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Unformatted text preview: Chapter 7 Selected Solutions 17. The Graves Corporation was incorporated in 2010 and incurred a net operating loss of $35,000. The company’s operating income in 2011 was $47,000. Because of a downturn in the local economy, the company suffers a net operating loss of $21,000 in 2012. What is the treatment of the 2012 loss? A corporation is a taxable entity that is responsible for the payment of tax on its income. Therefore, it is allowed a deduction for a net operating loss. The 2010 NOL is carried forward and used to reduce the 2011 operating income to $12,000 ($47,000 - $35,000). Graves pays a tax of $1,800 (15% x $12,000) on the income in 2011. The 2012 loss is carried back to 2011 and $12,000 of the $21,000 loss is used to reduce the 2011 income to zero. This results in a refund of the $1,800 of tax paid in 2011. The remaining $9,000 of loss is carried forward to 2013 and used to reduce income. 2010 2011 2012_ Operating income $ (35,000) $ 47,000 $ (21,000) Carryforward of 2010 loss (35,000 ) 2011 Taxable Income $ 12,000 Carryback of 2012 loss to 2011 (12,000 ) 12,000 Carryforward of 2012 loss to 2013 $ (9,000 ) 2011 Taxable income $ 12,000 Tax rate on $12,000 of income x 15 % 2011 Tax paid (refund of carryback) $ 1,800 Instructor's Note: Graves has the option of electing not to carry the 2012 loss back to 2011 and carrying the $21,000 loss forward to 2013. Graves should make the election if it feels that its marginal tax rate will increase and the net present value of the tax savings of carrying the loss forward exceed carrying back the current year's loss. How would your answer change if Graves were an S corporation? An S corporation is a conduit entity that does not pay tax on its income. The shareholders of Graves are taxed on any income and also receive their proportionate share of any losses generated by Graves. For 2012, the $21,000 operating loss is distributed to each shareholder. The shareholder then takes the appropriate allowable deduction on his/her return. Because the income and loss is passed through to the individual shareholders each year, S corporations do not have net operating loss carryforwards or carrybacks. 18. Habiby, Inc., has the following income and expenses for 2009 through 2012. What is the amount of tax that Habiby should pay each year? Use the corporate tax rate schedules in Appendix A to compute the tax liability. 2009 2010 2011 2012 Income $ 280,000 $ 300,000 $ 290,000 $ 320,000 Expenses (180,000 ) (200,000 ) (600,000 ) (220,000 ) Taxable Income $ 100,000 $ 100,000 $ (310,000) $ 100,000 Using the corporate tax rate schedules, Habiby would have paid a tax of $22,250 each year on its 2009 and 2010 taxable income of $100,000....
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- Fall '11
- Taxation in the United States