Quiz Of The Week: Corporate Taxation

1. A corporation's average gross receipts must not be greater than what amount for it to be classified as a small business corporation for avoiding the alternative minimum tax?

$2 million

$5 million

$7.5 million

$10 million

The correct answer is C, $7.5 million. The tentative minimum tax of a corporation is zero for a tax year (making the corporation exempt from AMT) if its average annual gross receipts for the three tax-year periods ending before the tax year does not exceed $7.5 million (Publication 542).

Explanation

The correct answer is C, $7.5 million. The tentative minimum tax of a corporation is zero for a tax year (making the corporation exempt from AMT) if its average annual gross receipts for the three tax-year periods ending before the tax year does not exceed $7.5 million (Publication 542).

2. For purposes of the accumulated earnings tax, reasonable needs of the business include all of the following with the exception of:

Acquiring the assets or stock of another business

Retiring debts

Providing working capital for the business

Making loans to shareholders

The correct answer is D, making loans to shareholders (this is false). Legitimate reasons for accumulating capital for reasonable business needs to avoid the accumulated earnings tax include: the expansion of a business; the replacement of capital assets; the replacement of plant; the acquisition of a business; working capital needs; product liability loss; loans to suppliers or customers; redemption under IRC Section 303 to pay the death taxes and administration expenses of a shareholder; realistic business hazards; the loss of a major customer or client; building a reserve for an actual lawsuit; to protect a family business from takeover by outsiders; debt retirement; and self-insurance. Invalid reasons include: loans to shareholders; loans to brother-sister corporations; future depression; unrealistic contingencies; investment in assets unrelated to the business; and retirement of stock without a curtailment of the business (Publication 542).

Explanation

The correct answer is D, making loans to shareholders (this is false). Legitimate reasons for accumulating capital for reasonable business needs to avoid the accumulated earnings tax include: the expansion of a business; the replacement of capital assets; the replacement of plant; the acquisition of a business; working capital needs; product liability loss; loans to suppliers or customers; redemption under IRC Section 303 to pay the death taxes and administration expenses of a shareholder; realistic business hazards; the loss of a major customer or client; building a reserve for an actual lawsuit; to protect a family business from takeover by outsiders; debt retirement; and self-insurance. Invalid reasons include: loans to shareholders; loans to brother-sister corporations; future depression; unrealistic contingencies; investment in assets unrelated to the business; and retirement of stock without a curtailment of the business (Publication 542).

3. During 20X1, Helen incorporated her accounting practice. Helen is the sole shareholder. The following assets were transferred to the corporation: • Cash – $1,000• Computer equipmentFMV – $10,000adjusted basis – $6,000original cost – $12,000 What is the corporation's total basis in all of the transferred assets?

$6,000

$7,000

$10,000

$11,000

The correct answer is B, $7,000. The corporation’s basis in property contributed in exchange for stock is equal to the contributor’s basis plus any gain the contributor recognizes on the exchange. See number 26 above for explanation of why there is no gain. The basis in all transferred assets equals $1,000 for the cash and $6,000 adjusted basis in the computer equipment, for a total of $7,000 (Publication 542).

Explanation

The correct answer is B, $7,000. The corporation’s basis in property contributed in exchange for stock is equal to the contributor’s basis plus any gain the contributor recognizes on the exchange. See number 26 above for explanation of why there is no gain. The basis in all transferred assets equals $1,000 for the cash and $6,000 adjusted basis in the computer equipment, for a total of $7,000 (Publication 542).

4. Elite Corporation, an accrual-method taxpayer, had accumulated earnings and profits of $100,000 as of December 31, last year. For its current year, Elite's books and records reflect the following:

taxable income per tax return – $125,000
tax-exempt interest received – $2,500
federal income taxes – $32,000
business meals in excess of the 50 percent limitation – $3,500
contributions in excess of limitations – $1,500

Based on the above, what is the amount of Elite Corporation's current earnings and profits for this year?

