c. are correct.

807. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 114 Which of the following statements correctly reflects the rules regarding inherited property in 2011?

*a. A particular beneficiary’s basis can be greater than, equal to, or less than the decedent’s basis.b. A particular beneficiary’s holding period includes the donor’s holding period.c. The alternate valuation date election only applies to those assets which have declined in value (i.e., does not cover assets that have increased in value).

d. Only a. and b. are correct.e. a., b., and c. are correct.

808. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 115 Al owns stock with an adjusted basis of $100,000 and a fair market value of $300,000. He gives the stock to Jane on July 1, 2010. When Jane dies, the fair market value of the stock is $900,000. Jane’s will provides that Al is to receive the stock. Which of the following is false?

a. If Jane dies on June 1, 2011, Al’s basis for the stock is $100,000.b. If Jane dies on August 1, 2011, Al’s basis for the stock is $900,000.*c. If Jane dies on June 15, 2011, Al’s basis is $300,000.d. If Jane dies on July 1, 2011, Al’s basis is $100,000.e. All of the above are true.

809. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 116 Emma gives 1,000 shares of Green, Inc. stock to her niece, Margaret. Emma’s adjusted basis for the stock is $400,000 and the fair market value is $600,000. Five months after the gift, Margaret is killed in an automobile accident. Emma inherits the stock which then is worth $700,000. What is the adjusted basis of the inherited stock to Emma?

a. $0.*b. $400,000.c. $600,000.d. $700,000.e. None of the above.

810. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 117 Taylor inherited 100 acres of land on the death of his father in 2011. A Federal estate tax return was filed and this land was valued therein at $650,000, its fair market value at the date of the father’s death. The father had originally acquired the land in 1965 for $112,000 and prior to his death he had expended $20,000 on permanent improvements. Determine Taylor’s holding period for the land.

a. Will begin with the date his father acquired the property.*b. Will automatically be long-term.c. Will begin with the date of his father’s death.d. Will begin with the date the property is distributed to him.e. None of the above.

811. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 118 Kelly inherits land which had a basis to the decedent of $95,000 and a fair market value of $50,000 on August 4, 2011, the date of the decedent’s death. The executor distributes the land to Kelly on November 12, 2011, at which time the fair market value is $49,000. The fair market value on February 4, 2012, is $45,000. In filing the estate

tax return, the executor elects the alternate valuation date. Kelly sells the land on June 10, 2012, for $48,000. What is her recognized gain or loss?

*a. ($1,000).b. ($2,000).c. ($47,000).d. $1,000.e. None of the above.

812. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 119 Iva owns Mauve, Inc. stock (adjusted basis of $40,000) which she sells to Joshua, her brother, for its fair market value of $32,000. Fifteen months later, he sells it to Faye, a friend, for its fair market value of $39,000. Determine Iva’s recognized loss, Joshua’s recognized gain or loss, and Faye’s adjusted basis for the stock. Iva’s recognized loss Joshua’s recognized gain or loss Faye’s basis

*a. $ –0– $ –0– $39,000b. $ –0– $7,000 $32,000c. $ –0– $7,000 $39,000d. $8,000 $7,000 $39,000e. None of the above.

813. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 120 Paul sells property with an adjusted basis of $45,000 to his daughter Dean, for $38,000. Dean subsequently sells the property to her brother, Preston, for $38,000. Three years later, Preston sells the property to Hun, an unrelated party, for $50,000. What is Preston’s recognized gain or loss on the sale of the property to Hun?

a. $0.b. $5,000.*c. $12,000.d. ($5,000).e. None of the above.

814. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 121 Karen purchased 100 shares of Gold Corporation stock for $11,500 on January 1, 2003. In the current tax year, she sells 25 shares of the 100 shares purchased on January 1, 2003, for $2,500. Twenty-five days earlier, she had purchased 30 shares for $3,000. What is Karen’s recognized gain or loss on the sale of the stock, and what is her basis in the 30 shares purchased 25 days earlier?

a. $375 recognized loss, $3,000 basis in new stock.b. $0 recognized loss, $3,000 basis in new stock.*c. $0 recognized loss, $3,375 basis in new stock.d. $0 recognized loss, $3,450 basis in new stock.e. None of the above.

815. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 122 Andrew acquires 2,000 shares of Eagle Corporation stock for $100,000 on March 31, 2004. On January 1, 2011, he sells 125 shares for $5,000. On January 22, 2011, he purchases 135 shares of Eagle Corporation stock for $6,075. When does Andrew’s holding period begin for the 135 shares?

a. January 22, 2011.b. January 1, 2011.c. March 31, 2004.*d. March 31, 2004, for 125 shares and January 22, 2011, for 10 shares.e. None of the above.

816. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 123 If personal use property is converted to business use:

a. Gain is recognized on the date of conversion to the extent of the excess of the fair market value over the adjusted basis.b. Loss is recognized on the date of conversion to the extent of the excess of the adjusted basis over the fair market value.c. The basis for gain is the lower of the taxpayer’s adjusted basis or the fair market value at the date of conversion.d. The basis for loss is the taxpayer’s adjusted basis on the date of conversion.*e. None of the above is correct.

817. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 124 Lynn purchases a house for $52,000. She converts the property to rental property when the fair market value is $115,000. After deducting depreciation (cost recovery) expense of $1,130, she sells the house for $120,000. What is her recognized gain or loss?

a. $0.b. $6,130.c. $37,630.*d. $69,130.e. None of the above.

818. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 125 In order to qualify for like-kind exchange treatment under § 1031, which of the following requirements must be satisfied?

a. The form of the transaction is an exchange.b. Both the property transferred and the property received are held either for productive use in a trade or business or for investment.c. The exchange must be completed by the end of the second tax year following the tax year in which the taxpayer relinquishes his or her like-kind property.*d. Only a. and b.

e. a., b., and c.

819. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 126 Which of the following qualify as a like-kind exchange?

a. Shares of stock in Texaco for shares of stock in BP.*b. Investment land for a building to be used in a trade or business.c. General partnership interest for a general partnership interest.d. Rental house for a house to be used as a principal residence.e. None of the above.

820. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 127 Brett owns investment land located in Tucson, Arizona. He exchanges it for other investment land. In which of the following locations may the other investment land be located and enable Brett to qualify for § 1031 like-kind exchange treatment?

a. Mexico City, Mexico.b. Toronto, Canada.c. Paris, France.d. Only a. and b.*e. None of the above.

821. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 128 Lily exchanges a building she uses in her rental business for a building owned by Kendall, her brother, which she will use in her rental business. The adjusted basis of Lily’s building is $120,000 and the fair market value is $170,000. Which of the following statements is correct?

a. Lily’s recognized gain is $50,000 and her basis for the building received is $120,000.b. Lily’s recognized gain is $50,000 and her basis for the building received is $170,000.*c. Lily’s recognized gain is $0 and her basis for the building received is $120,000.d. Lily’s recognized gain is $0 and her basis for the building received is $170,000.e. None of the above is correct.

822. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 129 Latisha owns a warehouse with an adjusted basis of $112,000. She exchanges it for a strip mall building worth $150,000. Which of the following statements is correct?

a. If the warehouse was used in Latisha’s business to store inventory and the strip mall building is to be rented to tenants, her recognized gain is $38,000 and her basis for the strip mall building is $150,000.

b. If the warehouse was used in Latisha’s business to store inventory and the strip mall building is to be used as a retail outlet for her business, her recognized gain is $0 and her basis for the strip mall building is $112,000.c. If the warehouse is used by Latisha to store personal use items such as excess furniture and the strip mall building is to be rented to tenants, her recognized gain is $38,000 and her basis for the strip mall building is $150,000.*d. Only b. and c. are correct.e. a., b., and c. are correct.

823. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 130 Peach, Inc., owns a delivery truck (cost of $20,000) on which depreciation of $14,000 has been deducted. The truck and $12,000 cash are used to acquire a new truck at a cost of $22,000. What is Peach’s basis for the new truck?

a. $0.*b. $18,000.c. $22,000.d. $32,000.e. None of the above.

824. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 131 Sonny exchanges a productive use machine (adjusted basis of $20,000) for a new machine worth $18,000. In addition, he receives cash of $6,000. What is the recognized gain or loss and the basis of the new machine?

a. $0 and $18,000.b. $0 and $22,000.*c. $4,000 and $18,000.d. $4,000 and $24,000.e. None of the above.

825. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 132 Maud exchanges a rental house at the beach with an adjusted basis of $400,000 and a fair market value of $350,000 for a rental house at the mountains with a fair market value of $320,000 and cash of $30,000. What is the recognized gain or loss?

*a. $0.b. $30,000.c. $50,000.d. ($50,000).e. None of the above.

826. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 133 Melvin receives stock as a gift from his uncle. No gift tax is paid. The adjusted basis of the stock is $19,000 and the fair market value is $25,000. Melvin trades the stock for bonds with a fair market value of

$22,000 and $3,000 cash. What is his recognized gain and the basis for the bonds?

a. $0, $16,000.b. $0, $19,000.c. $3,000, $19,000.*d. $6,000, $22,000.e. None of the above.

827. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 134 Moss exchanges a warehouse for a building he will use as an office building. The adjusted basis of the warehouse is $600,000 and the fair market value of the office building is $350,000. In addition, Moss receives cash of $150,000. What is the recognized gain or loss and the basis of the office building?

a. $0 and $350,000.*b. $0 and $450,000.c. ($150,000) and $300,000.d. ($200,000) and $350,000.e. None of the above.

828. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 135 Pam exchanges a rental building, which has an adjusted basis of $520,000, for investment land which has a fair market value of $700,000. In addition, Pam receives $100,000 in cash. What is the recognized gain or loss and the basis of the investment land?

a. $0 and $420,000.b. $100,000 and $420,000.*c. $100,000 and $520,000.d. $280,000 and $700,000.e. None of the above.

829. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 136 If boot is received in a § 1031 like-kind exchange and gain is recognized, which formula correctly calculates the basis for the like-kind property received?

*a. Adjusted basis of like-kind property surrendered + gain recognized - fair market value of boot received.b. Fair market value of like-kind property surrendered + gain recognized - fair market value of boot received.c. Fair market value of like-kind property received + gain recognized.d. Only a. and c.e. None of the above.

830. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 137 In determining the basis of like-kind property received, postponed

losses are:

a. Added to the basis of the old property.b. Subtracted from the basis of the old property.*c. Added to the fair market value of the like-kind property received.d. Subtracted from the fair market value of the like-kind property received.e. None of the above.

831. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 138 Molly exchanges a small machine (adjusted basis of $85,000; fair market value of $78,000) used in her business and investment land (adjusted basis of $10,000; fair market value of $15,000) for a large machine (fair market value of $93,000) to be used in her business in a like-kind exchange. What is Molly’s recognized gain or loss?

a. $0.*b. $5,000.c. ($2,000).d. ($7,000).e. None of the above.

832. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 139 In October 2011, Ben and Jerry exchange investment realty in a § 1031 like-kind exchange. Ben bought his real estate in 2001 while Jerry purchased his in 2004. In addition to the realty, Ben receives Pearl, Inc. stock worth $10,000 from Jerry. Ben’s realized gain is $30,000. On what date does the holding period for Ben’s realty received from Jerry begin? When does the holding period for the stock he receives begin?

*a. 2001, 2011.b. 2001, 2001.c. 2004, 2004.d. 2004, 2011.e. None of the above.

833. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 140 Ashley owns 200 acres of farm land is southeastern Virginia. Her adjusted basis for the land is $525,000 and there is a $390,000 mortgage on the land. She exchanges the land for an office building owned by Chris in Newark, New Jersey. The building has a fair market value of $450,000. Chris assumes Ashley’s mortgage on the land. What is the amount of Ashley’s recognized gain or loss on the exchange?

a. $0.*b. $315,000.c. $390,000.d. $840,000.e. None of the above.

834. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 141 On October 1, Paula exchanged an apartment building (adjusted basis of $375,000 and subject to a mortgage of $125,000) for another apartment building owned by Nick (fair market value of $550,000 and subject to a mortgage of $125,000). The property transfers were made subject to the mortgages. What amount of gain should Paula recognize?

*a. $0.b. $25,000.c. $125,000.d. $175,000.e. None of the above.

835. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 142 Nancy and Tonya exchanged assets. Nancy gave Tonya her personal residence with an adjusted basis of $280,000 and a fair market value of $560,000. The house has a mortgage of $200,000 which is assumed by Tonya. Tonya gave Nancy a yacht used in her business with an adjusted basis of $250,000 and a fair market value of $360,000. What is Tonya’s realized and recognized gain?

a. $310,000 realized and $310,000 recognized gain.b. $310,00 realized and $0 recognized gain.*c. $110,000 realized and $110,000 recognized gain.d. $110,000 realized and $0 recognized gain.e. None of the above.

836. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 143 If the taxpayer qualifies under § 1033 (nonrecognition of gain from an involuntary conversion), makes the appropriate election, and the amount reinvested in replacement property is less than the amount realized, realized gain is:

*a. Recognized to the extent of the deficiency (amount realized not reinvested).b. Recognized to the extent of realized gain.c. Recognized to the extent of the amount reinvested.d. Permanently not subject to taxation.e. None of the above.

837. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 144 Joyce, a farmer, has the following events occur during the tax year. Which of the events qualify as an involuntary conversion under § 1033 (nonrecognition of gain from an involuntary conversion)?

a. Her farm tractor is hauled to the city dump because it is worn out.b. She burns her barn because it is infested with termites.*c. Her personal residence, adjusted basis of $100,000, is condemned to make way for an interstate highway. She recovers condemnation proceeds of $175,000.d. She sells 10 acres of pasture land at a loss of $40,000

because she has reduced the size of her dairy herd due to a reduction in milk prices.e. None of the above.

838. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 145 An office building with an adjusted basis of $320,000 was destroyed by fire on December 30, 2011. On January 11, 2012, the insurance company paid the owner $450,000. The fair market value of the building was $500,000, but under the co-insurance clause, the insurance company is responsible for only 90 percent of the loss. The owner reinvested $410,000 in a new office building on February 12, 2012, that was smaller than the original office building. What is the recognized gain and the basis of the new building if § 1033 (nonrecognition of gain from an involuntary conversion) is elected?

a. $0 and $320,000.b. $0 and $410,000.*c. $40,000 and $320,000.d. $130,000 and 410,000.e. None of the above.

839. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 146 Which of the following statements is correct with respect to qualified replacement property in a § 1033 involuntary conversion?

a. If the functional use test applies, a warehouse used to store inventory can be replaced with a smaller building to be used to sell inventory.b. If the taxpayer use test applies, an office building rented to tenants can be replaced with a shopping mall to be rented to tenants.c. If the like-kind exchange test applies, a building used for manufacturing can be replaced with an office building to be rented to tenants.*d. Only b. and c.e. a., b., and c.

840. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 147 Ken, a fiscal year taxpayer with a tax year ending June 30, owns a dry cleaning business (adjusted basis of $325,000). The business is destroyed by a hurricane on May 28, 2011. Ken receives insurance proceeds of $350,000 on July 7, 2011. What is the latest date Ken can reinvest the proceeds in qualified property to avoid recognition of any realized gain?

a. May 28, 2011.b. June 30, 2013.c. December 31, 2013.*d. June 30, 2014.e. None of the above.

841. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 148 Which of the following statements is incorrect for a § 1033 involuntary conversion?

*a. An election can be made to postpone gain on a § 1033 involuntary conversion only if the proceeds received are reinvested in qualifying property no later than two years after the date of the involuntary conversion.b. The postponement of realized gain in a § 1033 involuntary conversion is elective.c. The functional use test is satisfied if a business warehouse is replaced with another business warehouse.d. The taxpayer use test is satisfied if a shopping mall rented to tenants is replaced with an office building to be rented to tenants.e. All of the above are correct.

842. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 149 Which of the following satisfy the time period requirement for postponement of gain as a § 1033 (nonrecognition of gain from an involuntary conversion) involuntary conversion?

a. Al’s business warehouse is destroyed by a tornado on October 31, 2011. Al is a calendar year taxpayer. He receives insurance proceeds on December 5, 2011. He reinvests the proceeds in another warehouse to be used in his business on December 29, 2013.b. Heather’s personal residence is destroyed by fire on October 31, 2011. She is a calendar year taxpayer. She receives insurance proceeds on December 5, 2011. She purchases another principal residence with the proceeds on October 31, 2013.c. Mack’s office building is condemned by the city as part of a road construction project. The date of the condemnation is October 31, 2011. He is a calendar year taxpayer. He receives condemnation proceeds from the city on that date. He purchases another office building with the proceeds on December 5, 2014.d. Lizzy’s business automobile is destroyed in an accident on October 31, 2011. Lizzy is a fiscal year taxpayer with the fiscal year ending on June 30th. She receives insurance proceeds on December 5, 2011. She purchases another business automobile with the proceeds on June 1, 2014.*e. All of the above.

843. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 150 Sam’s office building with an adjusted basis of $750,000 and a fair market value of $900,000 is condemned on November 30, 2011. Sam is a calendar year taxpayer. He receives a condemnation award of $875,000 on March 1, 2012. He builds a new office building at a cost of $845,000 which is completed and paid for on December 31, 2014. What is Sam’s recognized gain on receipt of the condemnation award and basis for the new office building assuming his objective is to minimize gain recognition?

a. $0; $720,000.*b. $30,000; $750,000.c. $30,000; $845,000.d. $150,000; $750,000.e. None of the above.

844. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 151 A factory building owned by Amber, Inc. is destroyed by a hurricane. The adjusted basis of the building was $400,000 and the appraised value was $425,000. Amber receives insurance proceeds of $390,000. A factory building is constructed during the nine-month period after the hurricane at a cost of $450,000. What is the recognized gain or loss and what is the basis of the new factory building?

a. $0 and $450,000.b. $0 and $460,000.c. ($10,000) and $440,000.*d. ($10,000) and $450,000.e. None of the above.

845. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 152 If the taxpayer qualifies under § 1033 (nonrecognition of gain from an involuntary conversion) and the amount reinvested in replacement property exceeds the amount realized, the basis of the replacement property is:

a. The cost of the replacement property.b. The fair market value of the involuntarily converted property.*c. The cost of the replacement property minus the postponed gain.d. The cost of the replacement property plus the excess of the reinvestment over the amount realized from the involuntary conversion.e. None of the above.

846. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 153 During 2011, Ted and Judy, a married couple, decided to sell their residence, which had a basis of $225,000. They had owned and occupied the residence for 16 years. To make it more attractive to prospective buyers, they had the outside painted in April at a cost of $10,000 and paid for the work immediately. They sold the house in May for $795,000. Broker’s commissions and other selling expenses amounted to $45,000. Since they both are age 68, they decide to rent an apartment. They purchase an annuity with the net proceeds from the sale. What is the recognized gain?

a. $0.b. $15,000.*c. $25,000.d. $525,000.e. None of the above.

847. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 154 Ross lives in a house he received as a gift from his father. His father had lived in the house for 12 years. The adjusted basis of the house to his father was $160,000 and the fair market value at the time of the gift was $140,000. Ross sells this residence after living in it for 18 months for $150,000 and purchases a new home for $125,000. He incurs selling expenses of $7,000. What is Ross’ recognized gain or loss and basis for the new residence?

a. ($17,000); $125,000.b. ($17,000); $142,000.c. $3,000; $125,000.d. $3,000; $128,000.*e. None of the above.

848. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 155 Paula inherits a home on July 1, 2011, that had a basis in the hands of the decedent at death of $290,000 and a fair market value of $500,000 at the date of the decedent’s death. She decides to sell her old principal residence, which she has owned and occupied for 9 years, with an adjusted basis of $125,000 and move into the inherited home. On September 16, 2011, she sells the old residence for $600,000. Paula incurs selling expenses of $30,000 and legal fees of $2,000. She decides to add a pool, deck, pool house, and recreation room to the inherited home at a cost of $100,000. These additions are completed and paid for on November 1, 2011. What is her recognized gain on the sale of her old principal residence and her basis in the inherited home?

a. $0; $500,000.*b. $193,000; $600,000.c. $443,000; $600,000.d. $475,000; $600,000.e. None of the above.

849. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 156 Which of the following types of exchanges of insurance contracts qualify for nonrecognition treatment under § 1035?

a. Exchange of life insurance contracts.b. Exchange of a life insurance contract for an endowment or annuity contract.c. Exchange of an endowment contract for an annuity contract.d. Only a. and c.*e. a., b., and c.

850. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 157 Which of the following types of transactions qualify for nonrecognition treatment?

a. Exchange by a shareholder of stock in Chevron for stock in Shell.

b. Investment of the proceeds from the sale of the stock of a publicly traded company in the common stock of a specialized small business investment company (SSBIC) within 60 days of the sale.c. Investment of proceeds from the sale of qualified small business stock in another qualified small business stock within 60 days of the sale.*d. Only b. and c.e. a., b., and c.

851. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 158 As part of the divorce agreement, Hale transfers his ownership interest in their personal residence to Monica. The house had been jointly owned by Hale and Monica and the adjusted basis is $620,000. At the time of the transfer to Monica, the fair market value is $800,000. What is the recognized gain to Hale, and what is Monica’s basis for the house?

*a. $0 and $620,000.b. $0 and $710,000.c. $90,000 and $710,000.d. $90,000 and $800,000.e. None of the above.

852. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 159 Which of the following statements is correct with respect to § 1044 (rollover of publicly traded securities gain into specialized small business investment companies)?

a. Section 1044 provides for permanent exclusion of gain.b. To qualify under § 1044, the proceeds must be reinvested within one year of the sale.c. The statutory ceilings on § 1044 treatment are the same for individual and corporate taxpayers.d. Only b. and c. are correct.*e. None of the above.

853. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 160 Robert sold his ranch which was his principal residence during the current taxable year. At the date of the sale, the ranch had an adjusted basis of $460,000 and was encumbered by a mortgage of $200,000. The buyer paid him $500,000 in cash, agreed to take the title subject to the $200,000 mortgage, and agreed to pay him $100,000 with interest at 6 percent one year from the date of sale. How much is Robert’s recognized gain on the sale?

Correct Answer:

Amount realized:

Cash $500,000 Mortgage (property taken subject to) 200,000 Note receivable 100,000

$800,000 Adjusted basis (460,000)Realized and recognized gain $340,000

If, however, the principal residence met the requirements of § 121, Robert could exclude $250,000 of the gain (or the entire $340,000 if married filing jointly).

854. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 161 Albert is considering two options for selling land for which he has an adjusted basis of $70,000 and on which there is a mortgage of $100,000. Under the first option, Albert will sell the land for $150,000 with a stipulation in the sales contract that he liquidate the mortgage before the sale is complete. Under the second option, Albert will sell the land for $50,000 and the buyer will assume the mortgage. Calculate Albert’s recognized gain under both options.

Correct Answer: Option 1 Option 2Amount realized $150,000 $150,000 Less: Adjusted basis (70,000) (70,000) Recognized gain $ 80,000 $ 80,000

Since the liability assumption is included in the calculation of Albert’s amount realized, the recognized gain is $80,000, the same as for the cash sale.

855. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 162 Annette purchased stock on March 1, 2011, for $150,000. At December 31, 2011, it was worth $160,000. She also purchased a bond on September 1, 2011, for $20,000. At year end, it was worth $12,000. Determine Annette’s realized and recognized gain or loss.

Correct Answer:Annette’s realized gain or loss is zero and her recognized gain or loss is zero. Since a sale or other disposition has not occurred, there is no realization or recognition on either the stock or the bond.

856. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 163 Nigel purchased a blending machine for $125,000 for use in his business. As to the machine, he has deducted MACRS cost recovery of $31,024, maintenance costs of $5,200, and repair costs of $4,000. Calculate Nigel’s adjusted basis for the machine.

Correct Answer:

Nigel’s adjusted basis for the machine is calculated as follows:

Cost $125,000 Less: Cost recovery (31,024)

Adjusted basis $ 93,976

Neither the maintenance cost of $5,200 nor the repair cost of $4,000 are capital expenditures. These costs are deducted in the tax year incurred.

857. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 164 Amanda uses a delivery van in her business. The adjusted basis is $29,000, and the fair market value is $25,000. The delivery van is stolen and Amanda receives insurance proceeds of $25,000. Determine Amanda’s realized and recognized gain or loss.

Correct Answer:Amount realized $25,000 Adjusted basis (29,000) Realized loss ($ 4,000)

Recognized loss ($ 4,000)

Since the proceeds received from the insurance company are less than the adjusted basis, the realized loss of $4,000 is recognized.

858. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 165 Renee purchases taxable bonds with a face value of $200,000 for $212,000. The annual interest paid on the bonds is $10,000. Assume Renee elects to amortize the bond premium. The total premium amortization for the first year is $1,600.

a. What is Renee’s interest income for the first year?

b. What is Renee’s interest deduction for the first year?

c. What is Renee’s adjusted basis for the bonds at the end of the first year?

Correct Answer:a. Renee receives interest payments of $10,000 each year. This amount is included in her

gross income because the bonds are taxable. b. Renee deducts the premium amortization of $1,600 for the first year because the bonds

are taxable. c. Renee’s adjusted basis for the bonds at the end of the first year is $210,400 ($212,000

cost – $1,600 premium amortization).

859. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 166 Boyd acquired tax-exempt bonds for $430,000 in December 2011. The bonds, which mature in December 2016, have a maturity value of $400,000. Boyd does not make any elections regarding the amortization of the bond premium. Determine the tax consequences to Boyd when he redeems the bonds in December 2016.

Correct Answer:

When Boyd redeems the bonds in 2016, he has no realized or recognized gain or loss.

Amount realized $400,000 Adjusted basis for bonds (400,000) Realized gain $ –0–

Recognized gain $ –0–

Amortization of the premium on tax-exempt bonds is mandatory. Thus, the adjusted basis of the bonds at the maturity date is $400,000 ($430,000 cost – $30,000 premium amortized). Since the bonds are tax-exempt, the amount of interest income included in Boyd’s gross income (i.e., $0) is not affected by the amortization of the bond premium.

860. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 167 Misty owns stock in Violet, Inc., for which her adjusted basis is $112,000. She receives a cash distribution of $40,000 from Violet.

a. What is Misty’s adjusted basis for the stock if the distribution is a taxable dividend?

b. What is Misty’s adjusted basis for the stock if the distribution is a return of capital?

Correct Answer:a. Since Misty must include the taxable dividend in her gross income, there is no effect on

the adjusted basis for the stock. Thus, the adjusted basis for the stock after the distribution is $112,000.

b. Since the distribution is classified as a return of capital, there is no effect on Misty’s gross income. She reduces the adjusted basis of her stock by the $40,000 distribution. Thus, the adjusted basis for the stock after the distribution is $72,000 ($112,000 – $40,000).

861. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 168 Hilary receives $10,000 for a 7-foot wide utility easement along one of the boundaries to her property. The easement provides that no structure

can be built on that portion of the property. Her adjusted basis for the property is $200,000 and the easement covers 15% of the total acreage. Determine the effect of the $10,000 payment on Hilary’s gross income and her basis for the property.

Correct Answer:Hilary does not report the $10,000 payment in her gross income. Instead, she reduces the basis for the property by the $10,000 payment from $200,000 to $190,000.

862. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 169 Ollie owns a personal use car for which he originally paid $42,000. He trades the car in on a sports utility vehicle (SUV) paying the automobile dealer cash of $24,000. If the negotiated price of the SUV is $45,000, what is Ollie’s recognized gain or loss and his adjusted basis for the SUV?

Correct Answer:

Ollie’s realized loss on the trade of his personal use car is calculated as follows:

Amount realized (trade-in value) $21,000 Adjusted basis (42,000) Realized loss ($21,000)

Since the car was a personal use asset, none of the realized loss of $21,000 is recognized. Ollie’s adjusted basis for the SUV is his cost of $45,000.

863. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 170 Omar has the following stock transactions during 2011:

Date Number of Number SellingStock purchased shares sold of shares Basis priceOrange 1/2009 100 $1,000 Blue 6/2009 200 3,000 Yellow 4/2010 50 1,250 Blue 2/2011 150 1,800 Yellow 3/2011 175 5,250 Blue 7/2011 250 $3,500Yellow 11/2011 200 7,200

a. What is Omar’s recognized gain or loss on the stock sales if his objective is to minimize the recognized gain and to maximize the recognized loss?

b. What is Omar’s recognized gain or loss if he does not identify the shares sold?

Correct Answer:a. Since Omar’s objective is to minimize recognized gain and maximize recognized loss, he

will identify the specific shares (i.e., specific identification method) being sold. He will select high basis shares to achieve his objective.

Sale of Blue stock

Amount realized $3,500 Basis: 200 shares from 6/2009 lot ($15 per share) $3,000 50 shares from 2/2011 lot ($12 per share) 600 (3,600) Realized loss ($ 100)

Recognized loss ($ 100)

Sale of Yellow stock

Amount realized $7,200 Basis: 175 shares from 3/2011 lot ($30 per share) $5,250 25 shares from 4/2010 lot ($25 per share) 625 (5,875)Realized gain $1,325

Recognized gain $1,325

b. Since Omar does not identify the shares sold, he is required to use the FIFO method.

Sale of Blue stock

Amount realized $3,500 Basis: 200 shares from 6/2009 lot ($15 per share) $3,000 50 shares from 2/2011 lot ($12 per share) 600 (3,600) Realized loss ($ 100)

Recognized loss ($ 100)

Sale of Yellow stock

Amount realized $7,200 Basis: 50 shares from 4/2010 lot ($25 per share) $1,250 150 shares from 3/2011 lot ($30 per share) 4,500 (5,750)Realized gain $1,450 Recognized gain $1,450

864. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 171 Hubert purchases Fran’s jewelry store for $950,000. The identifiable assets of the business are as follows:

Basis FMVInventory $ 90,000 $ 97,000 Accounts receivable 55,000 50,000 Building 100,000 225,000Land 280,000 300,000

Hubert and Fran agree to assign $110,000 to a 7-year covenant not to compete. How should Hubert allocate the $950,000 purchase price to the assets?

Correct Answer:

The purchase price is allocated to the assets as follows:

Inventory $ 97,000 Accounts receivable 50,000 Building 225,000 Land 300,000 Covenant 110,000 Goodwill 168,000 $950,000

Under the residual method, $168,000 ($950,000 – $782,000) is assigned to goodwill.

865. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 172 Marge purchases the Kentwood Krackers, a AAA level baseball team, for $1.5 million. The appraised values of the identified assets are as follows:

Prepaid season tickets $150,000Stadium lease 400,000Player contracts 500,000Equipment 100,000

The Krackers have won the pennant for the past two years. Determine Marge’s adjusted basis for the assets of the Kentwood Krackers.

Correct Answer:

The portion of the purchase price of $1.5 million assigned to the identified assets is as follows:

Prepaid season tickets $ 150,000Stadium lease 400,000Player contracts 500,000Equipment 100,000 $1,150,000

The residual value of $350,000 ($1,500,000 – $1,150,000) is assigned to goodwill.

866. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 173 Inez’s adjusted basis for 7,000 shares of Cardinal, Inc. common stock is $700,000. During the year, she receives a 6% stock dividend that is a nontaxable stock dividend.

a. What is the amount of Inez’s gross income?

b. What is Inez’s total basis for the stock?

c. What is Inez’s basis per share?

Correct Answer:a. Inez has no gross income because the dividend is a nontaxable stock dividend. b. Inez’s total stock basis remains at $700,000. c. The basis per share decreases to $94.34 per share ($700,000/7,420 shares).

867. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 174 Felix gives 100 shares of stock to his daughter, Monica. The stock was acquired in 2002 for $20,000, and at the time of the gift, it had a fair market value of $60,000. Felix paid a gift tax of $6,000.

a. Does the receipt of the stock result in gross income to Monica?

b. What is Monica’s basis in the stock?

Correct Answer:a. The receipt of the gift does not result in gross income to Monica.

b. Monica’s basis in the stock is calculated as follows:

$20,000 + ($40,000/$47,000* ´ $6,000) = $25,106

*The $47,000 is equal to the fair market value of the stock of $60,000 reduced by the per donee annual exclusion of $13,000.

868. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 175 On September 18, 2011, Jerry received land and a building from Ted as a gift. Ted had purchased the land and building on March 5, 2008, and his adjusted basis and the fair market value at the date of the gift were as follows:

Asset Adjusted Basis FMVLand $150,000 $200,000Building 90,000 100,000

Ted paid gift tax on the transfer to Jerry of $96,000.

a. Determine Jerry’s adjusted basis and holding period for the land and building.

b. Assume instead that the FMV of the land was $89,000 and the FMV of the building was $60,000. Determine Jerry’s adjusted basis and holding period for the land and building.

Correct Answer:a. Jerry’s total basis for the assets received from Ted is:

$150,000 + $90,000 +[($60,000/$287,000*) ´ $96,000] = $260,070

The basis is allocated to the land and building as follows:

Land: ($200,000/$300,000) ´ $260,070 = $173,380

Building: ($100,000/$300,000) ´ $260,070 = $86,690

Jerry’s holding period begins on March 5, 2008.

*The $287,000 is equal to the fair market value of the land and building of $300,000 reduced by the per donee annual exclusion of $13,000.

b. Since the land and building have declined in value, none of the gift tax paid by Ted is considered in calculating Jerry’s adjusted basis. Jerry’s basis for gain is:

Land $150,000 Building 90,000 Jerry’s basis for loss (the lower of Ted’s adjusted basis or the FMV at the date of the

gift) is: Land $89,000 Building 60,000 Jerry’s holding period begins on March 5, 2008, for the gain basis and September 18,

2011, for the loss basis.

869. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 176 Mel gives a parcel of land to his son, Scott. He had purchased the land in 1998 for $150,000 and its fair market value on the date of the gift is $142,000. No gift tax is paid. Scott subsequently sells the land for $148,000.

a. What is Scott’s basis for the land?b. What is Scott’s realized and recognized gain or loss from the sale

of the land?

Correct Answer:a. Scott’s basis for gain is $150,000 and his basis for loss is $142,000. b. Gain basis calculation: Amount realized $148,000 Basis for gain (150,000) Realized gain $ –0– Recognized gain $ –0– Note that a realized loss of $2,000 results if the basis for gain is used. Loss basis calculation: Amount realized $148,000 Basis for loss (142,000)

Realized loss $ –0– Recognized loss $ –0–

Note that a realized gain of $6,000 results if the basis for loss is used.

Since the amount realized of $148,000 is between Scott’s loss basis of $142,000 and gain basis of $150,000, neither gain nor loss results.

870. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 177 Teresa inherits land from her first cousin, Drew, in 2011. Drew’s adjusted basis in the land (purchased in September 2008) was $200,000 and it was included in his estate at a value of $270,000.

a. Determine Teresa’s basis and holding period for the land.

b. Determine Teresa’s basis and holding period for the land if it was included in her cousin’s estate at a value of $170,000.

Correct Answer:a. Teresa’s basis for the land is $270,000 and her holding period is automatically long

term. b. Teresa’s basis for the land is $170,000 and her holding period is automatically long

term.

871. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 178 Elbert gives stock worth $28,000 (no gift tax resulted) to his friend, Jeff, on June 8, 2011. Elbert purchased the stock on September 1, 2004, and his adjusted basis is $22,000. Jeff dies on December 8, 2012, and bequeaths the stock to Elbert. At that date, the fair market value of the stock is $31,000.

a. What is Jeff’s basis and holding period for the stock?

b. What is Elbert’s basis and holding period for the stock?

Correct Answer:a. Jeff has a carryover basis of $22,000 and a carryover holding period of September 1,

2004. b. Elbert has a new basis of $31,000. Since Elbert inherited the stock, his holding period is

automatically long term. Since the period between the date of the gift (June 8, 2011) and the date of Jeff’s death (December 8, 2012) is more than one year, the deathbed

gift provision does not apply.

872. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 179 On January 15 of the current taxable year, Merle sold stock with a cost of $40,000 to his brother Ned for $25,000, its fair market value. On June 21, Ned sold the stock to a friend for $26,000.

a. What are the tax consequences to Merle and Ned?

b. Would Ned recognize any gain if he sold the stock for $41,000?

Correct Answer:a. Merle realizes a loss of $15,000 [i.e., $25,000 (amount realized) – $40,000 (adjusted

basis)] which is disallowed because the stock was sold to a related party. Ned realizes a gain of $1,000 [i.e., $26,000 (amount realized) – $25,000 (adjusted basis)] on the sale to a friend, but does not recognize any gain. Ned’s gain of $1,000 is less than Merle’s previously disallowed loss of $15,000.

b. Ned would realize a gain of $16,000 [i.e., $41,000 (amount realized) – $25,000

(adjusted basis)]. Gain of $1,000 would be recognized [i.e., $16,000 (gain realized) – $15,000 (previously disallowed loss)].

873. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 180 Monica sells a parcel of land to her son, Elbert, for $90,000. Monica’s adjusted basis is $100,000. Three years later, Elbert gives the land to his fiancée, Karen. At that date, the land is worth $104,000. No gift tax is paid. Since Elbert is going to be stationed in the U.S. Army in Germany for 3 years, they do not plan on being married until his tour is completed. Six months after receiving the land, Karen sells it for $110,000. At the same time, Karen sends Elbert a “Dear John” email. Calculate Karen’s realized and recognized gain or loss.

Correct Answer:

Elbert’s adjusted basis for the land is his purchase price of $90,000. When Elbert gives the land to Karen, her adjusted basis is a carryover basis of $90,000. Karen’s gain on the sale is calculated as follows:

Amount realized $110,000 Adjusted basis (90,000) Realized gain $ 20,000

Recognized gain $ 20,000

Monica’s disallowed loss of $10,000 ($90,000 amount realized – $100,000

adjusted basis) could have been used as an offset by Elbert if he had sold the land at a realized gain. But, it cannot be used by Karen since she is not the original transferee (i.e., related-party buyer).

874. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 181 Justin owns 1,000 shares of Oriole Corporation common stock (adjusted basis of $9,800). On April 27, 2011, he sells 300 shares for $2,800, while on May 5, 2011, he purchases 200 shares for $2,500.

a. What is Justin’s recognized gain or loss resulting from these transactions?

b. What is Justin’s basis for the stock acquired on May 5, 2011?

c. Could Justin have obtained different tax consequences in a. and b. if he had sold the 300 shares on December 27, 2011, and purchased the 200 shares on January 5, 2012?

Correct Answer:a. To the extent of the substantially identical shares purchased during the 60-day period

beginning 30 days before April 27 and ending 30 days after April 27, the transaction is a wash sale. The realized loss on the April 27 sale is $140 ($2,800 amount realized – $2,940 adjusted basis of 300 shares). Because Justin acquired fewer shares than he sold, only a portion of the realized loss is disallowed. The disallowed loss is $93 [(200 shares acquired/ 300 shares sold) ´ $140] and the recognized loss is $47 ($140 – $93).

b. Justin’s adjusted basis for the stock acquired on May 5, 2011, is $2,593 ($2,500 purchase price + $93 disallowed loss).

c. The tax consequences would have been the same. Justin has a wash sale to the extent of the 200 shares purchased. To avoid the limitations of the wash sale, Justin should not purchase substantially identical stock within the 60-day window for a wash sale.

875. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 182 Laura transfers her personal use automobile to her business (a sole proprietorship). The car’s adjusted basis is $32,000 and the fair market value is $20,000. No cost recovery had been deducted by Laura, since she held the car for personal use. Determine the adjusted basis of the car to Laura’s sole proprietorship including the basis for cost recovery.

Correct Answer:In this circumstance, the car is dual basis property. The adjusted basis to the sole proprietorship for gain is $32,000 and the adjusted basis for loss is $20,000. The loss basis of $20,000 is used in calculating cost recovery.

876. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 183 For the following exchanges, indicate which qualify as like-kind property.

a. Inventory of a sporting goods store in Charleston for inventory of an appliance store in Savannah.

b. Inventory of a ladies dress shop in Cleveland for inventory of a ladies dress shop in Richmond.

c. Investment land in Virginia Beach for office building in Williamsburg.

d. Used automobile used in a business for a new automobile to be used in the business.

e. Investment land in Paris for investment land in San Francisco. f. Shares of Texaco stock for shares of Exxon Mobil stock.

Correct Answer:Only items c. (investment realty for investment realty or business realty) and d. (business personalty for business personalty of the same general business asset class) qualify. Items a. and b. do not qualify because they involve inventory. Item e. does not qualify because foreign realty is exchanged for domestic realty. Item f. does not qualify because shares of stock are not eligible for like-kind exchange treatment.

877. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 184 Rosa exchanges a truck used in her business for making deliveries for a smaller more fuel-efficient truck to be used in her business for making deliveries. The adjusted basis for her truck is $14,000. The smaller truck has a fair market value of $23,000. In addition, Rosa receives cash of $7,000.

a. Calculate Rosa’s realized and recognized gain or loss.

b. Calculate Rosa’s basis for the assets she received.

Correct Answer:a. Amount realized ($23,000 + $7,000) $30,000 Adjusted basis (14,000) Realized gain $16,000 Recognized gain $ 7,000 The realized gain is recognized to the extent of the boot received.

b. Basis for smaller truck: Fair market value $23,000 Less: Postponed gain (9,000) Basis $14,000 Basis of the cash $ 7,000

878. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 185 Sidney exchanges equipment used in his business in a like-kind exchange. The property exchanged is as follows:

Property Surrendered Property Received Adj. Basis FMV Adj. Basis FMVEquipment $39,000 $54,000 $49,000 $42,000Cash $ 3,000 $ 3,000Liability on equipment $ 9,000 $ 9,000

The other party assumes the liability.

a. What is Sidney’s recognized gain or loss?

b. What is Sidney’s basis for the assets he received?

Correct Answer:a. Amount realized: Equipment $42,000 Cash 3,000 Liability assumed 9,000 $54,000 Adjusted basis (39,000) Realized gain $15,000

Recognized gain $12,000

The recognized gain is the lesser of the boot received of $12,000 ($9,000 + $3,000) or the realized gain of $15,000.

b. Basis for equipment: Fair market value $42,000 Less: Postponed gain (3,000) Basis $39,000 Basis of the cash $ 3,000

879. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 186 Jake exchanges an airplane used in his business for a smaller airplane to be used in his business. His adjusted basis for the airplane is $325,000 and the fair market value is $310,000. The fair market value of the smaller airplane is $300,000. In addition, Jake receives cash of $10,000.

a. Calculate Jake’s realized and recognized gain or loss and his adjusted basis for the assets received.

b. Assume that the exchange is between Jake and Jake’s son. Calculate Jake’s realized and recognized gain or loss and his adjusted basis for the assets received if his son’s intention is to use the airplane in his trade or business.

Correct Answer:a. Amount realized ($300,000 + $10,000) $310,000 Adjusted basis (325,000) Realized loss ($ 15,000)

Recognized loss $ –0–

Section 1031 postponement is mandatory. Thus, the realized loss of $15,000 is postponed.

Basis for airplane: Fair market value $300,000 Plus: Postponed loss 15,000 Basis $315,000

Basis of the cash $ 10,000

b. Amount realized ($300,000 + $10,000) $310,000 Adjusted basis (325,000) Realized loss ($ 15,000)

Recognized loss $ –0–

Section 1031 postponement is mandatory. Even though the exchange is with a related party, § 1031 postponement applies. However, if Jake’s son should dispose of the airplane within two years of the date of the exchange, the realized loss of $15,000 would normally be

recognized as of that date under § 1031. However, since this is a related party transaction, § 267 would then disallow the loss.

Basis for airplane: Fair market value $300,000 Plus: Postponed loss 15,000 Basis $315,000 Basis of the cash $ 10,000

880. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 187 a. Orange Corporation exchanges a warehouse located in New York (adjusted basis of $480,000) for a warehouse located in New Jersey (adjusted basis of $450,000; fair market value of $440,000). Indicate the amount of gain or loss that is recognized by Orange Corporation on the exchange, and the basis of the warehouse acquired.

b. Assume that in addition to the warehouse Orange Corporation also received $100,000 in cash. Indicate the amount of gain or loss that is recognized by Orange Corporation on the exchange, and the basis of the warehouse acquired.

c. How would your answer in b. change if instead of receiving $100,000 in cash, the other party assumed Orange’s $100,000 mortgage on the New York warehouse?

Correct Answer:a. This is a nontaxable like-kind exchange. No gain or loss is recognized, and the basis for the

new warehouse (in New Jersey) is $480,000, the same as the basis for the old warehouse (in New York).

b. Amount realized: FMV of New Jersey warehouse $440,000 Cash 100,000 $540,000 Adjusted basis of New York warehouse (480,000) Realized gain $ 60,000 Recognized gain $ 60,000 FMV of New Jersey warehouse $440,000 Less: Postponed gain (–0–) Basis of New Jersey warehouse $440,000

c. The answer would the same as in b.

881. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 188 Eunice Jean exchanges land held for investment located in Rolla, Missouri, for land to be held for investment located near Madrid, Spain. Her basis for the land given up is $370,000 and the fair market value of the land received is $390,000. Eunice Jean also receives cash of $25,000.

a. What is Eunice Jean’s recognized gain?

b. What is her basis for the land received?

Correct Answer:a. Amount realized ($390,000 + $25,000) $415,000 Adjusted basis (370,000) Realized gain $ 45,000

Recognized gain $ 45,000

Real property located in the United States (Rolla) exchanged for foreign real property (near Madrid) does not qualify as like-kind property. So the recognized gain is not limited to the boot received of $25,000.

b. FMV of Madrid land $390,000 Less: Postponed gain ($45,000 – $45,000) (–0–) Basis for Madrid land $390,000

882. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 189 For each of the following involuntary conversions, determine if the property qualifies as replacement property.

a. Chuck’s restaurant building is destroyed by fire. He clears the site and builds another restaurant building.

b. Diane’s warehouse which she used for storing inventory is destroyed by a tornado. She purchases another warehouse in which she will store inventory.

c. Part of Andrew’s dairy farm land is condemned to make way for an interstate highway. He uses the condemnation proceeds to construct a barn to be used for storing cattle feed.

d. Liz owns a shopping mall which is destroyed by a flood. Since the tenant occupancy rate was down, she uses the insurance proceeds to purchase an office building which she will rent to tenants.

e. Eleanor’s Maserati Gran Turismo is stolen. The original cost was $125,000, and she had used it exclusively for personal use. Due to the limited supply of this model, it had appreciated in value. Eleanor received insurance proceeds of $130,000 and uses the proceeds to purchase a replacement Gran Turismo.

Correct Answer:All of the replacements qualify as replacement property for purposes of an involuntary conversion. Items a., b., and e. qualify under the functional use test; item c. qualifies under the like-kind test for condemned realty; and item d. qualifies under the taxpayer use test.

883. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 190 Patty’s factory building, which has an adjusted basis of $325,000, is destroyed by fire on March 5, 2011. Insurance proceeds of $475,000 are received on May 1, 2011. She has a new factory building constructed for $450,000, which she occupies on October 1, 2011. Assuming Patty’s objective is to minimize the tax liability, calculate her recognized gain or loss and the basis of the new factory building.

Correct Answer:Amount realized $475,000 Adjusted basis of building (325,000)Realized gain $150,000

Amount realized $475,000 Less: Reinvestment (450,000)Deficiency $ 25,000

Since Patty’s objective is to minimize the tax liability, she would elect § 1033 postponement treatment. Thus, her recognized gain would be $25,000. The basis of the new factory building would be $325,000 ($450,000 cost – $125,000 postponed gain).

884. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 191 Evelyn’s office building is destroyed by fire on July 12, 2011. The adjusted basis is $315,000. She receives insurance proceeds of $350,000 on August 31, 2011. Calculate the amount that Evelyn must reinvest in qualifying property in order that her recognized gain be $20,000. Assume she elects § 1033 (nonrecognition of gain from an involuntary conversion) postponement treatment.

Correct Answer:Amount realized $350,000 Adjusted basis (315,000)Realized gain $ 35,000 Required reinvestment $350,000 Less: Deficiency (recognized gain) (20,000) Actual reinvestment $330,000

885. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 192 Don, who is single, sells his personal residence on October 5, 2011, for $380,000. His adjusted basis was $102,000. He pays realtor’s commissions of $18,000. He owned and occupied the residence for 14 years. Having decided that he no longer wants the burdens of home ownership, he invests the sales proceeds in a mutual fund and enters into a 1-year lease on an apartment. The detriments of renting, including a crying child next door, cause Don to rethink his decision. Therefore, he purchases another residence on November 6, 2012, for $188,000. Is Don eligible for exclusion of gain treatment under § 121 (exclusion of gain on sale of principal residence)? Calculate Don’s recognized gain and his basis for the new residence.

Correct Answer:

Don is eligible for § 121 exclusion treatment. At the date of the sale of his residence, he owned and occupied it as his principal residence for at least two years during the 5-year period ending on the date of sale.

Amount realized ($380,000 – $18,000) $362,000 Adjusted basis (102,000)Realized gain $260,000 § 121 exclusion (250,000)Recognized gain $ 10,000

Whether Don replaces his principal residence is not relevant in determining his qualification for the § 121 exclusion. His basis for his new residence is the cost of $188,000.

886. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 193 Sandy and Greta form Tan, Inc. by transferring the following assets to the corporation in exchange for 1,000 shares of stock each.

Sandy: Cash of $200,000Greta: Land (worth $200,000; adjusted basis of $75,000).

How much gain must Tan recognize on the receipt of these assets?

Correct Answer:Tan has no recognized gain on the receipt of these assets. Section 1032 provides that a corporation does not recognize any gain or loss on the

receipt of money or other property in exchange for its stock.

887. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 194 Ashley sells investment land (adjusted basis of $190,000) that she has owned for 4 years to her husband, Richard, for its fair market value of $175,000.

a. Calculate Ashley’s recognized gain or loss. b. Calculate Richard’s basis for the land. c. How would your answers in a. and b. change if Ashley and Richard

were not married (i.e., merely good friends)? d. Would the answer in a. and b. change if the selling price was

$250,000?

Correct Answer:a. Amount realized $175,000 Adjusted basis (190,000) Realized loss ($ 15,000)

Recognized loss $ –0–

Since Richard is Ashley’s spouse, Ashley’s realized loss of $15,000 is disallowed.

b. Because Richard is Ashley’s spouse, he has a carryover basis in the land of $190,000 rather than the $175,000 he paid Ashley.

c. Ashley’s recognized loss would be $15,000. Richard’s basis for the investment land would be $175,000.

d. The answers in a. and b. would be the same.

888. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 195 After 5 years of marriage, Dave and Janet decided to get a divorce. As part of the divorce settlement, Janet transfers to Dave the house she purchased prior to their marriage. Janet’s adjusted basis for the house is $125,000 and the fair market value is $200,000 on the date of the

transfer. What are the tax consequences to Janet and to Dave as a result of the transfer?

Correct Answer:Janet has a realized gain of $75,000 ($200,000 – $125,000). However, no gain is recognized as § 1041 provides that transfers of property between former spouses incident to divorce are nontaxable transactions.

Dave’s basis in the house is a carryover basis of $125,000 (i.e., the same as Janet’s adjusted basis).

889. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 196 Walter owns stock in Target, Inc. (adjusted basis of $50,000) which he sells for $70,000 on March 21, 2011. On May 1, 2011, he uses the $70,000 to acquire stock in Lime, Inc., a specialized small business investment company. Calculate Walter’s recognized gain on the sale of the Target stock and his basis in the stock acquired.

Correct Answer:Amount realized $70,000 Adjusted basis (50,000) Realized gain $20,000

Recognized gain $ –0–

Under § 1044, Walter’s realized gain of $20,000 is postponed because he reinvested the sales proceeds in the stock of a specialized small business investment company within the 60-day period.

Walter’s basis for the stock acquired is calculated as follows:

Cost of new stock $70,000 Less: Postponed gain (20,000) Basis for new stock $50,000

890. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 197 When a property transaction occurs, what four questions should be considered with respect to the sale or other disposition?

Correct Answer:

The following questions need to be answered.

· Is there a realized gain or loss?

· If so, is the gain or loss recognized?

· If the gain or loss is recognized, is it ordinary or capital?

· What is the basis of any replacement property that is acquired?

891. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 198 Discuss the effect of a liability assumption on the seller’s amount realized and the buyer’s adjusted basis.

Correct Answer:If the buyer assumes the seller’s liability associated with the acquisition of property, both the seller’s amount realized and the buyer’s adjusted basis are increased by the amount of the liability assumed.

892. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 199 Define fair market value as it relates to property transactions.

Correct Answer:The fair market value of property received in a sale or other disposition has been defined by the courts as the price at which property will change hands between a willing seller and a willing buyer when neither is compelled to sell or to buy.

893. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 200 What is the general formula for calculating the adjusted basis of property?

Correct Answer:Adjusted basis is determined as follows:

Cost (or other adjusted basis) on date of acquisition+ Capital additions– Capital recoveries= Adjusted basis

894. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 201 What is the difference between the depreciation (or cost recovery) allowed and the depreciation (or cost recovery) allowable and what effect does each have on the adjusted basis of property?

Correct Answer:Normally, there is no difference between the depreciation (or cost recovery) allowed or allowable. The allowed depreciation (or cost recovery) is the amount actually taken, whereas the allowable depreciation (cost recovery) is the amount that could have been taken under the applicable depreciation (or cost recovery) method. The basis of the property is reduced by the cost recovery allowed, but this amount cannot be less than the allowable amount.

895. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 202 What effect does a deductible casualty loss have on the adjusted basis of property?

Correct Answer:A deductible casualty loss reduces the basis of property.

896. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 203 If a taxpayer purchases taxable bonds at a premium, the amortization of the premium is elective. However, if a taxpayer purchases tax-exempt bonds at a premium, the amortization of the premium is mandatory. Explain this difference in the treatment.

Correct Answer:If mandatory amortization were not required for tax-exempt bonds, a taxpayer who held such bonds to maturity would have a recognized loss to the extent of the premium. This is not consistent with the rule that interest earned on the bonds is tax-exempt. Mandatory amortization, therefore, results in the adjusted basis of the bonds ultimately being equal to the maturity value. Thus, no loss results upon maturity. Furthermore, the amortization of the premium on tax-exempt bonds is not deductible.

For the taxable bonds and if the taxpayer does not elect to amortize the premium, a recognized capital loss results to this extent at maturity. Typically, the taxpayer will elect to amortize the premium so that it can be claimed over the life of the bond as an ordinary (rather than capital) deduction.

897. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 204 Maurice sells his personal use automobile at a realized loss. Under what circumstances can Maurice deduct the loss?

Correct Answer:Under no circumstance can Maurice recognize (deduct) a loss on the sale of a personal use asset. Note that if the automobile had been used in a trade or business or held for the production of income, the loss could have been deducted.

898. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 205 Define a bargain purchase of property and discuss the related tax consequences.

Correct Answer:A bargain purchase can occur when an employer transfers property to an employee at less than the fair market value. It results in compensation for services. It also occurs when a corporation sells property to a shareholder at less than its fair market value. The result is a dividend. The amount included in income is the difference between the purchase price and the property’s fair market value. The basis of the property acquired in the bargain purchase is the property’s fair market value.

899. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 206 If a taxpayer purchases a business and the price exceeds the fair market value of the listed assets, how is the excess allocated among the purchased assets?

Correct Answer:The excess is not allocated among the listed assets. Instead, the excess is assigned to goodwill.

900. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 207 Taylor owns common stock in Taupe, Inc., with an adjusted basis of $100,000. She receives a preferred stock dividend which is nontaxable.

a. What effect does the preferred stock dividend have on Taylor’s adjusted basis of the common stock?

b. How is the basis of the preferred stock calculated?

Correct Answer:a. Part of the adjusted basis of the common stock must be allocated to the preferred stock

thereby decreasing the basis of the common.

b. The amount that is allocated to the preferred stock is based on the relative fair market values of the common stock and the preferred stock on the date of the distribution.

901. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 208 For gifts made after 1976, when will part of the gift tax paid by the donor be added to the donee’s basis?

Correct Answer:This result would occur if the fair market value at the date of the gift exceeds the donor’s adjusted basis. In this case, the portion of the gift tax paid that is related to the appreciation is added to the donor’s basis in calculating the donee’s gain basis for the property.

902. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 209 How is the donee’s basis calculated for the gift of appreciated property for a gift made before 1977? Assume the donor pays gift tax.

Correct Answer:If the gift is made before 1977, the donee’s adjusted basis is the sum of the donor’s adjusted basis for the property plus all of the gift tax paid by the donor. However, the total cannot exceed the fair market value of the property at the date of the gift.

903. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 210 Joseph converts a building (adjusted basis of $50,000 and fair market value of $40,000) from personal use to business use. Justin receives a building with a $40,000 fair market value ($50,000 donor’s adjusted basis) from his mother as a gift. Discuss the tax consequences with respect to Joseph’s and Justin’s adjusted basis.

Correct Answer:Upon conversion from personal use to business use, the building receives dual basis treatment. That is, Joseph’s gain basis for the building is $50,000, the adjusted basis on the date of the conversion from personal use to business use. Joseph’s loss basis is $40,000, the lower of the adjusted basis or the fair market value on the date of the conversion. Justin’s basis for the building upon receipt of the gift is treated in the same manner according to gift basis rules (i.e., dual basis treatment).

904. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 211 Discuss the application of holding period rules to property acquired by gift and inheritance.

Correct Answer:The holding period for inherited property is always long-term. For gift property, if the donee’s basis is the donor’s adjusted basis (i.e., gain basis), the holding period starts on the date the property was acquired by the donor. If the donee’s basis is fair market value (i.e., loss basis), the holding period starts on the date of the gift.

905. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 212 What is a deathbed gift and what tax consequences apply?

Correct Answer:A deathbed gift occurs when a donor makes a gift of appreciated property to a terminal person with the understanding that the donor (or the donor’s spouse) will inherit the property on the donee’s death. If the period between the date of the gift and the date of the donee’s death exceeds one year, the usual transfer-by-death basis rules apply. However, if this period is one year or less, the transfer-by-gift basis rules apply.

906. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 213 Explain how the sale of investment property at a loss to a brother is treated differently from a sale to a nephew.

Correct Answer:The brother is a related party under the § 267 loss disallowance provision. Consequently, the realized loss on the sale of the investment property is disallowed. The brother’s basis for the investment property is its cost. However, if the brother sells the investment property at a realized gain, he can offset this gain with as much of the prior disallowed loss as is needed to reduce it to zero. Otherwise, the disallowed loss is wasted.

Because a nephew is not treated as a related party under § 267, the realized loss on the sale of the investment property is recognized. The nephew’s basis for the investment property is its cost.

907. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 214 For disallowed losses on related-party transactions, who has the right of offset?

Correct Answer:The right of offset is available only to the related-party buyer (i.e., the original transferee). If the related-party buyer transfers the property to another party by either gift or inheritance, the right of offset is not available to that party.

908. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 215 What is the easiest way for a taxpayer who is going to sell property that has declined in value to avoid the § 267 loss disallowance provision?

Correct Answer:In this circumstance, the easiest way for a taxpayer to recognize the realized loss (by avoiding the § 267 loss disallowance provision) is to sell the property to someone who is not a related party as defined in § 267 (i.e., sell in the marketplace).

909. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 216 Tariq sold certain U.S. Government bonds and State of Oregon bonds at a loss to offset short-term capital gain from a previous transaction. He felt that the U.S. Government and State of Oregon bonds were “good” investments, so he repurchased identical securities within one week. Do these transactions constitute wash sales?

If the bond sales resulted in the recognition of gain (rather than loss), would the wash sale provisions prevent the gains from being recognized?

Correct Answer:The wash sale rules apply because Tariq purchased substantially identical securities within the meaning of § 1091. If the bonds were sold at a gain, however, the wash sale rules would not apply.

910. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 217 Mitchell owned an SUV that he had purchased two years ago for $48,000 and which he transfers to his sole proprietorship. How is the sole proprietorship’s basis for the SUV calculated? What additional information does Mitchell need?

Correct Answer:Mitchell needs to calculate both the gain basis and the loss basis of the SUV for the sole proprietorship. The gain basis is a carryover basis and the loss basis is the lower of Mitchell’s adjusted basis or

the fair market value on the date of the transfer. So Mitchell needs to determine the FMV and to identify the beginning of the holding period. The holding period associated with the gain basis includes the two years that Mitchell has owned the SUV. The holding period associated with the loss basis starts on the date of the transfer.

911. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 218 Alice is terminally ill and does not expect to live much longer. Pondering the consequences of her estate, she decides how to allocate her property to her nieces. She makes a gift of depreciated property (i.e., adjusted basis exceeds fair market value) to Marsha, a gift of appreciated property (i.e., fair market value exceeds adjusted basis) to Jan, and leaves appreciated property to Cindy in her will. Each of the properties has the same fair market value. From an income tax perspective, which niece is her favorite?

Correct Answer:Alice appears to like Cindy best. Cindy receives the most beneficial tax treatment by receiving a stepped-up basis (i.e., fair market value on the date of Alice’s death) in the inherited property. Therefore, she would recognize less gain than Jan. Further, she would not have to deal with the dual basis issue like Marsha if she decided to sell the property. Because Jan receives a gift of appreciated property, she will realize gain equal to the amount of appreciation if she decides to sell. This is because her basis (i.e., carryover) is equal to Alice’s adjusted basis.

Alice appears to be indifferent about Marsha. A gift of depreciated property receives a loss basis to Marsha of the lower of the adjusted basis or the fair market value on the date of the gift. This eliminates a possible loss deduction for Alice and also prevents Marsha from taking a loss deduction for the decline in value while Alice owned the property. On the other hand, Marsha’s gain basis is equal to Alice’s adjusted basis for the property (and is greater than Cindy’s basis). Therefore, if the property appreciates while owned by Marsha, she will have recognized gain on the sale only if the property appreciates to a fair market value in excess of Alice’s adjusted basis for the property.

912. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 219 Why is it generally undesirable to pass property by death when its fair market value is less than basis?

Correct Answer:Assuming the property is not personal use property (where neither the decedent nor the beneficiary is able to deduct any of the loss), the decedent should sell the property prior to his or her death to recognize the loss.

913. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 220 Identify two tax planning techniques that can be used to avoid the wash sale disallowance of loss.

Correct Answer:

One technique to avoid a wash sale result is to not purchase substantially identical stock or securities. Another is to avoid the 60-day wash sale window.

914. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 221 Discuss the logic for mandatory deferral of realized gain or loss for a § 1031 like-kind exchange.

Correct Answer:The property received is considered to be a continuation of the property exchanged (i.e., nothing of economic significance has occurred). Therefore, a realized gain or realized loss is not recognized, and the property received has a carryover basis and holding period.

915. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 222 What requirements must be satisfied to receive nontaxable exchange treatment under § 1031?

Correct Answer:

The following requirements must be satisfied to receive nontaxable exchange treatment under § 1031.

· The form of the transaction is an exchange.· Both the property transferred and the property received are held either for productive use in

a trade or business or for investment.· The property is like-kind property.

916. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 223 What kinds of property do not qualify under the like-kind provisions?

Correct Answer:The property exchanged may not qualify for § 1031 treatment for five reasons. First, the property involved in the exchange (i.e., transferred and received) must be business use or investment property. Thus, personal use property does not qualify. In addition, the types of property contained in the language of § 1031(a)(2) do not qualify as business use or investment property (i.e., inventory, partnership interests, stocks, bonds, notes, chooses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest). Second, one kind or class of property may not be exchanged for a different kind or class (i.e., real property for personal property or vice versa). Third, real property located in the United States exchanged for foreign real property (and vice versa) does not qualify as like-kind property. Fourth, livestock of different sexes do not qualify as like-kind property. Fifth, depreciable tangible personal property held for productive use in a business is like-kind property only if the exchanged properties are within the same general

business asset class or the same product class.

917. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 224 Can related parties take advantage of the like-kind exchange provisions?

Correct Answer:Yes. A special rule exists for related parties. In addition to satisfying the other requirements for like-kind exchange treatment, a holding period requirement must be met. The taxpayer and the related party must not dispose of the like-kind property received within the two-year period following the date of the exchange. If an early disposition does occur, the postponed gain is recognized as of the date of the early disposition.

918. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 225 Discuss the relationship between the postponement of realized gain under § 1031 (like-kind exchanges) and the adjusted basis and holding period for the replacement property.

Correct Answer:Section 1031 results in the mandatory postponement of realized gain or realized loss on like-kind exchanges. Therefore, the basis for the replacement property is a carryover basis and the holding period is a carryover holding period.

919. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 226 Discuss the relationship between realized gain and boot received in a § 1031 like-kind exchange.

Correct Answer:Realized gain serves as the ceiling on the amount of the gain that is recognized in a § 1031 like-kind exchange. If no boot is received, then none of the realized gain is recognized. If boot is received and its fair market value is less than the realized gain, then gain is recognized to the extent of the boot received. If boot is received and its fair market value is greater than the realized gain, then gain is recognized to the extent of the realized gain (i.e., full recognition occurs).

920. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 227 Under what circumstance is there recognition of some or all of the realized gain associated with the giving of boot by the taxpayer in a like-kind exchange?

Correct Answer:Generally, the giving of boot by the taxpayer in a like-kind exchange does not trigger the recognition of realized gain (e.g., cash). However, if the basis of the boot is less than the fair market value of the boot, then gain is recognized to the extent of this excess (e.g.,

appreciated stock).

921. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 228 Define an involuntary conversion.

Correct Answer:An involuntary conversion results from the destruction (complete or partial), theft, seizure, requisition, or condemnation, or sale or exchange under threat or imminence of requisition or condemnation of the taxpayer’s property.

922. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 229 Discuss the treatment of realized gains from involuntary conversions.

Correct Answer:Realized gains from involuntary conversions are recognized unless the taxpayer elects postponement treatment under § 1033. In order to defer the realized gain, the taxpayer must reinvest an amount at least equal to the amount realized in qualifying property within the statutory time period. If there is an investment deficiency, realized gain is recognized to the extent of the deficiency. The ceiling on gain recognition is the realized gain. Note that for a direct conversion (i.e., into property), the deferral provision is mandatory (i.e., an election is not required).

923. Chapter 7 - Property Transactions: Basis, Gain and Loss, and 230 Sam sells land with an adjusted basis of $35,000 and a fair market value of $50,000 to Cynthia, his wife, for $50,000. Discuss how the tax consequences would differ if Sam and Cynthia had never been married.

Correct Answer:Section 1041 provides that realized gains or losses on transfers of property between spouses are not recognized. Thus, none of Sam’s realized gain of $15,000 ($50,000 amount realized – $35,000 adjusted basis) is recognized. Even though Cynthia paid $50,000 for the land, her basis is a carryover basis of $35,000.

If Sam and Cynthia had never been married, Sam’s realized gain of $15,000 ($50,000 amount realized – $35,000 adjusted basis) would be recognized. Cynthia’s basis for the land would be her cost of $50,000.

924. Chapter 8 - Property Transactions: Capital Gains and Losses, Sec The tax law does not require that capital gains and losses be separated from other types of gains and losses because there is no alternative tax calculation when taxable income includes net long-term capital gain.

a. True*b. False

925. Chapter 8 - Property Transactions: Capital Gains and Losses, S 2 The tax law does not require that capital gains and losses be separated from other types of gains and losses because there are no limitations on the deduction of net capital losses.

a. True*b. False

926. Chapter 8 - Property Transactions: Capital Gains and Losses, S 3 If a capital asset is sold at a gain, the holding period is not important.

a. True*b. False

927. Chapter 8 - Property Transactions: Capital Gains and Losses, S 4 An accrual basis taxpayer accepts a note receivable from a retail customer with a weak credit rating. The taxpayer immediately sells the note to a bank for less than the note’s stated value. The taxpayer has a capital loss.

a. True*b. False

928. Chapter 8 - Property Transactions: Capital Gains and Losses, S 5 A business taxpayer sells depreciable business property with an adjusted basis of $40,000 for $32,000. The taxpayer held the property for more than a year. The taxpayer has an $8,000 long-term capital loss.

a. True*b. False

929. Chapter 8 - Property Transactions: Capital Gains and Losses, S 6 An individual taxpayer received a valuable antique vase from his aunt, a famous collector. The collector purchased the vase. After the taxpayer held the vase for two years, he sold it for a $400,000 gain. The gain is a long-term capital gain.

*a. Trueb. False

930. Chapter 8 - Property Transactions: Capital Gains and Losses, S 7 Even though the Code defines what a capital asset is, often the courts still have to help determine what is and what is not a capital asset.

a. True*b. False

931. Chapter 8 - Property Transactions: Capital Gains and Losses, S 8 Section 1237 allows certain professional real estate sales persons capital gain treatment if they engage only in limited sales activities.

a. True*b. False

932. Chapter 8 - Property Transactions: Capital Gains and Losses, S 9 Real property subdivided for resale into lots, even when substantial physical improvements have been made to the property, always causes the gain from sale of the lots to be treated as capital gain.

a. True*b. False

933. Chapter 8 - Property Transactions: Capital Gains and Losses, S10 A security that is a capital asset becomes worthless. The loss is deemed to have occurred on the day that the security was declared worthless.

a. True*b. False

934. Chapter 8 - Property Transactions: Capital Gains and Losses, S11 As a general rule, the sale or exchange of an option to buy or sell property results in capital gain or loss if the property subject to the option is (or would be) a capital asset in the hands of the option holder.

*a. Trueb. False

935. Chapter 8 - Property Transactions: Capital Gains and Losses, S12 The only things that the grantee of an option may do with an option are to exercise it or sell or to exchange it.

a. True*b. False

936. Chapter 8 - Property Transactions: Capital Gains and Losses, S13 When a patent is sold, a common form of payment received by the transferor is a periodic payment.

*a. Trueb. False

937. Chapter 8 - Property Transactions: Capital Gains and Losses, S14 A franchisor licenses its mode of business operation to a franchisee.

*a. Trueb. False

938. Chapter 8 - Property Transactions: Capital Gains and Losses, S15 A lease cancellation payment received by a lessee is generally treated as an exchange because the lease extinguished is usually a capital asset.

*a. Trueb. False

939. Chapter 8 - Property Transactions: Capital Gains and Losses, S16 Lease cancellation payments received by a lessor are always ordinary income because they are considered to be in lieu of rental payments.

*a. Trueb. False

940. Chapter 8 - Property Transactions: Capital Gains and Losses, S17 To compute the holding period, start counting on the day the property was acquired and include the day of disposition.

a. True*b. False

941. Chapter 8 - Property Transactions: Capital Gains and Losses, S18 The holding period of property given up in a like-kind exchange includes the holding period of the asset received if the property that has been exchanged is a capital asset.

a. True*b. False

942. Chapter 8 - Property Transactions: Capital Gains and Losses, S19 Tom has owned 20 shares of Burgundy Corporation stock for four years. He sells the stock short for a total of $800. One month later, he closes the short sale by purchasing and delivering 20 shares of Burgundy Corporation stock for a total of $600. Tom has a $200 short-term capital gain.

*a. Trueb. False

943. Chapter 8 - Property Transactions: Capital Gains and Losses, S20 Short-term capital losses are netted against long-term capital gains and long-term capital losses are netted against short-term capital gains.

a. True*b. False

944. Chapter 8 - Property Transactions: Capital Gains and Losses, S21 Short-term capital gain is eligible for a special tax rate only when it exceeds long-term capital gain.

a. True*b. False

945. Chapter 8 - Property Transactions: Capital Gains and Losses, S22 A net short-term capital loss first offsets any 28% net long-term capital gain before it offsets either 25% net long-term capital gain or 0%/15% net long-term capital gain.

*a. Trueb. False

946. Chapter 8 - Property Transactions: Capital Gains and Losses, S23 All collectibles long-term gain is subject to a potential alternative tax rate of 28%.

*a. Trueb. False

947. Chapter 8 - Property Transactions: Capital Gains and Losses, S24 An individual taxpayer with 2011 net short-term capital loss of $5,000 generally can deduct up to $3,000 for AGI and carry the balance forward to 2012.

*a. Trueb. False

948. Chapter 8 - Property Transactions: Capital Gains and Losses, S25 Section 1231 applies to the sale or exchange of business properties, but not to personal use activity casualties.

*a. Trueb. False

949. Chapter 8 - Property Transactions: Capital Gains and Losses, S26 Rental use depreciable real estate held more than 15 months is an example of a § 1231 asset.

*a. Trueb. False

950. Chapter 8 - Property Transactions: Capital Gains and Losses, S27 If there is a net § 1231 loss, it is treated as a long-term capital loss.

a. True*b. False

951. Chapter 8 - Property Transactions: Capital Gains and Losses, S28 Section 1231 property includes nonpersonal use property where casualty gains exceed casualty losses for the taxable year.

*a. Trueb. False

952. Chapter 8 - Property Transactions: Capital Gains and Losses, S29 Section 1231 property generally includes certain intangible assets (such as patents and goodwill) that are developed by the taxpayer and that are not eligible for amortization, but are held for more than one year.

a. True*b. False

953. Chapter 8 - Property Transactions: Capital Gains and Losses, S30 Section 1231 property generally does not include paintings of artistic value held by the creator.

*a. Trueb. False

954. Chapter 8 - Property Transactions: Capital Gains and Losses, S31 Section 1231 property generally does not include notes receivable arising in the ordinary course of business.

*a. Trueb. False

955. Chapter 8 - Property Transactions: Capital Gains and Losses, S32 Casualty gains and losses from nonpersonal use assets are netted against casualty gains and losses from personal use assets to determine the net casualty gain or loss.

a. True*b. False

956. Chapter 8 - Property Transactions: Capital Gains and Losses, S33 If § 1231 asset casualty gains and losses net to a gain, the gain is treated as a § 1231 loss.

a. True*b. False

957. Chapter 8 - Property Transactions: Capital Gains and Losses, S34 Involuntary conversion gains may not be deferred if the proceeds of the involuntary conversion are not reinvested.

*a. Trueb. False

958. Chapter 8 - Property Transactions: Capital Gains and Losses, S35 Personal use property casualty gains and losses are not subject to the § 1231 rules.

*a. Trueb. False

959. Chapter 8 - Property Transactions: Capital Gains and Losses, S36 In the “General Procedure for § 1231 Computation: Step 2. § 1231 Netting,” if the gains exceed the losses, the net gain is offset by the “lookback” nonrecaptured § 1231 losses.

*a. Trueb. False

960. Chapter 8 - Property Transactions: Capital Gains and Losses, S37 Nonrecaptured § 1231 losses from the six prior tax years may cause current year net § 1231 gain to be treated as ordinary income.

a. True*b. False

961. Chapter 8 - Property Transactions: Capital Gains and Losses, S38 The Code contains two major depreciation recapture provisions—§§ 1243 and 1248.

a. True*b. False

962. Chapter 8 - Property Transactions: Capital Gains and Losses, S39 The maximum § 1245 depreciation recapture generally equals the accumulated depreciation.

*a. Trueb. False

963. Chapter 8 - Property Transactions: Capital Gains and Losses, S40 Section 1245 may apply to amortizable § 197 intangibles.

*a. Trueb. False

964. Chapter 8 - Property Transactions: Capital Gains and Losses, S41 For § 1245 recapture to apply, accelerated depreciation must have been taken on the property.

a. True*b. False

965. Chapter 8 - Property Transactions: Capital Gains and Losses, S42 Section 1250 depreciation recapture will apply when accelerated depreciation was used on property used outside the United States and the property is sold at a gain.

*a. Trueb. False

966. Chapter 8 - Property Transactions: Capital Gains and Losses, S43 The maximum amount of the unrecaptured § 1250 gain (25% gain) is the depreciation taken on real property sold at a recognized gain.

*a. Trueb. False

967. Chapter 8 - Property Transactions: Capital Gains and Losses, S44 Section 1231 lookback losses may convert some or all of § 1250 gain into ordinary income.

a. True*b. False

968. Chapter 8 - Property Transactions: Capital Gains and Losses, S45 Section 1245 depreciation recapture potential carries over from the deceased taxpayer to the beneficiary taxpayer.

a. True*b. False

969. Chapter 8 - Property Transactions: Capital Gains and Losses, S46 The § 1245 depreciation recapture potential does not reduce the amount of the charitable contribution deduction under § 170.

a. True*b. False

970. Chapter 8 - Property Transactions: Capital Gains and Losses, S47 The tax law requires that capital gains and losses be separated from other types of gains and losses. Among the reasons for this treatment are:

a. Long-term capital gains may be taxed at a higher rate than ordinary gains.b. Capital losses that are short term are not deductible.*c. Net capital loss is deductible only up to $3,000 per year for individual taxpayers.d. Short-term capital gains may be taxed at a lower rate than ordinary gains.e. None of the above.

971. Chapter 8 - Property Transactions: Capital Gains and Losses, S48 Recognized gains and losses must be properly classified. Proper classification depends upon:

a. The tax status of the property.b. The type of transferor and transferee when the property is disposed of.c. The holding period of the property.*d. a. and c.e. None of the above.

972. Chapter 8 - Property Transactions: Capital Gains and Losses, S49 The three tax statuses are:

a. Ordinary asset, capital asset, § 1251 asset.*b. Capital asset, ordinary asset, § 1231 asset.c. § 1251 asset, investment asset, ordinary asset.d. Investment asset, § 1231 asset, ordinary asset.e. None of the above.

973. Chapter 8 - Property Transactions: Capital Gains and Losses, S50 A business taxpayer sells inventory for $60,000. The adjusted basis of the property is $58,000 at the time of the sale and the inventory had been held more than one year. The taxpayer has:

a. No gain or loss.b. Sold a long-term capital asset.c. Sold a short-term capital asset.*d. An ordinary gain.e. None of the above.

974. Chapter 8 - Property Transactions: Capital Gains and Losses, S51 Sam operates a retail hardware store as a sole proprietorship. Which of the following items are capital assets in the hands of Sam?

a. The store’s counters and display cases.b. A portable workbench that has been in the store’s inventory for over a year.c. The store building that is an asset of the sole proprietorship.*d. An interest-bearing savings account used to keep the store’s excess cash.e. None of the above.

975. Chapter 8 - Property Transactions: Capital Gains and Losses, S52 Monty is in the business of painting. He paints for wealthy investors. He paints a portrait and sells it for a lump sum. He has:

a. Sold a capital asset.b. Sold an ordinary asset.c. No gain or loss.d. An ordinary gain.*e. b. and d.

976. Chapter 8 - Property Transactions: Capital Gains and Losses, S53 Ramon is in the business of buying and selling securities. Which of the following is a capital asset for Ramon?

a. The securities he buys and sells each day in the normal course of his business.*b. The securities he designates as held for investment at the end of the day of acquisition.c. The securities he holds more than 12 months.d. All the securities he owns.e. b., c., and d.

977. Chapter 8 - Property Transactions: Capital Gains and Losses, S54 Sean purchased vacant land in 2005 that she subdivided for resale as lots. All 10 of the lots were sold during 2011. The lots had a tax basis of $7,000 each and sold for $45,000 each. Sean made no substantial improvements to the lots. She acted as her own real estate broker; so there were no sales expenses for selling the lots. Which of the following statements is correct?

a. Sean must hold the lots for at least 10 years before she is eligible for the special capital gain treatment of § 1237.b. The $380,000 gain from the sale of the ten lots is all ordinary income.c. All of the $380,000 gain from the sale of the ten lots is long-term capital gain.d. To be eligible for the special capital gain treatment of § 1237, Sean must be a real estate dealer.*e. None of the above.

978. Chapter 8 - Property Transactions: Capital Gains and Losses, S55 A worthless security had a holding period of 10 months when it became

worthless on November 10, 2011. The investor who had owned the security had a basis of $10,000 for it. Which of the following statements is correct?

a. The investor has a long-term capital loss of $10,000.*b. The investor has a short-term capital loss of $10,000.c. The investor has a nondeductible loss of $10,000.d. The investor has a long-term capital gain of $10,000.e. None of the above.

979. Chapter 8 - Property Transactions: Capital Gains and Losses, S56 On June 1, 2011, Bruce purchased an option to buy 1,000 shares of General, Inc. at $30 per share. He purchased the option for $2,000. It was to remain in effect for six months. The market experienced a decline during the latter part of the year, so Bruce decided to let the option lapse as of December 1, 2011. On his 2011 tax return, what should Bruce report?

a. A $2,000 long-term capital loss.*b. A $2,000 short-term capital loss.c. A $2,000 § 1231 loss.d. A $2,000 ordinary loss.e. None of the above.

980. Chapter 8 - Property Transactions: Capital Gains and Losses, S57 Which of the following events causes the purchaser of an option to add the cost of the option to the basis of the property to which the option relates?

*a. The option is exercised.b. The option is sold.c. The option lapses.d. The option is rescinded.e. None of the above.

981. Chapter 8 - Property Transactions: Capital Gains and Losses, S58 Hidasu is a mechanical engineer and, while unemployed, invents a switching device for computer networks. He patents the device, but does not reduce it to practice. Hidasu has a zero tax basis for the patent. In consideration of $600,000 plus a $2 royalty per device sold, Hidasu assigns the patent to a computer manufacturing company. Hidasu assigned all substantial rights in the patent. Which of the following is correct?

a. Hidasu automatically has long-term capital gain from the lump sum payment, but not from the royalty payments.b. Hidasu automatically has long-term capital gain from the royalty payments, but not from the lump sum payment.*c. Hidasu automatically has long-term capital gain from both the lump sum payment and the royalty payments.d. Hidasu does not have automatic long-term capital gain from either the lump sum payment or the royalty payments.

e. None of the above.

982. Chapter 8 - Property Transactions: Capital Gains and Losses, S59 Cyan Company signs a 13-year franchise agreement with Cyan Too. Cyan Too retained significant powers, rights, and a continuing interest. Cyan (the franchisee) makes noncontingent payments of $17,000 per year for the first five years of the franchise. Cyan Company also pays a contingent fee of 1% of gross sales every month. Which of the following statements is correct?

a. Cyan Company may deduct the $17,000 per year noncontingent payments in full as they are made.*b. Cyan Company may deduct the monthly contingent fee as it is paid.c. Cyan Company may deduct both the noncontingent annual fee and the contingent monthly fees as they are paid.d. Cyan Company may not deduct either the noncontingent annual fee or the contingent monthly fees as they are paid.e. None of the above.

983. Chapter 8 - Property Transactions: Capital Gains and Losses, S60 A lessor is paid $5,000 by its residential tenant as a lease cancellation fee. The tenant wanted to get out of her lease so she could move to a different city. The lease had been in force for two years before it was canceled. The lessor had a zero tax basis for the lease. The lessor has received:

*a. Ordinary income of $5,000.b. Long-term capital gain of $5,000.c. Short-term capital gain of $5,000.d. Neither gain nor loss.e. None of the above.

984. Chapter 8 - Property Transactions: Capital Gains and Losses, S61 Spiro was leasing an apartment from Grey, Inc. Grey paid Spiro $11,000 to cancel his lease and move out so that Grey could demolish the building. As a result:

*a. Spiro has an $11,000 capital gain.b. Spiro has an $11,000 capital loss.c. Grey has an $11,000 capital loss.d. Grey has an $11,000 capital gain.e. None of the above.

985. Chapter 8 - Property Transactions: Capital Gains and Losses, S62 On June10, 2011, Ebon, Inc. acquired an office building as a result of a like-kind exchange. Ebon had given up a factory building that it had owned for 26 months as part of the like-kind exchange. Which of the statements below is correct?

a. The holding period of the office building does not include the holding period of the factory building.b. The holding period of the factory building starts on June 11, 2011.c. The holding period of the factory building starts on June 10, 2011.*d. The holding period of the office building includes the holding period of the factory building.e. None of the above.

986. Chapter 8 - Property Transactions: Capital Gains and Losses, S63 Yellow, Inc. sold a forklift on April 12, 2011, for $3,000 (its FMV) to its 100% shareholder, Anibal. Yellow’s adjusted basis for the forklift was $7,000. Anibal’s holding period for the forklift:

a. Includes Yellow’s holding period for the forklift.b. Begins on April 12, 2011.*c. Begins on April 13, 2011.d. Does not begin until Anibal sells the forklift.e. None of the above.

987. Chapter 8 - Property Transactions: Capital Gains and Losses, S64 Harry inherited a residence from his mother when she died. The mother had a tax basis of $566,000 for the residence when she died and the residence was worth $433,000 at the date of her death. Which of the statements below is correct?

a. Harry’s holding period for the residence includes his mother’s holding period for the residence.b. Harry’s holding period for the residence does not include his mother’s holding period for the residence.c. Harry’s holding period for the residence is automatically long term.*d. b and ce. None of the above.

988. Chapter 8 - Property Transactions: Capital Gains and Losses, S65 Which of the following is correct concerning short sales of stock?

a. At the time the short sale is made, the taxpayer does not deliver to the purchaser the shares sold short.*b. At the time the short sale is made, the taxpayer delivers to the purchaser the shares sold short.c. At the time the short sale is made, the taxpayer may already own the shares sold short.d. At the time the short sale is made, the taxpayer always already owns the shares sold short.e. None of the above.

989. Chapter 8 - Property Transactions: Capital Gains and Losses, S66 Ronald has the following capital gains and losses for 2011: $8,000

STCL, $6,000 28% gain, $4,000 25% gain, and $16,000 0%/15% gain. Which of the following is correct?

*a. The net capital gain is composed of $2,000 25% gain and $16,000 0%/15% gain.b. The net capital gain is composed of $6,000 28% gain and $12,000 0%/15% gain.c. The net capital gain is composed of $6,000 28% gain, $4,000 25% gain, and $8,000 0%/15% gain.d. The net capital gain is composed of $2,000 28% gain and $16,000 0%/15% gain.e. None of the above.

990. Chapter 8 - Property Transactions: Capital Gains and Losses, S67 In 2011, Manuelo has $29,000 short-term capital loss, $10,000 28% gain, and $6,000 0%/15% gain. Which of the statements below is correct?

a. Manuelo has a $13,000 capital loss deduction.*b. Manuelo has a $3,000 capital loss deduction.c. Manuelo has a $13,000 net capital gain.d. Manuelo has a $3,000 net capital gain.e. Manuelo has a $18,000 net capital loss.

991. Chapter 8 - Property Transactions: Capital Gains and Losses, S68 In 2010, Jenny had a $12,000 net short-term capital loss and deducted $3,000 as a capital loss deduction. In 2011, Jenny has a $16,000 0%/15% long-term capital gain and no other capital gain or loss transactions. Which of the statements below is correct?

a. Jenny has a 2011 $18,000 net capital gain.*b. Jenny has a 2011 $7,000 net capital gain.c. Jenny has a 2011 $7,000 net capital loss.d. Jenny has a 2011 $3,000 capital loss deduction.e. Jenny has a 2011 $7,000 capital loss deduction.

992. Chapter 8 - Property Transactions: Capital Gains and Losses, S69 Cason is filing as single and has 2011 taxable income of $38,000 which includes $36,000 of 0%/15% net long-term capital gain. What is his tax on taxable income using the alternative tax method?

a. $0.*b. $725.c. $5,700.d. $5,625.e. None of the above.

993. Chapter 8 - Property Transactions: Capital Gains and Losses, S70 Sara is filing as head of household and has 2011 taxable income of $27,000 which includes $13,000 of net long-tem capital gain. The net long-term capital gain is made up of $10,000 25% gain and $3,000 0%/15% gain. What is the tax on her taxable income using the alternative tax

method?

a. $0.b. $3,993.*c. $2,993.d. $3,443.e. None of the above.

994. Chapter 8 - Property Transactions: Capital Gains and Losses, S71 Seamus had $16,000 of net short-term capital loss in 2010. In 2011, Seamus has $15,000 of long-term capital loss and $26,000 of long-term capital gain. Which of the following statements is correct?

a. Seamus had a $13,000 short-term capital loss carryover to 2011.b. Seamus has an $11,000 2011 net long-term capital gain.c. Seamus has a $2,000 2011 net short-term capital loss.*d. a. and c.e. None of the above.

995. Chapter 8 - Property Transactions: Capital Gains and Losses, S72 Which of the following comparisons is correct?

*a. Corporations may carryback capital losses; individuals may not.b. Both corporation and individual long-term capital losses carryover as short-term capital losses.c. Corporations may carryforward capital losses indefinitely; individuals may only carryforward capital losses for five years.d. Both corporations and individuals may use an alternative tax rate on net capital gains.e. None of the above.

996. Chapter 8 - Property Transactions: Capital Gains and Losses, S73 Robin Corporation has ordinary income from operations of $30,000, net long-term capital gain of $10,000, and net short-term capital loss of $15,000. What is the taxable income for 2011?

a. $25,000.b. $27,000.c. $28,500.*d. $30,000.e. None of the above.

997. Chapter 8 - Property Transactions: Capital Gains and Losses, S74 Tan, Inc., has a 2011 $50,000 long-term capital gain included in its $185,000 taxable income. Which of the following is correct?

a. Tan will benefit from an alternative tax on net capital gains computation.*b. Tan’s regular tax on taxable income will be the same as its

tax using an alternative tax on net capital gains approach.c. Tan’s $50,000 net capital gain is not taxable.d. Tan’s regular tax on taxable income will be greater than its tax using an alternative tax on net capital gain approach.e. None of the above.

998. Chapter 8 - Property Transactions: Capital Gains and Losses, S75 Blue Company acquires a used machine for $45,000 and uses it in Blue’s manufacturing operations. A few months after Blue places the machine in service, it discovers that the machine is not suitable for Blue’s business. Blue had fully expensed the machine in the year of acquisition using § 179. Blue sells the machine for $5,000 in the tax year after it was acquired, but held the machine only for a total of 10 months. What was the tax status of the machine when it was disposed of and the amount of the gain or loss?

a. A capital asset and $5,000 gain.*b. An ordinary asset and $5,000 gain.c. A § 1231 asset and $5,000 gain.d. A § 1231 asset and $5,000 loss.e. None of the above.

999. Chapter 8 - Property Transactions: Capital Gains and Losses, S76 Which of the following assets held by a wholesale business is an ordinary asset?

