3 Regulation Class Questions 1. CPA-02030 Lind and Post organized Ace Corp., which issued voting common stock with a fair market value of $120,000. They each transferred property in exchange for stock as follows: Adjusted basis $40,000 $5,000 Fair market value $82,000 $48,000 Percentage of Ace stock acquired 60% 40%
Lind Post
Property Building Land
The building was subject to a $10,000 mortgage that was assumed by Ace. What amount of gain did Lind recognize on the exchange? a. b. c. d. $0 $10,000 $42,000 $52,000
CPA-02030 Choice "a" is correct. The formation of a corporation under these circumstances is a nontaxable event. Thus Lind would report zero gain upon the formation of the corporation. Choices "b", "c", and "d" are incorrect. Because the formation of this corporation is a nontaxable event, no gain or loss would be reported by Lind.
2. CPA-02034 Lind and Post organized Ace Corp., which issued voting common stock with a fair market value of $120,000. They each transferred property in exchange for stock as follows: Adjusted basis $40,000 $5,000 Fair market value $82,000 $48,000 Percentage of Ace stock acquired 60% 40%
Lind Post
Property Building Land
The building was subject to a $10,000 mortgage that was assumed by Ace. What was Ace's basis in the building? a. b. c. d. $30,000 $40,000 $72,000 $82,000
CPA-02034 Choice "b" is correct. Ace's basis in the building is the same as Lind's basis immediately prior to its contribution to the corporation. Choice "a" is incorrect. Ace's basis in the building is computed separately from any debt that it assumes related to the building. Choice "c" is incorrect. Ace uses Lind's basis, not the building's fair market value, as its basis. Furthermore, the debt assumed by Ace does not affect the basis of the building to Ace. Choice "d" is incorrect. Ace uses Lind's basis, not the building's fair market value, as its basis.
1
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 3. CPA-02036 Lind and Post organized Ace Corp., which issued voting common stock with a fair market value of $120,000. They each transferred property in exchange for stock as follows: Adjusted basis $40,000 $5,000 Fair market value $82,000 $48,000 Percentage of Ace stock acquired 60% 40%
Lind Post
Property Building Land
The building was subject to a $10,000 mortgage that was assumed by Ace. What was Lind's basis in Ace stock? a. b. c. d. $82,000 $40,000 $30,000 $0
CPA-02036 Choice "c" is correct. Lind computes his basis as the basis of property and cash (none here) contributed, less the amount of any debt he is relieved of. Here he contributes property with an adjusted basis of $40,000, but the $10,000 debt he is relieved of must be subtracted, resulting in a net basis of $30,000. This can also be thought of as giving Lind a basis equivalent to the amount of equity he had in the contributed building. Choice "a" is incorrect. The basis of Lind's stock is based on his basis in the contributed property, not its fair market value. Choice "b" is incorrect. Lind must subtract the $10,000 of debt he is relieved of from his $40,000 basis in the property to arrive at his basis in the stock. Choice "d" is incorrect. Because Lind contributed property with a basis above zero, his basis in the stock is greater than zero.
2
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 4. CPA-02106 Axis Corp. is an accrual basis calendar year corporation. On December 13, 1993, the Board of Directors declared a two percent of profits bonus to all employees for services rendered during 1993 and notified them in writing. None of the employees own stock in Axis. The amount represents reasonable compensation for services rendered and was paid on March 13, 1994. Axis' bonus expense may: a. Not be deducted on Axis' 1993 tax return because the per share employee amount cannot be determined with reasonable accuracy at the time of the declaration of the bonus. b. Be deducted on Axis' 1993 tax return. c. Be deducted on Axis' 1994 tax return. d. Not be deducted on Axis' tax return because payment is a disguised dividend. CPA-02106 Choice "b" is correct. The deduction is an ordinary and necessary business expense treated just as any other compensation expense is treated. Axis is an accrual basis taxpayer, and the deduction is taken on the return for the year in which the expense accrued because it was paid within 2 1/2 months of year-end. Choice "a" is incorrect. The bonus was declared 11 months into the taxable year, so the amount, while not precisely known, could be determined with reasonable accuracy. Choice "c" is incorrect. The deduction accrued is in 1993 and is taken on the 1993 return. An accrualbasis taxpayer deducts expenses in the year in which they accrue, not the year in which they are paid. Choice "d" is incorrect. Since none of the recipient employees are shareholders of Axis, the bonus will not be a disguised dividend.
