Q 1. Senior Corp. completely liquidates its 80%-owned subsidiary, Junior Corp. The liquidation results in a distribution to Senior of property with a fair market value of $1,000,000 and an adjusted basis to Junior of $400,000. How much gain, if any, will Senior and Junior each recognize on the transaction?
Correct! Although distributions of property in complete liquidation of a corporation will
generally result in a gain or loss equal to the difference between the fair value of the property and its tax basis, when the distribution is made from a subsidiary to a parent as part of the liquidation of the subsidiary, no gain or loss is recognized, as would be the case with Junior’s distribution to Senior.
Q 2. Calamity Corp. distributes five unimproved parcels of swampland to its shareholders as part of a complete liquidation. The fair market value of each parcel is $25,000 and Calamity’s adjusted basis in each parcel is $40,000. $40,000. What amount of gain or loss, if any, will Calamity Corp. recognize as a result of distributing the parcels?
Perry Partnership distributed cash of $15,000 and a parcel of land in a liquidating distribution to Gupta, a partner. The land had a fair market value of $50,000 and an inside basis of $52,000 at the time of the distribution. Gupta’s outside basis in Perry just prior to the distribution was was $70,000. What is Gupta’s Gupta’s resulting resulting basis in the land? land?
Correct! Since the distribution to Gupta is a liquidating distribution, Gupta’s partnership interest will
be reduced first by the $15,000 in cash received from $70,000 to $55,000. In order to reduce Gupta’s basis in the partnership to zero, the land will have a basis to Gupta for the remaining $55,000.
Q4. Osha, a cash-basis calendar-year partnership, began business on April 1, Year 1. Osha incurred and paid the following following during Year 1: Legal work associated with formation of the partnership: $15,260 Accounting fees associated with promoting and selling partnership interests: $10,000 What is the maximum amount of organizational costs deductible on Osha’s Year 1 partnership return?
A partnership may deduct up to a maximum of $5,000 of organizational costs in the year incurred with the remainder amortizated over 180 months. Legal fees of 15,260 would be included but accounting fees incurred to raise additional capital would not. Osha would be included to deduct $5,000+9/180*10,260 = 5,513
Q5. Prairie partnership partnership has four equal partners, Dodd, Crank, Pick, and Mack. Each of the partners had a tax basis of $320,000 as of January 1, Year 1. Prairie’s Year 1 ordinary business income was $152,000 before deducting any guaranteed payments to the partners. During Year 1, Prairie Prairie paid Mack guaranteed payments payments of $4,000 for deductible services services rendered. rendered. During Year 1, each each of the four partners partners took a distribution of $50,000. What is Mack’s tax basis in Prairie on December 31, Year 1?
The guaranteed payment to Mack of
$4,000 is treated as an ordinary business expense by the partnership and reduces its ordinary income from $152,000 to $148,000. Each partner will have ¼ or $37,000 allocated. As a result, Mack, and each of the other partners, will have a basis of $320,000+$37,000-$50,000 = $307,000
Correct! The guaranteed payment to Mack of $4,000 is treated as an ordinary business expense by the partnership and reduces its taxable income from $152,000 to $148,000. Each partner will have ¼, or $37,000 allocated. As a result, Mack, and each of the other partners, will have a basis of $320,000 + $37,000 income - $50,000 distribution, for a net amount of $307,000.
Q 6. Pettifog Partnership distributes cash of $20,000, hot assets worth $5,000, and a parcel of land in a liquidating distribution to Li, a partner. The hot assets have a basis of $0 to the partnership. The land has a fair market value of $80,000 and an inside basis of $55,000. Li’s outside basis in Pettifog just prior to the distribution is $85,000. What amount of gain or loss, if any, must Li recognize and what is Li’s resulting basis in the land?
When a liquidating distribution is received, a partner will first reduce the partner’s basis in the partnership by any cash or hot assets that are received. Gupta will reduce the $85,000 basis by $20,000, resulting in a basis of $65,000. The remainder will be the basis of any other property distributed, providing Gupta a $65,000 basis in the land.