*a. Inventory.b. A machine used in the business and held more than one year.c. A factory building used in the business and held more than one year.d. Accounts payable.e. All of the above.

1000. Chapter 8 - Property Transactions: Capital Gains and Losses, S77 Which of the following assets held by a cash basis law firm is a § 1231 asset?

a. An account receivable from a client.b. A desk used in the business and held less than one year.c. An investment in Orange Company common stock.*d. A computer used in the business, held more than one year, but fully depreciated under § 179 when acquired.e. b. and d.

1001. Chapter 8 - Property Transactions: Capital Gains and Losses, S78 A silo held more than one year and used in a business is destroyed in an earthquake. The silo originally cost $356,000 and was fully depreciated using straight-line depreciation. The silo was insured for its $543,000 replacement cost minus a deductible of $1,000. Which of the statements below is correct concerning these facts?

a. The silo was a long-term personal use asset.b. There is a casualty loss from disposition of the silo.c. The recognized gain from disposition of the silo is $186,000.*d. The recognized gain from disposition of the silo is subject to special netting rules.e. c. and d.

1002. Chapter 8 - Property Transactions: Capital Gains and Losses, S79 Which of the following would not be included in the netting of § 1231 gains and losses?

*a. Personal use property net casualty loss.b. Section 1231 loss.c. Section 1231 gain.d. All of the above.e. b. and c.

1003. Chapter 8 - Property Transactions: Capital Gains and Losses, S80 Velvet, Inc., has a 2011 net § 1231 loss of $74,000 and had a $12,000 net § 1231 gain in 2010. For 2011, Velvet’s net § 1231 loss is treated as:

*a. Ordinary loss.b. Ordinary gain.c. Capital loss.d. Capital gain.e. None of the above.

1004. Chapter 8 - Property Transactions: Capital Gains and Losses, S81 Verdum, Inc., has a 2011 net § 1231 gain of $57,000 and had a $12,000 net § 1231 loss in 2010. For 2011, Verdum’s net § 1231 gain is treated as:

a. $45,000 long-term capital gain and $12,000 ordinary loss.b. $57,000 ordinary gain.*c. $45,000 long-term capital gain and $12,000 ordinary gain.d. $57,000 capital gain.e. None of the above.

1005. Chapter 8 - Property Transactions: Capital Gains and Losses, S82 Orange, Inc., has a 2011 net § 1231 gain of $45,000 and had a $72,000 net § 1231 loss in 2010. For 2011, Orange’s net § 1231 gain is treated as:

a. $45,000 ordinary loss.*b. $45,000 ordinary gain.c. $45,000 capital loss.d. $45,000 capital gain.e. None of the above.

1006. Chapter 8 - Property Transactions: Capital Gains and Losses, S83 The following assets in Jack’s business were sold in 2011:

Asset Holding Period Gain/(Loss)Office Furniture 2 years $3,100Automobile 8 months ($ 800)XYZ Stock (capital asset) 2 years $1,400

The office furniture had a zero adjusted basis and was purchased for $8,000. The automobile was purchased for $2,000 and sold for $1,200. The XYZ stock was purchased for $1,800 and sold for $3,200. In 2011 (the year of sale), Jack should report what amount of net capital gain and net ordinary income?

a. $3,700 LTCG.b. $600 LTCG and $2,300 ordinary gain.*c. $1,400 LTCG and $2,300 ordinary gain.d. $4,500 LTCG and $800 ordinary loss.e. None of the above.

1007. Chapter 8 - Property Transactions: Capital Gains and Losses, S84 An individual had the following gains and losses during 2011 on property held for the long-term holding period: sale of Magenta common stock ($8,000 gain); sale of real property used in the taxpayer’s business ($1,800 loss); destruction of real property used in the taxpayer’s business by flood ($1,000 loss). Which of the following is correct?

a. The flood loss would reduce the real property sale loss.b. The flood loss would reduce the stock sale gain.c. The sale of real property loss would be netted against the stock sale gain.*d. The sale of real property is a § 1231 loss.e. None of the above.

1008. Chapter 8 - Property Transactions: Capital Gains and Losses, S85 Spencer has an investment in two parcels of vacant land. Parcel 1 is a capital asset and parcel 2 is a § 1231 asset. Spencer already has short-term capital loss for the year he would like to offset with capital gain. Spencer has § 1231 lookback loss that exceeds the gain from the disposition of either land parcel. Spencer only wants to sell one land parcel and each of them would yield the same amount of gain. The gain that would be recognized exceeds the short-term capital loss Spencer already has. Which of the statements below is correct?

a. Spencer will have a net capital loss no matter which land parcel he sells.*b. Spencer will have a net capital loss if he sells parcel 2.c. Spencer will have a net capital loss if he sells parcel 1.d. Spencer will have a net capital gain if he sells either parcel 1 or parcel 2.

e. None of the above.

1009. Chapter 8 - Property Transactions: Capital Gains and Losses, S86 Bronze Corporation sold machinery for $27,000 on December 31, 2011. The machinery had been purchased on January 2, 2008, for $40,000 and had an adjusted basis of $21,000 at the date of the sale. For 2011, what should Bronze Corporation report?

*a. Ordinary income of $6,000.b. A § 1231 gain of $3,000 and $3,000 of ordinary income.c. A § 1231 gain of $6,000.d. A § 1231 gain of $6,000 and $3,000 of ordinary income.e. None of the above.

1010. Chapter 8 - Property Transactions: Capital Gains and Losses, S87 Which of the following creates potential § 1245 depreciation recapture and potential § 1231 gain?

*a. Depreciable equipment held more than one year and sold for more than its original cost.b. Amortizable goodwill held more than one year and disposed of for less than its adjusted basis.c. Land held more than one year and sold for more than was paid for it.d. Inventory held more than one year and sold for more than was paid for it.e. None of the above.

1011. Chapter 8 - Property Transactions: Capital Gains and Losses, S88 Cyan Company sold machinery for $55,000 on December 23, 2011. The machinery had been acquired on April 1, 2009, for $69,000 and its adjusted basis was $14,200. The § 1231 gain, § 1245 recapture gain, and § 1231 loss from this transaction are:

*a. $0 § 1231 gain, $40,800 § 1245 recapture gain, $0 § 1231 loss.b. $0 § 1231 gain, $0 § 1245 recapture gain, $54,800 § 1231 loss.c. $4,000 § 1231 gain, $54,800 § 1245 recapture gain, $0 § 1231 loss.d. $0 § 1231 gain, $54,800 § 1245 recapture gain, $14,200 § 1231 loss.e. None of the above.

1012. Chapter 8 - Property Transactions: Capital Gains and Losses, S89 Ebon Company had an involuntary conversion on December 23, 2011. The machinery had been acquired on April 1, 2009, for $69,000 and its adjusted basis was $14,200. The machinery was completely destroyed by fire and Ebon received $10,000 of insurance proceeds for the machine and did not replace it. This was Ebon’s only casualty or theft event for the year. As a result of this event, Ebon initially has:

a. $10,000 § 1231 loss.b. $10,000 § 1245 recapture gain.*c. $4,200 casualty loss.d. $4,200 § 1231 loss.e. None of the above.

1013. Chapter 8 - Property Transactions: Capital Gains and Losses, S90 Opaque Company had machinery destroyed by a flood on December 23, 2011. The machinery had been acquired on April 1, 2009, for $69,000 and its adjusted basis was $14,200. The machinery was completely destroyed and Opaque received $30,000 of insurance proceeds for the machine and did not replace it. This was Opaque’s only casualty or theft event for the year. As a result of this event, Opaque has:

a. $4,200 ordinary loss.*b. $15,800 § 1245 recapture gain.c. $14,200 § 1245 recapture gain.d. $30,000 § 1231 gain.e. None of the above.

1014. Chapter 8 - Property Transactions: Capital Gains and Losses, S91 Which of the following events could result in § 1250 depreciation recapture?

a. Sale at a loss of a depreciable business building held more than one year.b. Sale at a gain of a business building held more than a year on which straight-line depreciation was taken.c. Sale at a gain of a depreciable business building held for 9 months.d. Sale at a gain of depreciable equipment held more than a year on which straight-line depreciation was taken.*e. None of the above.

1015. Chapter 8 - Property Transactions: Capital Gains and Losses, S92 Which of the following real property could be subject to § 1250 depreciation recapture?

*a. Leasehold improvements placed in service in 2011 on which § 168(k) additional first-year depreciation was taken.b. A building acquired in 1997 on which straight-line depreciation was taken.c. Equipment on which accelerated depreciation was taken.d. Land which was not depreciated.e. a. and b.

1016. Chapter 8 - Property Transactions: Capital Gains and Losses, S93 Assume a building is subject to § 1250 depreciation recapture because it was acquired before 1987 and accelerated depreciation was used to depreciate it. The building is destroyed in a fire and this is the taxpayer’s only casualty or theft for the year. In which of the

following situations could there be a § 1250 depreciation recapture gain?

a. There is a loss because the insurance recovery is less than the adjusted basis.*b. There is a gain because the insurance recovery exceeds the adjusted basis.c. Because of the length of time the building has been held, there is no remaining additional depreciation.d. There is an insurance recovery, the adjusted basis of the building is zero, and straight-line depreciation was used.e. None of the above.

1017. Chapter 8 - Property Transactions: Capital Gains and Losses, S94 Lynne owns depreciable residential rental real estate which has accumulated depreciation (all from straight-line) of $45,000. If Lynne sold the property, she would have a $53,000 gain. The initial characterization of the gain would be:

a. Section 1245 gain.*b. Section 1231 gain.c. Section 1250 gain.d. Section 1239 gain.e. None of the above.

1018. Chapter 8 - Property Transactions: Capital Gains and Losses, S95 A retail building used in the business of a sole proprietor is sold on March 10, 2011, for $322,000. The building was acquired in 2001 for $400,000 and straight-line depreciation of $104,000 had been taken on the building. What is the maximum unrecaptured § 1250 gain from the disposition of this building?

a. $400,000.b. $322,000.*c. $104,000.d. $26,000.e. None of the above.

1019. Chapter 8 - Property Transactions: Capital Gains and Losses, S96 Which of the following statements is correct?

a. When depreciable property is gifted to another individual taxpayer, the depreciation recapture potential is extinguished.*b. When depreciable property is inherited by a taxpayer, the depreciation recapture potential is extinguished.c. When corporate depreciable property is distributed as a dividend, the depreciation recapture potential is generally not recognized.d. When depreciable property is contributed to charity, the depreciation recapture potential has no effect on the amount of the charitable contribution deduction.

e. All of the above are correct.

1020. Chapter 8 - Property Transactions: Capital Gains and Losses, S97 An individual has a $10,000 § 1245 gain, a $15,000 § 1231 gain, a $13,000 § 1231 loss, a $4,000 § 1231 lookback loss, and a $15,000 long-term capital gain. The net long-term capital gain is:

a. $30,000.b. $40,000.c. $17,000.*d. $15,000.e. None of the above.

1021. Chapter 8 - Property Transactions: Capital Gains and Losses, S98 An individual has the following recognized gains and losses from disposition of § 1231 assets (all the assets were vacant land): $15,000 gain, $10,000 loss, $25,000 gain, and $2,000 loss. The individual has a $5,500 § 1231 lookback loss. The individual also has a $16,000 net short-term capital loss from the disposition of stock. Which of the following statements is correct?

*a. The taxpayer has $5,500 ordinary gain and $6,500 net long-term capital gain.b. The taxpayer has $12,000 net long-term capital gain.c. The taxpayer has $28,000 ordinary gain and $16,000 net short-term capital loss.d. The taxpayer has $5,500 ordinary loss and $6,500 net long-term capital gain.e. None of the above.

1022. Chapter 8 - Property Transactions: Capital Gains and Losses, S99 Ann had the following transactions during 2011: a painting held for three years and sold at a gain of $85,000; 100 shares of Gray stock held six months and sold for a loss of $3,000; 50 shares of Yellow stock held 18 months and sold for a gain of $36,000. Ann also had $364,000 of taxable income from other sources than these property transactions. What is Ann’s net capital gain or loss and what is her taxable income?

Correct Answer:

Ann has taxable income of $482,000.

Long-term capital gain from painting $ 85,000 Long-term capital gain from Yellow stock 36,000 Net long-term capital gain $121,000 Short-term capital loss from Gray stock (3,000) Net long-term capital gain $118,000 Other taxable income 364,000 Total taxable income $482,000

1023. Chapter 8 - Property Transactions: Capital Gains and Losses, 100 On January 10, 2011, Wally sold an option for $1,000 on vacant land he held as an investment. He had purchased the land in 2007 for $66,000. The option allowed the option holder to purchase the property for $132,000 plus the cost of the option. On March 1, 2011, the option holder exercised the option. What is the amount and nature of Wally’s gain or loss from disposition of the land?

Correct Answer:Wally’s proceeds from selling the land are $133,000 ($1,000 option proceeds + $132,000 sale proceeds). Wally’s gain is $67,000 ($133,000 – $66,000) and is all long-term capital gain because the asset was a capital asset held more than 12 months.

1024. Chapter 8 - Property Transactions: Capital Gains and Losses, 101 Septa is the owner of vacant land that he purchased in 2006 for $400,000 and held for investment. On January 22, 2010, he was paid $45,000 for an eighteen-month option on the land by Samantha. Samantha could buy the land for an additional $1,200,000 by exercising the option. Samantha had hoped to develop the land into a shopping center, but was unable to get the zoning changed to accommodate building a shopping center on the land. Consequently, Samantha did not exercise her option and the option expired on August 15, 2011. What is Septa’s basis, gain, and type of gain from these events?

Correct Answer:Septa held the land for investment; consequently it was a capital asset. Septa had no recognized gain or loss in 2010 from the receipt of the $45,000 option proceeds. When the option expired in 2011, the $45,000 option price is ordinary income because the option property was not stocks, securities, commodities, or commodity futures.

1025. Chapter 8 - Property Transactions: Capital Gains and Losses, 102 Lee was the holder of a patent on a wireless modem. During 2011, he sold all substantial rights in the patent for $365,000 in cash and a 2% royalty on the purchaser’s first $10,600,000 of sales each year related to the product in which the patent is incorporated. Lee had not reduced the patent to practice. He had a $56,000 basis for the patent. During 2011, he received $10,000 in royalties. What is the nature and amount of Lee’s gain?

Correct Answer:Lee was the holder of a patent and transferred all substantial rights to it. Consequently, § 1235 grants automatic long-term capital gain treatment to both the cash received and the royalties received. Lee recovers his $56,000 basis and has a $319,000 ($365,000 + $10,000 – $56,000) 0%/15% long-term capital gain.

1026. Chapter 8 - Property Transactions: Capital Gains and Losses, 103 Phil’s father died on January 10, 2011. The father had owned stock for

20 years with a basis of $45,000 that was transferred to Phil as a gift on August 10, 2010, when the stock was worth $430,000. His father paid gift tax of $31,000. This stock was worth $566,000 at the date of the father’s death. Phil sold the stock for $545,000 net of commissions on February 23, 2011. What is the amount and nature of Phil’s gain or loss from disposition of this property?

Correct Answer:Phil had a tax basis for the stock equal to its $45,000 basis at the date of his father’s gift of the stock increased by the gift tax paid on the stock’s unrealized appreciation in his father’s hands. He also had a long-term holding period because the father’s 20-year holding period is added to Phil’s holding period. Consequently, he had a $471,447 ($545,000 – $73,553) long-term capital gain when he sold the stock.

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1027. Chapter 8 - Property Transactions: Capital Gains and Losses, 104 On January 18, 2010, Martha purchased 200 shares of Blue Corporation stock for $2,000. On November 11, 2011, she sold short 200 shares of Blue Corporation stock which she borrowed from her broker for $2,300. On February 10, 2012, Martha closed the short sale by delivering the 200 shares of Blue Corporation stock which she had acquired in 2010. On that date, Blue Corporation stock had a market price of $4 per share. What is Martha’s recognized gain or loss and its character in 2011? In 2012?

Correct Answer:Since Martha owned substantially identical stock on the date of the short sale and did not close the short sale before January 31, 2012, she is deemed to have closed the short sale on November 11, 2011 (the date of the short sale). On her 2011 tax return, she would report a $300 long-term capital gain ($2,300 short sale price – $2,000 cost). On February 10, 2012, Martha has a $1,500 short-term capital loss [$2,300 basis for the shares sold – $800 (200 shares ´ $4 per share)] because the holding period of the shares used to close the short sale commences with the date of the short sale.

1028. Chapter 8 - Property Transactions: Capital Gains and Losses, 105 Sandy has the following results of netting her short-term and long-term capital gains and losses for 2011: $38,000 short-term capital loss, $22,000 net long-term capital gain ($21,000 0%/15% long-term capital gain, and $1,000 28% long-term capital gain). What is her net capital gain or loss for 2011 and, if there is a net capital loss, how much of the loss and what type of loss carries over to 2012?

Correct Answer:Sandy has a 2011 net short-term capital loss of $16,000 ($38,000 short-term capital loss – $22,000 net long-term capital gain). $3,000 of the loss is deductible for AGI in 2011 and the balance of $13,000 carries over as a short-term capital loss to 2012.

1029. Chapter 8 - Property Transactions: Capital Gains and Losses, 106 The chart below details Sheen’s 2009, 2010, and 2011 stock transactions. What is the capital loss carryover to 2011 and what is the net capital gain or loss for 2011?

Tax YearShort-termCapital Gains

Short-termCapital Losses

Long-termCapital Gains

Long-term Capital Losses

2009 $ 4,000 $ 6,000 $ 2,000 $13,0002010 $16,000 $14,000 $23,000 $28,0002011 $55,000 $52,000 $67,000 $33,000

Correct Answer:There was a $2,000 net short-term capital loss and a $11,000 net long-term capital loss in 2009. All of the short-term capital loss and $1,000 of the long-term capital loss were used for the $3,000 capital loss deduction and $10,000 of long-term capital loss carried forward to 2010. The $10,000 long-term capital loss carryforward is grouped with the 2010 long-term losses. In 2010, there is $2,000 net short-term capital gain that is netted against the $15,000 ($23,000 long-term gain – $28,000 2010 long-term loss – $10,000 long-term loss carryforward) net long-term capital loss, resulting in a $13,000 net long-term capital loss for 2010. After the $3,000 capital loss deduction, $10,000 carried forward as long-term capital loss to 2011. In 2011, the $10,000 is added to the long-term capital losses. There is a 2011 net short-term capital gain of $3,000 and a net long-term gain of $24,000 ($67,000 long-term gain – $33,000 2011 long-term loss – $10,000 long-term loss carryforward). The net result for 2011 is both net short-term capital gain of $3,000 and long-term capital gain of $24,000.

1030. Chapter 8 - Property Transactions: Capital Gains and Losses, 107 Martha is single with one dependent and files as head of household. She had 2011 taxable income of $45,000 which included $16,000 of 0%/15% net long-term capital gain. What is her tax on taxable income using the alternative tax on net long-term capital gain method?

Correct Answer:Martha has a tax of $3,743. Her tax on regular taxable income of $29,000 ($45,000 – $16,000) is $3,743. Her tax on the $16,000 of 0%/15% at 0% is $0 (she is not out of the 15% regular tax bracket, so she pays 0% on the entire net long-term capital gain of $16,000). Martha would have paid tax of $6,143 on her taxable income if it did not include any net long-term capital gain.

1031. Chapter 8 - Property Transactions: Capital Gains and Losses, 108 A business taxpayer sold all the depreciable assets of the business, calculated the gains and losses, and would like to know the final character of those gains and losses. The taxpayer had $53,000 of adjusted gross income before considering the gains and losses from sale of the business assets. The taxpayer had unrecaptured § 1231 lookback loss of $22,000. What is the treatment of the gains and losses summarized in the chart below after all possible netting and

reclassification has been completed? What is the taxpayer’s adjusted gross income? (Ignore the self-employment tax deduction.)

Asset Purchase Date Sale Date Depreciation Gain (Loss)Machine #1 10/10/09 11/11/11 $323,000 $76,000Machine #2 10/02/08 11/11/11 65,000 (15,000)Machine #3 09/23/07 11/11/11 183,000 23,000Machine #4 09/23/07 11/11/11 28,000 34,000

Correct Answer:The taxpayer has adjusted gross income of $171,000 after including the affect of the property transactions. Machine #1’s $76,000 gain is all ordinary income due to § 1245 depreciation recapture. Machine #3’s $23,000 gain is all ordinary income due to § 1245 depreciation recapture. Machine #4 has $28,000 of ordinary income due to § 1245 depreciation recapture (equals depreciation taken) and $6,000 § 1231 gain ($34,000 – $28,000). Machine #2’s $15,000 loss is a § 1231 loss. There is a $9,000 net § 1231 loss ($6,000 gain – $15,000 loss) for the year. The net ordinary gain for the year is $118,000 ($76,000 + $23,000 + $28,000 – $9,000). There is no net § 1231 gain, so the $22,000 § 1231 unrecaptured lookback loss does not affect the character of the current year’s gains. Adjusted gross income is $171,000 ($53,000 + $118,000).

1032. Chapter 8 - Property Transactions: Capital Gains and Losses, 109 A business taxpayer sold all the depreciable assets of the business, calculated the gains and losses, and would like to know the final character of those gains and losses. The taxpayer had $53,000 of adjusted gross income before considering the gains and losses from sale of the business assets. The taxpayer had unrecaptured § 1231 lookback loss of $12,000. What is the treatment of the gains and losses summarized in the chart below after all possible netting and reclassification has been completed? What is the taxpayer’s adjusted gross income? (Ignore the self-employment tax deduction.)

Asset Purchase Date Sale Date Depreciation Gain (Loss)Machine #1 10/10/09 11/11/11 $323,000 $76,000Machine #2 10/02/08 11/11/11 65,000 (15,000)Machine #3 09/23/07 11/11/11 183,000 23,000Machine #4 09/23/07 11/11/11 28,000 64,000

Correct Answer:The taxpayer has adjusted gross income of $201,000 after including the effect of the property transactions. Machine #1’s $76,000 gain is all ordinary income due to § 1245 depreciation recapture. Machine #3’s $23,000 gain is all ordinary income due to § 1245 depreciation recapture. Machine #4 has $28,000 of ordinary income due to § 1245

depreciation recapture (equals depreciation taken) and $36,000 § 1231 gain ($64,000 – $28,000). Machine #2’s $15,000 loss is a § 1231 loss. There is a $21,000 net § 1231 gain ($36,000 gain – $15,000 loss) for the year. The $12,000 § 1231 unrecaptured lookback loss converts $12,000 of this gain to ordinary income, leaving $9,000 of the net § 1231 gain to be treated as long-term capital gain. The net ordinary gain for the year is $139,000 ($76,000 + $23,000 + $28,000 + $12,000). Adjusted gross income is $201,000 ($53,000 + $139,000 + $9,000).

1033. Chapter 8 - Property Transactions: Capital Gains and Losses, 110 A business machine purchased April 10, 2009, for $102,000 was fully depreciated in 2009 using § 179 immediate expensing. On August 15, 2011, the machine was sold for $67,000. What is the amount and nature of the gain or loss from disposition of the machine?

Correct Answer:The machine was a § 1231 asset because it was held for more than 12 months. However, all of the $67,000 ($67,000 sales price – $0 adjusted basis) gain is ordinary gain due to § 1245 depreciation recapture.

1034. Chapter 8 - Property Transactions: Capital Gains and Losses, 111 An individual taxpayer has the gains and losses shown below. There are $5,000 of § 1231 lookback losses. What is the net long-term capital gain?

Holding Period/Property Character of Gain or Loss Amount5 years/vacant land § 1231 gain $7,000 2 years/business equipment § 1245 gain 3,200 3 years/publicly traded stock

Long-term capital gain 890

8 months/publicly traded stock

Short-term capital loss (1,870)

Correct Answer:The taxpayer has a net long-term capital gain of $2,890 and a net short-term capital loss of $1,870. The $3,200 of § 1245 gain is ordinary income and does not affect the net long-term capital gain computation. Since there is $5,000 of § 1231 lookback loss, $5,000 of $7,000 § 1231 gain is treated as ordinary income and the remaining $2,000 of § 1231 gain is treated as long-term capital gain. The $1,870 of short-term capital loss offsets the $2,890 of long-term capital gain, resulting is a net capital gain of $1,020 (0%/15% gain).

1035. Chapter 8 - Property Transactions: Capital Gains and Losses, 112 Vivien owned an office building that had been held more than one year when it was sold for $67,000. The real estate had an adjusted basis of $5,000 for the land and $33,000 for the building. Straight-line depreciation of $62,000 had been taken on the building. What is the amount and initial character of the gain or loss from disposition of

the real estate? Is any of the gain unrecaptured § 1250 (25%) gain?

Correct Answer:The real estate was used in business and held more than one year. Therefore, the property was a § 1231 asset. Since straight-line depreciation was taken, there is no § 1250 depreciation recapture because no accelerated depreciation was taken. The entire gain of $29,000 [$67,000 sale price – ($5,000 land adjusted basis + $33,000 building adjusted basis)] is § 1231 gain. Since the recognized gain is less than the $62,000 of depreciation, there is $29,000 of unrecaptured § 1250 gain in the $29,000 recognized gain.

1036. Chapter 8 - Property Transactions: Capital Gains and Losses, 113 The chart below describes the § 1231 assets sold by the Ecru Company (a sole proprietorship) this year. Compute the gain or loss from each asset disposition and determine the net § 1231 gain treated as long-term capital gain for the year. Assume there is a § 1231 lookback loss of $4,000.

Asset Acquired Sold Cost Depreciation

Sale Price

Stamping machine 3/10/07 8/10/2011 $40,000 $29,736 $32,000Factory building 2/12/04 7/23/2011 80,000 18,838 90,000Tractor 5/16/06 11/13/2011 52,000 52,000 30,000Overhead crane 11/12/00 2/25/2011 74,000 74,000 18,000

Correct Answer:

The stamping machine ($21,736), tractor ($30,000), and overhead crane ($18,000) are each sold at a gain and the gain is ordinary due to § 1245 depreciation recapture. The factory building yields a § 1231 gain of $28,838. There is no § 1250 depreciation recapture because straight-line depreciation was used (i.e., the building was placed in service after 1986). $4,000 of the $28,838 gain is treated as ordinary income because of the $4,000 § 1231 lookback loss. Consequently, the net § 1231 gain treated as long-term capital gain is $24,838 ($28,838 – $4,000). The chart below provides detail on the computations:

Asset Acquired Sold Cost Depreciation BasisSalePrice

Gain (Loss)

Stamping machine

3/10/07 8/10/2011 $40,000 $29,736 $10,264 $32,000 $21,736

Factory building

2/12/04 7/23/2011 80,000 18,838 61,162 90,000 28,838

Tractor 5/16/06 11/13/2011 52,000 52,000 –0– 30,000 30,000Overhead crane

11/12/00 2/25/2011 74,000 74,000 –0– 18,000 18,000

1037. Chapter 8 - Property Transactions: Capital Gains and Losses, 114 The chart below describes the § 1231 assets sold by the Tan Company (a sole proprietorship) this year. Compute the gain or loss from each asset disposition and determine the net § 1231 gain treated as long-term capital gain for the year. Assume there is a § 1231 lookback loss of $14,000.

Asset Acquired Sold Cost Depreciation Sale PriceStamping machine 3/10/07 8/10/2011 $40,000 $29,736 $ 2,000Factory building 2/12/04 7/23/2011 80,000 18,838 90,000Tractor 5/16/06 11/13/2011 52,000 52,000 60,000Overhead crane 11/12/00 2/25/2011 74,000 74,000 18,000

Correct Answer:

The stamping machine is sold at a $8,264 loss which is a § 1231 loss. The factory building yields a § 1231 gain of $28,838. There is no § 1250 depreciation recapture because straight-line depreciation was used (i.e., the building was placed in service after 1986). The tractor has $60,000 of gain, $52,000 of ordinary gain due to § 1245 depreciation recapture (equal to the deprecation taken) and $8,000 of § 1231 gain. The $18,000 gain on the overhead crane is ordinary due to § 1245 depreciation recapture. $14,574 of net § 1231 gain ($28,838 + $8,000 – $8,264 – $14,000 § 1231 lookback loss) is treated as long-term capital gain. The chart below provides details on the computations:

Asset Acquired Sold Cost Depreciation Basis SalePrice

Gain(Loss)

Stamping machine

3/10/07 8/10/2011 $40,000 $29,736 $10,264 $ 2,000 ($ 8,264)

Factory building

2/12/04 7/23/2011 80,000 18,838 61,162 90,000 28,838

Tractor 5/16/06 11/13/2011 52,000 52,000 –0– 60,000 60,000Overhead crane

11/12/00 2/25/2011 74,000 74,000 –0– 18,000 18,000

1038. Chapter 8 - Property Transactions: Capital Gains and Losses, 115 Residential real estate was purchased in 2008 for $145,000, held as rental property, and depreciated straight-line. Assume the land cost was $45,000 and the building cost was $100,000. Depreciation totaled $4,089. The building and land were sold on June 10, 2011, for $383,000 total. What is the tax status of the property, the nature of the gain from the disposition, and is any of it § 1250 depreciation recapture gain or unrecaptured § 1250 gain?

Correct Answer:The adjusted basis of the property at the date of sale is $140,911 ($145,000 cost – $4,089 depreciation). The asset is a § 1231 asset because it was depreciable property or real property used in business

(rental is a form of business) and it was held more than one year. The recognized gain is $242,089 ($383,000 sale price – $140,911 adjusted basis) and it is all § 1231 gain since only straight-line depreciation was taken on the building. Thus, there is no § 1250 depreciation recapture because there was no additional depreciation due to accelerated depreciation. However, there is potential unrecaptured § 1250 gain of $4,089 because the depreciation taken is less than the recognized gain. The $238,000 ($242,089 – $4,089) balance of the gain is potential 0%/15% long-term capital gain.

1039. Chapter 8 - Property Transactions: Capital Gains and Losses, 116 Jonah owned a rental building (but not the land) that was destroyed by a fire. The building was insured and Jonah has a $66,000 gain because his insurance recovery exceeded his adjusted basis for the building. Jonah does not intend to replace the building. Jonah had taken $45,000 of depreciation on the building, has no § 1231 lookback loss, has no other § 1231 transactions for the year, and has no Schedule D transactions for the year. What is the final nature of Jonah’s gain for the year and what tax rate(s) apply to the gain?

Correct Answer:Jonah initially has a casualty gain of $66,000 from business use property. Since he has a net casualty gain, the gain is treated as § 1231 gain and that gain is treated as a long-term capital gain because he has no § 1231 lookback loss. Jonah has a net long-term capital gain of $66,000 because he has no other Schedule D transactions. The unrecaptured § 1250 portion of the gain is $45,000 (equal to the depreciation taken on the destroyed property). That portion of the gain is subject to an alternative tax rate of 25%. The $21,000 ($66,000 – $45,000) remaining gain is subject to the 0%/15% alternative tax rate.

1040. Chapter 8 - Property Transactions: Capital Gains and Losses, 117 A business machine purchased April 10, 2010, for $62,000 was fully depreciated in 2010 using § 179 immediate expensing. On August 15, 2011, the sole proprietor who owned the machine gave it to his son. On that date, the machine’s fair market value was $57,000. The son did not use the machine in business or hold it as inventory and the machine was sold on November 22, 2011, for $53,000.What is the amount and nature of the gain or loss from disposition of the machine? Where is it reported in the son’s tax return?

Correct Answer:A gift does not extinguish potential § 1245 depreciation recapture potential. The son that received the machine had a $0 basis for the asset because he has a carryover basis from the donor. The father’s holding period tacks on to the son’s holding period; therefore, the son had a long-term holding period on the date of the gift and potential § 1245 depreciation recapture of $57,000 [the lesser of the depreciation taken ($62,000) or the realized gain at the date of the gift ($57,000)]. However, since the machine was sold for only $53,000, there is only $53,000 of § 1245 depreciation recapture gain. The son should complete Form 4797 Part III for this transaction and then carry the gain to Part II as ordinary income.

1041. Chapter 8 - Property Transactions: Capital Gains and Losses, 118 Betty, a single taxpayer with no dependents, has the gains and losses shown below. Before considering these transactions, Betty has $45,000 of other taxable income. What is the treatment of the gains and losses and what is Betty’s taxable income?

§ 1245 gain $18,000 § 1250 gain 3,000 Business equipment long-term casualty loss (8,000)Business real property long-term casualty gain

12,000

§ 1231 gain 13,000 § 1231 lookback loss (2,000)

Correct Answer:

The § 1245 and § 1250 recapture gains are combined and result in a $21,000 ordinary gain. The nonpersonal use property casualty gain and loss are combined and result in a $4,000 net gain. The net gain is treated as a § 1231 gain and when combined with the other $13,000 § 1231 gain results in a $17,000 net § 1231 gain. Due to the $2,000 § 1231 lookback loss, $2,000 of the net § 1231 gain is an ordinary gain and the $15,000 balance of the gain is treated as a long-term capital gain. Since this is the only capital gain or loss, there is a $15,000 net long-term capital gain.

Other taxable income $45,000Ordinary gain due to recapture 21,000Ordinary gain due to § 1231 lookback 2,000Net long-term capital gain 15,000 Taxable income $83,000

1042. Chapter 8 - Property Transactions: Capital Gains and Losses, 119 Jason (now 37 years old) owns a collection of “video games” that he acquired when he was a teenager. He had forgotten about them until his mother sent them to him. She had discovered them in a box in her attic while she was cleaning out her house before selling it. Jason had originally acquired all the video games as gifts from his parents, so he has no way to establish a basis for the video games. Using information from the Internet, he prepares a careful inventory of the video games that includes their name, when they were first available for sale, their current value, and other pertinent information. He then lists them for sale on the Internet. To his surprise, he quickly gets an offer of $5,000 for all of them and sells them. Jason has no other gain or loss transactions for the year and is in the 25% marginal tax bracket. What issues do these facts create?

Correct Answer:

Jason has to determine the holding period, tax status, basis, gain or loss from the disposition of the video games and, if they are sold at a gain, the tax rate applicable to the gain. At the time of the sale, it appears that Jason is holding the video games as an investment and, therefore, they are a capital asset. His original intent was to hold the video games as a personal use activity. However, when he discovered what they were worth, his intent seems to have become investment. He has no determinable basis for the video games, so their basis is zero. They have been held long-term, so the $5,000 gain is a long-term capital gain. The alternative tax rate applicable to the gain is 15% because Jason’s regular taxable income puts him above the 15% regular tax bracket. The gain is not subject to the collectibles 28% alternative tax rate because the video games are neither a work of art nor an antique.

1043. Chapter 8 - Property Transactions: Capital Gains and Losses, 120 In early 2010, Wilma paid $56,000 for an option on a parcel of land she intended to hold as an investment. After a survey of the land (paid for by the grantor) determined that the parcel was much smaller than the grantor said it was, she let the option lapse when it expired in 2011 after 14 months. How should Wilma treat these events in 2010? 2011?

Correct Answer:If an option holder (grantee) fails to exercise the option, the lapse of the option is considered a sale or exchange on the option expiration date. Thus, the loss is a capital loss if the property subject to the option is (or would be) a capital asset in the hands of the grantee. Wilma has no gain or loss in 2010 because the option had not yet expired. Wilma has a $56,000 long-term capital loss in 2011 when the option expires because the land would have been a capital asset if Wilma had exercised the option.

1044. Chapter 8 - Property Transactions: Capital Gains and Losses, 121 What characteristics must the seller of a patent have in order to be classified as a holder?

Correct Answer:The holder of a patent must be an individual and must either have created the patented invention or have purchased it from the inventor before the invention was reduced to practice.

1045. Chapter 8 - Property Transactions: Capital Gains and Losses, 122 “Collectibles” held long-term and sold at a gain are subject to maximum tax rate of 28%. An individual taxpayer recently sold a baseball card for $400. The card had been held for several years and $40 was originally paid for it. The card depicts a famous baseball player (who hit 73 home runs in a recent season) when he was a rookie in the major leagues. Explain why the baseball card is or is not a collectible.

Correct Answer:The definition of “collectibles” is quite ambiguous. Consequently, the baseball card is a collectible if it is a work of art or an antique. Also, the § 408(m) regulations add “historical object” to the list of

collectibles. The baseball card does not seem to fit any of these categories, so it is probably not a collectible for tax purposes.

1046. Chapter 8 - Property Transactions: Capital Gains and Losses, 123 When an individual taxpayer has a net long-term capital gain that includes both 25% gain and 0%/15% gain, which of these gains will be taxed first when the alternative tax on net long-term capital gain method is used and what difference does it make?

Correct Answer:The 25% gain is taxed after the regular taxable income is taxed and before the 28% gain and the 0%/15% gain is taxed. Taxing the 25% gain first may mean that some or all of the 0%/15% gain will not be eligible for the 0% tax if the taxpayer’s taxable income after taxing the regular taxable income and the 25% gain puts the taxpayer out of the regular 15% bracket.

1047. Chapter 8 - Property Transactions: Capital Gains and Losses, 124 Is it generally better to have a net § 1231 loss year followed by a net § 1231 gain year rather than a net § 1231 gain year followed by a net § 1231 loss year?

Correct Answer:No, it is generally better to have a net § 1231 gain year followed by a net § 1231 loss year rather than a net § 1231 loss year followed by a net § 1231 gain year because the § 1231 lookback loss rules will be avoided. The net § 1231 gain in the first year is treated as a long-term capital gain and, therefore, potentially eligible for the reduced long-term capital gain rates. The second year net § 1231 loss is deductible for AGI as an ordinary deduction.

1048. Chapter 8 - Property Transactions: Capital Gains and Losses, 125 A business taxpayer trades in a used fully depreciated machine on a replacement machine. Because the machine traded in was worth less than the replacement machine, the taxpayer paid cash in the transaction. Assume the used machine originally cost $100,000, was worth $12,000 when it was traded in, and the replacement machine was worth $20,000. Consequently, the taxpayer paid $12,000 cash in the transaction. Is there recognized gain in this transaction and, if so, what type of gain?

Correct Answer:Since “boot” was paid in this like-kind exchange, there is no gain recognized to the extent of the lower of the realized gain or the boot received. There is a realized gain of $12,000 (the fair market value of the machine traded in less its zero adjusted basis). There was $100,000 of depreciation taken, so there is $100,000 of potential § 1245 depreciation recapture carried over to the replacement machine.

1049. Chapter 9 - Corporations: Organization, Capital Structure, and O Olga’s proprietorship earned a net profit of $95,000 during the year and she withdrew $70,000 of this profit. Olga must report $70,000 net

income from the proprietorship on her individual income tax return (Form 1040).

a. True*b. False

1050. Chapter 9 - Corporations: Organization, Capital Structure, and 2 Rose is a 50% partner in Wren Partnership. During the year, Wren earned net profit of $100,000 ($210,000 gross income – $110,000 operating expenses) and distributed $20,000 to each partner. Rose must report Wren Partnership profit of $20,000 on her Federal income tax return.

a. True*b. False

1051. Chapter 9 - Corporations: Organization, Capital Structure, and 3 Rajib is the sole shareholder of Robin Corporation, a calendar year S corporation. Robin earned net profit of $350,000 ($520,000 gross income – $170,000 operating expenses) and distributed $80,000 to Rajib. Rajib must report Robin Corporation profit of $350,000 on his Federal income tax return.

*a. Trueb. False

1052. Chapter 9 - Corporations: Organization, Capital Structure, and 4 Donald owns a 60% interest in a partnership that earned $230,000 in the current year. He also owns 60% of the stock in a C corporation that earned $230,000 during the year. Donald received $50,000 in distributions from each of the two entities during the year. With respect to this information, Donald must report $188,000 of income on his individual income tax return for the year.

*a. Trueb. False

1053. Chapter 9 - Corporations: Organization, Capital Structure, and 5 Quail Corporation is a C corporation with net income of $300,000 during 2011. If Quail paid dividends of $50,000 to its shareholders, the corporation must pay tax on $300,000 of net income. Shareholders must report the $50,000 of dividends as income.

*a. Trueb. False

1054. Chapter 9 - Corporations: Organization, Capital Structure, and 6 Eagle Company, a partnership, had a short-term capital loss of $10,000 during the year. Aaron, who owns 25% of Eagle, will report $2,500 of Eagle’s short-term capital loss on his individual tax return.

*a. Trueb. False

1055. Chapter 9 - Corporations: Organization, Capital Structure, and 7 Katherine, the sole shareholder of Purple Corporation, a calendar year C corporation, has the corporation pay her a salary of $450,000 in the current year. The Tax Court has held that $150,000 represents unreasonable compensation. Purple Corporation’s taxable income is unaffected by the Tax Court’s determination.

a. True*b. False

1056. Chapter 9 - Corporations: Organization, Capital Structure, and 8 Double taxation of corporate income results because dividend distributions are included in a shareholder’s gross income but are not deductible by the corporation.

*a. Trueb. False

1057. Chapter 9 - Corporations: Organization, Capital Structure, and 9 Jake, the sole shareholder of Peach Corporation, a C corporation, has the corporation pay him $100,000. For tax purposes, Jake would prefer to have the payment treated as salary instead of dividend.

a. True*b. False

1058. Chapter 9 - Corporations: Organization, Capital Structure, and10 Thrush Corporation files Form 1120, which reports taxable income of $110,000. The corporation’s tax is $26,150.

*a. Trueb. False

1059. Chapter 9 - Corporations: Organization, Capital Structure, and11 The corporate marginal tax rates range from 15% to 39%, while the individual marginal tax rates range from 10% to 35%.

*a. Trueb. False

1060. Chapter 9 - Corporations: Organization, Capital Structure, and12 There is no Federal income tax assessed on partnerships (including those formed as LLCs) or S corporations. Since all states follow the Federal approach as to entity taxation, state income taxation is a neutral factor in the selection of an entity form.

a. True*b. False

1061. Chapter 9 - Corporations: Organization, Capital Structure, and13 Under the “check-the-box” Regulations, a single-member LLC that fails to elect to be to treated as a corporation will be taxed as a sole proprietorship.

*a. Trueb. False

1062. Chapter 9 - Corporations: Organization, Capital Structure, and14 Section 351 (which permits transfers to controlled corporations to be tax deferred) can be justified under the wherewithal to pay concept.

*a. Trueb. False

1063. Chapter 9 - Corporations: Organization, Capital Structure, and15 Similar to like-kind exchanges, the receipt of “boot” under § 351 can cause loss to be recognized.

a. True*b. False

1064. Chapter 9 - Corporations: Organization, Capital Structure, and16 Tina incorporates her sole proprietorship with assets having a fair market value of $100,000 and an adjusted basis of $110,000. Even though § 351 applies, Tina may recognize her realized loss of $10,000.

a. True*b. False

1065. Chapter 9 - Corporations: Organization, Capital Structure, and17 In a § 351 transfer, a shareholder receives boot of $10,000 but ends up with a realized loss of $3,000. Only $7,000 of the boot will be taxed to the shareholder.

a. True*b. False

1066. Chapter 9 - Corporations: Organization, Capital Structure, and18 In a § 351 transfer, the receipt of boot is not taxed if the shareholder has a realized loss.

*a. Trueb. False

1067. Chapter 9 - Corporations: Organization, Capital Structure, and19 In a § 351 transfer, gain will be recognized to the extent of the lesser of realized gain or the boot received.

*a. Trueb. False

1068. Chapter 9 - Corporations: Organization, Capital Structure, and20 Allen transfers marketable securities with an adjusted basis of $120,000, fair market value of $300,000, for 85% of the stock of Heron Corporation. In addition, he receives cash of $40,000. Allen recognizes a capital gain of $40,000 on the transfer.

*a. Trueb. False

1069. Chapter 9 - Corporations: Organization, Capital Structure, and21 The definition of property for purposes of § 351 includes unrealized receivables transferred by a cash basis taxpayer.

*a. Trueb. False

1070. Chapter 9 - Corporations: Organization, Capital Structure, and22 The transfer of an installment obligation in a transaction qualifying under § 351 is a disposition of the obligation that causes gain to be recognized by the transferor.

a. True*b. False

1071. Chapter 9 - Corporations: Organization, Capital Structure, and23 A secret process and patentable invention both constitute “property” for purposes of § 351.

*a. Trueb. False

1072. Chapter 9 - Corporations: Organization, Capital Structure, and24 Since services are not considered property under § 351, a taxpayer must report as income the fair market value of stock received for such services.

*a. Trueb. False

1073. Chapter 9 - Corporations: Organization, Capital Structure, and25 The receipt of securities (i.e., long-term debt) in exchange for the transfer of appreciated property to a controlled corporation results in

recognition of realized gain to the transferor.

*a. Trueb. False

1074. Chapter 9 - Corporations: Organization, Capital Structure, and26

In a § 351 transaction, if a transferor receives consideration other than stock, the transaction can be taxable.

*a. Trueb. False

1075. Chapter 9 - Corporations: Organization, Capital Structure, and27 The receipt of nonqualified preferred stock in exchange for the transfer of appreciated property to a controlled corporation results in recognition of gain to the transferor.

*a. Trueb. False

1076. Chapter 9 - Corporations: Organization, Capital Structure, and28 Jill transfers property worth $200,000 (basis of $190,000) to Blue Corporation. In return, she receives 80% of the stock in Blue Corporation (fair market value of $180,000) and a long-term note, executed by Blue and made payable to Jill (fair market value of $20,000). Jill recognizes gain of $20,000 on the transfer.

a. True*b. False

1077. Chapter 9 - Corporations: Organization, Capital Structure, and29 Three individuals form Skylark Corporation with the following contributions: Cliff, cash of $50,000 for 50 shares; Brad, land (fair market value of $20,000) for 20 shares; and Ron, cattle (fair market value of $9,000) for 9 shares and services (fair market value of $21,000) for 21 shares. Section 351 will not apply in this situation because the control requirement has not been satisfied.

a. True*b. False

1078. Chapter 9 - Corporations: Organization, Capital Structure, and30 In order to retain the services of Bonnie, a key employee in Ralph’s sole proprietorship, Ralph contracts with Bonnie to make her a 25% owner. Ralph incorporates the business receiving in return 100% of the stock. Three days later, Ralph transfers 25% of the stock to Bonnie. Under these circumstances, § 351 will not apply to the incorporation of

Ralph’s business.

*a. Trueb. False

1079. Chapter 9 - Corporations: Organization, Capital Structure, and31 One month after Sally incorporates her sole proprietorship, she gives 25% of the stock to her children. Section 351 cannot apply to Sally because she has not satisfied the 80% control requirement.

a. True*b. False

1080. Chapter 9 - Corporations: Organization, Capital Structure, and32 A person who performs services for a corporation in exchange for stock cannot be treated as a member of the transferring group even if that person also transfers some property to the corporation.

a. True*b. False

1081. Chapter 9 - Corporations: Organization, Capital Structure, and33 The use of § 351 is not limited to the initial formation of a corporation, and it can apply to later transfers as well.

*a. Trueb. False

1082. Chapter 9 - Corporations: Organization, Capital Structure, and34 The bona fide business requirement of § 357(b) is easily satisfied as long as the liability arose in the normal course of conducting the business that is incorporated.

*a. Trueb. False

1083. Chapter 9 - Corporations: Organization, Capital Structure, and35 When incorporating her sole proprietorship, Samantha transfers all of its assets and liabilities. Included in the $30,000 of liabilities assumed by the corporation is $500 that relates to a personal expenditure. Under these circumstances, the entire $30,000 will be treated as boot.

*a. Trueb. False

1084. Chapter 9 - Corporations: Organization, Capital Structure, and36 In determining whether § 357(c) applies, assess whether the liabilities involved exceed the bases of all assets a shareholder transfers to the

corporation.

*a. Trueb. False

1085. Chapter 9 - Corporations: Organization, Capital Structure, and37

A taxpayer transfers assets and liabilities to a corporation in return for its stock. If the liabilities exceed the basis of the assets transferred, the taxpayer will recognize gain to avoid having a negative basis in the stock.

*a. Trueb. False

1086. Chapter 9 - Corporations: Organization, Capital Structure, and38 If both §§ 357(b) and (c) apply to the same transfer (i.e., the liability is not supported by a bona fide business purpose and also exceeds the basis of the properties transferred), § 357(c) predominates.

a. True*b. False

1087. Chapter 9 - Corporations: Organization, Capital Structure, and39 When a taxpayer transfers property subject to a mortgage to a controlled corporation in an exchange qualifying under § 351, the transferor shareholder’s basis in stock received in the transferee corporation is increased by the amount of the mortgage on the property.

a. True*b. False

1088. Chapter 9 - Corporations: Organization, Capital Structure, and40 In a § 351 transaction, Gerald transfers equipment worth $85,000 (basis of $120,000) in exchange for all of the Rust Corporation stock. Gerald’s stock basis is $120,000 and Rust’s basis in the equipment is $120,000.

a. True*b. False

1089. Chapter 9 - Corporations: Organization, Capital Structure, and41 Carl and Ben form Eagle Corporation. Carl transfers cash of $50,000 for 50 shares of stock of Eagle. Ben transfers a secret process with a tax basis of zero and a fair market value of $50,000 for the remaining 50 shares in Eagle. Carl will have a tax basis of $50,000 in his stock in Eagle Corporation, but Ben’s basis in his stock will be zero.

*a. Trueb. False

1090. Chapter 9 - Corporations: Organization, Capital Structure, and42 Isabella and Marta form Pine Corporation. Isabella transfers land (basis of $40,000 and fair market value of $180,000) for 50 shares plus $20,000 cash, while Marta transfers $160,000 cash for the other 50 shares in Pine Corporation. Pine Corporation has a basis of $40,000 in the land it receives from Isabella.

a. True*b. False

1091. Chapter 9 - Corporations: Organization, Capital Structure, and43 Carmen and Carlos form White Corporation. Carmen transfers cash of $100,000 for 100 shares in White. Carlos transfers property (basis of $20,000 and fair market value of $80,000) and agrees to serve as manager of White Corporation for one year; in return, Carlos receives 100 shares in White. The value of Carlos’s services is $20,000. White Corporation can deduct $20,000 as compensation expense for the value of the services Carlos will render.

*a. Trueb. False

1092. Chapter 9 - Corporations: Organization, Capital Structure, and44 Kim, a real estate dealer, and others form Eagle Corporation under § 351. Kim contributes inventory (land held for resale) in return for Eagle stock. The holding period for the stock includes the holding period of the inventory.

a. True*b. False

1093. Chapter 9 - Corporations: Organization, Capital Structure, and45 A corporation’s holding period for property received under § 351 includes the holding period of the transferor shareholder.

*a. Trueb. False

1094. Chapter 9 - Corporations: Organization, Capital Structure, and46 A shareholder’s holding period for stock received under § 351 includes the holding period of the property transferred to the corporation.

*a. Trueb. False

1095. Chapter 9 - Corporations: Organization, Capital Structure, and47 When depreciable property is transferred to a controlled corporation under § 351, any recapture potential disappears and does not carry over to the corporation.

a. True*b. False

1096. Chapter 9 - Corporations: Organization, Capital Structure, and48 In order to encourage the development of an industrial park, a county donates land to Ecru Corporation. The donation does not result in gross income to Ecru.

*a. Trueb. False

1097. Chapter 9 - Corporations: Organization, Capital Structure, and49 Silver Corporation receives $1 million in cash from Madison County as an inducement to expand its operations. Within one year, Silver spends $1.5 million to enlarge its existing plant. Silver Corporation’s basis in the expansion is $500,000.

*a. Trueb. False

1098. Chapter 9 - Corporations: Organization, Capital Structure, and50 To ease a liquidity problem, all of the shareholders of Osprey Corporation contribute additional cash to its capital. Osprey has no tax consequences from the contribution.

*a. Trueb. False

1099. Chapter 9 - Corporations: Organization, Capital Structure, and51 Rosa, the sole shareholder of Robin Corporation, contributes land (basis of $40,000 and fair market value of $100,000) to the corporation but does not receive additional stock. Neither Rosa nor Robin Corporation will have to recognize gain as a result of this transfer.

*a. Trueb. False

1100. Chapter 9 - Corporations: Organization, Capital Structure, and52 If a corporation is thinly capitalized, all debt is reclassified as equity.

a. True*b. False

1101. Chapter 9 - Corporations: Organization, Capital Structure, and53 To help avoid the thin capitalization problem, it is advisable to make the repayment of the debt contingent upon the corporation’s earnings.

a. True*b. False

1102. Chapter 9 - Corporations: Organization, Capital Structure, and54 Azul Corporation, a calendar year C corporation, received a dividend of $50,000 from Naranja Corporation. Azul owns 10% of the Naranja Corporation stock. Assuming it is not subject to the taxable income limitation, Azul’s dividends received deduction is $35,000.

*a. Trueb. False

1103. Chapter 9 - Corporations: Organization, Capital Structure, and55 The dividends received deduction may be subject to a limitation based on a percentage of taxable income computed without regard to the NOL deduction, the domestic production activities deduction, the dividends received deduction, and any capital loss carryback to the current tax year.

*a. Trueb. False

1104. Chapter 9 - Corporations: Organization, Capital Structure, and56 No dividends received deduction is allowed unless the corporation has held the stock for more than 45 days.

*a. Trueb. False

1105. Chapter 9 - Corporations: Organization, Capital Structure, and57 Black Corporation, an accrual basis taxpayer, was formed and began operations on February 1, 2011. During its first year of operations (February 1 – December 31, 2011), Black incurred the following expenses: fee paid to state of incorporation of $2,000, accounting and legal services incident to organization of $9,000, and expenses related to the printing and sale of stock certificates of $10,000. Black has $11,000 of qualified organizational expenditures that it may elect to amortize.

*a. Trueb. False

1106. Chapter 9 - Corporations: Organization, Capital Structure, and58 A corporation may elect to amortize startup expenditures over the 60-month period beginning with the month in which the corporation begins

business.

a. True*b. False

1107. Chapter 9 - Corporations: Organization, Capital Structure, and59 A personal service corporation with taxable income of $100,000 will have a tax liability of $22,250.

a. True*b. False

1108. Chapter 9 - Corporations: Organization, Capital Structure, and60 Ed, an individual, incorporates two separate businesses that he owns by establishing two new corporations. Each corporation generates taxable income of $50,000. Each corporation will have a tax liability of $7,500.

a. True*b. False

1109. Chapter 9 - Corporations: Organization, Capital Structure, and61 Generally, corporations with no taxable income must file a Form 1120.

*a. Trueb. False

1110. Chapter 9 - Corporations: Organization, Capital Structure, and62 The due date (not including extensions) for filing a 2010 Federal income tax return for a calendar year C corporation (Form 1120) is April 15, 2011.

a. True*b. False

1111. Chapter 9 - Corporations: Organization, Capital Structure, and63 For purposes of the estimated tax payment rules, a “large corporation” is defined as a corporation that had an average taxable income of $1 million or more over the preceding three-year period.

a. True*b. False

1112. Chapter 9 - Corporations: Organization, Capital Structure, and64 Income that is included in net income per books but not included in taxable income is an addition item on Schedule M-1.

a. True*b. False

1113. Chapter 9 - Corporations: Organization, Capital Structure, and65 An expense that is deducted in computing net income per books but not deductible in computing taxable income is an addition item on Schedule M-1.

*a. Trueb. False

1114. Chapter 9 - Corporations: Organization, Capital Structure, and66 On December 31, 2011, Flamingo, Inc., a calendar year, accrual method C corporation, accrues a bonus of $50,000 to its president (a cash basis taxpayer), who owns 75% of the corporation’s outstanding stock. The $50,000 bonus is paid to the president on February 1, 2012. For Flamingo’s 2011 Form 1120, the $50,000 bonus will be a subtraction item on Schedule M-1.

a. True*b. False

1115. Chapter 9 - Corporations: Organization, Capital Structure, and67 Canary Corporation, which sustained a $5,000 net capital loss during the year, will enter $5,000 as a addition item on Schedule M-1.

*a. Trueb. False

1116. Chapter 9 - Corporations: Organization, Capital Structure, and68 Schedule M-2 is used to reconcile unappropriated retained earnings at the beginning of the year with unappropriated retained earnings at the end of the year.

*a. Trueb. False

1117. Chapter 9 - Corporations: Organization, Capital Structure, and69 A corporation with $10 million or more in assets must file Schedule M-3 (instead of Schedule M-1).

*a. Trueb. False

1118. Chapter 9 - Corporations: Organization, Capital Structure, and70

Schedule M-3 is similar to Schedule M-1 in that the form is designed to reconcile net income per books with taxable income. However, an

objective of Schedule M-3 is more transparency between financial statements and tax returns than that provided by Schedule M-1.

*a. Trueb. False

1119. Chapter 9 - Corporations: Organization, Capital Structure, and71 Juanita owns 45% of the stock in a C corporation that had a profit of $120,000 in 2011. Carlos owns a 45% interest in a partnership that had a profit of $120,000 during the year. The corporation distributed $20,000 to Juanita, and the partnership distributed $20,000 to Carlos. Which of the following statements relating to 2011 is incorrect?

a. Juanita must report $20,000 of income from the corporation.b. The corporation must pay corporate tax on $120,000 of income.*c. Carlos must report $20,000 of income from the partnership.d. The partnership is not subject to a Federal entity-level income tax.e. None of the above.

1120. Chapter 9 - Corporations: Organization, Capital Structure, and72 Bjorn owns a 60% interest in an S corporation that earned $150,000 in 2011. He also owns 60% of the stock in a C corporation that earned $150,000 during the year. The S corporation distributed $30,000 to Bjorn and the C corporation paid dividends of $30,000 to Bjorn. How much income must Bjorn report from these businesses?

a. $0 income from the S corporation and $30,000 income from the C corporation. *b. $90,000 income from the S corporation and $30,000 income from the C corporation.c. $90,000 income from the S corporation and $0 income from the C corporation.d. $30,000 income from the S corporation and $30,000 of dividend income from the C corporation.e. None of the above.

1121. Chapter 9 - Corporations: Organization, Capital Structure, and73 Luis is the sole shareholder of a C corporation, and Eduardo owns a sole proprietorship. Both businesses were started in 2011, and each business has a long-term capital gain of $20,000 for the year. Neither business made any distributions during the year. With respect to this information, which of the following statements is incorrect?

a. Eduardo must report a $20,000 long-term capital gain on his 2011 tax return.b. Louis’s corporation does not receive a preferential tax rate on the $20,000 long-term capital gain.*c. Luis must report a $20,000 long-term capital gain on his 2011 tax return.d. Eduardo receives a preferential tax rate on a long-term

capital gain of $20,000.e. None of the above.

1122. Chapter 9 - Corporations: Organization, Capital Structure, and74 Norma formed Hyacinth Enterprises, a proprietorship, in 2011. In its first year, Hyacinth had operating income of $400,000 and operating expenses of $240,000. In addition, Hyacinth had a long-term capital loss of $10,000. Norma, the proprietor of Hyacinth Enterprises, withdrew $75,000 from Hyacinth during the year. Assuming Norma has no other capital gains or losses, how does this information affect her taxable income for 2011?

a. Increases Norma’s taxable income by $75,000.b. Increases Norma’s taxable income by $160,000.c. Increases Norma’s taxable income by $150,000 ($160,000 ordinary business income – $10,000 long-term capital loss). *d. Increases Norma’s taxable income by $157,000 ($160,000 ordinary business income – $3,000 long-term capital loss). e. None of the above.

1123. Chapter 9 - Corporations: Organization, Capital Structure, and75 Francisco is the sole owner of Rose Company. For 2011, the only income of Rose was a long-term capital gain of $25,000. The business made no distributions during the year to Francisco. Irrespective of Rose Company, Francisco’s marginal tax rate is 35% and he has no capital asset transactions. Which of the following statements is incorrect?

a. If Rose Company is a sole proprietorship or S corporation, Francisco must report the $25,000 long-term capital gain on his personal income tax return.b. If Rose Company is a C corporation, Francisco will report none of the $25,000 long-term capital gain on his personal income tax return.c. If Rose Company is a sole proprietorship or S corporation, a preferential tax rate applies to the $25,000 long-term capital gain.d. If Rose Company is a C corporation, a preferential tax rate does not apply to the $25,000 long-term capital gain.*e. None of the above.

1124. Chapter 9 - Corporations: Organization, Capital Structure, and76 Glen and Michael are equal partners in Trout Enterprises, a calendar year partnership. During the year, Trout Enterprises had gross income of $400,000 and operating expenses of $220,000. In addition, the partnership sold land that had been held for investment purposes for a long-term capital gain of $100,000. During the year, Glen withdrew $60,000 from the partnership, and Michael withdrew $60,000. Discuss the impact of this information on the taxable income of Trout, Glen, and Michael.

a. Trout pays tax on $0 income, Glen’s taxable income increases by $60,000, and Michael’s taxable income increases by $60,000.

b. Trout pays tax on $280,000 income, Glen’s taxable income increases by $60,000, and Michael’s taxable income increases by $60,000.c. Trout pays tax on $0 income, Glen’s taxable income increases by $200,000, and Michael’s taxable income increases by $200,000.*d. Trout pays tax on $0 income, Glen’s taxable income increases by $140,000, and Michael’s taxable income increases by $140,000.e. None of the above.

1125. Chapter 9 - Corporations: Organization, Capital Structure, and77 Elk, a C corporation, has $370,000 operating income and $290,000 operating expenses during the year. In addition, Elk has a $10,000 long-term capital gain and a $17,000 short-term capital loss. Elk’s taxable income is:

a. $90,000.*b. $80,000.c. $73,000. d. $63,000. e. None of the above.

1126. Chapter 9 - Corporations: Organization, Capital Structure, and78 Flycatcher Corporation, a C corporation, has two equal individual shareholders, Nancy and Pasqual. In the current year, Flycatcher earned $200,000 net profit and paid a dividend of $40,000 to each shareholder. Regardless of any tax consequences resulting from their interests in Flycatcher, Nancy is in the 28% marginal tax bracket and Pasqual is in the 35% marginal tax bracket. With respect to the current year, which of the following statements is incorrect?

*a. Flycatcher can avoid the corporate tax altogether by paying out all $200,000 of net profit as dividends to the shareholders. b. Nancy incurs income tax of $6,000 on her dividend income.c. Pasqual incurs income tax of $6,000 on his dividend income.d. Flycatcher pays corporate tax on $200,000.e. None of the above.

1127. Chapter 9 - Corporations: Organization, Capital Structure, and79 Which of the following statements is incorrect about LLCs and the check-the-box Regulations?

a. A limited liability company with one owner can elect to be taxed as a corporation.b. All 50 states have passed laws that allow LLCs.c. An entity with more than one owner and formed as a corporation cannot elect to be taxed as a partnership.d. If a limited liability company with one owner does not make an election, the entity is taxed as a sole proprietorship.*e. If a limited liability company with more than one owner does not make an election, the entity is taxed as a corporation.

1128. Chapter 9 - Corporations: Organization, Capital Structure, and80 Jane and Walt form Orange Corporation. Jane transfers equipment worth $475,000 (basis of $100,000) and cash of $25,000 to Orange Corporation for 50% of its stock. Walt transfers a building and land worth $525,000 (basis of $200,000) for 50% of Orange’s stock and $25,000 cash.

a. Jane recognizes a gain of $375,000; Walt recognizes a gain of $325,000.b. Jane recognizes a gain of $25,000; Walt recognizes no gain.c. Neither Jane nor Walt recognizes gain.*d. Jane recognizes no gain; Walt recognizes a gain of $25,000.e. None of the above.

1129. Chapter 9 - Corporations: Organization, Capital Structure, and81 Eve transfers property (basis of $120,000 and fair market value of $400,000) to Green Corporation for 80% of its stock (worth $350,000) and a long-term note (worth $50,000), executed by Green Corporation and made payable to Eve. As a result of the transfer:

a. Eve recognizes no gain.b. Eve recognizes a gain of $230,000.c. Eve recognizes a gain of $280,000.*d. Eve recognizes a gain of $50,000.e. None of the above.

1130. Chapter 9 - Corporations: Organization, Capital Structure, and82 Ann, Irene, and Bob incorporate their respective businesses and form Dove Corporation. Ann exchanges her property (basis of $100,000 and fair market value of $400,000) for 200 shares in Dove Corporation on March 1, 2009. Irene exchanges her property (basis of $140,000 and fair market value of $600,000) for 300 shares in Dove Corporation on April 11, 2009. Bob transfers his property (basis of $250,000 and fair market value of $1,000,000) for 500 shares in Dove Corporation on May 15, 2011. Bob’s transfer is not part of a prearranged plan with Ann and Irene to incorporate their businesses. What gain, if any, will Bob recognize on the transfer?

a. $1,000,000.*b. $750,000.c. $250,000.d. $0.e. None of the above.

1131. Chapter 9 - Corporations: Organization, Capital Structure, and83 Tom and George form Swan Corporation with the following investments: Tom transfers machinery worth $100,000 (basis of $40,000), while George transfers land worth $90,000 (basis of $20,000) and services rendered in organizing the corporation worth $10,000. Each is issued 25 shares in Swan Corporation. With respect to the transfers:

a. Tom has no recognized gain; George recognizes gain/income of $80,000.

b. Neither Tom nor George recognizes gain or income.c. Swan Corporation has a basis of $30,000 in the land.*d. George has a basis of $30,000 in the shares of Swan Corporation.e. None of the above.

1132. Chapter 9 - Corporations: Organization, Capital Structure, and84 Ann transferred land worth $200,000, with a tax basis of $40,000, to Brown Corporation, an existing entity, for 100 shares of its stock. Brown Corporation has two other shareholders, Bill and Bob, each of whom holds 100 shares. With respect to the transfer:

a. Ann has no recognized gain.b. Brown Corporation has a basis of $160,000 in the land.*c. Ann has a basis of $200,000 in her 100 shares in Brown Corporation.d. Ann has a basis of $40,000 in her 100 shares in Brown Corporation.e. None of the above.

1133. Chapter 9 - Corporations: Organization, Capital Structure, and85 Kevin and Nicole form Indigo Corporation with the following transfers: inventory from Kevin (basis of $360,000 and fair market value of $400,000) and improved real estate from Nicole (basis of $320,000 and fair market value of $375,000). Nicole, an accountant, agrees to contribute her services (worth $25,000) in organizing Indigo. The corporation’s stock is distributed equally to Kevin and Nicole. As a result of these transfers:

a. Indigo can deduct $25,000 as a business expense.b. Nicole has a recognized gain of $55,000 on the transfer of the real estate.*c. Indigo has a basis of $360,000 in the inventory.d. Indigo has a basis of $375,000 in the real estate.e. None of the above.

1134. Chapter 9 - Corporations: Organization, Capital Structure, and86 Tara incorporates her sole proprietorship, transferring it to newly formed Black Corporation. The assets transferred have an adjusted basis of $240,000 and a fair market value of $300,000. Also transferred was $10,000 in liabilities, $1,000 of which was personal and the balance of $9,000 being business related. In return for these transfers, Tara receives all of the stock in Black Corporation.

a. Black Corporation has a basis of $241,000 in the property.b. Black Corporation has a basis of $240,000 in the property.c. Tara’s basis in the Black Corporation stock is $241,000.d. Tara’s basis in the Black Corporation stock is $249,000.*e. None of the above.

1135. Chapter 9 - Corporations: Organization, Capital Structure, and87 Tim, a cash basis taxpayer, incorporates his sole proprietorship. He transfers the following items to newly created Wren Corporation.

Adjusted Fair Market Basis Value Cash $ 20,000 $ 20,000 Building 110,000 160,000 Mortgage payable (secured by the building and held for 15 years) 135,000 135,000

With respect to this transaction:

a. Wren Corporation’s basis in the building is $110,000.b. Tim has no recognized gain.c. Tim has a recognized gain of $25,000.*d. Tim has a recognized gain of $5,000.e. None of the above.

1136. Chapter 9 - Corporations: Organization, Capital Structure, and88 Mary transfers a building (adjusted basis of $15,000 and fair market value of $90,000) to White Corporation. In return, Mary receives 80% of White Corporation’s stock (worth $65,000) and an automobile (fair market value of $5,000). In addition, there is an outstanding mortgage of $20,000 (taken out 15 years ago) on the building, which White Corporation assumes. With respect to this transaction:

*a. Mary’s recognized gain is $10,000.b. Mary’s recognized gain is $5,000.c. Mary has no recognized gain.d. White Corporation’s basis in the building is $15,000.e. None of the above.

1137. Chapter 9 - Corporations: Organization, Capital Structure, and89 Kim owns 100% of the stock of Cardinal Corporation. In the current year Kim transfers an installment obligation, tax basis of $30,000 and fair market value of $200,000, for additional stock in Cardinal worth $200,000.

*a. Kim recognizes no taxable gain on the transfer.b. Kim has a taxable gain of $170,000.c. Kim has a taxable gain of $180,000.d. Kim has a basis of $200,000 in the additional stock she received in Cardinal Corporation.e. None of the above.

1138. Chapter 9 - Corporations: Organization, Capital Structure, and90 Sarah and Emily form Red Corporation with the following investments: Sarah transfers computers worth $200,000 (basis of $80,000), while

Emily transfers real estate worth $180,000 (basis of $40,000) and services (worth $20,000) rendered in organizing the corporation. Each is issued 600 shares in Red Corporation. With respect to the transfers:

a. Sarah has no recognized gain; Emily recognizes income/gain of $160,000.b. Neither Sarah nor Emily recognizes gain or income.c. Red Corporation has a basis of $60,000 in the real estate.*d. Emily has a basis of $60,000 in the shares of Red Corporation.e. None of the above.

1139. Chapter 9 - Corporations: Organization, Capital Structure, and91 Wade and Paul form Swan Corporation with the following investments. Wade transfers machinery (basis of $40,000 and fair market value of $100,000), while Paul transfers land (basis of $20,000 and fair market value of $90,000) and services rendered (worth $10,000) in organizing the corporation. Each is issued 25 shares in Swan Corporation. With respect to the transfers:

a. Wade has no recognized gain; Paul recognizes income/gain of $80,000.b. Neither Wade nor Paul has recognized gain or income on the transfers.c. Swan Corporation has a basis of $30,000 in the land transferred by Paul.*d. Paul has a basis of $30,000 in the 25 shares he acquires in Swan Corporation.e. None of the above.

1140. Chapter 9 - Corporations: Organization, Capital Structure, and92 Rick transferred the following assets and liabilities to Warbler Corporation.

Adjusted Fair Market Basis Value Building $210,000 $225,000Equipment 45,000 75,000Trucks 15,000 30,000Mortgage (held for four years) on building 30,000 30,000

In return, Rick received $75,000 in cash plus 90% of Warbler Corporation’s only class of stock outstanding (fair market value of $225,000).

*a. Rick has a recognized gain of $60,000.b. Rick has a recognized gain of $75,000.c. Rick’s basis in the stock of Warbler Corporation is $270,000.d. Warbler Corporation has the same basis in the assets received as Rick does in the stock.

e. None of the above.

1141. Chapter 9 - Corporations: Organization, Capital Structure, and93 Sarah and Tony (mother and son) form Dove Corporation with the following investments: cash by Sarah of $55,000; land by Tony (basis of $35,000 and fair market value of $45,000). Dove Corporation issues 200 shares of stock, 100 each to Sarah and Tony. Thus, each receives stock in Dove worth $50,000.

a. Section 351 cannot apply since Sarah should have received 110 shares instead of only 100.b. As a result of the transfer, Tony recognizes a gain of $10,000.c. Tony’s basis in the stock of Dove Corporation is $50,000.*d. Section 351 may apply because stock need not be issued to Sarah and Tony in proportion to the value of the property transferred.e. None of the above.

1142. Chapter 9 - Corporations: Organization, Capital Structure, and94 Hunter and Warren form Tan Corporation. Hunter transfers equipment (basis of $210,000 and fair market value of $180,000) while Warren transfers land (basis of $15,000 and fair market value of $150,000) and $30,000 of cash. Each receives 50% of Tan’s stock. As a result of these transfers:

a. Hunter has a recognized loss of $30,000; Warren has a recognized gain of $135,000.*b. Neither Hunter nor Warren has any recognized gain or loss.c. Hunter has no recognized loss; Warren has a recognized gain of $30,000.d. Tan Corporation has a basis in the land of $45,000.e. None of the above.

1143. Chapter 9 - Corporations: Organization, Capital Structure, and95 Erica transfers land worth $500,000, basis of $100,000, to a newly formed corporation, Robin Corporation, for all of Robin’s stock, worth $300,000, and a 10-year note. The note was executed by Robin and made payable to Erica in the amount of $200,000. As a result of the transfer:

a. Erica does not recognize gain.b. Erica recognizes gain of $400,000.c. Robin Corporation has a basis of $100,000 in the land.*d. Robin Corporation has a basis of $300,000 in the land.e. None of the above.

1144. Chapter 9 - Corporations: Organization, Capital Structure, and96 Kathleen transferred the following assets to Mockingbird Corporation.

Adjusted Fair Market Basis Value Cash $100,000 $100,000Equipment 48,000 36,000Land 108,000 144,000

In exchange, Kathleen received 40% of Mockingbird Corporation’s only class of stock outstanding. The stock has no established value. However, all parties sincerely believe that the value of the stock Kathleen received is the equivalent of the value of the assets she transferred. The only other shareholder, Rick, formed Mockingbird Corporation five years ago.

a. Kathleen has no gain or loss on the transfer.b. Mockingbird Corporation has a basis of $48,000 in the equipment and $108,000 in the land.c. Kathleen has a basis of $256,000 in the stock of Mockingbird Corporation.*d. Mockingbird Corporation has a basis of $36,000 in the equipment and $144,000 in the land. e. None of the above.

1145. Chapter 9 - Corporations: Organization, Capital Structure, and97 Dawn, a sole proprietor, was engaged in a service business and reported her income on a cash basis. Later, she incorporates her business and transfers the assets of the business to the corporation in return for all the stock in the corporation plus the corporation’s assumption of the liabilities of her proprietorship. All the receivables and the unpaid trade payables are transferred to the newly formed corporation. The assets of the proprietorship had a basis of $105,000 and fair market value of $300,000. The trade accounts payable totaled $25,000. There was a note payable to the bank in the amount of $95,000 that the corporation assumes. The note was issued for the purchase of computers and other business equipment.

a. Dawn has a gain on the transfer of $15,000.b. The basis of the assets to the corporation is $300,000.*c. Dawn has a basis of $10,000 in the stock she receives.d. Dawn has a zero basis in the stock she receives.e. None of the above.

1146. Chapter 9 - Corporations: Organization, Capital Structure, and98 Carl transfers land to Cardinal Corporation for 90% of the stock in Cardinal Corporation worth $20,000 plus a note payable to Carl in the amount of $40,000 and the assumption by Cardinal Corporation of a mortgage on the land in the amount of $100,000. The land, which has a basis to Carl of $70,000, is worth $160,000.

a. Carl will have a recognized gain on the transfer of $90,000.b. Carl will have a recognized gain on the transfer of $30,000.

c. Cardinal Corporation will have a basis in the land transferred by Carl of $70,000.d. Cardinal Corporation will have a basis in the land transferred by Carl of $160,000.*e. None of the above.

1147. Chapter 9 - Corporations: Organization, Capital Structure, and99 Kirby and Helen form Red Corporation. Kirby transfers property, basis of $20,000 and value of $300,000, for 100 shares in Red Corporation. Helen transfers property, basis of $40,000 and value of $280,000, and provides legal services in organizing the corporation. The value of her services is $20,000. In return Helen receives 100 shares in Red Corporation. With respect to the transfers:

a. Kirby will recognize gain.b. Helen will not recognize any gain or income.c. Red Corporation will have a basis of $280,000 in the property it acquired from Helen.d. Red will have a business deduction of $20,000.*e. None of the above.

1148. Chapter 9 - Corporations: Organization, Capital Structure, an100 Joe and Kay form Gull Corporation. Joe transfers cash of $250,000 for 200 shares in Gull Corporation. Kay transfers property with a basis of $50,000 and fair market value of $240,000. She agrees to accept 200 shares in Gull Corporation for the property and for providing bookkeeping services to the corporation in its first year of operation. The value of Kay’s services is $10,000. With respect to the transfer:

a. Gull Corporation has a basis of $240,000 in the property transferred by Kay.b. Neither Joe nor Kay recognizes gain or income on the exchanges.*c. Gull Corporation has a business deduction under § 162 of $10,000.d. Gull capitalizes $10,000 as organizational costs.e. None of the above.

1149. Chapter 9 - Corporations: Organization, Capital Structure, an101 Earl and Mary form Crow Corporation. Earl transfers property, basis of $200,000 and value of $1,600,000, for 50 shares in Crow Corporation. Mary transfers property, basis of $80,000 and value of $1,480,000, and agrees to serve as manager of Crow for one year; in return Mary receives 50 shares of Crow. The value of Mary’s services is $120,000. With respect to the transfers:

a. Mary will not recognize gain or income.b. Earl will recognize a gain of $1,400,000.c. Crow Corporation has a basis of $1,480,000 in the property it received from Mary.*d. Crow will have a business deduction of $120,000 for the value of the services Mary will render.

e. None of the above.

1150. Chapter 9 - Corporations: Organization, Capital Structure, an102 Four individuals form Chickadee Corporation under § 351. Two of these individuals, Jane and Walt, made the following contributions:

Adjusted Fair Market Basis Value From Jane— Cash $360,000 $360,000 Patent –0– 40,000 From Walt— Equipment (depreciation claimed of $100,000) 240,000 370,000

Both Jane and Walt receive stock in Chickadee Corporation equal to the value of their investments.

a. Jane must recognize income of $40,000; Walt has no income.*b. Neither Jane nor Walt recognize income.c. Walt must recognize income of $130,000; Jane has no income.d. Walt must recognize income of $100,000; Jane has no income.e. None of the above.

1151. Chapter 9 - Corporations: Organization, Capital Structure, an103 Leonard transfers equipment (basis of $40,000 and fair market value of $100,000) for additional stock in Green Corporation. After the transfer, Leonard owns 90% of the stock. Leonard had claimed depreciation of $50,000 on the equipment prior to transferring it to Green Corporation. With respect to the transfer:

a. Leonard has ordinary income of $50,000.b. Leonard has ordinary income of $50,000 and a § 1231 gain of $10,000.c. Green Corporation has ordinary income of $50,000.d. Green Corporation has a basis of $40,000 in the equipment and it will have no depreciation recapture if it later disposes of the equipment in a taxable transaction.*e. None of the above.

1152. Chapter 9 - Corporations: Organization, Capital Structure, an104 In order to induce Yellow Corporation to build a new manufacturing facility in Knoxville, Tennessee, the city donates land (fair market value of $400,000) and cash of $100,000 to the corporation. Several months after the donation, Yellow Corporation spends $450,000 (which includes the $100,000 received from Knoxville) on the construction of a new plant located on the donated land.

a. Yellow recognizes income of $100,000 as to the donation.b. Yellow has a zero basis in the land and a basis of $450,000 in the plant.c. Yellow recognizes income of $500,000 as to the donation.*d. Yellow has a zero basis in the land and a basis of $350,000 in the plant.e. None of the above.

1153. Chapter 9 - Corporations: Organization, Capital Structure, an105 Thomas transfers cash of $160,000 to Grouse Corporation, a newly formed corporation, for 100% of the stock in Grouse worth $90,000 and debt in the amount of $70,000, payable in equal annual installments of $7,000 plus interest at the rate of 5% per annum. In the first year of operation, Grouse has net taxable income of $40,000. If Grouse pays Thomas interest of $3,500 and $7,000 principal payment on the note:

a. Thomas has dividend income of $10,500.b. Grouse Corporation does not have a tax deduction with respect to the payment.*c. Grouse Corporation has an interest expense deduction of $3,500.d. Thomas has dividend income of $7,000.e. None of the above.

1154. Chapter 9 - Corporations: Organization, Capital Structure, an106 Adam transfers cash of $300,000 and land worth $200,000 to Camel Corporation for 100% of the stock in Camel. In the first year of operation, Camel has net taxable income of $70,000. If Camel distributes $50,000 to Adam:

*a. Adam has taxable income of $50,000.b. Camel Corporation has a tax deduction of $50,000.c. Adam has no taxable income from the distribution.d. Camel Corporation reduces its basis in the land to $150,000.e. None of the above.

1155. Chapter 9 - Corporations: Organization, Capital Structure, an107 Red Corporation, which owns stock in Blue Corporation, had net operating income of $200,000 for the year. Blue pays Red a dividend of $40,000. Red takes a dividends received deduction of $28,000. Which of the following statements is correct?

a. Red owns 80% of Blue Corporation.b. Red owns 20% or more, but less than 80% of Blue Corporation.*c. Red owns less than 20% of Blue Corporation. d. Red owns 80% or more of Blue Corporation.e. None of the above.

1156. Chapter 9 - Corporations: Organization, Capital Structure, an108 Eagle Corporation owns stock in Hawk Corporation and has taxable income of $100,000 for the year before considering the dividends received

deduction. Hawk Corporation pays Eagle a dividend of $130,000, which was considered in calculating the $100,000. What amount of dividends received deduction may Eagle claim if it owns 25% of Hawk’s stock?

a. $0.b. $80,000.c. $100,000.*d. $104,000.e. None of the above.

1157. Chapter 9 - Corporations: Organization, Capital Structure, an109 Copper Corporation owns stock in Bronze Corporation and has net operating income of $900,000 for the year. Bronze Corporation pays Copper a dividend of $150,000. What amount of dividends received deduction may Copper claim if it owns 65% of Bronze stock (assuming Copper’s dividends received deduction is not limited by its taxable income)?

a. $97,500.b. $105,000.*c. $120,000.d. $150,000.e. None of the above.

1158. Chapter 9 - Corporations: Organization, Capital Structure, an110 Orange Corporation owns stock in White Corporation and has net operating income of $400,000 for the year. White Corporation pays Orange a dividend of $60,000. What amount of dividends received deduction may Orange claim if it owns 15% of White stock (assuming Orange’s dividends received deduction is not limited by its taxable income)?

a. $9,000.*b. $42,000.c. $48,000.d. $60,000.e. None of the above.

1159. Chapter 9 - Corporations: Organization, Capital Structure, an111 Which of the following statements is incorrect regarding the dividends received deduction?

*a. A corporation must hold stock for more than 90 days in order to qualify for a deduction with respect to dividends on such stock.b. The taxable income limitation does not apply with respect to the 100% deduction available to members of an affiliated group.c. If a stock purchase is financed 75% by debt, the deduction for dividends on such stock is reduced by 75%.d. The taxable income limitation does not apply if the normal deduction (i.e., 70% or 80% of dividends) results in a net operating loss for the corporation.

e. None of the above.

1160. Chapter 9 - Corporations: Organization, Capital Structure, an112 Emerald Corporation, a calendar year C corporation, was formed and began operations on July 1, 2011. The following expenses were incurred during the first tax year (July 1 through December 31, 2011) of operations:

Expenses of temporary directors and of organizational meetings $9,000Fee paid to the state of incorporation 1,000Accounting services incident to organization 2,500Legal services for drafting the corporate charter and bylaws 3,500Expenses incident to the printing and sale of stock certificates 4,000

Assuming a § 248 election, what is the Emerald’s deduction for organizational expenditures for 2011?

a. $0.b. $533.*c. $5,367.d. $5,500.e. None of the above.

1161. Chapter 9 - Corporations: Organization, Capital Structure, an113 During 2011, Sparrow Corporation, a calendar year C corporation, had operating income of $510,000, operating expenses of $370,000, a short-term capital loss of $25,000, and a long-term capital gain of $80,000. How much is Sparrow’s tax liability for 2011?

a. $46,100.*b. $59,300.c. $69,050.d. $76,050.e. None of the above.

1162. Chapter 9 - Corporations: Organization, Capital Structure, an114 George Judson is the sole shareholder and employee of Black Corporation, a C corporation that is engaged exclusively in engineering services. During the year, Black has gross revenues of $420,000 and operating expenses (excluding salary) of $200,000. Further, Black Corporation pays George a salary of $190,000. The salary is reasonable in amount and George is in the 35% marginal tax bracket irrespective of any income from Black. Assuming that Black Corporation distributes all after-tax income as dividends, how much total combined income tax do Black and George pay in the current year? (Ignore any employment tax considerations.)

a. $66,675.*b. $79,925.c. $83,325.

d. $87,500.e. None of the above.

1163. Chapter 9 - Corporations: Organization, Capital Structure, an115 Which of the following statements is incorrect regarding the taxation of C corporations?

a. The highest corporate marginal tax rate is 39%.b. Taxable income of a personal service corporation is taxed at a flat rate of 35%.c. A tax return must be filed whether or not the corporation has taxable income.*d. Similar to those applicable to individuals, the marginal tax rate brackets for corporations are adjusted for inflation.e. None of the above.

1164. Chapter 9 - Corporations: Organization, Capital Structure, an116 Which of the following statements is correct regarding the taxation of C corporations?

*a. The due date for a corporate income tax return (ignoring extensions) is the fifteenth day of the third month following the close of the corporation’s tax year.b. A corporation with taxable income of less than $500 need not file a tax return.c. The alternative minimum tax does not apply. d. In general, the required annual payment for corporate estimated taxes is 90% of the corporation’s final tax for the current year.e. None of the above.

1165. Chapter 9 - Corporations: Organization, Capital Structure, an117 Vireo Corporation, a calendar year C corporation, has taxable income of $1.3 million and $3 million for 2010 and 2011, respectively. The minimum 2011 estimated tax installment payments for Vireo are:

a. April 15, 2011, $110,500; June 15, 2011, $110,500; September 15, 2011, $110,500; December 15, 2011, $110,500.b. April 15, 2011, $110,500; June 15, 2011, $399,500; September 15, 2011, $399,500; December 15, 2011, $399,500.*c. April 15, 2011, $110,500; June 15, 2011, $399,500; September 15, 2011, $255,000; December 15, 2011, $255,000.d. April 15, 2011, $255,000; June 15, 2011, $255,000; September 15, 2011, $255,000; December 15, 2011, $255,000.e. None of the above.

1166. Chapter 9 - Corporations: Organization, Capital Structure, an118 Schedule M-1 of Form 1120 is used to reconcile financial net income with taxable income reported on the corporation’s income tax return as follows: net income per books + additions – subtractions = taxable

income. Which of the following items is an addition on Schedule M-1?

*a. Premiums paid on key employee life insurance.b. Proceeds of life insurance paid on death of key employee.c. Charitable contributions carryover from previous year.d. Tax-exempt interest.e. None of the above.

1167. Chapter 9 - Corporations: Organization, Capital Structure, an119 Schedule M-1 of Form 1120 is used to reconcile financial net income with taxable income reported on the corporation’s income tax return as follows: net income per books + additions – subtractions = taxable income. Which of the following items is a subtraction on Schedule M-1?

*a. Proceeds on key employee life insurance.b. Excess of capital losses over capital gains.c. Book depreciation in excess of tax depreciation.d. Income subject to tax but not recorded on the books.e. None of the above.

1168. Chapter 9 - Corporations: Organization, Capital Structure, an120 During the current year, Waterthrush Company had operating income of $510,000 and operating expenses of $400,000. In addition, Waterthrush had a long-term capital gain of $30,000. How does Lucinda, the sole owner of Waterthrush Company, report this information on her individual income tax return under following assumptions?

a. Waterthrush is a proprietorship, and Lucinda does not withdraw any funds from the company during the year.

b. Waterthrush is an LLC, and Lucinda does not withdraw any funds from

the company during the year. c. Waterthrush is an S corporation, and Lucinda does not withdraw any

funds from the company during the year. d. Waterthrush is a regular corporation, and Lucinda does not withdraw

any funds from the company during the year.

Correct Answer:a. Revenues, expenses, gains, and losses of a proprietorship flow through to the proprietor.

Consequently, Lucinda reports the $110,000 operating profit and $30,000 long-term capital gain on her individual return. The preferential tax rate on LTCG applies with respect to the $30,000 gain.

b. A single-member LLC is taxed as a proprietorship. Consequently, Lucinda reports the $110,000 operating profit and $30,000 long-term capital gain on her individual return. The preferential tax rate on LTCG applies with respect to the $30,000 gain.

c. Revenues, expenses, gains, and losses of an S corporation flow through to the shareholders. Separately stated items (e.g., capital gains and losses), retain their character at the shareholder level. Consequently, Lucinda reports the $110,000 operating profit and $30,000 long-term capital gain on her individual return. The preferential tax rate on LTCG applies with respect to the $30,000 gain.

d. Shareholders of a regular (C) corporation report income from the corporation to the extent of dividends received. Therefore, Lucinda does not report any of Waterthrush’s operating profit or capital gain on her individual return. [Waterthrush Company would report taxable income of $140,000 ($110,000 operating profit + $30,000 long-term capital gain) on its corporate return (Form 1120). C corporations do not receive preferential tax rate treatment with respect to LTCGs.]

1169. Chapter 9 - Corporations: Organization, Capital Structure, an121 Beige Company has approximately $250,000 in net income in 2011 before deducting any compensation or other payment to its sole owner, Janet (who is single). Assume that Janet is in the 35% marginal tax bracket. Discuss the tax aspects of each of the following arrangements. (Ignore any employment tax considerations.)

a. Janet operates Beige Company as a proprietorship. b. Janet incorporates Beige Company and pays herself a salary of

$150,000 and no dividend. c. Janet incorporates the company and pays herself a $150,000 salary

and a dividend of $77,750 ($100,000 – $22,250 corporate income tax). d. Janet incorporates the company and pays herself a salary of

$250,000.

Correct Answer:a. Janet’s tax on $250,000 at 35% $87,500

b. Janet’s tax on $150,000 at 35% $52,500 Beige’s tax on $100,000 at corporate rates 22,250 Total tax $74,750

c. Beige’s tax on $100,000 at corporate rates $22,250 Janet’s tax on $77,750 dividend distributed at 15% 11,663 Janet’s tax on $150,000 salary at 35% 52,500 Total tax $86,413

d. Janet’s tax on $250,000 at 35% $87,500

1170. Chapter 9 - Corporations: Organization, Capital Structure, an122 During the current year, Shrike Company had $220,000 net profit from operations. Carlos, the sole owner of Shrike, is in the 35% marginal tax bracket. Determine the combined tax burden for Shrike and Carlos under the following two independent situations. (Ignore any employment taxes.)

a. Shrike Company is a C corporation and all of its after-tax income is distributed to Carlos.

b. Shrike Company is a proprietorship and all of its after-tax income

is withdrawn by Carlos.