5. CPA-02039 In 1994, Starke Corp., an accrual-basis calendar year corporation, reported book income of $380,000. Included in that amount was $50,000 municipal bond interest income, $170,000 for federal income tax expense, and $2,000 interest expense on the debt incurred to carry the municipal bonds. What amount should Starke's taxable income be as reconciled on Starke's Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return? a. b. c. d. $330,000 $500,000 $502,000 $550,000
CPA-02039 Choice "c" is correct. Municipal bond interest, interest on debt incurred to carry the municipal bonds, and federal income tax expense are not included in taxable income. Reported book income Municipal bond interest Federal income tax expense Interest to carry municipal bonds Taxable income $380,000 (50,000) 170,000 2,000 $502,000
Choices "a", "b", and "d" are incorrect. Each of these answers does not take into account at least one of the items of the above calculation.
3
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 6. CPA-02149 Brown Corp., a calendar-year taxpayer, was organized and actively began operations on July 1, 2004, and incurred the following costs: Legal fees to obtain corporate charter Commission paid to underwriter Other stock issue costs $41,000 25,000 10,000
Brown wishes to amortize its organizational costs over the shortest period allowed for tax purposes. In 2004, what amount should Brown deduct for the organizational expenses? a. b. c. d. $1,200 $5,000 $6,200 $8,600
CPA-02149 Choice "c" is correct. Organizational costs are amortizable over a minimum period of 15 years (180 months). In addition, subject to a $50,000 total expenditure limitation, a $5,000 deduction is allowed in year one. Allowable costs in connection with the corporate organization are legal fees to obtain the corporate charter, necessary accounting services, expenses of temporary directors, and incorporation fees paid to the state. Organizational costs exclude stock issue costs and commissions paid to underwriters to help sell the shares. Only the legal fees of $41,000 qualify as organizational costs. $41,000 - $5,000 = $36,000/180 months = $200 6 months = $1,200 + $5,000 (expense in year 1) = $6,200.
4
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 7. CPA-02021 On January 2 of the current year, Shaw Corp., an accrual-basis, calendar-year C corporation, purchased all the assets of a sole proprietorship, including $300,000 in goodwill. Current-year federal income tax expense of $110,100 and $7,500 for goodwill impairment were deducted to arrive at Shaw's reported book income of $239,200. What should be the amount of Shaw's current-year taxable income, as reconciled on Shaw's Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return? a. b. c. d. $239,200 $329,300 $336,800 $349,300
CPA-02021 Choice "c" is correct. $336,800 should be reported as Shaw's current-year taxable income, reconciled as follows on Shaw's Schedule M-1 on the Form 1120: Book income Add: Federal income tax expense Less: Excess of tax amortization over book impairment of goodwill Taxable income $239,200 110,100 (12,500) $336,800 [1] [2]
[1] Federal income taxes paid are not deductible for tax purposes. [2] The excess amortization is determined as follows: Total purchased goodwill Divided by 15 years Tax amortization Less: Book impairment (given) Excess tax amortization for the current year $300,000 /15 [tax amortization period] $20,000 (7,500) $12,500
Choice "a" is incorrect. This answer is the amount of book income without any adjustments. Choice "b" is incorrect. This answer adds back the federal income tax expense paid of $110,100 (as is proper) and also deducts the entire $20,000 of tax amortization as additional expense (which is not proper because $7,500 of this amount is already deducted from the book income). Choice "d" is incorrect. This answer adds back the federal income tax expense of $110,100 but does not deduct the additional $12,500 of tax amortization for the year.