$88,000

$90,500

$92,000

$95,500

The correct answer is B, $90,500. Earnings and profits are increased or decreased for taxable income (add $125,000). Income tax liabilities reduce earnings and profits as of the close of the tax year for an accrual basis corporation and, according to some courts, also for a cash-basis corporation (subtract $32,000). Exempt income, such as state and local bond interest, increases earnings and profits (add $2,500). Contributions in excess of the ten percent of income limitation reduce earnings and profits in the year paid and increase earnings and profits in the year they are deducted (subtract $1,500). Business meals in excess of the 50 percent limitation reduce earnings and profits in the year paid (subtract $3,500). Earnings and profits equal $90,500 (Publication 542).

Explanation

The correct answer is B, $90,500. Earnings and profits are increased or decreased for taxable income (add $125,000). Income tax liabilities reduce earnings and profits as of the close of the tax year for an accrual basis corporation and, according to some courts, also for a cash-basis corporation (subtract $32,000). Exempt income, such as state and local bond interest, increases earnings and profits (add $2,500). Contributions in excess of the ten percent of income limitation reduce earnings and profits in the year paid and increase earnings and profits in the year they are deducted (subtract $1,500). Business meals in excess of the 50 percent limitation reduce earnings and profits in the year paid (subtract $3,500). Earnings and profits equal $90,500 (Publication 542).

5. A corporation has the following income and expense items during the current year:

net loss from operations (before dividend income) – $20,000
dividends from 25-percent-owned corporations – $190,000

The allowed dividends-received deduction is:

$133,000

$136,000

$152,000

The correct answer is C, $136,000. In addition to the 70 percent dividends-received deduction (see number 7 above), a C corporation can deduct 80 percent of dividends received or accrued from 20 percent-owned corporations, up to 80 percent of taxable income (Publication 542). Eighty percent of $170,000 ($20,000 operating loss plus $190,000 in dividends received) leaves a $136,000 dividends-received deduction. Answer D, $152,000, is incorrect because it does not take into account the taxable income limitation.

Explanation

The correct answer is C, $136,000. In addition to the 70 percent dividends-received deduction (see number 7 above), a C corporation can deduct 80 percent of dividends received or accrued from 20 percent-owned corporations, up to 80 percent of taxable income (Publication 542). Eighty percent of $170,000 ($20,000 operating loss plus $190,000 in dividends received) leaves a $136,000 dividends-received deduction. Answer D, $152,000, is incorrect because it does not take into account the taxable income limitation.

6. For this tax year, Myers Corporation had taxable income of $60,000 before using any of the NOL from the previous year. Myers has never elected to forgo the carry-back of its losses since incorporating five years ago. Myers's books and records reflect the following income (loss) since its incorporation:

five years ago – $10,000
four years ago – $(35,000)
three years ago – $20,000
two years ago – $25,000
last year – $(30,000)

What amount of taxable income (loss) should Myers report on its current tax return?

$30,000

$50,000

$60,000

None of the above

The correct answer is B, $50,000. Looking at the chart of information, there are actually two NOLs: one four years ago for $35,000 and one last year for $30,000. The total amount of the NOLs is $65,000. The $35,000 loss in year four is carried back into year five and applied against the income in that year. The remaining $25,000 is then carried forward to year three. Because the loss exceeds the income in that year by $5,000, the excess loss is carried forward and becomes a deduction in year two. Last year’s loss of $30,000 must first be carried into year two, where it absorbs the $20,000 in income remaining in that year. The remaining portion of last year’s loss ($10,000) is carried forward and becomes a deduction on the current year’s tax return (Publication 542).

Explanation

The correct answer is B, $50,000. Looking at the chart of information, there are actually two NOLs: one four years ago for $35,000 and one last year for $30,000. The total amount of the NOLs is $65,000. The $35,000 loss in year four is carried back into year five and applied against the income in that year. The remaining $25,000 is then carried forward to year three. Because the loss exceeds the income in that year by $5,000, the excess loss is carried forward and becomes a deduction in year two. Last year’s loss of $30,000 must first be carried into year two, where it absorbs the $20,000 in income remaining in that year. The remaining portion of last year’s loss ($10,000) is carried forward and becomes a deduction on the current year’s tax return (Publication 542).

7. Taylor transfers assets with a $100,000 FMV (basis $50,000) and $80,000 of liabilities to a corporation in exchange for 100 percent of the corporation's stock. The corporation assumes the $80,000 mortgage. What is the corporation's gain?