Correct Answer:a. If Shrike Company is a C corporation, the $220,000 is taxable at the corporate level,

resulting in corporate tax of $69,050. The after-tax dividend distribution of $150,950 ($220,000 – $69,050) to Carlos will result in tax of $22,642.50 ($150,950 ´ 15%). Total taxes amount to $91,692.5 ($69,050 + $22,642.50).

b. If Shrike Company is a proprietorship, there is no entity level Federal income tax. Instead,

the income of the proprietorship is reported on Carlos’s personal tax return, resulting in tax of $77,000 ($220,000 ´ 35%). Carlos’s withdrawal of the after-tax income has no income tax consequences.

1171. Chapter 9 - Corporations: Organization, Capital Structure, an123 Penny, Miesha, and Sabrina transfer property to Owl Corporation for 75% of its stock. Nancy, their attorney, receives 25% of the stock in Owl for legal services rendered in incorporating the business. What are the tax consequences of these transactions? How should this transaction have been handled?

Correct Answer:Based on the facts provided, the transaction will be taxable to all persons involved. Section 351 treatment will be lost if stock is transferred to persons who did not contribute property, causing those who did to lack control immediately after the exchange. However, if a person performs services for the corporation in exchange for stock and also transfers some property, he or she may be treated as a member of the transferring group although the value of the stock issued for services is taxed.

1172. Chapter 9 - Corporations: Organization, Capital Structure, an124 Julio exchanges property, basis of $100,000 and fair market value of $1.8 million, for 75% of the stock of Lime Corporation. The other 25% is owned by Gloria who acquired it several years ago. What are the tax consequences to the parties involved?

Correct Answer:Julio has a taxable gain of $1.7 million. Although § 351 also applies to transfers of property to existing corporations, Julio did not receive at least an 80% stock ownership. Thus, the transaction is a taxable exchange. Julio has a $1.8 million basis in his stock, and Lime Corporation has a basis of $1.8 million in the property it received.

1173. Chapter 9 - Corporations: Organization, Capital Structure, an125 Robert organized Redbird Corporation 10 years ago by contributing property worth $3 million, basis of $550,000, for 2,000 shares of stock in Redbird, representing 100% of the stock in the corporation. Robert later gave each of his children, Brittany and Julie, 600 shares of stock in Redbird Corporation. In the current year, Robert transfers property worth $700,000, basis of $150,000, to Redbird for 1,000 shares in the corporation. What gain, if any, will Robert recognize on the transfer?

Correct Answer:Robert recognizes a gain of $550,000 on the transfer [$700,000 (value of the stock received) – $150,000 (basis in the property)]. The transfer does not qualify under § 351. Although Robert originally owned 100% of Redbird Corporation, Robert only owns 60% of Redbird Corporation after the transfer [2,000 (shares originally owned) – 1,200 (shares transferred to Brittany and Julie) + 1,000 (shares acquired in the transfer), or 1,800 shares out of a total of 3,000 shares]. [The ownership of the shares held by Brittany and Julie cannot be counted because the attribution rules of § 318 (discussed in Chapter 6) do not apply to a § 351 transfer.]

1174. Chapter 9 - Corporations: Organization, Capital Structure, an126 Ashley, a 70% shareholder of Wren Corporation, transfers property with a basis of $250,000 and a fair market value of $900,000 to Wren Corporation for additional stock. Ashley owns 78% of Wren after the transfer. Two other shareholders in Wren transfer a nominal amount of property to Wren along with Ashley’s transfer so that Ashley and the two shareholders own 90% of the Wren stock after the transfer. Does

Ashley have taxable gain on the transfer?

Correct Answer:Ashley would have a taxable gain of $650,000 on the transfer. She does not have the requisite 80% control. The transfer by the two shareholders will not qualify the transfer for § 351 treatment because the primary purpose of the transfer was to qualify under this section. Should the transfer of property by the two shareholders have a value equal to or in excess of 10% of the fair market value of the stock owned by them after the transfer, the transfer would qualify.

1175. Chapter 9 - Corporations: Organization, Capital Structure, an127 Trudy forms Oak Corporation by transferring land with a basis of $150,000 (fair market value of $800,000), subject to a mortgage of $450,000. Two weeks prior to incorporating Oak, Trudy borrows $10,000 for personal purposes and gives the lender a second mortgage on the land. Oak Corporation issues stock worth $340,000 to Trudy and assumes the two mortgages on the land. What are the tax consequences to Trudy and to Oak Corporation?

Correct Answer:Both §§ 357(b) and (c) come into play. Because the land is subject to liabilities in excess of basis, Trudy has a recognized gain of $310,000 pursuant to § 357(c). Section 357(b) also applies because Trudy borrowed the $10,000 shortly before incorporating and used the money for personal purposes. Section 357(b) causes all the liabilities ($460,000) to be tainted and treated as boot. Under § 357(b), Trudy’s realized gain of $650,000 [$800,000 (value of the stock received and release of mortgages) – $150,000 (basis in the land)] is recognized to the extent of the boot of $460,000. When §§ 357(b) and (c) both apply to the same transfer, § 357(b) predominates. Thus, Trudy has a recognized gain of $460,000 on the transfer. Oak Corporation has a basis of $610,000 in the land, computed as follows: $150,000 (carryover basis from Trudy) + $460,000 (gain recognized by Trudy). Trudy has a $150,000 basis in her stock, computed as follows: $150,000 (basis in the land) + $460,000 (gain recognized) – $460,000 (liabilities assumed by Oak Corporation).

1176. Chapter 9 - Corporations: Organization, Capital Structure, an128 Nancy, Guy, and Rod form Goldfinch Corporation with the following consideration.

Adjusted Fair Market Basis Value From Nancy— Cash $120,000 $120,000 Inventory 90,000 130,000 From Guy— Land and building 120,000 250,000 From Rod— Legal and accounting services to –0– 50,000

incorporate

Goldfinch issues its 500 shares of stock as follows: 250 to Nancy, 200 to Guy, and 50 to Rod. In addition, Guy gets $50,000 in cash.

a. Does Nancy, Guy, or Rod recognize gain (or income)? b. What basis does Guy have in the Goldfinch stock? c. What basis does Goldfinch Corporation have in the inventory? In the

land and building? d. What basis does Rod have in the Goldfinch stock?

Correct Answer:a. Nancy recognizes no gain. Due to the boot he receives, Guy recognizes $50,000 of gain.

Rod has ordinary income of $50,000 for the services he performs. b. Guy’s basis in the Goldfinch stock is $120,000 [$120,000 (basis in the land and building) +

$50,000 (gain recognized) – $50,000 (boot received)]. c. Goldfinch Corporation’s basis in the inventory is $90,000. Its basis in the land and building is

$170,000 [$120,000 (Guy’s basis) + $50,000 (gain recognized by Guy)]. d. Rod’s basis in the Goldfinch stock is $50,000.

1177. Chapter 9 - Corporations: Organization, Capital Structure, an129 Sean, a sole proprietor, is engaged in a service business and uses the cash basis of accounting. In the current year, Sean incorporates his business by forming Aqua Corporation. In exchange for all of its stock, Aqua receives: assets (basis of $400,000 and fair market value of $2 million), trade accounts payable of $110,000, and loan due to a bank of $390,000. The proceeds from the bank loan were used by Sean to provide operating funds for the business. Aqua Corporation assumes all of the liabilities transferred to it.

a. Does Sean recognize any gain on the incorporation? Explain. b. What basis does Sean have in the Aqua stock? c. What basis does Aqua Corporation have in the assets it receives?

Correct Answer:a. Initially it seems as if the liabilities of $500,000 [$110,000 (trade accounts payable) +

$390,000 (bank loan)] exceed the basis of the assets so as to make § 357(c) apply. However, for this purpose the trade accounts payable are not counted since they originate

from a cash basis taxpayer and would give rise to a deduction. Thus, Sean has no recognized gain.

b. $10,000 [$400,000 (basis in the assets) – $390,000 (bank loan assumed by Aqua

Corporation)]. c. $400,000 (Sean’s basis in the assets).

1178. Chapter 9 - Corporations: Organization, Capital Structure, an130 Barry and Irv form Swift Corporation. Barry transfers cash of $100,000 and equipment (basis of $300,000 and fair market value of $400,000) for 50% of Swift’s stock. Irv transfers land and building (basis of $510,000 and fair market value of $450,000) and agrees to manage the business for one year for the other 50% of Swift’s stock. The value of Irv’s services for one year is $50,000.

a. What is Barry’s recognized gain? Basis in the Swift Corporation stock?

b. What are the tax consequences to Irv? c. What are the tax consequences to Swift Corporation?

Correct Answer:a. Section 351 applies to these transfers as Irv’s stock can be counted in satisfying the control

requirement. The property Irv transfers has more than nominal value in comparison to the services rendered. (The property has a value of at least 10% of the value of the services.) Consequently, Barry has no recognized gain. His basis in the Swift Corporation stock is $400,000 [$100,000 (cash) + $300,000 (basis of property transferred) + $0 (gain recognized)].

b. Irv has no recognized gain or loss on the property transfer due to § 351. However, he has

ordinary income of $50,000 as to the services he renders. He has a basis in the Swift Corporation stock of $560,000 [$510,000 (basis in the land and building) + $50,000 (income recognized related to services rendered)].

c. Swift Corporation has a compensation deduction of $50,000. Swift’s basis in the equipment

is $300,000. However, the basis in the land and building must be reduced from $510,000 to $450,000 (their fair market value) because of the $60,000 built-in loss.

1179. Chapter 9 - Corporations: Organization, Capital Structure, an131 In order to encourage the development of its industrial park, Union County gives Darter Corporation land (fair market value of $800,000) and cash of $500,000. Within one year, Darter constructs a new plant at the site at a cost of $1,200,000.

a. How much income, if any, must Darter Corporation recognize as a result of these transfers?

b. What basis will Darter Corporation have in the land? In the plant?

Correct Answer:a. None, as these are contributions to the capital of a corporation by a nonshareholder. b. Zero basis in the land and $700,000 basis in the new plant. The cost of the plant

($1,200,000) must be reduced by the cash ($500,000) received from Union County.

1180. Chapter 9 - Corporations: Organization, Capital Structure, an132 Lark City donates land worth $300,000 and cash of $100,000 to Orange Corporation as an inducement to locate in the city. Four months later, Orange purchases additional land and a building at a cost of $500,000 and moves its operations to Lark City. Ann, the sole shareholder, contributes equipment (basis of $70,000 and fair market value of $200,000) to help Orange in its new operations. What are the tax consequences of these transfers to Orange Corporation?

Correct Answer:Orange Corporation will not have income on the transfers from Lark City or Ann. However, its basis in the donated land is zero. In addition, Orange must reduce its basis in the purchased land and building from $500,000 to $400,000. The basis of any property acquired with money received from a nonshareholder during a 12-month period beginning on the day the contribution is received is reduced by the amount of the contribution. Orange will have a basis of $70,000 in the equipment it receives from Ann. Finally, the transfer, which is a capital contribution by Ann, increases her stock basis in Orange by $70,000.

1181. Chapter 9 - Corporations: Organization, Capital Structure, an133 Stock in Merlin Corporation is held equally by Jane, Eve, and Fred. Merlin seeks additional capital to buy a valuable tract of land that will cost $6,000,000. Jane, Eve, and Fred propose to loan Merlin $2,000,000 each, taking from Merlin a $2,000,000 ten-year note with interest payable annually at five points above the prime rate. Merlin Corporation has current taxable income of $7,000,000. How are the payments on the notes treated for tax purposes?

Correct Answer:Payments on the notes will probably be treated as dividends for tax purposes. The debt instruments have too many features of stock. The debt does not bear a legitimate rate of interest, and the debt is proportionate to the stock holdings of Jane, Eve, and Fred. Merlin Corporation has substantial current taxable income indicating an attempt to withdraw earnings in the form of principal and interest payments on debt obligations rather than as dividends.

1182. Chapter 9 - Corporations: Organization, Capital Structure, an134 During the current year, Quartz Corporation (a calendar year C corporation) has the following transactions:

Income from operations $450,000Expenses from operations 500,000Dividends received from ABC Corporation 100,000

Quartz owns 15% of ABC Corporation’s stock. How much is Quartz Corporation’s taxable income (loss) for the year?

Correct Answer:

Quartz has an NOL, computed as shown below:

Gross income: From operations $450,000 Dividends 100,000 $550,000 Less: Expenses from operations $500,000 Dividends received deduction ($100,000 ´ 70%) 70,000 (570,000) Net operating loss ($ 20,000)

The dividends received deduction is not limited to the taxable income limitation because it creates a net operating loss.

1183. Chapter 9 - Corporations: Organization, Capital Structure, an135 During the current year, Coyote Corporation (a calendar year C corporation) has the following transactions:

Income from operations $260,000Expenses from operations 285,000Dividends received from Roadrunner Corporation 115,000

a. Coyote owns 5% of Roadrunner Corporation’s stock. How much is Coyote Corporation’s taxable income (loss) for the year?

b. Would your answer change if Coyote owned 25% of Roadrunner

Corporation’s stock?

Correct Answer:a. The key to this question is the relationship between the dividends received deduction and

the NOL deduction. The dividends received deduction is limited to a percentage of taxable income of the corporation (unless taking the full dividends received deduction would cause or increase an NOL). In this case, the dividends received deduction is limited to 70% of taxable income.

Gross income: From operations $260,000 Dividends 115,000 $375,000 Less: Expenses from operations (285,000) Taxable income before the dividends received deduction $ 90,000 Dividends received deduction (70% ´ $90,000) (63,000) Taxable income $ 27,000 The dividends received deduction is limited to 70% of taxable income because taking 70% of

$115,000 ($80,500) would not create an NOL.

b. If Coyote Corporation owns 25% of Roadrunner Corporation’s stock, the percentage for calculating the dividends received deduction is 80%. Under these circumstances, taking the full dividends received deduction would create an NOL.

Gross income: From operations $260,000 Dividends 115,000 $375,000 Less: Expenses from operations (285,000) Taxable income before the dividends received deduction $ 90,000 Dividends received deduction (80% ´ $115,000) (92,000) Net operating loss ($ 2,000)

1184. Chapter 9 - Corporations: Organization, Capital Structure, an136 Warbler Corporation, an accrual method regular corporation, was formed and began operations on March 1, 2011. The following expenses were incurred during its first year of operations (March 1 - December 31, 2011):

Expenses of temporary directors and organizational meetings

$25,000

Incorporation fee paid to state 2,000Expenses incurred in printing and selling stock certificates

10,000

Accounting services incident to organization 12,000

a. Assuming a valid election under § 248 to amortize organizational expenditures, what is the amount of Warbler’s deduction for 2011?

b. Same as a., except that Warbler also incurred in 2011 legal fees

of $15,000 for the drafting of the corporate charter and bylaws. What is the amount of Warbler’s 2011 deduction for organizational expenditures?

Correct Answer:a. Warbler has qualifying organizational expenditures of $39,000 [$25,000 (expenses of

temporary directors and organizational meetings) + $2,000 (incorporation fee) + $12,000 (accounting fees)]. Expenses related to the printing or selling of stock or other securities do not qualify as organizational expenditures. Warbler’s 2011 deduction for the organizational expenditures is $6,889 {$5,000 + [($39,000 – $5,000)/180 ´ 10 months]}.

b. Warbler now has qualifying organizational expenditures of $54,000 [$39,000 (as computed

in a., above) + $15,000 (legal fees)]. Warbler’s 2011 deduction for the organizational expenditures is $3,944 {$1,000 + [($54,000 – $1,000)/180 ´ 10 months]}. The $5,000 immediate expensing amount is reduced to the extent qualifying organizational expenditures exceed $50,000; thus, only $1,000 of the expenditures are immediately deductible, and the remainder of the expenditures are amortized over 180 months.

1185. Chapter 9 - Corporations: Organization, Capital Structure, an137 In each of the following independent situations, determine the corporation’s income tax liability. Assume that all corporations use a calendar year and that the year involved is 2011.

Taxable Income

Violet Corporation $ 22,000Indigo Corporation 90,000Orange Corporation 220,000Blue Corporation 5,100,000Green Corporation 19,800,000

Correct Answer:Violet Corporation: Tax on $22,000 ´ 15% $3,300 Indigo Corporation: Tax on $90,000— $50,000 ´ 15% $ 7,500 $25,000 ´ 25% 6,250 $15,000 ´ 34% 5,100 Total tax $18,850 Orange Corporation: Tax on $220,000— $100,000 $22,250 $120,000 ´ 39% 46,800 Total tax $69,050 Blue Corporation: Tax on $5,100,000— $335,000 $ 113,900 $4,765,000 ´ 34% 1,620,100 Total tax $1,734,000

Green Corporation: Tax on $19,800,000 ´ 35% $6,930,000,000

1186. Chapter 9 - Corporations: Organization, Capital Structure, an138 Almond Corporation, a calendar year C corporation, had taxable income of $900,000, $1.1 million, and $790,000 for 2008, 2009, and 2010, respectively. Almond’s taxable income is $1.5 million for 2011. Compute the minimum estimated tax payments for 2011 for Almond Corporation.

Correct Answer:

A corporation that had taxable income of $1 million or more in any of the three preceding years is a “large corporation” for purposes of utilizing the prior year’s tax exception for estimated tax payments. As such, Almond Corporation can use the prior year’s tax exception for computing its first 2011 estimated tax payment only, and any shortfall as a result of such use must be paid with the second installment.

Payment Amount April 15, 2011 $ 67,150* June 15, 2011 187,850** September 15, 2011 127,500 December 15, 2011 127,500 Total $510,000

*Based on preceding year’s tax, for first installment only: [$790,000 taxable income ´ 34% (see Exhibit 2.1)] = $268,600 ¸ 4 = $67,150.

**Based on current year’s tax, for remaining installments: [$1.5 million taxable income ´ 34% (see Exhibit 2.1)] = $510,000 ÷ 4 = $127,500. Second installment must include shortfall from first installment: [$127,500 + ($127,500 – $67,150)] = $187,850.

1187. Chapter 9 - Corporations: Organization, Capital Structure, an139 Heron Corporation, a calendar year, accrual basis taxpayer, provides the following information for this year and asks you to prepare Schedule M-1:

Net income per books (after-tax) $257,950Taxable income 150,000Federal income tax liability 41,750Interest income from tax-exempt bonds 15,000Interest paid on loan incurred to purchase tax-exempt bonds

1,500

Life insurance proceeds received as a result of death of Heron’s president

150,000

Premiums paid on policy on life of Heron’s president 7,800Excess of capital losses over capital gains 6,000

Retained earnings at beginning of year 375,000Cash dividends paid 90,000

Correct Answer:

Net income per books is reconciled to taxable income as follows:

Net income per books (after tax) $257,950 Plus: Items that decreased net income per books but did not affect taxable income + Federal income tax liability 41,750 + Excess of capital losses over capital gains 6,000 + Interest paid on loan incurred to purchase tax-exempt bonds 1,500 + Premiums paid on policy on life of president of the corporation 7,800 Subtotal $315,000 Minus: Items that increased net income per books but did not affect taxable income – Interest income from tax-exempt bonds (15,000) – Life insurance proceeds received as a result of the death of the corporate president (150,000)Taxable income $150,000

1188. Chapter 9 - Corporations: Organization, Capital Structure, an140 Compare the basic tax and nontax factors of doing business as a partnership, an S corporation, and a C corporation. Circle the correct answers.

Tax QuestionsColumn APartnership

Column BS Corporation

Column CC Corporation

Who pays tax on the entity’s income?

PartnersPartnership

ShareholdersS corporation

ShareholdersC Corporation

Are operating losses passed through to owners?

YesNo

YesNo

YesNo

Are capital gains (losses) reported on owners’ tax returns as such?

YesNo

YesNo

YesNo

Are distributions of profits taxable to owners?

YesNo

YesNo

YesNo

Nontax Factors Partnership S Corporation C Corporation

Is the liability of owners limited?

YesNo

YesNo

YesNo

Is there free Yes Yes Yes

transferability of ownership interests?

No No No

Correct Answer:

The correct answers are shaded.

Tax QuestionsColumn APartnership

Column BS Corporation

Column CC Corporation

Who pays tax on the entity’s income? Partners

Partnership

Shareholders

S corporation

Shareholders

C CorporationAre operating losses passed through to owners?

Yes

No

Yes

No

Yes

NoAre capital gains (losses) reported on owners’ tax returns as such?

Yes

No

Yes

No

Yes

NoAre distributions of profits taxable to owners?

Yes

No

Yes

No

Yes

No Nontax Factors Partnership S Corporation C Corporation

Is the liability of owners limited? Yes

No

Yes

No

Yes

No

Is there free transferability of ownership interests?

Yes

No

Yes

No

Yes

No

1189. Chapter 9 - Corporations: Organization, Capital Structure, an141 Osprey Company had a net loss of $200,000 from merchandising operations in 2011, its first year of operations. Mary, the sole owner of Osprey, works full time in the business. She has a large amount of income from other sources and is in the 35% marginal tax bracket irrespective of Osprey. Considering this information, compare the affect of Osprey’s loss to Mary under the various types of entity forms discussed in the chapter.

Correct Answer:If Osprey were a proprietorship, LLC, or S corporation, the company’s net loss of $200,000 would pass through to Mary. In such cases, Mary would deduct the $200,000 loss on her individual income tax return for 2011, thus saving $70,000 of tax ($200,000 ´ 35%). If Osprey were a regular (C) corporation, the net loss would not pass through to Mary and instead, would have to be carried forward to succeeding tax years

of the corporation.

1190. Chapter 9 - Corporations: Organization, Capital Structure, an142 Shareholders of closely held C corporations frequently engage in transactions that produce a tax benefit to the corporations. In many cases, shareholders receive compensation for employment with closely held corporations, and such payments generate a deduction for the corporations. To avoid the double taxation effect, shareholders generally prefer these and other corporate deductible payments over dividend distributions. Explain how this strategy avoids double taxation, including examples of other shareholder-corporation transactions that could be used for such purpose. Also, discuss the possible pitfalls surrounding corporate payments to shareholders.

Correct Answer:Other transactions frequently used to reduce corporate taxes include interest payments to a shareholder-creditor and rent payments to a shareholder-lessor. To the extent payments to shareholders result in corporate deductions, the double taxation effect associated with dividend distributions is avoided. Corporate income that is offset by trade or business deductions effectively avoids the corporate income tax. As a result, such income is taxed only at the shareholder level (e.g., as compensation, interest, or rent income). Since dividends are not deductible, corporate income that is distributed in such form is subject to both the corporate income tax and the shareholder level income tax (e.g., individual income tax).

The IRS is aware of the preference for deductible payments to shareholders over nondeductible dividend distributions. As a result, corporate payments to shareholders of purported trade or business expenditures generally will attract increased IRS scrutiny. In particular, the IRS will examine whether such payments satisfy the reasonableness requirement for a § 162 trade or business deduction. When shareholder compensation (or other payment) is unreasonable, the IRS may recharacterize the excessive amount as a constructive dividend and disallow the associated corporate deduction. To satisfy the reasonableness requirement of § 162, corporate payments to shareholders should be comparable to amounts that would be paid to unrelated parties in similar transactions (i.e., an arms-length price).

1191. Chapter 9 - Corporations: Organization, Capital Structure, an143 Nancy is a 40% shareholder and president of Robin Corporation, a regular corporation. The board of directors of Robin has decided to pay Nancy a $250,000 bonus for the year based on her outstanding performance. The directors want to pay the $250,000 as salary, but Nancy would prefer to have it paid as a dividend. If both Robin Corporation and Nancy are in a 35% marginal tax bracket irrespective of the treatment of the bonus, discuss which form of payment would be most beneficial for each party. (Ignore any employment tax considerations.)

Correct Answer:Robin Corporation prefers treating the payment as salary, as a $250,000 deduction for such would provide the corporation with a tax savings of $87,500 [$250,000 (salary deduction) ´ 35% (marginal tax rate)]. If,

instead, the payment were treated as a dividend, none of the $250,000 would deductible by Robin.

Nancy prefers treating the payment as a dividend, as a preferential tax rate of 15% would apply to the $250,000 and result in only $37,500 of tax. If, instead, the payment were treated as salary, Nancy would incur tax of $87,500 [$250,000 (salary) ´ 35% (marginal tax rate)]. Thus, Nancy would save $50,000 of tax if the payment were treated as a dividend instead of salary.

1192. Chapter 9 - Corporations: Organization, Capital Structure, an144 Red Corporation, a C corporation that has two equal shareholders, earned $450,000 during 2011. Orange Company, a partnership that has two equal partners, earned $450,000 during the year. Red did not make any distributions to its shareholders, and Orange’s partners did not make any withdrawals. Contrast the tax treatment of the shareholders of Red Corporation and the partners of Orange Company.

Correct Answer:A C corporation is a separate taxable entity, so its taxable income has no effect on the shareholders until such time a dividend is paid. When dividends are paid, shareholders must report dividend income on their tax returns. Thus, Red Corporation will be taxed on $450,000 and the shareholders have no tax consequences. On the other hand, the income of a partnership is passed through to and reported by the partners on their tax returns. Thus, each partner will receive a passthrough of $225,000 of income from Orange Company ($450,000 ÷ 2 partners).

1193. Chapter 9 - Corporations: Organization, Capital Structure, an145 Describe the Federal tax treatment of entities formed as limited liability companies.

Correct Answer:When the IRS issued the check-the-box Regulations in 1996, the Federal tax treatment of limited liability companies (LLCs) was simplified. Currently, an entity formed as an LLC has great flexibility in determining the manner in which it will be taxed for Federal purposes. Under the check-the-box Regulations, an LLC with more than one owner can elect to be taxed as a partnership or as a corporation. If no election is made, the LLC will be taxed as a partnership. An LLC with only one owner can elect under the Regulations to be taxed as a sole proprietorship or as a corporation. If no election is made for a single-owner LLC, the entity will be taxed as a sole proprietorship.

An election as to entity classification is made by filing Form 8832 (Entity Classification Election). Entities that are incorporated under state law and entities that are required to be taxed as corporations under Federal law (e.g., certain publicly traded partnerships) are not eligible to make an election under the check-the-box Regulations.

1194. Chapter 9 - Corporations: Organization, Capital Structure, an146 What is the rationale underlying the tax deferral treatment available under § 351?

Correct Answer:Realized gain or loss is not recognized in a § 351 transaction when a taxpayer’s economic status has not changed. This provision reflects the principle that gain should not be recognized when a taxpayer’s investment has not substantively changed. When a business is incorporated, the owner’s economic status remains the same; only the form of the investment has changed.

Gain deferral is also justified under the wherewithal to pay concept discussed in Chapter 1. This concept recognizes that if the shareholder receives solely stock in the exchange, he or she is hardly in a position to pay a tax on any realized gain.

Finally, § 351 was enacted because Congress believed that taxes should not be triggered on the incorporation of a business. Otherwise tax consequences could impede the exercise of sound business judgment (e.g., choice of corporate form of doing business).

1195. Chapter 9 - Corporations: Organization, Capital Structure, an147 Issues relating to basis arise when a taxpayer is involved in a § 351 transaction. Describe the underlying rules, and the purpose they serve.

Correct Answer:To the extent that § 351 causes a realized gain or loss to go unrecognized, the deferral continues until the shareholder disposes of the stock received in a taxable transaction. To ensure that postponed gain or loss ultimately will be recognized, the basis rules are utilized.

Stock received in a § 351 transaction is given a substituted basis. The stock’s basis is the same as the basis the taxpayer had in the property transferred, increased by any gain recognized on the exchange and decreased by boot received.

The basis of property received by the corporation is determined under a carryover basis rule that provides a basis equal to the basis in the hands of the transferor increased by the amount of any gain recognized by the transferor-shareholder.

However, an adjustment to the corporation’s basis in property received or the shareholder’s stock basis may be required when loss property is contributed to a corporation in a § 351 transaction. In the event a shareholder transfers property with an aggregate adjusted basis in excess of its fair market value, § 362(e)(2) generally requires the corporation to step down the carryover basis amount for the property by the amount of the net built-in loss. However, if the shareholder and the corporation elect, the reduction can instead be taken against the shareholder’s stock basis.

1196. Chapter 9 - Corporations: Organization, Capital Structure, an148 How is the transfer of liabilities in a property transaction generally treated for tax purposes? How is a transfer of liabilities generally treated in a § 351 transaction? What exceptions could arise to this usual treatment in a § 351 setting?

Correct Answer:Generally when another party assumes a liability in a property transaction, the party no longer responsible for the debt is treated as having received cash or boot. This is consistent with the rule dealing with like-kind exchanges under § 1031. However, when the acquiring corporation assumes a liability in a § 351 transaction, § 357(a) provides that the transfer does not result in boot to the transferor-shareholder for gain recognition purposes. To do so could trigger gain to the property transferor if the corporation assumed a mortgage on the transfer of encumbered property, which could, in turn, discourage the use of the corporate form of business.

The general rule of § 357(a) has two exceptions: (1) § 357(b) provides that if the principal purpose of the assumption of the liabilities is to avoid tax or if there is no bona fide business purpose behind the exchange, the liabilities are treated as boot; and (2) § 357(c) provides that if the sum of the liabilities exceeds the adjusted basis of the properties transferred, the excess is taxable gain.

1197. Chapter 9 - Corporations: Organization, Capital Structure, an149 When forming a corporation, a transferor-shareholder may choose to receive some corporate debt along with stock. Identify some of the issues the transferor must consider when deciding whether debt should be a part of the transaction.

Correct Answer:

Significant tax differences exist between debt and equity in the capital structure.

· Interest payments on debt are deductible by the corporation while dividend payments on stock are not.

· Loan repayments of debt are not taxable to investors unless the repayments exceed basis;

however, a shareholder’s nonliquidating receipt of property from a corporation cannot be tax-free as long as the corporation has earnings and profits.

· Dividend income on equity holdings is taxed to individual investors at the preferential capital gains rates while interest income on debt is taxed at the higher ordinary income tax rates.

1198. Chapter 9 - Corporations: Organization, Capital Structure, an150 In connection with the deduction of organizational expenditures under § 248, comment on the following:

a. Expenditures qualifying for the deduction. b. Determination of the deduction amount. c. The election requirement.

Correct Answer:a. Expenditures that qualify as “organizational expenditures” include the following: legal

services incident to organization, such as costs of drafting the corporate charter, the bylaws, the minutes, and the terms of original stock certificates; necessary accounting services; expenses of temporary directors and of organizational meetings of directors or stockholders; and fees paid to the state of incorporation. Expenditures that do not qualify for amortization include those connected with the issuing or selling of shares of stock or other securities (e.g., commissions, professional fees, and printing costs) or with the transfer of assets to a corporation.

To qualify for amortization under § 248, the expenditure must be incurred before the end of the taxable year in which the corporation begins business. In this regard, the corporation’s method of accounting is of no consequence. Expenditures incurred by a cash basis corporation in its first tax year but paid in a subsequent year qualify for the election.

b. In general, the first $5,000 of qualifying organizational expenditures are deductible in

the current year plus an amortization of the remaining expenditures over the 180-month period beginning with the month in which the corporation begins business. However, the $5,000 first-year expensing amount is reduced to the extent qualifying organizational expenditures exceed $50,000.

c. A corporation is deemed to have made the § 248 election by claiming the allowable

deduction on the tax return for its first tax year. No separate statement or specific identification of the deducted amount as organizational expenditures is required. A corporation can elect to forgo the deemed election by clearly electing to capitalize organizational expenditures on a timely filed return for its first tax year. In such cases, organizational expenditures cannot be deducted until the corporation ceases to do business and liquidates. (However, if the corporate charter limits the life of the corporation, the expenditures could be amortized over the life of the corporation.)

1199. Chapter 9 - Corporations: Organization, Capital Structure, an151 What is the annual required estimated tax payment for a C corporation? What are the rules regarding payment of the estimated tax?

Correct Answer:Estimated tax payments are required if the corporation’s tax liability is expected to be $500 or more. The required annual payment (which includes estimated AMT liability) is the lesser of (1) 100% of the corporation’s tax for the current year or (2) 100% of the corporation’s tax for the preceding year. Estimated payments are made quarterly, due on or before the 15th day of the 4th, 6th, 9th, and 12th month of the taxable year. Underpayment of estimated tax penalty can be avoided if

the quarterly payments are filed timely and equal to the corporation’s tax liability for the prior year (or tax liability computed on an annualized method). A corporation with taxable income of $1 million or more in any of its three preceding years can use the prior year’s tax liability for computing only the first installment payment. In such cases, the corporation’s second installment payment must include any shortfall resulting from using the prior year’s liability for the first installment (instead of the current year’s liability).

1200. Chapter 9 - Corporations: Organization, Capital Structure, an152 Discuss the purpose of Schedule M-1. Give two examples of an addition and two examples of a subtraction that could be reported on Schedule M-1.

Correct Answer:Schedule M-1 is used to reconcile the differences between net income per books with taxable income (before any dividends received deduction and NOL deduction). Examples of items that are additions include Federal income tax expense, excess of capital losses over capital gains, income subject to tax but not recognized for book purposes, book depreciation in excess of tax depreciation, and nondeductible expenditures (e.g., fines and penalties, meals and entertainment disallowance). Examples of items that are subtractions include tax-exempt income (e.g., life insurance proceeds), tax depreciation in excess of book depreciation, carryover amounts deductible in current year but expensed in prior year for book purposes (e.g., charitable contribution carryover deductible in current year), and domestic production activities deduction.

1201. Chapter 9 - Corporations: Organization, Capital Structure, an153 What is the purpose of Schedule M-3? Which corporations are required to file Schedule M-3?

Correct Answer:Schedule M-3 was created, in part, in response to financial reporting scandals, such as Enron and WorldCom. Schedule M-3 requires corporations to report much more information regarding the differences between financial net income (loss) and taxable income than is required of Schedule M-1. This greater transparency should allow the IRS to more easily identify corporations that engage in aggressive tax practices, as those transactions generally result in book/tax differences that must be reported on Schedule M-3. Entities with total assets of $10 million or more must file Schedule M-3 (in lieu of Schedule M-1). The financial figures (e.g., amount of total assets, net income or loss) required of the Schedule M-3 are drawn from the corporation’s Form 10-K. If Form 10-K is not filed, then another financial source, e.g., certified financial statements, is used.

1202. Chapter 10: Corporations:Earnings Profits and Distributions Que Distributions by a corporation to its shareholders are presumed to be a return of capital unless the parties can prove otherwise.

a. True*b. False

1203. Chapter 10: Corporations:Earnings Profits and Distributions Q 2 A distribution from a corporation will be taxable to the recipient shareholders only to the extent of the corporation’s E & P.

a. True*b. False

1204. Chapter 10: Corporations:Earnings Profits and Distributions Q 3 Distributions that are not dividends are a return of capital and decrease the shareholder’s basis. Once basis is reduced to zero, any excess is taxed as a capital gain.

*a. Trueb. False

1205. Chapter 10: Corporations:Earnings Profits and Distributions Q 4 Cash distributions received from a corporation with a positive balance in accumulated E & P at the beginning of the year will be taxed as dividend income.

a. True*b. False

1206. Chapter 10: Corporations:Earnings Profits and Distributions Q 5 A distribution in excess of E & P is treated as capital gain by shareholders.

a. True*b. False

1207. Chapter 10: Corporations:Earnings Profits and Distributions Q 6 The terms “earnings and profits” and “retained earnings” are identical in meaning.

a. True*b. False

1208. Chapter 10: Corporations:Earnings Profits and Distributions Q 7 To determine E & P, some (but not all) previously excluded income items are added back to taxable income.

a. True*b. False

1209. Chapter 10: Corporations:Earnings Profits and Distributions Q 8 When computing E & P, taxable income is not adjusted for additional first-year depreciation.

a. True*b. False

1210. Chapter 10: Corporations:Earnings Profits and Distributions Q 9 When computing current E & P, taxable income is not adjusted for the deferred gain in a § 1031 like-kind exchange.

*a. Trueb. False

1211. Chapter 10: Corporations:Earnings Profits and Distributions Q10 An increase in the LIFO recapture amount must be added to taxable income to determine E & P.

*a. Trueb. False

1212. Chapter 10: Corporations:Earnings Profits and Distributions Q11 Use of MACRS cost recovery when computing taxable income does not require an E & P adjustment.

a. True*b. False

1213. Chapter 10: Corporations:Earnings Profits and Distributions Q12 When a corporation makes an installment sale, for E & P purposes the realized gain is recognized in the year of sale.

*a. Trueb. False

1214. Chapter 10: Corporations:Earnings Profits and Distributions Q13 A corporation borrows money to purchase State of Texas bonds. The interest on the loan has no impact on either taxable income or current E & P.

a. True*b. False

1215. Chapter 10: Corporations:Earnings Profits and Distributions Q14 Federal income tax paid in the current year must be subtracted from taxable income to determine E & P.

*a. Trueb. False

1216. Chapter 10: Corporations:Earnings Profits and Distributions Q15 When computing E & P, an adjustment to taxable income is necessary for any domestic production activities deduction.

*a. Trueb. False

1217. Chapter 10: Corporations:Earnings Profits and Distributions Q16 Nondeductible meal and entertainment expenses must be subtracted from taxable income to determine current E & P.

*a. Trueb. False

1218. Chapter 10: Corporations:Earnings Profits and Distributions Q17 The dividends received deduction is added back to taxable income to determine E & P.

*a. Trueb. False

1219. Chapter 10: Corporations:Earnings Profits and Distributions Q18 A realized gain from an involuntary conversion under § 1033 that is not recognized for income tax purposes has no effect on E & P.

*a. Trueb. False

1220. Chapter 10: Corporations:Earnings Profits and Distributions Q19 In the current year, Pink Corporation has a § 179 expense of $80,000. As a result, next year, taxable income must be decreased by $16,000 to determine current E & P.

*a. Trueb. False

1221. Chapter 10: Corporations:Earnings Profits and Distributions Q20 Any loss in current E & P must be treated as occurring ratably during the year.

a. True*b. False

1222. Chapter 10: Corporations:Earnings Profits and Distributions Q21 When current E & P has a deficit and accumulated E & P is positive, the

two accounts are netted at the date of the distribution. If a positive balance results, the distribution is a dividend to the extent of the balance.

*a. Trueb. False

1223. Chapter 10: Corporations:Earnings Profits and Distributions Q22 When current E & P is positive and accumulated E & P has a deficit balance, the two accounts are netted for dividend determination purposes.

a. True*b. False

1224. Chapter 10: Corporations:Earnings Profits and Distributions Q23 Regardless of any deficit in current E & P, distributions during the year are taxed as dividends to the extent of accumulated E & P.

a. True*b. False

1225. Chapter 10: Corporations:Earnings Profits and Distributions Q24 Corporate distributions are presumed to be paid out of E & P and are treated as dividends unless the parties to the transaction can show otherwise.

*a. Trueb. False

1226. Chapter 10: Corporations:Earnings Profits and Distributions Q25 During the year, Blue Corporation distributes land to its sole shareholder. If the fair market value of the land is less than its adjusted basis, Blue will recognize a loss on the distribution.

a. True*b. False

1227. Chapter 10: Corporations:Earnings Profits and Distributions Q26 In certain circumstances, the amount of dividend income recognized by a shareholder from a property distribution is not reduced by the amount of liability assumed by a shareholder.

a. True*b. False

1228. Chapter 10: Corporations:Earnings Profits and Distributions Q27 Property distributed by a corporation as a dividend is subject to a liability in excess of its basis. For purposes of determining gain on

the distribution, the basis of the property is treated as being not less than the amount of liability.

a. True*b. False

1229. Chapter 10: Corporations:Earnings Profits and Distributions Q28 A corporation that distributes a property dividend must reduce its E & P by the adjusted basis of the property less any liability on the property.

a. True*b. False

1230. Chapter 10: Corporations:Earnings Profits and Distributions Q29 Under certain circumstances, a distribution can generate (or add to) a deficit in E & P.

a. True*b. False

1231. Chapter 10: Corporations:Earnings Profits and Distributions Q30 Constructive dividends do not need to satisfy the legal requirements for a dividend as set forth by applicable state law.

*a. Trueb. False

1232. Chapter 10: Corporations:Earnings Profits and Distributions Q31 Constructive dividends have no effect on a distributing corporation’s E & P.

a. True*b. False

1233. Chapter 10: Corporations:Earnings Profits and Distributions Q32 If a stock dividend is taxable, the shareholder’s basis in the newly received shares is equal to the fair market value of the shares received in the distribution.

*a. Trueb. False

1234. Chapter 10: Corporations:Earnings Profits and Distributions Q33 A corporate shareholder that receives a constructive dividend cannot apply a dividends received deduction to the distribution.

a. True*b. False

1235. Chapter 10: Corporations:Earnings Profits and Distributions Q34 If a stock dividend is nontaxable, then the basis of the stock received is the fair market value of the stock received.

a. True*b. False

1236. Chapter 10: Corporations:Earnings Profits and Distributions Q35 A pro rata distribution of nonconvertible preferred stock to common shareholders is not generally taxable.

*a. Trueb. False

1237. Chapter 10: Corporations:Earnings Profits and Distributions Q36 If a stock dividend is taxable, the recipient has income to the extent of the fair market value of the stock received.

*a. Trueb. False

1238. Chapter 10: Corporations:Earnings Profits and Distributions Q37 For tax purposes, all stock redemptions are treated as dividend distributions.

a. True*b. False

1239. Chapter 10: Corporations:Earnings Profits and Distributions Q38 Noncorporate shareholders generally prefer a nonqualified stock redemption over a qualifying stock redemption due to the availability of the dividends received deduction.

a. True*b. False

1240. Chapter 10: Corporations:Earnings Profits and Distributions Q39 A shareholder’s basis in property received in a stock redemption is the property’s fair market value.

*a. Trueb. False

1241. Chapter 10: Corporations:Earnings Profits and Distributions Q40 As a general rule, a liquidating corporation recognizes gains and

losses on the distribution of property in complete liquidation.

*a. Trueb. False

1242. Chapter 10: Corporations:Earnings Profits and Distributions Q41 When a shareholder receives property subject to a liability pursuant to a complete liquidation (not a parent-subsidiary liquidation), the fair market value of the property is reduced by the amount of the liability in computing the shareholder’s gain (or loss) on the liquidation.

*a. Trueb. False

1243. Chapter 10: Corporations:Earnings Profits and Distributions Q42 A corporation that always distributes all of its profits as dividends will not be subject to the accumulated earnings tax.

*a. Trueb. False

1244. Chapter 10: Corporations:Earnings Profits and Distributions Q43 The § 531 penalty tax on unreasonable accumulations will be avoided if the accumulations can be justified as being to meet the reasonable needs of the business.

*a. Trueb. False

1245. Chapter 10: Corporations:Earnings Profits and Distributions Q44 If a corporation is subject to the § 541 penalty tax on personal holding companies, it cannot also be subject to the penalty tax on unreasonable accumulations under § 531.

*a. Trueb. False

1246. Chapter 10: Corporations:Earnings Profits and Distributions Q45 The tax treatment of corporate distributions at the shareholder level does not depend on:

*a. The character of the property being distributed.b. The earnings and profits of the corporation.c. The basis of stock in the hands of the shareholder.d. Whether the distributed property is received by an individual or a corporation.e. None of the above.

1247. Chapter 10: Corporations:Earnings Profits and Distributions Q46 Scarlet Corporation (a calendar year taxpayer) has taxable income of $150,000, and its financial records reflect the following for the year.

Federal income taxes paid $55,000Net operating loss carryforward deducted currently 35,000Gain recognized this year on an installment sale from a prior year 22,000Depreciation deducted on tax return (ADS depreciation would have been $5,000) 20,000Interest income on Iowa state bonds 4,000

Scarlet Corporation’s current E & P is:

*a. $127,000.b. $107,000.c. $97,000.d. $57,000.e. None of the above.

1248. Chapter 10: Corporations:Earnings Profits and Distributions Q47 Blue Corporation, a cash basis taxpayer, has taxable income of $700,000 for the current year. Blue elected $80,000 of § 179 expense. It also had a related party loss of $30,000 and a realized (not recognized) gain from an involuntary conversion of $85,000. It paid Federal income tax of $185,000 and a nondeductible fine of $20,000. Blue’s current E & P is:

a. $465,000.*b. $529,000.c. $614,000.d. $630,000.e. None of the above.

1249. Chapter 10: Corporations:Earnings Profits and Distributions Q48 Platinum Corporation, a calendar year taxpayer, has taxable income of $500,000. Among its transactions for the year are the following:

Collection of proceeds from insurance policy on life of corporate officer (in excess of cash surrender value) $75,000Realized gain (not recognized) on an involuntary conversion 10,000Nondeductible fines and penalties 40,000

Disregarding any provision for Federal income taxes, Platinum Corporation’s current E & P is:

a. $455,000.*b. $535,000.c. $545,000.

d. $625,000.e. None of the above.

1250. Chapter 10: Corporations:Earnings Profits and Distributions Q49 Which of the following statements is incorrect with respect to determining current E & P?

a. All tax-exempt income should be added back to taxable income.b. Dividends received deductions should be added back to taxable income.c. Charitable contributions in excess of the 10% of taxable income limit should be subtracted from taxable income.d. Federal income tax refunds should be added back to taxable income.*e. None of the above statements are incorrect.

1251. Chapter 10: Corporations:Earnings Profits and Distributions Q50 Ashley and Andrew, equal shareholders in Parrot Corporation, receive $250,000 each in distributions on December 31 of the current year. During the current year, Parrot sold an appreciated asset for $500,000 (basis of $150,000). Payment for the sale of the asset will be made as follows: 50% next year and 50% in the following year, with interest payable at a rate of 7.5%. Before considering the effect of the asset sale, Parrot’s current year E & P is $400,000 and it has no accumulated E & P. How much of Ashley’s distribution will be taxed as a dividend?

a. $0.b. $200,000.*c. $250,000.d. $425,000.e. None of the above.

1252. Chapter 10: Corporations:Earnings Profits and Distributions Q51 Tracy and Lance, equal shareholders in Macaw Corporation, receive $600,000 each in distributions on December 31 of the current year. Macaw’s current year taxable income is $1 million and it has no accumulated E & P. Last year, Macaw sold an appreciated asset for $1,200,000 (basis of $400,000). Payment for one-half of the sale of the asset was made this year. How much of Tracy’s distribution will be taxed as a dividend?

a. $0.*b. $300,000.c. $500,000.d. $600,000.e. None of the above.

1253. Chapter 10: Corporations:Earnings Profits and Distributions Q52 Pheasant Corporation ended its first year of operations with taxable income of $225,000. At the time of Pheasant’s formation, it incurred $50,000 of organizational expenses. In calculating its taxable income

for the year, Pheasant claimed an $8,000 amortization deduction for the organizational expenses. What is Pheasant’s current E & P?

a. $175,000.b. $183,000.c. $225,000.*d. $233,000.e. None of the above.

1254. Chapter 10: Corporations:Earnings Profits and Distributions Q53 During the current year, Goose Corporation sold equipment for $500,000 (adjusted basis of $260,000). The equipment was purchased a few years ago for $560,000 and $300,000 in MACRS deductions have been claimed. ADS depreciation would have been $200,000. As a result of the sale, the adjustment to taxable income needed to determine current E & P is:

a. No adjustment is required.*b. Subtract $100,000.c. Add $100,000.d. Add $80,000.e. None of the above.

1255. Chapter 10: Corporations:Earnings Profits and Distributions Q54 On January 2, 2011, Orange Corporation purchased equipment for $300,000 with an ADS recovery period of 10 years and a MACRS useful life of 7 years. Section 179 was not elected. MACRS depreciation properly claimed on the asset, including depreciation in the year of sale, totaled $79,605. The equipment was sold on July 1, 2012, for $290,000. As a result of the sale, the adjustment to taxable income needed to arrive at current E & P is:

a. No adjustment is required.*b. Decrease $49,605.c. Increase $49,605.d. Decrease $79,605.e. None of the above.

1256. Chapter 10: Corporations:Earnings Profits and Distributions Q55 Tungsten Corporation, a calendar year cash basis taxpayer, made estimated tax payments of $800 each quarter in 2011, for a total of $3,200. Tungsten filed its 2011 tax return in 2012 and the return showed a tax liability $4,200. At the time of filing, March 15, 2012, Tungsten paid an additional $1,000 in Federal income taxes. How does the additional payment of $1,000 impact Tungsten’s E & P?

a. Increase by $1,000 in 2011.b. Increase by $1,000 in 2012.c. Decrease by $1,000 in 2011.*d. Decrease by $1,000 in 2012.e. None of the above.

1257. Chapter 10: Corporations:Earnings Profits and Distributions Q56 Duck Corporation is a calendar year taxpayer formed in 2005. Duck’s E & P for each of the past 5 years is listed below.

2010 $280,0002009 $400,0002008 $390,0002007 $680,0002006 $160,000

Duck Corporation made the following distributions in the previous 5 years.

2009 Land (basis of $700,000, fair market value of $800,000) 2006 $200,000 cash

Duck’s accumulated E & P as of January 1, 2011 is:

a. $910,000.*b. $950,000.c. $1,010,000.d. $1,050,000.e. None of the above.

1258. Chapter 10: Corporations:Earnings Profits and Distributions Q57 Stacey and Andrew each own one-half of the stock in Parakeet Corporation, a calendar year taxpayer. Cash distributions from Parakeet are: $350,000 to Stacey on April 1 and $150,000 to Andrew on May 1. If Parakeet’s current E & P is $60,000, how much is allocated to Andrew’s distribution?

a. $5,000.b. $10,000.*c. $18,000.d. $30,000.e. None of the above.

1259. Chapter 10: Corporations:Earnings Profits and Distributions Q58 Maria and Christopher each own 50% of Cockatoo Corporation, a calendar year taxpayer. Distributions from Cockatoo are: $750,000 to Maria on April 1 and $250,000 to Christopher on May 1. Cockatoo’s current E & P is $300,000 and its accumulated E & P is $600,000. How much of the accumulated E & P is allocated to Christopher’s distribution?

a. $0.*b. $75,000.c. $150,000.d. $300,000.e. None of the above.

1260. Chapter 10: Corporations:Earnings Profits and Distributions Q59 Gander, a calendar year corporation, has a deficit in current E & P of

$100,000 and a $290,000 positive balance in accumulated E & P. If Gander determines that a $500,000 distribution to its shareholders is appropriate at some point during the year, what is the maximum amount of the distribution that could potentially be treated as a dividend?

a. $0.b. $190,000.c. $240,000.*d. $290,000.e. None of the above.

1261. Chapter 10: Corporations:Earnings Profits and Distributions Q60 Falcon Corporation has $200,000 of current E & P and a deficit in accumulated E & P of $90,000. If Swan pays a $300,000 distribution to its shareholders on July 1, how much dividend income do the shareholders report?

a. $0.b. $10,000.c. $110,000.*d. $200,000.e. None of the above.

1262. Chapter 10: Corporations:Earnings Profits and Distributions Q61 Glenda is the sole shareholder of Condor Corporation. She sold her stock to Melissa on October 31 for $150,000. Glenda’s basis in Condor stock was $50,000 at the start of the year. Condor distributed land to Glenda immediately before the sale. Condor’s basis in the land was $20,000 (fair market value of $25,000). On December 31, Melissa received a $75,000 cash distribution from Condor. During the year, Condor has $20,000 of current E & P and its accumulated E & P balance on January 1 is $10,000. Which of the following statements is true?

*a. Glenda recognizes a $110,000 gain on the sale of her stock.b. Glenda recognizes a $100,000 gain on the sale of her stock.c. Melissa receives $5,000 of dividend income.d. Glenda receives $20,000 of dividend income.e. None of the above.

1263. Chapter 10: Corporations:Earnings Profits and Distributions Q62 Orange Corporation has a deficit in accumulated E & P of $600,000 and has current E & P of $450,000. On July 1, Orange distributes $500,000 to its sole shareholder, Morris, who has a basis in his stock of $105,000. As a result of the distribution, Morris has:

*a. Dividend income of $450,000 and reduces his stock basis to $55,000.b. Dividend income of $105,000 and reduces his stock basis to zero.c. Dividend income of $450,000 and no adjustment to stock basis.d. No dividend income, reduces his stock basis to zero, and has a capital gain of $500,000.

e. None of the above.

1264. Chapter 10: Corporations:Earnings Profits and Distributions Q63 Renee, the sole shareholder of Indigo Corporation, sold her stock to Chad on July 1 for $180,000. Renee’s stock basis at the beginning of the year was $120,000. Indigo made a $60,000 cash distribution to Renee immediately before the sale, while Chad received a $120,000 cash distribution from Indigo on November 1. As of the beginning of the current year, Indigo had $26,000 in accumulated E & P, while current E & P (before distributions) was $90,000. Which of the following statements is correct?

a. Renee recognizes a $60,000 gain on the sale of the stock.*b. Renee recognizes a $64,000 gain on the sale of the stock.c. Chad recognizes dividend income of $120,000.d. Chad recognizes dividend income of $30,000.e. None of the above.

1265. Chapter 10: Corporations:Earnings Profits and Distributions Q64 Tangelo Corporation has an August 31 year-end. Tangelo had $50,000 in accumulated E & P at the beginning of its 2012 fiscal year (September 1, 2011) and during the year, it incurred a $75,000 operating loss. It also distributed $65,000 to its sole shareholder, Cass, on November 30, 2011. If Cass is a calendar year taxpayer, how should she treat the distribution when she files her 2011 income tax return (assuming the return is filed by April 15, 2012)?

*a. $65,000 of dividend income.b. $60,000 of dividend income and $5,000 recovery of capital.c. $50,000 of dividend income and $15,000 recovery of capital.d. The distribution has no effect on Cass in the current year.e. None of the above.

1266. Chapter 10: Corporations:Earnings Profits and Distributions Q65 As of January 1, Warbler Corporation has a deficit in accumulated E & P of $150,000. For the year, current E & P (accrued ratably) is $260,000 (prior to any distributions). On July 1, Warbler Corporation distributes $295,000 to its sole shareholder. The amount of the distribution that is a dividend is:

a. $10,000.b. $110,000.*c. $260,000.d. $295,000.e. None of the above.

1267. Chapter 10: Corporations:Earnings Profits and Distributions Q66 At the beginning of the current year, Doug and Alfred each own 50% of Amaryllis Corporation (a calendar year taxpayer). In July, Doug sold his stock to Kevin for $140,000. At the beginning of the year, Amaryllis Corporation had accumulated E & P of $240,000 and its current

E & P is $280,000 (prior to any distributions). Amaryllis distributed $300,000 on February 15 ($150,000 to Doug and $150,000 to Alfred) and distributed another $300,000 on November 1 ($150,000 to Kevin and $150,000 to Alfred). Kevin has dividend income of:

a. $150,000.b. $140,000.*c. $110,000.d. $70,000.e. None of the above.

1268. Chapter 10: Corporations:Earnings Profits and Distributions Q67 On January 1, Gull Corporation (a calendar year taxpayer) has accumulated E & P of $200,000. During the year, Gull incurs a net loss of $280,000 from operations that accrues ratably. On June 30, Gull distributes $120,000 to Sharon, its sole shareholder, who has a basis in her stock of $75,000. How much of the $120,000 is a dividend to Sharon?

a. $0.*b. $60,000.c. $75,000.d. $120,000.e. None of the above.

1269. Chapter 10: Corporations:Earnings Profits and Distributions Q68 In the current year, Verdigris Corporation (with E & P of $250,000) made the following property distributions to its shareholders (all corporations):

Adjusted Fair Market Basis ValueBlack Corporation stock (held for investment) $75,000 $60,000 Non-LIFO inventory 40,000 55,000

Verdigris Corporation is not a member of a controlled group. As a result of the distribution:

a. The shareholders have dividend income of $100,000.b. The shareholders have dividend income of $130,000.c. Verdigris has a gain of $15,000 and a loss of $15,000, both of which it must recognize.d. Verdigris has no recognized gain or loss.*e. None of the above.

1270. Chapter 10: Corporations:Earnings Profits and Distributions Q69 Swan Corporation makes a property distribution to its sole shareholder, Matthew. The property distributed is a cottage (fair market value of $135,000; basis of $110,000) that is subject to a $175,000 mortgage that Matthew assumes. Before considering the consequences of the

distribution, Swan’s current E & P is $25,000 and its accumulated E & P is 100,000. Swan makes no other distributions during the current year. What is Swan’s taxable gain on the distribution of the cottage?

a. $0.b. $15,000.c. $25,000.*d. $65,000.e. None of the above.

1271. Chapter 10: Corporations:Earnings Profits and Distributions Q70 Navy Corporation makes a property distribution to its sole shareholder, Troy. The property distributed is a car (fair market value of $10,000; basis of $15,000) that is subject to a $2,000 liability which Troy assumes. Navy makes no other distributions during the current year. Navy has no accumulated E & P and $15,000 of current E & P from other sources during the year. What is Navy’s E & P after taking into account the distribution of the car?

*a. $2,000.b. $3,000.c. $5,000.d. $7,000.e. None of the above.

1272. Chapter 10: Corporations:Earnings Profits and Distributions Q71 Pelican Corporation has E & P of $260,000. It distributes land with a fair market value of $80,000 (adjusted basis of $30,000) to its sole shareholder, Bernard. The land is subject to a liability of $45,000 that Bernard assumes. Bernard has a taxable dividend of:

a. $10,000.*b. $35,000.c. $55,000.d. $80,000.e. None of the above.

1273. Chapter 10: Corporations:Earnings Profits and Distributions Q72 Which one of the following statements about property distributions is false?

*a. When the basis of distributed property is greater than its fair market value, a deficit may be created in E & P.b. When the basis of distributed property is less than its fair market value, the distributing corporation recognizes gain.c. When the basis of distributed property is greater than its fair market value, the distributing corporation does not recognize loss.d. The amount of a distribution received by a shareholder is measured by using the property’s fair market value.e. All of the above statements are true.

1274. Chapter 10: Corporations:Earnings Profits and Distributions Q73 Samantha owns stock in Pigeon Corporation (basis of $80,000) as an investment. Pigeon distributes property (fair market value of $300,000; basis of $150,000) to her during the year. Pigeon has current E & P of $20,000 and accumulated E & P of $80,000 and makes no other distributions during the year. What is Samantha’s capital gain on the distribution?

a. $0.b. $80,000.*c. $120,000.d. $150,000.e. None of the above.

1275. Chapter 10: Corporations:Earnings Profits and Distributions Q74 Blue Corporation distributes property to its sole shareholder, Zeke. The property has a fair market value of $450,000, an adjusted basis of $305,000, and is subject to a liability of $250,000. Current E & P is $550,000. With respect to the distribution, Blue has a gain of:

a. $200,000 and Zeke has dividend income of $450,000.b. $145,000 and Zeke’s basis is the distributed property is $305,000.c. $200,000 and Zeke’s basis in the distributed property is $450,000.*d. $145,000 and Zeke has dividend income of $200,000.e. None of the above.

1276. Chapter 10: Corporations:Earnings Profits and Distributions Q75 Purple Corporation has accumulated E & P of $100,000 on January 1, 2011. In 2011, Purple has current E & P of $130,000 (before any distribution). On December 31, 2011, the corporation distributes $250,000 to its sole shareholder, Cindy (an individual). Purple Corporation’s E & P as of January 1, 2012 is:

*a. $0.b. ($20,000).c. $100,000.d. $130,000.e. None of the above.

1277. Chapter 10: Corporations:Earnings Profits and Distributions Q76 Rust Corporation has accumulated E & P of $30,000 on January 1, 2011. In 2011, Rust Corporation had an operating loss of $40,000. It distributed cash of $20,000 to Andre, its sole shareholder, on December 31, 2011. Rust Corporation’s balance in its E & P account as of January 1, 2012, is:

a. $30,000 deficit.*b. $10,000 deficit.c. $0.

d. $30,000.e. None of the above.

1278. Chapter 10: Corporations:Earnings Profits and Distributions Q77 Robin Corporation distributes furniture (basis of $40,000; fair market value of $50,000) as a property dividend to its shareholders. The furniture is subject to a liability of $55,000. Robin Corporation recognizes gain of:

a. $55,000.*b. $15,000.c. $10,000.d. $0.e. None of the above.

1279. Chapter 10: Corporations:Earnings Profits and Distributions Q78 Ten years ago, Connie purchased 4,000 shares in Platinum Corporation for $40,000. In the current year, Connie receives a nontaxable stock dividend of 40 shares of Platinum preferred. Values at the time of the dividend are: $8,000 for the preferred stock and $72,000 for the common. Based on this information, Connie’s basis is:

a. $40,000 in the common and $16,000 in the preferred.b. $4,000 in the common and $136,000 in the preferred.*c. $36,000 in the common and $4,000 in the preferred.d. $39,600 in the common and $400 in the preferred.e. None of the above.

1280. Chapter 10: Corporations:Earnings Profits and Distributions Q79 Which of the following statements regarding constructive dividends is not correct?

a. Constructive dividends do not need to be formally declared or designated as a dividend.b. Constructive dividends need not be paid pro rata to the shareholders.*c. Corporations that receive constructive dividends may not use the dividends received deduction.d. Constructive dividends are taxable as dividends only to the extent of earnings and profits.e. All of the above.

1281. Chapter 10: Corporations:Earnings Profits and Distributions Q80 Five years ago, Eleanor transferred property she had used in her sole proprietorship to Blue Corporation for 1,000 shares of Blue Corporation in a transaction that qualified under § 351. The assets had a tax basis to her of $100,000 and a fair market value of $270,000 on the date of the transfer. In the current year, Blue Corporation (E & P of $800,000) redeems 250 shares from Eleanor for $220,000 in a transaction that does not qualify for sale or exchange treatment. With respect to the

redemption, Eleanor will have a:

a. $195,000 capital gain.b. $220,000 capital gain.c. $195,000 dividend. *d. $220,000 dividend. e. None of the above.

1282. Chapter 10: Corporations:Earnings Profits and Distributions Q81 Five years ago, Eleanor transferred property she had used in her sole proprietorship to Blue Corporation for 1,000 shares of Blue Corporation in a transaction that qualified under § 351. The assets had a tax basis to her of $100,000 and a fair market value of $270,000 on the date of the transfer. In the current year, Blue Corporation ( E & P $800,000) redeems 250 shares from Eleanor for $220,000 in a transaction that qualifies for sale or exchange treatment. With respect to the redemption, Eleanor will have a:

*a. $195,000 capital gain. b. $220,000 capital gain. c. $195,000 dividend.d. $220,000 dividend.e. None of the above.

1283. Chapter 10: Corporations:Earnings Profits and Distributions Q82 Finch Corporation distributes property (basis of $140,000, fair market value of $200,000) to a shareholder in a distribution that is a qualifying stock redemption. The property is subject to a liability of $90,000, which the shareholder assumes. The basis of the property to the shareholder is:

a. $0.b. $50,000.c. $110,000.d. $140,000.*e. None of the above.

1284. Chapter 10: Corporations:Earnings Profits and Distributions Q83 Kingbird Corporation (E & P of $800,000) has 1,000 shares of stock outstanding. That stock is held by Amata (550 shares) and Esteban (450 shares), who are unrelated individuals. Kingbird redeems 200 of Amata’s shares for $1,000 per share. Amata paid $300 per share for her Kingbird stock nine years ago. Which of the following statements is correct with respect to the stock redemption?

a. Amata has dividend income of $200,000.*b. Amata has a long-term capital gain of $140,000.c. Amata’s basis in her remaining 350 shares is $60,000. d. Kingbird reduces its E & P by $200,000. e. None of the above.

1285. Chapter 10: Corporations:Earnings Profits and Distributions Q84 Pursuant to a complete liquidation, Woodpecker Corporation distributes the following assets to its unrelated shareholders: land held for six years as an investment (basis of $100,000, fair market value of $300,000), inventory (basis of $100,000, fair market value of $140,000), and marketable securities held for two years as an investment (basis of $200,000, fair market value of $120,000). What are the tax results to Woodpecker Corporation as a result of the liquidation?

a. Woodpecker Corporation would recognize ordinary income of $40,000 and a net capital gain of $200,000. *b. Woodpecker Corporation would recognize ordinary income of $40,000 and a net capital gain of $120,000.c. Woodpecker Corporation would recognize ordinary income of $40,000 and a net capital loss of $80,000.d. Woodpecker Corporation would recognize no gain or loss on the liquidation.e. None of the above.

1286. Chapter 10: Corporations:Earnings Profits and Distributions Q85 For purposes of the penalty tax on accumulated earnings under § 531, reasonable needs of the business does not include:

*a. Loans to shareholders.b. Self-insurance.c. Loans to suppliers and customers.d. Product liability losses.e. Plant expansion.

1287. Chapter 10: Corporations:Earnings Profits and Distributions Q86 Using the legend provided, classify each statement accordingly. In all cases, assume that taxable income is being adjusted to arrive at current E & P for 2011.Gain on installment sale in 2011 deferred until 2012.Interest received from municipal bonds in 2011.Federal income tax refunds from tax paid in prior years.Loss on sale between related parties in 2011.Meal and entertainment expenses not deducted in 2011 because of the 50% limitation.Cash dividends distributed to shareholders in 2011.Gain realized, but not recognized, in a like-kind exchange transaction in 2011.Domestic production activities deduction claimed in 2011.Premiums paid on key employee life insurance policy (assume no increase in cash surrender value of policy) in 2011.Section 179 expense in second year following election.Increase Increase Increase Decrease Decrease Decrease No effect Increase Decrease Decrease

[a] 1. Gain on installment sale in 2011 deferred until 2012.[b] 2. Interest received from municipal bonds in 2011.[c] 3. Federal income tax refunds from tax paid in prior

years.[d] 4. Loss on sale between related parties in 2011.[e] 5. Meal and entertainment expenses not deducted in 2011

because of the 50% limitation.

[f] 6. Cash dividends distributed to shareholders in 2011.[g] 7. Gain realized, but not recognized, in a like-kind

exchange transaction in 2011.[h] 8. Domestic production activities deduction claimed in

2011.[i] 9. Premiums paid on key employee life insurance policy

(assume no increase in cash surrender value of policy) in 2011.[j] 10. Section 179 expense in second year following election.

a. Increaseb. Increasec. Increased. Decreasee. Decreasef. Decreaseg. No effecth. Increasei. Decreasej. Decrease

1288. Chapter 10: Corporations:Earnings Profits and Distributions Q87 Using the legend provided, classify each statement accordingly. In all cases, assume that taxable income is being adjusted to determine current E & P.Penalties paid to state government for failure to comply with state law.Dividends received deduction.Charitable contribution carryforward deducted in the current year.Intangible drilling costs deducted currently.Gain realized (but not recognized) on a like-kind exchange.A decrease in the LIFO recapture amount during the year.Excess capital loss in year incurred.State income tax paid in the current year. Proceeds of life insurance received upon the death of a key employee (policy had no cash surrender value).Decrease Increase Increase Increase No effect Decrease Decrease No effect Increase

[a] 1. Penalties paid to state government for failure to comply with state law.

[b] 2. Dividends received deduction.[c] 3. Charitable contribution carryforward deducted in the

current year.[d] 4. Intangible drilling costs deducted currently.[e] 5. Gain realized (but not recognized) on a like-kind

exchange.[f] 6. A decrease in the LIFO recapture amount during the

year.[g] 7. Excess capital loss in year incurred.[h] 8. State income tax paid in the current year.[i] 9. Proceeds of life insurance received upon the death of a

key employee (policy had no cash surrender value).

a. Decreaseb. Increasec. Increased. Increasee. No effectf. Decreaseg. Decrease

h. No effecti. Increase

1289. Chapter 10: Corporations:Earnings Profits and Distributions Q88 On January 1, Tulip Corporation (a calendar year taxpayer) has accumulated E & P of $300,000. Its current E & P for the year is $90,000 (before considering dividend distributions). During the year, Tulip distributes $600,000 ($300,000 each) to its equal shareholders, Anne and Tom. Anne has a basis in her stock of $65,000, while Tom’s basis is $120,000. What is the effect of the distribution by Tulip Corporation on Anne and Tom?

Correct Answer:Anne and Tom each have dividend income of $195,000 {[$300,000 (Tulip’s accumulated E & P) + $90,000 (Tulip’s current E & P)] ÷ 2}. The remaining $210,000 distributed reduces the basis in Tulip stock, with the excess treated as capital gain. Thus, Anne reduces her stock basis to zero and has a capital gain of $40,000 [($210,000 distribution in excess of E & P ÷ 2) – $65,000 basis]. Tom reduces his stock basis to $15,000 [$120,000 basis – ($210,000 distribution in excess of E & P ÷ 2)].

1290. Chapter 10: Corporations:Earnings Profits and Distributions Q89 Daisy Corporation is the sole shareholder of Ostrich Corporation, which it hopes to sell within the next three years. The Ostrich stock (basis of $25 million) is currently worth $30 million, but Daisy believes that it would be easier to find a buyer if it was worth less. To lower the value of its stock, Ostrich distributes $4 million cash to Daisy (sufficient E & P exists to cover the distribution). At a later date, Daisy sells Ostrich for $26 million.

a. What are the tax consequences to Daisy on the sale? b. What would be the tax consequences if Ostrich had not first

distributed the $4 million in cash and Daisy sold the Ostrich stock for $30 million?

Correct Answer:a. Because Daisy is the sole shareholder of Ostrich, it has a 100% dividends received

deduction on the $4 million cash distribution. Thus, Daisy Corporation is not taxed on the $4 million distribution, and it has a gain on the sale of its stock in Ostrich of $1 million [$26 million (sales price) – $25 million (stock basis)].

b. If Daisy had sold the stock for $30 million, Daisy would have a taxable gain on the sale of $5

million [$30 million (sales price) – $25 million (stock basis)].

1291. Chapter 10: Corporations:Earnings Profits and Distributions Q90 Ashley, the sole shareholder of Hawk Corporation, has a stock basis of

$200,000 at the beginning of the year. On July 1, she sells all of her stock to Matt for $1 million. On January 1, Hawk has accumulated E & P of $90,000 and during the year, current E & P of $160,000. Hawk makes the following cash distributions: $270,000 to Ashley on March 31 and $90,000 to Matt on December 1. How are the distributions taxed to Ashley and Matt? What is Ashley’s recognized gain on the sale to Matt?

Correct Answer:The $160,000 in current E & P is allocated pro rata to the two distributions made during the year; thus, $120,000 is allocated to Ashley and $40,000 is allocated to Matt. As accumulated E & P is applied in chronological order, it is allocated entirely to Ashley. Consequently, of the $270,000 distribution to Ashley on March 31, $210,000 is taxed as dividend income [$90,000 (accumulated E & P) + $120,000 (current E & P)] and the remaining $60,000 reduces her stock basis to $140,000. She then recognizes a capital gain of $860,000 on the sale of her stock [$1 million (sales price) – $140,000 (remaining stock basis)]. As to the $90,000 distribution to Matt, $40,000 is taxed as a dividend (from current E & P) and the remaining $50,000 reduces his basis to $950,000 [$1 million (original basis) – $50,000 (return of capital)].

1292. Chapter 10: Corporations:Earnings Profits and Distributions Q91 Puce Corporation, an accrual basis taxpayer, has struggled to survive since its formation, six years ago. As a result, it has a deficit in accumulated E & P at the beginning of the year of $340,000. This year, however, Puce earned a significant profit; taxable income was $240,000. Consequently, Puce made two cash distributions to Martha, its sole shareholder: $150,000 on July 1 and $200,000 December 31. The following information might be relevant to determining the tax treatment of the distributions.

· This year’s taxable income included a net operating loss carryover of $50,000.

· The corporation’s Federal income tax liability is $72,000 for the

year. · Puce paid nondeductible fines and kickbacks of $10,000. The company

also paid nondeductible life insurance premiums of $22,000. · The cash surrender value of the corporate-owned life insurance

policies increased by $11,000 during the year. · The company sold a piece of equipment during the year and reported a

§ 1231 gain of $105,000 and recapture income under § 1245 of $35,000. There were no other § 1231 transactions during the year, but the corporation did have a capital loss carryforward of $30,000.

· MACRS depreciation exceeds E & P depreciation by $14,000. In

addition, an election under § 179 was made this year for $18,000 of assets.

a. Compute Puce’s E & P for the year. b. What are the tax consequences of the two distributions made during

the year to Martha (her stock basis is $74,000)?

Correct Answer:a. Taxable income $240,000 Net operating loss carryover 50,000 Federal income tax (72,000) Fines and kickbacks (10,000) Life insurance premiums (22,000) Cash surrender value of life insurance 11,000 Capital loss carryforward 30,000 Excess of MACRS depreciation over E & P depreciation 14,000 Section 179 expense (80% ´ $18,000) 14,400 Current E & P $255,400

b. Martha has a dividend of $255,400 (the amount of the current E & P). The distributions during the year exceed current E & P by $94,600 ($350,000 – $255,400). Consequently, Martha’s stock basis is reduced to $0 and she has a capital gain equal to the extent to which the $94,600 exceeds her stock basis ($74,000), or $20,600.

1293. Chapter 10: Corporations:Earnings Profits and Distributions Q92 Stephanie is the sole shareholder and president of Hawk Corporation. She feels that she can justify at least a $220,000 bonus this year because of her performance. However, rather than a bonus in the form of a salary, she plans to have Hawk pay her a $220,000 dividend. Because Stephanie’s marginal tax rate is 35%, she prefers to receive a dividend taxed at 15%. Her accountant, however, suggests a $310,000 bonus in lieu of the $220,000 dividend since Hawk Corporation is in the 34% tax bracket. Should Stephanie take the $220,000 dividend or the $310,000 bonus? Support your answer by computing the after-tax cost of the two alternatives to Hawk and to Stephanie.

Correct Answer:Stephanie should choose the $310,000 bonus instead of the $220,000 dividend because the after-tax benefit to her is greater and the after-tax cost for Hawk is less. Stephanie’s after-tax benefit for the bonus is $201,500 [$310,000 ´ (1 – .35)], while her after-tax benefit for the dividend is $187,000 [$220,000 ´ (1 – .15)]. Hawk Corporation’s after-tax cost for the bonus is $204,600 [$310,000 bonus – ($310,000 ´ .34) taxes saved], while its after-tax cost for the dividend is $220,000 (the dividend is not deductible).

1294. Chapter 10: Corporations:Earnings Profits and Distributions Q93 Ali is in the 35% tax bracket. He acquired 1,000 shares of stock in Cardinal Corporation seven years ago for $100 a share. In the current year, Cardinal Corporation (E & P of $1 million) redeems all of his shares for $300,000. What are the tax consequences to Ali if:

a. The redemption qualifies for sale or exchange treatment, and Ali has no other transactions in the current year involving capital assets?

b. The redemption does not qualify for sale or exchange treatment?

Correct Answer:a. If the redemption qualifies for sale or exchange treatment, Ali will have a long-term capital

gain of $200,000 [$300,000 (amount realized) – $100,000 (stock basis)]. His income tax liability on the $200,000 gain will be $30,000 ($200,000 ´ 15%).

b. If the redemption distribution of $300,000 does not qualify as a sale or exchange, it will be

treated as dividend income and his tax liability will be $45,000 ($300,000 ´ 15%). (The entire $300,000 will be subject to tax at the 15% rate; Ali will have no basis offset.)

1295. Chapter 10: Corporations:Earnings Profits and Distributions Q94 Jill has a capital loss carryover in the current tax year of $80,000. She owns 1,000 shares of stock in Black Corporation which she purchased nine years ago for $75 per share. In the current year, Black Corporation (E & P of $800,000) redeems all of her shares for $600,000. Jill is in the 35% tax bracket. What are the tax consequences to Jill if:

a. The redemption qualifies for sale or exchange treatment, and Jill has no other transactions in the current year involving capital assets?

b. The redemption does not qualify for sale or exchange treatment?

Correct Answer:a. Jill will have a capital gain of $525,000 on the redemption [$600,000 (amount realized) –

$75,000 (stock basis)]. Jill can offset the $80,000 capital loss carryover against the $525,000 gain. Her income tax liability on the remaining $445,000 gain will be $66,750 ($445,000 ´ 15%).

b. If the redemption distribution does not qualify for sale or exchange treatment, the entire

$600,000 will be taxed at 15%, producing a tax of $90,000. With no other capital gain transactions in the current year, Jill can deduct only $3,000 of the $80,000 capital loss carryover to offset her other (ordinary) income.

1296. Chapter 10: Corporations:Earnings Profits and Distributions Q95 Ivory Corporation (E & P of $650,000) has 1,000 shares of common stock outstanding owned by unrelated parties as follows: Veronica, 500 shares, and Tommie, 500 shares. Veronica and Tommie each paid $125 per share for the Ivory stock 12 years ago. In May of the current year, Ivory distributes securities held as an investment (basis of $140,000, fair market value of $250,000) to Veronica in redemption of 200 of her shares.

a. What are the tax results to Veronica on the redemption of her Ivory stock?

b. What are the tax results to Ivory Corporation on the distribution of

the securities?

Correct Answer:a. Veronica has a long-term capital gain of $225,000 [$250,000 (amount realized) – $25,000

(stock basis)]. The distribution qualifies as a disproportionate redemption under § 302(b)(2). Veronica has a 50% (500 shares ¸ 1,000 shares) ownership interest in Ivory Corporation before the redemption and a 37.5% (300 shares ¸ 800 postredemption shares) ownership interest after the redemption. Both the 50% and the 80% [i.e., 37.5% < 40% (80% ´ 50%)] tests are met. Veronica will have a basis of $250,000 in the securities.

b. Ivory Corporation has a recognized capital gain of $110,000 [$250,000 (fair market value) – $140,000 (adjusted basis)] on the distribution of the securities. Gains (but not losses) are recognized in nonliquidating distributions. In a qualifying stock redemption, E & P is reduced by no more than the ratable share of the E & P attributable to the stock redeemed; thus, Ivory reduces its E & P by $130,000 [$650,000 E & P ´ 20% (percentage of stock redeemed)].

1297. Chapter 10: Corporations:Earnings Profits and Distributions Q96 Gold Corporation has accumulated E & P of $2 million as of January 1 of the current year. During the year, it expects to have earnings from operations of $1,680,000 and to distribute $900,000 in cash to shareholders. Gold Corporation also expects to sell an asset for a loss of $2 million. Thus, it anticipates incurring a deficit of $320,000 for the year. What can Gold do to minimize the amount of dividend income to its shareholders?

Correct Answer:Gold should recognize the loss as soon as possible and immediately thereafter make the cash distribution. For example, assume these two steps took place on January 2. Because current E & P is a deficit,

accumulated E & P is brought up to date. At the time of the distribution, the combined E & P balance is zero [$2 million (beginning balance in E & P) – $2 million (existing deficit in current E & P)], and the entire $900,000 is a return of capital. Current deficits are allocated pro rata throughout the year unless the parties can provide otherwise. Here they can.

1298. Chapter 10: Corporations:Earnings Profits and Distributions Q97 Timothy owns 100% of Forsythia Corporation’s stock. Corporate employees and annual salaries include Timothy ($300,000); Richard, Timothy’s son ($80,000); Rita, Timothy’s daughter ($100,000); and Sandy ($120,000). The operation of Forsythia Corporation is shared about equally between Timothy and Sandy (an unrelated party). Richard and Rita are full-time college students at a university about 150 miles away. Forsythia Corporation has substantial E & P but has not distributed a dividend for the past five years. Discuss problems related to the salary arrangement for Forsythia Corporation.

Correct Answer:The salaries paid to Richard and Rita are vulnerable to constructive dividend treatment. Neither appears to earn their salaries. Although they are not shareholders, their relationship to Timothy is enough of a tie-in to raise the unreasonable compensation issue. There is also a problem regarding the $300,000 salary payment to Timothy. Why is he receiving $180,000 more than Sandy when it appears they share equally in the operation of the corporation? Forsythia Corporation has not distributed a dividend for the past five years although it has substantial E & P. The IRS might be successful in contending the entire salaries paid to Richard and Rita are unreasonable compensation and that $180,000 of the salary paid to Timothy is unreasonable.

1299. Chapter 10: Corporations:Earnings Profits and Distributions Q98 Briefly describe the reason a corporation might distribute a property dividend to a shareholder in lieu of a cash distribution. Describe the tax effects of the property distribution on the shareholder and on the corporation.

Correct Answer:A corporation could distribute property to a shareholder because a shareholder may want a particular piece of property held by the corporation. Another reason might be that the corporation has low cash reserves but still wants to make a distribution to its shareholders.

The amount distributed to the shareholder is measured by the fair market value of the property on the date of distribution. Like cash, the portion of a property distribution covered by existing E & P is a dividend, and any excess is treated as a return of capital. If the market value of the property distributed exceeds the corporation’s E & P and the shareholder’s basis in the stock investment, a capital gain usually results. The amount distributed is reduced by any liabilities to which the distributed property is subject immediately before and immediately after the distribution and by any liabilities of the corporation assumed by the shareholder. The basis of the distributed property for the shareholder is the fair market value of the property

on the date of the distribution.

All distributions of appreciated property generate gain to the distributing corporation. In effect, a corporation that distributes gain property is treated as if it had sold the property to the shareholder for its fair market value. However, the distributing corporation does not recognize loss on the distributions of property. If the distributed property is subject to a liability in excess of basis or the shareholder assumes such a liability, a special rule applies. For purposes of determining gain on the distribution, the fair market value of the property is treated as not being less than the amount of the liability. Corporate distributions reduce E & P by the greater of the fair market value or the adjusted basis of property distributed, less the amount of any liability on the property. E & P is increased by gain recognized on appreciated property distributed as a property dividend. A property distribution cannot generate a deficit in E & P or add to a deficit in E & P.

1300. Chapter 11 - Partnerships and Limited Liability Entities Questio In a limited partnership, all partners are protected from debts of the partnership.

a. True*b. False

1301. Chapter 11 - Partnerships and Limited Liability Entities Quest 2 A limited liability company offers all “members” protection from claims by the LLC’s creditors.

*a. Trueb. False

1302. Chapter 11 - Partnerships and Limited Liability Entities Quest 3 A limited liability limited partnership (LLLP) is a limited partnership (LP) in which all partners, including the general partners, are protected from debts of the partnership.

*a. Trueb. False

1303. Chapter 11 - Partnerships and Limited Liability Entities Quest 4 The governing document of a limited liability company (LLC) is a partnership agreement which should spell out the partners’ rights and obligations.

a. True*b. False

1304. Chapter 11 - Partnerships and Limited Liability Entities Quest 5 The taxable income of a partnership flows through to the partners, who report the income on their tax returns.

*a. Trueb. False

1305. Chapter 11 - Partnerships and Limited Liability Entities Quest 6 The partnership reports each partner’s share of income to the partner in a single amount on Form 1099.

a. True*b. False

1306. Chapter 11 - Partnerships and Limited Liability Entities Quest 7 On Form 1065, partners’ capital accounts should be determined using the same method on Schedule L, Schedule M-2, and the Schedules K-1 prepared for the partners.

a. True*b. False

1307. Chapter 11 - Partnerships and Limited Liability Entities Quest 8 The amount of a partnership’s income and loss from operating activities is combined with separately stated income and expenses in determining the partnership’s net income (loss). This amount is reconciled to book income on the partnership’s Schedule M-1 or Schedule M-3.

*a. Trueb. False

1308. Chapter 11 - Partnerships and Limited Liability Entities Quest 9 An example of the “entity concept” underlying partnership taxation is the fact that the partners (rather than the partnership) pay tax on partnership income.

a. True*b. False

1309. Chapter 11 - Partnerships and Limited Liability Entities Quest10 A partner has a profit-sharing percent, a loss-sharing percent, and a capital-sharing ownership percent. Depending on the provisions in the partnership agreement, these amounts may or may not be the same for a given partner.

*a. Trueb. False

1310. Chapter 11 - Partnerships and Limited Liability Entities Quest11 The “outside basis” is defined as a partner’s basis in the partnership interest.

*a. Trueb. False

1311. Chapter 11 - Partnerships and Limited Liability Entities Quest12 Section 721 provides that no gain or loss is recognized on contribution of property to a partnership in exchange for an interest in the partnership. A disguised sale is an exception to nonrecognition of gain or loss under § 721.

*a. Trueb. False

1312. Chapter 11 - Partnerships and Limited Liability Entities Quest13 Morgan and Kristen formed an equal partnership on August 1 of the current year. Morgan contributed $60,000 cash and land with a basis of $18,000 and a fair market value of $40,000. Kristen contributed equipment with a basis of $42,000 and a value of $100,000. Kristen’s tax basis in her interest is $42,000; Morgan’s tax basis is $78,000.

*a. Trueb. False

1313. Chapter 11 - Partnerships and Limited Liability Entities Quest14 Tyler and Travis formed the equal T&T Partnership during the current year, with Tyler contributing $300,000 in cash and Travis contributing land (basis of $120,000, fair market value of $160,000) and inventory (basis of $30,000, fair market value of $140,000). Travis recognizes no gain or loss on the contribution and his basis in his partnership interest is $150,000.

*a. Trueb. False

1314. Chapter 11 - Partnerships and Limited Liability Entities Quest15 Justin and Kevin formed the equal JK Partnership during the current year, with Justin contributing $60,000 in cash and Kevin contributing land (basis of $40,000, fair market value of $30,000) and equipment (basis of $0, fair market value of $30,000). Kevin recognizes a $20,000 gain on the contribution and his basis in his partnership interest is $60,000.

a. True*b. False

1315. Chapter 11 - Partnerships and Limited Liability Entities Quest16 Julie owns property that is treated as a capital asset in her hands.

She contributed a parcel of land (basis $60,000; fair market value $58,000) to a real estate partnership, which will hold it as inventory. After three years, the partnership sells the land for $56,000. The partnership will recognize a $4,000 ordinary loss on sale of the property.

a. True*b. False

1316. Chapter 11 - Partnerships and Limited Liability Entities Quest17 If the partnership properly makes an election for treatment of a specific tax item, the partner is bound by that treatment.

*a. Trueb. False

1317. Chapter 11 - Partnerships and Limited Liability Entities Quest18 JLK Partnership incurred $15,000 of organizational costs and $75,000 of startup costs in 2011. JKL may deduct $5,000 each of organizational and startup costs, and the remaining costs ($10,000 of organizational costs and $70,000 of startup costs) may be amortized over 180 months.

a. True*b. False

1318. Chapter 11 - Partnerships and Limited Liability Entities Quest19 The MNO Partnership, a calendar year taxpayer, was formed on July 1 of the current year and started business on October 1. MNO incurred $30,000 in startup costs. MNO may deduct $5,000 and amortize the remaining $25,000 over 120 months starting in July.

a. True*b. False

1319. Chapter 11 - Partnerships and Limited Liability Entities Quest20 Syndication costs arise when partnership interests are being marketed to investors. These costs are amortized over 180 months.

a. True*b. False

1320. Chapter 11 - Partnerships and Limited Liability Entities Quest21 A partnership must provide any information to the partners that the partners would need to calculate deductions not permitted at the partnership level, such as for oil and gas depletion or the corporate dividends received deduction.

*a. Trueb. False

1321. Chapter 11 - Partnerships and Limited Liability Entities Quest22 The JPM Partnership is a US-based manufacturing company. JPM calculates the domestic production activities deduction (§ 199) and deducts that amount on its Form 1065.

a. True*b. False

1322. Chapter 11 - Partnerships and Limited Liability Entities Quest23 Henry contributes property valued at $60,000 (basis $50,000) in exchange for a 25% interest in the HIKE Partnership. If the property is later sold for $80,000, gain of $7,500 will be allocated to Henry.

a. True*b. False

1323. Chapter 11 - Partnerships and Limited Liability Entities Quest24 Ashley purchased her partnership interest from Lindsey on the first day of the current year for $40,000 cash. She received a $10,000 cash distribution from the partnership during the year, and her share of partnership income is $15,000. If her share of partnership liabilities on the last day of the partnership year is $20,000, her outside basis for her partnership interest at the end of the year is $65,000.

*a. Trueb. False

1324. Chapter 11 - Partnerships and Limited Liability Entities Quest25 Emma’s basis in her BBDE LLC interest is $60,000 at the beginning of the tax year. Her allocable share of LLC items are as follows: $20,000 of ordinary income, $2,000 tax-exempt interest income, and a $6,000 long-term capital gain. In addition, the LLC distributed $12,000 of cash to Emma during the year. Assuming the LLC had no liabilities at the beginning or the end of the year, Emma’s ending basis in her LLC interest is $88,000.

a. True*b. False

1325. Chapter 11 - Partnerships and Limited Liability Entities Quest26 During the current year, John and Ashley form the JA Partnership and agree to share profits and losses equally. Ashley contributes land with a fair market value of $80,000 (subject to a $30,000 nonrecourse mortgage). On the contribution date, Ashley’s adjusted basis in the land is $40,000. Immediately after formation, Ashley’s partnership outside basis is $25,000.

*a. Trueb. False

1326. Chapter 11 - Partnerships and Limited Liability Entities Quest27 If a partnership allocates losses to the partners, the partners must first apply the passive loss limitations, then the basis limitation, and finally the at-risk limitations. If all three hurdles are met, the partner may deduct the loss.

a. True*b. False

1327. Chapter 11 - Partnerships and Limited Liability Entities Quest28 Hardy’s basis in his partnership interest was $5,000 at the beginning of the tax year. For the year, his share of the partnership’s loss was $6,000, and he also received a distribution of $3,000. Hardy can deduct a $2,000 loss, and the remaining $4,000 loss is suspended until a year in which he has adequate basis.