5
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 8. CPA-02101 For the year ended December 31, 2004, Taylor Corp. had a net operating loss of $200,000. Taxable income for the earlier years of corporate existence, computed without reference to the net operating loss, was as follows: Taxable income 1999 $5,000 2000 $10,000 2001 $20,000 2002 $30,000 2003 $40,000 What amount of net operating loss will be available to Taylor for the year ended December 31, 2005? a. b. c. d. $200,000 $130,000 $110,000 $95,000
CPA-02101 Choice "b" is correct. 2002 - 2003, Taylor will carry its NOL back two years and forward until it is used (but not more than 20 years). Carrying the NOL back to 2002 - 2003 absorbs $70,000 of the $200,000 NOL generated in 2004 leaving $130,000 to be absorbed in 2005 and later years. Choice "a" is incorrect. Taylor does not waive the two year carryback, therefore the NOL will carry back to the second preceding tax year. Choice "c" is incorrect. The NOL carryback goes first to the second preceding tax year (2002), not the third preceding year (2001). Choice "d" is incorrect. The NOL carryback goes first to the second preceding tax year (2002), not the fifth preceding year (1999).
6
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 9. CPA-02047 In 1994, Best Corp., an accrual-basis calendar-year C corporation, received $100,000 in dividend income from the common stock that it held in an unrelated domestic corporation. The stock was not debtfinanced and was held for over a year. Best recorded the following information for 1994: Loss from Best's operations Dividends received Taxable income (before dividends-received deduction) Best's dividends-received deduction on its 1994 tax return was: a. b. c. d. $100,000 $80,000 $70,000 $63,000 $(10,000) 100,000 $ 90,000
CPA-02047 Choice "d" is correct. The dividends-received deduction (DRD) is 70% of the lesser of: i) taxable income (70% $90,000 = $63,000), or ii) dividends received (70% $100,000 = $70,000). In this case, $63,000 is the dividends-received deduction. 70% is used in this case because the question indicates the corporations are "unrelated" (i.e., less than 20% owned). Choice "a" is incorrect. The 100% DRD is available only when 80-100% of the stock is owned (making theses entities related). Choice "b" is incorrect. The 80% DRD is used when 20-80% of the stock is owned. Choice "c" is incorrect. The deduction is limited to 70% of the lesser of taxable income or the dividends received. 10. CPA-02042 Bent Corp., a calendar-year C corporation, purchased and placed into service residential real property during February 1998. No other property was placed into service during 1998. What convention must Bent use to determine the depreciation deduction for the alternative minimum tax? a. b. c. d. Full-year. Half-year. Mid-quarter. Mid-month.
CPA-02042 Choice "d" is correct. Real property (buildings) is subject to the mid-month convention under MACRS. Only personal property (machinery & equipment) is subject to the half-year and/or mid-quarter conventions.
7
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 11. CPA-02058 On August 1, 1994, Graham purchased and placed into service an office building costing $264,000 including $30,000 for the land. What was Graham's MACRS deduction for the office building in 1994? a. b. c. d. $9,600 $6,000 $3,600 $2,250
CPA-02058 Choice "d" is correct. Only the building is depreciable, so the depreciable portion is $264,000 less $30,000 land, for a net of $234,000. The MACRS rules provide a 39-year life, straight-line depreciation, and a "mid-month" acquisition convention that treats the property as acquired in the middle of the month, regardless of the actual date of acquisition. Therefore, the August 1, 1994, service date provides a halfmonth's depreciation for August, plus a full month for September through December, for a total of 4.5 months for 1994. ($234,000/39 years) (4.5/12) = $2,250. Choice "a" is incorrect. The recovery period for nonresidential real property is 39 years and the midmonth convention is used. The building is treated as if acquired in the middle of the month, regardless of the actual date of acquisition. Depreciation may only be taken for the months after the building was placed in service. Choice "b" is incorrect. The mid-month convention is used for real property. The building is treated as if acquired in the middle of the month, of regardless the actual date of acquisition. Depreciation may only be taken for the months after the building was placed in service. Choice "c" is incorrect. The recovery period for nonresidential real property is 39 years.