$0

$30,000

$50,000

$80,000

The correct answer is A, zero. There is no gain to the transferee corporation when it exchanges its stock for property or money, even if there is boot (IRC Section 1032(a), Publication 542).

Explanation

The correct answer is A, zero. There is no gain to the transferee corporation when it exchanges its stock for property or money, even if there is boot (IRC Section 1032(a), Publication 542).

8. Sensor Corporation was formed and began operations in 20X1. For that year, it had operating income of $50,000, long-term capital gains of $25,000, and short-term capital losses of $10,000. In 20X2, the corporation had $5,000 of net long-term capital losses, and in 20X3 it had $20,000 of net long-term capital losses. How much capital loss is available to carry forward after the 20X1 and 20X2 carry-backs are applied?

$10,000

$15,000

$20,000

$25,000

The correct answer is A, $10,000. In 20X1 there are net long-term gains of $25,000 and net short-term losses of $10,000, leaving a net long-term gain of $15,000. The carry-back of the 20X2 $5,000 net long-term loss reduces the 20X1 $15,000 gain to $10,000. The $20,000 net long-term loss in 20X3 when carried back will reduce the remaining 20X1 $10,000 gain to zero, leaving a $10,000 loss to carry forward to 20X4 (Publication 542).

Explanation

The correct answer is A, $10,000. In 20X1 there are net long-term gains of $25,000 and net short-term losses of $10,000, leaving a net long-term gain of $15,000. The carry-back of the 20X2 $5,000 net long-term loss reduces the 20X1 $15,000 gain to $10,000. The $20,000 net long-term loss in 20X3 when carried back will reduce the remaining 20X1 $10,000 gain to zero, leaving a $10,000 loss to carry forward to 20X4 (Publication 542).

9. A corporation's taxable income for the current year is $335,000. Its tax liability is:

$84,250

$102,150

$113,900

$117,250

The correct answer is C, $113,900. The rates for domestic corporations other than qualified personal service corporations are set by IRC Section 11(b). The tax on $335,000 is $113,900 plus 34 percent on the excess over $335,000 but less than $10 million (Publication 542).

Explanation

The correct answer is C, $113,900. The rates for domestic corporations other than qualified personal service corporations are set by IRC Section 11(b). The tax on $335,000 is $113,900 plus 34 percent on the excess over $335,000 but less than $10 million (Publication 542).

10. Alice and Bill form AB Corporation. Alice transfers land and a building with a $60,000 adjusted basis and a $100,000 FMV in exchange for 50 percent of the stock of AB Corporation and a $10,000 note. Bill transfers equipment with a $95,000 adjusted basis and a $100,000 FMV in exchange for 50 percent of the stock and a note valued at $10,000. Bill's basis in the stock received is:

$85,000

$90,000

$95,000

$100,000

The correct answer is B, $90,000. The facts in numbers 12, 13, 14, and 15 are the same. The $95,000 adjusted basis is reduced for the $5,000 amount of the $10,000 boot received, which was not recognized as income (Publication 542).

Explanation

The correct answer is B, $90,000. The facts in numbers 12, 13, 14, and 15 are the same. The $95,000 adjusted basis is reduced for the $5,000 amount of the $10,000 boot received, which was not recognized as income (Publication 542).

11. Double taxation occurs:

Because corporate tax rates are double that of individual taxpayers for the same amount of taxable income

When corporate earnings are distributed as dividends to shareholders

Because corporations receive a deduction for the distribution of dividends to shareholders

When individual taxpayers pay for their shares of corporate stock

The correct answer is B, when corporate earnings are distributed as dividends to shareholders. Corporate tax rates are not double that of individual taxpayers (Publication 542). Corporations do not receive a deduction for distributions to shareholders (this is the opposite of the correct answer). Paying for shares of corporate stock is not a tax. The distribution of earnings and profits, which were taxed to the company, to the shareholders, who are again taxed on these distributions, is known as corporate double taxation (Publication 542).

Explanation

The correct answer is B, when corporate earnings are distributed as dividends to shareholders. Corporate tax rates are not double that of individual taxpayers (Publication 542). Corporations do not receive a deduction for distributions to shareholders (this is the opposite of the correct answer). Paying for shares of corporate stock is not a tax. The distribution of earnings and profits, which were taxed to the company, to the shareholders, who are again taxed on these distributions, is known as corporate double taxation (Publication 542).