*a. Trueb. False

1328. Chapter 11 - Partnerships and Limited Liability Entities Quest29 Nicholas, a 1/3 partner with a basis in the interest of $80,000 at the beginning of the year, received a guaranteed payment in the current year of $50,000. Partnership income before consideration of the guaranteed payment was $20,000. Nicholas must report a $10,000 ordinary loss from partnership operations, and the $50,000 guaranteed payment as ordinary income.

*a. Trueb. False

1329. Chapter 11 - Partnerships and Limited Liability Entities Quest30 William is a general partner in the WST partnership. During the current year, he receives a guaranteed payment of $10,000 for services he provides to the partnership, and his distributive share of partnership income is $30,000. William is required to pay self-employment tax on the $10,000 guaranteed payment, but not on his distributive share of partnership income.

a. True*b. False

1330. Chapter 11 - Partnerships and Limited Liability Entities Quest31 Maria owns a 60% interest in the KLM Partnership. Four years ago her father gave her a parcel of land. The gift basis of the land to Maria is $60,000. In the current year, Maria had still not figured out how to use the land for her own personal or business use; consequently, she sold the land to the partnership for $75,000. The partnership immediately started using the land as a parking lot for its employees. Maria’s recognized gain of $15,000 on the sale is capital—not ordinary.

a. True*b. False

1331. Chapter 11 - Partnerships and Limited Liability Entities Quest32 One of the disadvantages of the partnership form is that the partner’s share of the partnership’s taxable income is taxed to the partner, regardless of whether or not distributed.

*a. Trueb. False

1332. Chapter 11 - Partnerships and Limited Liability Entities Quest33 Which of the following partnership owners is personally liable for the entity’s debts to general creditors?

a. A partner in a limited liability partnership.b. A member of a limited liability company.c. A limited partner in a limited partnership.*d. A general partner in a limited partnership.e. None of these owners are personally liable for entity debts.

1333. Chapter 11 - Partnerships and Limited Liability Entities Quest34 Which one of the following statements regarding partnership taxation is incorrect?

a. A partnership is not a taxable entity for Federal income tax purposes.b. Partnership income is comprised of ordinary partnership income or loss and separately stated items.c. A partnership is required to file a return with the IRS.*d. A partner’s profit-sharing ratio equals the partner’s loss-sharing ratio.e. All of these statements are correct.

1334. Chapter 11 - Partnerships and Limited Liability Entities Quest35 On a partnership’s Form 1065, which of the following statements is not true?

a. The partnership reconciles its net income (including separately stated items) to book income on Schedule M-1 or M-3.b. The partnership balance sheet on Schedule L is generally presented on a financial (book) basis.*c. All partnership income and expense items are reported on Form 1065, page 1.d. The partnership’s equivalent of taxable income is reported in the “Analysis of Income (Loss).”e. All of the above statements are true.

1335. Chapter 11 - Partnerships and Limited Liability Entities Quest36 Which of the following is a correct definition of a concept related to

partnership taxation?

*a. The entity concept treats partners and partnerships as separate units and gives the partnership its own tax “personality.”b. A partner’s capital sharing ratio is defined as the percent of partnership profits that will be allocated to the partner.c. The partnership’s inside basis is defined as the sum of each partner’s capital account balance. d. A special allocation is defined as an amount that could differently affect the tax liabilities of two or more partners.e. None of these statements is correct.

1336. Chapter 11 - Partnerships and Limited Liability Entities Quest37 A partnership will take a carryover basis in an asset it acquires when:

a. The partnership acquires the asset through a § 1031 like-kind exchange.b. A partner owning 25% of partnership capital and profits sells the asset to the partnership.c. The partnership leases the asset from a partner on a one-year lease. *d. The partnership acquires the asset from a partner as a contribution to partnership capital under § 721(a).e. None of the above.

1337. Chapter 11 - Partnerships and Limited Liability Entities Quest38 On January 1 of the current year, Jenna and Rob form an equal partnership. Jenna makes a cash contribution of $80,000 and a property contribution (adjusted basis of $120,000; fair market value of $160,000) in exchange for her interest in the partnership. Rob contributes property (adjusted basis of $190,000; fair market value of $240,000) in exchange for his partnership interest. Which of the following statements is true concerning the income tax results of this partnership formation?

*a. Jenna has a $200,000 tax basis for her partnership interest.b. Rob recognizes a $50,000 gain on his property transfer. c. Rob has a $240,000 tax basis for his partnership interest.d. The partnership has a $160,000 adjusted basis in the property contributed by Jenna. e. None of the statements is true.

1338. Chapter 11 - Partnerships and Limited Liability Entities Quest39 Kevin, Cody, and Greg contributed assets to form the equal KCG Partnership. Kevin contributed cash of $50,000 and land with a basis of $80,000 (fair market value of $50,000). Cody contributed cash of $30,000 and land with a basis of $40,000 (fair market value of $70,000). Greg contributed cash of $60,000 and a fully depreciated property ($0 basis) valued at $40,000. Which of the following tax treatments is not correct?

a. Kevin’s basis in his partnership interest is $130,000.*b. Cody’s basis in his partnership interest is $100,000.c. Greg’s basis in his partnership interest is $60,000.d. KCG has a basis of $80,000, $40,000, and $0 in the land and property (excluding cash) contributed by Kevin, Cody, and Greg, respectively.e. All of these statement are correct.

1339. Chapter 11 - Partnerships and Limited Liability Entities Quest40 Tara and Robert formed the TR Partnership four years ago. Because they decided the company needed some expertise in multimedia presentations, they offered Katie a 1/3 interest in partnership capital and profits if she would come to work for the partnership. On July 1 of the current year, the unrestricted partnership interest (fair market value of $25,000) was transferred to Katie. How should Katie treat the receipt of the partnership interest in the current year?

a. Nontaxable.*b. $25,000 ordinary income.c. $25,000 short-term capital gain. d. $25,000 long-term capital gain. e. None of the above.

1340. Chapter 11 - Partnerships and Limited Liability Entities Quest41 Partner Tom transferred property (basis of $20,000; fair market value of $50,000) to the TUV Partnership in exchange for a partnership interest. At a later date, when Tom's outside basis for his partnership interest was $70,000, Tom received a $50,000 cash distribution from the partnership. Which one of the following statements is not true?

a. If the cash distribution occurred two months after the property contribution, the IRS may treat the transaction as a disguised sale.*b. If the transaction is treated as a disguised sale, Tom's basis in the partnership interest will be $20,000.c. If Tom would have made the property contribution anyway, even if he knew that the partnership would probably not have any cash to distribute to him, the IRS would not likely contend the transaction was a disguised sale.d. If the IRS treated the transaction as a disguised sale, the partnership's basis in the property would be $50,000.

1341. Chapter 11 - Partnerships and Limited Liability Entities Quest42 In which of the following independent situations would the transaction most likely be characterized as a disguised sale?

a. Partner George contributes appreciated property to the GMVV Partnership, and three years later GMVV distributes $100,000 proportionately to all the partners.b. Brianna contributes property with a basis of $20,000 and a fair market value of $50,000 to the BGB Partnership in exchange for a 20% interest therein. The partnership agrees to distribute

$20,000 to Brianna in fifteen months, if partnership cash flows from operations exceed $100,000 at that time. The partnership does not expect to produce operating cash flows of over $100,000 for at least five years.c. Luis contributes appreciated property to the BLP Partnership. Thirty months later, he receives a distribution from the partnership of $15,000 cash. None of the other partners received a distribution. There was no agreement that BLP would make the distribution, and Luis would have made the contribution whether or not the partnership made the distribution.*d. None of the above transactions will be treated as a disguised sale.e. a., b., and c. are all treated as disguised sales.

1342. Chapter 11 - Partnerships and Limited Liability Entities Quest43 When property is contributed to a partnership for a capital and profits interest, the holding period of the contributing partner’s interest:

a. Always starts the day after the contribution date.b. Always starts the day the property was contributed.*c. May include the holding period of the contributed property. d. Never includes the holding period of the contributed property.e. None of the above.

1343. Chapter 11 - Partnerships and Limited Liability Entities Quest44 Lexi and Allie formed a partnership. Lexi received a 30% interest in partnership capital and profits in exchange for land with a basis of $50,000 and a fair market value of $90,000. Allie received a 70% interest in partnership capital and profits in exchange for $210,000 of cash. Three years after the contribution date, the land contributed by Lexi is sold by the partnership to a third party for $120,000. How much taxable gain will Lexi recognize from the sale?

a. $21,000.b. $40,000.*c. $49,000.d. $70,000.e. None of the above.

1344. Chapter 11 - Partnerships and Limited Liability Entities Quest45 Which of the following is an election or calculation made by the partner rather than the partnership?

*a. Whether to claim a tax credit or deduction for foreign taxes.b. Whether to capitalize, amortize, or expense research and experimental costs.c. The taxable year of the partnership.d. The depreciation method used for partnership property.e. All of the above elections are made by the partnership.

1345. Chapter 11 - Partnerships and Limited Liability Entities Quest46 TEC Partners was formed during the current tax year. It incurred $10,000 of organizational expenses, $80,000 of startup expenses, $200,000 of syndication costs, and $5,000 of transfer taxes to retitle property contributioned by a partner. Which of the following statements is correct regarding these payments?

a. TEC may deduct $5,000 of the syndication costs; the remaining amount must be amortized.b. TEC must amortize the $10,000 of organizational expenses over 180 months.c. TEC’s startup expenses are amortized over 60 months.*d. TEC must add the transfer tax to the basis of the contributed property.e. None of the above statements are true.

1346. Chapter 11 - Partnerships and Limited Liability Entities Quest47 Which of the following statements is always correct regarding assets acquired by a newly formed partnership? If a partner contributes:

a. Depreciable property: the partnership treats the property as newly acquired depreciable property, and may claim a § 179 deduction.b. Unrealized (cash-basis) receivables: the partnership will report a capital gain when the receivable is collected.*c. Inventory (in the partner’s hands): the partnership reports ordinary income if the property is held as a capital asset and sold within five years of the contribution date.d. Land valued at less than its basis: the partnership reports a § 1231 loss if the property is sold at a loss.e. None of these statements is correct.

1347. Chapter 11 - Partnerships and Limited Liability Entities Quest48 Erika contributed property with a basis of $30,000 and a value of $40,000 to the BE Partnership in exchange for a 40% interest in partnership capital and profits. During the first year of partnership operations, BE had net taxable income of $60,000. The partnership distributed $10,000 cash to Erika. Erika’s adjusted basis (outside basis) for her partnership interest at year-end is:

a. $24,000.b. $30,000.*c. $44,000.d. $54,000.e. None of the above.

1348. Chapter 11 - Partnerships and Limited Liability Entities Quest49 In the current year, the POD Partnership received revenues of $200,000 and paid the following amounts: $50,000 in rent and utilities, and $20,000 as a distribution to partner Olivia. In addition, the partnership earned $6,000 of long-term capital gains during the year. Partner Donald owns a 50% interest in the partnership. How much income

must Donald report for the tax year?

a. $68,000 ordinary income.b. $78,000 ordinary income.c. $65,000 ordinary income; $3,000 of long-term capital gains.*d. $75,000 ordinary income; $3,000 of long-term capital gains.e. None of the above.

1349. Chapter 11 - Partnerships and Limited Liability Entities Quest50 Kaylyn is a 40% partner in the KKM Partnership. During the current year, KKM reported gross receipts of $160,000 and a charitable contribution of $10,000. The partnership paid office expenses of $100,000. In addition, KKM distributed $10,000 each to partners Kaylyn and Kristie, and the partnership paid partner Megan $20,000 for administrative services. Kaylyn reports the following income from KKM during the current tax year:

*a. $16,000 ordinary income; $4,000 charitable contribution. b. $8,000 ordinary income; $4,000 charitable contribution. c. $4,000 ordinary income.d. $12,000 ordinary income.e. None of the above.

1350. Chapter 11 - Partnerships and Limited Liability Entities Quest51 Rick is a 30% partner in the ROC Partnership. At the beginning of the tax year, Rick’s basis in the partnership interest was $60,000, including his share of partnership liabilities. During the current year, ROC reported net ordinary income of $40,000. In addition, ROC distributed $5,000 to each of the partners ($15,000 total). At the end of the year, Rick’s share of partnership liabilities increased by $20,000. Rick’s basis in the partnership interest at the end of the year is:

a. $120,000.*b. $87,000.c. $75,000. d. $60,000. e. None of the above.

1351. Chapter 11 - Partnerships and Limited Liability Entities Quest52 Marissa is a 50% partner in the BAM Partnership. At the beginning of the tax year, Marissa’s basis in the partnership interest was $200,000, including her share of partnership liabilities. During the current year, BAM reported an ordinary loss of $100,000. In addition, BAM distributed $10,000 to Marissa and paid partner Brian a $20,000 consulting fee (neither of these amounts was deducted in determining the $100,000 loss from operations). At the end of the year, Marissa’s share of partnership liabilities decreased by $30,000. Assuming loss limitation rules do not apply, Marissa’s basis in the partnership interest at the end of the year is:

a. $135,000.*b. $100,000.c. $95,000. d. $90,000. e. None of the above.

1352. Chapter 11 - Partnerships and Limited Liability Entities Quest53 BCD Partners reported the following items on the partnership’s Schedule K: ordinary income, $72,000; interest income, $5,000; long-term capital gain, $8,000; charitable contributions, $3,000; post-1986 depreciation adjustment, $4,000; and cash distributions to partners, $20,000. How much will BCD show as net income (loss) on its Analysis of Income (Loss)?

a. $58,000.b. $72,000.c. $78,000.*d. $82,000.e. $85,000.

1353. Chapter 11 - Partnerships and Limited Liability Entities Quest54 At the beginning of the year, Heather’s “tax basis” capital account balance in the HEP Partnership was $60,000. During the tax year, Heather contributed property with a basis of $10,000 and a fair market value of $30,000. Her share of the partnership’s ordinary income and separately stated income and deduction items was $26,000. At the end of the year, the partnership distributed $10,000 of cash to Heather. Also, the partnership allocated $15,000 of recourse debt and $25,000 of nonrecourse debt to Heather. What is Heather’s ending capital account balance determined using the “tax basis” method?

*a. $86,000.b. $96,000.c. $101,000.d. $126,000.e. $136,000.

1354. Chapter 11 - Partnerships and Limited Liability Entities Quest55 Which of the following statements is not a requirement of the substantial economic effect test?

*a. Income, gains, losses, and deductions must be allocated to the partners in accordance with their capital contributions.b. An allocation of income must increase the partner’s capital account balance, and an allocation of deduction must decrease the partner’s capital account balance.c. A partner with a negative capital account balance must “restore” that capital account, generally by contributing cash to the partnership.d. On liquidation of the partner’s interest in the partnership, the partner must receive assets that have a fair market value equal to that partner’s (positive) capital account balance.

e. All of the above statements are requirements of the substantial economic effect test.

1355. Chapter 11 - Partnerships and Limited Liability Entities Quest56 Brooke and John formed a partnership. Brooke received a 40% interest in partnership capital and profits in exchange for contributing land (basis of $30,000 and fair market value of $120,000). John received a 60% interest in partnership capital and profits in exchange for contributing $180,000 of cash. Three years after the contribution date, the land contributed by Brooke is sold by the partnership to a third party for $150,000. How much taxable gain will Brooke recognize from the sale?

*a. $102,000.b. $90,000.c. $48,000.d. $36,000.e. $0.

1356. Chapter 11 - Partnerships and Limited Liability Entities Quest57 Michelle and Jacob formed the MJ Partnership. Michelle contributed $20,000 of cash in exchange for her 50% interest in the partnership capital and profits. During the first year of partnership operations, the following events occurred: the partnership had a net taxable income of $10,000; Michelle received a distribution of $8,000 cash from the partnership; and Michelle had a 50% share in the partnership’s $16,000 of recourse liabilities on the last day of the partnership year. Michelle’s adjusted basis for her partnership interest at year end is:

a. $17,000.b. $20,000.*c. $25,000.d. $33,000.e. $38,000.

1357. Chapter 11 - Partnerships and Limited Liability Entities Quest58 Which of the following statements is correct regarding the manner in which partnership liabilities are reflected in the partners’ bases in their partnership interests?

a. Nonrecourse debt is allocated to the partners according to their loss-sharing ratios.b. Recourse debt is allocated to the partners to the extent of the partnership’s minimum gain in the property.c. An increase in partnership debts results in a decrease in the partners’ bases in the partnership interest.*d. A decrease in partnership debt is treated as a distribution from the partnership to the partner and reduces the partner’s basis in the partnership interest.e. Partnership debt is not reflected in the partners’ bases in their partnership interests.

1358. Chapter 11 - Partnerships and Limited Liability Entities Quest59 Alicia and Barry form the AB Partnership at the start of the current year with a land contribution by Barry and a cash contribution by Alicia. Barry’s contributed property is subject to a recourse mortgage assumed by the partnership. Barry has an 80% interest in AB’s profits and losses. The land has been held by Barry for the past 6 years as an investment. It will be used by AB as an operating asset in its parking lot business. Which of the following statements is correct?

a. Immediately after formation, Alicia’s basis in the partnership equals the cash contributed by Alicia.*b. Immediately after formation, Alicia’s basis in the partnership equals the cash she contributed plus her share of the recourse debt contributed by Barry.c. Since the debt is recourse, the constructive liquidation scenario is not applicable for determining the allocation of debt to the partners.d. AB’s basis in the land contributed by Barry equals Barry’s basis in the land immediately before the contribution date, less the amount of the recourse debt assumed by the partnership.e. None of the above.

1359. Chapter 11 - Partnerships and Limited Liability Entities Quest60 Which of the following is not an adjustment to the partners’ basis in the partnership interest?

a. Increased by contributions the partner made to the partnership.*b. Decreased by the amount of guaranteed payments the partner received from the partnership.c. Increased by the partner’s share of tax-exempt income.d. Decreased by any decrease in the partner’s share of partnership liabilities.e. Increased by the partner’s share of separately stated income items.

1360. Chapter 11 - Partnerships and Limited Liability Entities Quest61 Rebecca is a partner in the RST Partnership, which is not publicly traded. Her allocable share of RST’s passive ordinary losses from a nonrealty activity for the current year is ($60,000). Rebecca has a $40,000 adjusted basis (outside basis) for her interest in RST (before deduction of any of the passive losses). Her amount “at risk” under § 465 is $30,000 (before deduction of any of the passive losses). She also has $25,000 of passive income from other sources. How much of her ($60,000) allocable loss can Rebecca deduct on her current year’s tax return?

*a. $25,000.b. $30,000.c. $40,000.d. $60,000.

e. None of the above.

1361. Chapter 11 - Partnerships and Limited Liability Entities Quest62 At the beginning of the tax year, Zach’s basis for his partnership interest and his amount at risk in the partnership was $30,000. His share of partnership items for the year consisted of tax-exempt interest income of $2,000 and an ordinary loss of $44,000. He also received a distribution from the partnership of $20,000 cash during the year. For the tax year, Zach will report:

a. A nontaxable distribution of $20,000, an ordinary loss of $10,000, and a suspended loss carryforward of $34,000.b. An ordinary loss of $32,000, a suspended loss carryforward of $12,000, and a taxable distribution of $20,000.*c. A nontaxable distribution of $20,000, an ordinary loss of $12,000, and a suspended loss carryforward of $32,000.d. An ordinary loss of $44,000 and a nontaxable distribution of $20,000.

1362. Chapter 11 - Partnerships and Limited Liability Entities Quest63 Victor is a 40% owner (member) of Real Properties R Us, LLC (RPRU). During the current tax year, RPRU reported a loss from rental real estate activities of ($200,000) which is treated as a passive loss. Victor is a material participant in RPRU and meets the active participation requirements for rental real estate activities. His modified AGI is $120,000. In addition, Victor has passive income from other sources of $60,000. Assuming Victor meets the basis and at risk limitations, what amount of the RPRU loss may Victor deduct under the passive loss rules?

a. $80,000.*b. $75,000.c. $70,000.d. $60,000.e. $0.

1363. Chapter 11 - Partnerships and Limited Liability Entities Quest64 Paul sells one parcel of land (basis of $200,000) for its fair market value of $250,000 to a partnership in which he owns a 75% capital interest. Paul held the land for investment purposes. The partnership is in the real estate development business, and will build residential housing (for sale to customers) on the land. Paul will recognize:

a. $0 gain or loss.b. $37,500 ordinary income.c. $37,500 capital gain.*d. $50,000 ordinary income.e. $50,000 capital gain.

1364. Chapter 11 - Partnerships and Limited Liability Entities Quest65 Molly is a 40% partner in the MAP Partnership. During the current tax

year, the partnership reported ordinary income of $210,000 before payment of guaranteed payments and distributions to partners. The partnership made an ordinary cash distribution of $30,000 to Molly, and paid guaranteed payments to partners Molly, Amber, and Pat of $30,000 each ($90,000 total). How much will Molly’s adjusted gross income increase as a result of the above items?

a. $88,000.*b. $78,000.c. $66,000.d. $36,000.e. None of the above.

1365. Chapter 11 - Partnerships and Limited Liability Entities Quest66 Stephanie is a calendar year cash basis taxpayer. She owns a 50% profit and loss interest in a cash basis partnership with a September 30 year-end. The partnership’s operating income (after deducting guaranteed payments) was $120,000 ($10,000 per month) and $144,000 ($12,000 per month), respectively, for the partnership tax years ended September 30, 2011 and 2012. The partnership paid guaranteed payments to Stephanie of $2,000 and $3,000 per month during the fiscal years ended September 30, 2011 and 2012. How much will Stephanie’s adjusted gross income be increased by these partnership items for her tax year ended December 31, 2011?

a. $60,000.b. $72,000.*c. $84,000.d. $90,000.e. $108,000.

1366. Chapter 11 - Partnerships and Limited Liability Entities Quest67 Joseph is the managing general partner of JKL, in which he owns a 40% interest. For the year, JKL reported income of $300,000 (after deducting all guaranteed payments). Joseph received a guaranteed payment of $20,000 for capital that he had loaned the partnership, and he received a guaranteed payment of $100,000 for services he performed for JKL. How much income from self-employment did Joseph earn from JKL?

a. $20,000.b. $100,000.c. $120,000.*d. $220,000.e. $240,000.

1367. Chapter 11 - Partnerships and Limited Liability Entities Quest68 Which of the following is not a correct statement regarding the advantage of the partnership entity form over the subchapter C corporate form?

a. A partnership typically has easier administrative and filing requirements than does a C corporation.

b. Partnership income is subject to a single level of taxation; corporate income is double taxed.c. Partnerships may specially allocate income and expenses among the partners, provided the substantial economic effect requirements are met; corporate dividends must be proportionate to shareholdings.*d. Partners in a general partnership have less personal liability for entity claims than shareholders of a C corporation.e. All of the above are advantages of partnership taxation.

1368. Chapter 11 - Partnerships and Limited Liability Entities Quest69 Match each of the following statements with the terms below that provide the best definition.Limited partnershipCheck the box regulationsProfits interestLimited liability partnershipAggregate conceptSubstitutedLimited liability companySyndication costsDisguised saleSeparately stated itemCarryoverEntity conceptGeneral partnershipMust have at least one general and one limited partner. Allows many unincorporated entities to select their Federal tax status. Partner’s percentage allocation of current operating results. Organizational choice of many large accounting firms. Theory treating the partnership as a collection of taxpayers joined in an agency relationship. Partner’s basis in partnership interest after tax-free contribution of asset to partnership. Owners are “members.” Brokerage and registration fees incurred for promoting and marketing partnership interests. Transfer of asset to partnership followed by immediate distribution of cash to partner. Might affect any two partners’ tax liabilities in different ways. Partnership’s basis in asset after tax-free contribution of asset to partnership. Theory treating the partner and partnership as separate economic units. All partners are jointly and severally liable for entity debts. No correct match provided.

[a] 1. Limited partnership[b] 2. Check the box regulations[c] 3. Profits interest[d] 4. Limited liability partnership[e] 5. Aggregate concept[f] 6. Substituted[g] 7. Limited liability company[h] 8. Syndication costs[i] 9. Disguised sale[j] 10. Separately stated item[k] 11. Carryover[l] 12. Entity concept[m] 13. General partnership

a. Must have at least one general and one limited partner.b. Allows many unincorporated entities to select their Federal

tax status.c. Partner’s percentage allocation of current operating

results.d. Organizational choice of many large accounting firms.e. Theory treating the partnership as a collection of

taxpayers joined in an agency relationship.f. Partner’s basis in partnership interest after tax-free

contribution of asset to partnership.

g. Owners are “members.”h. Brokerage and registration fees incurred for promoting and

marketing partnership interests.i. Transfer of asset to partnership followed by immediate

distribution of cash to partner.j. Might affect any two partners’ tax liabilities in different

ways.k. Partnership’s basis in asset after tax-free contribution of

asset to partnership.l. Theory treating the partner and partnership as separate

economic units.m. All partners are jointly and severally liable for entity

debts.n. No correct match provided.

1369. Chapter 11 - Partnerships and Limited Liability Entities Quest70 Match each of the following statements with the terms below that provide the best definition.Organizational costsCost versus percentage depletion decisionInside basisStartup costs§ 179 deductionPrecontribution gainDomestic production activities deductionOutside basisGuaranteed paymentNo correct match is provided. Tax accounting election made by partner. Adjusted basis of each partnership asset. Operating expenses incurred after entity is formed but before it begins doing business. Tax accounting election made by partnership. Will eventually be allocated to partner making tax-free property contribution to partnership. Tax accounting calculation made by partner. Each partner’s basis in the partnership. Amount that may be received by partner for performance of services for the partnership. Designed to prevent excessive deferral of taxation of partnership income. Computation that determines the way recourse debt is shared. Must be satisfied if a loss item is to be allocated to a partner. Justification for a tax year other than the required taxable year.

[a] 1. Organizational costs[b] 2. Cost versus percentage depletion decision[c] 3. Inside basis[d] 4. Startup costs[e] 5. § 179 deduction[f] 6. Precontribution gain[g] 7. Domestic production activities deduction[h] 8. Outside basis[i] 9. Guaranteed payment

a. No correct match is provided.b. Tax accounting election made by partner.c. Adjusted basis of each partnership asset.d. Operating expenses incurred after entity is formed but

before it begins doing business.e. Tax accounting election made by partnership.f. Will eventually be allocated to partner making tax-free

property contribution to partnership.g. Tax accounting calculation made by partner.h. Each partner’s basis in the partnership.i. Amount that may be received by partner for performance of

services for the partnership.

j. Designed to prevent excessive deferral of taxation of partnership income.

k. Computation that determines the way recourse debt is shared.

l. Must be satisfied if a loss item is to be allocated to a partner.

m. Justification for a tax year other than the required taxable year.

1370. Chapter 11 - Partnerships and Limited Liability Entities Quest71 Greg and Justin are forming the GJ Partnership. Greg contributes $500,000 cash and Justin contributes nondepreciable property with an adjusted basis of $200,000 and a fair market value of $550,000. The property is subject to a $50,000 liability, which is also transferred into the partnership and is shared equally by the partners for basis purposes. Greg and Justin share in all partnership profits equally except for any precontribution gain, which must be allocated according to the statutory rules for built-in gain allocations.

a. What is Justin’s adjusted tax basis for his partnership interest immediately after the partnership is formed?

b. What is the partnership’s adjusted basis for the property

contributed by Justin? c. If the partnership sells the property contributed by Justin for

$600,000, how is the tax gain allocated between the partners?

Correct Answer:a. Justin’s adjusted basis is $175,000. Computation: Basis of property contributed $200,000 Plus: Justin’s share of partnership liability 25,000 Less: Justin’s liability transferred to partnership (50,000) $175,000

b. Partnership’s basis (carryover basis) is $200,000.

c. Justin is allocated $375,000 of the gain and Greg is allocated gain of $25,000. Computation: Sales price $600,000 Less: Adjusted basis (200,000) Total gain on sale $400,000

Justin Greg Built-in (precontribution) gain $350,000 $ –0– Remaining gain 25,000 25,000 Gain allocated to partner $375,000 $25,000

1371. Chapter 11 - Partnerships and Limited Liability Entities Quest72 Andrew contributes property with a fair market value of $6,000,000 and an adjusted basis of $2,000,000 to AP Partnership. Andrew shares in $3,000,000 of partnership debt under the liability sharing rules, giving him an initial adjusted basis for his partnership interest of $5,000,000. One month after the contribution, Andrew receives a cash distribution from the partnership of $3,000,000. Andrew would not have contributed the property if the partnership had not contractually obligated itself to make the distribution. Assume Andrew’s share of partnership liabilities will not change as a result of this distribution.

a. Under the IRS’s likely treatment of this transaction, what is the amount of gain or loss that Andrew will recognize because of the $3,000,000 cash distribution?

b. What is the partnership’s basis for the property after the

distribution? c. If Andrew is unhappy with this result, can you suggest a possible

alternative that may provide him with a better answer?

Correct Answer:a. Andrew will likely recognize a $2,000,000 [($6,000,000 – $2,000,000) ´ 50% ] gain on the

transaction. Andrew received a cash payment equal to one-half the value of the property he contributed. The IRS would likely treat this as a disguised sale of the property. A disguised sale is presumed to occur when a contractual agreement requires a contribution by a partner to be followed within two years by a specified distribution by the partnership, and the distribution is made without regard to partnership profits. Both these tests are satisfied in this scenario. While Andrew could argue that the intent of this transaction is not to create a disguised sale, it is doubtful that he would be successful.

b. The partnership’s total basis for the property is $4,000,000. Its basis for the purchased

property is the $3,000,000 cost of the property (the partnership is deemed to have paid for the property). In addition, the partnership has a $1,000,000 carryover basis for the portion of the property that was not “purchased.”

c. If Andrew can wait for more than two years to receive the distribution and if the distribution is

not contractually guaranteed, the contribution and distribution transactions will be presumed not to be a disguised sale. The distribution will be treated as a normal distribution that will not create capital gain for Andrew unless the distribution amount exceeds the adjusted basis for his partnership interest when the distribution is made.

1372. Chapter 11 - Partnerships and Limited Liability Entities Quest73 During the current year, MAC Partnership reported the following items of receipts and expenditures: $300,000 sales, $20,000 utilities, $30,000 rent, $100,000 salaries to employees, $40,000 guaranteed payment to partner Mitchell, investment interest income of $4,000, a charitable contribution of $6,000, and a distribution of $20,000 to partner Chad. Austin is a 40% partner. What items will be reflected on Austin’s Schedule K-1?

Correct Answer:

The partnership’s ordinary taxable income is:

Sales $300,000 Utilities (20,000)Rent (30,000)Salaries (100,000)Guaranteed payment to Mitchell (40,000) Partnership ordinary income $110,000

Separately stated interest income $ 4,000 Separately stated charitable contribution $ 6,000

The distribution to Chad is not deductible by the partnership. Austin’s share of partnership items is $110,000 ´ 40% = $44,000 ordinary income, $4,000 ´ 40% = $1,600 interest income, and $6,000 ´ 40% = $2,400 charitable contribution.

1373. Chapter 11 - Partnerships and Limited Liability Entities Quest74 The LN partnership reported the following items of income and deduction during the current tax year: revenues, $200,000; cost of goods sold, $80,000; tax-exempt interest income, $5,000; salaries to employees, $50,000; and long-term capital gain, $5,000. In addition, the partnership distributed $10,000 of cash to 50% partner Nina and $20,000 of cash to 50% partner Len. What is Nina’s share of ordinary partnership income and separately stated items?

Correct Answer:The partnership’s ordinary taxable income is: Revenues $200,000 Cost of goods sold (80,000) Salaries (50,000) Partnership ordinary income $ 70,000

Nina’s share ($70,000 ´ 50%) $ 35,000

Separately stated tax-exempt income (not reported) $ 2,500

Separately stated long-term capital gain (reported) $ 2,500

The distributions to the partners are not deductible.

1374. Chapter 11 - Partnerships and Limited Liability Entities Quest75 Crystal contributes land to the newly formed CD Partnership in exchange for a 40% interest. The land has an adjusted basis and fair market value of $200,000 and is subject to a liability of $50,000, which the partnership assumes. None of this liability is repaid at year-end. At the end of the year, the partnership has trade accounts payable of $60,000. Assume all liabilities are allocated proportionately to the partners. Total partnership income for the year is $300,000. What is Crystal’s basis in her partnership interest at the end of the year?

Correct Answer:

Crystal’s basis in the partnership interest at the end of the year is determined as follows:

Basis in land contributed to CD $200,000 Less: relief of liability assumed by partnership (50,000)Plus: share of liability related to land ($50,000 ´ 40%) 20,000 Plus: share of trade accounts payable ($60,000 ´ 40%) 24,000 Plus: share of partnership income 120,000 Ending basis in partnership interest $314,000

1375. Chapter 11 - Partnerships and Limited Liability Entities Quest76 An examination of the RB Partnership’s tax books provides the following information for the current year:

Operating (ordinary) income before guaranteed payments $225,000 Long-term capital gain 4,000 Guaranteed payment to Barry 25,000 Cash distributions to each partner 30,000 Interest on Georgia state bonds (exempt interest income) 2,000 Interest paid on funds used to purchase Georgia state bonds

500

Charitable contributions made by partnership 4,000 Increase in partnership liabilities from 1/1-12/31 30,000

Barry is a 30% partner in partnership capital, profits, and losses. Assume the adjusted basis of his partnership interest is $50,000 at the beginning of the year, and he shares in 30% of the partnership liabilities for basis purposes.

a. What is Barry’s adjusted basis for the partnership interest at the end of the year?

b. How much income must Barry report on his tax return for the current

year? What is the character of income?

Correct Answer:a. Barry’s adjusted basis for his partnership interest is $89,450. Adjusted basis, beginning of year $50,000 Plus: Share of income after guaranteed payment ($200,000 ´ 30%) $60,000 Long-term capital gain 1,200 Share of interest on Georgia state bonds 600 Increase in share of partnership liabilities 9,000 70,800 Less: Cash distributions $30,000 Share of interest used to purchase bonds 150 Share of partnership charitable deductions 1,200 (31,350) Adjusted basis, 12/31 $89,450

b. Barry will report $60,000 of income from the partnership plus a long-term capital gain of $1,200. He may be able to deduct $1,200 of charitable contributions as an itemized deduction. In addition, Barry must report the $25,000 guaranteed payment as income. The bond interest income is nontaxable and the related interest expense is nondeductible.

1376. Chapter 11 - Partnerships and Limited Liability Entities Quest77 Katherine invested $80,000 this year to purchase a 30% interest in the KLM Partnership. The partnership reported $200,000 of net income from operations, a $2,000 short-term capital loss, and a $10,000 charitable contribution. In addition, the partnership distributed $20,000 to Katherine and $10,000 each to partners Lauren and Missy. Assuming the partnership has no beginning or ending liabilities, what is Katherine’s basis in her partnership interest at the end of the year?

Correct Answer:$116,400. Katherine’s initial basis of $80,000 is increased by her 30% share of partnership income from operations ($60,000). Her basis is decreased by her 30% share of the partnership’s charitable contribution ($3,000) and the short-term capital loss ($600). It is also decreased by the $20,000 distribution she received. The distributions to Lauren and Missy do not affect Katherine’s basis. Katherine’s ending basis, then, is $116,400 ($80,000 + $60,000 – $600 – $3,000 – $20,000).

1377. Chapter 11 - Partnerships and Limited Liability Entities Quest78 Jamie contributed fully depreciated ($0 basis) property valued at $30,000 to the JKLM Partnership in exchange for a 40% interest in partnership capital and profits. During the first year of partnership operations, JKLM had net taxable income of $80,000 and tax-exempt income of $10,000. The partnership distributed $20,000 cash to Jamie.

Her share of partnership recourse liabilities on the last day of the partnership year was $13,000. What is Jamie’s adjusted basis (outside basis) for her partnership interest at the end of the tax year?

Correct Answer:

$29,000. Jamie is a 40% partner and will share in 40% of the partnership’s taxable income and tax-exempt income. In addition, her basis will include her allocable share of the partnership’s recourse liabilities. Her basis will be reduced by the cash distribution during the year. Jamie’s ending basis is calculated as follows:

Beginning basis $ –0– Plus: Share of partnership ordinary income (40% ´ $80,000) 32,000 Plus: Share of tax-exempt income (40% ´ $10,000) 4,000 Plus: Share of partnership liabilities 13,000 Basis before losses and distributions $49,000 Less: Distribution (20,000) $29,000

1378. Chapter 11 - Partnerships and Limited Liability Entities Quest79 In the current year, the DOE Partnership received revenues of $100,000 and paid the following amounts: $20,000 in rent and utilities, a $30,000 guaranteed payment to 50% partner Dave, $6,000 to partner Ethan for consulting services, and $10,000 as a distribution to partner Olivia. In addition, the partnership earned $4,000 of interest income during the year. Dave’s basis in his partnership interest was $35,000 at the beginning of the year, and includes a $10,000 share of partnership liabilities. At the end of the year, his share of partnership liabilities was $20,000.

a. How much income must Dave report for the tax year and what is the character of the income?

b. What is Dave’s basis in his partnership interest at the end of the

tax year?

Correct Answer:a. The partnership’s ordinary income is calculated as follows:

Revenues $100,000 Less: rent and utilities (20,000) Less: guaranteed payment to Dave (30,000) Less: consulting expenses to Ethan (6,000) Ordinary income $ 44,000

The distribution to Oliva is not deductible. The payment to Ethan is a deductible business expense. Dave’s share of DOE’s ordinary income is $22,000. The $4,000 of interest income is a separately stated item, of which Dave’s share is $2,000. In addition, Dave must report the $30,000 guaranteed payment as income.

b. Dave’s basis in his partnership interest is calculated as follows:

Beginning basis $35,000 Plus: increase in share of partnership liabilities 10,000 Plus: share of ordinary income 22,000 Plus: share of interest income 2,000 Ending basis $69,000

Dave’s guaranteed payment does not affect his basis.

1379. Chapter 11 - Partnerships and Limited Liability Entities Quest80 Sharon and Sara are equal partners in the S&S Partnership. On January 1 of the current year, each partner’s adjusted basis in S&S was $50,000 (including each partner’s $15,000 share of the partnership’s $30,000 of liabilities). During the current year, S&S repaid the $30,000 of liabilities and borrowed $20,000 for which Sharon and Sara are equally liable. In the current year ended December 31, S&S also sustained a net operating loss of $25,000 and earned $5,000 of interest income from investments. If liabilities are shared equally by the partners, on January 1 of the next year how much is each partner’s basis in her interest in S&S?

Correct Answer:

$35,000. Each partner’s initial basis in the partnership is $50,000. The basis is reduced by the $15,000 of repaid debt and increased by each partner’s $10,000 share of new liabilities. Each partner’s basis is then reduced by the $12,500 share of the net operating loss and increased by the $2,500 share of interest income, as follows:

Beginning basis $50,000 Plus: share of interest income 2,500 Less: decrease in share of partnership debt (5,000)Less: share of S&S loss (12,500) $35,000

1380. Chapter 11 - Partnerships and Limited Liability Entities Quest81 In the current year, the CAR Partnership received revenues of $400,000 and paid the following amounts: $160,000 in rent, utilities, and salaries; a $40,000 guaranteed payment to partner Ryan; $20,000 to partner Amy for consulting services; and a $40,000 distribution to 25% partner Cameron. In addition, the partnership realized a $12,000 net long-term capital gain. Cameron’s basis in his partnership interest was $60,000 at the beginning of the year, and included his $25,000 share of partnership liabilities. At the end of the year, his share of

partnership liabilities was $15,000.

a. How much income must Cameron report for the tax year? b. What is Cameron’s basis in the partnership interest at the end of

the year?

Correct Answer:a. $45,000 ordinary income and $3,000 LTCG. The partnership’s ordinary income is calculated

as follows: Revenues $400,000 Less: rent, utilities, and salaries (160,000) Less: guaranteed payment to Ryan (40,000) Less: consulting expenses to Amy (20,000) Ordinary income $180,000 The distribution to Cameron is not deductible. The payment to Amy is a deductible business

expense. Cameron’s share of CAR’s ordinary income is $45,000. The $12,000 net long-term capital gain is a separately stated item, of which Cameron’s share is $3,000.

b. Cameron’s basis in his partnership interest is calculated as follows: Beginning basis $60,000 Plus: share of ordinary income 45,000 Plus: share of net long-term capital gain 3,000 Less: decrease in share of partnership liabilities (10,000) Less: cash distribution to Cameron (40,000) Ending basis $58,000

1381. Chapter 11 - Partnerships and Limited Liability Entities Quest82 In the current year, Derek formed an equal partnership with Cody. Derek contributed land with an adjusted basis of $110,000 and a fair market value of $200,000. Derek also contributed $50,000 cash to the partnership. Cody contributed land with an adjusted basis of $80,000 and a fair market value of $230,000. The land contributed by Derek was encumbered by a $60,000 nonrecourse debt. The land contributed by Cody was encumbered by $40,000 of nonrecourse debt. Assume the partners share debt equally. Immediately after the formation, what is the basis of Cody’s partnership interest?

Correct Answer:

$90,000. Cody’s basis is determined as follows:

Basis of land $80,000 Deemed cash distribution (relief of Cody’s debt) (40,000)Share of Cody’s debt 20,000 Share of Derek’s debt 30,000

Cody’s basis $90,000

1382. Chapter 11 - Partnerships and Limited Liability Entities Quest83 Meagan is a 40% general partner in the calendar year, cash basis MKK Partnership. The partnership received $100,000 income from services and paid the following other amounts:

Rent expense $10,000Salary expense to employees 30,000Payment to Meagan for services, per the partnership agreement

20,000

Distributions to partners, Kristin and Kaylyn 12,000Payment to 40% cash basis partner Kaylyn for tax and accounting services

8,000

How much will Meagan’s adjusted gross income increase as a result of the above items?

Correct Answer:

$32,800. The $20,000 payment to Meagan is a guaranteed payment and is deductible by the partnership. The $8,000 payment to Kaylyn is deductible under § 707(a), since it was paid during the year. The distributions to Kristen and Kaylyn are not deductible by the partnership. The partnership’s ordinary income, then, is $32,000.

Income from services $100,000 Less: Rent expense $10,000 Salaries to employees 30,000 Guaranteed payment to Meagan 20,000 Payment to Kaylyn for services 8,000 (68,000) Partnership income $ 32,000

Of this $32,000 partnership income, 40%, or $12,800, is allocated to Meagan. She must also include the $20,000 guaranteed payment in her gross income this year, since she and the partnership use the same reporting period.

1383. Chapter 11 - Partnerships and Limited Liability Entities Quest84 The MOP Partnership is involved in leasing heavy equipment under long-term leases of five years or more. Patricia has an adjusted basis for her partnership interest on January 1 of the current year of $600,000, consisting of the following:

Capital account $350,000Share of partnership recourse debt 50,000Share of partnership nonrecourse debt 200,000

$600,000

During the year, the partnership has an operating loss of $1.2 million and distributes $60,000 of cash to Patricia. Partnership liabilities were the same at the end of the tax year, and the nonrecourse debt is not “qualified nonrecourse debt.” If she owns a 60% share of partnership profits, capital, and losses, and is a material participant in the partnership, how much of her share of the operating loss can Patricia deduct? What Code provisions could cause a suspension of the loss?

Correct Answer:

Patricia can only deduct $340,000 of her $720,000 share of the partnership’s operating loss on her tax return. Patricia’s adjusted basis for her partnership interest immediately before the deduction of any portion of the loss is $540,000 ($600,000 – $60,000 distribution). The amount of the loss that can be deducted is first limited by the $540,000 adjusted basis. Then, the remaining loss is limited by the “at-risk” amount of $340,000 ($600,000 – $60,000 distribution – $200,000 nonrecourse debt). (Patricia is not “at risk” for her $200,000 share of the nonrecourse debt.) The passive loss rules do not apply, since Patricia is a material participant in the partnership. Therefore, she can deduct a $340,000 loss on her return.

Deductible SuspendedAdjusted basis [§ 704(d)] $540,000 $180,000At risk amount (§ 465) 340,000 200,000Passive loss rules (§ 469) Not applicable

1384. Chapter 11 - Partnerships and Limited Liability Entities Quest85 Cassandra is a 10% limited partner in C&C, Ltd. Her basis in the interest is $60,000 before loss allocations, including her $30,000 share of the partnership’s nonrecourse debt. (This debt is not qualified nonrecourse financing.) Cassandra is also a 10% limited partner in RSTU, in which her basis is $30,000. Cassandra is allocated an $80,000 loss from C&C, and $20,000 of income from RSTU. How much of the loss from C&C may Cassandra deduct? Under what Code provisions are the remaining losses suspended?

Correct Answer:

Cassandra’s $80,000 loss from C&C is first limited by the basis rules of § 704(d); $20,000 of the loss ($80,000 loss – $60,000 basis) is limited under this rule. The remaining $60,000 loss is tested under the at-risk rules. Cassandra’s amount at risk is $30,000 (her basis less the nonrecourse debt); $30,000 of the loss ($60,000 – $30,000) is suspended under the at-risk rules. As a limited partner, the remaining $30,000 loss is treated as a passive loss. That loss can be deducted to the extent of Cassandra’s passive income from RSTU, or $20,000. The remaining $10,000 of loss is suspended under the passive loss rules.

Deductible SuspendedAdjusted basis [§ 704(d)] $60,000 $20,000At risk amount (§ 465) 30,000 30,000Passive loss rules 20,000 10,000

1385. Chapter 11 - Partnerships and Limited Liability Entities Quest86 James and Kendis created the JK Partnership by contributing $60,000 each. The $120,000 cash was used by the partnership to acquire a depreciable asset. The partnership agreement provides that the partners’ capital accounts will be maintained in accordance with Reg. § 1.704-1(b) (the “economic effect” Regulations) and that any partner with a deficit capital account will be required to restore that capital account when the partner’s interest is liquidated. The partnership agreement provides that MACRS will be allocated 10% to James and 90% to Kendis. All other items of partnership income, gain, loss, deduction, and credit will be allocated equally between the partners. In the first year, MACRS is $20,000 and no other operating transactions occur. The property is sold at the end of the year for $100,000 and the partnership is liquidated immediately thereafter.

To satisfy the economic effect test, how much of the $100,000 cash (from the sale) is allocated each to James and Kendis?

Correct Answer:Distributions upon liquidation must follow the capital accounts for each partner. After MACRS allocations, James will have a capital account balance of $58,000 ($60,000 – $2,000) and Kendis’s capital account balance will be $42,000 ($60,000 – $18,000). If the asset is sold for its $100,000 carrying value on the partnership books, no gain or loss will be recognized on the sale and, therefore, no further adjustment needs to be made to the partner’s capital accounts. Upon liquidation, the partners will receive the balances in their capital accounts.

1386. Chapter 12 - S Corporations Question TF #1 The alternative minimum tax may apply to an S corporation.

a. True*b. False

1387. Chapter 12 - S Corporations Question TF #2 The alternative minimum tax does not apply to an S corporation.

*a. Trueb. False

1388. Chapter 12 - S Corporations Question TF #3 Liabilities affect owners’ basis differently between a partnership and an S corporation.

*a. Trueb. False

1389. Chapter 12 - S Corporations Question TF #4 An S election allows shareholders to realize tax benefits from losses immediately.

*a. Trueb. False

1390. Chapter 12 - S Corporations Question TF #5 An NOL from a Subchapter C year can be used to offset operating income in an S corporation year.

a. True*b. False

1391. Chapter 12 - S Corporations Question TF #6 An estate can be an S corporation shareholder.

*a. Trueb. False

1392. Chapter 12 - S Corporations Question TF #7 A maximum dollar sales limitation applies to an S corporation.

a. True*b. False

1393. Chapter 12 - S Corporations Question TF #8 Differences in distribution or liquidation rights among shareholders do not create a second class of stock.

a. True*b. False

1394. Chapter 12 - S Corporations Question TF #9 Straight debt issued in an S corporation year will not be treated as a second class of stock and will not disqualify an S election.

a. True*b. False

1395. Chapter 12 - S Corporations Question TF #10 A widower and his spouse’s estate are treated as one shareholder.

*a. Trueb. False

1396. Chapter 12 - S Corporations Question TF #11 A former spouse is treated as being in the same family as the individual to whom he or she was married.

*a. Trueb. False

1397. Chapter 12 - S Corporations Question TF #12 A limited liability company can own S corporation stock.

a. True*b. False

1398. Chapter 12 - S Corporations Question TF #13 An S corporation can be a partner in a partnership.

*a. Trueb. False

1399. Chapter 12 - S Corporations Question TF #14 Most Roth IRAs can own S corporation stock.

a. True*b. False

1400. Chapter 12 - S Corporations Question TF #15 For S corporation status to apply in the current tax year, the election must be filed during the grace period before the 15th day of the third month of the current year.

a. True*b. False

1401. Chapter 12 - S Corporations Question TF #16 A limited liability company can make an S election.

*a. Trueb. False

1402. Chapter 12 - S Corporations Question TF #17 A voluntary revocation of an S election requires only a consent of shareholders owning a majority of shares on the day that the revocation

is made.

*a. Trueb. False

1403. Chapter 12 - S Corporations Question TF #18 A corporation can revoke its S status prospectively.

*a. Trueb. False

1404. Chapter 12 - S Corporations Question TF #19 There is no limit on the amount of passive investment income that an S corporation can receive during the year.

a. True*b. False

1405. Chapter 12 - S Corporations Question TF #20 Rents always are considered to be passive investment income in S status.

a. True*b. False

1406. Chapter 12 - S Corporations Question TF #21 Tax-exempt income is a Schedule K item for an S corporation.

*a. Trueb. False

1407. Chapter 12 - S Corporations Question TF #22 An S corporation’s separately stated items are identical to those separately stated by partnerships.

*a. Trueb. False

1408. Chapter 12 - S Corporations Question TF #23 An S corporation can take advantage of the dividends received deduction.

a. True*b. False

1409. Chapter 12 - S Corporations Question TF #24 The Section 179 expense deduction is a Schedule K item.

*a. Trueb. False

1410. Chapter 12 - S Corporations Question TF #25 Depreciation recapture income is a Schedule K item.

a. True*b. False

1411. Chapter 12 - S Corporations Question TF #26 A per-day, per-share allocation of flow-through S corporation items must be used, unless the shareholder disposes of the entire interest in the entity.

*a. Trueb. False

1412. Chapter 12 - S Corporations Question TF #27 Any distribution of cash or property by a corporation that does not exceed the balance of AAA with respect to the stock during a post-termination transition period of approximately one year is applied against and reduces the adjusted basis of the stock.

a. True*b. False

1413. Chapter 12 - S Corporations Question TF #28 All tax preference items flow through the S corporation, to be included in the shareholders’ AMT calculations.

*a. Trueb. False

1414. Chapter 12 - S Corporations Question TF #29 An S shareholder who dies during the corporate tax year must report his or her share of the pro rata income (or loss) up to the date of death on the final individual tax return.

*a. Trueb. False

1415. Chapter 12 - S Corporations Question TF #30 A capital loss allocated to a shareholder always reduces the other adjustments account.

a. True*b. False

1416. Chapter 12 - S Corporations Question TF #31 Tax-exempt income is not separately stated on Schedule K of Form 1120S.

a. True*b. False

1417. Chapter 12 - S Corporations Question TF #32 A distribution from OAA is taxable.

a. True*b. False

1418. Chapter 12 - S Corporations Question TF #33 An item that appears in the “Other Adjustments Account” affects stock basis, but not AAA, such as tax-exempt life insurance proceeds.

*a. Trueb. False

1419. Chapter 12 - S Corporations Question TF #34 An S corporation that has total assets of at least $5 million on Schedule L at the end of the tax year must file a Schedule M-3.

a. True*b. False

1420. Chapter 12 - S Corporations Question TF #35 The Schedule M-3 is the same for a C corporation and an S corporation.

a. True*b. False

1421. Chapter 12 - S Corporations Question TF #36 A distribution of cash or other property by an S corporation to shareholders that does not exceed the balance of AAA during a one-year period following an S election termination receives special capital gain treatment.

a. True*b. False

1422. Chapter 12 - S Corporations Question TF #37 Post-termination distributions that are charged against OAA do not get tax-free treatment.

*a. Trueb. False

1423. Chapter 12 - S Corporations Question TF #38 An S corporation does not recognize a loss when distributing assets that are worth less than their basis.

*a. Trueb. False

1424. Chapter 12 - S Corporations Question TF #39 When loss assets are distributed by an S corporation, a shareholder’s basis is equal to the asset’s fair market value.

*a. Trueb. False

1425. Chapter 12 - S Corporations Question TF #40 An S shareholder’s basis is increased by stock purchases and capital contributions.

*a. Trueb. False

1426. Chapter 12 - S Corporations Question TF #41 An S shareholder’s basis is decreased by distributions treated as being paid from AAA.

*a. Trueb. False

1427. Chapter 12 - S Corporations Question TF #42 Form 1120S provides a shareholder’s computation of his or her stock basis.

a. True*b. False

1428. Chapter 12 - S Corporations Question TF #43 An S corporation shareholder’s basis includes his or her direct investments plus a ratable share of any corporate liabilities.

a. True*b. False

1429. Chapter 12 - S Corporations Question TF #44 An S shareholder’s basis in his or her stock can be reduced below zero.

a. True*b. False

1430. Chapter 12 - S Corporations Question TF #45 Pass-through S corporation losses can reduce the basis in the shareholder’s loan to the entity, but distributions do not.

*a. Trueb. False

1431. Chapter 12 - S Corporations Question TF #46 An S shareholder’s stock basis is reduced by flow-through losses before accounting for distributions.

a. True*b. False

1432. Chapter 12 - S Corporations Question TF #47 An S shareholder’s stock basis includes a ratable share of any S corporation liabilities.

a. True*b. False

1433. Chapter 12 - S Corporations Question TF #48 Any excess of S corporation losses or deductions over the shareholder’s combined stock and debt basis is suspended until there is a subsequent stock or debt basis.

*a. Trueb. False

1434. Chapter 12 - S Corporations Question TF #49 An S corporation is entitled to a deduction for its NOL carryovers.

a. True*b. False

1435. Chapter 12 - S Corporations Question TF #50 Any distribution made by an S corporation during a tax year is taken into account before accounting for the year’s losses.

*a. Trueb. False

1436. Chapter 12 - S Corporations Question TF #51 The carryover period for the NOLs of a C corporation continues to run during S corporation years.

*a. Trueb. False

1437. Chapter 12 - S Corporations Question TF #52 Any losses that are suspended under the at-risk rules are carried forward and are available during an S corporation’s post-termination period.

*a. Trueb. False

1438. Chapter 12 - S Corporations Question TF #53 The § 1374 tax is a corporate-level tax on any built-in gain recognized in 2011 when an S corporation disposes of an asset in a taxable disposition within 7 tax years after the date on which the S election took effect.

a. True*b. False

1439. Chapter 12 - S Corporations Question TF #54 The LIFO recapture tax is a variation of the passive investment income penalty tax.

a. True*b. False

1440. Chapter 12 - S Corporations Question TF #55 Passive investment income includes net capital gains from the sale of stocks and securities.

*a. Trueb. False

1441. Chapter 12 - S Corporations Question TF #56 Compensation for services rendered to an S corporation is subject to FICA taxes.

*a. Trueb. False

1442. Chapter 12 - S Corporations Question TF #57 It is beneficial for an S corporation to issue § 1244 stock.

*a. Trueb. False

1443. Chapter 12 - S Corporations Question MC #1 Which statement is false?

a. S corporations are treated as corporations under state law.*b. The alternative minimum tax applies to an S corporation.c. Liabilities affect S shareholders differently than partners.d. S corporations may not allocate income like partnerships.e. None of the above.

1444. Chapter 12 - S Corporations Question MC #2 An S corporation may be subject to the following tax:

a. Corporation income tax (§ 11).*b. Passive investment income tax.c. Alternative minimum tax.d. None of the above applies to S corporations.

1445. Chapter 12 - S Corporations Question MC #3 Which statement is false?

a. S corporation status provides many of the benefits of partnership treatment.b. S corporation shareholders have limited liability.*c. Distributions of appreciated assets are not taxable in an S corporation.d. The personal holding company tax does not apply to an S corporation.e. None of the above.

1446. Chapter 12 - S Corporations Question MC #4 Which statement is false?

a. Partnership taxation rules do not apply to S corporations.b. A two-or-more member LLC operates under partnership principles.c. All income of an S corporation flows through to the S shareholders.d. S shareholders may use their proportionate shares of NOLs currently.*e. None of the above.

1447. Chapter 12 - S Corporations Question MC #5 Which statement is true?

a. Charitable contributions are subject to the 10% limitation at the corporate level.*b. The at-risk rules apply to S corporations.c. The passive loss limitations do not apply to S corporations.d. S corporations are exempted from state and local taxes.e. None of the above.

1448. Chapter 12 - S Corporations Question MC #6 An S corporation must possess the following characteristic(s):

a. No more than 100 shareholders.b. Corporation organized in the U.S.c. Only one class of stock.*d. All of the above are required of S corporations.e. None of the above is required for S corporations.

1449. Chapter 12 - S Corporations Question MC #7 Which is ineligible to be an S shareholder?

a. Individual.b. Estate.*c. Partnership.d. Spouse of a nonresident alien (common law state).e. None of the above.

1450. Chapter 12 - S Corporations Question MC #8 Identify a disadvantage of S corporation status.

*a. If the entity electing S status is currently a C corporation,NOL carryovers from prior years generally cannot be used in an S corporation year.b. Losses flow through to the shareholders.c. The ACE adjustment is avoided.d. Tax-exempt income flows through to the shareholders.e. None of the above is a disadvantage of the S election.

1451. Chapter 12 - S Corporations Question MC #9 Which, if any, of the following can be an eligible shareholder of an S corporation?

*a. A resident alien.b. Limited liability company.c. A foreign corporation.d. A Roth IRA.e. None of the above can own S corporation stock.

1452. Chapter 12 - S Corporations Question MC #10 Which, if any, of the following is not an eligible shareholder of an S corporation?

a. A child, age 9.*b. Spouse of a nonresident alien in a community property state.c. A voting trust.d. An estate of a deceased shareholder.e. All of the above can own S corporation stock.

1453. Chapter 12 - S Corporations Question MC #11 Which event will not terminate an S election?

*a. Receipt of passive income.b. Share of stock given to a nonresident alien.c. Shares of stock given to a corporation.d. A second class of stock issued.e. All of the above terminate an election.

1454. Chapter 12 - S Corporations Question MC #12 Which could constitute a second class of stock under the S corporation rules?

a. Treasury stock.b. Phantom stock.c. Unexercised stock options.d. Warrants.*e. None of the above.

1455. Chapter 12 - S Corporations Question MC #13 Which could constitute a second class of stock under the S corporation rules?

a. Unissued stock.b. Treasury stock.c. Stock appreciation rights.d. Convertible debentures.*e. None of the above.

1456. Chapter 12 - S Corporations Question MC #14 Which statement is incorrect with respect to filing for an S election?

a. Form 2553 must be filed.b. All shareholders must consent.c. The election may be filed in the previous year.d. An extension of time is available for filing Form 2553.*e. None of the above are incorrect.

1457. Chapter 12 - S Corporations Question MC #15 Several individuals acquire assets on behalf of Skip Corporation on May 28, 2011, purchased assets on June 3, 2011, and begin doing business on June 11, 2011. They subscribe to shares of stock, file articles of incorporation for Skip, and become shareholders on June 21, 2011. The S election must be filed no later than 2 1/2 months after:

*a. May 28, 2011.b. June 3, 2011.c. June 11, 2011.d. June 21, 2011.

e. December 31, 2011.

1458. Chapter 12 - S Corporations Question MC #16 The maximum number of S shareholders is:

a. 75.b. 100.c. 200.d. Some other fixed amount.*e. Indeterminable.

1459. Chapter 12 - S Corporations Question MC #17 Which statement is incorrect with respect to an S shareholder’s consent?

a. An S election requires a consent from all of the S corporation’s shareholders.b. Both husband and wife must consent if one owns the stock as community property.c. A consent extension is available only if Form 2553 is filed on a timely basis, reasonable cause is given, and the interests of the government are not jeopardized.d. A consent must be in writing.*e. None of the above statements is incorrect.

1460. Chapter 12 - S Corporations Question MC #18 Which item does not appear on Schedule K of Form 1120S?

a. Tax-exempt interest income.*b. Depreciation recapture income.c. Section 179 expense deduction.d. Section 1231 loss.e. All of the above appear on Schedule K.

1461. Chapter 12 - S Corporations Question MC #19 Which item does not appear in an S corporation’s nonseparately computed income?

a. Net sales.*b. Tax-exempt income.c. Cost of goods sold.d. Depreciation recapture.e. All of the above appear.

1462. Chapter 12 - S Corporations Question MC #20 Which item does not appear on Schedule K of Form 1120S?

a. Intangible drilling costs.b. Foreign loss.

c. Recovery of a tax benefit.*d. Interest expense.e. All of the above appear on Schedule K.

1463. Chapter 12 - S Corporations Question MC #21 What method is automatically used to allocate income or losses (unless an election is made)?

a. Short-year method.b. Long-year method.*c. Per-day allocation.d. FIFO method.e. LIFO method.

1464. Chapter 12 - S Corporations Question MC #22 Which item has no effect on an S corporation’s AAA?

a. Capital loss.b. Administrative expenses.c. Cost of goods sold.*d. Stock purchase by a shareholder.e. All of the above modify AAA.

1465. Chapter 12 - S Corporations Question MC #23 Which type of distribution from an S corporation is taxed at the 0/15% Federal income tax rate?

a. AAA.b. Nonseparately computed income.c. OAA.*d. AEP.e. None of the above.

1466. Chapter 12 - S Corporations Question MC #24 Which transaction affects the Other Adjustments Account on an S corporation’s Schedule M-2?

a. Taxable dividends.b. Stock dividend (taxable).c. Depreciation recapture income.*d. Tax-exempt income.e. None of the above.

1467. Chapter 12 - S Corporations Question MC #25 Which transaction affects the Other Adjustments Account on an S corporation’s Schedule M-2?

a. Charitable contributions.b. Unreasonable compensation.

c. Payroll tax penalty assessed.d. Domestic production activities deduction.*e. None of the above.

1468. Chapter 12 - S Corporations Question MC #26 Beginning in 2011, the AAA of Ewing, Inc., an S corporation, has a balance of $725,000. During the year, the following items occur.

Operating income $472,000 Interest income 6,500 Dividend income 14,050 Municipal bond interest income 6,000 Long-term capital loss from sale of investment land 7,400 Charitable contributions 19,000 Cash distributions to shareholders 57,000

Ewing’s ending AAA balance is:

a. $1,153,150.*b. $1,134,150.c. $1,127,650.d. $1,126,750.

1469. Chapter 12 - S Corporations Question MC #27 How large must total assets on Schedule L be at the end of the year for an S corporation to be required to file Schedule M-3?

a. $4 million.b. $5 million.c. $7.5 million.*d. $10 million.e. Not required to file.

1470. Chapter 12 - S Corporations Question MC #28 Distributions of which assets during an S corporation’s post-termination period receive favorable income tax treatment?

*a. Cash.b. Automobile.c. Real estate.d. Notes receivable.e. All of the above.

1471. Chapter 12 - S Corporations Question MC #29 During 2011, Dana Rippel, the sole shareholder of a calendar year S corporation, received a distribution of $16,000. On December 31, 2010, her stock basis was $4,000. The corporation earned $11,000 ordinary income during the year. It has no accumulated E & P. Which statement is

correct?

*a. Rippel recognizes a $1,000 LTCG.b. Rippel’s stock basis will be $2,000.c. Rippel’s ordinary income is $15,000.d. Rippel’s return of capital is $11,000.e. None of the above.

1472. Chapter 12 - S Corporations Question MC #30 On January 1, 2011, Zundel, Inc., an electing S corporation, has $4,000 of AEP and a balance of $10,000 in AAA. Zundel has two shareholders, Erin and Maine, each of whom owns 500 shares of Zundel’s stock. Zundel’s 2011 taxable income is $5,000. Zundel distributes $6,000 to each shareholder on February 1, 2011, and distributes another $3,000 to each shareholder on September 1. How is Erin taxed on this distribution?

a. $500 dividend income.b. $1,000 dividend income.*c. $1,500 dividend income.d. $3,000 dividend income.e. None of the above.

1473. Chapter 12 - S Corporations Question MC #31 Ryan is the sole shareholder of Sweetwater Apartments, an S corporation in Sour Lake, Texas. At a time when his stock basis is $10,000, the corporation distributes appreciated property worth $100,000 (basis of $10,000). There is no built-in gain. Ryan’s taxable gain is:

a. $0.b. $10,000.*c. $90,000.d. $100,000.e. None of the above.

1474. Chapter 12 - S Corporations Question MC #32 Which, if any, of the following items has no effect on the stock basis of an S corporation shareholder?

a. Net sales.b. Long-term capital gain.c. Cost of goods sold.d. Short-term capital loss.*e. A mortgage taken by the S corporation.

1475. Chapter 12 - S Corporations Question MC #33 You are given the following facts about a one-shareholder S corporation, and you are asked to prepare the shareholder’s ending stock basis.

Ordinary income $100,000Payroll tax penalty 2,140Stock purchases 32,000Domestic production activities deduction 18,500Tax-exempt insurance proceeds 49,000Insurance premiums paid (nondeductible) 2,700Beginning stock basis 38,800

a. $168,660.b. $170,800.*c. $214,960. d. $263,960.

1476. Chapter 12 - S Corporations Question MC #34 Samantha owned 1,000 shares in Evita, Inc., an S corporation, that uses the calendar year. On October 11, 2011, Samantha sells all of her Evita stock. Her basis at the beginning of 2011 was $60,000. Her share of the corporate income for 2011 was $22,000, and she receives a distribution of $37,000 between January 1 and October 11, 2011. Her stock basis at the time of the sale is:

*a. $45,000.b. $60,000.c. $75,000.d. $82,000.e. Some other answer.

1477. Chapter 12 - S Corporations Question MC #35 You are given the following facts about a 40% owner of an S corporation, and you are asked to prepare her ending stock basis.

Increase in AAA $32,000Increase in OAA 6,300Payroll tax penalty 2,140Ending PTI 6,125Beginning stock basis 36,800Tax-exempt interest income 4,800Insurance premiums paid (nondeductible) 2,700Stock purchases 22,000

a. $77,950.b. $82,750.c. $97,100.d. $103,225.*e. Some other answer.

1478. Chapter 12 - S Corporations Question MC #36 On January 2, 2010, David loans his S corporation $10,000, and by the end of 2010 David’s stock basis is zero and the basis in his note has been reduced to $8,000. During 2011, the company’s operating income is $10,000. The company also makes distributions to David of $11,000. Which statement is correct?

*a. $1,000 LTCG.b. $3,000 LTCG.c. $11,000 LTCG.d. Loan basis is $10,000.e. None of the above statements is correct.

1479. Chapter 12 - S Corporations Question MC #37 On January 2, 2010, Tim (the sole shareholder) loans his S corporation $10,000. By the end of 2010, Tim’s stock basis is zero, and the basis in his note has been reduced to $8,000. During 2011, the company’s operating income is $10,000. The company also makes distributions to Tim of $8,000. Which statement is correct?

*a. Loan basis is now $10,000.b. $8,000 LTCG.c. Stock basis is $2,000.d. $2,000 LTCG.e. None of the above statements is correct.

1480. Chapter 12 - S Corporations Question MC #38 During 2011, Oxen Corporation incurs the following transactions.

Net income from operations $100,000Interest income from savings account 3,000Long-term capital gain from sale of securities 10,000Short-term capital loss from sale of securities 4,000

Oxen maintains a valid S election and does not distribute any assets (cash or property) to its sole shareholder, Megan. As a result, Megan must recognize:

a. Ordinary income of $103,000 and long-term capital gain of $5,000.*b. Ordinary income of $103,000, long-term capital gain of $10,000, and $4,000 short-term capital loss.c. Ordinary income of $108,000.d. None of the above.

1481. Chapter 12 - S Corporations Question MC #39 On January 1, Bobby and Alice own equally all of the stock of an electing S corporation called Prairie Dirt Delight. The dirt company has a $60,000 loss for a non-leap year. On the 200th day of the year,

Bobby sells his one-half of the stock to his son, Saul. How much of the $60,000 loss, if any, is allocated to Bobby?

a. $0.*b. $13,562.c. $16,438.d. $32,877.e. None of the above.

1482. Chapter 12 - S Corporations Question MC #40 A calendar year C corporation has a $41,000 NOL in 2010, but it elects S status for 2011 and generates an NOL of $30,000 in 2011. At all times during 2011, the stock of the corporation was owned by the same 10 shareholders, each of whom owned 10% of the stock. Kris, one of the 10 shareholders, has an S stock basis of $2,300 at the beginning of 2011. How much of the loss, if any, is deductible by Kris in 2011?

a. None.*b. $2,300.c. $3,000.d. $7,100.

1483. Chapter 12 - S Corporations Question MC #41 An S corporation in Lawrence, Kansas has a recognized built-in gain of $110,000 and taxable income of $98,000. The company has an $8,000 NOL carryforward from a C corporation year, and a $7,000 business credit carryforward from a C corporation year. The built-in gains tax liability is:

a. $0.*b. $24,500.c. $28,700.d. $31,500.e. None of the above.

1484. Chapter 12 - S Corporations Question MC #42 A cash basis calendar year C corporation in Athens, Georgia, has $100,000 of accounts receivable on the date of its conversion to an S corporation on February 14. By the end of the year, $70,000 of these receivables are collected. Calculate any built-in gains tax, assuming that there is sufficient taxable income.

a. $0.b. $10,500.*c. $24,500.d. $35,000.e. Some other amount.

1485. Chapter 12 - S Corporations Question MC #43 Lott Corporation in Macon, Georgia converts to S corporation status in 2011. Lott used the LIFO inventory method in 2010 and had a LIFO

inventory of $420,000 (FIFO value of $550,000). How much tax must be added to the 2010 corporate tax liability, assuming that Lott is subject to a 35% tax rate.

a. $0.*b. $11,375.c. $45,500.d. $130,000.e. None of the above.

1486. Chapter 12 - S Corporations Question MC #44 Pepper, Inc., an S corporation in Norfolk, Virginia, has revenues of $400,000, taxable interest of $380,000, operating expenses of $250,000, and deductions attributable to the interest income of $140,000. What is Pepper’s passive income penalty tax payable, if any?

a. $0.*b. $40,895.c. $185,000.d. $380,000.e. Some other amount.

1487. Chapter 12 - S Corporations Question MC #45 Claude Bergeron sold 1,000 shares of Ditta, Inc., an S corporation located in Concord, North Carolina, for $12,000. He had owned the stock for three years and had a stock basis of $111,000 in the shares. Claude is single, and he is the original owner of the § 1244 stock shares. Calculate the appropriate tax treatment of any gain or loss.

a. No gain or loss.b. $50,000 LTCL; $49,000 ordinary deduction.*c. $50,000 ordinary deduction; $49,000 LTCL.d. $99,000 long-term capital loss.e. None of the above.

1488. Chapter 12 - S Corporations Question MC #46 Yates Corporation elects S status, effective for calendar year 2011. Yates’ only asset has a basis of $50,200 and a fair market value of $110,400 as of January 1, 2011. The asset is sold at the end of 2011 for $130,800. What amount must Mark Farris, a 60% owner and subject to a 15% income tax rate, pay, if any?

*a. $5,358.b. $12,642.c. $21,070.d. $35,718.e. None of the above.

1489. Chapter 12 - S Corporations Question MC #47 An S corporation with substantial AEP has operating revenues of $410,000, taxable interest income of $390,000, operating expenses of

$260,000, and deductions attributable to the interest of $150,000. The passive income penalty tax payable, if any, is:

a. $0.*b. $40,923.c. $116,923.d. $136,500.e. None of the above.

1490. Chapter 12 - S Corporations Question MC #48 Which tax provision does not apply to an S corporation?

a. Hobby loss rule.b. Section 1244 stock.c. Penalty for failure to file.*d. 10% charitable contribution limitation.e. Estimated tax payments.

1491. Chapter 12 - S Corporations Question MC #49 Which of these tax provisions does not apply to an S corporation?

a. Section 1244 stock.b. “Partial liquidation” stock redemption.c. Tax-free “A” reorganization.*d. Section 1202 capital gain exclusion.

1492. Chapter 12 - S Corporations Question MC #50 Grams, Inc., a calendar year S corporation, reports $20,000 DPGR and $15,000 of wages, and the S corporation’s QPAI is $5,000. Janet has a 40% interest in the S corporation. All expenses that reduce DPGR are from wages, and all wages paid relate to DPGR. How much QPAI and wages are allocated to Janet?

a. None.*b. $2,000 and $6,000.c. $5,000 and $15,000.d. $5,000 and $20,000.e. None of the above.

1493. Chapter 12 - S Corporations Question MA #1-4 Match the term with the proper response. There may be more than one responses for each term.AAAPassive investment income (for passive investment income penalty tax)OAABuilt-in gains taxCumulative total of undistributed non-separately and separately stated items. Includes gross receipts derived from royalties, passive rents, dividends, interest, etc. Tax-free distribution. Penalty tax to stop an S corporation from avoiding the corporate tax on disposition of appreciated property. Taxed as a dividend. Items that affect stock basis but not AAA go here.

[a] 1. AAA[b] 2. Passive investment income (for passive investment

income penalty tax)[c] 3. OAA[d] 4. Built-in gains tax

a. Cumulative total of undistributed non-separately and separately stated items.

b. Includes gross receipts derived from royalties, passive rents, dividends, interest, etc.

c. Tax-free distribution.d. Penalty tax to stop an S corporation from avoiding the

corporate tax on disposition of appreciated property.e. Taxed as a dividend.f. Items that affect stock basis but not AAA go here.

1494. Chapter 12 - S Corporations Question CO #1 S corporation status avoids the ____________________ taxation and ____________________ limitations inherent in the regular corporate form.

Correct Answer(s):a. doubleb. loss

1495. Chapter 12 - S Corporations Question CO #2 For Federal income tax purposes, taxation of S corporations resembles that of a(n) ____________________.

Correct Answer(s):a. partnership

1496. Chapter 12 - S Corporations Question CO #3 S corporation income is taxed at the ____________________ level and not at the ____________________ level.

Correct Answer(s):a. shareholderb. corporate

1497. Chapter 12 - S Corporations Question CO #4 An S corporation may have ____________________ class(es) of stock.

Correct Answer(s):a. one

1498. Chapter 12 - S Corporations Question CO #5 A(n) ____________________ alien cannot own stock in an S corporation.

Correct Answer(s):a. nonresident

1499. Chapter 12 - S Corporations Question CO #6 An S corporation must own ____________________% of a subsidiary’s stock in order to elect to treat the subsidiary as a QSSS.

Correct Answer(s):a. 100

1500. Chapter 12 - S Corporations Question CO #7 Voting common stock and voting preferred stock (with a preference on dividends) would be treated as ____________________ class(es) of stock.

Correct Answer(s):a. two

1501. Chapter 12 - S Corporations Question CO #8 An S corporation is limited to ____________________ (how many?) shareholders.

Correct Answer(s):a. 100

1502. Chapter 12 - S Corporations Question CO #9 To make a valid S election, the entity must file a properly completed Form ____________________.

Correct Answer(s):a. 2553

1503. Chapter 12 - S Corporations Question CO #10 A qualifying S election requires the consent of ____________________ of the corporate shareholders.

Correct Answer(s):a. allb. 100%

1504. Chapter 12 - S Corporations Question CO #11 Consent to an S election must be in ____________________, and it must be generally filed by the election ____________________.

Correct Answer(s):a. writingb. deadline

1505. Chapter 12 - S Corporations Question CO #12 Meeting the definition of a small business corporation is a ____________________ requirement for maintaining the S status.

Correct Answer(s):a. continuing

1506. Chapter 12 - S Corporations Question CO #13 If an S corporation has C corporate E & P and passive income in excess of ____________________ % of its gross receipts for ____________________ consecutive taxable years, the S election is terminated at the beginning of the ____________________ year.

Correct Answer(s):a. 25b. 3c. 4th

1507. Chapter 12 - S Corporations Question CO #14 Tax-exempt income is listed on Schedule ____________________ of Form 1120S.

Correct Answer(s):a. K

1508. Chapter 12 - S Corporations Question CO #15 Depreciation recapture income is a ____________________ computed amount.

Correct Answer(s):a. nonseparately

1509. Chapter 12 - S Corporations Question CO #16 An S corporation’s separately stated items generally are identical to those separately stated by _________________________.

Correct Answer(s):a. partnerships

1510. Chapter 12 - S Corporations Question CO #17 Separately stated items are listed on Schedule _________________________ of the Form 1120S.

Correct Answer(s):a. K

1511. Chapter 12 - S Corporations Question CO #18 In the case of a complete termination of an S corporation interest, a

____________________ tax year may occur.

Correct Answer(s):a. short

1512. Chapter 12 - S Corporations Question CO #19 The amount of any distribution to an S corporation shareholder is equal to the ____________________ plus the fair market value of any other property distributed.

Correct Answer(s):a. cash

1513. Chapter 12 - S Corporations Question CO #20 Post-termination distributions by a former S corporation that are charged against ____________________ do not get tax-free treatment.

Correct Answer(s):a. OAA

1514. Chapter 12 - S Corporations Question CO #21 Since loss property receives a ____________________ in basis without any loss recognition, S corporation distributions of loss property should be ____________________.

Correct Answer(s):a. step-down, avoided

1515. Chapter 12 - S Corporations Question CO #22 Realized gain is ____________________ by an S corporation on its distribution of appreciated property.

Correct Answer(s):a. recognized

1516. Chapter 12 - S Corporations Question CO #23 Non-separately computed loss ____________________ a S shareholder’s stock basis.

Correct Answer(s):a. reduces

1517. Chapter 12 - S Corporations Question CO #24 An S corporation recognizes a gain on any distribution of ____________________ property.

Correct Answer(s):a. appreciated

1518. Chapter 12 - S Corporations Question CO #25 Distribution of _________________ property by an S corporation to a shareholder generally should be avoided.

Correct Answer(s):a. loss

1519. Chapter 12 - S Corporations Question CO #26 Depletion in excess of basis in property causes a(n) ____________________ adjustment to an S shareholder’s basis.

Correct Answer(s):a. upwardb. (increase)

1520. Chapter 12 - S Corporations Question CO #27 Stock basis first is increased by income items, then ____________________ by distributions, and finally decreased by ____________________.

Correct Answer(s):a. decreased, losses

1521. Chapter 12 - S Corporations Question CO #28 If an S corporation shareholder’s basis in a loan to the entity has been reduced, the shareholder recognizes gross income when the S corporation ____________________ the shareholder.

Correct Answer(s):a. repays

1522. Chapter 12 - S Corporations Question CO #29 With respect to passive losses, there are three classes of income, losses, and credits: ____________________, ____________________, and passive.

Correct Answer(s):a. active, portfoliob. portfolio, active

1523. Chapter 12 - S Corporations Question CO #30 An S corporation’s LIFO recapture amount equals the excess of the inventory’s value under ____________________ over the ____________________ value.

Correct Answer(s):a. FIFO, LIFO

1524. Chapter 12 - S Corporations Question PR #1 Janet Wang is a 50% owner of a calendar year S corporation. During 2011, the S corporation has ordinary income of $175,000, short-term capital gain of $94,000, tax-exempt income of $22,000, and a charitable contribution of $18,000. What S corporation items must Janet report in 2011?

Correct Answer:Ms. Wang will report $87,500 ordinary income, $47,000 short-term capital gain, $11,000 of tax-exempt income, and a $9,000 charitable contribution.

1525. Chapter 12 - S Corporations Question PR #2 Simmen, Inc., a calendar year S corporation, incurred the following items in 2011.

Municipal bond interest $ 6,200Sales 122,000§ 1245 gain 11,000Long-term capital gain 16,000Cost of goods sold 39,000Administrative expenses 15,000Depreciation expenses 18,000Charitable contribution 12,000

Calculate Simmen’s nonseparately computed income.

Correct Answer:Sales $122,000 § 1245 gain 11,000 $133,000 Cost of goods sold $39,000Administrative expenses 15,000 Depreciation expense 18,000 72,000 $ 61,000

1526. Chapter 12 - S Corporations Question PR #3 Bidden, Inc., a calendar year S corporation, incurred the following items.

Sales $130,000 Depreciation recapture income 12,000 Short-term capital gain 30,000 Cost of goods sold (42,000)Municipal bond interest income 7,000

Administrative expenses (15,000)Depreciation expense (17,000)Charitable contributions (14,000)

Calculate Bidden’s nonseparately computed income.

Correct Answer:Sales $130,000 Depreciation recapture income 12,000 $142,000 Cost of goods sold $42,000 Administrative expenses 15,000 Depreciation expense 17,000 (74,000) Nonseparately computed income $ 68,000

1527. Chapter 12 - S Corporations Question PR #4 Gene Grams is a 45% owner of a calendar year S corporation during 2011. His beginning stock basis is $230,000, and the S corporation reports the following items.

Ordinary income $64,000 Short-term capital gain 16,000 § 1231 loss 6,000 Tax-exempt interest income 5,000

Calculate Grams’ stock basis at year-end.

Correct Answer:Beginning stock basis $230,000 Ordinary income (45% ´ $64,000) 28,800 STCG (45% ´ $16,000) 7,200 Tax-exempt interest (45% ´ $5,000) 2,250 § 1231 loss (45% ´ $6,000) (2,700) Ending basis $265,550

1528. Chapter 12 - S Corporations Question PR #5 During 2011, Ms. Rasic, the sole shareholder of a calendar year S corporation, received a distribution of $16,000. On December 31, 2010, Ms. Rasic’s stock basis was $4,000. The corporation earned $11,000 ordinary income during the year. Calculate the amount and type of income Ms. Rasic recognizes in 2011, assuming there is no C corporation AEP.

Correct Answer:$11,000 ordinary income; $15,000 return of capital; and $1,000 capital gain. Rasic’s stock basis is increased by the $11,000 ordinary income allocable to her, giving a basis of $15,000 before the distribution.

The first $15,000 of the distribution is a return of capital, reducing the stock basis to zero. The remaining $1,000 constitutes capital gain (the excess over stock basis).

1529. Chapter 12 - S Corporations Question PR #6 Individuals Adam and Bonnie form an S corporation, with Adam contributing cash of $100,000 for a 50% interest and Bonnie contributing appreciated ordinary income property with an adjusted basis of $20,000 and a fair market value of $100,000.

a. Determine Bonnie’s initial basis in her stock, assuming that she receives a 50% interest.

b. The S corporation sells the property for $120,000. Determine Adam’s

and Bonnie’s stock basis after the sale. c. Determine Adam’s and Bonnie’s gain or loss if the company is

liquidated.

Correct Answer:a. Bonnie’s initial basis in her stock is $20,000, pursuant to §§ 1371 and 358.

b. Adam’s and Bonnie’s bases in their stock after the sale of the property contributed by Bonnie is determined as follows.

Adam Bonnie Initial basis (§ 358) $100,000 $20,000 Gain on sale (§§ 1363 and 1366) 50,000 50,000 Adjusted basis $150,000 $70,000

c. If the sale described in b. took place, Adam’s and Bonnie’s gain (loss) recognized upon the liquidation of the company is determined as follows.

Adam Bonnie FMV of property distributed (§ 331) $110,000 $110,000 Less: Adjusted basis (150,000) (70,000) Gain/(loss) recognized ($ 40,000) $ 40,000

1530. Chapter 12 - S Corporations Question PR #7 You are a 60% owner of an S corporation. Calculate your ending stock basis, based upon these facts.

Beginning stock basis $42,570

Stock purchases 15,000Insurance premiums paid (nondeductible)

3,600

Tax-exempt interest income 5,230Payroll tax penalty 3,770Increase in AAA 22,400Increase in OAA 5,800

Correct Answer:$42,570 + $15,000 +.60($22,400) + .60($5,800) = $74,490.

1531. Chapter 12 - S Corporations Question PR #8 On December 31, 2010, Erica Sumners owns one share of an S corporation’s 10 outstanding shares of stock. The basis of Erica’s share is $300. During 2011, the S corporation has no income or deductions, but incurs a loss of $3,650. Determine the amount of the loss allocated to Erica, and calculate her stock basis at the end of 2011.

Correct Answer:The loss assigned to each day of the S corporation’s tax year is $10 ($3,650/365 days). For each day, $1 is allocated to each outstanding share ($10/10 shares). Erica is allocated $365 of loss for her one share owned during 2011. However, she is limited to a 2011 loss deduction of $300, i.e., such that her stock basis reaches zero. Her stock basis is zero at the end of 2011. She has a $65 loss carryforward available for deduction in subsequent years.

1532. Chapter 12 - S Corporations Question PR #9 Blue Corporation elects S status effective for tax year 2011. As of January 1, 2011, Blue’s assets were appraised as follows.

Adjusted Basis Fair Market ValueCashAccounts receivableInventory (FIFO)Investment in landBuildingGoodwill

$ 16,010 –0– 70,000 110,000 220,000 –0–

$ 16,01055,40090,000195,000275,00093,000

In each of the following situations, calculate any built-in gains tax, assuming that the highest corporate tax rate is 35%. C corporation taxable income would have been $100,000.

a. During 2011, Blue collects $48,000 of the accounts receivable and sells 80% of the inventory for $99,000.

b. In 2012, Blue sells the land held for investment for $203,000.

c. In 2013, the building is sold for $270,000.

Correct Answer:a. Inventory: FMV ($90,000 ´ .80) $72,000 Adjusted basis ($70,000 ´ .80) (56,000) Built-in gain realized $16,000 Collection of receivables 48,000 Built-in gain $64,000 Tax rate ´ 35% Liability $22,400 b. $195,000 – $110,000 = $85,000 ´ .35 = $29,750. c. $270,000 – $220,000 = $50,000 ´ .35 = $17,500.

(Sales price below fair market value at date of conversion.)

1533. Chapter 12 - S Corporations Question PR #10 Pepper, Inc., an S corporation in Norfolk, VA, generates revenues of $400,000, taxable interest of $380,000, operating expenses of $250,000, and deductions attributable to the interest income of $140,000. Calculate any passive investment income penalty tax payable by Pepper.

Correct Answer:

Pepper pays a § 1375 penalty tax of $40,895, calculated as follows.

ENPI = Net Passive Income ´ (PII – 25%GR)PII

ENPI = $380,000 – $140,000 ´ [$380,000 – (25% ´ $780,000)]$380,000

ENPI = 0.6315789 ´ $185,000

ENPI = $116,842 ´ 35% = $40,895

1534. Chapter 12 - S Corporations Question ES #1 Explain how family members are treated for purposes of the number of shareholders requirement concerning S corporation status.

Correct Answer:

A small business corporation theoretically is limited to 100 shareholders. Family members may be treated as one shareholder for purposes of determining the number of shareholders. The term “members of the family” is defined as the common ancestor, the lineal descendants of the common ancestor, and the spouses (or former spouses) of the lineal descendants or common ancestor. An estate of a family member also may be treated as a family member for purposes of determining the number of shareholders.

1535. Chapter 12 - S Corporations Question ES #2 List some of the separately stated items listed on Schedule K of the Form 1120S.

Correct Answer:· Tax-exempt income.· Long-term and short-term capital gains and losses.· Section 1231 gains and losses.· Charitable contributions (no grace period).· Passive gains, losses, and credits.· Certain portfolio income.· Section 179 expense deduction.· Domestic production gross receipts and deductions.· Tax preferences and adjustments for the alternative minimum tax.· Depletion.· Foreign income or loss.· Recoveries of tax benefit items.· Intangible drilling costs.· Investment interest, income, and expenses.

1536. Chapter 12 - S Corporations Question ES #3 Discuss the two methods of allocating S items to shareholders.

Correct Answer:A per-day, per-share method must be used by a shareholder to allocate S corporation items, unless there is a complete termination of the shareholder’s interest. This pro rata method assigns an equal amount of S corporation items to each day of the year. If a shareholder’s interest changes during the year, this per day method assigns the shareholder a pro rata share of each item for each day the stock is owned.If there is a complete termination of shareholder’s interest, all affected shareholders and the corporation may elect to treat the S taxable year as two tax years. There is an interim closing of the books, and the shareholders report their share on the S corporation items as they actually occur during the year.

1537. Chapter 12 - S Corporations Question ES #4 Compare the distribution of property rules for an S corporation with the corresponding partnership rules.

Correct Answer:The major difference involves distributions of appreciated property. Under the S corporation rules, realized gain on distributed appreciated property is recognized to the corporation, which passes through to the shareholders with no corporate-level tax (other than the built-in gains tax). The gain increases the shareholder’s stock basis. A realized loss, however, is not recognized for an S corporation distribution. The shareholder takes a market value basis in the property.

On the distribution, the shareholder’s stock basis is reduced by the fair market value of the property (but not below zero).

No gain or loss is recognized to a partnership or partners on the distribution of property. Basis to the partner in the asset is the lesser of the partner’s basis in the partnership or the entity’s basis in the asset.

1538. Chapter 12 - S Corporations Question ES #5 How may an S corporation manage its liability for the built-in gains tax?

Correct Answer:A taxable income limitation encourages an S corporation to create or accelerate deductions in the years that built-in gains are recognized. Although the postponed built-in gain is carried forward to future years, the time value of money makes the postponement beneficial. For example, the payment of compensation, rather than a shareholder distribution, creates a deduction that reduces taxable income and postpones the built-in gains tax. Any recognized gain deferred beyond the 7- or 10-year holding period is avoided entirely.

Giving built-in gain property to a charitable organization does not trigger the built-in gains tax. Built-in loss property may be sold in the same year that built-in gain property is sold, to reduce or eliminate the built-in gains tax. Generally, the taxpayer should sell built-in loss property in a year when at least as much built-in gain property is sold. Otherwise, the built-in loss could be wasted.

1539. Chapter 12 - S Corporations Question ES #6 Explain how the domestic production activities deduction is used for an S corporation.