12. CPA-02085 Edge Corp., a calendar-year C corporation, had a net operating loss and zero tax liability for its 1994 tax year. To avoid the penalty for underpayment of estimated taxes, Edge could compute its first quarter 1995 estimated income tax payment using the: Annualized income method Yes Yes No No Preceding year method Yes No Yes No
a. b. c. d.
CPA-02085 Choice "b" is correct. Edge should use the annualized income method for calculating its estimated tax payments. Edge cannot use the preceding year method because it did not have an income tax liability in the preceding taxable year. Choices "a", "c", and "d" are incorrect, per the above discussion.
8
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 13. CPA-02162 If a corporation's tentative minimum tax exceeds the regular tax, the excess amount is: a. b. c. d. Carried back to the first preceding taxable year. Carried back to the third preceding taxable year. Payable in addition to the regular tax. Subtracted from the regular tax.
CPA-02162 Choice "c" is correct. If a corporation's tentative minimum tax exceeds the regular tax, the excess amount is the alternative minimum tax which is payable in addition to the regular tax. Choice "a" is incorrect. There is no carryback of the alternative minimum tax. Choice "b" is incorrect. There is no carryback of the alternative minimum tax. Choice "d" is incorrect. The excess amount is added to the regular tax to get the total tax liability.
14. CPA-02090 Edge Corp. met the stock ownership requirements of a personal holding company. What sources of income must Edge consider to determine if the income requirements for a personal holding company have been met? I. Interest earned on tax-exempt obligations. II. Dividends received from an unrelated domestic corporation. a. b. c. d. I only. II only. Both I and II. Neither I nor II.
CPA-02090 Choice "b" is correct. Interest is normally included in personal holding company income, but only if it is included in the receiving corporation's gross income. Since interest income from tax-exempt obligations is not included in gross income, it is not personal holding company income. II. Dividend income from unrelated domestic corporations is personal holding company income. Choices "a", "c", and "d" are incorrect. Each of these answers treats I or II incorrectly. I.
9
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 15. CPA-02131 On January 1, 1993, Kee Corp., a C corporation, had a $50,000 deficit in earnings and profits. For 1993 Kee had current earnings and profits of $10,000 and made a $30,000 cash distribution to its stockholders. What amount of the distribution is taxable as dividend income to Kee's stockholders? a. b. c. d. $30,000 $20,000 $10,000 $0
CPA-02131 Choice "c" is correct. Taxable dividend income is paid out of the corporation's current or accumulated earnings and profits. Since Kee had a deficit, only current earnings and profits of $10,000 are available for dividends. Choice "a" is incorrect. Taxable dividend income is paid out of the corporation's current or accumulated earnings and profits; it is not based solely on the distributed property's fair market value (cash in this instance). Choice "b" is incorrect. Taxable dividend income is paid out of the corporation's current or accumulated earnings and profits; it is not calculated as the difference between current E&P and the cash distributed. Choice "d" is incorrect. Taxable dividend income is paid out of the corporation's current or accumulated earnings and profits.
16. CPA-02120 Tank Corp., which had earnings and profits of $500,000, made a nonliquidating distribution of property to its shareholders in 1993 as a dividend in kind. This property, which had an adjusted basis of $20,000 and a fair market value of $30,000 at the date of distribution, did not constitute assets used in the active conduct of Tank's business. How much gain did Tank recognize on this distribution? a. b. c. d. $30,000 $20,000 $10,000 $0
CPA-02120 Choice "c" is correct. The property distributed by Tank is treated as if it were sold to the shareholder at its fair market value on the date of distribution. Tank recognizes gain to the extent of the fair market value ($30,000) over the adjusted basis ($20,000) or $10,000. Choice "a" is incorrect. Gain is computed as the difference between the FMV and adjusted basis of the property. Choice "b" is incorrect. Gain is not equal to the adjusted basis of the property. Choice "d" is incorrect. Gain is recognized.