12. Tax characteristics of corporations include which of the following?I. At higher income levels, the lower tax rates are phased out through the use of the surtax.II. The corporate tax rates are 15 percent, 28 percent, 31 percent, and 39.6 percent.

Statement I is correct

Statement II is correct

Both statements are correct

Neither statement is correct

The correct answer is A, statement I is correct. The corporate tax rates are 15 percent, 25 percent, 34 percent, 39 percent, 34 percent, 35 percent, 38 percent, and 35 percent (Publication 543).

Explanation

The correct answer is A, statement I is correct. The corporate tax rates are 15 percent, 25 percent, 34 percent, 39 percent, 34 percent, 35 percent, 38 percent, and 35 percent (Publication 543).

13. Willie is the director of golf for Rooney Corporation. Willie owns a 20 percent interest in Rooney. He receives a salary of $60,000 and medical insurance benefits costing $6,000. Rooney's taxable income before considering the payments to and on behalf of Willie is $250,000. Rooney distributes a $50,000 dividend to its shareholders. How much income does Willie have from Rooney?

$60,000

$70,000

$76,000

$96,800

The correct answer is B, $70,000. The $60,000 salary is taxable income. Fringe benefits are generally not taxable to employees, even if they are shareholders of a corporation (Publication 525). The $50,000 corporate dividend must be multiplied by the 20 percent ownership interest of Willie to get Willie’s $10,000 portion of the taxable dividend. Willie’s total taxable income includes the $60,000 salary and the $10,000 dividend, for a total of $70,000.

Explanation

The correct answer is B, $70,000. The $60,000 salary is taxable income. Fringe benefits are generally not taxable to employees, even if they are shareholders of a corporation (Publication 525). The $50,000 corporate dividend must be multiplied by the 20 percent ownership interest of Willie to get Willie’s $10,000 portion of the taxable dividend. Willie’s total taxable income includes the $60,000 salary and the $10,000 dividend, for a total of $70,000.

14. Alice and Bill form AB Corporation. Alice transfers land and a building with a $60,000 adjusted basis and a $100,000 FMV in exchange for 50 percent of the stock of the AB Corporation and a $10,000 note. Bill transfers equipment with a $95,000 adjusted basis and a $100,000 FMV in exchange for 50 percent of the stock and a note valued at $10,000. Bill's recognized gain on the transfer is:

0

$5,000

$10,000

$20,000

The correct answer is B, $5,000. The facts in question numbers 12 and 13 are the same. The information in number 11 should explain the answer. The gain is equal to the $95,000 basis subtracted from the $100,000 FMV, giving a $5,000 gain. The $10,000 note of the AB Corporation is considered boot within the definition of IRC Section 351(b) (Publication 542). However, in this scenario, the $5,000 gain is less than the boot.

Explanation

The correct answer is B, $5,000. The facts in question numbers 12 and 13 are the same. The information in number 11 should explain the answer. The gain is equal to the $95,000 basis subtracted from the $100,000 FMV, giving a $5,000 gain. The $10,000 note of the AB Corporation is considered boot within the definition of IRC Section 351(b) (Publication 542). However, in this scenario, the $5,000 gain is less than the boot.

15. A corporation has the following income and expense items during the year:• net income from operations (before dividend income) – $70,000• dividends from ten-percent-owned corporations – $180,000The allowed dividends-received deduction is:

$70,000

$126,000

$144,000

$180,000

The correct answer is B, $126,000. A C corporation may deduct 70 percent of the dividends received or accrued from domestic corporations (Publication 542). The $180,000 dividends received is multiplied by 70 percent to get the $126,000 dividends-received deduction.

Explanation

The correct answer is B, $126,000. A C corporation may deduct 70 percent of the dividends received or accrued from domestic corporations (Publication 542). The $180,000 dividends received is multiplied by 70 percent to get the $126,000 dividends-received deduction.