Correct Answer:The § 199 deduction is determined at the shareholder level. Domestic production gross receipts (DPGR), attributable cost of goods sold (CGS), and allocable deductions earned by the S corporation are passed through to the shareholders. These corporate-level DPGR, CGS, and allocable deductions are combined with any DPGR, CGS, and allocable deductions that the shareholder has from other sources.

An allocable portion of W-2 wages of the S corporation is passed through to the shareholder, but only those wages properly allocable to DPGR. Thus, a shareholder is treated as having been paid wages equal to

the shareholder’s distributable share of wages from the S corporation.

1540. Chapter 13 - Multijurisdictional Taxation Question TF #1 The United States has income tax treaties with only members of the European Union.

a. True*b. False

1541. Chapter 13 - Multijurisdictional Taxation Question TF #2 Income tax treaties may provide for either higher or lower withholding tax rates on interest income than the rate provided under U.S. statutory law.

a. True*b. False

1542. Chapter 13 - Multijurisdictional Taxation Question TF #3 In all cases, the “residence of seller” rule is used in determining the sourcing of income.

a. True*b. False

1543. Chapter 13 - Multijurisdictional Taxation Question TF #4 Losses and deductions, similar to income items, can be U.S.- or foreign-source.

*a. Trueb. False

1544. Chapter 13 - Multijurisdictional Taxation Question TF #5 In allocating interest expense between U.S. and foreign sources, a taxpayer must use the tax basis of the income-producing assets.

a. True*b. False

1545. Chapter 13 - Multijurisdictional Taxation Question TF #6 The IRS can use § 482 reallocations to assure that transactions between related parties are properly reflected in a tax return.

*a. Trueb. False

1546. Chapter 13 - Multijurisdictional Taxation Question TF #7 A “U.S. shareholder” for purposes of CFC classification is any U.S. person who owns directly, indirectly, or constructively at least 10% of

the voting power or value of a foreign corporation.

a. True*b. False

1547. Chapter 13 - Multijurisdictional Taxation Question TF #8 Twelve unrelated U.S. persons own a foreign corporation equally. The foreign corporation is a CFC.

a. True*b. False

1548. Chapter 13 - Multijurisdictional Taxation Question TF #9 Hendricks Corporation, a domestic corporation, owns 40 percent of Shane Corporation and 55 percent of Ferrell Corporation, both foreign corporations. Ferrell owns the other 60 percent of Shane Corporation. Both Shane and Ferrell are CFCs.

*a. Trueb. False

1549. Chapter 13 - Multijurisdictional Taxation Question TF #10 Kipp, a U.S. shareholder under the CFC provisions, owns 40% of a CFC. If the CFC’s Subpart F income for the taxable year is $200,000, Kipp is not taxed on receipt of a constructive dividend of $80,000 because he doesn’t own more than 50% of the CFC.

a. True*b. False

1550. Chapter 13 - Multijurisdictional Taxation Question TF #11 ForCo, a foreign corporation, purchases widgets from USCo, Inc., its U.S. parent corporation. The widgets are sold by ForCo to another unrelated foreign corporation in the same country as ForCo. The income from sale of the widgets by ForCo is not Subpart F foreign base company sales income.

*a. Trueb. False

1551. Chapter 13 - Multijurisdictional Taxation Question TF #12 ForCo, a subsidiary of a U.S. corporation incorporated in Belgium, manufactures widgets in Belgium and sells the widgets to its 100%-owned subsidiary in Germany. The income from the sale of widgets is not Subpart F foreign base company sales income.

*a. Trueb. False

1552. Chapter 13 - Multijurisdictional Taxation Question TF #13 Subpart F income includes portfolio income like dividends and interest.

*a. Trueb. False

1553. Chapter 13 - Multijurisdictional Taxation Question TF #14 Jokerz, a CFC of a U.S. parent, generated $80,000 of Subpart F foreign base company services income in its first year of operations. The next year, Jokerz distributes $50,000 cash to the parent, from those service profits. The parent is taxed on $80,000 in the first year and $50,000 in the second year.

a. True*b. False

1554. Chapter 13 - Multijurisdictional Taxation Question TF #15 U.S. individuals who receive dividends from foreign corporations may claim the deemed-paid foreign tax credit related to such dividends.

a. True*b. False

1555. Chapter 13 - Multijurisdictional Taxation Question TF #16 Scott, Inc., a domestic corporation, receives a dividend of $700,000 from a non-CFC foreign corporation. Deemed-paid foreign taxes attributable to the dividend are $120,000. If Scott elects the FTC, its gross income attributable to this dividend is $700,000.

a. True*b. False

1556. Chapter 13 - Multijurisdictional Taxation Question TF #17 Collins, Inc. received gross foreign-source dividend income of $250,000. Foreign taxes withheld on the dividend were $25,000 and no § 902 credit is available. Its worldwide taxable income for the tax year is $500,000. U.S. tax before the FTC is $175,000. Collins’ current year FTC is $87,500.

a. True*b. False

1557. Chapter 13 - Multijurisdictional Taxation Question TF #18 Waltz, Inc., a U.S. taxpayer, pays foreign taxes of $50,000 on foreign-source general basket income of $90,000. Waltz’s worldwide taxable income is $450,000, on which it owes U.S. taxes of $157,500 before FTC. Waltz’s FTC is $50,000.

a. True*b. False

1558. Chapter 13 - Multijurisdictional Taxation Question TF #19 Unused foreign tax credits are carried back one year and then forward 10 years.

*a. Trueb. False

1559. Chapter 13 - Multijurisdictional Taxation Question TF #20 A U.S. taxpayer may take a current FTC equal to the greater of the FTC limit or the actual foreign taxes (direct or indirect) paid or accrued.

a. True*b. False

1560. Chapter 13 - Multijurisdictional Taxation Question TF #21 A nonresident alien is defined as someone who is not a citizen or resident of the U.S.

*a. Trueb. False

1561. Chapter 13 - Multijurisdictional Taxation Question TF #22 All of an NRA’s U.S.-source income that is not effectively connected with a U.S. trade or business is subject to a flat U.S. income tax rate of 30%, unless the tax rate is modified by a treaty.

a. True*b. False

1562. Chapter 13 - Multijurisdictional Taxation Question TF #23 A nonresident alien with U.S.-source income effectively connected with a U.S. trade or business can take effectively connected deductions against that income.

*a. Trueb. False

1563. Chapter 13 - Multijurisdictional Taxation Question TF #24 A domestic corporation is one whose assets are primarily (> 50%) located in the U.S.

a. True*b. False

1564. Chapter 13 - Multijurisdictional Taxation Question TF #25 The purpose of the transfer pricing rules is to ensure that taxpayers have ultimate flexibility in shifting profits between related entities.

a. True*b. False

1565. Chapter 13 - Multijurisdictional Taxation Question TF #26 The U.S. system for taxing income earned outside its borders by U.S. persons is referred to as the territorial approach because only income earned within the U.S. border is subject to taxation.

a. True*b. False

1566. Chapter 13 - Multijurisdictional Taxation Question TF #27 The U.S. system for taxing income earned inside its borders by non-U.S. persons is referred to as inbound taxation because such foreign persons are earning income by coming into the United States.

*a. Trueb. False

1567. Chapter 13 - Multijurisdictional Taxation Question TF #28 Politicians use tax devices to create economic development incentives.

*a. Trueb. False

1568. Chapter 13 - Multijurisdictional Taxation Question TF #29 All of the U.S. states have adopted a tax based on net taxable income.

a. True*b. False

1569. Chapter 13 - Multijurisdictional Taxation Question TF #30 States collect the most tax dollars from the corporate income tax.

a. True*b. False

1570. Chapter 13 - Multijurisdictional Taxation Question TF #31 The corporate income tax provides about 6 percent of the annual tax revenues for the typical U.S. state.

*a. Trueb. False

1571. Chapter 13 - Multijurisdictional Taxation Question TF #32 Most states begin the computation of taxable income with an amount from the Federal income tax return.

*a. Trueb. False

1572. Chapter 13 - Multijurisdictional Taxation Question TF #33 If a state follows Federal income tax rules, the state’s tax compliance and enforcement become easier to accomplish.

*a. Trueb. False

1573. Chapter 13 - Multijurisdictional Taxation Question TF #34 A typical state taxable income addition modification is the interest income from U.S. Treasury bonds.

a. True*b. False

1574. Chapter 13 - Multijurisdictional Taxation Question TF #35 A typical state taxable income addition modification is the Federal net operating loss (NOL) deduction.

*a. Trueb. False

1575. Chapter 13 - Multijurisdictional Taxation Question TF #36 A state cannot levy a tax on a business unless the business was incorporated in the state.

a. True*b. False

1576. Chapter 13 - Multijurisdictional Taxation Question TF #37 Typical indicators of nexus include the presence of employees based in the state, and the ownership or lease of realty there.

*a. Trueb. False

1577. Chapter 13 - Multijurisdictional Taxation Question TF #38 Under P.L. 86-272, the taxpayer is exempt from state taxes on income resulting from the mere solicitation of orders for the sale of in-state realty.

a. True*b. False

1578. Chapter 13 - Multijurisdictional Taxation Question TF #39 In most states, a taxpayer’s income is apportioned on the basis of a formula measuring the extent of business contact, and allocated according to the location of property owned or used.

*a. Trueb. False

1579. Chapter 13 - Multijurisdictional Taxation Question TF #40 All of the U.S. states use the same apportionment formula and factors.

a. True*b. False

1580. Chapter 13 - Multijurisdictional Taxation Question TF #41 Nonbusiness income includes dividends received from investment securities.

*a. Trueb. False

1581. Chapter 13 - Multijurisdictional Taxation Question TF #42 Double weighting the sales factor effectively increases the tax burden on taxpayers based in the state, such as corporations with in-state headquarters.

a. True*b. False

1582. Chapter 13 - Multijurisdictional Taxation Question TF #43 An assembly worker earns a $30,000 salary and receives a fringe benefit package worth $15,000. The payroll factor assigns $30,000 for this employee.

a. True*b. False

1583. Chapter 13 - Multijurisdictional Taxation Question TF #44 The property factor includes land and buildings used for business purposes.

*a. Trueb. False

1584. Chapter 13 - Multijurisdictional Taxation Question TF #45 The property factor includes business assets that the taxpayer owns, but also those merely used under a lease agreement.

*a. Trueb. False

1585. Chapter 13 - Multijurisdictional Taxation Question MC #1 GreenCo, a domestic corporation, earns $25 million of taxable income from U.S. sources and $5 million of taxable income from foreign sources. What amount of taxable income does GreenCo report on its U.S. tax return?

*a. $30 million.b. $25 million.c. $30 million less any tax paid on U.S. income.d. $25 million less any tax paid on the foreign income.

1586. Chapter 13 - Multijurisdictional Taxation Question MC #2 Without the foreign tax credit, double taxation would result when:

a. The United States taxes the U.S.-source income of a U.S. resident.*b. The United States and a foreign country both tax the foreign-source income of a U.S. resident.c. A foreign country taxes the foreign-source income of a nonresident alien.d. Only the United States taxes the foreign-source income of a U.S. resident (e.g., a treaty prevents foreign taxation).

1587. Chapter 13 - Multijurisdictional Taxation Question MC #3 U.S. income tax treaties:

*a. Provide rules by which multinational taxpayers avoid double taxation.b. Provide for taxation exclusively by the source country.c. Provide that the country with the highest tax rate will be allowed exclusive tax collection.d. Provide for taxation exclusively by the country of residence.

1588. Chapter 13 - Multijurisdictional Taxation Question MC #4 Which of the following statements is false in regard to the U.S. income tax treaty program?

a. There are over 50 income tax treaties between the U.S. and other countries.b. Tax treaties generally provide for primary taxing rights that require the other treaty partner to allow a credit for the taxes paid on the twice-taxed income.*c. Residence of the taxpayer is an important consideration in applying tax treaties, while the presence of a permanent

establishment is not.d. None of the above statements is false.

1589. Chapter 13 - Multijurisdictional Taxation Question MC #5 USCo, a domestic corporation, purchases inventory for resale from distributors within the U.S. and resells this inventory to customers outside the U.S., with title passing outside the U.S. What is the source of the USCo’s inventory sales income?

a. 50% U.S. source and 50% foreign source.b. 50% foreign source and 50% sourced based on location of manufacturing assets.c. 100% U.S. source.*d. 100% foreign source.

1590. Chapter 13 - Multijurisdictional Taxation Question MC #6 Olaf, a citizen of Norway with no trade or business activities in the United States, sells at a gain 200 shares of MicroShift, Inc., a U.S. company. The sale takes place through Olaf’s broker in Oslo. How is this gain treated for U.S. tax purposes?

a. It is foreign-source income subject to U.S. taxation.*b. It is foreign-source income not subject to U.S. taxation.c. It is U.S.-source income subject to U.S. taxation.d. It is U.S.-source income exempt from U.S. taxation.

1591. Chapter 13 - Multijurisdictional Taxation Question MC #7 Flan, a U.S. corporation, reports $250,000 interest expense for the tax year. None of the interest relates to nonrecourse debt or loans from affiliated corporations. Flan’s U.S. and foreign assets are as follows.

Fair market value— U.S. assets $ 5,000,000 Foreign assets $10,000,000Tax book value— U.S. assets $ 2,000,000 Foreign assets $ 1,000,000

How should Flan assign its interest expense between U.S. and foreign sources to maximize its FTC for the current year?

*a. Using tax book values.b. Using tax book value for U.S. source and fair market value for foreign source.c. Using fair market value.d. Using fair market value for U.S. source and tax book value for foreign source.

1592. Chapter 13 - Multijurisdictional Taxation Question MC #8 Which of the following statements best describes the purpose of § 482, under which the Treasury can reallocate income and deductions among related taxpayers?

a. To provide tax benefits to U.S. multinationals that export U.S. produced property.b. To allow the IRS to select the best method for determining transfer prices for U.S. taxpayers.c. To alleviate double taxation problems generated by related entities doing business in two or more countries.*d. To place a controlled entity on a tax parity with an uncontrolled entity with regard to prices charged by the entities.

1593. Chapter 13 - Multijurisdictional Taxation Question MC #9 Section 482 is used by the Treasury to:

*a. Force taxpayers to use arms-length transfer pricing on transactions between related parties.b. Reallocate income, deductions, etc., to a related taxpayer to minimize tax liability.c. Increase information that is reported about U.S. corporations with non-U.S. owners.d. All of the above.e. None of the above.

1594. Chapter 13 - Multijurisdictional Taxation Question MC #10 A tax haven often is:

a. A country with high internal taxes.b. A country without income tax treaties.*c. A country with no or low internal taxes.d. A country that prohibits “treaty shopping.”e. None of the above statements is true.

1595. Chapter 13 - Multijurisdictional Taxation Question MC #11 In which of the following independent situations would a foreign corporation be classified as a controlled foreign corporation?

a. The stock is directly owned 12% by Jen, 10% by Kathy, 12% by Leslie, 10% by David, 8% by Ben, and 48% by Mike. Jen, Kathy, Leslie, David, and Ben are all U.S. citizens. Mike is a foreign resident and citizen.b. The stock is directly owned 12% by Jen, 10% by Kathy, 12% by Leslie, 10% by David, 8% by Ben, and 48% by Mike. Jen, Kathy, Leslie, David, and Ben are all U.S. citizens. David is married to Kathy. Mike is a foreign resident and citizen.c. The stock is directly owned 12% by Jen, 10% by Kathy, 12% by Leslie, 10% by David, 8% by Ben, and 48% by Mike. Jen, Kathy, Leslie, David, and Ben are all U.S. citizens. Ben is Mike’s son. Mike is a foreign resident and citizen.

*d. The stock is directly owned 12% by Jen, 10% by Kathy, 12% by Leslie, 10% by David, 8% by Ben, and 48% by Mike. Jen, Kathy, Leslie, David, Ben, and Mike are all U.S. citizens.

1596. Chapter 13 - Multijurisdictional Taxation Question MC #12 The following persons own Schlecht Corporation, a foreign corporation.

Jim, U.S. individual 35%Gina, U.S. individual 15%Marina, U.S. individual 8%Pedro, U.S. individual 12%Chee, non-U.S. individual 30%

None of the shareholders are related. Subpart F income for the tax year is $300,000. No distributions are made. Which of the following statements is correct?

a. Schlecht is not a CFC.b. Chee includes $90,000 in gross income.*c. Marina is not a U.S. shareholder.d. Marina includes $24,000 in gross income.e. None of the above statements is correct.

1597. Chapter 13 - Multijurisdictional Taxation Question MC #13 Copp, Inc., a domestic corporation, owns 30% of a CFC that has $50 million of earnings and profits for the current year. Included in that amount is $20 million of Subpart F income. Copp has been a CFC for the entire year and makes no distributions in the current year. Copp must include in gross income (before any § 78 gross-up):

a. $0.b. $50 million.c. $20 million.*d. $6 million.

1598. Chapter 13 - Multijurisdictional Taxation Question MC #14 A controlled foreign corporation (CFC) realizes Subpart F income from:

a. Purchase of inventory from unrelated party and sale outside the CFC country.*b. Purchase of inventory from a related party and sale outside the CFC country.c. Services performed for the U.S. parent in a country in which the CFC was organized.d. Services performed on behalf of an unrelated party in a country outside the country in which the CFC was organized.e. None of the above transactions.

1599. Chapter 13 - Multijurisdictional Taxation Question MC #15 Which of the following income items does not represent Subpart F income if earned by a controlled foreign corporation? Purchase of inventory from the U.S. parent, followed by:

*a. Sale to anyone inside the CFC country.b. Sale to anyone outside the CFC country.c. Sale to a related party outside the CFC country.d. Sale to a non-related party outside the CFC country.

1600. Chapter 13 - Multijurisdictional Taxation Question MC #16 OutCo, a controlled foreign corporation, earns $600,000 in net interest and dividend income from investments in the bonds and stock of unrelated companies. All of the unrelated companies are located in OutCo’s country of incorporation. OutCo’s Subpart F income for the year is:

a. $0.b. $0 only if OutCo is engaged in a trade or business in its home country.c. $600,000 only if OutCo is engaged in a trade or business in its home country.*d. $600,000.

1601. Chapter 13 - Multijurisdictional Taxation Question MC #17 Peanut, Inc., a domestic corporation, receives $500,000 of foreign-source interest income on which foreign taxes of $5,000 are withheld. Its worldwide taxable income is $900,000, and U.S. tax liability before FTC is $315,000. What is Peanut’s foreign tax credit?

a. $500,000.b. $315,000.c. $175,000.*d. $5,000.

1602. Chapter 13 - Multijurisdictional Taxation Question MC #18 Abbott, Inc., a domestic corporation, reports worldwide taxable income of $8 million, including a $900,000 dividend from ForCo, a wholly-owned foreign corporation. ForCo’s post-1986 undistributed E & P are $18 million and it has paid $12 million of foreign income taxes attributable to these earnings. What is Abbott’s deemed paid foreign tax credit related to the dividend received (before consideration of any limitation)?

a. $0.*b. $600,000.c. $900,000.d. $18 million.

1603. Chapter 13 - Multijurisdictional Taxation Question MC #19 Ridge, Inc., a domestic corporation, reports worldwide taxable income

of $800,000, including a $300,000 dividend from Emma, Inc., a foreign corporation. Ridge’s U.S. tax liability before FTC is $280,000. Ridge owns 20% of Emma. Emma’s post-1986 E & P after taxes is $8 million and it has paid foreign taxes of $4 million attributable to that E & P. If Ridge elects the FTC, its U.S. gross income with regard to the dividend from Emma is:

*a. $450,000.b. $300,000.c. $90,000.d. $60,000.

1604. Chapter 13 - Multijurisdictional Taxation Question MC #20 Amber, Inc., a domestic corporation receives a $150,000 cash dividend from Starke, Ltd. Amber owns 15% of Starke. Starke’s post-1986 E & P is $2 million and it has paid foreign taxes of $1 million attributable to that E & P. What is Amber’s foreign tax credit related to the Starke dividend?

a. $200,000.b. $150,000.c. $100,000.*d. $75,000.

1605. Chapter 13 - Multijurisdictional Taxation Question MC #21 Amber, Inc., a domestic corporation receives a $150,000 cash dividend from Starke, Ltd. Amber owns 15% of Starke. Starke’s post-1986 E & P is $2 million and it has paid foreign taxes of $1 million attributable to that E & P. What is Amber’s gross income related to the Starke dividend?

*a. $225,000.b. $150,000.c. $33,750.d. $22,500.

1606. Chapter 13 - Multijurisdictional Taxation Question MC #22 Kilps, a U.S. corporation, receives a $200,000 dividend from a 20% owned foreign corporation. The deemed-paid taxes attributable to this dividend are $40,000 and foreign taxes withheld on remittance of the dividend are $30,000. Kilps’s U.S. tax liability before the FTC is $350,000, the gross dividend income is $240,000, and Kilps’s worldwide taxable income is $1 million. Kilps’s foreign tax credit for the taxable year is:

a. $84,000.*b. $70,000.c. $40,000.d. $30,000.

1607. Chapter 13 - Multijurisdictional Taxation Question MC #23 USCo, a domestic corporation, receives $100,000 of foreign-source income in the general income basket and $40,000 of foreign-source income in the passive income basket. Worldwide taxable income is $1,200,000 and the U.S. tax liability before FTC is $420,000. Foreign taxes attributable to the general income basket are $60,000 and to the passive income are $4,000. What is USCo’s foreign tax credit for the tax year?

*a. $39,000.b. $64,000.c. $60,000.d. $4,000.e. Some other amount.

1608. Chapter 13 - Multijurisdictional Taxation Question MC #24 Hickman, Inc., a U.S. corporation, operates an unincorporated branch manufacturing operation in the United Kingdom. Hickman, Inc., reports $900,000 of taxable income from the U.K. branch on its U.S. tax return along with $1,300,000 of taxable income from its U.S. operations. Hickman paid $270,000 in U.K. income taxes related to the $900,000 in branch income. Assuming a U.S. tax rate of 35%, what is Hickman’s U.S. tax liability after any allowable foreign tax credits?

a. $0.b. $455,000.*c. $500,000.d. $770,000.e. Some other amount.

1609. Chapter 13 - Multijurisdictional Taxation Question MC #25 Dark, Inc., a U.S. corporation, operates Dunkel, an unincorporated branch manufacturing operation in Germany. Dark reports $100,000 of taxable income from Dunkel on its U.S. tax return, along with $400,000 of taxable income from its U.S. operations. Dark paid $40,000 in German income taxes related to the $100,000 of Dunkel income. Assuming a U.S. tax rate of 35%, what is Dark’s U.S. tax liability after any allowable foreign tax credits?

a. $35,000.b. $135,000.*c. $140,000.d. $175,000.

1610. Chapter 13 - Multijurisdictional Taxation Question MC #26 Young, Inc., a U.S. corporation, earns foreign-source income classified in two different income baskets in the current year. It earns $100,000 in passive foreign-source income and suffers a net loss of $70,000 in the general basket. What is the numerator of the FTC limitation formula for the passive basket in the current year?

a. $0.*b. $30,000.c. $70,000.d. $100,000.

1611. Chapter 13 - Multijurisdictional Taxation Question MC #27 Old, Inc., a U.S. corporation, earns foreign-source income classified in two different limitation baskets in the current year. It earns $20,000 in passive income and suffers a net loss of $45,000 in the general limitation basket. What is the numerator of the FTC limitation formula for the passive basket in the current year?

a. ($25,000).*b. $0.c. $20,000.d. $25,000.

1612. Chapter 13 - Multijurisdictional Taxation Question MC #28 Waldo, Inc., a U.S. corporation, owns 100% of Orion, Ltd., a foreign corporation. Orion earns only general basket income. During the current year, Orion paid Waldo a $5,000 dividend. The foreign tax credit associated with this dividend is $3,000. The foreign jurisdiction requires a withholding tax of 10%, so Waldo received only $4,500 in cash as a result of the dividend. What is Waldo’s total U.S. gross income reported as a result of the $4,500 cash received?

*a. $8,000.b. $5,000.c. $4,500.d. $3,000.

1613. Chapter 13 - Multijurisdictional Taxation Question MC #29 Performance, Inc., a U.S. corporation, owns 100% of Krumb, Ltd., a foreign corporation. Krumb earns only general basket income. During the current year, Krumb paid Performance a $200,000 dividend. The foreign tax credit associated with this dividend is $30,000. The foreign jurisdiction requires a withholding tax of 30%, so Performance received only $140,000 in cash as a result of the dividend. What is Performance’s total U.S. gross income reported as a result of the $140,000 cash received?

a. $30,000.b. $140,000.c. $200,000.*d. $230,000.

1614. Chapter 13 - Multijurisdictional Taxation Question MC #30 Which of the following statements regarding the U.S. taxation of foreign persons is true?

a. Foreign persons never are subject to U.S. income tax.b. Foreign persons are subject to U.S. income tax only on gains from U.S. real property.c. Foreign persons are subject to a withholding tax on foreign-source portfolio income.*d. Foreign persons are subject to a withholding tax on U.S.-source portfolio income.

1615. Chapter 13 - Multijurisdictional Taxation Question MC #31 Which of the following statements regarding the U.S. taxation of foreign persons is true?

*a. A foreign person’s effectively connected income is subject to U.S. income taxation.b. A foreign person’s effectively connected income is tax free unless it is portfolio income.c. A foreign person may earn income from U.S. real property without incurring any U.S. income tax.d. A foreign person must spend at least 183 days in the United States before any effectively connected income is subject to U.S. taxation.

1616. Chapter 13 - Multijurisdictional Taxation Question MC #32 Which of the following statements regarding a foreign person’s U.S. tax consequences is true?

a. Foreign persons are subject to U.S. income or withholding tax only if they are engaged in a U.S.-trade or business.*b. Foreign persons may be subject to withholding tax on U.S.-source investment income even if not engaged in a U.S. trade or business.c. Foreign persons are not taxed on gains from U.S. real property as long as such property is not used in a U.S. trade or business.d. Once a foreign person is engaged in a U.S. trade or business, the foreign person’s worldwide income is subject to U.S. taxation.

1617. Chapter 13 - Multijurisdictional Taxation Question MC #33 Which of the following statements regarding a foreign person’s U.S. tax consequences is true?

a. Foreign persons must be physically present in the United States before any U.S.-source income is subject to U.S. income or withholding tax.b. Foreign individuals may be subject to U.S. income tax but foreign corporations are never subject to U.S. income tax.c. Foreign persons are only subject to U.S. income or withholding tax if engaged in a U.S. trade or business.*d. Foreign persons are potentially subject to U.S. withholding tax on U.S.-source investment income.

1618. Chapter 13 - Multijurisdictional Taxation Question MC #34 Which of the following persons typically is concerned with the U.S.-sourcing rules for gross income?

a. Foreign persons with only foreign activities.*b. U.S. persons with U.S. and foreign activities.c. U.S. persons with only U.S. activities.d. U.S. persons that earn only tax-exempt income.

1619. Chapter 13 - Multijurisdictional Taxation Question MC #35 Which of the following persons typically is not concerned with the U.S.-sourcing rules for gross income?

a. Foreign persons with U.S. activities.b. U.S. persons with foreign activities.c. U.S. employees working abroad.*d. Foreign persons with only foreign activities.

1620. Chapter 13 - Multijurisdictional Taxation Question MC #36 Which of the following determinations requires knowing the amount of one’s foreign-source gross income?

a. Itemized deductions.*b. Foreign tax credit.c. Calculation of a U.S. person’s total taxable income.d. Calculation of a U.S. person’s deductible interest expense.

1621. Chapter 13 - Multijurisdictional Taxation Question MC #37 Which of the following determinations does not require knowing the amounts of one’s U.S.- versus foreign-source income?

a. Calculation of U.S. withholding tax on the FDAP income of foreign persons.b. Calculation of a foreign person’s income effectively connected with carrying on a U.S. trade or business.c. Calculation of the foreign earned income exclusion.*d. Calculation of a U.S. person’s total taxable income.

1622. Chapter 13 - Multijurisdictional Taxation Question MC #38 Which of the following is a principle used in applying income sourcing under U.S. rules?

*a. Location of economic activity.b. Country with lowest tax rate.c. Country with highest tax rate.d. Potential size of allowed foreign tax credit.

1623. Chapter 13 - Multijurisdictional Taxation Question MC #39 Which of the following statements regarding income sourcing is correct?

*a. Everything else equal, larger foreign-source income increases the foreign tax credit limitation for U.S. persons.b. Everything else equal, larger foreign-source income decreases the foreign tax credit limitation for U.S. persons.c. Everything else equal, changing foreign-source income has no impact on the foreign tax credit limitation for U.S. persons.d. Everything else equal, larger U.S.-source income increases the foreign tax credit limitation for U.S. persons.

1624. Chapter 13 - Multijurisdictional Taxation Question MC #40 Which of the following statements regarding income sourcing is not correct?

a. U.S. persons benefit from earning low-tax foreign-source income.b. Foreign persons generally benefit from avoiding U.S.-source income classification.*c. U.S. persons are not concerned with source of income because all their income is subject to U.S. tax under a worldwide system.d. Foreign persons may be subject to tax on U.S.-source income without regard to their actual presence in the United States.

1625. Chapter 13 - Multijurisdictional Taxation Question MC #41 Which of the following statements concerning the sourcing of income from inventory produced by the taxpayer in the U.S. and sold outside the U.S. is true?

a. If title passes on the inventory outside the U.S., all of the inventory income is foreign source.b. Because the inventory is manufactured in the U.S., all of the inventory income is U.S. source.*c. The taxpayer may use the 50-50 method to source one-half the income based on title passage and one-half the income based on location of production assets.d. The taxpayer may use the 50-50 method to source one-half the income based on title passage and one-half the income based on where the sale negotiation takes place.

1626. Chapter 13 - Multijurisdictional Taxation Question MC #42 AirCo, a domestic corporation, purchases inventory for resale from unrelated distributors within the United States and resells this inventory to customers outside the United States with title passing outside the United States. What is the source of AirCo’s inventory sales income?

a. 50% U.S. source and 50% foreign source.b. 100% U.S. source.*c. 100% foreign source.d. 50% foreign source and 50% sourced based on location of

manufacturing assets.

1627. Chapter 13 - Multijurisdictional Taxation Question MC #43 WaterCo, a domestic corporation, purchases inventory for resale from unrelated distributors outside the United States and resells this inventory to customers inside the United States with title passing inside the United States. What is the source of WaterCo’s inventory sales income?

a. 50% U.S. source and 50% foreign source.*b. 100% U.S. source.c. 100% foreign source.d. 50% foreign source and 50% sourced based on location of manufacturing assets.

1628. Chapter 13 - Multijurisdictional Taxation Question MC #44 Which of the following statements regarding the sourcing of gross income is true?

a. Foreign persons not engaged in a U.S. trade or business are indifferent as to whether any of their income is U.S. source.b. All income earned by foreign persons not engaged in a U.S. trade or business is treated as foreign source.c. U.S.-source income is not subject to withholding so long as such income is not treated as effectively connected with a U.S. trade or business.*d. Certain U.S.-source investment income earned by foreign persons not engaged in a U.S. trade or business may be subject to a U.S. withholding tax.

1629. Chapter 13 - Multijurisdictional Taxation Question MC #45 Which of the following statements regarding the sourcing of gross income is true?

*a. All else equal, a U.S. corporation prefers that more of its U.S. taxable income be characterized as foreign source, to increase its foreign tax credit limitation.b. All else equal, a U.S. corporation prefers that less of its U.S. taxable income be characterized as foreign-source, to increase its foreign tax credit limitation.c. All trade or business income earned by a U.S. corporation is treated as U.S.-source income.d. All investment income earned by a U.S. corporation is treated as U.S.-source income.

1630. Chapter 13 - Multijurisdictional Taxation Question MC #46 Which of the following income items does not represent Subpart F income if earned by a CFC? Purchase of inventory from a U.S. parent and sale to:

*a. Anyone inside the CFC country.b. Anyone outside the CFC country.c. A related party outside the CFC country.d. A non-related party outside the CFC country.

1631. Chapter 13 - Multijurisdictional Taxation Question MC #47 Assuming all sales are made to unrelated customers outside the CFC’s country of incorporation, which of the following types of income earned by a CFC is Subpart F income?

a. Income from sale of property manufactured by the CFC.b. Income from the sale of property manufactured by a subsidiary of the CFC in the same country as the CFC.*c. Income from the sale of property manufactured by the U.S. parent of the CFC outside the CFC’s country.d. Income from the sale of property manufactured by an unrelated person outside the CFC’s country of incorporation.

1632. Chapter 13 - Multijurisdictional Taxation Question MC #48 Which of the following statements best describes the primary purpose of the Subpart F income provisions?

a. The Subpart F income provisions provide certainty as to the U.S. income tax treatment of cross-border transactions.b. The Subpart F income provisions allow deferral of foreign-source income from U.S. taxation.*c. The Subpart F income provisions prevent shifting of income from the United States to low-tax foreign jurisdictions.d. The Subpart F income provisions prevent shifting of income from the United States to high-tax foreign jurisdictions.

1633. Chapter 13 - Multijurisdictional Taxation Question MC #49 Which of the following items of CFC income constitute foreign base company sales income?

a. Sale of inventory property purchased from the CFC’s U.S. parent company and sold to related parties within the CFC’s country of incorporation.b. Sale of inventory property purchased from the CFC’s U.S. parent company and sold to unrelated parties within the CFC’s country of incorporation.*c. Sale of inventory property purchased from the CFC’s U.S. parent company and sold to related parties outside the CFC’s country of incorporation.d. Sale of inventory property purchased from unrelated parties and sold to related parties within the CFC’s country of incorporation.

1634. Chapter 13 - Multijurisdictional Taxation Question MC #50 USCo, a domestic corporation, receives $100,000 of foreign-source passive income on which foreign taxes of $5,000 are withheld. Its

worldwide taxable income is $700,000 and its U.S. tax liability before the foreign tax credit is $245,000. What is USCo’s allowed foreign tax credit?

a. $35,000.b. $30,000.*c. $5,000.d. $95,000.

1635. Chapter 13 - Multijurisdictional Taxation Question MC #51 USCo, a domestic corporation, receives $700,000 of foreign-source passive income on which foreign taxes of $70,000 are withheld. Its worldwide taxable income is $1,500,000 and its U.S. tax liability before the foreign tax credit is $525,000. What is USCo’s allowed foreign tax credit?

a. $245,000.*b. $70,000.c. $175,000.d. $770,000.

1636. Chapter 13 - Multijurisdictional Taxation Question MC #52 Which of the following foreign taxes paid by a U.S. corporation is eligible for the foreign tax credit?

a. Real property taxes.b. Value added taxes.*c. Dividend withholding taxes.d. Sales taxes.

1637. Chapter 13 - Multijurisdictional Taxation Question MC #53 USCo, a domestic corporation, has worldwide taxable income of $1,500,000, including a $300,000 dividend from ForCo, a wholly-owned foreign corporation. ForCo’s post-1986 undistributed earnings and profits are $16 million and it has paid $10 million of foreign income taxes attributable to these earnings. What is USCo’s deemed paid foreign tax credit related to the dividend received (before consideration of any limitation)?

a. $10 million.b. $16 million.*c. $187,500.d. $487,500.

1638. Chapter 13 - Multijurisdictional Taxation Question MC #54 USCo, a domestic corporation, has worldwide taxable income of $500,000, including a $100,000 dividend from ForCo, a wholly-owned foreign corporation. ForCo’s post-1986 undistributed earnings and profits are $1 million and it has paid $200,000 of foreign income taxes attributable to these earnings. What is USCo’s deemed paid foreign tax credit related to the dividend received (before consideration of any

limitation)?

a. $200,000.b. $120,000.c. $800,000.*d. $20,000.

1639. Chapter 13 - Multijurisdictional Taxation Question MC #55 The purpose of the deemed paid foreign tax credit is:

a. To allow foreign corporations to compete fairly with U.S. corporations doing business in the foreign jurisdiction.*b. To allow U.S. corporations operating through foreign subsidiaries to receive a foreign tax credit for income taxes paid by their subsidiaries.c. To allow U.S. corporations operating through foreign branches to receive a foreign tax credit for income taxes paid by their branches.d. To allow U.S. corporations to compete fairly with foreign corporations doing business in the United States.

1640. Chapter 13 - Multijurisdictional Taxation Question MC #56 USCo has foreign-source income from a manufacturing operation, from sales of the manufactured goods, and from stocks and bonds held for investment. How many categories or “baskets” of income does USCo have for foreign tax credit limitation purposes?

a. One.*b. Two.c. Three.d. Four.

1641. Chapter 13 - Multijurisdictional Taxation Question MC #57 Norman Corporation owns and operates two manufacturing facilities, one in State X and the other in State Y. Due to a temporary decline in the corporation’s sales, Norman has rented 20% of its Y facility to an unaffiliated corporation. Norman generated $1,000,000 net rental income and $2,000,000 income from manufacturing.

Norman is incorporated in Y. For X and Y purposes, rental income is classified as allocable nonbusiness income. By applying the statutes of each state, Norman determined that its apportionment factors are .65 for X and .35 for Y.

Norman’s income attributed to X is:

a. $0.b. $1,000,000.*c. $1,300,000.d. $2,000,000.e. $3,000,000.

1642. Chapter 13 - Multijurisdictional Taxation Question MC #58 Wailes Corporation is subject to a corporate income tax only in State X. The starting point in computing X taxable income is Federal taxable income. Wailes’ Federal taxable income is $750,000, which includes a $75,000 deduction for state income taxes. During the year, Wailes received $20,000 interest on Federal obligations. X tax law does not allow a deduction for state income tax payments.

Wailes’ taxable income for X purposes is:

a. $825,000.*b. $805,000.c. $750,000.d. $680,000.

1643. Chapter 13 - Multijurisdictional Taxation Question MC #59 Perez Corporation is subject to tax only in State A. Perez generated the following income and deductions.

Federal taxable income $500,000State A income tax expense 50,000Depreciation allowed for Federal tax purposes 300,000Depreciation allowed for state tax purposes 400,000

Federal taxable income is the starting point in computing A taxable income. State income taxes are not deductible for A tax purposes. Perez’s A taxable income is:

a. $400,000.*b. $450,000. c. $600,000.d. $650,000.

1644. Chapter 13 - Multijurisdictional Taxation Question MC #60 Federal taxable income is used as the starting point in computing the state’s income tax base, but numerous state adjustments or modifications generally are required to:

a. Reflect differences between state and Federal tax statutes.b. Remove income that a state is constitutionally prohibited from taxing.c. Allow for all of the states to use the same definition of taxable income.*d. a. and b.

1645. Chapter 13 - Multijurisdictional Taxation Question MC #61 The model law relating to the assignment of income among the states for

corporations is:

a. The Multistate Tax Treaty.*b. The Uniform Division of Income for Tax Purposes Act (UDITPA).c. Public Law 86-272.d. The Multistate Tax Commission (MTC).

1646. Chapter 13 - Multijurisdictional Taxation Question MC #62 Kurt Corporation realized $900,000 taxable income from the sales of its products in States X and Z. Kurt’s activities establish nexus for income tax purposes in both states. Kurt’s sales, payroll, and property among the states include the following.

State X State Z TotalsSales $2,000,000 $2,000,000 $4,000,000Property 2,000,000 –0– 2,000,000Payroll 1,000,000 –0– 1,000,000

Z utilizes an equally weighted three-factor apportionment formula. Kurt is incorporated in X. How much of Kurt’s taxable income is apportioned to Z?

a. $0.*b. $150,000.c. $900,000.d. $2,000,000.

1647. Chapter 13 - Multijurisdictional Taxation Question MC #63 José Corporation realized $600,000 taxable income from the sales of its products in States X and Z. José’s activities in both states establish nexus for income tax purposes. José’s sales, payroll, and property among the states include the following.

State X State Z TotalsSales $1,500,000 $1,000,000 $2,500,000Property 500,000 –0– 500,000Payroll 1,500,000 –0– 1,500,000

Z utilizes a double-weighted sales factor in its three-factor apportionment formula. How much of José’s taxable income is apportioned to Z?

a. $600,000.*b. $120,000.c. $80,000.

d. $0.

1648. Chapter 13 - Multijurisdictional Taxation Question MC #64 José Corporation realized $600,000 taxable income from the sales of its products in States X and Z. José’s activities in both states establish nexus for income tax purposes. José’s sales, payroll, and property among the states include the following.

State X State Z TotalsSales $1,500,000 $1,000,000 $2,500,000Property 500,000 –0– 500,000Payroll 1,500,000 –0– 1,500,000

X utilizes an equally weighted three-factor apportionment formula. How much of José’s taxable income is apportioned to X?

a. $600,000.*b. $520,200.c. $200,000.d. $79,800.

1649. Chapter 13 - Multijurisdictional Taxation Question MC #65 Mandy Corporation realized $1,000,000 taxable income from the sales of its products in States X and Z. Mandy’s activities establish nexus for income tax purposes only in Z. Mandy’s sales, payroll, and property among the states include the following.

State X State Z TotalsSales $1,000,000 $2,000,000 $3,000,000Property 2,000,000 500,000 2,500,000Payroll 1,000,000 1,000,000 2,000,000

X utilizes a sales-only factor in its three-factor apportionment formula. How much of Mandy’s taxable income is apportioned to X?

*a. $0.b. $333,333.c. $543,333. d. $1,000,000.

1650. Chapter 13 - Multijurisdictional Taxation Question MC #66 Helene Corporation owns manufacturing facilities in States A, B, and C. A uses a three-factor apportionment formula under which the sales, property and payroll factors are equally weighted. B uses a three-factor apportionment formula under

which sales are double-weighted. C employs a single-factor apportionment factor, based solely on sales.

Helene’s operations generated $1,000,000 of apportionable income, and its sales and payroll activity and average property owned in each of the three states is as follows.

State A State B State C Totals Sales $450,000 $750,000 $300,000 $1,500,000Payroll 100,000 150,000 50,000 300,000Property 200,000 200,000 200,000 600,000

Helene’s apportionable income assigned to A is:

a. $422,200.b. $333,333.*c. $322,200.d. $316,500.e. $300,000.

1651. Chapter 13 - Multijurisdictional Taxation Question MC #67 Simpkin Corporation owns manufacturing facilities in States A, B, and C. A uses a three-factor apportionment formula under which the sales, property and payroll factors are equally weighted. B uses a three-factor apportionment formula under which sales are double-weighted. C employs a single-factor apportionment factor, based solely on sales.

Simpkin’s operations generated $1,000,000 of apportionable income, and its sales and payroll activity and average property owned in each of the three states is as follows.

State A State B State C TotalsSales $450,000 $750,000 $300,000 $1,500,000Payroll 100,000 150,000 50,000 300,000Property 200,000 200,000 200,000 600,000

Simpkin’s apportionable income assigned to B is:

a. $611,100.b. $600,000.c. $500,000.*d. $458,300.e. $444,400.

1652. Chapter 13 - Multijurisdictional Taxation Question MC #68 Cruz Corporation owns manufacturing facilities in States A, B, and C. A uses a three-factor apportionment formula under which the sales, property and payroll factors are equally weighted. B uses a three-factor apportionment formula under which sales are double-weighted. C employs a single-factor apportionment factor, based solely on sales.

Cruz’s operations generated $1,000,000 of apportionable income, and its sales and payroll activity and average property owned in each of the three states is as follows.

State A State B State C Totals Sales $450,000 $750,000 $300,000 $1,500,000Payroll 100,000 150,000 50,000 300,000Property 200,000 200,000 200,000 600,000

Cruz’s apportionable income assigned to C is:

a. $1,000,000.b. $430,542.c. $333,333.*d. $200,000.e. $0.

1653. Chapter 13 - Multijurisdictional Taxation Question MC #69 Boot Corporation is subject to income tax in States A and B. Boot’s operations generated $200,000 of apportionable income, and its sales and payroll activity and average property owned in each of the states is as follows.

State A State B Totals Sales $200,000 $600,000 $800,000Payroll 100,000 50,000 150,000Property 200,000 50,000 250,000

How much more (less) of Boot’s income is subject to A income tax if, instead of using an equally-weighted three-factor apportionment formula, A uses a formula with a double-weighted sales factor?

a. ($50,000).b. $50,000.c. $16,100.*d. ($16,100).

1654. Chapter 13 - Multijurisdictional Taxation Question MC #70 General Corporation is taxable in a number of states. This year, General made a $100,000 sale from its A headquarters to an agency of

the U.S. government. State A applies a throwback rule. In which state(s) will the sale be included in the sales factor numerator?

*a. $100,000 in A.b. $50,000 in A, with the balance exempted from other states’ sales factors under the Colgate doctrine.c. $0 in A.d. In all of the states, according to the apportionment formulas of each, as the U.S. government is present in all states.

1655. Chapter 13 - Multijurisdictional Taxation Question MC #71 General Corporation is taxable in a number of states. This year, General made a $100,000 sale from its A headquarters to a State B office of an agency of the U.S. government. General has not established nexus with B. State A does not apply a throwback rule. In which state(s) will the sale be included in the sales factor numerator?

a. In all of the states, according to the apportionment formulas of each, as the U.S. government is present in all states.b. $100,000 in A.c. $100,000 in B.*d. $0 in both A and B.

1656. Chapter 13 - Multijurisdictional Taxation Question MC #72 General Corporation is taxable in a number of states. This year, General made a $100,000 sale from its A headquarters to a customer in B. This activity is not sufficient for General to create nexus with B. State A applies a throwback rule, but State B does not. In which state(s) will the sale be included in the sales factor numerator?

a. $0 in both A and B.*b. $100,000 in A.c. $100,000 in B.d. In both A and B, according to the apportionment formulas of each.

1657. Chapter 13 - Multijurisdictional Taxation Question MC #73 Britta Corporation’s entire operations are located in State A. Eighty percent ($800,000) of Britta’s sales are made in A and the remaining sales ($200,000) are made in State B. B has not adopted a corporate income tax. If A has adopted a throwback rule, the numerator of Britta’s A sales factor is:

a. $0.b. $200,000.c. $800,000.*d. $1,000,000.

1658. Chapter 13 - Multijurisdictional Taxation Question MC #74 The throwback rule requires that:

*a. Sales of tangible personal property are attributed to the state where they originated, if the taxpayer is not taxable in the state of destination.b. Sales of tangible personal property are attributed to the seller’s state, even if the taxpayer is not taxable in the state of destination.c. Sales of services are attributed to the state of commercial domicile.d. Capital gain/loss is attributed to the state of commercial domicile.

1659. Chapter 13 - Multijurisdictional Taxation Question MA #1-6 Match the definition with the correct term.Bilateral agreement between two countries related to tax issues.U.S. taxpayers earning income outside the United States.Foreign taxpayers earning income inside the United States.Method for sourcing income and deductions.Treasury powers over transfer pricing.A country with very low or no income tax.Income tax treaty Outbound Inbound Allocation and apportionment Section 482 Tax haven Qualified business unit

[a] 1. Bilateral agreement between two countries related to tax issues.

[b] 2. U.S. taxpayers earning income outside the United States.

[c] 3. Foreign taxpayers earning income inside the United States.

[d] 4. Method for sourcing income and deductions.[e] 5. Treasury powers over transfer pricing.[f] 6. A country with very low or no income tax.

a. Income tax treatyb. Outboundc. Inboundd. Allocation and apportionmente. Section 482f. Tax haveng. Qualified business unit

1660. Chapter 13 - Multijurisdictional Taxation Question MA #7-11 Match the definition with the correct term.Foreign tax credit allowed for withholding taxes on payments from foreign sources.Foreign tax credit allowed for income taxes paid by foreign corporation.Requirement that the amount of any deemed paid foreign tax credit be included in gross income.Direct ownership level before a deemed paid foreign tax credit is allowed a U.S. owner of foreign corporation.Number of foreign tax credit limitation baskets after 2006.Direct credit Indirect credit Section 78 10 percent Two 50 percent Six Overall foreign loss

[a] 1. Foreign tax credit allowed for withholding taxes on payments from foreign sources.

[b] 2. Foreign tax credit allowed for income taxes paid by foreign corporation.

[c] 3. Requirement that the amount of any deemed paid foreign tax credit be included in gross income.

[d] 4. Direct ownership level before a deemed paid foreign tax credit is allowed a U.S. owner of foreign corporation.

[e] 5. Number of foreign tax credit limitation baskets after 2006.

a. Direct creditb. Indirect creditc. Section 78d. 10 percente. Twof. 50 percentg. Sixh. Overall foreign loss

1661. Chapter 13 - Multijurisdictional Taxation Question PR #1 Goolsbee, Inc., a domestic corporation, generates U.S.-source and foreign-source gross income. Goolsbee’s assets (tax book value) are as follows.

Generating U.S.-source income $15,000,000Generating foreign-source income 25,000,000Total $40,000,000

Goolsbee incurs interest expense of $200,000. Using the asset method and the tax book value, apportion interest expense to foreign-source income.

Correct Answer:Using the asset method and the tax book value, interest expense is apportioned to the foreign-source income as follows.

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1662. Chapter 13 - Multijurisdictional Taxation Question PR #2 Given the following information, determine if FanCo, a foreign corporation, is a CFC.

Shareholders of Voting foreign corporation power ClassificationMurray 25% U.S. personNancy 24% U.S. personOtto 45% Foreign personPatricia 6% U.S. person

Patricia is Murray’s daughter.

Correct Answer: Voting power Voting power TotalShareholder held directly held constructively voting power

Murray 25% 6% (Patricia) 31%Nancy 24% 24%Patricia 6% 25% (Murray) 31% 55%

Murray, Nancy, and Patricia are U.S. shareholders. Murray owns 31%, 25% directly and 6% constructively through Patricia. Nancy owns 24% directly. Patricia also owns 31%, 6% directly and 25% constructively through Murray. Thus, Patricia is a U.S. shareholder. The corporation is a CFC because U.S. shareholders own 55% of the voting power. Constructive voting power is not counted twice in making this determination. It is counted only in determining if the U.S. persons are U.S. shareholders. Voting power held indirectly, i.e., through a foreign corporation, is counted in determining if a foreign corporation is a CFC.

If Patricia were not related to Murray or Nancy, Patricia would not be a U.S. shareholder and the corporation would not be a CFC.

1663. Chapter 13 - Multijurisdictional Taxation Question PR #3 Present, Inc., a domestic corporation, owns 60% of the stock of Past, Inc., a foreign corporation. For the current year, Present receives a dividend of $80,000 from Past. Past’s pools of post-’86 E & P (after taxes) and foreign taxes are $4,000,000 and $500,000, respectively. What is Present’s total gross income from this dividend if it elects to claim the FTC for deemed-paid foreign taxes?

Correct Answer:Dividend income is “grossed up” for the deemed-paid foreign taxes. The deemed-paid foreign taxes are calculated as follows. Thus, gross income from the dividend is $90,000 ($80,000 + $10,000).

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1664. Chapter 13 - Multijurisdictional Taxation Question PR #4 Britta, Inc., a U.S. corporation, reports foreign-source income and pays foreign taxes as follows.

Income TaxesPassive category $200,000 $ 10,000General limitation category 800,000 350,000

Britta’s worldwide taxable income is $1,600,000 and U.S. taxes before FTC are $560,000 (assume a 35% tax rate). What is Britta’s U.S. tax liability after the FTC?

Correct Answer:The FTC is computed separately for both of the two income baskets. Total FTC = $290,000 ($10,000 + $280,000). Net U.S. tax liability = $270,000 ($560,000 – $290,000).

FTC—passive basket

FTC is lesser of foreign taxes paid ($10,000) or the limitation:

$560,000 ´ $200,000/$1,600,000 = $70,000.

FTC = $10,000

FTC—general basket

FTC is lesser of foreign taxes paid ($350,000) or the limitation:

$560,000 ´ $800,000/$1,600,000 = $280,000.

FTC = $280,000

1665. Chapter 13 - Multijurisdictional Taxation Question PR #5 Compute Quail Corporation’s State Q taxable income for the year.

Addition modifications $50,000Allocated income – total $80,000Allocated income – State Q $50,000Allocated income – State P $30,000Apportionment percentage 20%Federal taxable income $200,000State tax credits $3,000Subtraction modifications $30,000Tax rate 5%

Correct Answer:

State Q taxable income is computed as follows.

Federal taxable income $200,000Addition modifications + 50,000Subtraction modifications – 30,000 State tax base $220,000Allocated income – total – 80,000 Apportionable income $140,000Apportionment percentage ´ 20% Apportioned income $ 28,000Allocated income – in-state + 50,000State taxable income $ 78,000Tax rate ´ 5% Gross income tax $ 3,900Credits – 3,000 Tax liability $ 900

1666. Chapter 13 - Multijurisdictional Taxation Question PR #6 Provide the required information for Wren Corporation, whose Federal taxable income totals $100 million. Wren apportions 60% of its business income to State C. Wren generates $10 million of nonbusiness income each year. Forty percent of that income is attributable to rentals of buildings located in C. Wren’s business income this year totals $60 million.

a. State C taxes how much of Wren’s business income?

b. State C taxes how much of Wren’s nonbusiness income?

c. Explain your results.

Correct Answer:a. $36,000,000 (60% ´ $60 million). b. $4,000,000 (40% ´ $10 million). c. Business income is apportioned to the state, using the apportionment formula. Nonbusiness

income is allocated to the state using a dollar-for-dollar assignment. In most states, business and nonbusiness income cannot be combined in applying the state income tax formula.

1667. Chapter 13 - Multijurisdictional Taxation Question PR #7 Condor Corporation generated $450,000 of state taxable income from selling its product in States A and B. For the taxable year, the corporation’s activities within the two states were as follows.

State A State B Total Sales $800,000 $200,000 $1,000,000Property 300,000 –0– 300,000Payroll 200,000 800,000 1,000,000

Condor has determined that it is subject to tax in both A and B. Both states utilize a three-factor apportionment formula that equally weights sales, property, and payroll. The rates of corporate income tax imposed in A and B are 5% and 3%, respectively. Determine Condor’s state income tax liability.

Correct Answer:Condor’s total state income tax liability is determined as follows.

STATE A INCOME TAX LIABILITY

Taxable income $450,000

Apportionment formula

Sales $800,000/$1,000,000 = 80.00%Property $300,000/$300,000 = 100.00%Payroll $200,000/$1,000,000 = 20.00% Total 200.00%

State A apportionment factor (200.00%/3) ´ 66.67% Taxable income apportioned to A $300,000 A tax rate ´ 5.00% A tax liability $ 15,000

STATE B INCOME TAX LIABILITY

Taxable income $450,000

Apportionment formula

Sales $200,000/$1,000,000 = 20.00%Property $0/$300,000 = –0–%Payroll $800,000/$1,000,000 = 80.00% Total 100.00%

State B apportionment factor (100.00%/3) ´ 33.33% Taxable income apportioned to B $150,000 B tax rate ´ 3.0% B tax liability $ 4,500

Total State Tax Liability

A tax liability $15,000 B tax liability 4,500 Total tax liability $19,500

1668. Chapter 13 - Multijurisdictional Taxation Question PR #8 Milt Corporation owns and operates two facilities that manufacture paper products. One of the facilities is located in State D, and the other is located in State E. Milt generated $1,200,000 of taxable income, comprised of $1,000,000 of income from its manufacturing facilities and a $200,000 gain from the sale of nonbusiness property located in E. E does not distinguish between business and nonbusiness property. D apportions business income. Milt’s activities within the two states are outlined below.

State D State E Total Sales of paper products $4,500,000 $1,500,000 $6,000,000Property 3,500,000 2,500,000 6,000,000Payroll 1,500,000 1,000,000 2,500,000

Both D and E utilize a three-factor apportionment formula, under which sales, property, and payroll are equally weighted. Determine the amount of Milt’s income that is subject to income tax by each state.

Correct Answer:STATE D TAXABLE INCOME Income subject to apportionment (business income only) $1,000,000

Apportionment formulaSales $4,500,000/$6,000,000 = 75.00%Property $3,500,000/$6,000,000 = 58.33%Payroll $1,500,000/$2,500,000 = 60.00% Total 193.33%

State D apportionment factor (193.33%/3) ´ 64.44% Taxable income apportioned to D $ 644,400 Plus: Income allocated to D* –0– D taxable income $ 644,400

*Since the property for which the $200,000 gain was derived was located in E, such income is not allocated to D.

STATE E TAXABLE INCOME

Income subject to apportionment (business and nonbusiness income) $1,200,000

Apportionment formulaSales $1,700,000*/$6,200,000* = 27.42%Property $2,500,000/$6,000,000 = 41.67%Payroll $1,000,000/$2,500,000 = 40.00%

Total 109.09%State E apportionment factor (109.09%/3) ´ 36.36% E taxable income $ 436,320

*Includes $200,000 gain on sale of nonbusiness property.

1669. Chapter 13 - Multijurisdictional Taxation Question PR #9 Dott Corporation generated $300,000 of state taxable income from selling its mapping software in States A and B. For the taxable year, the corporation’s activities within the two states were as follows.

State A State B Total Sales $500,000 $1,500,000 $2,000,000Property 250,000 –0– 250,000Payroll 200,000 300,000 500,000

Dott has determined that it is subject to tax in both A and B. Both states utilize a three-factor apportionment formula which equally weights sales, property, and payroll. The rates of corporate income tax imposed in A and B are 7% and 10%, respectively. Determine Dott’s state income tax liability.

Correct Answer:STATE A INCOME TAX LIABILITY Taxable income $300,000 Apportionment formula Sales $500,000/$2,000,000 = 25.00% Property $250,000/$250,000 = 100.00% Payroll $200,000/$500,000 = 40.00% Total 165.00%

State A apportionment factor (165.00%/3) ´ 55.00% Taxable income apportioned to A $165,000 A tax rate ´ 7.00% A tax liability $ 11,550 STATE B INCOME TAX LIABILITY Taxable income $300,000

Apportionment formula Sales $1,500,000/$2,000,000 = 75.00% Property $0/$250,000 = –0–% Payroll $300,000/$500,000 = 60.00% Total 135.00%

State B apportionment factor (135.00%/3) ´ 45.00% Taxable income apportioned to B $ 135,000 B tax rate ´ 10.00% B tax liability $ 13,500

Total State Tax Liability A tax liability $11,550 B tax liability 13,500 Total tax liability $25,050

1670. Chapter 13 - Multijurisdictional Taxation Question PR #10 Mercy Corporation, headquartered in F, sells wireless computer devices, including keyboards and bar code readers. Mercy’s degree of operations is sufficient to establish nexus only in E and F. Determine its sales factor in those states.

State E applies a throwback rule to sales, while State F does not. State G has not adopted an income tax to date. Mercy reported the following sales for the year. All of the goods were shipped from Mercy’s F manufacturing facilities.

Customer Customer’s Location This Year’s SalesNorCo E $ 60,000,000Tools, Inc. F 20,000,000UniBell G 50,000,000U.S. Department of Defense All 50 U.S. States 20,000,000Total $150,000,000

Correct Answer:Because F has not adopted a throwback rule, the sales to customers in G and to the U.S. government are not included in either state’s sales factor. Mercy creates $70 million in “nowhere sales.”

E Sales factor = $60 million/$150 million = 40.00%

F Sales factor = $20 million/$150 million = 13.33%

1671. Chapter 13 - Multijurisdictional Taxation Question ES #1 Discuss the primary purposes of income tax treaties.

Correct Answer:The primary purpose of an income tax treaty is to eliminate or reduce the double taxation of persons resident in one country earning income from sources within the treaty-partner country. Tax treaties can override the Code and generally provide lower tax burdens as compared with statutory tax provisions of a country.

1672. Chapter 13 - Multijurisdictional Taxation Question ES #2 With respect to income generated by non-U.S. persons, does the U.S. apply a “worldwide” or a “territorial” approach. Be specific.

Correct Answer:

The answer is “both.” U.S. persons are subject to worldwide taxation, with the foreign tax credit and tax treaty provisions allowing for a mitigation of some exposure to double taxation. Non-U.S. persons generally are subject to territorial approach, i.e., being taxed only on U.S.-sited business and portfolio income items.

1673. Chapter 13 - Multijurisdictional Taxation Question ES #3 Your supervisor has shifted your responsibilities from the Federal corporate income tax to a multistate corporate income tax practice. On which issues, if any, are the tax bases and procedures likely to overlap?

Correct Answer:

Interactions between state and Federal income tax laws can be found in the following.

· Most state taxable income computations for a corporation begin with a taxable income amount from one of the lines on the Federal Form 1120.

· States are allowed to piggyback their income tax collections with the Federal income taxing

process. · Most tax accounting periods and methods for state income tax purposes follow those of the

Federal return.

1674. Chapter 13 - Multijurisdictional Taxation Question ES #4 Compost Corporation has finished its computation of Federal taxable income. In State Q, the derivation of state corporate taxable income starts with the Federal amount and makes a number of modifications. List at least five such modifications that Compost is likely to encounter.

Correct Answer:State income tax modifications include the following commonly encountered items.

Addition modifications

· Municipal bond interest · Cost recovery deductions, where the Federal deduction exceeds the state’s · State income tax expense · Federal and out-of-state net operating losses

Subtraction modifications

· U.S. Treasury interest income · Cost recovery deductions, where the Federal deduction is less than the state’s · State income tax refunds · Federal income tax expense.

1675. Chapter 13 - Multijurisdictional Taxation Question ES #5 A number of court cases in the last several decades have involved the application of a state’s nexus rules concerning a business taxpayer. What is the significance of the term nexus when discussing state income taxation?

Correct Answer:A U.S. state cannot levy an income tax on an out-of-state entity unless that entity has conducted a significant degree of business activity within the state’s borders. Each state defines differently the degree of nexus (connection) that is required before the right to tax the business arises. Typically, sufficient nexus is present when a corporation sells goods or services within the state, owns or leases in-state property, employs personnel in the state, or holds physical or financial capital there.

Lacking sufficient nexus, the state cannot place an income tax on the business. A state may define nexus differently for sales/use tax purposes.

1676. Chapter 13 - Multijurisdictional Taxation Question ES #6 Discuss how a multistate business divides up its corporate taxable income among the states in which it operates. Hint: use the terms allocation and apportionment in your comments.

Correct Answer:Generally, business income is apportioned by a formula to the state(s) in which the income is derived, and nonbusiness income is allocated to the state(s) of its situs. These income assignments are made into states with which the taxpayer has established nexus. An apportionment formula generally is an average of the relative sales, property, and payroll activities of the taxpayer in a particular state. Allocation usually is made with respect to the rental income, interest, dividends, and capital gains of the taxpayer.

1677. Chapter 13 - Multijurisdictional Taxation Question ES #7 A state wants to increase its income tax collections, but politically it would be unwise to raise taxes on in-state individuals or businesses. Identify some changes to the income tax apportionment formula that would shift the scheduled income tax increases to out-of-

state businesses.

Correct Answer:· Over-weighting the sales factor. · Sales-factor only apportionment. · Apportioning nonbusiness income. · Special apportionment formula for targeted industries, e.g., telecommunications, airlines.

1678. Chapter 14 - Business Tax Credits and Corporate Alternative Mini The tax benefit received from a tax credit is never affected by the tax rate of the taxpayer.

*a. Trueb. False

1679. Chapter 14 - Business Tax Credits and Corporate Alternative Mi 2 The tax benefits resulting from tax credits and tax deductions are affected by the tax rate bracket of the taxpayer.

a. True*b. False

1680. Chapter 14 - Business Tax Credits and Corporate Alternative Mi 3 Any unused general business credit must be carried back 3 years and then forward for 20 years.

a. True*b. False

1681. Chapter 14 - Business Tax Credits and Corporate Alternative Mi 4 A FIFO method is applied to general business credit carryovers, carrybacks, and utilization of credits earned during a particular year.

*a. Trueb. False

1682. Chapter 14 - Business Tax Credits and Corporate Alternative Mi 5 The purpose of the tax credit for rehabilitation expenditures is to encourage the relocation of businesses from older, economically distressed areas (i.e., inner city) to newer locations.

a. True*b. False

1683. Chapter 14 - Business Tax Credits and Corporate Alternative Mi 6 Qualified rehabilitation expenditures include the cost of acquiring the building and the land.

a. True*b. False

1684. Chapter 14 - Business Tax Credits and Corporate Alternative Mi 7 The tax credit for rehabilitation expenditures for certified historic structures differs from that for qualifying structures that are not certified historic structures.

*a. Trueb. False

1685. Chapter 14 - Business Tax Credits and Corporate Alternative Mi 8 Some (or all) of the tax credit for rehabilitation expenditures will have to be recaptured if the rehabilitated property is disposed of prematurely or if it ceases to be qualifying property.

*a. Trueb. False

1686. Chapter 14 - Business Tax Credits and Corporate Alternative Mi 9 If a taxpayer is required to recapture any tax credit for rehabilitation expenditures, the recapture amount must be added to the adjusted basis of the rehabilitation expenditures.

*a. Trueb. False

1687. Chapter 14 - Business Tax Credits and Corporate Alternative Mi10 The purpose of the work opportunity tax credit is to encourage employers to hire individuals from specified target groups traditionally subject to high rates of unemployment.

*a. Trueb. False

1688. Chapter 14 - Business Tax Credits and Corporate Alternative Mi11 Employers are encouraged by the work opportunity tax credit to hire individuals who have been long-term recipients of family assistance welfare benefits.

*a. Trueb. False

1689. Chapter 14 - Business Tax Credits and Corporate Alternative Mi12 The work opportunity tax credit is available only for wages paid to

qualifying individuals during their first year of employment.

a. True*b. False

1690. Chapter 14 - Business Tax Credits and Corporate Alternative Mi13 An employer’s tax deduction for wages is not affected by the work opportunity tax credit.

a. True*b. False

1691. Chapter 14 - Business Tax Credits and Corporate Alternative Mi14 The incremental research activities credit is 20% of the qualified research expenses that exceed the base amount.

*a. Trueb. False

1692. Chapter 14 - Business Tax Credits and Corporate Alternative Mi15 All taxpayers are eligible to take the basic research credit.

a. True*b. False

1693. Chapter 14 - Business Tax Credits and Corporate Alternative Mi16 Qualified research and experimentation expenditures are not only eligible for the 20% tax credit, but also can be expensed in the year incurred.

*a. Trueb. False

1694. Chapter 14 - Business Tax Credits and Corporate Alternative Mi17 The disabled access credit was enacted to encourage small businesses to make their businesses more accessible to disabled individuals.

*a. Trueb. False

1695. Chapter 14 - Business Tax Credits and Corporate Alternative Mi18 The disabled access credit is computed at the rate of 50% of all access expenditures incurred by the taxpayer during the year.

a. True*b. False

1696. Chapter 14 - Business Tax Credits and Corporate Alternative Mi19 If the cost of a building constructed and placed into service by an eligible small business in the current year includes the cost of a wheelchair ramp, the cost of the ramp qualifies for the disabled access credit.

a. True*b. False

1697. Chapter 14 - Business Tax Credits and Corporate Alternative Mi20 A small employer incurs $1,400 for consulting fees related to establishing a qualified retirement plan for its 75 employees. As a result, the employer may claim the credit for small employer pension plan startup costs for $700.

a. True*b. False

1698. Chapter 14 - Business Tax Credits and Corporate Alternative Mi21 BlueCo incurs $700,000 during the year to construct a facility that will be used exclusively for the care of its employees’ pre-school age children during normal working hours. The credit for employer-provided child care available to BlueCo this year is $175,000.

a. True*b. False

1699. Chapter 14 - Business Tax Credits and Corporate Alternative Mi22 Cardinal Company incurs $800,000 during the year to construct a facility that will be used exclusively for the care of its employees’ pre-school age children during normal working hours. Assuming Cardinal claims the credit for employer-provided child care this year, its basis in the newly constructed facility is $640,000.

a. True*b. False

1700. Chapter 14 - Business Tax Credits and Corporate Alternative Mi23 In computing the foreign tax credit, the greater of the foreign income taxes paid or the overall limitation is allowed.

a. True*b. False

1701. Chapter 14 - Business Tax Credits and Corporate Alternative Mi24 Unused foreign tax credits can be carried back three years and forward fifteen years.

a. True*b. False

1702. Chapter 14 - Business Tax Credits and Corporate Alternative Mi25 Some foreign taxes do not qualify for the foreign tax credit.

*a. Trueb. False

1703. Chapter 14 - Business Tax Credits and Corporate Alternative Mi26 Because current U.S. corporate income tax rates are higher than many foreign corporate income tax rates, the overall limitation does not yield a lower foreign tax credit than the amount of foreign taxes actually paid.

*a. Trueb. False

1704. Chapter 14 - Business Tax Credits and Corporate Alternative Mi27 If a taxpayer chooses not to claim a foreign tax credit, the foreign income taxes paid can be claimed as a deduction.

*a. Trueb. False

1705. Chapter 14 - Business Tax Credits and Corporate Alternative Mi28 The purpose of the AMT is to replace the regular income tax.

a. True*b. False

1706. Chapter 14 - Business Tax Credits and Corporate Alternative Mi29 The AMT does not apply to qualifying “small corporations.”

*a. Trueb. False

1707. Chapter 14 - Business Tax Credits and Corporate Alternative Mi30 A tax preference increases alternative minimum taxable income while an adjustment decreases alternative minimum taxable income.

a. True*b. False

1708. Chapter 14 - Business Tax Credits and Corporate Alternative Mi31 Since most tax preferences are merely timing differences, they eventually will reverse and net to zero.

a. True*b. False

1709. Chapter 14 - Business Tax Credits and Corporate Alternative Mi32 If circulation expenditures are amortized over a ten-year period for regular income tax purposes, there will be no AMT adjustment.

a. True*b. False

1710. Chapter 14 - Business Tax Credits and Corporate Alternative Mi33 Danica incurs circulation expenditures of $120,000 in 2011. No additional circulation expenditures are incurred in 2012 or 2013. The cumulative adjustment for circulation expenditures for 2011, 2012, and 2013 is $120,000.

a. True*b. False

1711. Chapter 14 - Business Tax Credits and Corporate Alternative Mi34 Kay had percentage depletion of $119,000 for the current year for regular income tax purposes. Cost depletion was $60,000. Her basis in the property was $90,000 at the beginning of the current year. Kay must treat the percentage depletion deducted in excess of cost depletion, or $59,000, as a tax preference in computing AMTI.

a. True*b. False

1712. Chapter 14 - Business Tax Credits and Corporate Alternative Mi35 Interest income on private activity bonds issued before 2009, reduced by expenses incurred in carrying the bonds, is a tax preference item that is included in computing AMTI.

*a. Trueb. False

1713. Chapter 14 - Business Tax Credits and Corporate Alternative Mi36 Keosha acquires 10-year personal property to use in her business in 2011 and takes the maximum cost recovery deduction for regular income tax purposes. As a result of this, Keosha will have a positive AMT adjustment in 2011.

*a. Trueb. False

1714. Chapter 14 - Business Tax Credits and Corporate Alternative Mi37 Joel placed real property in service in 2011 that cost $750,000 and used MACRS for regular income tax purposes. He is not required to make

a positive or negative adjustment for AMT purposes in 2011.

*a. Trueb. False

1715. Chapter 14 - Business Tax Credits and Corporate Alternative Mi38 After personal property is fully depreciated for both regular income tax purposes and AMT purposes, the positive and negative adjustments that have been made for AMT purposes will net to zero.

*a. Trueb. False

1716. Chapter 14 - Business Tax Credits and Corporate Alternative Mi39 The required adjustment for AMT purposes for pollution control facilities placed in service in 2011 is equal to the difference between the amortization deduction allowed for regular income tax purposes and the depreciation deduction computed under ADS.

a. True*b. False

1717. Chapter 14 - Business Tax Credits and Corporate Alternative Mi40 Income from some long-term contracts can be reported using the completed contract method for regular income tax purposes, but the percentage of completion method is required for AMT purposes for all long-term contracts.

*a. Trueb. False

1718. Chapter 14 - Business Tax Credits and Corporate Alternative Mi41 Evan is a contractor who constructs both commercial and residential buildings. Even though some of the contracts could qualify for the use of the completed contract method, Evan decides to use the percentage of the completion method for all of his contracts. Therefore, no AMT adjustment is required.

*a. Trueb. False

1719. Chapter 14 - Business Tax Credits and Corporate Alternative Mi42 For a building placed in service before 1999, the adjusted basis can be different for regular income tax purposes and for AMT purposes.

*a. Trueb. False

1720. Chapter 14 - Business Tax Credits and Corporate Alternative Mi43 Tricia sold land that originally cost $105,000 for $92,000. There is a negative AMT adjustment of $13,000 associated with the sale of the land.

a. True*b. False

1721. Chapter 14 - Business Tax Credits and Corporate Alternative Mi44 Because passive losses are not deductible in computing either taxable income or AMTI, no adjustment for passive losses is required for AMT purposes.

a. True*b. False

1722. Chapter 14 - Business Tax Credits and Corporate Alternative Mi45 The C corporation AMT rate can be higher than the individual AMT rates.

a. True*b. False

1723. Chapter 14 - Business Tax Credits and Corporate Alternative Mi46 The AMT exemption for C corporations is $40,000 reduced by 25% of the amount by which AMTI exceeds $150,000.

*a. Trueb. False

1724. Chapter 14 - Business Tax Credits and Corporate Alternative Mi47 As to the AMT, a C corporation has no adjustments or preferences for itemized deductions or for the standard deduction.

*a. Trueb. False

1725. Chapter 14 - Business Tax Credits and Corporate Alternative Mi48 Corporations are subject to a positive AMT adjustment equal to 75% of the excess of ACE over AMTI before the ACE adjustment.

*a. Trueb. False

1726. Chapter 14 - Business Tax Credits and Corporate Alternative Mi49 All of a corporation’s AMT is available for carryover as a minimum tax credit regardless of whether the adjustments and preferences originate from timing differences or AMT exclusions.

*a. Trueb. False

1727. Chapter 14 - Business Tax Credits and Corporate Alternative Mi50 The ACE adjustment can be positive or negative.

*a. Trueb. False

1728. Chapter 14 - Business Tax Credits and Corporate Alternative Mi51 A negative ACE adjustment is beneficial to a corporation.

*a. Trueb. False

1729. Chapter 14 - Business Tax Credits and Corporate Alternative Mi52 AMTI may be defined as regular taxable income after AMT adjustments (other than the NOL and ACE adjustments) and after tax preferences.

a. True*b. False

1730. Chapter 14 - Business Tax Credits and Corporate Alternative Mi53 Roger is considering making a $6,000 investment in a venture that its promoter promises will generate immediate tax benefits for him. Roger, who does not anticipate itemizing his deductions, is in the 30% marginal income tax bracket. If the investment is of a type that produces a tax credit of 40% of the amount of the expenditure, by how much will Roger’s tax liability decline because of the investment?

a. $0.b. $1,800.c. $2,200.*d. $2,400.e. None of the above.

1731. Chapter 14 - Business Tax Credits and Corporate Alternative Mi54 Ahmad is considering making a $10,000 investment in a venture which its promoter promises will generate immediate tax benefits for him. Ahmad, who normally itemizes his deductions, is in the 28% marginal tax bracket. If the investment is of a type where the taxpayer may claim either a tax credit of 25% of the amount of the expenditure or an itemized deduction for the amount of the investment, what treatment normally would be most beneficial to Ahmad and by how much will Ahmad’s tax liability decline because of the investment?

a. $0, take neither the itemized deduction nor the tax credit.b. $2,500, take the tax credit.*c. $2,800, take the itemized deduction.d. Both options produce the same benefit.

e. None of the above.

1732. Chapter 14 - Business Tax Credits and Corporate Alternative Mi55 The components of the general business credit include all of the following except:

a. Credit for employer-provided child care.b. Disabled access credit.c. Research activities credit.d. Tax credit for rehabilitation expenditures.*e. All of the above are components of the general business credit.

1733. Chapter 14 - Business Tax Credits and Corporate Alternative Mi56 Which of the following best describes the treatment applicable to unused business credits?

a. Unused amounts are carried forward indefinitely.*b. Unused amounts are first carried back one year and then forward for 20 years.c. Unused amounts are first carried back one year and then forward for 10 years.d. Unused amounts are first carried back three years and then carried forward for 15 years.e. None of the above.

1734. Chapter 14 - Business Tax Credits and Corporate Alternative Mi57 Molly has generated general business credits over the years that have

not been utilized. The amounts generated and not utilized follow:

2007 $2,5002008 7,5002009 5,0002010 4,000

In the current year, 2011, her business generates an additional $15,000 general business credit. In 2011, based on her tax liability before credits, she can utilize a general business credit of up to $20,000. After utilizing the carryforwards and the current year credits, how much of the general business credit generated in 2011 is available for future years?

a. $0.b. $1,000.*c. $14,000.d. $15,000.e. None of the above.

1735. Chapter 14 - Business Tax Credits and Corporate Alternative Mi58 Which of the following correctly describes the tax credit for rehabilitation expenditures?

a. The cost of enlarging any existing business building is a qualifying expenditure.b. The cost of facilities related to the building (e.g., a parking lot) is a qualifying expenditure.c. No recapture provisions apply.*d. No credit is allowed for the rehabilitation of personal use property.e. None of the above.

1736. Chapter 14 - Business Tax Credits and Corporate Alternative Mi59 Several years ago, Sarah purchased a structure for $150,000 that was originally placed in service in 1929. In the current year, she incurred qualifying rehabilitation expenditures of $200,000. The amount of the tax credit for rehabilitation expenditures, and the amount by which the building’s basis for cost recovery would increase as a result of the rehabilitation expenditures are the following amounts:

*a. $20,000 credit, $180,000 basis.b. $20,000 credit, $200,000 basis.c. $20,000 credit, $350,000 basis.d. $40,000 credit, $160,000 basis.e. None of the above.

1737. Chapter 14 - Business Tax Credits and Corporate Alternative Mi60 Several years ago, Tom purchased a structure for $300,000 that was originally placed in service in 1929. Three and one-half years ago he incurred qualifying rehabilitation expenditures of $600,000. In the current year, Tom sold the property in a taxable transaction. Calculate the amount of the recapture of the tax credit for rehabilitation expenditures.

a. $0.*b. $24,000.c. $36,000.d. $48,000.e. None of the above.

1738. Chapter 14 - Business Tax Credits and Corporate Alternative Mi61 Cardinal Corporation hires two persons certified to be eligible employees for the work opportunity tax credit under the general rules (e.g., food stamp recipients), each of whom is paid $9,000 during the year. As a result of this event, Cardinal Corporation may claim a work opportunity credit of:

a. $1,440.b. $2,880.*c. $4,800.d. $7,200.

e. None of the above.

1739. Chapter 14 - Business Tax Credits and Corporate Alternative Mi62 Black Company paid wages of $360,000, of which $80,000 was qualified wages for the work opportunity tax credit under the general rules. Black Company’s deduction for wages for the year is:

a. $280,000.*b. $328,000.c. $332,000.d. $360,000.e. None of the above.

1740. Chapter 14 - Business Tax Credits and Corporate Alternative Mi63 In March 2011, Gray Corporation hired two individuals, both of whom were certified as long-term recipients of family assistance benefits. Each employee was paid $11,000 during 2011. Only one of the individuals continued to work for Gray Corporation in 2012, earning $9,000 during the year. No additional workers were hired in 2012. Gray Corporation’s work opportunity tax credit amounts for 2011 and 2012 are:

a. $4,000 in 2011, $4,000 in 2012.*b. $8,000 in 2011, $4,500 in 2012.c. $8,000 in 2011, $5,000 in 2012.d. $8,000 in 2011, $9,000 in 2012.e. None of the above.

1741. Chapter 14 - Business Tax Credits and Corporate Alternative Mi64 During the year, Green, Inc., incurs the following research expenditures:

In-house wages, supplies, computer time $60,000Paid to Blue Foundation for research 30,000

Green’s qualifying research expenditures for the year are:

a. $60,000.b. $75,000.*c. $79,500.d. $90,000.e. None of the above.

1742. Chapter 14 - Business Tax Credits and Corporate Alternative Mi65 Which, if any, of the following correctly describes the research activities credit?

a. The research activities credit is the greater of the incremental research credit, the basic research credit, or the energy research credit.

b. If the research activities credit is claimed, no deduction is allowed for research and experimentation expenditures.*c. The credit is not available for research conducted outside the United States.d. All corporations qualify for the basic research credit.e. None of the above.

1743. Chapter 14 - Business Tax Credits and Corporate Alternative Mi66 Green Company, in the renovation of its building, incurs $9,000 of expenditures that qualify for the disabled access credit. The disabled access credit is:

a. $8,750.b. $4,500.*c. $4,375.d. $4,250.e. None of the above.

1744. Chapter 14 - Business Tax Credits and Corporate Alternative Mi67 Amber is in the process this year of renovating the office building (originally placed in service in 1976) used by her business. Because of current Federal Regulations that require the structure to be accessible to handicapped individuals, she incurs an additional $11,000 for various features, such as ramps and widened doorways, to make her office building more accessible. The $11,000 incurred will produce a disabled access credit of what amount?

a. $0.*b. $5,000.c. $5,125.d. $5,500.e. None of the above.

1745. Chapter 14 - Business Tax Credits and Corporate Alternative Mi68 During the year, Green Corporation (a U.S. corporation) has U.S.-source income of $750,000 and foreign income of $500,000. The foreign-source income generates foreign income taxes of $240,000. The U.S. income tax before the foreign tax credit is $425,000. Green Corporation’s foreign tax credit is:

*a. $170,000.b. $240,000.c. $425,000.d. $500,000.e. None of the above.

1746. Chapter 14 - Business Tax Credits and Corporate Alternative Mi69 During the year, Purple Corporation (a U.S. Corporation) has U.S.-source income of $1,800,000 and foreign income of $600,000. The foreign-source income generates foreign income taxes of $150,000. The U.S. income tax before the foreign tax credit is $816,000. Purple

Corporation’s foreign tax credit is:

a. $112,500.*b. $150,000.c. $204,000.d. $816,000.e. None of the above.

1747. Chapter 14 - Business Tax Credits and Corporate Alternative Mi70 Which of the following statements is correct?

a. A C corporation classified as a small corporation is eligible to have the AMT calculated using the AMT provisions for individuals.*b. A C corporation classified as a small corporation is not subject to the AMT.c. A C corporation classified as a small corporation is subject to the AMT only on its adjusted current earnings.d. A C corporation classified as a small corporation is eligible to use the 15%/0% tax rate on net capital gain and qualified dividends rather than the regular tax rates applicable to other C corporations.e. a., b., and c. are correct.

1748. Chapter 14 - Business Tax Credits and Corporate Alternative Mi71 During its first year of operations, Sherry’s business incurred circulation expenditures of $150,000. Since the income of the business is small, Sherry decides to capitalize the expenditures and to amortize them over 3 years for regular income tax purposes. The AMT adjustment for circulation expenditures for the first year of operations is:

*a. $0.b. Negative adjustment of $50,000.c. Positive adjustment of $50,000.d. Positive adjustment of $100,000.e. None of the above.

1749. Chapter 14 - Business Tax Credits and Corporate Alternative Mi72 Eula owns a mineral property that had a basis of $23,000 at the beginning of the year. Cost depletion is $19,000. The property qualifies for a 15% depletion rate. Gross income from the property was $200,000 and net income before the percentage depletion deduction was $50,000. What is Eula’s tax preference for excess depletion?

a. $15,000.b. $23,000.c. $25,000.d. $0.*e. None of the above.

1750. Chapter 14 - Business Tax Credits and Corporate Alternative Mi73 Which of the following can produce an AMT preference rather than an AMT adjustment?

a. Circulation expenditures.b. Research and experimental expenditures.*c. Percentage depletion.d. Incentive stock options (ISOs).e. None of the above.

1751. Chapter 14 - Business Tax Credits and Corporate Alternative Mi74 On January 3, 1997, White Corporation acquired an office building for $100,000 and claimed MACRS depreciation of 2.461%. The Alternative Depreciation System rate for the first recovery year is 2.396%. What was White’s AMT adjustment (or preference) for depreciation with respect to the office building in 1997?

*a. $65 positive adjustment.b. $65 negative adjustment.c. $0 adjustment or preference.d. $2,461 positive adjustment.e. None of the above.

1752. Chapter 14 - Business Tax Credits and Corporate Alternative Mi75 Omar acquires used 7-year personal property for $100,000 to use in his business in February 2011. Omar does not elect § 179 expensing, but does take the maximum regular cost recovery deduction. As a result, Omar will have a positive AMT adjustment in 2011 of what amount?

a. $0.*b. $3,580.c. $10,710.d. $14,290.e. None of the above.

1753. Chapter 14 - Business Tax Credits and Corporate Alternative Mi76 Factors that can cause the adjusted basis for AMT purposes to be different from the adjusted basis for regular income tax purposes include the following:

a. A different amount of depreciation (cost recovery) has been deducted for AMT purposes and regular income tax purposes.b. The spread on an incentive stock option (ISO) is recognized for AMT purposes, but is not recognized for regular income tax purposes.c. A different amount has been deducted for circulation expenditures for AMT purposes and for regular income tax purposes.d. Only a. and b.*e. a., b., and c.

1754. Chapter 14 - Business Tax Credits and Corporate Alternative Mi77 In 2011, Glenda had a $97,000 loss on a passive activity. None of the loss is attributable to AMT adjustments or preferences. She has no other passive activities. Which of the following statements is correct?

a. In 2011, Glenda can deduct $97,000 for regular income tax purposes and for AMT purposes.b. Glenda will have a $97,000 tax preference in 2011 as a result of the passive activity.*c. For regular income tax purposes, none of the loss is allowed in 2011.d. In 2011, Glenda will have a positive adjustment of $25,000 as a result of the passive loss.e. None of the above.

1755. Chapter 14 - Business Tax Credits and Corporate Alternative Mi78 Sand Corporation, a calendar year taxpayer, has alternative minimum taxable income [before adjustment for adjusted current earnings (ACE)] of $750,000 for 2011. If Sand’s (ACE) is $975,000, its tentative minimum tax for 2011 is:

a. $150,000.*b. $183,750.c. $195,000.d. $225,000.e. None of the above.

1756. Chapter 14 - Business Tax Credits and Corporate Alternative Mi79 Mauve, Inc., has the following for 2010, 2011, and 2012 and no prior ACE adjustments.

2010 2011 2012Pre-adjusted AMTI $12,000 $15,000 $8,000Adjusted current earnings 10,000 17,000 5,000 What is the ACE adjustment for each of the three years?

2010 2011 2012

*a. $0 $1,500 ($1,500)b. ($2,000) $2,000 ($3,000)c. $2,000 ($2,000) $3,000 d. ($1,500) $1,500 $2,250 e. $1,500 ($1,500) ($2,250)

1757. Chapter 14 - Business Tax Credits and Corporate Alternative Mi80 Primeline, Inc., has the following items related to the AMT:

Alternative minimum tax base $102,755,000Regular corporate tax 11,125,000Foreign AMT tax credit 2,300,000

The corporation’s AMT, if any, is:

a. $0.*b. $7,126,000.c. $9,426,000.d. $18,251,000.e. None of the above.

1758. Chapter 14 - Business Tax Credits and Corporate Alternative Mi81 Tanver Corporation, a calendar year corporation, has alternative minimum taxable income of $7 million in 2011 (before adjustment for adjusted current earnings). If Tanver’s adjusted current earnings is $16 million, its tentative minimum tax for 2011 is:

a. $310,000.*b. $2,750,000.c. $6,750,000.d. $7,000,000.e. Some other amount.

1759. Chapter 14 - Business Tax Credits and Corporate Alternative Mi82 Steve has a tentative general business credit of $110,000 for the current year. His net regular tax liability before the general business credit is $125,000, and his tentative minimum tax is $100,000. Compute Steve’s allowable general business credit for the year.

Correct Answer:

Steve’s allowable general business credit for the year is limited to $25,000, determined as follows:

Net income tax $125,000*Less: The greater of:

· $100,000 (tentative minimum tax) (100,000)

· $25,000 [25% ´ ($125,000 – $25,000)]

Amount of general business credit allowed $ 25,000

*Net income tax = $125,000 (regular tax liability) + $0 [alternative minimum tax ($100,000 tentative minimum tax – $125,000 regular tax

liability)] – $0 (nonrefundable credits).

1760. Chapter 14 - Business Tax Credits and Corporate Alternative Mi83 In January 2011, Tammy acquired an office building in downtown Syracuse, New York for $400,000. The building was originally constructed in 1932. Of the $400,000 cost, $40,000 was allocated to the land. Tammy immediately placed the building into service, but quickly realized that substantial renovation would be required to keep and attract new tenants. The renovations, costing $600,000, were of the type that qualifies for the rehabilitation credit. The improvements were completed in October 2011.

a. Compute Tammy’s rehabilitation tax credit for the year of acquisition.

b. Determine the cost recovery deduction for 2011.

c. What is the basis in the property at the end of its first year of use by Tammy?

Correct Answer:a. Tammy’s adjusted basis in the building before the rehabilitation expenditures and

current year cost recovery is $360,000 ($400,000 – $40,000) minus the cost recovery for the period January through September. Because the rehabilitation expenditures of $600,000 exceed the greater of (1) the adjusted basis of the building before the rehabilitation ($360,000 minus the cost recovery for the period January through September), or (2) $5,000, Tammy is allowed a rehabilitation tax credit of $60,000 (10% ´ $600,000).

b. The improvements are treated as separate property items for purposes of computing

cost recovery. The recovery period for these improvements begins in October 2011 when the improvements are placed in service by Tammy. (Rev. Rul. 87-57, 1987-2 C.B. 687) The cost recovery period for the underlying structure begins in January 2011 when it was placed in service by Tammy. The straight-line method over 39 years under MACRS of § 168(c) must be used. Using Table 8.6 in Chapter 8 for straight-line depreciation for 39-year nonresidential real property, the appropriate cost recovery percentage for the building is 2.461% and the percentage for the improvements is 0.535%.