10
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 17. CPA-02026 Elm Corp. is an accrual-basis calendar-year C corporation with 100,000 shares of voting common stock issued and outstanding as of December 28, 1995. On Friday, December 29, 1995, Hall surrendered 2,000 shares of Elm stock to Elm in exchange for $33,000 cash. Hall had no direct or indirect interest in Elm after the stock surrender. Additional information follows: Hall's adjusted basis in 2,000 shares of Elm on December 29, 1995 ($8 per share) Elm's accumulated earnings and profits at January 1, 1995 Elm's 1995 net operating loss What amount of income did Hall recognize from the stock surrender? a. b. c. d. $33,000 dividend. $25,000 dividend. $18,000 capital gain. $17,000 capital gain. $16,000 25,000 (7,000)
CPA-02026 Choice "d" is correct. Hall's gain is the difference in the $33,000 he received for his stock and his basis of $16,000, for a gain of $17,000 which is a capital gain. Choice "a" is incorrect. Because this is a sale of Hall's interest in Elm, this is not a dividend. Choice "b" is incorrect. The accumulated earnings of Elm have no relationship to the stock surrender. Choice "c" is incorrect. The amount of the capital gain calculated on the stock surrender is not based on the end of year amount of accumulated earnings and profits.
18. CPA-02027 Mintee Corp., an accrual-basis calendar-year C corporation, had no corporate shareholders when it liquidated in 1996. In cancellation of all their Mintee stock, each Mintee shareholder received in 1996 a liquidating distribution of $2,000 cash and land with tax basis of $5,000 and a fair market value of $10,500. Before the distribution, each shareholder's tax basis in Mintee stock was $6,500. What amount of gain should each Mintee shareholder recognize on the liquidating distribution? a. b. c. d. $0 $500 $4,000 $6,000
CPA-02027 Choice "d" is correct. When a corporation liquidates and distributes assets to shareholders, gain is recognized to the extent that the fair market value of assets distributed to a shareholder exceeds the shareholder's basis in the corporation's stock. Choice "a" is incorrect. In a corporate liquidation, gain is recognized to the extent that the fair market value of the assets received exceeds the shareholder's basis in the stock. Choice "b" is incorrect. The gain is figured using the fair market value of assets received, not the basis of the assets received. Choice "c" is incorrect. This is simply the difference in the fair market value of the land and the shareholder's basis in the stock, and is not how the gain is computed.
11
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 19. CPA-02081 Ace Corp. and Bate Corp. combine in a qualifying reorganization and form Carr Corp., the only surviving corporation. This reorganization is tax-free to the: a. b. c. d. Shareholders Yes Yes No No Corporations Yes No Yes No
CPA-02081 Choice "a" is correct. Rule: A qualifying corporate reorganization is tax-free to all corporations involved and to all their shareholders. Choices "b", "c", and "d" are incorrect, per the above rule.
20. CPA-01984 Which of the following conditions will prevent a corporation from qualifying as an S Corporation? a. b. c. d. The corporation has both common and preferred stock. The corporation has one class of stock with different voting rights. One shareholder is an estate. One shareholder is a grantor trust.
CPA-01984 Choice "a" is correct. An S corporation can only have one class of stock outstanding. Common and preferred stock would constitute two classes of stock. Choice "b" is incorrect. One class of stock with different voting rights is allowed for S corporations. Choice "c" is incorrect. Individuals, estates, and certain trusts may be shareholders in an S corporation. Choice "d" is incorrect. Grantor trusts, Section 678 trusts, qualified Subchapter S trusts (QSSTs), certain testamentary trusts, and voting trusts are allowed to be shareholders in an S corporation.