16. A corporation distributes land with a FMV of $80,000 (basis $60,000). The land has a mortgage of $90,000 assumed by the shareholder. Gain to the corporation is:

0

$20,000

$30,000

$90,000

The correct answer is C, $30,000. All distributions of appreciated property cause gain to the distributing corporation (IRC Section 311). The corporation that makes a property distribution is treated as if it had sold the property to the shareholder for its FMV. The corporation does not recognize loss on distributions of property when the tax basis is in excess of FMV. If the distributed property is subject to a liability in excess of basis or the shareholder assumes such a liability, the FMV of the property for the purposes of determining gain on the distribution is treated as not being less than the amount of the liability (Publication 542).

Explanation

The correct answer is C, $30,000. All distributions of appreciated property cause gain to the distributing corporation (IRC Section 311). The corporation that makes a property distribution is treated as if it had sold the property to the shareholder for its FMV. The corporation does not recognize loss on distributions of property when the tax basis is in excess of FMV. If the distributed property is subject to a liability in excess of basis or the shareholder assumes such a liability, the FMV of the property for the purposes of determining gain on the distribution is treated as not being less than the amount of the liability (Publication 542).

17. A corporation has the following capital gains and losses during the current year:

long-term capital gain – $25,000
long-term capital loss – $10,000
short-term capital gain – $4,000
short-term capital loss – $12,000

The tax result to the corporation is:

A $7,000 net long-term capital gain is included in gross income

A $7,000 net long-term capital loss is carried over to the next year

The correct answer is A, $7,000 net long-term capital gain is included in gross income. The long-term gain of $25,000 and loss of $10,000 give a net long-term gain of $15,000. The short-term gain of $4,000 and the loss of $12,000 give a net short-term loss of $8,000. The net long-term gain of $15,000 less the net short-term loss of $8,000 gives a net-long term gain of $7,000 (Publication 542).

Explanation

The correct answer is A, $7,000 net long-term capital gain is included in gross income. The long-term gain of $25,000 and loss of $10,000 give a net long-term gain of $15,000. The short-term gain of $4,000 and the loss of $12,000 give a net short-term loss of $8,000. The net long-term gain of $15,000 less the net short-term loss of $8,000 gives a net-long term gain of $7,000 (Publication 542).

18. Taylor transfers assets with a $100,000 FMV (basis $50,000) and $80,000 of liabilities to a corporation in exchange for 100 percent of the corporation's stock. The corporation assumes the $80,000 mortgage. What is the corporation's basis in the property?

$50,000

$80,000

$100,000

$130,000

The correct answer is B, $80,000. The $80,000 mortgage assumed exceeds the $50,000 basis in the property, resulting in a gain to the transferor of $30,000. Under IRC Section 362(a), the basis to the corporation is the $50,000 basis in the hands of the transferor increased by the $30,000 amount of gain recognized by the transferor shareholder (Publication 542).

Explanation

The correct answer is B, $80,000. The $80,000 mortgage assumed exceeds the $50,000 basis in the property, resulting in a gain to the transferor of $30,000. Under IRC Section 362(a), the basis to the corporation is the $50,000 basis in the hands of the transferor increased by the $30,000 amount of gain recognized by the transferor shareholder (Publication 542).

19. Travis Romer transfers land with a FMV of $125,000 (basis $25,000) to a corporation in exchange for 100 percent of the corporation's stock. What amount of gain must Travis recognize as a result of this transaction?

$0

$25,000

$100,000

$125,000

The correct answer is A, zero. Since Travis is in control of the corporation immediately after the transfer, no gain or loss is recognized under IRC Section 351. See number 28 above for definition of control. Travis’s basis in the stock will be $25,000 (Publication 542).

Explanation

The correct answer is A, zero. Since Travis is in control of the corporation immediately after the transfer, no gain or loss is recognized under IRC Section 351. See number 28 above for definition of control. Travis’s basis in the stock will be $25,000 (Publication 542).