Cost recovery for the property for 2011 is as follows:

Cost recovery of building ($360,000 ´ 2.461%) $ 8,860 Plus: Cost recovery of improvements Cost of improvements $600,000 Less: Credit (10%) (60,000) Cost recovery basis $540,000 Cost recovery of improvements ($540,000 ´ 0.535%) 2,889

Total cost recovery for 2011 $11,749 c. Tammy’s basis in the property at the end of 2011 is determined as follows: Land $ 40,000 Building: Cost [$400,000 – $40,000 (land)] $360,000 Less: Cost recovery (8,860) Adjusted basis of building 351,140 Improvements: Cost [$600,000 – $60,000 (credit)] $540,000 Less: Cost recovery (2,889) Adjusted basis of improvements 537,111 Total adjusted basis of property $928,251

1761. Chapter 14 - Business Tax Credits and Corporate Alternative Mi84 In May 2007, Alma incurred qualifying rehabilitation expenditures of $400,000 on a certified historic structure and properly claimed the tax credit for rehabilitation expenditures. In March 2011, she sold the building at a loss. Calculate the rehabilitation expenditures credit recapture that she must report in 2011.

Correct Answer:Amount of original credit ($400,000 ´ 20%) $80,000

Amount of rehabilitation expenditures credit recapture ($80,000 ´ 40%) $32,000

Because the property was held by Alma for more than three years but less than four years, the recapture percentage is 40%.

1762. Chapter 14 - Business Tax Credits and Corporate Alternative Mi85 In May 2011, Blue Corporation hired Camilla, Jolene, and Tyrone, all of whom are certified as long-term family assistance recipients. Each employee is paid $12,000 during 2011. Camilla and Tyrone continued to work for Blue Corporation in 2012, earning $14,000 each. Blue hired no additional employees during 2012.

a. Compute Blue Corporation’s work opportunity tax credits for 2011 and 2012.

b. Assume Blue Corporation pays total wages of $500,000 to its employees during 2011 and $560,000 during 2012. How much may Blue Corporation claim as a wage deduction for 2011 and 2012 if the work opportunity tax credit is claimed in both years?

Correct Answer:a. The work opportunity tax credit for 2011 is calculated as follows:

3 qualified employees ´ $10,000 limit on wages for each employee ´ 40% $12,000

The work opportunity tax credit for 2012 is calculated as follows:

2 qualified employees in second year of employment ´ $10,000 limit on wages per employee ´ 50%

$10,000

b. The wage deduction for 2011 is $488,000 [$500,000 (total wages) – $12,000 (credit)]. The wage deduction for 2012 is $550,000 [$560,000 (total wages) – $10,000 (credit)].

1763. Chapter 14 - Business Tax Credits and Corporate Alternative Mi86 Golden Corporation is an eligible small business for purposes of the disabled access credit. During the year, Golden makes the following expenditures on a structure originally placed in service in 1988.

Removal of architectural barriers $ 8,500Acquired equipment for disabled persons 6,250 $14,750

In addition, $8,000 was expended by Golden on a building originally placed in service in the current year to ensure easy accessibility by disabled individuals. Calculate the amount of the disabled access credit available to Golden Corporation.

Correct Answer:Eligible access expenditures ($8,500 + $6,250); limited to $10,250 $10,250 Less: Threshold amount (250) Disabled access credit base $10,000 Tax credit rate ´ 50% Disabled access credit $ 5,000

The expenditures of $8,000 incurred on the building originally placed in service in the current year do not qualify for the credit. The outlay is not considered an eligible expenditure because it is incurred on a structure placed in service after the enactment of the disabled access credit provision (November 5, 1990).

1764. Chapter 14 - Business Tax Credits and Corporate Alternative Mi87 Summer Corporation’s business is international in scope and is subject to income taxes in several countries. Summer’s earnings and income taxes paid in

the relevant foreign countries are:

Country Income TaxesA $1,000,000 $500,000B 300,000 30,000C 400,000 120,000Total $1,700,000 $650,000

If Summer Corporation’s worldwide income subject to taxation in the United States is $2,400,000 and the U.S. income tax due prior to the foreign tax credit is $816,000, compute the allowable foreign tax credit. If, instead, the total foreign income taxes paid were $550,000, compute the allowable foreign tax credit.

Correct Answer:

Overall limitation:

Foreign-source taxable income ´ U.S. tax = OverallWorldwide taxable income before FTC limitation

$1,700,000 ´ $816,000 = $578,000$2,400,000

Therefore, because the overall limitation is less than the foreign taxes actually paid ($650,000), the foreign tax credit is $578,000.

However, if $550,000 of foreign taxes were paid, the foreign tax credit would be limited to the amount of foreign taxes actually paid, or $550,000.

1765. Chapter 14 - Business Tax Credits and Corporate Alternative Mi88 Sage, Inc., has the following gross receipts and taxable income:

Gross receipts Taxable income2001 $5,600,000 $120,0002002 4,300,000 190,0002003 7,200,000 162,0002004 9,000,000 180,0002005 6,200,000 150,0002006 6,500,000 160,0002007 6,800,000 162,0002008 7,000,000 154,0002009 7,200,000 190,0002010 7,100,000 200,0002011 7,300,000 185,000

Is Sage, Inc., subject to the AMT in 2011?

Correct Answer:Sage, Inc. is not subject to the AMT in 2011. It qualifies for the small corporation exemption (i.e., had average annual gross receipts of less than $5 million for the 3-year period beginning after 1993 and had average annual gross receipts of less than $7.5 million for the 3-year period preceding each subsequent current tax year). Even if these requirements were not satisfied for 2001, the small corporation exemption would apply for the first year of existence of the corporation.

For 2002 (the $7.5 million requirement)[($0 + $0 + $5,600,000)/1] = $5.6 million

For 2003 (the $7.5 million requirement)[($0 + $5,600,000 + $4,300,000)/2] = $4.95 million

For 2004 (the $7.5 million requirement)[($5,600,000 + $4,300,000 + $7,200,000)/3] = $5.7 million

For 2005 (the $7.5 million requirement) [($4,300,000 + $7,200,000 + $9,000,000)/3] = $6.83 million

For 2006 (the $7.5 million requirement) [($7,200,000 + $9,000,000 + $6,200,000)/3] = $7.47 million

For 2007 (the $7.5 million requirement) [($9,000,000 + $6,200,000 + $6,500,000)/3] = $7.23 million

For 2008 (the $7.5 million requirement) [($6,200,000 + $6,500,000 + $6,800,000)/3] = $6.5 million

For 2009 (the $7.5 million requirement)[($6,500,000 + $6,800,000 + $7,000,000)/3]= $6,766,667

For 2010 (the $7.5 million requirement) [($6,800,000 + $7,000,000 + $7,200,000)/3] = $7 million

For 2011 (the $7.5 million requirement) [($7,000,000 + $7,200,000 + $7,100,000)/3] = $7.1 million

1766. Chapter 14 - Business Tax Credits and Corporate Alternative Mi89 In 2011, Louise incurs circulation expenses of $210,000 which she deducts in calculating taxable income.

a. Calculate Louise’s AMT adjustment for circulation expenses for 2011, 2012, 2013, and 2014.

b. Advise Louise on how she could reduce or eliminate the AMT

adjustment in 2011.

Correct Answer:a. Louise deducted the $210,000 circulation expenses in 2011 for regular income tax

purposes. For AMT purposes, the $210,000 must be amortized over a 3-year period ($70,000 per year). So Louise has a positive AMT adjustment of $140,000 ($210,000 – $70,000) in 2011. In 2012 and 2013, she has a negative AMT adjustment of $70,000 each year. There is no regular income tax or AMT effect in 2014.

b. Louise could elect to amortize the circulation expenses of $210,000 over a 3-year

period ($70,000 each year). In this case, the deduction for regular income tax and AMT purposes would be the same and no AMT adjustment is necessary.

1767. Chapter 14 - Business Tax Credits and Corporate Alternative Mi90 In September, Dorothy purchases a building for $900,000 to use in her business as a warehouse. Dorothy uses the depreciation method which will provide her with the greatest deduction for regular income tax purposes.

a. Calculate the AMT adjustment for depreciation in 2011 if Dorothy purchased the building in 2011.

b. Calculate the AMT preference for depreciation in 2011 if Dorothy purchased the building in 1986.

Correct Answer:a. $0. For real property placed in service after 1998, the MACRS recovery periods are used in

calculating the AMT depreciation. Thus, the depreciation deduction [$6,741 ($900,000 ´ 0.749%)] is the same for both regular income tax and AMT purposes.

b. For real property placed in service before 1987, the AMT preference is the excess of accelerated over straight-line depreciation. However, since the building is fully depreciated at the end of the 20th year for both regular income tax and AMT purposes, the AMT preference is $0. The 26th year of the building’s life is 2011.

1768. Chapter 14 - Business Tax Credits and Corporate Alternative Mi91 Frederick sells land and building whose adjusted basis for regular income tax purposes is $287,000 and for AMT purposes is $360,000. The sales proceeds are $700,000. Determine the effect on:

a. Taxable income.

b. AMTI.

Correct Answer:a. Amount realized $700,000 Adjusted basis (287,000) Recognized gain $413,000

The recognized gain increases taxable income by $413,000.

b. Amount realized $700,000 Adjusted basis (360,000) Recognized gain $340,000

Using the direct method to calculate AMTI, the recognized gain increases AMTI by $340,000. Using the indirect method, the recognized gain using the regular income tax adjusted basis increases taxable income by $413,000 which would in turn increase AMTI by the same amount. However, a negative AMT adjustment of $73,000 is made in calculating AMTI for the difference between the recognized gain for regular income tax purposes of $413,000 and the recognized gain for AMT purposes of $340,000.

1769. Chapter 14 - Business Tax Credits and Corporate Alternative Mi92 Smoke, Inc., provides you with the following information:

Regular corporate tax liability $ 22,250 AMT adjustments and preferences (excluding ACE adjustment)

60,000

ACE adjustment (prior positive adjustments are $30,000) (10,000)Taxable income 100,000

Calculate Smoke’s AMT for 2011.

Correct Answer:

Smoke’s AMT is calculated as follows:

Taxable income $100,000 + AMT adjustments and preferences (excluding ACE adjustment) 60,000 – AMT adjustment for ACE (10,000) AMTI $150,000 – AMT exemption [$40,000 – 25%($150,000 – $150,000)] (40,000) = AMT base $110,000 ´ Rate 20% = Tentative AMT $ 22,000 – Regular income tax liability (22,250) AMT $ –0–

1770. Chapter 14 - Business Tax Credits and Corporate Alternative Mi93 Calico, Inc., has AMTI of $305,000. Calculate the amount of the AMT exemption if:

a. Calico is a small corporation for AMT purposes.

b. Calico is not a small corporation for AMT purposes.

Correct Answer:a. If Calico is a small corporation for AMT purposes, the AMT does not apply to Calico. b. If Calico is not a small corporation for AMT purposes, the AMT exemption is calculated

a follows:

AMTI $305,000 – AMT exemption threshold (150,000) Excess $155,000 ´ 25% = Phaseout of exemption amount $ 38,750 Statutory exemption amount $ 40,000 – AMT exemption phaseout (38,750) AMT exemption $ 1,250

1771. Chapter 14 - Business Tax Credits and Corporate Alternative Mi94 Discuss the treatment of unused general business credits.

Correct Answer:Unused general business credits are initially carried back one year and applied to reduce the income tax liability during that year. Thus, the taxpayer may receive a tax refund as a result of the carryback. Any remaining unused credits are then carried forward 20 years. A FIFO method is applied to the carrybacks, carryovers, and utilization of credits earned during a particular year. This procedure minimizes the potential for loss of a general business credit benefit.

1772. Chapter 14 - Business Tax Credits and Corporate Alternative Mi95 Explain the purpose of the tax credit for rehabilitation expenditures and describe the general characteristics of its computation.

Correct Answer:The rehabilitation expenditures credit is intended to discourage businesses from moving from older, economically distressed areas (e.g.,

inner cities) to newer locations and to encourage the preservation of historic structures. To that end, taxpayers are allowed a tax credit for expenditures incurred to rehabilitate industrial and commercial buildings and certified historic structures. To calculate the credit, qualifying expenditures are multiplied by 10 percent for nonresidential buildings and residential rental property (other than historic structures) originally placed in service before 1936. For nonresidential and residential certified historic structures, a 20 percent rate is applied. To qualify for the credit, the buildings must be substantially rehabilitated.

1773. Chapter 14 - Business Tax Credits and Corporate Alternative Mi96 Explain the purpose of the disabled access credit and describe the general characteristics of its computation.

Correct Answer:The disabled access credit is designed to encourage small businesses to make their businesses more accessible to disabled individuals. The credit is only available to eligible small businesses and is based on eligible access expenditures made by such taxpayers. In general, the credit is calculated at the rate of 50% of the eligible expenditures that exceed $250 but do not exceed $10,250. The credit applies only to buildings placed in service before November 6, 1990.

1774. Chapter 14 - Business Tax Credits and Corporate Alternative Mi97 Why is there a need for a second tax system called the alternative minimum tax?

Correct Answer:The AMT was enacted as a backup to the regular income tax. The purpose is to ensure that no taxpayer with significant economic income can avoid significant tax liability by using the exclusions, deductions, and credits contained in the regular income tax system.

1775. Chapter 14 - Business Tax Credits and Corporate Alternative Mi98 Under what circumstances are corporations exempt from the AMT?

Correct Answer:Small corporations are exempt from the AMT. A corporation is automatically classified as a small corporation in the first tax year of existence. For subsequent tax years, a corporation is a small corporation if it had average annual gross receipts of not more than $5 million for the three-year period beginning after December 1993 and not more than $7.5 million for intervening three-year periods (i.e., three-year running average up to three-year period preceding the current tax year).

1776. Chapter 14 - Business Tax Credits and Corporate Alternative Mi99 What is the relationship between the regular income tax liability and the tentative AMT?

Correct Answer:

If the tentative AMT exceeds the regular income tax liability, the AMT is the amount of the excess. If the regular income tax liability is equal to or greater than the tentative AMT, the AMT is zero.

1777. Chapter 14 - Business Tax Credits and Corporate Alternative M100 Can AMT adjustments and preferences be both positive and negative?

Correct Answer:AMT adjustments can be both positive and negative. AMT preferences can only be positive.

1778. Chapter 14 - Business Tax Credits and Corporate Alternative M101 Will all AMT adjustments reverse? That is, do they relate to timing differences?

Correct Answer:Most, but not all, AMT adjustments do relate to timing differences and thus will reverse. However, since not all AMT adjustments relate to timing differences, not all will reverse. For example, some of the AMT adjustments relating to itemized deductions will not reverse.

1779. Chapter 14 - Business Tax Credits and Corporate Alternative M102 In determining the amount of the AMT adjustments, discuss the difference in the treatment of a building placed in service after 1986 and before January 1, 1999 and a building placed in service after December 31, 1998.

Correct Answer:For a building placed in service after December 31, 1998, the same MACRS recovery periods and methods are used in calculating depreciation for both regular income tax purposes and AMT purposes. Therefore, there is no AMT adjustment necessary.

For a building placed in service after 1986 and before January 1, 1999, depreciation is computed for AMT purposes under the alternative depreciation system (ADS) using the straight-line method over a 40-year life. For a building placed in service after 1986 and before January 1, 1999, depreciation is computed for regular income tax purposes under MACRS using the straight-line method over a 27.5, 31.5, or 39-year life. The difference between the depreciation amounts is the adjustment in computing the AMT. However, if the taxpayer elects to use ADS in calculating deprecation for regular income tax purposes, there is no AMT adjustment.

1780. Chapter 14 - Business Tax Credits and Corporate Alternative M103 Durell owns a construction company that builds residential housing. The company is eligible to use the completed contract method for regular income tax purposes. What can Durell do to minimize his AMT?

Correct Answer:The use of the completed contract method for regular income tax purposes by Durell will result in the excess of the income calculated

under the percentage of completion method over that reported under the completed contract method being treated as a positive adjustment for AMT purposes. Likewise, if for a particular tax year, the income calculated under the percentage of completion method is less than that under the completed contract method, this difference is a negative adjustment for AMT purposes. Durell can eliminate this AMT positive or negative adjustment by using the percentage of completion method for regular income tax purposes. Then, the same method of accounting will be used for both regular income tax purposes and AMT purposes.

1781. Chapter 14 - Business Tax Credits and Corporate Alternative M104 How can interest on a private activity bond issued in 2008 result in both an AMT adjustment that decreases AMTI and an AMT preference that increases AMTI?

Correct Answer:The interest on a private activity bond issued in 2008 is not included in taxable income, but the interest (net of related expenses) is a tax preference that increases AMTI.

For regular income tax purposes, the interest on a private activity bond is not included in net investment income in calculating the deduction for investment interest. However, for AMT purposes such interest is included in net investment income in calculating the deduction for investment interest. To the extent that such private activity bond interest increases the amount of the investment interest deduction for AMT purposes, therefore, it is a negative AMT adjustment. If the bond had been issued in 2009 or 2010, the related private activity bond interest would not be a tax preference.

1782. Chapter 14 - Business Tax Credits and Corporate Alternative M105 Identify an AMT adjustment that applies for the individual taxpayer that does not apply for the corporate taxpayer and identify an AMT adjustment that applies for the corporate taxpayer that does not apply for the individual taxpayer.

Correct Answer:

Among the AMT adjustments that apply for the individual taxpayer that do not apply for the corporate taxpayer are the following:

· Adjustment for ISOs.

· Adjustments for certain itemized deductions.

An adjustment that applies only to corporate taxpayers is the ACE adjustment.

1783. Chapter 14 - Business Tax Credits and Corporate Alternative M106 Are the AMT rates for the individual taxpayer the same as those for a

corporate taxpayer?

Correct Answer:No, the rates are different. The corporate AMT rate is 20%. The individual taxpayer has two rates: 26% for the first $175,000 of AMT base and 28% for the AMT basis that is greater than $175,000.

1784. Chapter 14 - Business Tax Credits and Corporate Alternative M107 For the ACE adjustment, discuss the relationship between ACE and unadjusted AMTI.

Correct Answer:A positive AMT adjustment occurs if the ACE amount exceeds unadjusted AMTI. A negative AMT adjustment occurs if unadjusted AMTI exceeds the ACE amount. A negative adjustment is limited to the aggregate of the positive adjustments under ACE for prior years, reduced by the previously claimed negative adjustments.

1785. Chapter 15 - Comparative Forms of Doing Business Question TF #1 A business entity is not always taxed the same way as its legal form.

*a. Trueb. False

1786. Chapter 15 - Comparative Forms of Doing Business Question TF #2 A business organized as a C corporation will always encounter lower tax rates than a business organized as a sole proprietorship or as a partnership.

a. True*b. False

1787. Chapter 15 - Comparative Forms of Doing Business Question TF #3 The check-the-box Regulations have made it easier for a business entity to be classified as a partnership for Federal income tax purposes.

*a. Trueb. False

1788. Chapter 15 - Comparative Forms of Doing Business Question TF #4 A limited liability company (LLC) is a hybrid business form that combines the corporate characteristic of limited liability for the owners with the tax characteristics of a partnership.

*a. Trueb. False

1789. Chapter 15 - Comparative Forms of Doing Business Question TF #5 A limited liability company (LLC) can elect under the check-the-box

rules to be taxed as an S corporation.

a. True*b. False

1790. Chapter 15 - Comparative Forms of Doing Business Question TF #6 Depending on the election made under the check-the-box provisions, a limited liability company (LLC) with two or more owners might have to file a Form 1065 or a Form 1120.

*a. Trueb. False

1791. Chapter 15 - Comparative Forms of Doing Business Question TF #7 Each of the following can pass profits and losses through to the owners: general partnership, limited partnership, S corporation, and limited liability company.

*a. Trueb. False

1792. Chapter 15 - Comparative Forms of Doing Business Question TF #8 Nontax factors are less important than tax factors in making a business decision.

a. True*b. False

1793. Chapter 15 - Comparative Forms of Doing Business Question TF #9 The § 465 at-risk provision and the § 469 passive activity loss provision have decreased the tax attractiveness of investments in real estate for partnerships and for limited liability companies.

*a. Trueb. False

1794. Chapter 15 - Comparative Forms of Doing Business Question TF #10 A C corporation offers greater flexibility in terms of the types of owners and capital structure than an S corporation.

*a. Trueb. False

1795. Chapter 15 - Comparative Forms of Doing Business Question TF #11 An S corporation has a lesser degree of limited liability than a C corporation.

a. True*b. False

1796. Chapter 15 - Comparative Forms of Doing Business Question TF #12 A limited partner in a limited partnership has limited liability whereas a general partner in a limited partnership has unlimited liability unless the limited partners agree that the general partner will have limited liability.

a. True*b. False

1797. Chapter 15 - Comparative Forms of Doing Business Question TF #13 A limited partnership can indirectly avoid unlimited liability of the general partner if the general partner is a corporation.

*a. Trueb. False

1798. Chapter 15 - Comparative Forms of Doing Business Question TF #14 C corporations and their shareholders are subject to double taxation. S corporations and their shareholders typically are subject to single taxation. Therefore, for any given amount of corporate taxable income, the combined tax liability of a C corporation and its shareholders will exceed that of an S corporation and its shareholders.

a. True*b. False

1799. Chapter 15 - Comparative Forms of Doing Business Question TF #15 Lime, Inc., has taxable income of $330,000. If Lime is a C corporation, its tax liability must be either $111,950 [($50,000 ´ 15%) + ($25,000 ´ 25%) + ($25,000 ´ 34%) + ($230,000 ´ 39%)] or $115,500.

*a. Trueb. False

1800. Chapter 15 - Comparative Forms of Doing Business Question TF #16 A major benefit of the S corporation election is the general avoidance of double taxation.

*a. Trueb. False

1801. Chapter 15 - Comparative Forms of Doing Business Question TF #17 Obtaining a deduction on payments made by a C corporation to shareholders is a technique for reducing double taxation.

*a. Trueb. False

1802. Chapter 15 - Comparative Forms of Doing Business Question TF #18 A corporation may alternate between S corporation and C corporation status each year, depending on which results in more tax savings.

a. True*b. False

1803. Chapter 15 - Comparative Forms of Doing Business Question TF #19 If a C corporation has earnings and profits at least equal to the amount of a distribution, the tax consequences to the shareholders are the same, regardless of whether the distribution is classified as a dividend or as a stock redemption.

a. True*b. False

1804. Chapter 15 - Comparative Forms of Doing Business Question TF #20 When a C corporation is classified as a small corporation for AMT purposes, both the corporation and its shareholders are exempt from the AMT.

a. True*b. False

1805. Chapter 15 - Comparative Forms of Doing Business Question TF #21 An S corporation is not subject to the AMT, but its shareholders are in that the S corporation’s AMT adjustments and preferences are passed through to them.

*a. Trueb. False

1806. Chapter 15 - Comparative Forms of Doing Business Question TF #22 The AMT statutory rate for C corporations and for S corporation shareholders on the AMT base is 20%.

a. True*b. False

1807. Chapter 15 - Comparative Forms of Doing Business Question TF #23 The AMT tax rate for a C corporation is less than the regular tax rate for C corporations.

a. True*b. False

1808. Chapter 15 - Comparative Forms of Doing Business Question TF #24 C corporations and S corporations can generate an AMT adjustment known as Adjusted Current Earnings (ACE).

a. True*b. False

1809. Chapter 15 - Comparative Forms of Doing Business Question TF #25 The ACE adjustment associated with the C corporation AMT can only be positive.

a. True*b. False

1810. Chapter 15 - Comparative Forms of Doing Business Question TF #26 An S corporation election for Federal income tax purposes also is effective for all states’ income tax purposes.

a. True*b. False

1811. Chapter 15 - Comparative Forms of Doing Business Question TF #27 Of the corporate types of entities, all are subject to double taxation on current earnings.

a. True*b. False

1812. Chapter 15 - Comparative Forms of Doing Business Question TF #28 If the amounts are reasonable, salary payments to shareholder-employees can reduce or avoid the double taxation result of a C corporation.

*a. Trueb. False

1813. Chapter 15 - Comparative Forms of Doing Business Question TF #29 If lease rental payments to a noncorporate shareholder-lessor are classified as unreasonable, the taxable income of a C corporation remains the same and the gross income of the shareholder increases.

a. True*b. False

1814. Chapter 15 - Comparative Forms of Doing Business Question TF #30 If the IRS reclassifies debt as equity under § 385, the repayment of the debt by the corporation to the shareholder automatically is treated as a dividend.

a. True*b. False

1815. Chapter 15 - Comparative Forms of Doing Business Question TF #31 Actual dividends paid to shareholders result in double taxation. Likewise, deemed dividends (e.g., free use of corporate assets by a shareholder) result in double taxation.

*a. Trueb. False

1816. Chapter 15 - Comparative Forms of Doing Business Question TF #32 An effective way for all C corporations to avoid double taxation is not to make dividend distributions.

a. True*b. False

1817. Chapter 15 - Comparative Forms of Doing Business Question TF #33 The accumulated earnings tax rate in 2011 is the same as the highest tax rate for a C corporation.

a. True*b. False

1818. Chapter 15 - Comparative Forms of Doing Business Question TF #34 A corporation can avoid the accumulated earnings tax by demonstrating that it has plans to distribute earnings at a later date.

a. True*b. False

1819. Chapter 15 - Comparative Forms of Doing Business Question TF #35 Only C corporations are subject to the accumulated earnings tax (i.e., S corporations are not).

*a. Trueb. False

1820. Chapter 15 - Comparative Forms of Doing Business Question TF #36 Roger owns 40% of the stock of Silver, Inc. (adjusted basis of $500,000). Silver redeems 75% of his shares for $650,000. If the stock redemption qualifies for return of capital treatment, Roger’s recognized gain is $150,000.

a. True*b. False

1821. Chapter 15 - Comparative Forms of Doing Business Question TF #37 In its first year of operations, a corporation projects losses of $200,000. Since losses are involved, the corporation definitely should elect S corporation status.

a. True*b. False

1822. Chapter 15 - Comparative Forms of Doing Business Question TF #38 Dave contributes land (adjusted basis of $30,000; fair market value of $100,000) to Tan, Inc., in exchange for all of its stock. The land is encumbered by a mortgage of $27,000 which Tan assumes. Since the transaction qualifies for nonrecognition treatment under § 351, Tan’s adjusted basis for the land is $73,000 ($100,000 – $27,000) and Dave’s adjusted basis for the stock is $3,000 ($30,000 – $27,000).

a. True*b. False

1823. Chapter 15 - Comparative Forms of Doing Business Question TF #39 Amos contributes land with an adjusted basis of $70,000 and a fair market value of $100,000 to White, Inc., an S corporation, in exchange for 50% of the stock of White, Inc. Carol contributes cash of $100,000 for the other 50% of the stock. If White later sells the land for $110,000, $35,000 [$30,000 + 50%($10,000)] is allocated to Amos and $5,000 ($10,000 ´ 50%) is allocated to Carol.

a. True*b. False

1824. Chapter 15 - Comparative Forms of Doing Business Question TF #40 To the extent of built-in gain or built-in loss at the time of contribution, partnerships may choose to allocate or not allocate this built-in gain or loss to the contributing partner on the sale of the contributed property by the partnership.

a. True*b. False

1825. Chapter 15 - Comparative Forms of Doing Business Question TF #41 If an individual contributes an appreciated personal use asset to a C corporation in a transaction which qualifies for nonrecognition treatment under § 351, the corporation’s basis in the asset is the same as was the shareholder’s adjusted basis.

*a. Trueb. False

1826. Chapter 15 - Comparative Forms of Doing Business Question TF #42 Wally contributes land (adjusted basis of $30,000; fair market value of

$100,000) to an S corporation in a transaction which qualifies under § 351. The corporation subsequently sells the land for $120,000, recognizing a gain of $90,000 ($120,000 – $30,000). If Wally owns 30% of the stock, $76,000 [$70,000 + 30%($20,000)] of the $90,000 recognized gain is allocated to Wally.

a. True*b. False

1827. Chapter 15 - Comparative Forms of Doing Business Question TF #43 It is easier to satisfy the § 721 requirements for the nonrecognition of gain or loss on partner contributions than it is to satisfy the § 351 requirements for the nonrecognition of gain or loss on shareholder contributions.

*a. Trueb. False

1828. Chapter 15 - Comparative Forms of Doing Business Question TF #44 The profits of a business owned by Taylor (60%) and Maggie (40%) for the current tax year are $100,000. If the business is a C corporation or an S corporation, there is no effect on Taylor’s basis in her stock. If the business is a partnership or an LLC, Taylor’s basis in her partnership interest or basis in her stock is increased by $60,000.

a. True*b. False

1829. Chapter 15 - Comparative Forms of Doing Business Question TF #45 Carol is a 60% owner of a business entity and has an adjusted basis in such interest of $60,000. For the current tax year, the entity has profits of $50,000. If the entity is a C corporation, the corporate profits have no effect on Carol’s basis in her stock. However, if the entity is an S corporation, Carol’s basis increases to $90,000 [$60,000 + (60% ´ $50,000)].

*a. Trueb. False

1830. Chapter 15 - Comparative Forms of Doing Business Question TF #46 A benefit of an S corporation when compared with a C corporation is that it is subject to Federal income tax only in limited circumstances.

*a. Trueb. False

1831. Chapter 15 - Comparative Forms of Doing Business Question TF #47 If an S corporation distributes appreciated property as a dividend, it must recognize gain as to the appreciation.

*a. Trueb. False

1832. Chapter 15 - Comparative Forms of Doing Business Question TF #48 Samantha’s basis for her partnership interest is $85,000. If she receives a cash distribution of $95,000, her recognized gain is $10,000 and her basis for her partnership interest is reduced to $0. Samantha is still a partner after the distribution.

*a. Trueb. False

1833. Chapter 15 - Comparative Forms of Doing Business Question TF #49 Personal service corporations can offset passive activity losses against active income, but not against portfolio income.

a. True*b. False

1834. Chapter 15 - Comparative Forms of Doing Business Question TF #50 The special allocation opportunities that are available to partnerships are available to S corporations only if a majority of the corporate shareholders elect to do so.

a. True*b. False

1835. Chapter 15 - Comparative Forms of Doing Business Question TF #51 From the perspective of the seller of a C corporation business whose assets have appreciated, the seller prefers to sell the assets.

a. True*b. False

1836. Chapter 15 - Comparative Forms of Doing Business Question TF #52 Mercedes owns a 40% interest in Teal Partnership (basis of $35,000) which she sells to Eric for $60,000. Mercedes’ recognized gain of $25,000 will be classified as capital gain.

a. True*b. False

1837. Chapter 15 - Comparative Forms of Doing Business Question TF #53 Section 1244 ordinary loss treatment is available to shareholders in a C corporation but not to those in an S corporation.

a. True*b. False

1838. Chapter 15 - Comparative Forms of Doing Business Question MC #1 Which of the following is correct regarding the form for filing the annual Federal income tax return?

Business entity form Tax form

*a. Sole proprietorship Form 1040-Schedule Cb. Partnership Form 1065Pc. C corporation Form 1120Cd. LLC Form 1120Se. S corporation Form 1120

1839. Chapter 15 - Comparative Forms of Doing Business Question MC #2 A limited liability company:

a. Could be subject to double taxation.b. Is normally taxed as a partnership.c. Is normally taxed as an S corporation.*d. Only a. and b.e. a., b., and c.

1840. Chapter 15 - Comparative Forms of Doing Business Question MC #3 For a limited liability company with 100 owners,

a. An election can be made to be taxed as a C corporation.b. An election can be made to be taxed as an S corporation.c. An election can be made to be taxed as a partnership.*d. Only a. and c. are correct.e. a., b., and c. are correct.

1841. Chapter 15 - Comparative Forms of Doing Business Question MC #4 Which of the following statements is correct?

a. The number of owners of an LLC is not limited.b. If the LLC has three or more corporate characteristics, it will be taxed as a C corporation.c. An LLC can elect to be taxed as a C corporation or as a partnership.*d. Only a. and c.e. a., b., and c. are correct.

1842. Chapter 15 - Comparative Forms of Doing Business Question MC #5 Which of the following statements is not correct?

a. An S corporation has a greater opportunity to raise capital than does an C corporation.b. A general partnership has a greater opportunity to raise capital than does a limited partnership.c. A partnership has a greater opportunity to raise capital than does a sole proprietorship.

*d. Only a. and b. are not correct.e. a., b., and c. are not correct.

1843. Chapter 15 - Comparative Forms of Doing Business Question MC #6 Nontax factors that affect the choice of business entity include:

a. Ease of capital formation.b. Limited liability.c. Single versus double taxation.*d. Only a. and b.e. a., b., and c.

1844. Chapter 15 - Comparative Forms of Doing Business Question MC #7 Amber, Inc., has taxable income of $212,000. In addition, Amber accumulates the following information which may affect its AMT.

· Depreciation on buildings placed in service in the early 1990s was $52,000. ADS would have been $41,000.

· The president of Amber exercised stock options on Amber stock. She paid $30,000 for the

stock, which had a fair market value at exercise date of $49,000. At the end of the year, the stock was worth $54,000.

· Amber deducted percentage depletion of $65,000. The adjusted basis of the natural resource

at the beginning of the year was $39,000. · Amber contributed CSX stock worth $20,000 to the Red Cross. Amber purchased the stock

four months ago for $19,000.

What is Amber’s AMTI?

a. $212,000.b. $233,000.c. $238,000.*d. $249,000.e. None of the above

1845. Chapter 15 - Comparative Forms of Doing Business Question MC #8 Which of the following statements is correct?

a. The AMT applies to both the individual taxpayer and the C corporation.b. The individual AMT rates are 26% and 28%.c. The C corporation AMT rate is 20%.d. Only a. and b. are correct.*e. a., b., and c. are correct.

1846. Chapter 15 - Comparative Forms of Doing Business Question MC #9 Brown, Inc., has accumulated earnings and profits at the end of the year of $600,000. Brown pays a salary and bonus of $175,000 to Alice, its CEO. Brown’s taxable income before the salary and bonus is $200,000. The IRS classifies $75,000 of the salary and bonus as unreasonable. Calculate Brown’s taxable income after the reclassification.

a. $21,250.b. $25,000.c. $77,750.*d. $100,000.e. None of the above.

1847. Chapter 15 - Comparative Forms of Doing Business Question MC #10 Robin Company has $100,000 of income before payment of $100,000 of reasonable salaries to its owners/employees (who are in the 33% bracket). Which form of business results in the least amount of combined tax being paid by the company and its owners?

a. Partnership.b. C corporation.c. S corporation.*d. a., b., and c. all result in the same amount of tax.e. a. and c. result in the least amount of tax.

1848. Chapter 15 - Comparative Forms of Doing Business Question MC #11 Aaron purchases a building for $500,000 which is going to be used by his wholly-owned corporation. Which of the following statements are correct?

a. If Aaron contributes the building to the corporation, there will be no recognition under § 351 and a carryover basis of $500,000.b. If Aaron leases the building to the corporation, lease-rental payments of $30,000 per year to Aaron will result in a $30,000 deduction for the corporation.c. If Aaron leases the building to the corporation, lease-rental payments of $30,000 per year to Aaron will result in $30,000 of gross income for Aaron.d. Leasing the building to the corporation will contribute to the tax avoidance objective of minimizing double taxation.*e. All of the above are correct.

1849. Chapter 15 - Comparative Forms of Doing Business Question MC #12 Tonya contributes $150,000 to Swan, Inc., for 80% of the stock. In addition, she loans Swan $600,000. The maturity date on the loan is 5 years and the interest rate is 6%, the same as the Federal rate. Which of the following statements are correct?

a. If the loan is reclassified as equity under § 385, Swan qualifies for a deduction of $600,000 when the loan is repaid,

and Tonya receives dividend income of $600,000 (assuming that Swan’s earnings and profits are at least $600,000).*b. If the loan is not reclassified as equity under § 385, Swan can deduct interest expense annually of $36,000, and Tonya includes in gross income annually interest income of $36,000.c. If the loan is reclassified as equity under § 385, Swan claims no interest deduction, and Tonya recognizes no income.d. Only a. and b.e. a., b., and c.

1850. Chapter 15 - Comparative Forms of Doing Business Question MC #13 Rocky and Sandra (shareholders) each loan Eagle Corporation $10,000 at the market rate of 10% interest. Which of the following statements are false?

a. Eagle may deduct the interest expense, and the interest income is taxable to Rocky and Sandra.b. When the note principal is repaid, neither Rocky nor Sandra recognizes gross income from the repayment.c. If the IRS were successful in reclassifying the notes as equity, the interest payments would not be deductible by Eagle, and Rocky and Sandra would still recognize income.d. If the IRS were successful in reclassifying the notes as equity, repayment of the note principal to Rocky and Sandra would not qualify for return of capital treatment and would most likely result in dividend income treatment for Rocky and Sandra.*e. All of the above are true.

1851. Chapter 15 - Comparative Forms of Doing Business Question MC #14 Austin is the sole shareholder of Purple, Inc. Purple’s accumulated E & P at the beginning of the year is $700,000. Purple’s taxable income after paying a salary and bonus to Austin of $100,000 is $500,000. Assume the salary and bonus payment are reasonable. Purple’s maximum exposure in calculating accumulated taxable income for purposes of the accumulated earnings tax for the current tax year is:

*a. $330,000.b. $500,000.c. $600,000.d. $1,300,000.e. None of the above.

1852. Chapter 15 - Comparative Forms of Doing Business Question MC #15 Which of the following statements regarding the accumulated earnings tax is correct in 2011?

a. If Blue, Inc.’s accumulated taxable income for 2011 is $180,000, the calculated accumulated earnings tax liability would be $53,450 [($50,000 ´ 15%) + ($25,000 ´ 25%) + ($25,000 ´ 34%) + ($80,000 ´ 39%)].b. Blue, Inc., calculates accumulated taxable income for 2011 of $100,000. Therefore, it should increase the amount paid to the

IRS for 2011 by $15,000 ($100,000 ´ 15%).c. The accumulated earnings tax applies to C corporations, but applies to S corporations at only the shareholder level.d. The tax rate for the accumulated earnings tax of 35% is the same as the highest tax bracket for the corporate taxpayer.*e. None of the above.

1853. Chapter 15 - Comparative Forms of Doing Business Question MC #16 Factors that should be considered in making the S corporation election for the current tax year include the following:

a. Are greater than 50% of the shareholders willing to consent to the election?*b. Can the requirements for qualification be satisfied by the 15th day of the third month of the tax year and also for the period of the tax year that precedes this date?c. Will the corporation have total capital not in excess of $1 million?d. Only b. and c.e. a., b., and c.

1854. Chapter 15 - Comparative Forms of Doing Business Question MC #17 Steve and Karen are going to establish a business entity. They expect the business to be very successful in the long-run, but project losses of approximately $100,000 for each of the first five years. Due to potential environmental concerns, limited liability is a requisite for the owners. Which form of business entity should they select?

a. General partnership.b. Limited partnership.c. C corporation.*d. S corporation.e. Any of the above should satisfy Steve and Karen.

1855. Chapter 15 - Comparative Forms of Doing Business Question MC #18 Beige, Inc., has 3,000 shares of stock authorized and 1,000 shares outstanding. The shares are owned by Sam (700 shares) and Lois (300 shares). Sam’s adjusted basis for his stock is $100,000 and Lois’ adjusted basis for her stock is $90,000. Beige’s earnings and profits are $500,000. Beige redeems 200 of Lois’ shares for $150,000. Determine the amount of Lois’ recognized gain (1) if she is Sam’s mother and (2) if they are unrelated.

a. $0 and $0.b. $150,000 and $60,000.*c. $150,000 and $90,000.d. $50,000 and $150,000.e. None of the above.

1856. Chapter 15 - Comparative Forms of Doing Business Question MC #19 Shania, Taylor, and Kelly form a corporation with the following contributions.

Basis FMVShania: Cash $100,000 $100,000Taylor: Land 60,000 100,000Kelly: Building 110,000 100,000

a. If the corporation is a C corporation, Taylor has a recognized gain of $40,000, a stock basis of $100,000, and the corporation has a basis for the land of $100,000.b. If the corporation is an S corporation, Kelly has a recognized gain or loss of $0, a stock basis of $110,000, and the corporation has a basis for the building of $110,000.c. If the corporation is a C corporation, Shania has a recognized gain or loss of $0, a stock basis of $100,000, and the corporation has a basis for the cash of $100,000.d. Only a. and c. are correct.*e. Only b. and c. are correct.

1857. Chapter 15 - Comparative Forms of Doing Business Question MC #20 Barb and Chuck each own one-half of the stock of Wren, Inc., a C corporation. Each shareholder has a stock basis of $125,000. Wren has accumulated E & P of $200,000. Wren’s taxable income for the current year is $90,000, and it distributes $60,000 to each shareholder. Barb’s stock basis at the end of the year is:

a. $0.b. $65,000.c. $110,000.*d. $125,000.e. None of the above.

1858. Chapter 15 - Comparative Forms of Doing Business Question MC #21 Barb and Chuck each own one-half the stock of Wren, Inc., an S corporation. Each shareholder has a stock basis of $125,000. Wren has no accumulated E & P. Wren’s taxable income for the current year is $90,000, and it distributes $60,000 to each shareholder. Barb’s stock basis at the end of the year is:

a. $0.b. $65,000.*c. $110,000.d. $125,000.e. None of the above.

1859. Chapter 15 - Comparative Forms of Doing Business Question MC #22 Barb and Chuck each have a 50% ownership in Wren Partnership. Each

partner has a partnership interest basis of $125,000. Wren’s taxable income for the current year is $90,000, and it distributes $60,000 to each partner. Barb’s basis in the partnership interest at the end of the year is:

a. $0.b. $65,000.*c. $110,000.d. $125,000.e. None of the above.

1860. Chapter 15 - Comparative Forms of Doing Business Question MC #23 Trolette contributes property with an adjusted basis of $80,000 and a fair market value of $100,000 to a newly formed business entity. If the entity is a C corporation and the transaction qualifies under § 351, the corporation’s basis for the property and the shareholder’s basis for the stock are:

Asset Basis Stock Basis

a. $ 80,000 $100,000b. $100,000 $ 80,000*c. $ 80,000 $ 80,000d. $100,000 $100,000e. None of the above.

1861. Chapter 15 - Comparative Forms of Doing Business Question MC #24 Alanna contributes property with an adjusted basis of $80,000 and a fair market value of $100,000 to a newly formed business entity. If the entity is a partnership and the transaction qualifies under § 721, the partnership’s basis for the property and the partner’s basis for the partnership interest are:

Asset Basis Stock Basis

a. $ 80,000 $100,000b. $100,000 $ 80,000*c. $ 80,000 $ 80,000d. $100,000 $100,000e. None of the above.

1862. Chapter 15 - Comparative Forms of Doing Business Question MC #25 Marcus contributes property with an adjusted basis of $80,000 and a fair market value of $100,000 to a newly formed business entity. If the entity is an S corporation and the transaction qualifies under § 351, the S corporation’s basis for the property and the shareholder’s basis for the stock are:

Asset Basis Stock Basis

a. $ 80,000 $100,000b. $100,000 $ 80,000

*c. $ 80,000 $ 80,000d. $100,000 $100,000e. None of the above.

1863. Chapter 15 - Comparative Forms of Doing Business Question MC #26 Brenda contributes appreciated property (i.e., adjusted basis of $65,000 and a fair market value of $100,000) to her business entity in a transaction which qualifies for nonrecognition of gain. Brenda’s ownership interest is 60%. The business entity later sells the appreciated property for $110,000. The property is not depreciable. Which of the following statement(s) is correct?

*a. If the entity is a partnership, Brenda’s gross income is increased by $41,000 [($35,000 ´ 100%) + ($10,000 ´ 60%)] in the year of the sale of the property by the partnership.b. If the entity is a C corporation, the corporation’s gross income is increased by $10,000 in the year of the sale of the property by the corporation.c. If the entity is an S corporation, the S corporation’s gross income is increased by $10,000 in the year of the sale of the property by the S corporation and Brenda’s gross income is increased by $6,000 ($10,000 ´ 60%).d. All of the above.e. None of the above.

1864. Chapter 15 - Comparative Forms of Doing Business Question MC #27 Alice contributes equipment (fair market value of $50,000; adjusted basis of $15,000), subject to a $10,000 liability, to form Orange Partnership, a general partnership. Mary contributes $40,000 cash. Alice and Mary share equally in partnership profits and losses. What is Alice’s and Mary’s basis for their partnership interests?

*a. $10,000 to Alice, $45,000 to Mary.b. $25,000 to Alice, $25,000 to Mary.c. $15,000 to Alice, $40,000 to Mary.d. $5,000 to Alice, $40,000 to Mary.e. $20,000 to Alice, $45,000 to Mary.

1865. Chapter 15 - Comparative Forms of Doing Business Question MC #28 Melba contributes land (basis of $190,000; fair market value of $250,000) to a business entity in exchange for 100% of the stock. During the first year of operations, the entity earns a profit of $75,000. At the end of the first year, the entity has outstanding liabilities of $30,000 ($20,000 recourse and $10,000 nonrecourse).

a. If the entity is a C corporation, Melba’s basis for her stock at the end of the first year is $265,000 ($190,000 + $75,000) and her at-risk basis is $265,000.b. If the entity is a partnership, Melba’s basis for her partnership interest (outside basis) at the end of the first year is $355,000 ($250,000 + $75,000 + $30,000) and her at-risk basis is $345,000 ($250,000 + $75,000 + $20,000).

c. If the entity is an S corporation, Melba’s basis for her stock at the end of the first year is $345,000 ($250,000 + $75,000 + $20,000) and her at-risk basis is $345,000.d. Only a. and c. are correct.*e. a., b., and c. are incorrect.

1866. Chapter 15 - Comparative Forms of Doing Business Question MC #29 Catfish, Inc., a closely held corporation which is not a PSC, owns a 45% interest in Trout Partnership, which is classified as a passive activity. Trout’s taxable loss for the current year is $250,000. During the year, Catfish receives a $60,000 cash distribution from Trout. Other relevant data for Catfish are as follows:

Net income from operations $800,000Dividend income 25,000Rent income 20,000

How much of Catfish’s share of Trout’s loss may it deduct in calculating its taxable income?

a. $0.b. $20,000.c. $45,000.*d. $112,500.e. None of the above.

1867. Chapter 15 - Comparative Forms of Doing Business Question MC #30 Bart contributes $160,000 to the Tuna Partnership for a 30% interest. During the first year of operations, Tuna has a profit of $30,000. At the end of the first year, Tuna has outstanding loans from the following banks.

First Bank (recourse) $20,000Second Bank (nonrecourse) 40,000

What is Bart’s at-risk basis in Tuna at the end of the first year?

a. $160,000.b. $169,000.*c. $175,000.d. $187,000.e. None of the above.

1868. Chapter 15 - Comparative Forms of Doing Business Question MC #31 Which of the following special allocations are mandatory for the partners in a partnership?

a. Section 704(a) special allocation requiring limited partners to share losses in accordance with their capital interests in the partnership.b. Section 704(c) special allocation for the difference between the adjusted basis and fair market value of contributed property.c. Section 734 (optional adjustment to basis) special allocation for distributions to partners when the partnership does have a § 754 election in effect or does make a § 754 election.*d. Only b. and c. are mandatory.e. a., b., and c. are mandatory.

1869. Chapter 15 - Comparative Forms of Doing Business Question MC #32 Albert’s sole proprietorship owns the following assets:

Adjusted Basis Fair Market ValueAccounts receivable $ –0– $ 60,000Inventory 20,000 30,000Machinery and equipment* 50,000 90,000Buildings** 120,000 170,000Land 80,000 140,000 $270,000 $490,000

* Potential § 1245 recapture of $45,000.** Straight-line depreciation was used.

Albert sells his sole proprietorship for $500,000. Calculate Albert’s recognized gain or loss and classify it as capital or ordinary.

a. $230,000 ordinary income.b. $230,000 capital gain.c. $115,000 ordinary income and $115,000 capital gain.*d. $110,000 ordinary income and $120,000 capital gain.e. None of the above.

1870. Chapter 15 - Comparative Forms of Doing Business Question MC #33 Mr. and Ms. Smith’s partnership owns the following assets:

Adjusted Basis Fair Market ValueAccounts receivable $ –0– $ 60,000Inventory 20,000 30,000Machinery and equipment* 50,000 90,000Buildings** 120,000 170,000Land 80,000 140,000 $270,000 $490,000

* Potential § 1245 recapture of $45,000.** Straight-line depreciation was used.

Mr. and Ms. Smith each have a basis for their partnership interest of $135,000. Calculate their combined recognized gain or loss and classify it as capital or ordinary if they sell their partnership interests for $500,000.

a. $230,000 ordinary income.b. $230,000 capital gain.c. $115,000 ordinary income and $115,000 capital gain.*d. $110,000 ordinary income and $120,000 capital gain.e. None of the above.

1871. Chapter 15 - Comparative Forms of Doing Business Question MC #34 Kristine owns all of the stock of a C corporation which owns the following assets:

Adjusted Basis Fair Market ValueAccounts receivable $ –0– $ 60,000Inventory 20,000 30,000Machinery and equipment* 50,000 90,000Buildings** 120,000 170,000Land 80,000 140,000 $270,000 $490,000

* Potential § 1245 recapture of $45,000.** Straight-line depreciation was used.

Her adjusted basis for her stock is $270,000. Calculate Kristine’s recognized gain or loss and classify it as capital or ordinary if she sells her stock for $500,000.

a. $230,000 ordinary income.*b. $230,000 capital gain.c. $115,000 ordinary income and $115,000 capital gain.d. $110,000 ordinary income and $120,000 capital gain.e. None of the above.

1872. Chapter 15 - Comparative Forms of Doing Business Question MC #35 Devon owns 40% of the Agate Company for which his basis is $300,000. He sells one-fourth of his ownership interest to Bernice for $100,000. Which of the following statements is correct?

a. If Agate is an S corporation, Devon has a recognized gain of $25,000, some of which may be capital and some of which may be ordinary income.*b. If Agate is a C corporation, Devon has a recognized capital gain of $25,000.c. If Agate is a partnership, Devon has a recognized capital gain of $25,000.d. Only b. and c. are correct.e. a., b., and c. are correct.

1873. Chapter 15 - Comparative Forms of Doing Business Question MC #36 Which of the following statements is correct?

a. The sale of an unincorporated sole proprietorship is always treated as the sale of the individual business assets.b. The sale of a partnership is treated as the sale of the individual assets only if the sales transaction is structured as the sale of the individual assets.c. The sale of a corporation is either treated as the sale of the corporate stock or as the sale of the individual assets.d. Only a. and b. are correct.*e. a., b., and c. are correct.

1874. Chapter 15 - Comparative Forms of Doing Business Question MC #37 Which of the following statements is correct?

*a. The purchase of an unincorporated sole proprietorship is always treated as the purchase of the individual business assets.b. A taxpayer purchasing a corporation in which the assets are appreciated would prefer to purchase the stock of the corporation.c. The purchase of a corporation is always treated as the purchase of the corporate stock.d. Only a. and b. are correct.e. a., b., and c. are correct.

1875. Chapter 15 - Comparative Forms of Doing Business Question MA #1- Match the following tax attributes with the different forms. A particular attribute may apply to more than one entity form.S corporationC corporationLimited partnershipGeneral partnershipSole proprietorshipAbility of all owners to have limited liability. Ability of all owners to have limited liability. Ability to pass tax attributes through to the owners. Ability to pass tax attributes through to the owners. Ability to pass tax attributes through to the owners. Right of all owners to participate in the management of the business. Number of owners is limited. Ability to have multiple owners.

[a] 1. S corporation[b] 2. C corporation[c] 3. Limited partnership[d] 4. General partnership[e] 5. Sole proprietorship

a. Ability of all owners to have limited liability.b. Ability of all owners to have limited liability.c. Ability to pass tax attributes through to the owners.d. Ability to pass tax attributes through to the owners.e. Ability to pass tax attributes through to the owners.f. Right of all owners to participate in the management of the

business.g. Number of owners is limited.

h. Ability to have multiple owners.

1876. Chapter 15 - Comparative Forms of Doing Business Question MA #6- Match the following statements:Sale of the individual assets of an unincorporated sole proprietorship by the owner.Sale of the corporate assets by the C corporation.Sale of corporate stock by the C corporation shareholders.Sale of corporate stock by the S corporation shareholders.Sale of an ownership interest by a partner.Gain or loss is calculated separately for each asset and is subject to single taxation. Subject to double taxation. Transaction in this form enables double taxation to be avoided. Transaction in this form enables double taxation to be avoided. The sale is treated as the sale of a capital asset under § 741 subject to ordinary income potential under § 751. Not subject to double taxation on the sale of corporate stock.

[a] 1. Sale of the individual assets of an unincorporated sole proprietorship by the owner.

[b] 2. Sale of the corporate assets by the C corporation.[c] 3. Sale of corporate stock by the C corporation

shareholders.[d] 4. Sale of corporate stock by the S corporation

shareholders.[e] 5. Sale of an ownership interest by a partner.

a. Gain or loss is calculated separately for each asset and is subject to single taxation.

b. Subject to double taxation.c. Transaction in this form enables double taxation to be

avoided.d. Transaction in this form enables double taxation to be

avoided.e. The sale is treated as the sale of a capital asset under §

741 subject to ordinary income potential under § 751.f. Not subject to double taxation on the sale of corporate

stock.

1877. Chapter 15 - Comparative Forms of Doing Business Question MA #11 Match the following statements:Organization costsAlternative minimum taxNet capital gainNet capital lossCharitable contributionsMust be capitalized, but can be amortized over 180 months. For the corporate taxpayer, the rate is 20%. For the corporate taxpayer, are taxed using the regular tax rates. For the corporate taxpayer, cannot be deducted at all in the current tax year. For the corporate taxpayer, limited to 10% of taxable income before certain deductions.

[a] 1. Organization costs[b] 2. Alternative minimum tax[c] 3. Net capital gain[d] 4. Net capital loss[e] 5. Charitable contributions

a. Must be capitalized, but can be amortized over 180 months.b. For the corporate taxpayer, the rate is 20%.c. For the corporate taxpayer, are taxed using the regular tax

rates.d. For the corporate taxpayer, cannot be deducted at all in

the current tax year.e. For the corporate taxpayer, limited to 10% of taxable

income before certain deductions.

1878. Chapter 15 - Comparative Forms of Doing Business Question MA #16 Match the following:S corporationC corporationLimited partnershipGeneral partnershipRealized gains on the contribution of appreciated property to the entity are not recognized by the contributor when an 80% control requirement is satisfied. Realized gains on the contribution of appreciated property to the entity are not recognized by the contributor when an 80% control requirement is satisfied. Contribution of appreciated property to the business entity by an owner is never subject to taxation. Contribution of appreciated property to the business entity by an owner is never subject to taxation. Realized losses on the contribution of loss property to the entity are never recognized by the contributor. Realized losses on the contribution of loss property to the entity are recognized by the contributor unless an 80% control requirement is satisfied. Basis of ownership interest to the owner is dependent on whether gain or loss is recognized to the owner on the contribution of assets to the business entity.

[a] 1. S corporation[b] 2. C corporation[c] 3. Limited partnership[d] 4. General partnership

a. Realized gains on the contribution of appreciated property to the entity are not recognized by the contributor when an 80% control requirement is satisfied.

b. Realized gains on the contribution of appreciated property to the entity are not recognized by the contributor when an 80% control requirement is satisfied.

c. Contribution of appreciated property to the business entity by an owner is never subject to taxation.

d. Contribution of appreciated property to the business entity by an owner is never subject to taxation.

e. Realized losses on the contribution of loss property to the entity are never recognized by the contributor.

f. Realized losses on the contribution of loss property to the entity are recognized by the contributor unless an 80% control requirement is satisfied.

g. Basis of ownership interest to the owner is dependent on whether gain or loss is recognized to the owner on the contribution of assets to the business entity.

1879. Chapter 15 - Comparative Forms of Doing Business Question MA #20 Match the following statements:Technique for minimizing double taxationAMTS corporationsC corporationsPartnershipsNot making distributions to shareholders. Rate for a corporate taxpayer is 20%. Status applies only if elected by the taxpayer. Subject to double

taxation. Eligible for special allocations.

[a] 1. Technique for minimizing double taxation[b] 2. AMT[c] 3. S corporations[d] 4. C corporations[e] 5. Partnerships

a. Not making distributions to shareholders.b. Rate for a corporate taxpayer is 20%.c. Status applies only if elected by the taxpayer.d. Subject to double taxation.e. Eligible for special allocations.

1880. Chapter 15 - Comparative Forms of Doing Business Question PR #1 Agnes is going to invest $90,000 in a business entity. She will manage the business entity. Her projected share of the loss for the first year is $36,000. Agnes’ marginal tax rate is 33%. Determine the cash flow benefit of the loss to Agnes if the business form is:

a. A general partnership. b. An S corporation. c. An LLC. d. A C corporation.

Correct Answer:a. Under the conduit concept applicable for a general partnership, Agnes will deduct the

$36,000 loss on her Form 1040. Thus, the cash flow benefit to Agnes will be $11,880 ($36,000 ´ 33%).

b. Under the conduit concept applicable for an S corporation, Agnes will deduct the $36,000

loss on her Form 1040. Thus, the cash flow benefit to Agnes will be $11,880 ($36,000 ´ 33%).

c. Under the conduit concept applicable for an LLC, Agnes will deduct the $36,000 loss on her

Form 1040. Thus, the cash flow benefit to Agnes will be $11,880 ($36,000 ´ 33%). d. Under the entity concept applicable for C corporations, the corporate loss is not passed

through to the shareholders. Thus, the cash flow benefit to Agnes will be $0.

1881. Chapter 15 - Comparative Forms of Doing Business Question PR #2 Candace, who is in the 33% tax bracket, is establishing a business which could have potential environmental liability problems. Therefore, she is trying to decide between the C corporation form and the S corporation form. She projects that the business will generate earnings of about $75,000 each year. Advise Candace on the tax consequences of

each tax form.

Correct Answer:If the form selected is an S corporation, the corporation has no tax liability, and Candace has a tax liability associated with the business of $24,750 ($75,000 ´ 33%). A distribution of the $75,000 of earnings to Candace would result in no additional tax liability.

If the form selected is a C corporation, the corporation has a tax liability of $13,750. A distribution of the after-tax earnings of $61,250 ($75,000 – $13,750) would result in an additional tax liability for Candace of $9,188 ($61,250 ´ 15%). Thus, the total tax liability on the $75,000 would be $22,938 ($13,750 + $9,188). The C corporation could follow a no-dividend distribution policy without any adverse tax consequences (i.e., accumulated earnings tax) if the earnings are invested in the growth of the business.

Thus, a significant factor affecting the choice between a C corporation and an S corporation for Candace is the projected distribution policy. For C corporations, the marginal tax rate increases from 25% to 34% (i.e., for taxable income between $75,000 and $100,000) and to 39% (i.e., for taxable income between $100,000 and $335,000).

1882. Chapter 15 - Comparative Forms of Doing Business Question PR #3 Mallard, Inc., is a C corporation that is not eligible for the small business exception to the AMT. Its adjusted current earnings (ACE) and unadjusted alternative minimum taxable income (unadjusted AMTI) for 2011 and 2012 are as follows:

2011 2012ACE $212,000 $250,000Unadjusted AMTI 175,000 300,000

Calculate the amount of the ACE adjustment for 2011 and 2012.

Correct Answer:

For 2011, there is a positive ACE adjustment of $27,750.

ACE $212,000 Unadjusted AMTI (175,000) $ 37,000 ´ 75% Positive ACE adjustment $ 27,750

For 2012, the calculation appears to produce a negative ACE adjustment of $37,500.

ACE $250,000 Unadjusted AMTI (300,000)

($ 50,000) ´ 75% Tentative negative ACE adjustment ($ 37,500)

However, negative ACE adjustments are limited to the amount of the prior positive ACE adjustments. So the negative ACE adjustment is limited to $27,750.

1883. Chapter 15 - Comparative Forms of Doing Business Question PR #4 Saul’s AMT base is $300,000. Green, Inc.’s (a C corporation) AMT base also is $300,000.

a. Calculate the tentative AMT for Saul. b. Calculate the tentative AMT for Green, Inc. c. Why are the amounts in a. and b. not the same since the AMT base for

both is $300,000? d. Would your answer in b. change if Green, Inc. was an S corporation?

Correct Answer:a. Saul’s tentative AMT is $80,500. $175,000 ´ 26% = $45,500 $125,000 ´ 28% = 35,000 $80,500 b. Green, Inc’s tentative AMT is $60,000. $300,000 ´ 20% = $60,000 c. The individual AMT rates are higher than the corporate AMT rates. So for a given amount of

AMT base, the tentative AMT for a C corporation will be less than the tentative AMT for an individual.

d. Yes, the AMT attributes would pass through to the S corporation shareholders and be part of

the individual taxpayer tentative AMT calculation.

1884. Chapter 15 - Comparative Forms of Doing Business Question PR #5

Kirby, the sole shareholder of Falcon, Inc., leases a building to the corporation. The taxable income of the corporation for 2011, before deducting the lease payments, is projected to be $300,000.

a. What are the tax consequences to Kirby and to Falcon if Kirby

leases a building to the corporation for $280,000? b. Is there a potential pitfall? How would it change the tax

consequences to Kirby and to Falcon?

Correct Answer:a. Kirby would include the $280,000 of lease income in his gross income. By deducting

the lease payment, Falcon would reduce its taxable income and related tax liability to $20,000 ($300,000 – $280,000).

b. If the IRS determines that Falcon’s lease payments of $280,000 are not reasonable,

then it will reclassify part of the lease payments as a dividend. Since dividends are not deductible by the corporation, the corporate taxable income increases by the amount of lease payments deemed unreasonable. Kirby’s gross income would not change. His lease income decreases and dividend income increases by the amount of the lease payments reclassified as a dividend. Note that Kirby’s dividend income would be eligible for the beneficial tax rate (15%).

1885. Chapter 15 - Comparative Forms of Doing Business Question PR #6 Blue, Inc., has taxable income before salary payments to its president of $700,000 in 2011. Blue is in the 34% tax bracket, and the president is in the 35% tax bracket.

a. Calculate the tax liability to Blue if the president’s salary is $400,000 and if it is $100,000.

b. What tax benefit is there of paying the larger salary to the

president? c. What negative tax result may occur associated with the payment of

the higher salary?

Correct Answer:a. Taxable income before salary $700,000 $700,000 Salary (400,000) (100,000) Taxable income $300,000 $600,000 Tax liability $100,250* $204,000** * ($50,000 ´ 15%) + ($25,000 ´ 25%) + ($25,000 ´ 34%) + ($200,000 ´ 39%) = $100,250. ** ($600,000 ´ 34%) = $204,000.

b. The salary is included in the gross income of the recipient. Therefore, for the $400,000 salary, the president’s tax liability will increase by $140,000 ($400,000 ´ 35%), whereas for the $100,000 salary, his or her tax liability will increase by $35,000 ($100,000 ´ 35%). Even though the president’s tax liability increase (35% rate) in either case is greater than the corporation’s tax savings (34%) rate, the salary provides a way to get funds out of the

corporation to shareholder/employees with the corporation deducting the salary. A payment to the president in the form of a dividend would not be deductible by the corporation and would still be included in his or her gross income. Qualified dividends are taxed to noncorporate shareholders at a beneficial 15% rate.

c. If the IRS should classify part of the president’s salary as unreasonable compensation, the president would have dividend income rather than salary income. While the president’s taxable income would not change as a result of this, his or her tax liability would decrease (i.e., dividend income is taxed at a 15% rate whereas salary income is taxed at a 35% rate). However, the corporation would not receive a deduction of the amount classified as a dividend. Thus, the corporate tax liability would increase.

1886. Chapter 15 - Comparative Forms of Doing Business Question PR #7 Albert and Bonnie each own 50% of the stock of Crow, Inc. (a C corporation). To cover what is perceived as temporary working capital needs, each shareholder loans Crow $150,000 with an annual interest rate of 5% (same as the Federal rate) and a maturity date of one year. The loan is made at the beginning of 2011.

a. What are the tax consequences to Albert, Bonnie, and Crow if the loans are classified as debt?

b. What are the tax consequences to Albert, Bonnie, and Crow if the

loans are classified as equity?

Correct Answer:a. If the loans are classified as debt, Crow would deduct interest expense of $15,000 ($300,000

´ 5%). Albert and Bonnie would each include $7,500 ($150,000 ´ 5%) of interest income in gross income. The repayment of the $300,000 one year hence by Crow would be the repayment of a liability by Crow and a nontaxable return of capital to Albert and Bonnie.

b. If the loans are reclassified as equity by the IRS, Crow would treat the $15,000 annual

payment as a nondeductible dividend. Albert and Bonnie would each include $7,500 of dividend income in gross income. The repayment of the $300,000 one year hence by Crow (assuming adequate E & P) would be treated as the payment of a nondeductible dividend. Albert and Bonnie would each include $150,000 of dividend income in gross income.

1887. Chapter 15 - Comparative Forms of Doing Business Question PR #8 Daisy, Inc., has taxable income of $850,000 during 2011, its first year of operations. Daisy distributes dividends of $200,000 to its 10 shareholders (i.e., $20,000 each). Daisy earmarks $361,000 of its earnings for potential future expansion into other cities.

a. Calculate Daisy’s total tax liability associated with the current

tax year if the $361,000 is treated as representing reasonable needs of the business.

b. Calculate Daisy’s total potential tax liability associated with the

current tax year if none of the $361,000 qualifies as reasonable needs of the business.

Correct Answer:a. If the reasonable needs provision is satisfied, then Daisy’s tax liability consists only of the

regular tax liability.

$850,000 ´ 34% = $289,000

b. If the reasonable needs provision is not satisfied, Daisy’s potential tax liability consists of both the regular income tax liability and the accumulated earnings tax.

Regular tax liability: $850,000 ´ 34% = $289,000 Accumulated earnings tax: Taxable income $850,000 Less: Accumulated earnings credit $250,000 Dividends paid 200,000 Current income tax 289,000 (739,000) Accumulated taxable income $111,000 Rate ´ 15% Accumulated earnings tax $ 16,650 Therefore, Daisy’s total tax liability if the IRS assesses the accumulated earnings tax is

$305,650 ($289,000 + $16,650).

1888. Chapter 15 - Comparative Forms of Doing Business Question PR #9 Eagle, Inc. recognizes that it may have an accumulated earnings tax problem. According to its calculation, Eagle anticipates it has accumulated taxable income, before reduction for dividends paid, of $600,000 in 2011. Assume that its shareholders are in the 35% marginal tax bracket.

a. Calculate the maximum amount of tax that Eagle and its shareholders might pay if the accumulated earnings tax is assessed.

b. Calculate the maximum amount of tax that Eagle and its shareholders

might pay if it distributes dividends to prevent an accumulated earnings tax assessment from occurring.

Correct Answer:

a. The accumulated earnings tax levied on Eagle would be $90,000 ($600,000 ´ 15%). If Eagle were later to make a distribution to its shareholders of the after-tax amount of $510,000 ($600,000 – $90,000), the shareholders’ tax liability would be $76,500 ($510,000 ´ 15%). Thus, the combined corporation/shareholder tax liability would be $166,500 ($90,000 + $76,500).

b. By distributing $600,000 in dividends to its shareholders, Eagle could reduce its accumulated taxable income to $0. The shareholders’ tax liability would be $90,000 ($600,000 ´ 15%).

1889. Chapter 15 - Comparative Forms of Doing Business Question PR #10 Swallow, Inc., is going to make a distribution of $550,000 to Marjean who is in the 35% tax bracket.

a. Determine the tax liability to Marjean if the form of the distribution is a dividend.

b. Determine the tax liability to Marjean if the form of the

distribution is a stock redemption. Assume Marjean’s adjusted basis for the stock redeemed is $400,000 and that she has owned the stock for five years.

Correct Answer:a. If the distribution is a dividend, Marjean’s tax liability is $82,500 ($550,000 ´ 15%).

b. If the distribution is a stock redemption, Marjean’s recognized gain is calculated as follows: Amount realized $550,000 Adjusted basis (400,000) Realized gain $150,000 Recognized gain $150,000 The gain is classified as a long-term capital gain. Using the alternative tax rate of 15%,

Marjean’s tax liability is $22,500 ($150,000 ´ 15%).

1890. Chapter 15 - Comparative Forms of Doing Business Question PR #11 Kirk is establishing a business in 2011 which could have potential environmental liability problems. Therefore, he is trying to decide between the C corporation form and the S corporation form. He projects that the business will generate losses of approximately $100,000 each year for the first 3 years and then will generate profits of at least

$200,000 each year thereafter. All profits will be reinvested in the growth of the business. Kirk projects he will be in the 35% bracket in 2011 and thereafter. Advise Kirk on which tax form he should select.

Correct Answer:

If the business operates as a C corporation, the $300,000 of projected losses will not benefit Kirk on his individual tax return. Instead, the corporation will carry the losses forward to offset against future profits. Assuming profits of $200,000 in year 4 and thereafter, $200,000 of the net operating loss will be used in year 4 and the remaining $100,000 will be used in year 5. From a cash flow perspective, this will result in tax savings to the corporation in years 4 and 5 of $100,250 ($61,250 + $39,000).

Year 4 Year 5 Tax liability if no NOL carryforward $61,250 $61,250 Tax liability with NOL carryforward (–0–) (22,250) Tax savings $61,250 $39,000

For year 6 and thereafter, the annual tax liability will be $61,250.

If the S election is made, the $100,000 losses for each of the first 3 years can be passed through to Kirk and deducted on his individual tax return. This will result in tax savings to him of $35,000 ($100,000 ´ 35%) in 2011, $35,000 ($100,000 ´ 35%) in 2012, and $35,000 ($100,000 ´ 35%) in 2013. When the time value of money concept is considered, the benefit of the S election is even greater compared with C corporation status.

At the end of year 3 (2013), Kirk may want to terminate the S corporation election. If the election is maintained, Kirk’s annual tax liability will be increased by $70,000 ($200,000 ´ 35%) in 2014, and $70,000 ($200,000 ´ 35%) each year thereafter for the S corporation earnings. If the election is terminated, the annual tax liability of the C corporation will be $61,250 [($50,000 ´ 15%) + ($25,000 ´ 25%) + ($25,000 ´ 34%) + ($100,000 ´ 39%)]. This assumes that the after tax earnings of the C corporation will be reinvested in the growth of the business rather than distributed to the shareholders as dividends.

1891. Chapter 15 - Comparative Forms of Doing Business Question PR #12 Melanie and Sonny form Bird Enterprises. Sonny contributes cash of $100,000 and land worth $50,000 (adjusted basis of $30,000). Melanie contributes land and building worth $280,000 (adjusted basis of $200,000) and performs services worth $20,000 associated with the formation of the entity. Melanie receives a two-thirds ownership interest and Sonny receives a one-third ownership interest. Determine the tax consequences of the contributions to Melanie, Sonny, and Bird if the business is:

a. An S corporation.

b. A C corporation c. A partnership.

Correct Answer:a. Under § 351, no gain or loss is recognized at the time of the contribution of the assets to the

S corporation. Since Melanie and Sonny satisfy the 80% control requirement, § 351 applies. Sonny’s basis for his stock is $130,000 ($100,000 + $30,000) and Melanie’s basis for her stock is $220,000 ($200,000 + $20,000). The corporation’s basis for its assets is a carryover basis (i.e., $100,000 for the cash, $30,000 for the land, $200,000 for the land and building, and $20,000 for the organization costs). Melanie has $20,000 of ordinary income for the services provided.

b. The tax consequences for Melanie, Sonny, and the C corporation are the same as in a.,

above (i.e., § 351 applies to both C corporations and S corporations). c. Under § 721, no gain or loss is recognized at the time of the contribution of the assets to the

partnership. Note that § 721, unlike § 351, does not have a control requirement. Sonny’s basis for his partnership interest is $130,000 ($100,000 + $30,000), and Melanie’s basis for her partnership interest is $220,000 ($200,000 + $20,000). The partnership’s basis for its assets is a carryover basis (i.e., $100,000 for the cash, $30,000 for the land, $200,000 for the land and building, and $20,000 for the organization costs). Melanie has $20,000 of ordinary income for the services she provided.

1892. Chapter 15 - Comparative Forms of Doing Business Question PR #13 Sam and Vera are going to establish a business. Sam will contribute cash of $100,000 for a 50% interest, and Vera will contribute land and a building worth $135,000 (adjusted basis of $65,000) for a 50% interest. The land and building is encumbered by a $35,000 mortgage which the entity assumes. Determine the tax consequences of the contribution to Sam, Vera, and the entity if the business is:

a. An S corporation. b. A partnership. c. A C corporation.

Correct Answer:a. Under § 351, no gain or loss is recognized at the time of the contribution of the assets to the

S corporation. Since Sam and Vera satisfy the 80% control requirement, § 351 applies. Sam’s basis for his stock is $100,000 and Vera’s basis for her stock is $30,000 ($65,000 – $35,000), a carryover basis. The corporation’s basis for its assets is a carryover basis (i.e., $100,000 for the cash and $65,000 for the land and building).

b. Under § 721, no gain or loss is recognized at the time of the contribution of the assets to the

partnership. Note that § 721, unlike § 351, does not have a control requirement. Sam’s basis for his partnership interest is $117,500 [$100,000 + (50% ´ $35,000)], and Vera’s basis for

her partnership interest is $47,500 ($65,000 – $17,500), a carryover basis. The partnership’s basis for its assets is a carryover basis (i.e., $100,000 for the cash and $65,000 for the land and building).

c. The tax consequences for Sam, Vera, and the C corporation are the same as in a., above

(i.e., § 351 applies to both C corporation and S corporations).

1893. Chapter 15 - Comparative Forms of Doing Business Question PR #14 Colin and Reed formed a business entity several years ago. At that date, Colin’s basis for his ownership interest was $40,000 and Reed’s basis for his ownership interest was $50,000. Colin’s profit and loss percentage is 40% and Reed’s profit and loss percentage is 60%. During the intervening period, the entity has reported profits of $200,000. At the beginning of the current year, the entity had liabilities (all recourse) of $50,000. At the end of the current year, the liabilities (all recourse) had increased to $70,000. Determine Colin and Reed’s basis for their ownership interest if the entity is:

a. A partnership. b. A C corporation. c. An S corporation.

Correct Answer:a. Colin Reed Original basis $ 40,000 $ 50,000 + Share of profits 80,000 120,000 + Share of liabilities 28,000 42,000 Ending basis $148,000 $212,000 Profits and liability increases both increase the partner’s basis for his or her ownership

interest. Colin Reedb. Original basis $40,000 $50,000 + Adjustments –0– –0– Ending basis $40,000 $40,000 Profits and liability increases have no effect on a shareholder’s basis for his or her stock in a

C corporation. c. Colin Reed Original basis $ 40,000 $ 50,000 + Share of profits 80,000 120,000 Ending basis $120,000 $170,000 Profits increase a shareholder’s basis for his or her stock in an S corporation.

1894. Chapter 15 - Comparative Forms of Doing Business Question PR #15 Ashley contributes property to the TCA Partnership which was formed 7 years ago by Clark and Tara. Ashley’s basis for the property is $70,000 and the fair market value is $150,000. Ashley receives a 25% interest for his contribution. Because the TCA Partnership is unsuccessful in having the property rezoned from agricultural to commercial, it sells the property 12 months later for $210,000.

a. Determine the tax consequences to Ashley and to the partnership on the contribution of the property to the partnership.

b. Determine the tax consequences to Ashley and the other partners on

the sale of the property. c. Would the tax consequences in b. differ if the entity were an S

corporation?

Correct Answer:a. Ashley has no recognized gain under § 721 and a carryover basis for his partnership interest

of $70,000. The partnership has a carryover basis for Ashley’s property of $70,000.

b. Amount realized $210,000 Basis for property (70,000) Recognized gain $140,000 The precontribution appreciation of $80,000 ($150,000 – $70,000) is allocated to Ashley. Of

the $60,000 balance, $15,000 ($60,000 ´ 25%) is allocated to Ashley and $45,000 ($60,000 ´ 75%) is allocated to the other partners.

c. If the entity were an S corporation, the recognized gain would be allocated based on stock ownership. Thus, $35,000 ($140,000 ´ 25%) would be allocated to Ashley and $105,000 ($140,000 ´ 75%) would be allocated to the other partners.

1895. Chapter 15 - Comparative Forms of Doing Business Question PR #16 Alice has a 70% interest in a business entity. Her basis for her ownership interest is $260,000. The net income of the business for the tax year is $100,000 and the entity liabilities have increased by $50,000. Determine the effect of the earnings and the liabilities on Alice’s basis for her ownership interest if the business is:

a. A C corporation.

b. An S corporation. c. A partnership.

Correct Answer:a. If the entity is a C corporation, Alice’s basis for her stock remains at $260,000. b. If the entity is an S corporation, Alice’s basis for her stock increases by $70,000 ($100,000 ´

70%) to $330,000 ($260,000 + $70,000). c. IIf the entity is a partnership, Alice’s basis for her partnership interest increases by $105,000

[($100,000 ´ 70%) + ($50,000 ´ 70%)] to $365,000.

1896. Chapter 15 - Comparative Forms of Doing Business Question PR #17 Wren, Inc. is owned by Alfred (30%) and Mabel (70%). Alfred’s marginal tax rate is 25% and Mabel’s marginal tax rate is 33%. Wren’s taxable income for 2011 is $400,000.

a. Determine the amount of the distribution that Wren would make to enable Alfred and Mabel to pay their tax liabilities associated with Wren’s $400,000 taxable income if Wren is an S corporation.

b. If Wren is a C corporation.

Correct Answer:a. If Wren is an S corporation, then Wren is the tax reporter and Alfred and Mabel are the

taxpayers. Their tax liabilities on their shares of Wren’s $400,000 taxable income would be as follows:

Alfred ($400,000 ´ 30% ´ 25%) $30,000 Mabel ($400,000 ´ 70% ´ 33%) $92,400 Thus, Wren would need to distribute $122,400 ($30,000 + $92,400) to enable Alfred and

Mabel to pay their tax liabilities associated with Wren.

b. If Wren is a C corporation, Wren is the taxpayer. Its tax liability would be $136,000 ($400,000 ´ 34%). There would be no need to make any distributions to Alfred and Mabel since they are taxed only if they receive distributions from Wren.

1897. Chapter 15 - Comparative Forms of Doing Business Question PR #18 Eagle, Inc., a C corporation, distributes $250,000 to its shareholder,

Jean, and land worth $250,000 (adjusted basis of $190,000) to its shareholder, Pam. Eagle has earnings and profits of $700,000. Determine the tax consequences to Eagle, Jean, and Pam.

Correct Answer:The distribution of the appreciated land is a taxable transaction to Eagle under § 311. Therefore, Eagle has a recognized gain of $60,000 ($250,000 – $190,000). Jean has dividend income of $250,000, and Pam has dividend income of $250,000. The recognized gain to Eagle increases earnings and profits by $60,000, and the dividend distributions decrease earnings and profits by $500,000.

1898. Chapter 15 - Comparative Forms of Doing Business Question PR #19 Maurice purchases a bakery from Philip for $410,000. He spends an additional $150,000 (financed with a nonrecourse loan) updating the bakery equipment. During the first year of operations as a sole proprietorship, the bakery incurs a loss of $125,000. Maurice has $300,000 of salary income as the chief financial officer of a publicly-traded corporation. He has interest income of $30,000 and dividend income of $50,000.

a. What amount can Maurice deduct for the loss if he is a material participant?

b. What amount can Maurice deduct for the loss if he is not a material

participant?

Correct Answer:a. If Maurice is a material participant in the bakery, the § 469 passive activity loss rules do not

apply. So the only limit on his ability to deduct the $125,000 loss is his § 465 at-risk basis. Since his at-risk basis is greater than $125,000, he can deduct the entire loss against his active income and portfolio income.

b. If Maurice is not a material participant in the bakery, the § 469 passive activity loss rules apply. Assuming that he does not have any passive income, he cannot deduct any of the $125,000 passive activity loss against his active income and portfolio income.

1899. Chapter 15 - Comparative Forms of Doing Business Question PR #20 Lee owns all the stock of Vireo, Inc., a C corporation for which he has an adjusted basis of $150,000. The assets of Vireo, Inc., are as follows:

Adjusted Basis FMV Cash $35,000 $35,000Accounts receivable 20,000 20,000Inventory 22,000 25,000

Building 28,000 30,000Land 40,000 90,000

Lee sells his stock to Katrina for $200,000.

a. Determine the tax consequences to Lee. b. Determine the tax consequences to Katrina. c. Determine the tax consequences to Vireo, Inc.

Correct Answer:a. Lee has a recognized gain of $50,000 ($200,000 amount realized – $150,000 adjusted

basis). The gain is a capital gain and is a long-term capital gain if the holding period for the stock is over one year.

b. Katrina has an adjusted basis for her stock of $200,000.

c. Vireo, Inc., was not involved in the transaction. Therefore, the adjusted basis for its assets remains unchanged.

1900. Chapter 15 - Comparative Forms of Doing Business Question PR #21 Ralph owns all the stock of Silver, Inc., a C corporation for which his adjusted basis is $225,000. Ralph founded Silver 12 years ago. The assets and liabilities of Silver are as follows:

Assets Basis FMV Cash $ 15,000 $ 15,000Accounts receivable –0– 25,000Inventory 30,000 35,000Machinery and equipment* 70,000 90,000Land 60,000 150,000 $175,000 $315,000 Liabilities Basis FMV Accounts payable $ 5,000 $ 5,000Notes payable 10,000 10,000 $15,000 $15,000

*Accumulated depreciation of $55,000 has been deducted.

Ralph and the purchaser, Marilyn, have agreed to a purchase price of $350,000 less any outstanding liabilities. They are both in the 35% tax bracket, and Silver is in the 34% tax bracket.

a. Advise Ralph on whether the form of the sales transaction should be a stock sale or an asset sale.

b. Advise Marilyn on whether the form of the purchase transaction

should be a stock purchases or an asset purchase.

Correct Answer:a. Ralph would prefer that the form of the transaction be a stock sale in order to avoid double

taxation. Amount realized ($350,000 – $15,000) $335,000 Stock basis (225,000) Recognized gain (LTCG) $110,000 A LTCG of $110,000 on the sale of the stock will result in an increase of Ralph’s tax liability

of $16,500 ($110,000 LTCG ´ 15%). Liquidating Silver, Inc., (i.e., an asset sale) would result in the following recognized gain and

the related classification at the corporate level. Classification Asset Gain OI LTCG Cash $ –0– $ –0– Accounts receivable 25,000 25,000 Inventory 5,000 5,000 Machinery and equipment 20,000 20,000 Land 90,000 $ 90,000* Goodwill 20,000 20,000 $160,000 $50,000 $110,000 *If this is the only § 1231 transaction, the § 1231 gain is LTCG. The sale of Silver, Inc., assets will result in a corporate tax liability of $54,400 ($160,000 ´

34%). In addition, when Silver distributes the available cash to Ralph, his tax liability will be as

follows: Amount realized ($350,000 – $15,000 – $54,400) $280,600 Stock basis (225,000) Recognized gain (LTCG) $ 55,600 The LTCG of $55,600 to Ralph produces a tax liability of $8,340 ($55,600 LTCG ´ 15%).

Thus, the combined tax liability associated with the liquidation of Silver is $62,740 ($54,400 + $8,340).

b. Marilyn would prefer to purchase the assets so she can step the basis of each asset up to the purchase price (i.e., FMV) of $335,000. With a stock purchase, the assets of the corporation will have a carryover basis of $175,000.

1901. Chapter 15 - Comparative Forms of Doing Business Question ES #1 Included among the factors that influence the choice of the form of a business entity are the following:

· Capital formation. · Limited liability. · Estimated life of the business. · Number of owners and their roles in the management of the

business. · Freedom of choice in transferring ownership interest. · Organizational formality including the related cost and

extent of governmental regulations.

Evaluate the validity of the statement.

Correct Answer:All of these factors are relevant factors in selecting the form of a business entity.

1902. Chapter 15 - Comparative Forms of Doing Business Question ES #2 Lisa is considering investing $25,000 in a limited partnership which is raising additional capital. According to the prospectus, for the past 10-year period the average earnings have been 15% and for the past 5-year period the average earnings have been 8%. Lisa is in the 33% tax bracket.

a. List some factors Lisa should consider in making a decision on the potential investment.

b. Assuming the partnership finances its activities with equity

rather than debt, what is the maximum cash flow benefit Lisa can receive if the partnership generates losses?

Correct Answer:a. Above all, the investment should make economic sense. Among the nontax factors,

Lisa should consider the following: · What has caused the decline in the average earnings rate for the 10-year average

of 15% to the 5-year average of 8%? · What is the projected earnings rate for the future? · To what extent do the limited partners participate in profits and losses? · Why does the limited partnership need additional owner financing? · Are there any contingent liabilities that could affect the limited partner’s ability to

recoup his or her investment? · What distributions, if any, can limited partners expect? · What other investment options does Lisa have? b. If the partnership generates losses, the maximum amount Lisa will be able to deduct

on her individual income tax return is her investment of $25,000. From a cash flow perspective, this could generate tax savings of $8,250 ($25,000 ´ 33%). A related issue that needs to be addressed by Lisa is the risk that she will not recover her investment.

1903. Chapter 15 - Comparative Forms of Doing Business Question ES #3 Which of the following business entity forms are subject to single taxation on the profits and which are subject to double taxation?

a. Sole proprietorship. b. Partnership. c. C corporation. d. S corporation. e. LLC.

Correct Answer:a., b., c., d., and e.

The sole proprietorship, partnership, and S corporation are subject to single taxation (i.e., the owners rather than the entity are subject to Federal income tax). The C corporation is subject to double taxation (i.e., the entity is subject to Federal income tax on its profits and the owners are taxed on distributions received from the corporation). The LLC could be subject to either single taxation or double taxation depending on what election is made under the check-the-box Regulations (i.e., normally single taxation since the partnership form usually is selected).

1904. Chapter 15 - Comparative Forms of Doing Business Question ES #4 List some techniques which can be used to avoid and/or reduce double

taxation for a C corporation.

Correct Answer:

Techniques that can be used to avoid and/or reduce double taxation include the following:

· Making distributions to the shareholders that are deductible to the corporation. · Not making distributions to the shareholders. · Making distributions that qualify for return of capital treatment. · Making the S corporation election.

1905. Chapter 15 - Comparative Forms of Doing Business Question ES #5 List some techniques for reducing and/or avoiding double taxation by making distributions to the shareholders that are deductible to the corporation.

Correct Answer:

Making distributions to the shareholders that are deductible to the corporation include the following:

· Salary payments to shareholder-employees. · Lease rental payments to shareholder-lessors. · Interest payments to shareholder-creditors.

1906. Chapter 15 - Comparative Forms of Doing Business Question ES #6 What is the major pitfall associated with attempting to reduce and/or avoid double taxation by a corporation not making distributions to shareholders?

Correct Answer:The major pitfall in this case is the potential assessment by the IRS of the accumulated earnings tax.

1907. Chapter 15 - Comparative Forms of Doing Business Question ES #7 Why does stock redemption treatment for an individual shareholder produce more favorable tax consequences than a dividend?

Correct Answer:Both a stock redemption (assuming the holding period is long-term) and a dividend (assuming the dividend is a qualified dividend) are taxed at

beneficial tax rates (i.e., 15%/0%). The full amount of a dividend is subject to taxation (i.e., included in gross income). For a stock redemption, only the recognized gain (amount realized – basis) is subject to taxation (i.e., included in gross income).

1908. Chapter 15 - Comparative Forms of Doing Business Question ES #8 What special adjustment is required in calculating the AMT of a C corporation that does not apply in calculating the AMT of an individual taxpayer?

Correct Answer:In calculating the AMT of a C corporation, the ACE adjustment applies. The amount of the positive adjustment is 75% of the excess of adjusted current earnings (ACE) over unadjusted alternative minimum taxable income (AMTI) for the tax year. If unadjusted AMTI exceeds ACE for the tax year, the adjustment is negative. Note, however, that the total negative ACE adjustments cannot exceed the total positive ACE adjustments in prior tax years.

1909. Chapter 15 - Comparative Forms of Doing Business Question ES #9 What tax rates apply for the AMT for an individual taxpayer and for a C corporation?

Correct Answer:

For the individual taxpayer, the AMT tax rates are as follows:

· AMT base up to $175,000 26% · AMT base above $175,000 28%

For a C corporation, the AMT rate is 20%.

1910. Chapter 15 - Comparative Forms of Doing Business Question ES #10 To which of the following entities does the AMT apply?

· Sole proprietorship. · Partnership. · LLC. · S corporation. · C corporation.

Correct Answer:

The AMT applies directly to a C corporation. The AMT applies indirectly to the other four entities in that the AMT attributes flow through to the individual’s tax return where the AMT is imposed.

1911. Chapter 15 - Comparative Forms of Doing Business Question ES #11 How can double taxation be avoided or reduced by owning assets outside a C corporation?

Correct Answer:The shareholder can lease the assets to the corporation. Assuming such rental payments are deductible, the corporate taxable income is reduced and the corporation gets cash out of the corporation to the shareholder. Although the shareholder must include the rental income in gross income, single taxation is achieved.

1912. Chapter 15 - Comparative Forms of Doing Business Question ES #12 Normally a C corporation shareholder would prefer to receive a return of capital distribution (e.g., stock redemption) rather than a dividend distribution. Provide an example of where the opposite is true.

Correct Answer:

Return of capital distributions result in recognized gain being the difference between the amount of the distribution and the adjusted basis for the stock. Dividend distributions result in the full amount of the distribution being included in gross income. In terms of the effect on gross income, therefore, return of capital treatment is preferred.

Return of capital distributions normally qualify for beneficial capital gain treatment (e.g., 15%). Qualified dividend distributions also qualify for the same beneficial rate (e.g., 15%). Since identical tax rates apply, a return of capital treatment is favored because less income results.