21. CPA-01974 On February 10, 1994, Ace Corp., a calendar-year corporation, elected S corporation status and all shareholders consented to the election. There was no change in shareholders in 1994. Ace met all eligibility requirements for S status during the preelection portion of the year. What is the earliest date on which Ace can be recognized as an S corporation? a. b. c. d. February 10, 1995. February 10, 1994. January 1, 1995. January 1, 1994.
CPA-01974 Choice "d" is correct. Rule: An S election made by the 15th day of the third month of the taxable year is retroactively effective on the first day of the taxable year. Choices "a", "b", and "c" are incorrect, per the above rule. 12
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 22. CPA-01966 Bristol Corp. was formed as a C corporation on January 1, 2000, and elected S corporation status on January 1, 2002. At the time of the election, Bristol had accumulated C corporation earnings and profits, which have not been distributed. Bristol has had the same 25 shareholders throughout its existence. In 2005 Bristol's S election will terminate if it: a. b. c. d. Increases the number of shareholders to 100. Adds a decedent's estate as a shareholder to the existing shareholders. Takes a charitable contribution deduction. Has passive investment income exceeding 90% of gross receipts in each of the three consecutive years ending December 31, 2004.
CPA-01966 Choice "d" is correct. S corporations that are former C corporations with undistributed C corporation earnings and profits are restricted in the amount of passive investment income they can realize without terminating their S election. The restriction is 25% of total gross receipts from passive investment income. After 3 years with 90% of its gross receipts from passive sources, Bristol will lose its S corporation status on the first day of its 2005 taxable year. Choice "a" is incorrect. An S corporation can have as many as 100 shareholders. Choice "b" is incorrect. A decedent's estate may be an S corporation shareholder. Choice "c" is incorrect. S corporations pass their charitable contribution deductions through to their shareholders.
23. CPA-01955 Lane Inc., an S corporation, pays single coverage health insurance premiums of $4,800 per year and family coverage premiums of $7,200 per year. Mill is a ten percent shareholder-employee in Lane. On Mill's behalf, Lane pays Mill's family coverage under the health insurance plan. What amount of insurance premiums is includible in Mill's gross income? a. b. c. d. $0 $720 $4,800 $7,200
CPA-01955 Choice "d" is correct. $7,200 of insurance premiums (the amount of family coverage premiums, as indicated in the question) is includible in Mill's gross income. Rule: Fringe benefits paid by an S corporation are deductible by the S corporation only for nonshareholder employees and those employee-shareholders owning 2% or less of the S Corporation. Other fringe benefits paid are deductible by the S corporation if included as part of gross income from the S corporation for the individual receiving the benefits (i.e., included as part of income on the shareholder's W-2). Choices "a", "b", and "c" are incorrect, per the above rule.
13
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Regulation 3 Class Questions 24. CPA-01957 Beck Corp. has been a calendar-year S corporation since its inception on January 2, 1995. On January 1, 1998, Lazur and Lyle each owned 50% of the Beck stock, in which their respective tax bases were $12,000 and $9,000. For the year ended December 31, 1998, Beck had $81,000 in ordinary business income and $10,000 in tax-exempt income. Beck made a $51,000 cash distribution to each shareholder on December 31, 1998. What was Lazur's tax basis in Beck after the distribution? a. b. c. d. $1,500 $6,500 $52,500 $57,500
CPA-01957 Choice "b" is correct. Lazur's tax basis after the distribution was $6,500. Rule: The adjusted basis of S corporation stock goes up for undistributed earnings (including tax-exempt income) and vice-versa, as it would in a partnership. Rule: Amounts distributed (including distributions not taxable as dividends) reduce the adjusted basis of the stock. Lazur's basis at 1/1/98 Add: 50% of ordinary income 40,500 [$81,000 50%] 50% of tax-exempt income 5,000 [$10,000 50%] Less: Distribution to Lazur Basis at 12/31/98 (51,000) $ 6,500 $12,000
Choices "a", "c", and "d" are incorrect, per the above rules.
14
2009 DeVry/Becker Educational Development Corp. All rights reserved.