20. Alice and Bill form AB Corporation. Alice transfers land and a building with a $60,000 adjusted basis and a $100,000 FMV in exchange for 50 percent of the stock of AB Corporation and a $10,000 note. Bill transfers equipment with a $95,000 adjusted basis and a $100,000 FMV in exchange for 50 percent of the stock and a note valued at $10,000. Alice's recognized gain on the transfer is:

0

$10,000

$20,000

$40,000

The correct answer is B, $10,000. Alice’s recognized gain on the transfer is the lower of the amount of the cash boot or the gain on the transfer (IRC Section 351(b)). The $10,000 note of the AB Corporation is considered boot within the definition of IRC Section 351(b). The gain is equal to the $60,000 basis subtracted from the $100,000 FMV, or $40,000 (Publication 542).

Explanation

The correct answer is B, $10,000. Alice’s recognized gain on the transfer is the lower of the amount of the cash boot or the gain on the transfer (IRC Section 351(b)). The $10,000 note of the AB Corporation is considered boot within the definition of IRC Section 351(b). The gain is equal to the $60,000 basis subtracted from the $100,000 FMV, or $40,000 (Publication 542).

21. All of the following are accurate statements about corporations, except:

A corporation does not compute AGI

A corporation is not allowed a standard deduction

Dividends received from a domestic corporation are fully taxed like ordinary income

The limit on the charitable contribution deduction is ten percent of taxable income (with certain adjustments)

The correct answer is C, dividends received from a domestic corporation are fully taxed like ordinary income. C corporations may deduct 70 percent of the dividends received or accrued from domestic corporations (Publication 542). A corporation’s charitable deduction for a tax year cannot exceed ten percent of its taxable income for that year (Publication 542). Standard deductions and AGI are all characteristics of individual income tax returns and not part of C corporation law. There is no provision for a standard deduction on Form 1120 or Form 1120A.

Explanation

The correct answer is C, dividends received from a domestic corporation are fully taxed like ordinary income. C corporations may deduct 70 percent of the dividends received or accrued from domestic corporations (Publication 542). A corporation’s charitable deduction for a tax year cannot exceed ten percent of its taxable income for that year (Publication 542). Standard deductions and AGI are all characteristics of individual income tax returns and not part of C corporation law. There is no provision for a standard deduction on Form 1120 or Form 1120A.

22. With respect to charitable contributions by corporations, which of the following rules does not apply?

Unused contributions are treated as capital losses

Unused contributions are carried forward five years

The correct answer is A, unused contributions are treated as capital losses. Unused contributions are not treated as capital losses; the excess is carried forward for five years (Publication 542). The contributions are limited to ten percent of taxable income, computed without regard to the charitable contribution deduction, dividends-received deduction, or NOL or capital loss carry-backs. Accrual-basis corporations may accrue a contribution deduction in the year preceding payment if the board of directors authorizes such payment prior to the end of the tax year and the payment is actually made within two and a half months following the end of the tax year. Unused contributions are carried forward five years.

Explanation

The correct answer is A, unused contributions are treated as capital losses. Unused contributions are not treated as capital losses; the excess is carried forward for five years (Publication 542). The contributions are limited to ten percent of taxable income, computed without regard to the charitable contribution deduction, dividends-received deduction, or NOL or capital loss carry-backs. Accrual-basis corporations may accrue a contribution deduction in the year preceding payment if the board of directors authorizes such payment prior to the end of the tax year and the payment is actually made within two and a half months following the end of the tax year. Unused contributions are carried forward five years.

23. During 20X1, David incorporated his carpet cleaning business. David is the sole shareholder. The following assets were transferred to the corporation: • Cash – $1,000• Cleaning equipmentFMV – $10,000adjusted basis – $6,000original cost – $12,000• VanFMV – $10,000adjusted basis – $16,000original cost – $32,000 How much gain (loss) did David recognize from the transfer of the assets to the corporation?

$0

$2,000 loss

$4,000 gain

$10,000 gain

The correct answer is A, zero. No gain is recognized to the transferor (David) on a transfer of assets to a corporation in exchange for stock, as long as the transferor receives no boot, (meaning cash, FMV of assets, or a loan assumed by the corporation in excess of the basis of the property contributed in exchange for stock). See number 11 above for further explanation (Publication 542).

Explanation

The correct answer is A, zero. No gain is recognized to the transferor (David) on a transfer of assets to a corporation in exchange for stock, as long as the transferor receives no boot, (meaning cash, FMV of assets, or a loan assumed by the corporation in excess of the basis of the property contributed in exchange for stock). See number 11 above for further explanation (Publication 542).