Correct! No loss is recognized because the partner received property other than cash and hot
assets in the liquidating distribution. When a liquidating distribution is received, a partner will first
reduce the partner’s basis in the partnership by any cash or hot assets that are received. Li will reduce the $85,000 basis by $20,000, resulting in a basis of $65,000. The remainder will be the basis of any other property distributed, providing Li with a $65,000 basis in the land. Q7. Which of the following statements most accurately describes the concept of apportionment
for purposes of state and local taxation?
8. Catherine has a $100,000 basis in her partnership interest. On April 28 of the current tax year, as part of an operating distribution, the partnership distributes to her cash of $32,000, cash basis receivables with an inside basis of $0 and a fair market value of $12,000, and a parcel of land with a fair market value of $75,000 and a basis to the partnership of $65,000. After accounting for this distribution, what is Catherine’s basis in the land?
Since
this is a nonliquidating distribution, Catherine will first apply the $32,000 cash received against her basis in the partnership, reducing it to $68,000. Catherine’s basis in the receivables will be $0, the same as the partnership, not affecting her basis. Since the partnership’s basis in the land does not exceed her remaining basis in the partnership, it will have a basis of $65,000, the same as the partnership’s basis, reducing her basis in the partnership to $3,000.
Q 9. Calvin owns 40% of the outstanding shares of Copernicus Corp., which has
accumulated earnings and profits of $100,000 as of December 31, Year 1. The outstanding shares not owned by Calvin are owned by parties unrelated to Calvin. On January 1 of Year 2, Calvin, wishing to pursue another business opportunity, sells his stock back to Copernicus Corp. Copernicus distributes cash of $250,000 in redemption of all of Calvin’s stock. If Calvin’s adjusted basis for the stock on the date of redemption is $125,000, what will be the tax effect of the redemption to Calvin?
Correct! A redemption of shares, which is a repurchase of shares from the shareholder, is treated
as a sale or exchange by the shareholder and generally results in a capital gain as long as the redemption is not essentially equivalent to a dividend; is substantially disproportionate; involves redemption of all of the shareholder’s stock, provided other shareholders are not related; is from a non-corporate shareholder in partial liquidation; or is a redemption of stock to pay death taxes under Section 303. Since this is a redemption of all of Calvin’s stock, and other shareholders are not related, the gain, equal to the excess of the $250,000 distribution over the $125,000 basis, or $125,000, would be a capital gain.
Q 10. Jackson, an individual, is a shareholder in Cadduceus Corp., a C corporation
with $40,000 in accumulated earnings and profits. Cadduceus Corp. redeems some of its stock from Jackson for $200,000 as part of a qualifying partial liquidation. Jackson’s adjusted basis in the stock at the time of redemption was $50,000. For tax purposes, how will Jackson report the effects of this redemption of stock?
Correct! A redemption of shares, which is a repurchase of shares from the shareholder, is treated
as a sale or exchange by the shareholder and generally results in a capital gain as long as the redemption is not essentially equivalent to a dividend; is substantially disproportionate; involves redemption of all of the shareholder’s stock, provided other sharehold ers are not related; is from a non-corporate shareholder in partial liquidation; or is a redemption of stock to pay death taxes under Section 303. Since this is a redemption of shares from a non-corporate shareholder in partial liquidation, the gain, equal to the excess of the $200,000 distribution over the $50,000 basis, or $150,000, would be a capital gain.
Q 11. Ravi, a prosperous businessman, owns devalued property; its basis to him exceeds its fair market value (FMV), which is $600,000. He would like to give the property to his daughter, Ritu, but is unsure about the tax consequences to Ritu depending on the timing of the gift. Should he give it as a gift now, or leave it to her in his will? Why? Assume it is highly unlikely the FMV will have risen to the level of Ravi’s basis by the time of Ravi’s death.