However, it is possible for the dividend treatment to yield a smaller tax liability than return of capital treatment. This could be caused by substantial appreciation and the return of capital distribution being taxed at ordinary income rates (e.g., short-term capital gain). For example, assume a distribution of $100,000, an adjusted basis of $5,000, a short-term holding period, and a marginal tax rate of 35%.

· Return of capital treatment: As a short-term capital gain results, the tax liability on the distribution is $33,250 [($100,000 – $5,000) ´ 35%].

· Dividend treatment: If the dividend is qualified, the tax liability on the distribution is $15,000

($100,000 ´ 15%).

1913. Chapter 15 - Comparative Forms of Doing Business Question ES #13 Aubrey has been operating his business as a C corporation for the past 5 years. The corporation pays him a reasonable salary. The profits of the corporation, after paying Federal income tax, are distributed to him each year as a dividend. He is considering electing S status for his corporation in order to avoid double taxation. What factors should he consider assuming after-tax earnings will continue to be distributed to him?

Correct Answer:

Normally, one needs to consider the following factors:

· Are all the shareholders willing to consent to the election? · Can the qualification requirements under § 1361 be satisfied at the time of the election? · Since the qualification requirements become maintenance requirements, can these

requirements continue to be satisfied? · For what period will the conditions that make the election beneficial continue to prevail? · Will the corporate distribution policy create wherewithal to pay problems at the shareholder

level?

An analysis of Aubrey’s situation indicates that none of the above factors should deter him from electing S status for his corporation. A factor normally considered that is not present for Aubrey is the existence of NOLs for the C corporation. An S corporation cannot offset C corporation NOLs against S corporation profits, but the 20-year time period does run.

1914. Chapter 15 - Comparative Forms of Doing Business Question ES #14 Why are S corporations not subject to the accumulated earnings tax?

Correct Answer:The purpose of the accumulated earnings tax is to penalize the C corporation for not making dividend distributions and thereby avoiding double taxation. The earnings of the S corporation are taxed at the shareholder level rather than at the corporate level. Thus, the S corporation is not subject to double taxation.

1915. Chapter 15 - Comparative Forms of Doing Business Question ES #15 Marsha is going to contribute the following assets to a business entity in exchange for an ownership interest.

Adjusted Basis

FMV

Cash $100,000 $100,000Land and building 60,000 95,000

What are the tax consequences of the contribution to Marsha if the business entity is a(n):

a. Sole proprietorship? b. Partnership? c. C corporation? d. S corporation?

Correct Answer:a. Since the business entity is a sole proprietorship, transactions between Marsha and the

entity are not taxable. The sole proprietorship has a carryover basis for the assets received from her (i.e., cash = $100,000, land = $60,000).

b. Contributions by a partner to a partnership are not subject to taxation under § 721. Marsha’s basis for her ownership interest is a carryover basis of $160,000 under § 722. The partnership’s basis for the assets is a carryover basis (i.e., cash = $100,000, land and building = $60,000) under § 723.

c. If Marsha and any other shareholders involved in the transaction satisfy the § 368(c) control requirement (i.e., 80%), § 351 provides that realized gain is not recognized. In this case, Marsha’s basis for her stock is a carryover basis of $160,000. The C corporation’s basis for the assets is a carryover basis (i.e., cash = $100,000, land and building = $60,000). However, if the control requirement is not satisfied, then Marsha’s realized gain of $35,000 is recognized. In this case, Marsha’s basis for her stock is the fair market value of the assets contributed of $195,000. The C corporation’s basis for the assets also is the fair market value (i.e., cash = $100,000, land and building = $95,000).

d. The tax consequences for the S corporation are the same as those for the C corporation in c. above.

1916. Chapter 15 - Comparative Forms of Doing Business Question ES #16 Gladys contributes land with an adjusted basis of $70,000 and a fair market value of $100,000 to a business entity in which she is an 80% owner on the first day of the tax year. Discuss the tax consequences to Gladys if the business entity sells the land six months later for $130,000 if:

a. The business entity is a partnership?

b. The business entity is a C corporation? c. The business entity is an S corporation?

Correct Answer:a. For a partnership, the precontribution gain of $30,000 ($100,000 – $70,000) must be

allocated to Gladys. Thus, Gladys’ share of the recognized gain of $60,000 ($130,000 – $70,000) on the sale of the land by the partnership is $54,000 [$30,000 + ($30,000 ´ 80%)].

b. None of the $60,000 gain is allocated to the shareholders. All of the gain is taxed to the

corporation. c. The $60,000 gain is passed through to the shareholders of the S corporation based on the

stock ownership. Thus, $48,000 ($60,000 ´ 80%) is allocated to Gladys.

1917. Chapter 15 - Comparative Forms of Doing Business Question ES #17 Terry has a 20% ownership interest in a business for which his basis is $100,000. During the year, the entity earns profits of $90,000 and makes cash distributions to the owners of $50,000. How do these transactions affect Terry’s basis if:

a. The entity is a C corporation? b. The entity is a general partnership? c. The entity is an S corporation.

Correct Answer:a. If the entity is a C corporation, Terry’s stock basis remains at $100,000. The profits are taxed

at the C corporation level. Since the $50,000 distribution is a dividend (i.e., current E & P is $90,000), this transaction does not affect Terry’s stock basis.

b. If the entity is a general partnership, Terry’s basis for his ownership interest is affected by both the profits and by the distribution.

Beginning basis $100,000 Plus: Share of profits ($90,000 ´ 20%) 18,000 Less: Distribution received (10,000) Ending basis $108,000

c. If the entity is an S corporation, Terry’s stock basis is affected by both the profits and the distribution.

Beginning stock basis $100,000 Plus: share of profits ($90,000 ´ 20%) 18,000 Less: Distribution received ($50,000 ´ 20%) (10,000) Ending basis $108,000

1918. Chapter 15 - Comparative Forms of Doing Business Question ES #18 A business entity has appreciated land (basis of $50,000 and fair market value of $75,000) which it is going to distribute to Craig, one of its owners. The entity has earned substantial profits during its 15 years of operations and has reinvested most of them in the business. What are the tax consequences of the distribution to the business entity and to Craig if the business entity is a(n):

a. C corporation? b. S corporation? c. Partnership?

Correct Answer:a. Gain of $25,000 [$75,000 (fair market value) – $50,000 (adjusted basis)] is recognized

by the corporation under § 311(b) on the distribution of the land. Since the corporation apparently has substantial earnings and profits, Craig recognizes dividend income of $75,000.

b. Gain of $25,000 [$75,000 (fair market value) – $50,000 (adjusted basis)] is recognized

by the S corporation under § 311(b) on the distribution of the land. This gain is passed through to the shareholders to report on their tax returns and increases their stock basis. Assuming that Craig’s stock basis is at least $75,000, he incurs no additional recognized gain due to the distribution and reduces his stock basis by $75,000. If his stock basis is less than $75,000, he reduces his stock basis to zero, and the excess of the distribution over the stock basis is capital gain.

c. The distribution of the land does not result in recognition of gain to the partner or

partnership. If Craig’s basis in his partnership interest is at least $50,000, he reduces the basis by $50,000 and assigns a $50,000 basis to the land. If his basis for his partnership interest is less than $50,000, he reduces the basis to zero and assigns the amount of the partnership interest basis before the distribution to the land (e.g., if his partnership interest basis was $42,000, then his basis for the land is $42,000).

1919. Chapter 15 - Comparative Forms of Doing Business Question ES #19 In calculating the owner’s initial basis for an ownership interest, which of the following business entity forms have a carryover basis and which have a stepped-up or stepped-down basis associated with its formation?

a. C corporation. b. S corporation. c. Partnership.

Correct Answer:a., b., and c.

For the partnership, a partner’s basis for his or her ownership interest is a carryover basis under § 722. For the corporation (i.e., both C and S), a shareholder’s basis for his or her stock is a carryover basis under § 358 if the 80% control requirement under § 351 is satisfied. If the control requirement is not satisfied, then a shareholder’s basis for his or her stock is a stepped-up or stepped-down basis (i.e., fair market value of the assets on the date of contribution).

1920. Chapter 15 - Comparative Forms of Doing Business Question ES #20 Under what circumstances, if any, do the § 469 passive activity loss rules apply to C corporations?

Correct Answer:The general passive activity loss rules (i.e., passive activity losses cannot be offset against active income or portfolio income) apply to C corporations that are personal service corporations (PSCs). The passive activity loss rules apply to a closely held C corporation that is not a PSC in a different manner. While passive activity losses cannot be offset against portfolio income, they can be offset against active income.

1921. Chapter 15 - Comparative Forms of Doing Business Question ES #21 For a C corporation to be classified as a personal service corporation (PSC) for § 469 purposes, what requirements must be satisfied?

Correct Answer:

The following requirements must be satisfied.

· The principal activity of the corporation is the performance of personal services. · The services are substantially performed by owner-employees. · Owner employees own more than 10% in value of the stock of the corporation.

1922. Chapter 15 - Comparative Forms of Doing Business Question ES #22 Do the § 465 at-risk rules apply to partnerships, LLCs, and S corporations?

Correct Answer:The statutory language of § 465 does not mention partnerships, LLCs, or S corporations. However, since the conduit concept applies to each of these entities, the at-risk rules do apply at the owner level.

1923. Chapter 15 - Comparative Forms of Doing Business Question ES #23 Do the § 465 at-risk rules treat recourse debt and nonrecourse debt differently?

Correct Answer:Yes. In calculating the at-risk basis for a taxpayer, only recourse debt is included in the calculation.

1924. Chapter 15 - Comparative Forms of Doing Business Question ES #24 With respect to special allocations, is the S corporation treated more like a partnership or a C corporation?

Correct Answer:With respect to special allocations, an S corporation is treated more like a C corporation than a partnership. For example, the § 704(c)(1) allocations of built-in gain or loss are mandatory for partnerships. Such a special allocation is not permitted for an S corporation under the per share/per day rule.

1925. Chapter 15 - Comparative Forms of Doing Business Question ES #25 Agnes owns a sole proprietorship for which the assets have appreciated in value. If she is going to sell the business to Abner, should she structure the sale as (1) a sale of the individual assets or (2) a sale of the sole proprietorship?

Correct Answer:The form of the sale does not matter to Agnes for Federal income tax purposes. The sales transaction will be treated as the sale of the individual assets. Thus, ordinary and capital gain or loss will result depending on the nature of the asset sold.

1926. Chapter 15 - Comparative Forms of Doing Business Question ES #26 Peter is going to purchase the assets of Kirsten’s sole proprietorship. The assets of Kirsten’s sole proprietorship have appreciated in value. From Peter’s perspective, does it matter whether the purchase is structured as (1) the purchase of the individual assets or (2) the purchase of the sole proprietorship?

Correct Answer:No. Regardless of the legal form of the purchase transaction, the basis of the individual assets will be assigned a cost (same as fair market value) basis. If the purchase price exceeds the FMV of the assets, such

excess is assigned to goodwill.

1927. Chapter 15 - Comparative Forms of Doing Business Question ES #27 Ralph wants to purchase either the stock or the assets of Red, Inc., a C corporation.

a. Under what circumstances would Ralph prefer to purchase the stock from the shareholders?

b. Under what circumstances would Ralph prefer to purchase the assets

from the corporation?

Correct Answer:a. If the fair market value of the corporate assets does not exceed the adjusted basis, a stock

purchase is preferable. The adjusted basis of the corporate assets will remain unchanged. b. If the fair market value of the corporate assets exceeds the adjusted basis, an asset

purchase from Red, Inc. is preferable. Then Ralph could contribute the assets to a corporation under § 351. The adjusted basis of the corporate assets will equal the amount Ralph paid for them (i.e., FMV).

1928. Chapter 15 - Comparative Forms of Doing Business Question ES #28 Walter wants to sell his wholly-owned C corporation, Cream, Inc. The fair market value of his stock exceeds the corporation’s adjusted basis for the assets. Should Walter sell his stock or have Cream sell its assets and make a liquidating distribution to him?

Correct Answer:Selling the stock will result in single taxation at the beneficial capital gain rate. Selling the assets will result in double taxation with only Walter’s recognized gain qualifying for the beneficial capital gain rate. Therefore, Walter should sell his stock.

1929. Chapter 15 - Comparative Forms of Doing Business Question ES #29 In the sale of a partnership, does the way the sale is structured (i.e., sale of the partnership interests versus the sale of the assets) produce different tax consequences?

Correct Answer:The sale of the assets is treated as the sale of the individual assets. Consequently, the recognized gain or loss is calculated for each asset and is classified accordingly (i.e., capital and/or ordinary). The sale of a partnership interest is treated as the sale of a capital asset (subject to ordinary income treatment for unrealized receivables and substantially appreciated inventory). So the sale of the assets is likely to produce more ordinary income and less capital gain for the selling partners than in the case of the sale of partnership interests.

1930. Chapter 16 - Introduction To Taxation Of Individuals Question TF Al owns an investment in Vireo Corporation stock which during the year increased in value by $10,000. The $10,000 appreciation must be included in Al’s gross income for the year.

a. True*b. False

1931. Chapter 16 - Introduction To Taxation Of Individuals Question 2 Under the Federal income tax formula for individuals, the determination of adjusted gross income (AGI) precedes that of taxable income (TI).

*a. Trueb. False

1932. Chapter 16 - Introduction To Taxation Of Individuals Question 3 As used in the income tax formula, gross income would not include the receipt of a loan the taxpayer obtained from a bank.

*a. Trueb. False

1933. Chapter 16 - Introduction To Taxation Of Individuals Question 4 Under the income tax formula, a taxpayer must choose between deductions for AGI and the standard deduction.

a. True*b. False

1934. Chapter 16 - Introduction To Taxation Of Individuals Question 5 An “above the line” deduction refers to a deduction for AGI.

*a. Trueb. False

1935. Chapter 16 - Introduction To Taxation Of Individuals Question 6 Once TI (taxable income) is determined, the taxpayer must make a choice between itemizing or claiming the standard deduction.

a. True*b. False

1936. Chapter 16 - Introduction To Taxation Of Individuals Question 7 The filing status of a taxpayer (e.g., single, head of household) must be identified before taxable income is determined.

*a. Trueb. False

1937. Chapter 16 - Introduction To Taxation Of Individuals Question 8 Lee, a citizen of Korea, is a resident of the U.S. Any income Lee receives from land he owns in Korea is not subject to the U.S. income tax.

a. True*b. False

1938. Chapter 16 - Introduction To Taxation Of Individuals Question 9 An increase in the amount of a taxpayer’s AGI will not affect the amount of medical expenses allowed as a deduction.

a. True*b. False

1939. Chapter 16 - Introduction To Taxation Of Individuals Question 10 The additional standard deduction for age and blindness is the same amount for single as for married taxpayers.

a. True*b. False

1940. Chapter 16 - Introduction To Taxation Of Individuals Question 11 The basic and additional standard deductions are not subject to an annual adjustment for inflation.

a. True*b. False

1941. Chapter 16 - Introduction To Taxation Of Individuals Question 12 A taxpayer who itemizes his deductions from AGI can claim the property taxes on his personal residence as a deduction.

*a. Trueb. False

1942. Chapter 16 - Introduction To Taxation Of Individuals Question 13 Claude’s deductions from AGI slightly exceed the standard deduction allowed for 2011. Under these circumstances, Claude cannot claim the standard deduction.

a. True*b. False

1943. Chapter 16 - Introduction To Taxation Of Individuals Question 14 It is possible for an individual taxpayer to claim more than one type of standard deduction.

*a. Trueb. False

1944. Chapter 16 - Introduction To Taxation Of Individuals Question 15 Tad claims his 70-year-old mother as a dependent. The mother may not claim an additional standard deduction for her age.

a. True*b. False

1945. Chapter 16 - Introduction To Taxation Of Individuals Question 16 In 2011, Ed is 66 and single. If he has itemized deductions of $7,200, he should claim the standard deduction alternative.

*a. Trueb. False

1946. Chapter 16 - Introduction To Taxation Of Individuals Question 17 Jason and Peg are married and file a joint return. Both are over 65 years of age and Jason is blind. Their standard deduction for 2011 is $15,050 ($11,600 + $1,150 + $1,150 + $1,150).

*a. Trueb. False

1947. Chapter 16 - Introduction To Taxation Of Individuals Question 18 Derek, age 46, is a surviving spouse. If he has itemized deductions of $11,700 for 2011, Derek should not claim the standard deduction.

*a. Trueb. False

1948. Chapter 16 - Introduction To Taxation Of Individuals Question 19 Buddy and Hazel are ages 72 and 71 and file a joint return. If they have itemized deductions of $13,500 for 2011, they should not claim the standard deduction.

a. True*b. False

1949. Chapter 16 - Introduction To Taxation Of Individuals Question 20 Clara, age 68, claims head of household filing status. If she has itemized deductions of $9,500 for 2011, she should not claim the

standard deduction.

a. True*b. False

1950. Chapter 16 - Introduction To Taxation Of Individuals Question 21 Monique is a citizen of the U.S. and a resident of France. If she files a U.S. income tax return, Monique can claim the standard deduction.

*a. Trueb. False

1951. Chapter 16 - Introduction To Taxation Of Individuals Question 22 Benjamin, age 16, is claimed as a dependent by his parents. During 2011, he earned $700 at a car wash. Benjamin’s standard deduction is $1,250 ($950 + $300).

a. True*b. False

1952. Chapter 16 - Introduction To Taxation Of Individuals Question 23 Debby, age 18, is claimed as a dependent by her mother. During 2011, she earned $1,100 in interest income on a savings account. Debby’s standard deduction is $1,400 ($1,100 + $300).

a. True*b. False

1953. Chapter 16 - Introduction To Taxation Of Individuals Question 24 Katrina, age 16, is claimed as a dependent by her parents. During 2011, she earned $5,600 as a checker at a grocery store. Her standard deduction is $5,900 ($5,600 earned income + $300).

a. True*b. False

1954. Chapter 16 - Introduction To Taxation Of Individuals Question 25 A dependent cannot claim a personal exemption on his or her own return.

*a. Trueb. False

1955. Chapter 16 - Introduction To Taxation Of Individuals Question 26 When separate income tax returns are filed by married taxpayers, one spouse cannot claim the other spouse as an exemption.

a. True*b. False

1956. Chapter 16 - Introduction To Taxation Of Individuals Question 27 Butch and Minerva are divorced in December of 2011. Since they were married for more than one-half of the year, they are considered as married for 2011.

a. True*b. False

1957. Chapter 16 - Introduction To Taxation Of Individuals Question 28 For the year a spouse dies, the surviving spouse is considered married for the entire year for income tax purposes.

*a. Trueb. False

1958. Chapter 16 - Introduction To Taxation Of Individuals Question 29 In determining whether the support test is met for dependency exemption purposes, only the taxable portion of a scholarship is considered.

a. True*b. False

1959. Chapter 16 - Introduction To Taxation Of Individuals Question 30 Roy and Linda were divorced in 2010. The divorce decree awards custody of their children to Linda but is silent as to who is entitled to claim them as dependents. If Roy furnished more than half of their support, he can claim them as dependents in 2011.

a. True*b. False

1960. Chapter 16 - Introduction To Taxation Of Individuals Question 31 Darren, age 20 and not disabled, earns $3,500 during 2011. Darren’s parents cannot claim him as a dependent unless he is a full-time student.

a. True*b. False

1961. Chapter 16 - Introduction To Taxation Of Individuals Question 32 Keith, age 17 and single, earns $3,000 during 2011. Keith’s parents can claim him as a dependent even if he does not live with them.

*a. Trueb. False

1962. Chapter 16 - Introduction To Taxation Of Individuals Question 33 Sarah furnishes more than 50% of the support of her son and daughter-in-law who live with her. If the son and daughter-in-law file a joint return, Sarah cannot claim them as dependents.

a. True*b. False

1963. Chapter 16 - Introduction To Taxation Of Individuals Question 34 Kim, a resident of Oregon, supports his parents who are residents of Canada but citizens of Korea. Kim can claim his parents as dependents.

*a. Trueb. False

1964. Chapter 16 - Introduction To Taxation Of Individuals Question 35 Stealth taxes are directed at higher income taxpayers.

*a. Trueb. False

1965. Chapter 16 - Introduction To Taxation Of Individuals Question 36 An individual taxpayer uses a fiscal year February 1-January 31. The due date of this taxpayer’s Federal income tax return is May 15 of each tax year.

*a. Trueb. False

1966. Chapter 16 - Introduction To Taxation Of Individuals Question 37 Surviving spouse filing status begins in the year in which the deceased spouse died.

a. True*b. False

1967. Chapter 16 - Introduction To Taxation Of Individuals Question 38 Katelyn is divorced and maintains a household in which she and her daughter, Crissa, live. Crissa, age 22, earns $11,000 during 2011 as a model. Katelyn does qualify for head of household filing status.

a. True*b. False

1968. Chapter 16 - Introduction To Taxation Of Individuals Question 39 In terms of income tax consequences, abandoned spouses are treated the same way as married persons filing separate returns.

a. True*b. False

1969. Chapter 16 - Introduction To Taxation Of Individuals Question 40 Since an abandoned spouse is treated as single and has one or more dependent children, he or she qualifies for the standard deduction available to head of household.

*a. Trueb. False

1970. Chapter 16 - Introduction To Taxation Of Individuals Question 41 The kiddie tax does not apply as to a child whose earned income is more than one-half of his or her support.

*a. Trueb. False

1971. Chapter 16 - Introduction To Taxation Of Individuals Question 42 Once a child reaches age 19, the kiddie tax no longer applies.

a. True*b. False

1972. Chapter 16 - Introduction To Taxation Of Individuals Question 43 When the kiddie tax applies, the child need not file an income tax return because the child’s income will be reported on the parents’ return.

a. True*b. False

1973. Chapter 16 - Introduction To Taxation Of Individuals Question 44 A child who has unearned income of $1,900 or less cannot be subject to the kiddie tax.

*a. Trueb. False

1974. Chapter 16 - Introduction To Taxation Of Individuals Question 45 Ted earned $150,000 during the current year. He paid Alice, his former wife, $75,000 in alimony. The $75,000 payment reduces Ted’s AGI and increases Alice’s AGI.

*a. Trueb. False

1975. Chapter 16 - Introduction To Taxation Of Individuals Question 46 George and Erin are divorced, and George is required to pay Erin $20,000 of alimony each year. George earns $75,000 a year. Erin is not required to include the alimony payments in gross income because George earned the income and therefore he should pay the tax on the income.

a. True*b. False

1976. Chapter 16 - Introduction To Taxation Of Individuals Question 47 After the divorce, Jeff was required to pay $18,000 per year to his former spouse, Darlene, who had custody of their child. Jeff’s payments will be reduced to $12,000 per year in the event the child dies or reaches age 21. During the year, Jeff paid the $18,000 required under the divorce agreement. Darlene must include the $12,000 in gross income.

*a. Trueb. False

1977. Chapter 16 - Introduction To Taxation Of Individuals Question 48 Paula transfers stock to her former spouse, Fred. The transfer is pursuant to a divorce agreement. Paula’s cost of the stock was $75,000 and its fair market value on the date of the transfer is $95,000. Fred later sells the stock for $100,000. Fred’s recognized gain from the sale of the stock is $5,000.

a. True*b. False

1978. Chapter 16 - Introduction To Taxation Of Individuals Question 49 Jacob and Emily were co-owners of a personal residence. As part of their divorce agreement, Emily received sole ownership of their personal residence. This property transfer is classified as a property settlement rather than as alimony as the transfer was a result of a divorce.

*a. Trueb. False

1979. Chapter 16 - Introduction To Taxation Of Individuals Question 50 If a lottery prize winner transfers the prize to a qualified government unit or nonprofit organization, then the prize is excluded from the winner’s gross income if the amount of the prize does not exceed 30% of the winner’s AGI.

a. True*b. False

1980. Chapter 16 - Introduction To Taxation Of Individuals Question 51 John told his nephew, Steve, “if you maintain my house when I cannot, I will leave the house to you when I die. Steve maintained the house and when John died Steve inherited the house. The value of the residence must be included in Steve’s gross income.

*a. Trueb. False

1981. Chapter 16 - Introduction To Taxation Of Individuals Question 52 Brooke works part-time as a waitress in a restaurant. For groups of 7 or more customers, the customer is charged 15% of the bill for Brooke’s services. For parties of less than 7, the tips are voluntary. Brooke received $11,000 from the groups of 7 or more and $7,000 in voluntary tips from all other customers. Using the customary 15% rate, her voluntary tips would have been only $6,000. Brooke must include $17,000 ($11,000 + $6,000) in gross income.

a. True*b. False

1982. Chapter 16 - Introduction To Taxation Of Individuals Question 53 Agnes receives a $5,000 scholarship which covers her tuition at Parochial High School. She may exclude the $5,000 scholarship she received although the scholarship is to attend a private high school.

*a. Trueb. False

1983. Chapter 16 - Introduction To Taxation Of Individuals Question 54 If a scholarship does not satisfy the requirements for a gift, the scholarship must be included in gross income.

a. True*b. False

1984. Chapter 16 - Introduction To Taxation Of Individuals Question 55 Ashley received a scholarship to be used as follows: tuition $9,000; room and board $6,000; and books and laboratory supplies $2,000. Ashley is required to include only $6,000 in her gross income.

*a. Trueb. False

1985. Chapter 16 - Introduction To Taxation Of Individuals Question 56 In December 2011, Emily, a cash basis taxpayer, received a $2,500 cash scholarship for the Spring semester of 2012. However, she did not use the funds to pay the tuition until January 2012. Emily can exclude the $2,500 from her gross income in 2011.

*a. Trueb. False

1986. Chapter 16 - Introduction To Taxation Of Individuals Question 57 In 2011, Theresa was in an automobile accident and suffered physical injuries. The accident was caused by Ramon’s negligence. In 2012, Theresa collected from his insurance company. She received $15,000 for loss of income, $25,000 punitive damages, and $8,000 for medical expenses which she had deducted on her 2011 tax return (the amount in excess of 7.5% of adjusted gross income). As a result of the above, Theresa’s 2012 gross income is increased by $33,000.

*a. Trueb. False

1987. Chapter 16 - Introduction To Taxation Of Individuals Question 58 Workers’ compensation benefits are included in gross income because the payments replace wages the individual would have otherwise received.

a. True*b. False

1988. Chapter 16 - Introduction To Taxation Of Individuals Question 59 Sarah’s employer pays the hospitalization insurance premiums for a policy that covers all employees and their family members. Sarah can exclude from her gross income the premiums for herself and her family members.

*a. Trueb. False

1989. Chapter 16 - Introduction To Taxation Of Individuals Question 60 The election to itemize is appropriate when total itemized deductions are less than the standard deduction based on the taxpayer’s filing status.

a. True*b. False

1990. Chapter 16 - Introduction To Taxation Of Individuals Question 61 A medical expense does not have to relate to a particular ailment to be deductible.

*a. Trueb. False

1991. Chapter 16 - Introduction To Taxation Of Individuals Question 62 Upon the recommendation of a physician, Ed has a swimming pool installed at his residence because of a heart condition. If he is

allowed to deduct all or part of the cost of the pool, Ed’s increase in utility bills due to the operation of the pool qualifies as a medical expense.

*a. Trueb. False

1992. Chapter 16 - Introduction To Taxation Of Individuals Question 63 Carol pays the medical expenses of her son, Chad. Chad would qualify as Carol’s dependent except that he earns $7,500 during the year. Carol may not claim Chad’s medical expenses because he is not a dependent.

a. True*b. False

1993. Chapter 16 - Introduction To Taxation Of Individuals Question 64 Georgia contributed $2,000 to a qualifying Health Savings Account in 2011. The entire amount qualifies as a medical expense and is potentially deductible as an itemized deduction.

a. True*b. False

1994. Chapter 16 - Introduction To Taxation Of Individuals Question 65 Sergio was required by the city to pay $2,000 for the cost of new curbing installed by the city in front of his personal residence. The new curbing was installed throughout Sergio’s neighborhood as part of a street upgrade project. Sergio may not deduct $2,000 as a tax, but he may add the $2,000 to the basis of his property.

*a. Trueb. False

1995. Chapter 16 - Introduction To Taxation Of Individuals Question 66 Albert is the sole proprietor of a grocery store. He cannot deduct real property taxes on his store building and state income taxes related to his net income from the grocery store as a business deduction.

a. True*b. False

1996. Chapter 16 - Introduction To Taxation Of Individuals Question 67 In April 2011, Bart, a calendar year cash basis taxpayer, had to pay the state of Alabama additional income tax for 2010. Even though it relates to 2010, for Federal income tax purposes the payment qualifies as a tax deduction for tax year 2011.

*a. Trueb. False

1997. Chapter 16 - Introduction To Taxation Of Individuals Question 68 Phyllis, a calendar year cash basis taxpayer who itemized deductions, overpaid her 2010 state income tax and is entitled to a refund of $400. Phyllis chooses to apply the $400 overpayment toward her state income taxes for 2011. She is required to recognize that amount as income in 2011.

*a. Trueb. False

1998. Chapter 16 - Introduction To Taxation Of Individuals Question 69 For purposes of computing the deduction for qualified residence interest, a qualified residence includes only the taxpayer’s principal residence.

a. True*b. False

1999. Chapter 16 - Introduction To Taxation Of Individuals Question 70 Interest paid or accrued during the tax year on aggregate acquisition indebtedness of $2 million or less ($1 million or less for married persons filing separate returns) is deductible as qualified residence interest.

a. True*b. False

2000. Chapter 16 - Introduction To Taxation Of Individuals Question 71 A taxpayer pays points to obtain financing to purchase a rental house. At the election of the taxpayer, the points can be deducted as interest expense for the year paid.

a. True*b. False

2001. Chapter 16 - Introduction To Taxation Of Individuals Question 72 Leona borrows $100,000 from First National Bank and uses the proceeds to purchase City of Houston bonds. The interest Leona pays on this loan is deductible as investment interest subject to the investment interest limits.

a. True*b. False

2002. Chapter 16 - Introduction To Taxation Of Individuals Question 73 Carolyn mailed a check for $1,000 to a qualified charitable organization on December 31, 2011. The $1,000 contribution is not deductible on Carolyn’s 2011 tax return because the charity does not

receive the check until 2012.

a. True*b. False

2003. Chapter 16 - Introduction To Taxation Of Individuals Question 74 Judy paid $40 for Girl Scout cookies and $40 for Boy Scout popcorn. Judy may claim an $80 charitable contribution deduction.

a. True*b. False

2004. Chapter 16 - Introduction To Taxation Of Individuals Question 75 For all of the current year, Randy (a calendar year taxpayer) allowed the Salvation Army to use a building he owns rent-free. The building normally rents for $24,000 a year. Randy will be allowed a charitable contribution deduction this year of $24,000.

a. True*b. False

2005. Chapter 16 - Introduction To Taxation Of Individuals Question 76 Dwayne contributed stock worth $17,000 to a qualified charity. He acquired the stock fourteen months ago for $8,000. He may deduct $17,000 as a charitable contribution deduction (subject to percentage limitations).

*a. Trueb. False

2006. Chapter 16 - Introduction To Taxation Of Individuals Question 77 In the year of her death, Maria made significant charitable contributions of capital gain property. In fact, the amount of the contributions exceeds 30% of her AGI. Maria’s executor can elect to deduct charitable contributions of up to 50% of Maria’s AGI on Maria’s final income tax return.

*a. Trueb. False

2007. Chapter 16 - Introduction To Taxation Of Individuals Question 78 Excess charitable contributions that come under the 30% of AGI ceiling are always subject to the 30% of AGI ceiling in the carryover year.

*a. Trueb. False

2008. Chapter 16 - Introduction To Taxation Of Individuals Question 79 Contributions to public charities in excess of 50% of AGI may be

carried back 3 years or forward for up to 5 years.

a. True*b. False

2009. Chapter 16 - Introduction To Taxation Of Individuals Question 80 Employee business expenses for travel qualify as itemized deductions subject to the 2% floor if they are not reimbursed.

*a. Trueb. False

2010. Chapter 16 - Introduction To Taxation Of Individuals Question 81 An individual generally may claim a credit for adoption expenses in the year in which the expenses are paid.

a. True*b. False

2011. Chapter 16 - Introduction To Taxation Of Individuals Question 82 The child tax credit is based on the number of the taxpayer’s qualifying children under age 17.

*a. Trueb. False

2012. Chapter 16 - Introduction To Taxation Of Individuals Question 83 The maximum child tax credit under current law is $1,500 per qualifying child.

a. True*b. False

2013. Chapter 16 - Introduction To Taxation Of Individuals Question 84 The maximum credit for child and dependent care expenses is $2,100 if only one spouse is employed and the other spouse is a full-time student.

*a. Trueb. False

2014. Chapter 16 - Introduction To Taxation Of Individuals Question 85 Expenses that are reimbursed by a taxpayer’s employer under a dependent care assistance program can also qualify for the credit for child and dependent care expenses.

a. True*b. False

2015. Chapter 16 - Introduction To Taxation Of Individuals Question 86 For purposes of computing the credit for child and dependent care expenses, the qualifying employment-related expenses are limited to an individual’s actual or deemed earned income.

*a. Trueb. False

2016. Chapter 16 - Introduction To Taxation Of Individuals Question 87 A taxpayer may qualify for the credit for child and dependent care expenses if the taxpayer’s dependent is under age 17.

a. True*b. False

2017. Chapter 16 - Introduction To Taxation Of Individuals Question 88 The education tax credits (i.e., the American Opportunity credit and the lifetime learning credit) are available to help defray the cost of higher education regardless of the income level of the taxpayer.

a. True*b. False

2018. Chapter 16 - Introduction To Taxation Of Individuals Question 89 Both education tax credits are available for qualified tuition expenses, and in certain instances, also may be available for room and board.

a. True*b. False

2019. Chapter 16 - Introduction To Taxation Of Individuals Question 90 The American Opportunity credit is available per eligible student, while the lifetime learning credit is calculated per taxpayer.

*a. Trueb. False

2020. Chapter 16 - Introduction To Taxation Of Individuals Question 91 Qualifying tuition expenses paid from the proceeds of a tax-exempt scholarship do not give rise to an education tax credit.

*a. Trueb. False

2021. Chapter 16 - Introduction To Taxation Of Individuals Question MC In terms of the tax formula applicable to individual taxpayers, which,

if any, of the following statements is correct?

a. The formula does not apply if a taxpayer elects to claim the standard deduction.b. In arriving at AGI, personal and dependency exemptions must be subtracted from gross income.c. In arriving at taxable income, a taxpayer must choose between the standard deduction and claiming personal and dependency exemptions.*d. In arriving at taxable income, a taxpayer must choose between the standard deduction and deductions from AGI.e. None of the above.

2022. Chapter 16 - Introduction To Taxation Of Individuals Question 92 Which, if any, of the following is a deduction for AGI?

*a. Alimony payments.b. Child support payments.c. Funeral expenses.d. Loss on the sale of a personal residence.e. Interest on home mortgage.

2023. Chapter 16 - Introduction To Taxation Of Individuals Question 93 Which, if any, of the following is a deduction for AGI?

a. State and local sales taxes.b. Interest on home mortgage.c. Unreimbursed employee expenses.d. Charitable contributions.*e. None of the above.

2024. Chapter 16 - Introduction To Taxation Of Individuals Question 94 Which, if any, of the statements regarding the standard deduction is correct?

*a. Some taxpayers may qualify for two types of standard deductions.b. Not available to taxpayers who choose to deduct their personal and dependency exemptions.c. Not available to taxpayers who choose to claim their deduction for AGI.d. The basic standard deduction is indexed for inflation but the additional standard deduction is not. e. None of the above.

2025. Chapter 16 - Introduction To Taxation Of Individuals Question 95 During 2011, Esther had the following transactions:

Salary $50,000

Bank loan (proceeds used to buy personal auto) 10,000Alimony received 6,000Child support received 12,000Gift from aunt 20,000

Esther’s AGI is:

a. $32,000.b. $38,000.c. $44,000.*d. $56,000.e. $64,000.

2026. Chapter 16 - Introduction To Taxation Of Individuals Question 96 During 2011, Marvin had the following transactions:

Salary $70,000Interest income on City of Denver bonds 2,000Inheritance from uncle 40,000Contribution to traditional IRA 5,000Capital losses 3,000

Marvin’s AGI is:

*a. $62,000.b. $65,000.c. $67,000.d. $102,000.e. $104,000.

2027. Chapter 16 - Introduction To Taxation Of Individuals Question 97 During 2011, Anna had the following transactions:

Salary $ 80,000Interest income on IBM bonds 2,000Damages for personal injury (car accident) 100,000Punitive damages (same car accident) 200,000Cash dividends from Chevron Corporation stock 5,000

Anna’s AGI is:

a. $185,000.b. $187,000.c. $285,000.*d. $287,000.

e. $385,000.

2028. Chapter 16 - Introduction To Taxation Of Individuals Question 98 In 2011, Justin had the following transactions:

Salary $90,000 Capital loss from a stock investment (4,000)Moving expense to change jobs (11,000)Received repayment of $20,000 loan she made to her brother in 2006 (includes no interest) 20,000 State income taxes (5,000)

Justin’s AGI is:

a. $73,000.*b. $76,000.c. $78,000.d. $81,000.e. $89,000.

2029. Chapter 16 - Introduction To Taxation Of Individuals Question 99 Sylvia, age 17, is claimed by her parents as a dependent. During 2011, she had interest income from a bank savings account of $2,000 and income from a part-time job of $4,200. Sylvia’s taxable income is:

a. $4,200 – $4,500 = $0.b. $6,200 – $5,700 = $500.*c. $6,200 – $4,500 = $1,700.d. $6,200 – $950 = $5,250.e. None of the above.

2030. Chapter 16 - Introduction To Taxation Of Individuals Question100 Tony, age 15, is claimed as a dependent by his grandmother. During 2011, Tony had interest income from Boeing Corporation bonds of $1,000 and earnings from a part-time job of $700. Tony’s taxable income is:

a. $0.b. $1,700 – $700 – $950 = $50.*c. $1,700 – $1,000 = $700.d. $1,700 – $950 = $750.e. None of the above.

2031. Chapter 16 - Introduction To Taxation Of Individuals Question101 Merle is a widow, age 80 and blind, who is claimed as a dependent by her son. During 2011, she received $4,800 in Social Security benefits, $2,200 in bank interest, and $1,800 in cash dividends from stocks. Merle’s taxable income is:

*a. $4,000 – $950 – $2,900 = $150.b. $4,000 – $2,900 = $1,100.c. $4,000 – $950 – $1,450 = $1,600.d. $8,800 – $950 – $2,900 = $4,950.e. None of the above.

2032. Chapter 16 - Introduction To Taxation Of Individuals Question102 Wilma, age 70 and single, is claimed as a dependent on her daughter’s tax return. During 2011, she had interest income of $2,400 and $800 of earned income from baby sitting. Wilma’s taxable income is:

a. $700.b. $850.c. $1,800.d. $2,250.*e. None of the above.

2033. Chapter 16 - Introduction To Taxation Of Individuals Question103 Kyle and Liza are married and under 65 years of age. During 2011, they furnish more than half of the support of their 18-year old daughter, May, who lives with them. May earns $15,000 from a part-time job, most of which she sets aside for future college expenses. Kyle and Liza also provide more than half of the support of Kyle’s cousin who lives with them. Liza’s father, who died on January 3, 2011, at age 90, has for many years qualified as their dependent. How many personal and dependency exemptions should Kyle and Liza claim?

a. Two.b. Three.c. Four.*d. Five.e. None of the above.

2034. Chapter 16 - Introduction To Taxation Of Individuals Question104 Evan and Eileen Carter are husband and wife and file a joint return for 2011. Both are under 65 years of age. They provide more than half of the support of their daughter, Pamela (age 25), who is a full-time medical student. Pamela receives a $5,000 scholarship covering her tuition at college. They furnish all of the support of Belinda (Evan’s grandmother), who is age 80 and lives in a nursing home. They also support Peggy (age 66), who is a friend of the family and lives with them. How many personal and dependency exemptions may the Carters claim?

a. Two.b. Three.c. Four.*d. Five.e. None of the above.

2035. Chapter 16 - Introduction To Taxation Of Individuals Question105 A qualifying child cannot include:

a. A nonresident alien.b. A married son who files a joint return.c. A daughter who is away at college.d. A brother who is 28 years of age and disabled.*e. A grandmother.

2036. Chapter 16 - Introduction To Taxation Of Individuals Question106 Ellen, age 12, lives in the same household with her father, grandfather, and uncle. The cost of maintaining the household is provided by her grandfather (40%) and her uncle (60%). Disregarding tie-breaker rules, Ellen is a qualifying child as to:

a. Only her father.b. Only her grandfather and uncle.c. Only her uncle.*d. All parties involved (i.e., father, grandfather, and uncle). e. None of the above.

2037. Chapter 16 - Introduction To Taxation Of Individuals Question107 Millie, age 80, is supported during the current year as follows:

Percent of SupportWeston (a son) 10%Faith (a daughter) 35%Jake (a cousin) 35%Brayden (unrelated close family friend) 20%

During the year, Millie lives in an assisted living facility. Under a multiple support agreement, indicate which parties can qualify to claim Millie as a dependent.

a. Weston, Faith, Jake, and Brayden.b. Faith.c. Weston and Faith.d. Faith, Jake, and Brayden.*e. None of the above.

2038. Chapter 16 - Introduction To Taxation Of Individuals Question108 The Hutters filed a joint return for 2011. They provide more than 50% of the support of Carla, Melvin, and Aaron. Carla (age 20) is a cousin and earns $3,000 from a part-time job. Melvin (age 25) is their son and is a full-time law student. He received from the university a $3,800 scholarship for tuition. Aaron is a brother who is a citizen of Israel but resides in France. Carla and Melvin live with the Hutters. How many personal and dependency exemptions can the Hutters claim on their

Federal income tax return?

a. Two.b. Three.*c. Four.d. Five.e. None of the above.

2039. Chapter 16 - Introduction To Taxation Of Individuals Question109 Kyle, whose wife died in December 2008, filed a joint tax return for 2008. He did not remarry, but has continued to maintain his home in which his two dependent children live. What is Kyle’s filing status as to 2011?

*a. Head of household.b. Surviving spouse.c. Single.d. Married filing separately.e. None of the above.

2040. Chapter 16 - Introduction To Taxation Of Individuals Question110 Emily, whose husband died in December 2010, maintains a household in which her dependent daughter lives. Which (if any) of the following is her filing status for the tax year 2011? (Note: Emily is the executor of her husband’s estate.)

a. Single.b. Married, filing separately.*c. Surviving spouse.d. Head of household.e. Married, filing jointly.

2041. Chapter 16 - Introduction To Taxation Of Individuals Question111 Nelda is married to Chad, who abandoned her in early June of 2011. She has not seen or communicated with him since then. She maintains a household in which she and her two dependent children live. Which of the following statements about Nelda’s filing status in 2011 is correct?

a. Nelda can use the rates for single taxpayers.b. Nelda can file a joint return with Chad.c. Nelda can file as a surviving spouse.*d. Nelda can file as a head of household.e. None of the above statements is appropriate.

2042. Chapter 16 - Introduction To Taxation Of Individuals Question112 In which, if any, of the following situations will the kiddie tax not apply?

*a. The child has unearned income of $1,900 or less.b. The child is married but does not file a joint return.

c. The child has unearned income that exceeds more than half of his (or her) support.d. The child is under age 24 and a full-time student.e. None of the above.

2043. Chapter 16 - Introduction To Taxation Of Individuals Question113 Travis and Andrea were divorced. Their only marital property consisted of a personal residence (fair market value of $400,000, cost of $200,000), and publicly-traded stocks (fair market value of $800,000, cost basis of $500,000). Under the terms of the divorce agreement, Andrea received the personal residence and Travis received the stocks. In addition, Andrea was to receive $50,000 for eight years.

I. If the $50,000 annual payments are to be made to Andrea or her estate (if she dies before the end of the eight years), the payments will qualify as alimony.

II. Andrea has a taxable gain from an exchange of her one-half interest in the stocks for Travis’ one-half interest in the house and cash.

III. If Travis sells the stocks for $900,000, he must recognize a $400,000 gain.

*a. Only III is true.b. Only I and III are true.c. Only I and II are true.d. I, II, and III are true.e. None of the above are true.

2044. Chapter 16 - Introduction To Taxation Of Individuals Question114 Tim and Janet were divorced. Their only marital property was a personal residence with a value of $120,000 and cost of $50,000. Under the terms of the divorce agreement, Janet would receive the house and Janet would pay Tim $15,000 each year for 5 years, or until Tim’s death, whichever should occur first. Tim and Janet lived apart when the payments were made to Tim. The divorce agreement did not contain the word “alimony.”

a. Tim must recognize a $35,000 [$60,000 – 1/2($50,000)] gain on the sale of his interest in the house.b. Tim does not recognize any income from the above transactions.c. Janet is not allowed any alimony deductions.*d. Janet is allowed to deduct $15,000 each year for alimony paid.e. None of the above.

2045. Chapter 16 - Introduction To Taxation Of Individuals Question115 Thelma and Mitch were divorced. The couple had a joint brokerage account that included stocks with a basis of $600,000 and a fair market value of $1,000,000. Under the terms of the divorce agreement, Mitch would receive the stocks and Mitch would pay Thelma $100,000 each year for 6 years, or until Thelma’s death, whichever should occur first. Thelma and Mitch lived apart when the payments were made by Mitch. Mitch paid the $600,000 to Thelma over the six-year period. The divorce

agreement did not contain the word “alimony.” Then, Mitch sold the stocks for $1,300,000. Mitch’s recognized gain from the sale is:

a. $0.b. $1,000,000 ($1,300,000 – $300,000).*c. $700,000 ($1,300,000 – $600,000).d. $300,000 ($1,300,000 – $1,000,000).e. None of the above.

2046. Chapter 16 - Introduction To Taxation Of Individuals Question116 Under the terms of a divorce agreement, Kim was to pay her husband Tom $3,000 per month in alimony and $2,000 per month in child support. For a twelve-month period, Kim can deduct from gross income (and Tom must include in gross income):

a. $60,000.*b. $36,000.c. $24,000.d. $0.e. None of the above.

2047. Chapter 16 - Introduction To Taxation Of Individuals Question117 Under the terms of a divorce agreement, Lanny was to pay his wife Joyce $2,000 per month in alimony and $500 per month in child support. For a twelve-month period, Lanny can deduct from gross income (and Joyce must include in gross income):

a. $0.b. $6,000.*c. $24,000.d. $30,000.e. None of the above.

2048. Chapter 16 - Introduction To Taxation Of Individuals Question118 Under the terms of a divorce agreement, Ron is to pay his former wife Jill $12,000 per month. The payments are to be reduced to $4,000 per month when their 15 year-old child reaches age 18. During the current year, Ron paid $144,000 under the agreement. Assuming all of the other conditions for alimony are satisfied, Ron can deduct from gross income (and Jill must include in gross income) as alimony:

a. $144,000.b. $96,000.*c. $48,000.d. $0.e. None of the above is correct.

2049. Chapter 16 - Introduction To Taxation Of Individuals Question119 A scholarship recipient at State University may exclude from gross income the scholarship proceeds used to pay for:

a. Only tuition.*b. Tuition, books, and supplies.c. Tuition, books, supplies, meals, and lodging.d. Meals and lodging.e. None of the above.

2050. Chapter 16 - Introduction To Taxation Of Individuals Question120 Ron, age 19, is a full-time graduate student at City University. During 2011, he received the following payments:

State scholarship for ten months (tuition and books) $ 6,000Loan from college financial aid office 3,000Cash support from parents 2,500Cash award for being the outstanding resident adviser 1,500 $13,000

Ron served as a resident advisor in a dormitory and, therefore, the university waived the $2,500 charge for the room he occupied. What is Ron’s adjusted gross income for 2011?

*a. $1,500.b. $4,000.c. $7,500.d. $15,500.e. None of the above.

2051. Chapter 16 - Introduction To Taxation Of Individuals Question121 Jena is a full-time student at State University and is claimed by her parents as a dependent. Her only source of income is a $10,000 scholarship ($1,000 for books, $4,000 tuition, $500 student activity fee, and $4,500 room and board). Jena’s gross income for the year is:

a. $5,000.*b. $4,500.c. $500.d. $0.e. None of the above.

2052. Chapter 16 - Introduction To Taxation Of Individuals Question122 As an executive of Cherry, Inc., Ollie receives a fringe benefit in the form of annual tuition scholarships of $10,000 to each of his three children. The scholarships are paid by the company directly to each child’s educational institution and are payable only if the student maintains a B average.

a. The tuition payments of $30,000 may be excluded from Ollie’s gross income as a scholarship.b. The tuition payments of $10,000 each must be included in the child’s gross income.

c. The tuition payments of $30,000 may be excluded from Ollie’s gross income because the payments are for the academic achievements of the children.*d. The tuition payments of $30,000 must be included in Ollie’s gross income.e. None of the above.

2053. Chapter 16 - Introduction To Taxation Of Individuals Question123 In 2011, Khalid was in an automobile accident and suffered physical injuries. The accident was caused by Rashad’s negligence. Khalid threatened to file a lawsuit against Amber Trucking Company, Rashad’s employer, claiming $50,000 for pain and suffering, $25,000 for loss of income, and $100,000 in punitive damages. Amber’s insurance company will not pay punitive damages; therefore, Amber has offered to settle the case for $120,000 for pain and suffering, $25,000 for loss of income, and nothing for punitive damages. Khalid is in the 35% marginal tax bracket. What is the after-tax difference to Khalid between Khalid’s original claim and Amber’s offer?

a. Amber’s offer is $30,000 less. (– $100,000 punitive damages + $70,000 increased pain and suffering.)b. Amber’s offer is $10,500 less. [($30,000 ´ .35) = $10,500].c. Amber’s offer is $19,500 less. [$30,000(1 – .35) = $19,500].*d. Amber’s offer is $5,000 more. [$70,000 – (1 – .35)($100,000) = $65,000].e. None of the above.

2054. Chapter 16 - Introduction To Taxation Of Individuals Question124 Christie sued her former employer for a back injury she suffered on the job in 2010. As a result of the injury, she was partially disabled. In 2011, she received $240,000 for her loss of future income, $160,000 in punitive damages because of the employer’s flagrant disregard for the employee’s safety, and $15,000 for medical expenses she had deducted on her 2010 return. Christie’s 2011 gross income from the above is:

a. $415,000.b. $400,000.c. $255,000.*d. $175,000.e. $160,000.

2055. Chapter 16 - Introduction To Taxation Of Individuals Question125 Early in the year, Marion was in an automobile accident during the course of his employment. As a result of the physical injuries he sustained, he received the following payments during the year:

Reimbursement of medical expenses Marion paid by a medical insurance policy he purchased

$10,000

Damage settlement to replace his lost salary 15,000

What is the amount that Marion must include in gross income for the current year?

a. $25,000.b. $15,000.c. $12,500.d. $10,000.*e. $0.

2056. Chapter 16 - Introduction To Taxation Of Individuals Question126 Theresa sued her former employer for age, race, and gender discrimination. She claimed $250,000 in damages for loss of income and $500,000 in punitive damages. She settled the claim for $600,000. As a result of the settlement, Theresa must include in gross income:

a. $0.b. $400,000 [$500,000/($250,000 + $500,000) ´ $600,000].c. $500,000.*d. $600,000.e. None of the above.

2057. Chapter 16 - Introduction To Taxation Of Individuals Question127 Jack received a court award in a civil libel and slander suit against National Gossip. He received $120,000 for damages to his professional reputation, $100,000 for damages to his personal reputation, and $50,000 in punitive damages. Jack must include in his gross income as a damage award:

a. $0.b. $100,000.c. $120,000.*d. $270,000.e. None of the above.

2058. Chapter 16 - Introduction To Taxation Of Individuals Question128 Olaf was injured in an automobile accident and received $25,000 for his physical injury, $10,000 for his loss of income, and $50,000 punitive damages. As a result of the award, the amount Olaf must include in gross income is:

a. $10,000.*b. $50,000.c. $60,000.d. $85,000.e. None of the above.

2059. Chapter 16 - Introduction To Taxation Of Individuals Question129 Assuming a taxpayer qualifies for the exclusion treatment, the interest income on educational savings bonds:

a. Is gross income to the person who purchased the bond in the year the interest is earned.b. Is gross income to the student in the year the interest is earned.c. Is included in the student’s gross income in the year the savings bonds are sold or redeemed to pay educational expenses.*d. Is not included in anyone’s gross income if the proceeds are used to pay college tuition.e. None of the above.

2060. Chapter 16 - Introduction To Taxation Of Individuals Question130 The exclusion of interest on educational savings bonds:

a. Applies only to savings bonds owned by the child.*b. Applies to parents who purchase bonds for which the proceeds are used for their child’s education.c. Means that the child must include the interest in income if the bond is owned by the parent.d. Does apply even if used to pay for room and board.e. None of the above.

2061. Chapter 16 - Introduction To Taxation Of Individuals Question131 Nancy had an accident while skiing on vacation. She sustained facial injuries that required cosmetic surgery. While having the surgery done to restore her appearance, she had additional surgery done to reshape her nose, which was not injured in the accident. The surgery to restore her appearance cost $12,000 and the surgery to reshape her nose cost $5,000. How much of Nancy’s surgical fees will qualify as a deductible medical expense (before application of the 7.5% limitation)?

a. $0.b. $5,000.*c. $12,000.d. $17,000.e. None of the above.

2062. Chapter 16 - Introduction To Taxation Of Individuals Question132 Patrick and Leah are married and together have AGI of $100,000 in 2011. They have three dependents and file a joint return. They pay $3,000 for a high deductible health insurance policy and contribute $2,400 to a qualified Health Savings Account. During the year, they paid the following amounts for medical care: $8,200 in doctor and dentist bills and hospital expenses, and $2,500 for prescribed medicine and drugs. In December 2011, they received an insurance reimbursement of $3,400 for hospitalization. They expect to receive an additional reimbursement of $1,700 in January 2012. Determine the maximum deduction allowable for medical expenses in 2011.

a. $1,100.*b. $2,800.c. $5,200.d. $10,300.

e. None of the above.

2063. Chapter 16 - Introduction To Taxation Of Individuals Question133 Lon is employed as an accountant. For calendar year 2011, he had AGI of $120,000 and paid the following medical expenses:

Medical insurance premiums $4,200Doctor and dentist bills for Dick and Sue (Lon’s parents) 6,900Doctor and dentist bills for Lon 7,200Prescribed medicines for Lon 630Nonprescribed insulin for Lon 860

Dick and Sue would qualify as Lon’s dependents except that they file a joint return. Lon’s medical insurance policy does not cover them. Lon filed a claim for $3,800 of his own expenses with his insurance company in November 2011 and received the reimbursement in January 2012. What is Lon’s maximum allowable medical expense deduction for 2011?

a. $5,130.*b. $10,790.c. $12,730.d. $19,790.e. None of the above.

2064. Chapter 16 - Introduction To Taxation Of Individuals Question134 Marilyn, Ed’s daughter who would otherwise qualify as his dependent, filed a joint return with her husband Henry. Ed, who had AGI of $150,000, incurred the following expenses:

Laser surgery to correct Marilyn’s vision problem $ 2,900Marilyn’s prescribed medicines 500Ed’s doctor and dentist bills 6,200Prescribed drugs for Ed 1,350Contact lenses for Ed 350Cost of program for Ed to stop smoking 550Weight reduction program for Ed (related to morbid obesity) 650 Total $12,500

Ed has a medical expense deduction of:

a. $0.b. $50.*c. $1,250.d. $12,500.e. None of the above.

2065. Chapter 16 - Introduction To Taxation Of Individuals Question135 In 2011, Boris pays a $3,800 premium for high-deductible medical insurance for himself and his family. In addition, he contributes $3,400 to a Health Savings Account. Which of the following statements is true?

*a. If Boris is self-employed, he may deduct $7,200 as a deduction for AGI.b. If Boris is self-employed, he may deduct $3,400 as a deduction for AGI and may include the $3,800 premium when calculating his itemized medical expense deduction.c. If Boris is an employee, he may deduct $7,200 as a deduction for AGI.d. If Boris is an employee, he may include $7,200 when calculating his itemized medical expense deduction.e. None of the above.

2066. Chapter 16 - Introduction To Taxation Of Individuals Question136 During the current year, Vijay, a self-employed individual, paid the following amounts:

Real estate tax on Kansas residence $3,400State income tax 1,900Real estate taxes on land in Costa Rica (held as an investment) 1,100Gift tax paid on gift to daughter 1,500State sales taxes 1,950State occupational license fee 250Property tax on value of his automobile (used 100% for business) 450

What is the maximum amount Vijay can claim as taxes in itemizing deductions from AGI?

*a. $6,450.b. $6,700.c. $6,900.d. $7,150.e. None of the above.

2067. Chapter 16 - Introduction To Taxation Of Individuals Question137 Dirk, who uses the cash method of accounting, lives in a state that imposes an income tax (including withholding from wages). On April 14, 2011, he files his state return for 2010, paying an additional $800 in state income taxes. During 2011, his withholdings for state income tax purposes amount to $4,550. On April 13, 2012, he files his state return for 2011, claiming a refund of $900. Dirk receives the refund on August 3, 2012. If he itemizes deductions, how much may Dirk claim as a deduction for state income taxes on his Federal income tax return for calendar year 2011 (filed in April 2012)?

a. $4,450.b. $4,550.*c. $5,350.d. $6,250.e. None of the above.

2068. Chapter 16 - Introduction To Taxation Of Individuals Question138 Ron and Tom are equal owners in Robin Corporation. On July 1, 2011, each loans the corporation $20,000 at annual interest of 10%. Ron and Tom are brothers. Both shareholders are on the cash method of accounting, while Robin Corporation is on the accrual method. All parties use the calendar year for tax purposes. On June 30, 2012, Robin repays the loans of $40,000 together with the specified interest of $4,000. How much of the interest can Robin Corporation deduct in 2011?

*a. $0.b. $1,000.c. $2,000.d. $4,000.e. None of the above.

2069. Chapter 16 - Introduction To Taxation Of Individuals Question139 David, a single taxpayer, took out a mortgage on his home for $300,000 nine years ago. In August of this year, when the home had a fair market value of $550,000 and he owed $225,000 on the mortgage, he took out a home equity loan for $350,000. David used the funds to purchase a yacht to be used for recreational purposes. What is the maximum amount of debt on which he can deduct home equity interest?

a. $50,000.*b. $100,000.c. $325,000.d. $350,000.e. None of the above.

2070. Chapter 16 - Introduction To Taxation Of Individuals Question140 In 2011, Terry pays $10,000 to become a charter member of Eastern University’s Athletic Council. The membership ensures that Terry will receive choice seating at all of Eastern’s home basketball games. Also in 2011, Terry pays $1,200 (the regular retail price) for season tickets for himself and his wife. For these items, how much qualifies as a charitable contribution?

a. $6,000.b. $6,800.*c. $8,000.d. $10,000.e. None of the above.

2071. Chapter 16 - Introduction To Taxation Of Individuals Question141 Rosie owned stock in Acme Corporation that she donated to a university

(a qualified charitable organization) on September 6, 2011. What is the amount of Rosie’s charitable contribution deduction assuming that she had purchased the stock for $20,100 on October 22, 2010, and the stock had a value of $28,200 when she made the donation?

a. $8,100.*b. $20,100.c. $24,150.d. $28,200.e. None of the above.

2072. Chapter 16 - Introduction To Taxation Of Individuals Question142 Zeke made the following donations to qualified charitable organizations during 2011:

Basis Fair Market ValueUsed clothing (all acquired before 2010) of taxpayer and his family $ 1,350 $ 375Stock in ABC, Inc., held as an investment for fifteen months 12,000 10,875Stock in MNO, Inc., held as an investment for eleven months 15,000 18,000Real estate held as an investment for two years 15,000 30,000

The used clothing was donated to the Salvation Army; the other items of property were donated to Eastern State University. Both are qualified charitable organizations. Disregarding percentage limitations, Zeke’s charitable contribution deduction for 2011 is:

a. $43,350.*b. $56,250.c. $59,250.d. $60,375.e. None of the above.

2073. Chapter 16 - Introduction To Taxation Of Individuals Question143 Jennifer, a calendar year taxpayer, made the following donations to qualified charitable organizations in 2011:

Basis Fair Market ValueCash donation to Acme State University $40,000 $ 40,000Unimproved land to the City of Columbus, Ohio 80,000 240,000

The land had been held as an investment and was acquired 3 years ago. Shortly after receipt, the City of Columbus sold the land for $240,000. Jennifer’s AGI is $400,000. The allowable charitable contribution

deduction is:

a. $84,000 if the reduced deduction election is not made.b. $112,000 if the reduced deduction election is not made.*c. $160,000 if the reduced deduction election is not made.d. $200,000 if the reduced deduction election is made.e. None of the above.

2074. Chapter 16 - Introduction To Taxation Of Individuals Question144 During 2011, Ralph made the following contributions to the University of Oregon (a qualified charitable organization):

Cash $63,000Stock in Raptor, Inc. (a publicly traded corporation) 94,500

Ralph acquired the stock in Raptor, Inc., as an investment fourteen months ago at a cost of $42,000. Ralph’s AGI for 2011 is $189,000. What is Ralph’s charitable contribution deduction for 2011?

a. $56,700.b. $63,000.*c. $94,500.d. $157,500.e. None of the above.

2075. Chapter 16 - Introduction To Taxation Of Individuals Question145 Which of the following items would be an itemized deduction on Schedule A of Form 1040 subject to the 2%-of-AGI floor?

a. Professional dues to membership organizations.b. Work uniforms that cannot be used for normal wear.c. Job-hunting costs.d. Hobby losses up to the amount of hobby income.*e. All of the above.

2076. Chapter 16 - Introduction To Taxation Of Individuals Question146 In 2010, Juan and Juanita incur $9,800 in legal and adoption fees directly related to the adoption of an infant son born in a nearby state. Over the next year, they incur another $4,500 of adoption expenses. The adoption becomes final in 2011. Which of the following choices properly reflects the amounts and years in which the adoption expenses credit is available. 2010 2011

a. $9,800 $ 4,500*b. None $13,360c. None $14,300d. $9,800 $ 4,370

e. None of the above.

2077. Chapter 16 - Introduction To Taxation Of Individuals Question147 Which of the following statements regarding the adoption expenses credit is not true?

a. The adoption expenses credit is a nonrefundable credit.b. The adoption expenses credit starts to be phased out in 2011 beginning when a taxpayer’s modified AGI exceeds $185,210.c. No adoption expenses credit is a available in 2011 if a taxpayer’s modified AGI exceeds $225,210.*d. The adoption expenses credit is limited to no more than $13,170 per eligible child in 2011.e. All of the above statements are true.

2078. Chapter 16 - Introduction To Taxation Of Individuals Question148 George and Martha are married and file a joint tax return claiming their two children, ages 10 and 8 as dependents. Assuming their AGI is $123,450, George and Martha’s child tax credit is:

a. $0.b. $750.*c. $1,300.d. $2,000.e. None of the above.

2079. Chapter 16 - Introduction To Taxation Of Individuals Question149 Harry and Wilma are married and file a joint income tax return. On their tax return, they report $44,000 of adjusted gross income ($20,000 salary earned by Harry and $24,000 salary earned by Wilma) and claim two exemptions for their dependent children. During the year, they pay the following amounts to care for their 4-year old son and 6-year old daughter while they work.

ABC Day Care Center $3,200Blue Ridge Housekeeping Services 2,000Mrs. Mason (Harry’s mother) 1,000

Harry and Wilma may claim a credit for child and dependent care expenses of:

a. $840.b. $1,040.*c. $1,200.d. $1,240.e. None of the above.

2080. Chapter 16 - Introduction To Taxation Of Individuals Question150 Kevin and Sue have two children, ages 8 and 14. They spend $6,200 per year on eligible employment related expenses for the care of their children after school. Kevin and Sue each earns a salary of $18,000. What is the amount of the credit for child and dependent care expenses?

*a. $720.b. $1,035.c. $1,380.d. $1,488.e. None of the above.

2081. Chapter 16 - Introduction To Taxation Of Individuals Question151 Which of the following statements concerning the credit for child and dependent care expenses is not correct?

a. A taxpayer is not allowed both an exclusion from income and the credit for child and dependent care expenses on the same amount.b. A taxpayer is not allowed both a deduction as a medical expense and the credit for child and dependent care expenses on the same amount.c. If a taxpayer’s adjusted gross income exceeds $43,000, the rate for the credit for child and dependent care expenses is 20%.*d. If a taxpayer’s adjusted gross income exceeds $15,000 but is not over $17,000, the rate for the credit for child and dependent care expenses is 35%.e. All of the above are correct.

2082. Chapter 16 - Introduction To Taxation Of Individuals Question152 Jermaine and Kesha are married, file a joint tax return, have AGI of $82,500, and have two children. Devona is beginning her freshman year at State University during Fall 2011, and Arethia is beginning her senior year at Northeast University during Fall 2011 after having completed her junior year during the spring of that year. Both Devona and Arethia are claimed as dependents on their parents’ tax return. Devona’s qualifying tuition expenses and fees total $4,000 for the fall semester, while Arethia’s qualifying tuition expenses and fees total $6,200 for each semester during 2011. Full payment is made for the tuition and related expenses for both children during each semester. The American Opportunity credit available to Jermaine and Kesha for 2011 is:

a. $2,500.b. $3,000.*c. $5,000.d. $6,000.e. None of the above.

2083. Chapter 16 - Introduction To Taxation Of Individuals Question153 Bob and Sally are married, file a joint tax return, have AGI of $108,000, and have two children. Del is beginning her freshman year at

State College during Fall 2011, and Owen is beginning his senior year at Southwest University during Fall 2011. Owen completed his junior year during the Spring semester of 2009 (i.e., he took a “leave of absence” during the 2010-2011 school year). Both Del and Owen are claimed as dependents on their parents’ tax return. Del’s qualifying tuition expenses and fees total $5,000 for the Fall semester, while Owen’s qualifying tuition expenses were $6,100 for the Fall 2011 semester. Del’s room and board costs were $3,200 for the Fall semester. Owen did not incur room and board costs since he lived with his aunt and uncle during the year. Full payment is made for the tuition and related expenses for both children at the beginning of each semester. In addition to the children’s college expenses, Bob also spent $3,000 on professional education seminars during the year in order to maintain his license as a practicing dentist. Bob attended the seminars during July and August 2011. Compute the available education tax credits for Bob and Sally for 2011.

a. $3,100.b. $5,000.*c. $5,420.d. $5,600.e. None of the above.

2084. Chapter 16 - Introduction To Taxation Of Individuals Question154 Which of the following statements is true regarding the education tax credits?

a. The lifetime learning credit is available for qualifying tuition and related expenses incurred by students pursuing only graduate degrees.b. The American Opportunity credit permits a maximum credit of 20% of qualified expenses up to $10,000 per year.c. The American Opportunity credit is calculated per taxpayer, while the lifetime learning credit is available per eligible student.d. Continuing education expenses do not qualify for either education credit.*e. None of the above statements is true.

2085. Chapter 16 - Introduction To Taxation Of Individuals Question MA Regarding dependency exemptions, classify each statement in one of the four categories:A son lives with taxpayer and earns $18,000.A daughter who does not live with taxpayerA granddaughter, who lives with taxpayer, is 23 years old, earns $5,000, and is not a full-time studentAn uncle who lives with taxpayerA nephew who lives with taxpayerA niece who does not live with taxpayer, is 18 years old, earns $5,000, and is a full-time studentA half brother who lives with taxpayerA cousin who does not live with taxpayerA step daughter who does not live with taxpayerA daughter-in-law who lives with taxpayerA family friend who is supported by the taxpayer but lives in another stateAn ex-husband (divorce occurred last year) who lives with taxpayerCould be a qualifying child. Could be a qualifying relative. Could be neither a qualifying child nor a qualifying relative. Could be a qualifying relative. Could be either a qualifying child or a

qualifying relative. Could be neither a qualifying child nor a qualifying relative. Could be either a qualifying child or a qualifying relative. Could be neither a qualifying child nor a qualifying relative. Could be a qualifying relative. Could be a qualifying relative. Could be neither a qualifying child nor a qualifying relative. Could be a qualifying relative.

[a] 1. A son lives with taxpayer and earns $18,000.[b] 2. A daughter who does not live with taxpayer[c] 3. A granddaughter, who lives with taxpayer, is 23 years

old, earns $5,000, and is not a full-time student[d] 4. An uncle who lives with taxpayer[e] 5. A nephew who lives with taxpayer[f] 6. A niece who does not live with taxpayer, is 18 years

old, earns $5,000, and is a full-time student[g] 7. A half brother who lives with taxpayer[h] 8. A cousin who does not live with taxpayer[i] 9. A step daughter who does not live with taxpayer[j] 10. A daughter-in-law who lives with taxpayer[k] 11. A family friend who is supported by the taxpayer but

lives in another state[l] 12. An ex-husband (divorce occurred last year) who lives

with taxpayer

a. Could be a qualifying child.b. Could be a qualifying relative.c. Could be neither a qualifying child nor a qualifying

relative.d. Could be a qualifying relative.e. Could be either a qualifying child or a qualifying

relative.f. Could be neither a qualifying child nor a qualifying

relative.g. Could be either a qualifying child or a qualifying

relative.h. Could be neither a qualifying child nor a qualifying

relative.i. Could be a qualifying relative.j. Could be a qualifying relative.k. Could be neither a qualifying child nor a qualifying

relative.l. Could be a qualifying relative.

2086. Chapter 16 - Introduction To Taxation Of Individuals Question155 Match the statements that relate to each other. Note: Choice L may be used more than once.Surviving spouseNontaxable interest on municipal bondsAdditional standard deductionScholarship funds for room and boardAbandoned spouseBasic standard deductionCanada and MexicoAge of a qualifying child$950Kiddie tax appliesKiddie tax does not applyMultiple support agreementUnmarried taxpayer who can use the same tax rates as married persons filing jointly Not considered in applying the gross income test (for dependency exemption purposes) Not available to 65-year old taxpayer who itemizes Considered in applying gross income test (for dependency exemption purposes) Qualifies for head of household filing status Not available to 65-year old taxpayer who itemizes

Exception for U.S. citizenship or residency test (for dependency exemption purposes) Considered for dependency exemption purposes Largest basic standard deduction available to a dependent who has no earned income A child (age 15) who is a dependent and has only unearned income of $4,000 A child (age 16) who is a dependent and has only earned income Exception to the support test (for dependency exemption purposes) No correct match provided

[a] 1. Surviving spouse[b] 2. Nontaxable interest on municipal bonds[c] 3. Additional standard deduction[d] 4. Scholarship funds for room and board[e] 5. Abandoned spouse[f] 6. Basic standard deduction[g] 7. Canada and Mexico[h] 8. Age of a qualifying child[i] 9. $950[j] 10. Kiddie tax applies[k] 11. Kiddie tax does not apply[l] 12. Multiple support agreement

a. Unmarried taxpayer who can use the same tax rates as married persons filing jointly

b. Not considered in applying the gross income test (for dependency exemption purposes)

c. Not available to 65-year old taxpayer who itemizesd. Considered in applying gross income test (for dependency

exemption purposes)e. Qualifies for head of household filing statusf. Not available to 65-year old taxpayer who itemizesg. Exception for U.S. citizenship or residency test (for

dependency exemption purposes)h. Considered for dependency exemption purposesi. Largest basic standard deduction available to a dependent

who has no earned incomej. A child (age 15) who is a dependent and has only unearned

income of $4,000k. A child (age 16) who is a dependent and has only earned

incomel. Exception to the support test (for dependency exemption

purposes)m. No correct match provided

2087. Chapter 16 - Introduction To Taxation Of Individuals Question156 Match the statements that relate to each other. Note: Choice L may be used more than once.Multiple support agreementKiddie tax may be imposedNonresident alienTax Rate ScheduleGain on collectibles (held more than one year)Average income tax rateMarginal income tax rateAdditional standard deductionRelationship test (for dependency exemption purposes)Long-term capital gainsGlobal system of taxationTerritorial system of taxationNo one qualified taxpayer meets the support test No correct match provided Not eligible for the standard deduction Highest applicable rate is 35% Maximum rate is 28% Equal to tax liability divided by taxable income The highest income tax rate applicable to a taxpayer Available to a 70-year-old father claimed

as a dependent by his son Taxpayer’s ex-husband does not qualify Applicable rate could be as low as 0% Income from foreign sources subject to tax No correct match provided A dependent child (age 23) who has only earned income

[a] 1. Multiple support agreement[b] 2. Kiddie tax may be imposed[c] 3. Nonresident alien[d] 4. Tax Rate Schedule[e] 5. Gain on collectibles (held more than one year)[f] 6. Average income tax rate[g] 7. Marginal income tax rate[h] 8. Additional standard deduction[i] 9. Relationship test (for dependency exemption purposes)[j] 10. Long-term capital gains[k] 11. Global system of taxation[l] 12. Territorial system of taxation

a. No one qualified taxpayer meets the support testb. No correct match providedc. Not eligible for the standard deductiond. Highest applicable rate is 35%e. Maximum rate is 28%f. Equal to tax liability divided by taxable incomeg. The highest income tax rate applicable to a taxpayer h. Available to a 70-year-old father claimed as a dependent by

his soni. Taxpayer’s ex-husband does not qualifyj. Applicable rate could be as low as 0%k. Income from foreign sources subject to taxl. No correct match providedm. A dependent child (age 23) who has only earned income

2088. Chapter 16 - Introduction To Taxation Of Individuals Question PR Bertha had the following transactions during 2011:

Salary $80,000Interest income on bonds— Issued by City of Louisville $3,000 Issued by Dell Corporation 4,000 7,000Alimony received 5,000Child support received 18,000City and state income taxes paid 5,000Bank loan obtained to pay for vacation 10,000

What is Bertha’s AGI for 2011?

Correct Answer:$89,000. $80,000 (salary) + $4,000 (interest on Dell Corporation bonds) + $5,000 (alimony received). Interest on the City of Louisville bonds and the child support payments are exclusions from gross income. The bank loan has no tax effect, as Bertha is obligated to repay the amount

borrowed. City and state income taxes are deductions from AGI.

2089. Chapter 16 - Introduction To Taxation Of Individuals Question157 Bill had the following transactions for 2011:

Salary $ 90,000

Alimony paid 4,000 Recovery from car accident— Personal injury damages $30,000 Punitive damages 60,000 90,000 Gift from parents 20,000 Property sales— Loss on sale of boat (used for pleasure and owned 4 years)

($ 4,000)

Gain on sale of Chevron stock (held for 10 months as an investment)

3,000

(1,000)

What is Bill’s AGI for 2011?

Correct Answer:$149,000. $90,000 (salary) – $4,000 (alimony paid) + $60,000 (punitive damage award) + $3,000 (short-term capital gain on the sale of stock investment). The personal injury recovery and the gift from Bill’s parents are exclusions from gross income. The loss from the sale of the boat is personal and, therefore, nondeductible. The short-term capital gain on the sale of the Chevron stock is taxed in full as ordinary income.

2090. Chapter 16 - Introduction To Taxation Of Individuals Question158 Darcy had the following transactions for 2011:

Salary $ 80,000Moving expenses incurred to change jobs 10,000Inheritance received from deceased aunt 200,000Life insurance proceeds from policy on aunt’s life (Darcy was named the beneficiary)

100,000

Cash prize from church raffle 2,000Payment of church pledge 4,500

What is Darcy’s AGI for 2011?

Correct Answer:$72,000. $80,000 (salary) + $2,000 (raffle prize) – $10,000 (moving expenses). The inheritance and life insurance proceeds are exclusions from gross income. The payment by Darcy of her church pledge is a deduction from AGI. Thus, it does not enter into the determination of AGI.

2091. Chapter 16 - Introduction To Taxation Of Individuals Question159 Jim is single and for 2011 has AGI of $50,000. He is age 75 and has no dependents. For 2011, he has itemized deductions from AGI of $7,000. Determine Jim’s taxable income for 2011.

Correct Answer:$39,050. Jim’s standard deduction is $5,800 (basic) + $1,450 (additional) for a total of $7,250. Consequently, he should select the standard deduction option since it exceeds his itemized deductions of $7,000. Thus, his taxable income is determined as follows: $50,000 (AGI) – $7,250 (standard deduction) – $3,700 (personal exemption) = $39,050.

2092. Chapter 16 - Introduction To Taxation Of Individuals Question160 Warren, age 17, is claimed as a dependent by his father. In 2011, Warren has dividend income of $1,500 and earns $400 from a part-time job.

a. What is Warren’s taxable income for 2011?

b. Suppose Warren earned $1,200 (not $400) from the part-time job. What is Warren’s taxable income for 2011?

Correct Answer:a. $950. Warren’s standard deduction is the greater of $400 (earned income) + $300 or $950.

Thus, $1,500 + $400 – $950 = $950 taxable income.

b. $1,200. Warren’s standard deduction now becomes $1,500 ($1,200 + $300). Thus, $1,500 + $1,200 – $1,500 = $1,200 taxable income.

2093. Chapter 16 - Introduction To Taxation Of Individuals Question161 Meg, age 23, is a full-time law student and is claimed by her parents as a dependent. During 2011, she received $1,400 interest income from a bank savings account and $5,600 from a part-time job. What is Meg’s taxable income for 2011?

Correct Answer:$1,200. Meg’s standard deduction is the greater of $5,600 (earned income) + $300 or $950. But the $5,900 is limited to $5,800 (the standard deduction allowed a single person). Thus, $1,400 + $5,600 – $5,800 = $1,200 taxable income.

2094. Chapter 16 - Introduction To Taxation Of Individuals Question162 Pedro is married to Consuela, who lives with him. Both are U.S. citizens and residents of Nebraska. Pedro furnishes all of the support of his parents, who are citizens and residents of Mexico. He also

furnishes all of the support of Consuela’s parents, who are citizens and residents of El Salvador. Consuela has no gross income for the year. If Pedro files as a married person filing separately, how many personal and dependency exemptions can he claim on his return?

Correct Answer:Four. A personal exemption for Pedro and Consuela and dependency exemptions for Pedro’s parents. Consuela can be claimed because she has no income. Presumably she is not being claimed as a dependent by another. Although Pedro’s parents are neither U.S. citizens nor residents, they are residents of Mexico. Consuela’s parents meet neither the citizenship nor residency tests.

2095. Chapter 16 - Introduction To Taxation Of Individuals Question163 Homer (age 68) and his wife Jean (age 70) file a joint return. They furnish all of the support of Luther (Homer’s 90-year old father), who lives with them. For 2011, they received $6,000 of interest income on city of Chicago bonds and interest income on corporate bonds of $48,000. Compute Homer and Jean’s taxable income for 2011.

Correct Answer:$23,000. Their gross income is $48,000 since the $6,000 interest on municipal bonds is an exclusion. They are entitled to a basic standard deduction of $11,600 and additional standard deductions of $1,150 each for being age 65 or older. They can claim a dependency exemption of $3,700 for Luther and two personal exemptions for themselves. Thus, $48,000 – $11,600 – $2,300 (2 ´ $1,150) – $11,100 (3 ´ $3700) = $23,000.

2096. Chapter 16 - Introduction To Taxation Of Individuals Question164 Ellen, age 39 and single, furnishes more than 50% of the support of her parents, who do not live with her. Ellen practices as a self-employed interior decorator and has gross income in 2011 of $120,000. Her deductions are as follows: $30,000 business and $8,100 itemized.

a. What is Ellen’s taxable income for 2011?

b. Can Ellen qualify for head of household filing status? Explain.

Correct Answer:a. $70,400. $120,000 (gross income) - $30,000 (business deductions for AGI) = $90,000

(AGI) – $8,500 (standard deduction) – $3,700 (personal exemption) – $7,400 (dependency exemptions for parents) = $70,400 taxable income. The answer presumes that the parents meet the other dependency exemption tests (e.g., gross income) besides support.

b. Ellen can qualify for head of household filing status if she furnishes more than half of the

cost of maintaining her parents’ household. Also, at least one of Ellen’s parents must qualify as her dependent (see part a. above).

2097. Chapter 16 - Introduction To Taxation Of Individuals Question165 Barbara was injured in an automobile accident. She has threatened to file a suit against the other party involved in the accident and has proposed the following settlement:

Damages for 25% loss of the use of her right arm $200,000Medical expenses 30,000Loss of wages 10,000Punitive damages 100,000 $340,000

The defendant’s insurance company is reluctant to pay punitive damages. Also, the company disputes the amount of her loss of wages amount. Instead, the company offers to pay her $300,000 for damages to her arm and $30,000 medical expenses. Assuming Barbara is in the 35% marginal tax bracket, will her after-tax proceeds from accepting the offer be equal to what she considers to be her actual damages (listed above)?

Correct Answer:Barbara’s claim for punitive damages of $100,000 is the only taxable amount. Therefore, her after-tax proceeds from receiving the $340,000 would be $305,000 [$340,000 – .35($100,000)]. None of the offer from the insurance company ($340,000) would be taxable and therefore her after-tax proceeds from the settlement would be $340,000. Thus, both the insurance company and Barbara would benefit from her accepting the insurance company’s offer.

2098. Chapter 16 - Introduction To Taxation Of Individuals Question166 Jacqueline is employed as an architect. For calendar year 2011, she had AGI of $200,000 and paid the following medical expenses:

Medical insurance premiums $ 7,400Doctor bills for Craig and Christine (Jacqueline’s parents)

7,700

Doctor and dentist bills for Jacqueline 10,500Prescription medicines for Jacqueline 1,450Nonprescription insulin for Jacqueline 550

Craig and Christine would qualify as Jacqueline’s dependents except that they file a joint return. Jacqueline’s medical insurance policy does not cover them. Jacqueline filed a claim for reimbursement of $6,000 of her own expenses with her insurance company in December 2011 and received the reimbursement in January 2012. What is Jacqueline’s maximum allowable medical expense deduction for 2011?

Correct Answer:

Jacqueline’s medical expense deduction is $12,600, determined as follows:

Medical insurance premiums $ 7,400 Doctor bills for Craig and Christine 7,700 Doctor and dentist bills for Jacqueline 10,500 Prescription medicines for Jacqueline 1,450 Nonprescription insulin for Jacqueline 550 Total medical expenses $27,600 Less: 7.5% of $200,000 (AGI) (15,000)Deductible portion of medical expenses $12,600

Although Craig and Christine cannot be claimed as Jacqueline’s dependents, they could have been had they not filed a joint return. Therefore, their medical costs qualify for Jacqueline’s medical expense deduction. Insulin is an exception to the rule that nonprescribed drugs do not qualify as medical expenses. The insurance recovery was not received until 2012. Therefore, it has no effect on the medical expense deduction for 2011.

2099. Chapter 16 - Introduction To Taxation Of Individuals Question167 Brian, a self-employed individual, pays state income tax payments of:

$900 on January 18, 2011 (4th estimated tax payment for 2010) $1,000 on April 15, 2011 (1st estimated tax payment in 2011) $1,000 on June 15, 2011 (2nd estimated tax payment in 2011) $1,000 on September 15, 2011 (3rd estimated tax payment in 2011) $800 on January 17, 2012 (4th estimated tax payment of 2011)

Brian had a tax overpayment of $500 on his 2010 state income tax return and applied this to his 2011 state income taxes. What is the amount of Brian’s state income tax itemized deduction for his 2011 Federal income tax return?

Correct Answer:$4,400 is the itemized deduction. $900 + $1,000 + $1,000 + $1,000 + $500 (overpayment).

2100. Chapter 16 - Introduction To Taxation Of Individuals Question168 In 2004, Ross, who is single, purchased a personal residence for $170,000 and took out a mortgage of $100,000 on the property. In May of the current year, when the residence had a fair market value of $220,000 and Ross owed $70,000 on the mortgage, he took out a home equity loan for $110,000. He used the funds to purchase a BMW for himself and a Lexus SUV for his wife. For both vehicles, 100% of the use is for personal activities. What is the maximum amount on which Ross can deduct home equity interest?

Correct Answer:Interest is deductible only on the portion of a home equity loan that

does not exceed the lesser of:

· The fair market value of the residence, reduced by the acquisition indebtedness ($220,000 FMV – $70,000 acquisition indebtedness = $150,000).

· $100,000 ($50,000 for married persons filing separate returns).

Ross can deduct all of the interest on the first mortgage since it is acquisition indebtedness. Of the $110,000 home equity loan, interest on $100,000 is deductible as home equity interest.

2101. Chapter 16 - Introduction To Taxation Of Individuals Question169 Virginia had AGI of $100,000 in 2011. She donated Amber Corporation stock with a basis of $9,000 to a qualified charitable organization on July 5, 2011.

a. What is the amount of Virginia’s deduction, assuming that she purchased the stock on December 4, 2010, and the stock had a fair market value of $16,000 when she made the donation?

b. Assume the same facts as in a., except that Virginia purchased the stock on July 1, 2003.

c. Assume the same facts as in a., except that the stock had a fair market value of $5,000 (rather than $16,000) when Virginia donated it to the charity.

Correct Answer:

General discussion. The deduction for a contribution of capital gain property is based on the fair market value, while the deduction for a contribution of ordinary income property is equal to the lesser of the adjusted basis or the fair market value.

a. Because Virginia did not hold the stock for the long-term holding period (December 4, 2010 - July 5, 2011), it is short-term capital gain property that is subject to the rules for ordinary income property. Therefore, her deduction is limited to $9,000.

b. Virginia held the stock for the long-term holding period (July 1, 2003 - July 5, 2011); so it

is capital gain property. Therefore, her deduction is equal to the fair market value of the stock, $16,000.

c. The deduction for a contribution of loss property (FMV is less than adjusted basis) is

limited to the fair market value. Therefore, Virginia’s deduction is $5,000.

2102. Chapter 16 - Introduction To Taxation Of Individuals Question170 Freda, who has AGI of $100,000 in 2011, contributes stock in Tulip Corporation (a publicly traded corporation) to Central State University, a qualified charitable organization. The stock is worth $59,000, and Freda acquired it as an investment two years ago at a cost of $44,000.

a. What is the total amount that Freda can deduct as a charitable contribution, assuming she carries over any disallowed contribution from 2011 to future years?

b. What is the maximum amount that Freda can deduct as a charitable contribution in 2011?

c. What factors should Freda consider in deciding how to treat the contribution for Federal income tax purposes?

d. Assume Freda dies in December 2011. What advice would you give the executor of her estate with regard to possible elections that can be made relative to the contribution?

Correct Answer:

General discussion. The stock is appreciated capital gain property. The general rule limits the deduction for the contribution of such property to 30% of AGI. However, under the reduced deduction election, a taxpayer may choose to forgo a deduction of the appreciation on capital gain property. This enables the taxpayer to move from the 30% limitation to a 50% limitation.

a. Freda can deduct a total of $59,000, the fair market value of the stock. The deduction for 2011 is limited to $30,000 (30% of $100,000 AGI). The remaining $29,000 can be carried forward and deducted in the future, subject to the same percentage limitations.

b. If Freda makes the reduced deduction election, she can deduct $44,000 in 2011, but she

will forgo a deduction for the $15,000 appreciation ($59,000 FMV – $44,000 adjusted basis).

c. Although the reduced deduction election appears attractive, it should be considered

carefully. The election sacrifices a deduction for the appreciation on capital gain property that might eventually be allowed. Freda should do a present value analysis to compare the value of a deduction of $44,000 in 2011 versus the value of a $30,000 deduction in 2011 plus $29,000 of deductions to be carried over to future years.

d. If Freda dies in December 2011, her executor should make the reduced deduction

election, which would yield a charitable contribution deduction of $44,000. If the election is not made, the deduction will be $30,000 (30% of $100,000) and the $29,000 carryover will be lost because the 2011 return will be the final return for Freda.

2103. Chapter 16 - Introduction To Taxation Of Individuals Question171 Bradley has two college-age children, Clint, a freshman at State University, and Abigail, a junior at Northwest University. Both Clint and Abigail are full-time students. Clint’s expenses during the 2011 fall semester are as follows: $2,400 tuition, $250 books and course materials, and $1,600 room and board. Abigail’s expenses for the 2011 calendar year are as follows: $10,200 tuition, $1,200 books and course materials, and $3,600 room and board. Tuition and the applicable room and board costs are paid at the beginning of each semester. Bradley is married, files a joint tax return, claims both children as dependents, and has a combined AGI with his wife of $114,000 for 2011. Determine Bradley’s available education tax credit for 2011.

Correct Answer:In 2011, both Clint and Abigail qualify for the American Opportunity credit. Clint’s qualifying expenses are $2,650 ($2,400 tuition and $250 books and course materials); Abigail’s qualifying expenses are $11,400 ($10,200 tuition and $1,200 books and course materials).

Clint’s American Opportunity credit is $2,162.50 [100% of the first $2,000 of qualifying expenses plus 25% of the next $2,000 of qualifying expenses; $2,000 + ($650 ´ 25%)]. Abigail’s American Opportunity credit is $2,500 (100% of the first $2,000 of qualifying expenses plus 25% of the next $2,000 of qualifying expenses; $2,000 + ($2,000 ´ 25%)].

Although the American Opportunity credits are subject to a phaseout for higher income taxpayers, Bradley’s AGI of $114,000 is less than the phase-out starting point in 2011 ($160,000 for married taxpayers filing jointly).

So, the total education credit available for the year is $4,662.50 ($2,162.50 + $2,500).

2104. Chapter 16 - Introduction To Taxation Of Individuals Question ES Mr. Lee is a citizen and resident of Hong Kong, while Mr. Anderson is a citizen and resident of the U.S. In the taxation of income, Hong Kong uses a territorial approach, while the U.S. follows the global system. In terms of effect, explain what this means to Mr. Lee and Mr. Anderson.

Correct Answer:Mr. Lee is taxed only on the income he receives from Hong Kong, while Mr. Anderson is taxed on his global income. Under the U.S. approach, a citizen or resident is taxed on a worldwide basis. Since the U.S. system could lead to the same income being taxed twice, various relief provisions are necessitated (e.g., foreign tax credit).