24. Which of the following statements is inaccurate regarding requirements for non-recognition of gain or loss upon the transfer of assets to a corporation in exchange for stock?

Property must be transferred to the corporation solely in exchange for stock of the corporation

The transferor-shareholders must be in control of the corporation immediately after the exchange

Depreciation recapture applies to a transfer that falls under IRC Section 351.

The correct answer is D, depreciation recapture applies to a transfer that falls under IRC Section 351. No gain or loss is recognized if property is transferred to a corporation solely in exchange for stock of that corporation, provided that immediately after the transfer, the transferor or transferors are in control of the corporation (IRC Section 351). If boot (defined as property other than stock – for example, cash, non-qualified preferred stock, debt obligations including securities, or tangible personal property) is received by the transferors but the exchange otherwise qualifies as a tax-free Section 351 transfer, loss is not recognized to any transferor and gain is recognized up to the amount of boot he or she receives (for example, the cash and FMV of any other property, except stock other than non-qualified stock, of the transferee corporation). In a pure Section 351(a) non-taxable transfer to a controlled corporation with no boot involved, the recapture of accelerated cost recovery rules do not apply.

Explanation

The correct answer is D, depreciation recapture applies to a transfer that falls under IRC Section 351. No gain or loss is recognized if property is transferred to a corporation solely in exchange for stock of that corporation, provided that immediately after the transfer, the transferor or transferors are in control of the corporation (IRC Section 351). If boot (defined as property other than stock – for example, cash, non-qualified preferred stock, debt obligations including securities, or tangible personal property) is received by the transferors but the exchange otherwise qualifies as a tax-free Section 351 transfer, loss is not recognized to any transferor and gain is recognized up to the amount of boot he or she receives (for example, the cash and FMV of any other property, except stock other than non-qualified stock, of the transferee corporation). In a pure Section 351(a) non-taxable transfer to a controlled corporation with no boot involved, the recapture of accelerated cost recovery rules do not apply.

25. Alice and Bill form AB Corporation. Alice transfers land and a building with a $60,000 adjusted basis and a $100,000 FMV in exchange for 50 percent of the stock of AB Corporation and a $10,000 note. Bill transfers equipment with a $95,000 adjusted basis and a $100,000 FMV in exchange for 50 percent of the stock and a note valued at $10,000. Alice's basis in the stock received is:

$60,000

$70,000

$90,000

$100,000

The correct answer is A, $60,000. The facts in numbers 12, 13, and 14 are the same. Alice’s basis in the stock received is equal to the $60,000 adjusted basis in the property transferred for the stock. Adding the recognized gain and subtracting the distribution for the same amount makes no change in the amount of $60,000 (Publication 542).

Explanation

The correct answer is A, $60,000. The facts in numbers 12, 13, and 14 are the same. Alice’s basis in the stock received is equal to the $60,000 adjusted basis in the property transferred for the stock. Adding the recognized gain and subtracting the distribution for the same amount makes no change in the amount of $60,000 (Publication 542).

26. A liquidating corporation:

Recognizes gains and losses on the distribution of property

Recognizes gains and losses only on the distribution of the specific property contributed in a Section 351 transaction

Recognizes gains, but not losses, on the distribution of property

The correct answer is A, recognizes gains and losses on the distribution of property. IRC Section 351 does not apply to transfers in a bankruptcy, receivership, foreclosure, or similar proceeding. Any gain or loss is recognized to the extent that the stock received by the debtor in exchange for his assets is used to satisfy his indebtedness. Gains and loss are recorded on liquidation (Publication 542).

Explanation

The correct answer is A, recognizes gains and losses on the distribution of property. IRC Section 351 does not apply to transfers in a bankruptcy, receivership, foreclosure, or similar proceeding. Any gain or loss is recognized to the extent that the stock received by the debtor in exchange for his assets is used to satisfy his indebtedness. Gains and loss are recorded on liquidation (Publication 542).