If Ritu inherits the property from Ravi, her basis will be the fair value at the date of death, or six months after the date of death if the alternate valuation date is elected, which is presumed to be lower than Ravi’s basis. A sale would result in a gain equal to the difference between the sales price and that amount. If Ritu receives the property as a gift, since it is worth less than Ravi’s basis on the date of the gift, her basis will be Ravi’s basis if sold at a gain and the fair value at the date of the gif t if sold at a loss. As a result, Ritu will only have a taxable gain if the property is sold for more than Ravi’s basis, making a gift the more advantageous way for her to receive the property.
Q 12. Cadwallader has had a 30% interest in C&C Associates, a partnership, since Year 1. In Year 6 the partnership is liquidated. The partnership’s only assets at the time of liquidation are $50,000 in cash and land with a fair market value of $60,000 and a basis of $65,000. C&C Associates has no liabilities. Cadwallader’s adjusted basis in the partnership interest is $34,500, and Cadwallader receives $30,000 cash in liquidation of the entire interest. What amount and type of loss, if any, should Cadwallader recognize as a result of the liquidation of C&C Associates
Correct! Since Cadwallader is receiving a total of $30,000 in cash in total liquidation of her
partnership interest with a basis of $34,500, Cadwallader will recognize a capital loss for the difference of $4,500. Because the holding period is from Year 1 to Year 6, it will be a long-term capital loss.
Q13. Compendium Corp. distributed cash and personal property to its sole shareholder. Considering the following facts, what amount of gain would be recognized by Compendium as a result of making this distribution to its shareholder?
When appreciated property is distributed to shareholders, it’s treated as if sold for its fair value, resulting a taxable gain. Since the property was worth 10,000 and has a basis of 4,000, there would be a gain of 6,000. In addition, the shareholder assumed a liability for an amount that exceeds the fair value of the property, the excess of 2,000 will also be recognized as a gain by the corporation resulting a total gain of $8,000
Correct! When appreciated property is distributed to shareholders, it is treated as if it is sold for its
fair value, resulting in a taxable gain. Since the property was worth $10,000 and had a basis of $4,000, there would be a gain of $6,000. In addition, since the shareholder assumed a liability for an amount that exceeds the fair value of the property, the excess of $2,000 will also be recognized as a gain by the corporation, resulting in a total gain of $8,000 to Compendium Corp.
Q 14. Harper, Inc. is incorporated in State 1 but also has offices in States 2, 3, and 4. All four states use the Uniform Division of Income for Tax Purposes Act (UDITPA) three-factor formula for determining the state apportionment percentage. Based on the following financial information, what percentages of Harper’s income should be apportioned to States 1 and 2? Round to the nearest whole percentage.
State 1: 49.66%+37.38%+73.1% = 53.38% State 2: 14.48%+20.58%+7.6% = 14.22% Correct! Under the Uniform Division of Income for Tax Purposes Act (UDITPA) formula, the state
apportionment percentage is calculated by adding the following three ratios together for each state and dividing by 3:
Q 15. Candy Corp. is a C corporation that began operations in Year 1. Candy Corp.’s
Year 1 through Year 3 taxable earnings and profits are as follows: Year E&P 1 $(10,000) 2 5,000 3 10,000 Year E&P 1 $ ( 25,000) 2 5,000 3 10,000
On the last day of Year 3, Candy Corp. makes a $12,500 cash distribution, distributed equally among its two shareholders, Goode and Plenteau. Assuming Goode has sufficient basis in the Candy Corp. stock investment, what amount, if any, of Goode’s distribution is a nontaxable return of capital?
Corporate distributions to shareholders are taxed as dividends to the shareholders to the extent of the greater of current earnings and profits or cumulative earnings a nd profits. Candy’s current earnings and profits for year 3 were $10,000 and cumulative earning and profits, due to the $25,000 loss in year 1, were ($10,000). As a result, $10,000 of the $12,500 distribution would be dividend income to the shareholders and the remaining $2,500, $1,250 of which went to Goode, would be a return of capital
Correct! Corporate distributions to shareholders are taxed as dividends to the shareholders to the
extent of the greater of current earnings and profits or accumulated earnings and profits. Candy’s current earnings and profits for Year 3 were $10,000 and accumulated earnings and profits, due to the $25,000 loss in Year 1, were $(20,000). As a result, $10,000 of the $12,500 distribution would be dividend income to the shareholders and the remaining $2,500, $1,250 of which went to Goode, would be a return of capital.