2105. Chapter 16 - Introduction To Taxation Of Individuals Question172 The Deweys are expecting to save on their taxes for 2011. Not only have both incurred large medical expenses, but both reached age 65. During the year, they also recognized a $30,000 loss on some land they sold which was purchased as an investment several years ago. Are the Deweys under a mistaken understanding regarding their tax position? Explain.

Correct Answer:The Deweys are expecting to qualify for two additional standard deductions and anticipating a deduction for medical expenses. The two objectives cannot coexist. Claiming a medical deduction requires that they itemize. Taxpayers who itemize, however, cannot claim any type of standard deduction. Regarding the capital loss, and presuming no capital gains, only $3,000 can be deducted against their other income. The balance of $27,000 must be carried over to future years.

2106. Chapter 16 - Introduction To Taxation Of Individuals Question173 Deductions for AGI are often referred to as “above-the-line” or “page 1” deductions. Explain.

Correct Answer:“Above the line” means before the bottom line of page 1 of Form 1040, which is AGI. These deductions appear on page 1 of Form 1040.

2107. Chapter 16 - Introduction To Taxation Of Individuals Question174 During the current year, Doris received a large gift from her parents and a sizeable inheritance from an uncle. She also paid premiums on an insurance policy on her life. Doris is confused because she cannot find any place on Form 1040 to report these items. Explain.

Correct Answer:Gifts and inheritances are exclusions from gross income. Like most exclusions, they are not reported on Form 1040. Premiums on a personal life insurance policy are nondeductible. Nondeductible items, such as these premiums, are not reported on Form 1040

2108. Chapter 16 - Introduction To Taxation Of Individuals Question175 Mel is not quite sure whether an expenditure he made is a deduction for AGI or a deduction from AGI. Since he plans to choose the standard deduction option for the year, does the distinction matter? Explain.

Correct Answer:It makes a great deal of difference if the expenditure is a deduction for AGI. If it is, Mel will benefit taxwise. It makes no difference, however, if it is a deduction from. The standard deduction is in lieu of itemized deductions.

2109. Chapter 16 - Introduction To Taxation Of Individuals Question176 When filing their Federal income tax returns, the Youngs always claimed the standard deduction. After they purchased a home, however, they started to itemize their deductions from AGI.

a. Explain the reason for the change. b. Suppose they purchased the home in December 2010, but did not start

itemizing until tax year 2011. Why the delay as to itemizing?

Correct Answer:a. The interest on the home mortgage and the property taxes gave the Youngs itemized

deductions in excess of the applicable standard deduction. b. The home mortage interest and property taxes for one month (i.e., December) may not

have been enough to place the Youngs in a position to exceed the applicable standard deduction for 2010. In 2011, however, a full 12 months worth of home mortgage interest and property taxes in involved.

2110. Chapter 16 - Introduction To Taxation Of Individuals Question177 List several categories of persons that cannot be a qualified child but can be a qualified relative for dependency exemption purposes.

Correct Answer:Lineal ascendants (e.g., parents), collateral ascendants (e.g., uncles, aunts), in-laws, and strangers who are members of the taxpayper’s household.

2111. Chapter 16 - Introduction To Taxation Of Individuals Question178 In order to claim a dependency exemption for other than a qualifying child, a taxpayer must meet the support test. Generally, this is done by furnishing more than 50% of a dependent’s support. What exceptions exist, if any, where the support furnished need not be more than 50%?

Correct Answer:One exception involves the multiple support agreement. Here, family members collectively furnish more than 50% of the support, but no one person does so. For those qualified individuals who contribute more than 10%, the group can designate which person may claim the dependency exemption.

The second exception involves the divorced parents of children. The custodial parent is entitled to the dependency exemptions for the children. If this parent agrees not to claim the exemption(s), then the noncustodial parent may do so.

2112. Chapter 16 - Introduction To Taxation Of Individuals Question179 In meeting the criteria of a qualifying child for dependency exemption purposes, when if ever, might the child’s income become relevant?

Correct Answer:The amount of income earned by the qualifying child normally is of no consequence. If, however, such income is used to make the child self-supporting, then he or she can no longer be a qualifying child. Such child also would not be a qualifying relative due to the gross income and support tests.

2113. Chapter 16 - Introduction To Taxation Of Individuals Question180 What is a “stealth tax?”

Correct Answer:A “stealth tax” is not really a separate tax. Most often, it consists of conditions in the tax law that deny the benefits of a relief provision to persons in higher tax brackets. The stealth tax approach previously took the phaseout form in the case of the deduction for personal and dependency exemptions and the allowance of deductions from AGI.

2114. Chapter 16 - Introduction To Taxation Of Individuals Question181 Lena is 66 years of age, single, and blind and is not claimed as a dependent. How much gross income must she have before she is required to file a Federal income tax return for 2011?

Correct Answer:$10,950. $5,800 (basic standard deduction) + $1,450 (additional standard deduction for age) + $3,700 (personal exemption). Note that no additional standard deduction is allowed for blindness.

2115. Chapter 16 - Introduction To Taxation Of Individuals Question182 For the past few years, Corey’s filing status has been as follows: 2007 (married/joint); 2008 (married/separate); 2009 (surviving spouse); 2010 (surviving spouse); and 2011 (head of household). Explain what probably has happened.

Correct Answer:One probable explanation is that Corey’s wife died in 2008 and the executor of her estate refused to agree to filing a joint return. As surviving spouse status does not continue beyond two years, Corey is relegated to head of household status in 2011.

2116. Chapter 16 - Introduction To Taxation Of Individuals Question183 List at least three exceptions to the application of the kiddie tax.

Correct Answer:· Unearned income of $1,900 or less.· Age 19 (or age 24 if a full-time student) or older.· Both parents deceased.· Earned income in excess of 50% of support.· Married and filing a joint return with spouse.

2117. Chapter 16 - Introduction To Taxation Of Individuals Question184 The Martins have a teenage son who has become an accomplished bagpiper. With proper promotion and scheduling, the son has good income potential by charging for his services at special events (particularly funerals). However, the Martins are fearful that the income could generate a kiddie tax and cause them the loss of a dependency exemption deduction. Are the Martins’ concerns justified? Explain.

Correct Answer:

The income received by the son would be earned income. Therefore, the kiddie tax is not a problem since it applies only to unearned income. As long as the son is under age 19 (or a full-time student under age 24), he is a dependent as a qualifying child. Under these rules, the amount of the son’s income does not matter (unless he becomes self-supporting). If the son is age 19 (or older) and not a student, any dependency exemption must satisfy the qualifying relative rules. Here, not meeting the gross income test would cause the dependency exemption to be lost.

2118. Chapter 16 - Introduction To Taxation Of Individuals Question185 Sid and Andrea Peterson are married and together have AGI of $120,000 in 2011. They have two dependents and file a joint return. During the year, they paid $6,000 for medical insurance, $12,000 in doctor bills and hospital expenses, and $800 for prescribed medicine and drugs.

a. In December 2011, the Petersons received an insurance reimbursement of $3,800 for hospitalization expenses. Determine the deduction allowable for medical expenses paid during the year.

b. Assume instead that the Petersons received the $3,800 insurance reimbursement in January 2012. Determine the deduction allowable for medical expenses incurred in 2011.

c. Assume again that the Petersons received the $3,800 insurance reimbursement in January 2012. Discuss whether the reimbursement will be included in their gross income for 2012.

Correct Answer:

General discussion. All of the following expenses are deductible, subject to the 7.5% floor: $6,000 for medical insurance, $12,000 in doctor bills and hospital expenses, and $800 for prescribed medicine and drugs.

a. Assuming Sid and Andrea received the insurance reimbursement in December 2011, their medical expense deduction would be $6,000, computed as follows:

Medical insurance $ 6,000 Doctor bills and hospital expenses 12,000 Prescribed medicine and drugs 800 Total medical expenses incurred $18,800 Minus: December 2011 reimbursement (3,800) Total medical expenses after reimbursement $15,000 Minus: $120,000 AGI ´ 7.5% (9,000) Medical expense deduction $ 6,000

b. Assuming Sid and Andrea received the insurance reimbursement in January 2012, they could ignore the reimbursement in computing their 2011 medical expense deduction. Their medical expense deduction would be $9,800, computed as follows:

Medical insurance $ 6,000 Doctor bills and hospital expenses 12,000 Prescribed medicine and drugs 800 Total medical expenses incurred $18,800 Minus: $120,000 AGI ´ 7.5% (9,000) Medical expense deduction $ 9,800

c. If Sid and Andrea itemized in 2011, they would report the reimbursement as gross income in 2012, to the extent they received a tax benefit from itemizing in 2011. If they did not itemize in 2011 (i.e., took the standard deduction), they would not be required to report the reimbursement as gross income in 2012.

2119. Chapter 16 - Introduction To Taxation Of Individuals Question186 Central Bank has initiated an advertising campaign that encourages customers to take out home equity loans to pay for purchases of automobiles. Are there any tax advantages related to this type of borrowing? Explain.

Correct Answer:Yes. Home equity loans utilize a qualified residence of the taxpayer as security. The proceeds from these loans can be used for personal purposes such as purchasing a personal use automobile. The interest paid on the qualified residence loan is deductible as an itemized deduction on Schedule A while the interest paid on consumer loans is not deductible.

2120. Chapter 17 - Individuals As Employees And Proprietors Question T One indicia of independent contractor (rather than employee) status is when the individual performing the services is paid based on tasks performed (rather than time spent).

*a. Trueb. False

2121. Chapter 17 - Individuals As Employees And Proprietors Question 2 In some cases it may be appropriate for a taxpayer to report work-related expenses by using both Form 2106 and Schedule C.

*a. Trueb. False

2122. Chapter 17 - Individuals As Employees And Proprietors Question 3 Jake performs services for Maude. If Maude provides Jake with a helper and tools, this is indicative of independent contractor (rather than employee) status.

a. True*b. False

2123. Chapter 17 - Individuals As Employees And Proprietors Question 4

If an individual is subject to the direction or control of another only to the extent of the end result but not as to the means of accomplishment, an employer-employee relationship does not exist.

*a. Trueb. False

2124. Chapter 17 - Individuals As Employees And Proprietors Question 5 The work-related expenses of an independent contractor will be subject to the 2%-of-AGI floor.

a. True*b. False

2125. Chapter 17 - Individuals As Employees And Proprietors Question 6 For a person who is in the 35% marginal tax bracket, $1,000 of tax-exempt income is equivalent to over $1,500 of income that is subject to tax.

*a. Trueb. False

2126. Chapter 17 - Individuals As Employees And Proprietors Question 7 Sarah’s employer pays the hospitalization insurance premiums for a policy that covers all employees and their family members. Sarah can exclude from her gross income the premiums for herself and her family members.

*a. Trueb. False

2127. Chapter 17 - Individuals As Employees And Proprietors Question 8 Meg’s employer carries insurance on its employees that will pay an employee his or her regular salary while the employee is away from work due to illness. The premiums for Meg’s coverage were $1,200. Meg was absent from work for two months as a result of a kidney infection. Meg’s employer’s insurance company paid Meg’s regular salary of $8,000 while she was away from work. Meg also collected $2,000 on a wage continuation policy she had purchased. Meg is not taxed on any of the

above amounts.

a. True*b. False

2128. Chapter 17 - Individuals As Employees And Proprietors Question 9 If an employer pays for the employee’s long-term care insurance premiums, the employee can exclude from gross income the premiums and all of the benefits collected.

a. True*b. False

2129. Chapter 17 - Individuals As Employees And Proprietors Question10 Members of a research team must include in gross income the value of their lodging furnished at the research base located at the South Pole.

a. True*b. False

2130. Chapter 17 - Individuals As Employees And Proprietors Question11 Carla is a deputy sheriff. Her employer requires that she live in the county where she is employed. Housing is very expensive; so the county agreed to pay her $4,800 per year to cover the higher cost of housing. Carla can exclude the $4,800 housing supplement from gross income because she is required to live in the high cost area.

a. True*b. False

2131. Chapter 17 - Individuals As Employees And Proprietors Question12 Roger is in the 35% marginal tax bracket. Roger’s employer has created a flexible spending account for medical and dental expenses that are not covered by the company’s health insurance plan. Roger had his salary reduced by $1,200 during the year for contributions to the flexible spending plan. However, Roger incurred only $1,100 in actual expenses for which he was reimbursed. Under the plan, he must forfeit the $100 unused amount. His after-tax cost of overfunding the plan is $65.

*a. Trueb. False

2132. Chapter 17 - Individuals As Employees And Proprietors Question13 Mauve Company permits employees to occasionally use the copying machine for personal purposes. The copying machine is located in the office where the higher paid executives work. So they frequently use the machine. However, the machine is not convenient for use by the lower paid warehouse employees. Because this fringe benefit benefits the higher paid employees but not the lower paid warehouse employees, the

plan is discriminatory and thus the benefit is taxable to the executives.

a. True*b. False

2133. Chapter 17 - Individuals As Employees And Proprietors Question14 Fresh Bakery often has unsold donuts at the end of the day. The bakery allows employees to take the leftovers home. The employees are not required to recognize gross income because the bakery does not incur any additional cost.

a. True*b. False

2134. Chapter 17 - Individuals As Employees And Proprietors Question15 Nicole’s employer pays her $150 per month towards the cost of parking near a railway station where Nicole catches the train to work. The employer also pays the cost of the rail pass, $75 per month. Nicole can exclude both of these payments from her gross income.

*a. Trueb. False

2135. Chapter 17 - Individuals As Employees And Proprietors Question16 A U.S. citizen who works in France from February 1, 2010 until January 31, 2011 is not eligible for the foreign earned income exclusion in 2010 but is eligible for it in 2011.

a. True*b. False

2136. Chapter 17 - Individuals As Employees And Proprietors Question17 Generally, a U.S. citizen is not required to include in gross income the salary and wages earned while working in a foreign country if the foreign country taxes the income.

a. True*b. False

2137. Chapter 17 - Individuals As Employees And Proprietors Question18 After she finishes working at her main job, Ann returns home, has dinner, then drives to her second job. Ann may deduct the mileage between her home and second job.

a. True*b. False

2138. Chapter 17 - Individuals As Employees And Proprietors Question19 After the automatic mileage rate has been set by the IRS for a year, it cannot later be changed by the IRS.

a. True*b. False

2139. Chapter 17 - Individuals As Employees And Proprietors Question20 In choosing between the actual expense method and the automatic mileage method, a taxpayer should consider the cost of insurance on the automobile.

*a. Trueb. False

2140. Chapter 17 - Individuals As Employees And Proprietors Question21 A taxpayer who uses the automatic mileage method to compute auto expenses can also deduct the business portion of tolls and parking.

*a. Trueb. False

2141. Chapter 17 - Individuals As Employees And Proprietors Question22 Once the actual cost method is used, a taxpayer cannot change to the automatic mileage method in a later year.

a. True*b. False

2142. Chapter 17 - Individuals As Employees And Proprietors Question23 For tax purposes, “travel” is a broader classification than “transportation.”

*a. Trueb. False

2143. Chapter 17 - Individuals As Employees And Proprietors Question24 Amy lives and works in St. Louis. In the morning she flies to Boston, has a three-hour business meeting, and returns to St. Louis that evening. For tax purposes, Amy was away from home.

a. True*b. False

2144. Chapter 17 - Individuals As Employees And Proprietors Question25 Janet, who lives and works in Newark, travels to Atlanta for a Thursday-Friday business conference. She stays over after the conference and visits relatives and friends on Saturday. Under certain circumstances, the meals and lodging expenses for Saturday can be

considered as business related.

*a. Trueb. False

2145. Chapter 17 - Individuals As Employees And Proprietors Question26 A taxpayer who lives and works in Kansas City is sent to Chicago on an eight-day business trip. While in Chicago, taxpayer uses the hotel valet service to have some laundry done. The valet charge is a deductible travel expense.

*a. Trueb. False

2146. Chapter 17 - Individuals As Employees And Proprietors Question27 The tax law specifically provides that a taxpayer cannot be temporarily away from home for any period of employment that exceeds one year.

*a. Trueb. False

2147. Chapter 17 - Individuals As Employees And Proprietors Question28 A taxpayer who lives and works in Tulsa travels to Buffalo for five days. If three days are spent on business and two days are spent on visiting relatives, only 60% of the airfare is deductible.

a. True*b. False

2148. Chapter 17 - Individuals As Employees And Proprietors Question29 Bob lives and works in Newark, NJ. He travels to London for a three-day business meeting, after which he spends three days touring Scotland. All of his air fare is deductible.

*a. Trueb. False

2149. Chapter 17 - Individuals As Employees And Proprietors Question30 Edna lives and works in Cleveland. She travels to Berlin for an eight-day business meeting, after which she spends two days touring Germany. All of Edna’s airfare is deductible.

*a. Trueb. False

2150. Chapter 17 - Individuals As Employees And Proprietors Question31 Daniel just graduated from college. The cost of moving his personal belongings from his parents’ home to his first job site does not

qualify for the moving expense deduction.

a. True*b. False

2151. Chapter 17 - Individuals As Employees And Proprietors Question32 Tired of her 60 mile daily commute, Margaret purchases a condo that is only five miles from her job. Margaret’s moving expenses to her new condo are not allowed and cannot be claimed by her as a deduction.

*a. Trueb. False

2152. Chapter 17 - Individuals As Employees And Proprietors Question33 In November 2011, Katie incurs unreimbursed moving expenses to accept a new job. Katie cannot deduct any of these expenses when she timely files her 2011 income tax return since she has not yet satisfied the 39-week time test.

a. True*b. False

2153. Chapter 17 - Individuals As Employees And Proprietors Question34 In May 2011, after 11 months on a new job, Ken is fired after he assaults a customer. Ken must include in his gross income for 2011 any deduction for moving expenses he may have claimed on his 2010 tax return.

a. True*b. False

2154. Chapter 17 - Individuals As Employees And Proprietors Question35 A moving expense deduction is allowed even if at the time of the move the taxpayer did not have a job at the new location.

*a. Trueb. False

2155. Chapter 17 - Individuals As Employees And Proprietors Question36 Kelly, an unemployed architect, moves from Boston to Phoenix to accept a job as a chef at a restaurant. Kelly’s moving expenses are not deductible because her new job is in a different trade or business.

a. True*b. False

2156. Chapter 17 - Individuals As Employees And Proprietors Question37 Alexis (a CPA and JD) sold her public accounting practice in Des Moines and accepted a job with the Seattle office of a national accounting

firm. Her moving expenses are not deductible because she has changed employment status (i.e., went from self-employed to employee).

a. True*b. False

2157. Chapter 17 - Individuals As Employees And Proprietors Question38

Qualified moving expenses include the cost of lodging but not meals during the move.

*a. Trueb. False

2158. Chapter 17 - Individuals As Employees And Proprietors Question39 An education expense deduction can be allowed even if the education results in a promotion or pay raise for the employee.

*a. Trueb. False

2159. Chapter 17 - Individuals As Employees And Proprietors Question40 Lloyd, a practicing CPA, pays tuition to attend law school. Since a law degree involves education leading to a new trade or business, the tuition is not deductible.

a. True*b. False

2160. Chapter 17 - Individuals As Employees And Proprietors Question41 Under the right circumstances, a taxpayer’s meals and lodging expense can qualify as a deductible education expense.

*a. Trueb. False

2161. Chapter 17 - Individuals As Employees And Proprietors Question42 A taxpayer who always claims the standard deduction (i.e., does not itemize his or her deductions from AGI) will not be able to receive a tax benefit from any education expenses incurred.

a. True*b. False

2162. Chapter 17 - Individuals As Employees And Proprietors Question43 Ethan, a bachelor with no immediate family, uses the Pine Shadows Country Club exclusively for his business entertaining. All of Ethan’s

annual dues for his club membership are deductible.

a. True*b. False

2163. Chapter 17 - Individuals As Employees And Proprietors Question44 A sole proprietor is allowed a deduction for a $25 gift he gives to his office manager on her birthday.

*a. Trueb. False

2164. Chapter 17 - Individuals As Employees And Proprietors Question45

The $25 limitation on the deductibility of business gifts can be circumvented by making separate gifts to the family (e.g., spouse, children) of the client.

a. True*b. False

2165. Chapter 17 - Individuals As Employees And Proprietors Question46 If a taxpayer does not own a home but rents an apartment, the office in the home deduction is not available.

a. True*b. False

2166. Chapter 17 - Individuals As Employees And Proprietors Question47 The portion of the office in the home deduction that exceeds the income from the business can be carried over to future years.

*a. Trueb. False

2167. Chapter 17 - Individuals As Employees And Proprietors Question48 If the cost of uniforms is deductible, their maintenance cost (e.g., laundry, dry cleaning, alterations) also is deductible.

*a. Trueb. False

2168. Chapter 17 - Individuals As Employees And Proprietors Question49

Tired of renting, Dr. Smith buys the academic robes she will wear at her college’s graduation procession. The cost of this attire qualifies as a uniform expense.

*a. Trueb. False

2169. Chapter 17 - Individuals As Employees And Proprietors Question50

Frank, a recently retired FBI agent, pays job search expenses to obtain a position with a city police department. Frank’s job search expenses do not qualify as deductions.

a. True*b. False

2170. Chapter 17 - Individuals As Employees And Proprietors Question51 After graduating from college with a degree in chemistry, Alberto obtains a job as a chemist with DuPont. Alberto’s job search expenses qualify as deductions.

a. True*b. False

2171. Chapter 17 - Individuals As Employees And Proprietors Question52 Qualifying job search expenses are deductible even if the taxpayer does not change jobs.

*a. Trueb. False

2172. Chapter 17 - Individuals As Employees And Proprietors Question53 Madison is an instructor of fine arts at a local community college. If she spends $600 (not reimbursed) on art supplies for her classes, some of this amount can be claimed as a deduction for AGI.

a. True*b. False

2173. Chapter 17 - Individuals As Employees And Proprietors Question54 Both traditional and Roth IRAs possess the advantage of tax-free accumulation of income within the plan.

*a. Trueb. False

2174. Chapter 17 - Individuals As Employees And Proprietors Question55 When contributions are made to a traditional IRA, they are deductible by the participant. Later distributions from a the IRA, however, are

fully taxed.

*a. Trueb. False

2175. Chapter 17 - Individuals As Employees And Proprietors Question56 By itself, credit card receipts will not constitute adequate substantiation for travel expenses.

*a. Trueb. False

2176. Chapter 17 - Individuals As Employees And Proprietors Question57 For self-employed taxpayers, travel expenses are not subject to the 2%-of-AGI floor.

*a. Trueb. False

2177. Chapter 17 - Individuals As Employees And Proprietors Question58 A taxpayer who claims the standard deduction will not avoid the 2% floor on unreimbursed employee expenses.

a. True*b. False

2178. Chapter 17 - Individuals As Employees And Proprietors Question59 Employees who render an adequate accounting to the employer and are fully reimbursed will shift the 50% cutback adjustment to their employer.

*a. Trueb. False

2179. Chapter 17 - Individuals As Employees And Proprietors Question60 Only self-employed individuals are required to make estimated tax payments.

a. True*b. False

2180. Chapter 17 - Individuals As Employees And Proprietors Question61 The calculation of FICA and the self-employment tax both involve two components: the Social Security portion and the Medicare portion, each portion of which is imposed on the same base amounts.

a. True*b. False

2181. Chapter 17 - Individuals As Employees And Proprietors Question62 A participant has an adjusted basis of $0 in any nondeductible contributions to a traditional IRA.

a. True*b. False

2182. Chapter 17 - Individuals As Employees And Proprietors Question63 If a married taxpayer is an active participant in another qualified retirement plan, the traditional IRA deduction phaseout begins at $90,000 of AGI for a joint return in 2011.

*a. Trueb. False

2183. Chapter 17 - Individuals As Employees And Proprietors Question64 If an individual is ineligible to make a deductible contribution to a traditional IRA, nondeductible contributions of any amount can be made to a traditional IRA.

a. True*b. False

2184. Chapter 17 - Individuals As Employees And Proprietors Question65 The maximum annual contribution to a Roth IRA for an unmarried taxpayer who is age 35 is the smaller of $5,000 or the individual’s compensation for the year.

*a. Trueb. False

2185. Chapter 17 - Individuals As Employees And Proprietors Question66 An individual, age 40, who is not subject to the phase-out provision may contribute a deductible amount to a Roth IRA up to $5,000 per year in 2011.

a. True*b. False

2186. Chapter 17 - Individuals As Employees And Proprietors Question67 A participant who is at least age 59 1/2 can make a tax-free qualified withdrawal from a Roth IRA after a five-year holding period.

*a. Trueb. False

2187. Chapter 17 - Individuals As Employees And Proprietors Question68 Distributions from a Roth IRA that are subject to taxation are treated

first as from earnings and last as from contributions.

a. True*b. False

2188. Chapter 17 - Individuals As Employees And Proprietors Question69 Low- and middle-income taxpayers may make nondeductible contributions up to $2,000 per child per year to a Coverdell Education Savings Account (CESA).

*a. Trueb. False

2189. Chapter 17 - Individuals As Employees And Proprietors Question70 An individual is considered an active participant in an employer-sponsored retirement plan merely because an individual’s spouse is an active participant for any part of a plan year in applying the IRA phase-out provision.

a. True*b. False

2190. Chapter 17 - Individuals As Employees And Proprietors Question71 Deriving a profit in three consecutive years is not irrefutable evidence that an activity is profit seeking and not a hobby.

*a. Trueb. False

2191. Chapter 17 - Individuals As Employees And Proprietors Question72 If a taxpayer cannot satisfy the three-out-of-five year presumption test associated with hobby losses, then expenses from the activity cannot be deducted in excess of the gross income from the activity.

a. True*b. False

2192. Chapter 17 - Individuals As Employees And Proprietors Question73 If an activity involves horses, a profit in at least two of seven consecutive years meets the presumptive rule of § 183.

*a. Trueb. False

2193. Chapter 17 - Individuals As Employees And Proprietors Question74 A hobby activity can result in all of the hobby income being included in AGI and no deductions being allowed.

*a. Trueb. False

2194. Chapter 17 - Individuals As Employees And Proprietors Question75 If an item such as property taxes and home mortgage interest exceed the income from a hobby, the excess amount of this item over the hobby income can be deducted if the taxpayer itemizes deductions.

*a. Trueb. False

2195. Chapter 17 - Individuals As Employees And Proprietors Question76 Hobby activity expenses are deductible from AGI to the extent of hobby income. Such expenses not in excess of hobby income are not subject to the 2% of AGI floor.

a. True*b. False

2196. Chapter 17 - Individuals As Employees And Proprietors Question M Ryan performs services for Jordan. Which, if any, of the following factors indicate that Ryan is an employee, rather than an independent contractor?

*a. Jordan provides Ryan with support services (e.g., work assistants).b. Ryan obtained his own training (i.e., job skills).c. Ryan is paid based on tasks performed.d. Ryan makes his services available to others.e. None of the above.

2197. Chapter 17 - Individuals As Employees And Proprietors Question77 Corey performs services for Sophie. Which, if any, of the following factors indicate that Corey is an independent contractor, rather than an employee?

a. Sophie sets the work schedule.b. Sophie provides the tools used.c. Corey files a Form 2106 with his Form 1040.*d. Corey is paid based on the tasks performed.e. None of the above.

2198. Chapter 17 - Individuals As Employees And Proprietors Question78 Which, if any, of the following factors is not a characteristic of independent contractor status?

a. Services are performed for more than one party.b. Receipt of a Form 1099 reporting payments received.*c. Workplace fringe benefits are available.

d. Work-related income and expenses are reported on Schedule C.e. None of the above.

2199. Chapter 17 - Individuals As Employees And Proprietors Question79 A worker may prefer to be treated as an independent contractor (rather than an employee) for which of the following reasons:

a. Avoids the cutback adjustment as to business meals.b. All of the self-employment tax is deductible for income tax purposes.*c. Work-related expenses are not subject to the 2%-of-AGI floor.d. A Schedule C does not have to be filed.e. None of the above.

2200. Chapter 17 - Individuals As Employees And Proprietors Question80 A worker may prefer to be classified as an employee (rather than an independent contractor) for which of the following reasons:

*a. To avoid the self-employment tax.b. To claim unreimbursed work-related expenses as a deduction for AGI.c. To avoid the cutback adjustment on unreimbursed business entertainment expenses.d. To avoid the 2%-of-AGI floor on unreimbursed work-related expenses.e. None of the above.

2201. Chapter 17 - Individuals As Employees And Proprietors Question81 The taxpayer’s marginal tax bracket is 25%. Which would the taxpayer prefer?

a. $1.00 taxable income rather than $1.00 tax-exempt income.*b. $.80 tax-exempt income rather than $1.00 taxable income.c. $1.25 taxable income rather than $1.00 tax-exempt income.d. $1.30 taxable income rather than $1.00 tax-exempt income.e. None of the above.

2202. Chapter 17 - Individuals As Employees And Proprietors Question82 The exclusion for health insurance premiums paid by the employer applies to:

a. Only current employees.b. Only current employees and their spouses and children.c. Only current and retired former employees.*d. Present employees, retired former employees, and their spouses and children.e. None of the above.

2203. Chapter 17 - Individuals As Employees And Proprietors Question83 Julie was suffering from a viral infection that caused her to miss work

for 90 days. During the first 30 days of her absence, she received her regular salary of $4,000 from her employer. For the next 60 days, she received $6,000 under an accident and health insurance policy purchased by her employer. The premiums on the health insurance policy were excluded from her gross income. During the last 30 days, Julie received $2,000 on an income replacement policy she had purchased. Of the $12,000 she received, Julie must include in gross income:

a. $0.b. $4,000.c. $8,000.*d. $10,000.e. $12,000.

2204. Chapter 17 - Individuals As Employees And Proprietors Question84 All employees of United Company are covered by a group hospitalization insurance plan, but the employees must pay the premiums ($8,000 for each employee). None of the employees has sufficient medical expenses to deduct the premiums. Instead of giving raises next year, United is considering paying the employee’s hospitalization insurance premiums. If the change is made, the employee’s after-tax and insurance pay will:

a. Increase by the same amount for all employees.*b. Increase more for the highly paid employees (35% marginal tax bracket).c. Increase more for the low income (10% and 15% marginal tax bracket) employees.d. Decrease by the same amount for all employees.e. None of the above.

2205. Chapter 17 - Individuals As Employees And Proprietors Question85 The plant union is negotiating with the Eagle Company, which is on the verge of bankruptcy. Eagle has offered to pay for the employees’ hospitalization insurance in exchange for a wage reduction. The employees each currently pay premiums of $4,000 a year for their insurance.

a. If an employee’s wages are reduced by $5,000 and the employee is in the 28% marginal tax bracket, the employee would benefit from the offer.b. If an employee’s wages are reduced by $4,000 and the employee is in the 15% marginal tax bracket, the employee would benefit from the offer.c. If an employee’s wages are reduced by $6,000 and the employee is in the 35% marginal tax bracket, the employee would benefit from the offer.*d. a., b., and c.e. None of the above.

2206. Chapter 17 - Individuals As Employees And Proprietors Question86 James, a cash basis taxpayer, received the following compensation and fringe benefits in 2011:

Salary $66,000Disability income protection premiums 3,000Long-term care insurance premiums 4,000

His actual salary was $72,000. He received only $66,000 because his salary was garnished and the employer paid $6,000 on James’s credit card debt he owed. The wage continuation insurance is available to all employees and pays the employee three-fourths of the regular salary if the employee is sick or disabled. The long-term care insurance is available to all employees and pays $150 per day towards a nursing home or similar facility. What is James’s gross income from the above?

a. $66,000.*b. $72,000.c. $73,000.d. $75,000.e. None of the above.

2207. Chapter 17 - Individuals As Employees And Proprietors Question87 The First Chance Casino has gambling facilities, a bar, a restaurant, and a hotel. All employees are allowed to obtain food from the restaurant at no charge during working hours. In the case of the employees who operate the gambling facilities, bar, and restaurant, 60% of all of Casino’s employees, the meals are provided for the convenience of the Casino. However, the hotel workers, demanded equal treatment and therefore were also allowed to eat in the restaurant at no charge while they are at work. Which of the following is correct?

a. All the employees are required to include the value of the meals in their gross income.b. Only the restaurant employees may exclude the value of their meals from gross income.c. Only the employees who work in gambling, the bar, and the restaurant may exclude the meals from gross income.*d. All of the employees may exclude the value of the meals from gross income.e. None of the above.

2208. Chapter 17 - Individuals As Employees And Proprietors Question88 Section 119 excludes the value of meals from the employee’s gross income:

a. Whenever the employee is working during the normal mealtimes.b. When the employer pays for the meals, if the employee makes an accounting to the employer.*c. When the meals are provided for the employee, on the employer’s business premises, and as a convenience to the employer.d. When the meals are provided for the employee on the employer’s business premises as a convenience to the employee.

e. None of the above.

2209. Chapter 17 - Individuals As Employees And Proprietors Question89 Ridge is the manager of a motel. As a condition of his employment, Ridge is required to live in a room on the premises so that he would be there in case of emergencies. Ridge considered this a fringe benefit, since he would otherwise be required to pay $800 per month rent. The room that Ridge occupied normally rented for $70 per night, or $2,100 per month. On the average, 90% of the motel rooms were occupied. As a result of this rent-free use of a room, Ridge is required to include in gross income.

*a. $0.b. $800 per month.c. $2,100 per month.d. $1,890 ($2,100 ´ .90).e. None of the above.

2210. Chapter 17 - Individuals As Employees And Proprietors Question90 Adam repairs power lines for the Egret Utilities Company. He is generally working on a power line during the lunch hour. He must eat when and where he can and still get his work done. He usually purchases something at a convenience store and eats in his truck. Egret reimburses Adam for the cost of his meals.

*a. Adam must include the reimbursement in his gross income.b. Adam can exclude the reimbursement from his gross income since the meals are provided for the convenience of the employer.c. Adam can exclude the reimbursement from his gross income because he eats the meals on the employer’s business premises (the truck).d. Adam may exclude from his gross income the difference between what he paid for the meals and what it would have cost him to eat at home.e. None of the above.

2211. Chapter 17 - Individuals As Employees And Proprietors Question91 Under the Swan Company’s cafeteria plan, all full-time employees are allowed to select any combination of the benefits below, but the total received by the employee cannot exceed $8,000 a year.

I. Group medical and hospitalization insurance for the employee, $3,600 a year.II. Group medical and hospitalization insurance for the employee’s spouse and children,

$1,200 a year.III. Child-care payments, actual cost but not more than $4,800 a year.IV. Cash required to bring the total of benefits and cash to $8,000.

Which of the following statements is true?

a. Sam, a full-time employee, selects choices II and III and $2,000 cash. His gross income must include the $2,000.b. Paul, a full-time employee, elects to receive $8,000 cash because his wife’s employer provided these same insurance benefits for him. Paul is required to include the $8,000 in gross income.c. Sue, a full-time employee, elects to receive choices I, II and $3,200 for III. Sue is not required to include any of the above in gross income.*d. All of the above.e. None of the above.

2212. Chapter 17 - Individuals As Employees And Proprietors Question92 Heather is a full-time employee of the Drake Company and participates in the company’s flexible spending plan that is available to all employees. Which of the following is correct?

a. Heather reduced her salary by $1,200, actually spent $1,500, and received only $1,200 as reimbursement for her medical expenses. Heather’s gross income will be reduced by $1,500.*b. Heather reduced her salary by $1,200, and received only $900 as reimbursement for her actual medical expenses. She is not refunded the $300 remaining balance, but her gross income is reduced by $1,200.c. Heather reduced her salary by $1,200, and received only $800 as reimbursement for her medical expenses. She is not refunded the $400. Her gross income is reduced by $800.d. Heather reduced her salary by $1,200, and received only $900 as reimbursement for her medical expenses. She forfeits the $300. Her gross income is reduced by $300.e. None of the above.

2213. Chapter 17 - Individuals As Employees And Proprietors Question93 Employees of the Valley Country Club are allowed to use the golf course without charge before and after working hours on Mondays, when the number of players on the course is at its lowest. Tom, an employee of the country club played 40 rounds of golf during the year at no charge when the non-employee charge was $20 per round.

a. Tom must include $800 in gross income.b. Tom must include in gross income the employer’s marginal cost of providing the golf course and equipment.*c. Tom is not required to include anything in gross income because this is a “no-additional-cost service” fringe benefit.d. Tom is not required to include the $800 in gross income because the use of the course was a gift.e. None of the above.

2214. Chapter 17 - Individuals As Employees And Proprietors Question94 The Royal Motor Company manufactures automobiles. Employees of the company can buy a new automobile for Royal’s cost plus 2%. The automobiles are sold to dealers at cost plus 20%. Generally, employees

of Local Dealer, Inc., are allowed to buy a new automobile from the company at the dealer’s cost. Officers of Local Dealer are allowed to use a company vehicle (for personal use) at no cost.

a. None of the employees who take advantage of the fringe benefits described above are required to recognize income.b. Employees of Royal are required to recognize as gross income 18% (20% – 2%) of the cost of the automobile purchased.c. Employees of Local Dealer are required to recognize as gross income the gross profit Local Dealer loses as a result of the sale to the employees.*d. Local Dealer officers must recognize gross income from the personal use of the company vehicles.e. None of the above.

2215. Chapter 17 - Individuals As Employees And Proprietors Question95 Peggy is an executive for the Tan Furniture Manufacturing Company. Peggy purchased furniture from the company for $8,000. The price Tan ordinarily charges a wholesaler is $9,500. The retail price of the furniture was $12,500, and Tan’s cost was $9,000. The company also paid for Peggy’s parking space in a garage near the office. The parking fee was $600 for the year. All employees are allowed to buy furniture at a discounted price comparable to that charged to Peggy. However, the company does not pay other employees’ parking fees. Peggy’s gross income from the above is:

a. $0.*b. $1,000.c. $4,500.d. $6,000.e. None of the above.

2216. Chapter 17 - Individuals As Employees And Proprietors Question96 The employees of Mauve Accounting Services are permitted to use the copy machine for personal purposes, provided the privilege is not abused. Ed is the president of a civic organization and uses the copier to make several copies of the organization’s agenda for its meetings. The copies made during the year would have cost $150 at a local office supply.

a. Ed must include $150 in his gross income.b. Ed may exclude the cost of the copies as a no-additional cost fringe benefit.c. Ed may exclude the cost of the copies only if the organization is a client of Mauve.*d. Ed may exclude the cost of the copies as a de minimis fringe benefit.e. None of the above.

2217. Chapter 17 - Individuals As Employees And Proprietors Question97 The Perfection Tax Service gives employees $12.50 as “supper money” when they are required to work overtime, approximately 25 days each

year. The supper money received:

a. Must be included in the employee’s gross income.b. Must be included in the employee’s gross income if the employee does not spend it for supper.c. May be excluded from the employee’s gross income as a “no-additional cost” fringe benefit.*d. May be excluded from the employee’s gross income as a de minimis fringe benefit.e. None of the above.

2218. Chapter 17 - Individuals As Employees And Proprietors Question98 The president of Silver Corporation is assigned a secretary. When the secretary has completed work on company matters, the secretary is available to do the president’s personal matters (pick up laundry, buy groceries) so long as the privilege is not abused. No other employee has a personal secretary.

a. The value of the secretary’s services provided to the president may be excluded as no-additional-cost services.b. The value of the secretary’s services provided to the president may be excluded because the president did not receive cash.c. The value of the secretary’s services provided to the president may be excluded as no-additional-cost services because the services are not available to all employees.*d. If the value of secretary’s services are considered de minimis, the president may exclude the benefit from gross income even through other employees are not provided the same benefit.e. None of the above.

2219. Chapter 17 - Individuals As Employees And Proprietors Question99 Evaluate the following statements:

I. De minimis fringe benefits are those that are so immaterial that accounting for them is impractical.

II. De minimis fringe benefits are not subject to strict anti-discrimination requirements.III. Generally, a fringe benefit of less than $50 is considered de minimis and can be excluded

from gross income.

a. I, II, and III are true.b. Only III is true.c. Only I and III are true.*d. Only I and II are true.e. None of the above.

2220. Chapter 17 - Individuals As Employees And Proprietors Questio100 Kristen’s employer owns its building and provides parking space for its employees. The value of the free parking is $150 per month. Karen’s

employer does not have parking facilities, but reimburses its employee for the cost of parking in a nearby garage, up to $150 per month.

a. Kristen and Karen must recognize gross income from the parking services.b. Kristen can exclude the employer provided parking from gross income, but Karen must include her reimbursement in gross income.c. Kristen must include the value of the employer provided parking from her gross income, but Karen can exclude her reimbursement from gross income.*d. Neither Kristen nor Karen is required to include the cost of parking in gross income.e. None of the above.

2221. Chapter 17 - Individuals As Employees And Proprietors Questio101 .1In the case of a fringe benefit plan that is discriminatory (e.g., the plan favors officers over other employees),

a. All employees must include all benefits received in gross income.*b. De minimis fringes may be excluded from gross income.c. The value of a parking space provided (value of $100 per month) must be included in gross income.d. Those who are being discriminated against can exclude a certain portion of their cash compensation from gross income to achieve parity.e. None of the above.

2222. Chapter 17 - Individuals As Employees And Proprietors Questio102 A U.S. citizen worked in a foreign country for the period July 1, 2010 through August 1, 2011. Her salary was $10,000 per month. Also, in 2010 she received $5,000 in dividends from foreign corporations (not qualified dividends). No dividends were received in 2011. Which of the following is correct?

a. The taxpayer can exclude $60,000 from U.S. gross income for 2010 because the total salary earned in the foreign country in 2010 was less than the annual foreign earned income exclusion, but the dividends of $5,000 must be included in gross income.*b. The taxpayer can exclude a portion of the compensation income from U.S. gross income in 2010 and 2011, but must include the dividend income of $5,000 in gross income. c. The taxpayer can exclude from U.S. gross income $60,000 salary in 2010, but in 2010 the taxpayer will exceed the twelve month limitation and, therefore, all of the 2011 compensation must be included in gross income. All of the dividends must be included in 2010 gross income.d. The taxpayer can exclude a portion of the salary from U.S. gross income in 2010 and 2011, and all of the dividend income.e. None of the above.

2223. Chapter 17 - Individuals As Employees And Proprietors Questio103 Louise works in a foreign branch of her employer’s business. She earned $5,000 per month throughout the relevant period.

*a. If Louise worked in the foreign branch from May 1, 2011 until October 31, 2012, she may exclude $40,000 from gross income in 2011 and exclude $50,000 in 2012.b. If Louise worked in the foreign branch from May 1, 2011 until October 31, 2012, she cannot exclude anything from gross income because she was not present in the country for 330 days in either year.c. If Louise began work in the foreign country on May 1, 2011, she must work through November 30, 2012 in order to exclude $55,000 from gross income in 2012 but none in 2011.d. Louise will not be allowed to exclude any foreign earned income because she made less than $92,900.e. None of the above.

2224. Chapter 17 - Individuals As Employees And Proprietors Questio104 Michael is the city sales manager for “Chick-Stick,” a national fast food franchise. Every working day, Michael drives his car as follows:

MilesHome to office 20Office to Chick-Stick No. 1 15Chick-Stick No. 1 to No. 2 18Chick-Stick No. 2 to No. 3 13Chick-Stick No. 3 to home 30

Michael’s deductible mileage is:

a. 76 miles.*b. 46 miles.c. 30 miles.d. 0 miles.e. None of the above.

2225. Chapter 17 - Individuals As Employees And Proprietors Questio105

Aaron is a self-employed practical nurse who works out of his home. He provides nursing care for disabled persons living in their residences. During the day he drives his car as follows.

MilesAaron’s home to patient Louise 12Patient Louise to patient Carl 4Patient Carl to patient Betty 6Patient Betty to Aaron’s home 10

Aaron’s deductible mileage for each workday is:

*a. 32 miles.b. 22 miles.c. 20 miles.d. 12 miles.e. 10 miles.

2226. Chapter 17 - Individuals As Employees And Proprietors Questio106 When using the automatic mileage method, which, if any, of the following expenses also can be claimed?

a. Engine tune-up.b. Auto insurance.*c. Toll charges.d. MACRS depreciation.e. None of the above.

2227. Chapter 17 - Individuals As Employees And Proprietors Questio107 In which, if any, of the following situations is the automatic mileage available?

a. A limousine to be rented by the owner for special occasions (e.g., weddings, high school proms).b. The auto belongs to taxpayer’s mother.c. One of seven cars used to deliver pizzas.*d. MACRS statutory percentage method has not been claimed on the automobile.e. None of the above.

2228. Chapter 17 - Individuals As Employees And Proprietors Questio108 Under the actual expense method, which, if any, of the following expenses will not be allowed?

a. Car registration fees.b. Interest expense on a car loan (taxpayer is self-employed).c. Auto insurance.d. Dues to auto clubs.*e. Parking fines incurred during business use.

2229. Chapter 17 - Individuals As Employees And Proprietors Questio109 Bill is the regional manager for a national chain of auto-parts stores and is based in Salt Lake City. When the company opens new stores in Boise, Bill is given the task of supervising their initial operation. For three months, he works weekdays in Boise and returns home on weekends. He spends $410 returning to Salt Lake City but would have spent $390 had he stayed in Boise for the weekend. As to the weekend trips, how much, if any, qualifies as a deduction?

a. $0, since the trips are personal and not work related.b. $0, since Bill’s tax home has changed from Salt Lake City to Boise.*c. $390.d. $410.e. None of the above.

2230. Chapter 17 - Individuals As Employees And Proprietors Questio110 During the year, Walt went from Louisville to Hawaii on business. Preceding a five-day business meeting, he spent four days vacationing at the beach. Excluding the vacation costs, his expenses for the trip are:

Air fare $3,200Lodging 900Meals 800Entertainment 600

Presuming no reimbursement, deductible expenses are:

a. $5,500.*b. $4,800.c. $3,900.d. $3,200.e. None of the above.

2231. Chapter 17 - Individuals As Employees And Proprietors Questio111 During the year, Peggy went from Nashville to Quito (Ecuador) on business. She spent four days on business, two days on travel, and four days on vacation. Disregarding the vacation costs, Peggy’s unreimbursed expenses are:

Air fare $3,000Lodging 800Meals 600Entertainment 400

Peggy’s deductible expenses are:

a. $2,500.b. $2,800.*c. $3,100.d. $4,300.e. None of the above.

2232. Chapter 17 - Individuals As Employees And Proprietors Questio112 During the year, Oscar travels from Raleigh to Moscow (Russia) on business. His

time was spent as follows: 2 days travel (one day each way), 2 days business, and 2 days personal. His expenses for the trip were as follows (meals and lodging reflect only the business portion):

Air fare $3,000Lodging 2,000Meals and entertainment 1,000

Presuming no reimbursement, Oscar’s deductible expenses are:

a. $6,000.*b. $5,500.c. $4,500.d. $3,500.e. None of the above.

2233. Chapter 17 - Individuals As Employees And Proprietors Questio113 In terms of meeting the distance test for purposes of deducting moving expenses, which of the following statements is correct?

a. The taxpayer’s new job location must be at least 50 miles away from the old job.b. The taxpayer’s new residence must be at least 50 miles away from the new job.*c. The taxpayer’s new job location must be at least 50 miles farther from the old residence than the old residence was to the old job.d. The taxpayer’s new residence must be at least 50 miles away from the old residence.e. None of the above.

2234. Chapter 17 - Individuals As Employees And Proprietors Questio114 Due to a merger, Allison transfers from Miami to Chicago. Under a new job description, she is reclassified from employee to independent contractor status. Her moving expenses, which are not reimbursed, are as follows:

Transportation $1,400Meals 400Lodging 500Cost of moving household goods 4,000Penalty for breaking lease on Miami apartment 3,000

Allison’s deductible moving expense is:

a. $9,300.b. $8,900. c. $6,100.

*d. $5,900.e. None of the above.

2235. Chapter 17 - Individuals As Employees And Proprietors Questio115 Carolyn is single and has a college degree in finance. She is employed as a loan officer at a bank; her yearly AGI approximates $50,000. During 2010, she enrolled in a weekend MBA program and incurred the following nonreimbursed expenses: $3,900 (tuition), $300 (books), $200 (other school supplies), and $200 (transportation to and from campus). Disregarding the 2%-of-AGI limitation, as to the MBA program, Carolyn has a:

a. Deduction for and deduction from AGI of $0.*b. Deduction for AGI of $3,900 and deduction from AGI of $700.c. Deduction for AGI of $4,000 and deduction from AGI of $600.d. Deduction for AGI of $4,100 and deduction from AGI of $500.e. None of the above.

2236. Chapter 17 - Individuals As Employees And Proprietors Questio116 The § 222 deduction for tuition and related expenses is available:

a. Only if the taxpayer itemizes deductions from AGI.b. To deduct that portion of the tuition in excess of that allowed under the lifetime learning credit.c. To cover the tuition of a son who does not qualify as taxpayer’s dependent.d. Only if job related.*e. None of the above.

2237. Chapter 17 - Individuals As Employees And Proprietors Questio117 The § 222 deduction for tuition and related expenses is available:

a. Regardless of the amount of a taxpayer’s MAGI.b. To cover room and board expenses to attend college.c. To a married taxpayer filing a separate return.*d. Even if a taxpayer does claim the standard deduction.e. None of the above.

2238. Chapter 17 - Individuals As Employees And Proprietors Questio118 Henry entertains several of his key clients on January 1 of the current year. Expenses paid by Henry are as follows:

Cab fare $ 60Cover charge at supper club 200Dinner at club 800Tips to waiter 160

Presuming proper substantiation, Henry’s deduction is:

a. $1,220.b. $740.*c. $640.d. $610.e. None of the above.

2239. Chapter 17 - Individuals As Employees And Proprietors Questio119 Ralph made the following business gifts during the year.

To Robert (a key client) at Christmas $50To Angel (Robert’s 8-year old daughter) on her birthday 20To Art (Ralph’s secretary) on his birthday ($3 was for gift wrapping) 30To Paige (Ralph’s boss) at Christmas 40

Presuming proper substantiation, Ralph’s deduction is:

a. $0.*b. $53.c. $73.d. $78.e. $98.

2240. Chapter 17 - Individuals As Employees And Proprietors Questio120 Which of the following expenses, if any, qualify as deductible?

a. Contributions to a Coverdell Education Savings Account (CESA).b. Contributions to a qualified tuition program (§ 529 plan).c. Job hunting expense of FBI agent who applies for the job of city manager of Beaumont (TX).d. Contribution to a Roth IRA.*e. None of the above.

2241. Chapter 17 - Individuals As Employees And Proprietors Questio121 Which, if any, of the following expenses is subject to the 2%-of-AGI floor?

a. Qualified tuition expenses under § 222.b. Contribution to traditional IRA.c. Cost of a CPA exam review course—taxpayer just began employment with an accounting firm.*d. Office in the home deduction for an employee.e. None of the above.

2242. Chapter 17 - Individuals As Employees And Proprietors Questio122 One of the tax advantages of being self-employed (rather than being an

employee) is:

a. The self-employment tax is lower than the Social Security tax.b. The cutback adjustment does not apply.*c. Job-related expenses are deductions for AGI.d. The actual cost method for deducting the business use of an automobile can be selected.e. A deduction for an office in the home is available.

2243. Chapter 17 - Individuals As Employees And Proprietors Questio123 Which of the following correctly reflects current rules regarding estimated tax payments for individuals?

a. Employees are not subject to the estimated tax payment provisions.b. Any penalty imposed for underpayment is deductible for income tax purposes.c. Married taxpayers may not make joint estimated tax payments unless they file a joint income tax return.*d. No quarterly payments are required if the taxpayer’s estimated tax is under $1,000.e. None of the above.

2244. Chapter 17 - Individuals As Employees And Proprietors Questio124 During 2011, Eleanor earns $110,000 in wages as an employee of an accounting firm. She also earns $13,000 in gross income from an outside consulting service she operates. Deductible expenses paid in connection with the consulting service amount to $3,000. Eleanor also has a recognized long-term capital gain of $1,000 from the sale of a stock investment. She must pay a self-employment tax on:

a. $0.*b. $10,000.c. $13,000.d. $14,000.e. None of the above.

2245. Chapter 17 - Individuals As Employees And Proprietors Questio125 Pat generated self-employment income in 2011 of $70,000. The self-employment tax is:

a. $0.*b. $8,597.79.c. $9,310.00.d. $9,890.69.e. None of the above.

2246. Chapter 17 - Individuals As Employees And Proprietors Questio126 The ceiling amounts and percentages for 2011 for the two portions of the self-employment tax are:

Social Security portion Medicare portion

a. $106,800; 13.3% Unlimited; 2.9%b. $106,800; 12.4% Unlimited; 15.3%*c. $106,800; 10.4% Unlimited; 2.9%d. $106,800; 10.4% Unlimited; 13.3%e. None of the above.

2247. Chapter 17 - Individuals As Employees And Proprietors Questio127 Merrill is a participant in a SIMPLE § 401(k) plan, and he elects to contribute 4% of his $40,000 compensation to the account, while his employer contributes 3%. What amount will not vest immediately, if any?

*a. $0.b. $1,200.c. $1,600.d. $2,800.e. None of the above.

2248. Chapter 17 - Individuals As Employees And Proprietors Questio128 Susan is a self-employed accountant with a qualified defined

contribution plan (a Keogh plan). She has the following income items for the year:

Earned income from self-employment $50,000Dividend income 8,000Interest income 2,000Net short-term capital gain 12,000Adjusted gross income 72,000

What is the maximum amount Susan can deduct as a contribution to her retirement plan in 2011, assuming the self-employment tax rate is 15.3%?

a. $9,235.b. $12,000.c. $46,000.*d. $46,468.e. None of the above.

2249. Chapter 17 - Individuals As Employees And Proprietors Questio129 Joyce, age 39, and Sam, age 40, who have been married for seven years, are both active participants in qualified retirement plans. Their total AGI for 2011 is $120,000. Each is employed and earns a salary of $65,000. What are their combined deductible contributions to traditional IRAs?

*a. $0.b. $3,000.

c. $4,000.d. $8,000.e. None of the above.

2250. Chapter 17 - Individuals As Employees And Proprietors Questio130 Donna, age 27 and unmarried, is an active participant in a qualified retirement plan. Her AGI is $113,000. What amount, if any, may Donna contribute to a Roth IRA in 2011?

a. $0.*b. $3,000.c. $4,000.d. $5,000.e. None of the above.

2251. Chapter 17 - Individuals As Employees And Proprietors Questio131 Sammy, age 31, is unmarried and is not an active participant in a qualified retirement plan. His modified AGI is $55,000 in 2011. The maximum amount that Sammy can deduct for a contribution to a traditional IRA is:

a. $2,800.b. $3,500.c. $4,000.*d. $5,000.e. None of the above.

2252. Chapter 17 - Individuals As Employees And Proprietors Questio132 Marie establishes a Roth IRA at age 40 and contributes the maximum amount per year to the Roth IRA for 25 years. The account is now worth $199,000, consisting of $75,000 in contributions plus $124,000 in accumulated earnings. How much can Marie withdraw tax free in 2011?

a. $0.b. $75,000.c. $124,000.*d. $199,000.e. None of the above.

2253. Chapter 17 - Individuals As Employees And Proprietors Questio133 Tony receives a $2,000 distribution from a CESA. On this date, the total balance is $20,000, with $8,000 representing earnings. If his qualified higher education expenses are $2,195, what amount can he exclude from gross income?

a. None.b. $800.c. $1,200.*d. $2,000.e. Some other amount.

2254. Chapter 17 - Individuals As Employees And Proprietors Questio134 Harry receives a $10,000 distribution from a CESA. On this date, his total account balance is $16,000, with $4,000 representing earnings. If his qualified higher education expenses are $8,000, the amount included in gross income is:

a. None.*b. $500.c. $2,000.d. $2,500.e. None of the above.

2255. Chapter 17 - Individuals As Employees And Proprietors Questio135 What is the maximum amount Velvia can contribute to a Coverdell Education Savings Account (CESA) on behalf of a grandson in 2011? She is single with an AGI of $99,000.

a. $0.b. $500.*c. $1,467.d. $2,000.e. None of the above.

2256. Chapter 17 - Individuals As Employees And Proprietors Questio136 Which of the following is relevant in deciding whether an activity is profit-seeking or a hobby?

a. The time and effort expended.b. The expertise of the taxpayers or their advisers.c. The history of income or losses from the activity.d. The tax benefits of the activity to the taxpayer.*e. All of the above factors are to be considered.

2257. Chapter 17 - Individuals As Employees And Proprietors Questio137 For an activity classified as a hobby, the expenses are categorized as follows:

(1) Amounts that affect adjusted basis and would be deductible under other Code sections if the activity had been engaged in for profit (e.g., depreciation, amortization, and depletion).

(2) Amounts deductible under other Code sections without regard to the nature of the activity, such as property taxes and home mortgage interest.

(3) Amounts deductible under other Code sections if the activity had been engaged in for profit, but only if those amounts do not affect adjusted basis (e.g., maintenance, utilities, and supplies).

If these expenses exceed the gross income from the activity and are

thus limited, the sequence in which they are deductible is:

a. (1), (2), (3).b. (1), (3), (2).*c. (2), (3), (1).d. (2), (1), (3).e. (3), (2), (1).

2258. Chapter 17 - Individuals As Employees And Proprietors Questio138 Priscella pursued a hobby of making bedspreads in her spare time. Her AGI before considering the hobby is $40,000. During the year she sold the bedspreads for $10,000. She incurred expenses as follows:

Supplies $4,000Interest on loan to get business started 500Advertising 6,500

Assuming that the activity is deemed a hobby, how should she report these items on her tax return?

a. Include $10,000 in income and deduct $11,000 for AGI.b. Ignore both income and expenses since hobby losses are disallowed.*c. Include $10,000 in income, deduct nothing for AGI, and claim $10,000 of the expenses as itemized deductions.d. Include $10,000 in income and deduct interest of $500 for AGI.e. None of the above.

2259. Chapter 17 - Individuals As Employees And Proprietors Questio139 Al performs services for Jan. Regarding this arrangement, use the legend provided to classify each statement.The services are performed at Al’s premises.Al does no work for other parties.Al determines when the services are to be performed.Al has no unreimbursed expenses.Al was trained by Jan.Al uses Jan’s helpers.Al charges by the hour for his work.Al files a Form 2106 with his Form 1040.Al files a Schedule SE with his Form 1040.Al uses Jan’s tools.Indicates independent contractor status. Indicates employee status. Indicates independent contractor status. Indicates employee status. Indicates employee status. Indicates employee status. Indicates employee status. Indicates employee status. Indicates independent contractor status. Indicates employee status.

[a] 1. The services are performed at Al’s premises.[b] 2. Al does no work for other parties.[c] 3. Al determines when the services are to be performed.[d] 4. Al has no unreimbursed expenses.[e] 5. Al was trained by Jan.[f] 6. Al uses Jan’s helpers.[g] 7. Al charges by the hour for his work.[h] 8. Al files a Form 2106 with his Form 1040.[i] 9. Al files a Schedule SE with his Form 1040.

[j] 10. Al uses Jan’s tools.

a. Indicates independent contractor status.b. Indicates employee status.c. Indicates independent contractor status.d. Indicates employee status.e. Indicates employee status.f. Indicates employee status.g. Indicates employee status.h. Indicates employee status.i. Indicates independent contractor status.j. Indicates employee status.

2260. Chapter 17 - Individuals As Employees And Proprietors Questio140 Match the statements that relate to each other. (Note: Choice L may be used more than once.)Characteristic of a taxpayer who has the status of an employeeCharacteristic of a taxpayer who is self-employedActual cost method of determining auto expenseAutomatic mileage methodDeductible moving expenseNondeductible moving expenseMixed (both business and pleasure) foreign travelEducation expense that is not deductible to maintain or improve existing skillsTax home has not changedDeductible job-hunting expensesDeduction by an employee of unreimbursed office-in-the-home expensesSafety goggles purchased by an employed carpenterPayment for services rendered based on hours worked Taxpayer provides his own tools and helper Can include actual cost of parking Excludes use of MACRS depreciation Lodging while in route Meals while in route Transportation must be allocated if taxpayer spends two weeks on business and one week sightseeing Paralegal obtains a law degree Out-of-town job assignment is temporary Must involve the same trade or business Must be for the convenience of the employer Correct match not provided

[a] 1. Characteristic of a taxpayer who has the status of an employee

[b] 2. Characteristic of a taxpayer who is self-employed[c] 3. Actual cost method of determining auto expense[d] 4. Automatic mileage method[e] 5. Deductible moving expense[f] 6. Nondeductible moving expense[g] 7. Mixed (both business and pleasure) foreign travel[h] 8. Education expense that is not deductible to maintain or

improve existing skills[i] 9. Tax home has not changed[j] 10. Deductible job-hunting expenses[k] 11. Deduction by an employee of unreimbursed office-in-

the-home expenses[l] 12. Safety goggles purchased by an employed carpenter

a. Payment for services rendered based on hours workedb. Taxpayer provides his own tools and helperc. Can include actual cost of parkingd. Excludes use of MACRS depreciatione. Lodging while in routef. Meals while in routeg. Transportation must be allocated if taxpayer spends two

weeks on business and one week sightseeingh. Paralegal obtains a law degreei. Out-of-town job assignment is temporaryj. Must involve the same trade or businessk. Must be for the convenience of the employerl. Correct match not provided

2261. Chapter 17 - Individuals As Employees And Proprietors Questio141 |Match the statements that relate to each other. (Note: Choice L may be used more than once.)Actual cost method of determining car expenseDistance test (for moving expenses) not satisfiedTime test (for moving expenses) waivedTraditional IRAsKeogh (H.R. 10) plansCutback adjustment appliesCutback adjustment does not applyDeemed substantiationJob hunting expensesQualified tuition and related expenses (under § 222)Club dues deductibleClub dues not deductibleCan include cost of car insurance and automobile club dues Taxpayer moves to a new residence 55 miles closer to his present job Expatriate (U.S. person who is employed overseas) returns home to retire Contribution to plan is deductible Contribution to plan is deductible Cover charge paid to entertain client at a night club Company picnic sponsored by employer Use of Federal per diem allowance to substantiate meals while in travel status Deductible even if taxpayer does not take the new job Correct match not provided Correct match not provided Country club membership fee Does have to be job related Contribution to plan is not deductible

[a] 1. Actual cost method of determining car expense[b] 2. Distance test (for moving expenses) not satisfied[c] 3. Time test (for moving expenses) waived[d] 4. Traditional IRAs[e] 5. Keogh (H.R. 10) plans[f] 6. Cutback adjustment applies[g] 7. Cutback adjustment does not apply[h] 8. Deemed substantiation[i] 9. Job hunting expenses[j] 10. Qualified tuition and related expenses (under § 222)[k] 11. Club dues deductible[l] 12. Club dues not deductible

a. Can include cost of car insurance and automobile club duesb. Taxpayer moves to a new residence 55 miles closer to his

present jobc. Expatriate (U.S. person who is employed overseas) returns

home to retired. Contribution to plan is deductiblee. Contribution to plan is deductiblef. Cover charge paid to entertain client at a night clubg. Company picnic sponsored by employerh. Use of Federal per diem allowance to substantiate meals

while in travel statusi. Deductible even if taxpayer does not take the new jobj. Correct match not providedk. Correct match not providedl. Country club membership feem. Does have to be job related

n. Contribution to plan is not deductible

2262. Chapter 17 - Individuals As Employees And Proprietors Question P George is employed by the Quality Appliance Company. All the full time employees are allowed to purchase appliances at the company’s cost plus 10%. The employee also is given, at no cost, a 1-year service contract on all the goods purchased from the company. George purchased a refrigerator for $500. The company’s normal selling price for the refrigerator is $800. George also received a service contract, at no charge, that had a value of $150. During the year, George was required to have his refrigerator serviced once. The cost of the call would have been $75 if he had not had the service contract. Is George required to recognize any income from the purchase of the refrigerator, the receipt of the service contract, and the service call?

Correct Answer:George will probably be required to recognize $120 income from the service contract. The company can sell the service contract to an employee at a 20% discount and the employee is not required to recognize income. George received a 100% discount; therefore, $120 (80% ´ $150) must be included in his gross income. However, George can perhaps make a convincing argument that he is merely receiving a no-additional-cost service, and thus would not be required to recognize income. George will not be required to recognize income from the bargain purchase of the refrigerator because he paid more than the employer’s cost.

2263. Chapter 17 - Individuals As Employees And Proprietors Questio142 Sonja is a United States citizen who has worked in Spain for the past 10 months. She received $5,000 a month as compensation. Her employer has offered to extend Sonja’s contract to work in Spain for another 5 months at the same rate of pay. If she rejects the offer, she can return to the United States and receive the same salary. While working in Spain, she is subject to the Spain income tax, which is approximately 11% of her gross pay. The marginal tax rate on her income taxed in the United States is 25%. Compare Sonja’s after-tax income assuming she remains in Spain with her after-tax income if she returns to the United States.

Correct Answer:If Sonja returns to the United States, she will not be present in the foreign country for the requisite period (at least 330 days during any 12 consecutive months). Thus, she will not be eligible for the foreign earned income exclusion. Her income will be subject to the 25% rate in the United States. Although she will be given credit for the taxes paid in Spain, the net effect of not extending the stay is to increase her tax rate from 11% to 25% on her income for the 15-month period (the original 10 months plus the additional 5 months under consideration). This would cost her $10,500 [(.25 – .11) ´ (15 ´ $5,000)] in additional taxes.

2264. Chapter 17 - Individuals As Employees And Proprietors Questio143 Eva holds two jobs and attends graduate school on weekends. The

education improves her skills, but does not qualify her for a new trade of business. Before going to the second job, she returns home for dinner. Relevant mileage is as follows?

Home to first job 10 milesFirst job to second job 14 milesHome to second job 12 milesHome to university 8 miles

How much of the mileage qualifies for deduction purposes?

Correct Answer:30 miles. The mileage from the first job to the second job, 14 miles, qualifies. Also, round trip mileage to the university (16 miles) can be claimed if the education Eva is obtaining is deductible.

2265. Chapter 17 - Individuals As Employees And Proprietors Questio144 During 2011, Marcie used her car as follows: 13,000 miles (business), 2,400 miles (commuting), and 5,000 miles (personal). In addition, she spent $540 for tolls (business) and $410 for parking (business). If Marcie uses the automatic mileage method, what is the amount of her deduction?

Correct Answer:$7,580. (13,000 miles ´ $0.51) + $540 + $410 = $7,580.

2266. Chapter 17 - Individuals As Employees And Proprietors Questio145 Elsie lives and works in Detroit. She is the regional sales manager for a national fast-food chain. Due to unusual developments, she is compelled to work six straight weeks in the Cleveland area. Instead of spending the weekend there, she flies home every Friday night and returns early Monday morning. The cost of coming home for the weekend approximates $600. Had she stayed in Cleveland, deductible meals and lodging would have been $700. How much, if any, may Elsie deduct as to each weekend?

Correct Answer:$600 for each weekend, the lesser of the $600 cost of returning home or the $700 cost of staying in Cleveland.

2267. Chapter 17 - Individuals As Employees And Proprietors Questio146

Alfredo, a self-employed patent attorney, flew from his home in Chicago to Miami, had lunch alone at the airport, conducted business in the afternoon, and returned to Chicago in the evening. His expenses were as follows:

Airfare $900Airport parking (Chicago) 60Lunch 30

Taxis (Miami) 42

What is Alfredo’s deductible expense for the trip?

Correct Answer:$1,002 ($900 + $60 + $42). As Alfredo was not away from home, his lunch is not deductible.

2268. Chapter 17 - Individuals As Employees And Proprietors Questio147 Gwen went to Paris on business. While there, she spent 60% of the time on business and 40% on vacation. How much of the air fare of $4,000 can she deduct based on the following assumptions:

a. Gwen was gone five days (i.e., three business and two personal).

b. Gwen was gone six weeks (i.e., three business and three personal).

Correct Answer:a. $4,000.

b. $2,000. (50% ´ $4,000).

Transportation costs for mixed use (i.e., both business and personal) need not be allocated as long as domestic trips are involved. Such allocation is necessary, however, for foreign trips unless one of two exceptions applies. One exception deals with trips lasting seven days or less and covers part a. (but not part b.) above. The second exception, less than 25% of the time was for personal use, does not apply to part b., so an allocation must be made.

2269. Chapter 17 - Individuals As Employees And Proprietors Questio148 Nicole moved from California to Dallas to accept a better job. She incurred the following unreimbursed moving expenses:

Transportation $3,000Lodging 600Meals in route 700Penalty for breaking apartment lease 3,000Forfeiture of athletic club membership 600Moving company cost 8,000

What is Nicole’s moving expense deduction?

Correct Answer:$11,600 ($3,000 + $600 + $8,000). Meals ($700), lease penalty ($3,000), and membership forfeiture ($600) are not qualifying moving expenses.

2270. Chapter 17 - Individuals As Employees And Proprietors Questio149 After graduating from college, Arnold obtained employment in Baltimore. In moving from his parents’ home in Omaha to Baltimore, Arnold incurred the following expenses:

Transportation $ 900Meals 480Lodging 520Cost of moving household goods 2,500

a. How much may Arnold deduct as moving expense?

b. Would any deduction be allowed if Arnold claimed the standard deduction for the year of the move? Explain.

Correct Answer:a. $3,920 ($900 + $520 + $2,500). No deduction is allowed for meals. b. Yes. Moving expenses are deductions for AGI and can be claimed regardless of

whether a taxpayer takes the standard deduction or chooses to itemize.

2271. Chapter 17 - Individuals As Employees And Proprietors Questio150 Evan is employed as an assistant manager in the furniture division of a national chain of department stores. He is a recent college graduate with a degree in marketing. During 2011, he enrolls in the evening MBA program of a local university and incurs the following expenses: tuition, $4,300; books and computer supplies, $900; transportation expense to and from the university, $350; and meals while on campus, $300. Evan is single and his annual AGI is less than $65,000. As to these expenses, what are Evan’s:

a. Deductions for AGI?

b. Deductions from AGI?

Correct Answer:a. $4,000. Although the tuition was $4,300, § 222 imposes a limitation of $4,000 for tax year

2010.

b. $1,550. $300 (excess tuition not allowed under § 222) + $900 (books and computer supplies) + $350 (transportation) = $1,550. No deduction is allowed for meals, since Evan is not in travel status. Further adjustment will be required due to the 2%-of-AGI limitation on certain itemized deductions.

2272. Chapter 17 - Individuals As Employees And Proprietors Questio151 Cathy takes five key clients to a nightclub and incurs the following costs: $320 limousine rental, $460 cover charge, $920 drinks and dinner, and $200 tips. Several days after the function, Cathy mails each client a pen costing $25. The cost includes $4 for engraving of the client’s name. Assuming adequate substantiation and a business justification, what is Cathy’s deduction?

Correct Answer:$1,255. $320 + [($460 + $920 + $200) ´ 50%] = $1,110. Also allowed are the gifts of $145 (5 ´ $29). The cost of engraving ($4) can be added to the maximum amount of gift allowed ($25).

2273. Chapter 17 - Individuals As Employees And Proprietors Questio152 Brian makes gifts as follows:

Recipient Cost of Gift

Mr. Brown (a client) $27*Mrs. Brown (Mr. Brown’s wife) 15Ms. Smith (Brian’s receptionist) 30Mr. Jones (Brian’s boss) 40

* Includes $2 for engraving

Presuming adequate substantiation and no reimbursement, how much may Brian deduct?

Correct Answer:$52 ($27 + $25). The deduction for Mr. Brown’s gift can include nominal costs for gift-wrapping and engraving. No deduction is allowed for the gift to Mrs. Brown unless she is in a separate business. Otherwise, she falls under the $25 limit applicable to Mr. Brown. The deduction for Ms. Smith’s gift is limited to $25. No deduction is allowed for Brian’s gift to his boss.

2274. Chapter 17 - Individuals As Employees And Proprietors Questio153 Rocky has a full-time job as an electrical engineer for the city utility. In his spare time, Rocky repairs TV sets in the basement of his personal residence. Most of his business comes from friends and referrals from former customers, although occasionally he runs an ad in the local suburbia newspaper. Typically, the sets are dropped off at Rocky’s house and later picked up by the owner when notified that the

repairs have been made.

The floor space of Rocky’s residence is 2,500 square feet, and he estimates that 20% of this is devoted exclusively to the repair business. Gross income from the business is $13,000, while expenses (other than home office) are $5,000. Expenses relating to the residence are as follows:

Real property taxes $4,500Interest on home mortgage 8,000Operating expenses of residence 3,000Depreciation (based on 20% business use) 1,000

What is Rocky’s net income from the repair business?

Correct Answer:Business income $13,000 Less: Expenses (5,000) Net business income before home office expenses $ 8,000 Less: Real property taxes ($4,500 ´ 20%) (900) Mortgage interest ($8,000 ´ 20%) (1,600) Operating expenses ($3,000 ´ 20%) (600) Depreciation (1,000) Net income from business $ 3,900

2275. Chapter 17 - Individuals As Employees And Proprietors Questio154 In the current year, Bo accepted employment with a Kansas City law firm after graduating from law school. Her expenses for the year are listed below:

Cost of bar review course $1,500Qualified moving expenses 2,100Job hunting expenses 1,800Subscriptions to legal journals 450Membership dues in bar associations 620State bar dues 300

Since Bo worked just part of the year, her salary was only $32,100. In terms of deductions from AGI, how much does Bo have?

Correct Answer:$770. AGI is $30,000 [$32,100 (salary) – $2,100 (moving expenses)]. Thus, the 2%-of-AGI floor is $600 ($30,000 ´ 2%). Qualifying itemized deductions are $1,370 ($450 + $620 + $300). Thus, $1,370 – $600 = $770 is the allowable itemized deduction. No deduction is allowed for the bar review course and the job hunting expenses. In this case, it is apparent that Bo should claim the standard deduction and not itemize.

2276. Chapter 17 - Individuals As Employees And Proprietors Questio155 Susan generated $55,000 of net earnings from the conduct of a tax preparation business that she operated during the tax-filing season. She also received wages of $60,000 from her full-time job. Compute the self-employment taxes due for 2011.

Correct Answer:

Self-employment earnings subject to the Social Security portion of the self-employment tax:

Ceiling amount $106,800.00 Less: FICA wages (60,000.00) Net ceiling $ 46,800.00

Net self-employment income ($55,000 ´ 92.35%) $ 50,792.50 Lesser of net ceiling or net self-employment income $ 46,800.00 Social Security portion of the tax ($46,800 ´ 10.4%) $ 4,867.20 Self-employment earnings subject to the Medicare portion of the self- employment tax: $50,792.50 ´ 2.9% 1,472.98 Total self-employment tax $ 6,340.18

2277. Chapter 17 - Individuals As Employees And Proprietors Questio156 Calculate the net income includible in taxable income for the following hobby:

Income $23,000 Mortgage interest and property taxes allocable to hobby 12,000 Depreciation 4,000 Supplies and fees 7,000 Telephone for hobby 3,000

Correct Answer:Income (includible in gross income) $23,000 Itemized deductions: Mortgage interest and property taxes $12,000 Supplies and fees 7,000 Telephone 3,000 Depreciation (limited to $23,000 – $12,000 – $7,000 – $3,000) 1,000 (23,000) $ –0–

Otherwise deductible expenses must be deducted first; only enough other expenses are allowed to offset the remaining income. Deductions affecting depreciable basis are taken last. The mortgage interest and

property taxes are deductible as itemized deductions and the other hobby-related expenses are subject to the 2%-of-AGI floor. Once the taxpayer’s AGI is determined, the effect of the 2%-of-AGI floor on itemized deductions can be calculated.

2278. Chapter 17 - Individuals As Employees And Proprietors Question E If a business retains someone to provide services, that person may either be an employee or be self-employed (i.e., independent contractor).

a. What are the tax advantages to the business of having the service provider classified as self-employed?

b. What are the advantages and disadvantages to the service provider of self-employed status?

Correct Answer:a. Self-employed persons do not have to be included in various fringe benefits programs (e.g.,

group-term life insurance, accident and health plans) and retirement plans. Since they are not covered by FICA and FUTA, these payroll costs are avoided.

b. The advantages are that expenses qualify as deductions for AGI. Consequently, deductibility is not affected by the choice of the standard deduction, and no reduction is required for the 2%-of-AGI floor. In terms of disadvantages, being self-employed can lead to other state and local taxes (e.g., license fees, franchise taxes, occupation taxes, gross receipts levy). The most significant, however, is the self-employment tax that materializes.

2279. Chapter 17 - Individuals As Employees And Proprietors Questio157 Ben was hospitalized for back problems. While he was away from the job, he collected his regular salary from an employer-sponsored income protection insurance policy. Ben’s employer-sponsored hospitalization insurance policy also paid for 90% of his medical expenses. Ben also collected on an income protection policy that he purchased. Which of the above sources of income are taxable? Explain the basis for excluding any item or items.

Correct Answer:Only the collections on the employer-sponsored income protection policy are subject to tax. The hospitalization benefits received from the employer sponsored plan are specifically excluded. Both the premiums and the payments can be excluded. The amounts Ben collected on a policy he purchased are specifically excluded under the rationale that the payments are a recovery of Ben’s premiums.

2280. Chapter 17 - Individuals As Employees And Proprietors Questio158 The CEO of Cirtronics Inc., discovered that the company’s competitor had adopted a cafeteria plan for its employees. The CEO is concerned about retaining his talented employees and would like you to provide a

brief explanation as to why a cafeteria plan may be attractive to the company’s employees.

Correct Answer:Cafeteria plans are beneficial where employees desire different types of benefits. This often occurs when employees are married and their spouses receive some benefits from their employers. For example, if the husband is covered by health insurance provided by his employer, there is no need for the wife’s employer to provide coverage for the husband also. Moreover, some employees may need child care benefits while those without children may prefer cash. The cafeteria plan provides much greater flexibility in planning benefits.

2281. Chapter 17 - Individuals As Employees And Proprietors Questio159 Employers can provide numerous benefits to their employees and the employees are permitted to exclude the value of these benefits from gross income. What are the effects of the exclusions on:

a. The progressiveness of the tax system?

b. The complexity of the tax system?

Correct Answer:a. The benefit of an exclusion varies directly with the recipient’s marginal tax rate. Thus,

individuals with the highest marginal tax rate enjoy the greatest benefit from the exclusion and those taxpayers in the lowest marginal tax rate enjoy the least benefit. Also, generally, the exclusions are often available with the better paying jobs. This also causes the tax system to be less progressive than if the exclusions were not permitted.

b. Any exclusion creates complexities in the system because tests must be established to

determine whether the benefit is eligible (e.g., whether the benefit is provided on in a discriminatory manner) for the special treatment. Also, often limitations are often created, which requires even more testing.

2282. Chapter 17 - Individuals As Employees And Proprietors Questio160

Jacob is a landscape architect who works out of his home. He wonders whether or not he will have nondeductible commuting expenses when he drives to the locations of his clients. Please comment.

Correct Answer:Jacob has no commuting expenses since his tax home is his residence. Thus, his mileage to and from the premises of his clients should be fully deductible.

2283. Chapter 17 - Individuals As Employees And Proprietors Questio161 Once set for a year, when might the IRS change the rate for the automatic mileage method?

Correct Answer:Changes in the past have been justified by significant increases in fuel prices. Such a change places a premium on keeping track of mileage on a monthly basis.

2284. Chapter 17 - Individuals As Employees And Proprietors Questio162 Travel status requires that the taxpayer be away from home overnight.

a. What does “away from home overnight” mean?

b. What tax advantages result from being in travel status?

Correct Answer:a. “Home” for this purpose is the place of taxpayer’s principal employment. “Overnight”

need not be a 24-hour period, but it must be a time duration substantially longer than an ordinary day’s work such as to require rest or sleep.

b. If “travel status” exists, many otherwise nondeductible expenses (e.g., meals, lodging,

transportation) become deductible.

2285. Chapter 17 - Individuals As Employees And Proprietors Questio163 How are combined business/pleasure trips treated for travel within the United States as opposed to foreign travel?

Correct Answer:The major difference is that transportation charges are fully deductible if the trip is primarily for business and within the North American area. If the foreign trip is primarily business, transportation expenses must be allocated between business and personal unless (1) the taxpayer was away from home for seven days or less or (2) if less than 25% of the time was spent on personal pursuits.

2286. Chapter 17 - Individuals As Employees And Proprietors Questio164 Concerning the deduction for moving expenses, what circumstances, if any, will excuse a taxpayer from meeting the time test of 39 or 78 weeks?

Correct Answer:The time test will be disregarded if the taxpayer dies, becomes disabled, or is discharged (other than for willful misconduct) or transferred by the new employer. Under certain conditions, expatriates who retire while overseas are exempt from the time test.

2287. Chapter 17 - Individuals As Employees And Proprietors Questio165 In terms of IRS attitude, what do the following expenses have in common?

a. Cost of a CPA exam review course.

b. Cost of a review course for the bar exam.

c. Cost of a law degree by a taxpayer who does not intend to practice law.

Correct Answer:a. It is the position of the IRS that the costs associated with becoming a CPA are incurred

in order to acquire a basic skill and thus are not deductible as education expenses. b. The same reasoning as noted in part a. above applies to review course taken to pass the

bar exam. c. Regardless of a taxpayer’s career goals, the IRS considers a law degree to be the

acquisition of a basic skill.

2288. Chapter 17 - Individuals As Employees And Proprietors Questio166 Regarding § 222 (qualified higher education deduction for tuition and related expenses), comment on the following:

a. Advantages of the provision.

b. Disadvantages and limitations of the provision.

Correct Answer:a. Advantages are that the education need not be work related and that the amounts are

deductions for AGI. b. Disadvantages and limitations are: (1) monetary limitation imposed; (2) complete

disallowance if AGI exceeds a specified amount; (3) not allowed to a taxpayer who can be claimed as a dependent of another; and (4) not allowed to a married person filing a separate return.

2289. Chapter 17 - Individuals As Employees And Proprietors Questio167 Meg teaches the fifth grade at a local school. During 2011, she spends $1,200 for school supplies for use in her classroom. On her income tax return for 2011, some of this expense is not reported and the balance is deducted in two different places. Explain what has probably

happened.

Correct Answer:Meg probably has been reimbursed for some of these expenses. If she renders an adequate accounting to her employer, the reimbursement is not reported in her income nor is the expense involved deducted. As to the remaining expenses, she has claimed $250 as a deduction for AGI and the balance as a miscellaneous itemized deduction.

2290. Chapter 17 - Individuals As Employees And Proprietors Questio168 Faith just graduated from college and she needs advice on the tax treatment of the costs she incurs in connection with her first job (a loan officer at a bank). Specifically, she wants to know about the following items:

a. Job search costs.

b. Business wardrobe cost.

c. Moving expenses.

Correct Answer:a. Not deductible since it involves Faith’s first job. b. Not deductible since the clothes are suitable for street wear. c. As long as the time and distance requirements are met, the moving expenses are

deductible.

2291. Chapter 17 - Individuals As Employees And Proprietors Questio169 Regarding tax favored retirement plans for employees and self-employed persons, comment on the following:

a. The exclusion versus deduction approaches as to contributions by participants.

b. Tax-free accumulation of earnings.

c. The deferral of income tax consequences.

d. Employee versus self-employed status.

Correct Answer:a. Contributions by employees to retirement plans that are qualified provide a tax benefit

either in the form of an exclusion from gross income or as a deduction for AGI. The traditional IRA takes the deduction approach. This is also the case of contributions by a

self-employed person to a Keogh (H.R. 10) plan. b. A characteristic of all tax-favored retirement plans is that income accumulates free of

tax. This allows for a greater accumulation to take place up to the point of distribution. c. Except in the Roth IRA, the main objective of retirement plans is to defer taxation until

distributions are made. d. Keogh (H.R. 10) plans are, in effect, the self-employed version of employee retirement

plans.

2292. Chapter 17 - Individuals As Employees And Proprietors Questio170

Olivia and Joshua work for different companies and each has an IRA. Olivia can deduct the contributions to her IRA, while Joshua cannot. Explain.

Correct Answer:Olivia has a traditional IRA, while Joshua has a Roth IRA.

2293. Chapter 17 - Individuals As Employees And Proprietors Questio171 Felicia, a recent college graduate, is employed as an accountant by an oil company. She would like to continue her education and obtain a law degree. Discuss Felicia’s tax status if she attends a local law school on a:

a. Part-time basis. b. Full-time basis.

Correct Answer:a. Regarding the usual education expense justification of maintaining and improving on

existing skills, Felicia will not succeed. The IRS has successfully maintained that obtaining a law degree leads to a new trade or business. Reliance on § 222, however, is appropriate since the education need not be job related. Unfortunately, § 222 only covers tuition, is limited to $4,000, and may be reduced (or eliminated) by an AGI limitation.

b. If Felicia quits her job and returns to college on a full-time basis, she no longer is in a

trade or business. A temporary break in employment status (e.g., leave of absence), however, will cure this problem if properly structured. However, Felicia will still encounter the new trade or business provision.

2294. Chapter 17 - Individuals As Employees And Proprietors Questio172 Discuss the 2%-of-AGI floor and the 50% cutback limitation in

connection with various employee expenses under the following arrangements:

a. The employee is not reimbursed by the employer.

b. The employee is fully reimbursed under a nonaccountable plan.

c. The employee is partially reimbursed under an accountable plan.

d. The employee is fully reimbursed under an accountable plan.

Correct Answer:a. Any cutback adjustment and the 2%-of-AGI floor are imposed on the employee. The

employee has the burden of being able to substantiate the expenses involved. Furthermore, no deduction is available if the employee does not itemize deductions from AGI.

b. The reimbursement must be reported as income. Deductions are handled as in part a. above.

c. Unless the reimbursement identifies the expenses covered, it must be allocated between the items that are and are not subject to the cutback adjustment.

d. A washout results. In effect the expenses are treated as deductions for AGI and fully offset the reimbursement. As far as the employee is concerned, the expenses are not subject to the cutback adjustment or the 2%-of-AGI floor.

2295. Chapter 17 - Individuals As Employees And Proprietors Questio173 Ramon and Ingrid work in the field of public relations and incur sizable entertainment expenses. Ramon is employed by a consumer products company, while Ingrid is a self-employed consultant. Regarding the tax treatment of the entertainment expenses, when would:

a. Ramon be better off than Ingrid?

b. Ingrid be better off than Ramon?

Correct Answer:a. If Ramon renders an adequate accounting to his employer and is fully reimbursed. In

such a case, the employee reports no income or deduction as to these expenses. The cutback adjustment is suffered by the employer.

b. If Ramon does not render an adequate accounting to his employer, he will have to

recognize any reimbursement as income and substantiate any deduction. Even worse, he will be subject to the cutback adjustment and the deduction will be a miscellaneous itemized deduction upon which the 2%-of-AGI limit is imposed. Although Ingrid also will be subject to the cutback adjustment, she has a deduction for AGI upon which the 2%

rule does not apply.

2296. Chapter 17 - Individuals As Employees And Proprietors Questio174 How does the FICA tax compare to the self-employment tax? How are these two taxes similar and how do they differ?

Correct Answer:These taxes, commonly referred to as “payroll taxes,” are levied to support the Social Security and Medicare benefits payable to taxpayers by the Federal government during their retirement years. The FICA tax is levied on salary and wages earned by an employee, while the self-employment tax is levied on earnings from self-employment (e.g., gross income from a trade or business less allowable trade or business deductions, the distributive share of any partnership income or loss derived from a trade or business activity, and the net income for rendering personal services as an independent contractor).

Both taxes have two components: the Social Security tax and the Medicare tax. For FICA, withholdings from employees must continue until the maximum base amount is reached. In 2011, FICA withholding (calculated at 4.2% times earned wages subject to FICA) ceases once the employee has earned wages in the amount of $106,800. For the Medicare portion, the employer is required to withhold at the rate of 1.45% on all wages without limit. In addition, the employer is required to contribute an amount greater than the amount withheld from an employee’s earnings for 2011. For 2011, the self-employment tax is 10.4% of self-employment income up to $106,800 and 2.9% of the total amount of self-employment earnings.

2297. Chapter 17 - Individuals As Employees And Proprietors Questio175 What are the relevant factors to be considered in determining whether an activity is profit-seeking or a hobby?

Correct Answer:The nine relevant factors detailed in Reg. § 1.183-2(b) are as follows:

(1) Whether the activity is conducted in a businesslike manner.

(2) The expertise of the taxpayers or their advisers.

(3) he time and effort expended.

(4) The expectation that the assets of the activity will appreciate in value.

(5) The previous success of the taxpayer in the conduct of similar activities.

(6) The history of income and losses from the activity.

(7) The relationship of profits earned to losses incurred.

(8) The financial status of the taxpayer.

(9) Elements of personal pleasure or recreation in the activity.

2298. Chapter 17 - Individuals As Employees And Proprietors Questio176 In distinguishing whether an activity is a hobby or a trade or business, discuss the presumptive rule.

Correct Answer:The Code provides a rebuttable presumption that an activity is profit-seeking (i.e., a trade or business) rather than a hobby if the activity shows a profit in at least three of any five (two out of seven for horses) prior consecutive years. If this test is met, the activity is presumed to be a trade or business. The burden of proof thus shifts to the IRS to show otherwise.

2299. Chapter 17 - Individuals As Employees And Proprietors Questio177 Assuming an activity is deemed to be a hobby, discuss the order and limits in which expenses must be deducted.

Correct Answer:Amounts deductible under other Code sections without regard to the nature of the activity (e.g., property taxes and mortgage interest) must be deducted first.

Amounts deductible under other Code sections had the activity been profit-seeking which do not affect adjusted basis are deducted next.

Deductions affecting adjusted basis (e.g., depreciation) are taken next. At any point where the expenses exceed income, the deduction is limited to the remaining income.