27. Which of the following scenarios is not required for a Section 351 tax-free transfer?

Property is transferred to the corporation solely in exchange for stock of the corporation

Immediately after the exchange, the transferor-shareholders must be in control of the corporation

The correct answer is D, if property or money (other than stock of the transferee corporation) is received by the transferor, gain is recognized by the transferee corporation. See number 11 for explanation of why A, B, and C are true. There is no gain to the transferee corporation even if there is boot (Publication 542).

Explanation

The correct answer is D, if property or money (other than stock of the transferee corporation) is received by the transferor, gain is recognized by the transferee corporation. See number 11 for explanation of why A, B, and C are true. There is no gain to the transferee corporation even if there is boot (Publication 542).

28. Which, if any, of the following advantages apply to the corporate form of organization?I. The top marginal tax rate paid by a corporation is lower than the top marginal tax rate paid by an individual taxpayer.II. The corporation may claim a dividend deduction for profits it distributes to its shareholders.

Statement I is correct

Statement II is correct

Both statements are correct

Neither statement is correct

The correct answer is D, neither statement is correct. There is no deduction from taxable income for dividends distributed to shareholders. The top marginal tax rate for corporations is 39 percent, which is higher than the top marginal tax rate for individuals of 35 percent (Publication 542).

Explanation

The correct answer is D, neither statement is correct. There is no deduction from taxable income for dividends distributed to shareholders. The top marginal tax rate for corporations is 39 percent, which is higher than the top marginal tax rate for individuals of 35 percent (Publication 542).

29. Zeppo and Harpo are equal owners of the Marx Corporation. During the current year, they agree to admit Groucho as a shareholder. Groucho will contribute $25,000 in cash and property worth $50,000 (adjusted basis of $35,000) for 25 percent of Marx Corporation's stock. What is Groucho's basis in the Marx Corporation stock?

$45,000

$50,000

$60,000

$75,000

The correct answer is D, $75,000. Groucho will recognize gain on being admitted to the corporation since he will not be in control of the corporation immediately after transferring property in exchange for stock. The 25 percent interest in the corporation is not a controlling interest. Control is defined as ownership of at least 80 percent of the transferee’s voting stock and at least 80 percent of all its other classes of stock (IRC Section 351). Groucho will recognize a gain of $15,000 and his basis in stock will be $75,000, consisting of the $25,000 cash and the $50,000 FMV of the property contributed (Publication 542).

Explanation

The correct answer is D, $75,000. Groucho will recognize gain on being admitted to the corporation since he will not be in control of the corporation immediately after transferring property in exchange for stock. The 25 percent interest in the corporation is not a controlling interest. Control is defined as ownership of at least 80 percent of the transferee’s voting stock and at least 80 percent of all its other classes of stock (IRC Section 351). Groucho will recognize a gain of $15,000 and his basis in stock will be $75,000, consisting of the $25,000 cash and the $50,000 FMV of the property contributed (Publication 542).

30. A calendar-year corporation has $40,000 in current earnings and profits in the current year and a $30,000 positive accumulated earnings and profits balance at the beginning of the year. Assume that the shareholders of the corporation have a total basis in outstanding shares of $20,000. A $90,000 distribution is made to the shareholders. The tax results to the shareholders will be:

Dividend income of $40,000 and capital gain of $50,000

Dividend income of $70,000 and no other consequences

Dividend income of $70,000 and capital gain of $20,000

Dividend income of $70,000 and tax-free return of capital of $20,000

The correct answer is D, dividend income of $70,000 and tax-free return of capital of $20,000. Dividends are taxed to shareholders as ordinary income to the extent that the distributing corporation has earnings and profits both current and accumulated. The part of the distribution in excess of earnings and profits is treated as a tax-free return of capital and is applied against or reduces the shareholder’s basis in stock. Any distribution in excess of the shareholder’s basis in stock is treated as payment for the stock, specifically capital gain for stock as a capital asset (Publication 542).

Explanation

The correct answer is D, dividend income of $70,000 and tax-free return of capital of $20,000. Dividends are taxed to shareholders as ordinary income to the extent that the distributing corporation has earnings and profits both current and accumulated. The part of the distribution in excess of earnings and profits is treated as a tax-free return of capital and is applied against or reduces the shareholder’s basis in stock. Any distribution in excess of the shareholder’s basis in stock is treated as payment for the stock, specifically capital gain for stock as a capital asset (Publication 542).