Q 16. Indicate for each of the following financial statement items whether it would cause no adjustment or whether it would be either added to or subtracted from net income per books when computing taxable income on the Schedule M-1 or M-3: OK by ED as modified
Correct! Premiums paid on key employee life insurance, the excess of book depreciation over tax
depreciation, and accrued warranty expense all reduce financial statement income but are not deductible for tax purposes. As a result, each will be added to financial statement income on Schedule M-1 or M-3 to reconcile to taxable income.
Q 17. When preparing Schedule M-1 of Form 1120, which of the following must be added to net income per books to compute taxable income? OK by ED
Correct! To convert from book income to taxable income, bad debt expense accrued will have to be
added back because it is not deductible until the account is written off. Half, not 100%, of meals and entertainment expense would be added back to book income to calculate taxable income. Municipal bond interest is not taxable and would be deducted from, not added to, book income to determine taxable income. The excess of tax over book depreciation would be deducted from book income, not added to it, to determine taxable income.
Q 18. Which of the following correctly describes the purpose(s) of Schedules M-1 and M-3
Correct! Both Schedules M-1 and M-3 reconcile a corporation’s book income to its taxable
income. Schedule M-3, which is for corporations with total assets of $10 million or more, also differentiates between temporary differences and permanent differences, a distinction not made on Schedule M-1.
Q 19. In a qualifying reorganization, Acuity Corp. exchanges land valued at $225,000 with a $150,000 basis for all of Dull Corp.’s assets, which have a value of $300,000 and a $250,000 basis. What amount of gain or loss, if any, will Dull Corp.’s shareholders recognize as a result of this reorganization?
Correct! Although gains and losses are generally not recognized in a qualifying reorganization,
gains are recognized to the extent boot, or unlike property, is received. Losses may only be recognized by shareholders when shares are exchanged exclusively for unlike property. Since shareholders exchanged shares with a basis of $250,000 for unlike property with a value of $225,000, the shareholders will recognize a loss for the difference of $25,000.
Q. 20. Katsu Corp. distributes property to its shareholders as part of a complete liquidation. The fair market value of the property is $500,000, Katsu’s adjusted basis in the property is $150,000, and the property is subject to a liability of $200,000. What amount of gain will Katsu recognize as a result of the transaction?
Correct! When appreciated property is distributed as part of a complete liquidation, it is treated as if
it was sold for its fair value, resulting in a gain. Since the property had a basis of $150,000 and a fair value of $500,000, a gain for the difference of $350,000 will be recognized. When the distribution is subject to a liability, the gain is increased to the extent that the liability exceeds the fair value of the property. Since the $200,000 balance of the liability did not exceed the $500,000 fair value of the property, the gain will not be increased and will be taxable in the amount of $350,000.
Q 21. During the formation of Beecky partnership, Sam contributed property with an a djusted basis of $130,000 in exchange for a 25% interest in Beecky. The fair market value of the contributed property was $170,000 and the property was encumbered by recourse debt with a balance of $120,000. What amount of gain, if any, should Sam recognize from contributing property to the Beecky partnership?
a.
A partner does not recognize a gain on the contribution of appreciated property to a partnership unless it is subject to a liability that exceeds the contributing partner’s basis in the property. Sam is contributing property with a basis of $130,000, subject to a liability of $120,000, for a 25% interest in the partnership. As a result, Sam would have a basis in the partnership of the $130,000 basis in the contributed property, minus the $120,000 liability assumed by the partnership, plus Sam’s porti on of the liability, 25% x $120,000 or $30,000. Sam would not, however, recognize any gain on the contribution.
Correct! A partner does not recognize a gain on the contribution of appreciated property to a
partnership subject to a recourse liability unless the liability relieved exceeds the sum of the contributing partner’s basis in the property plus the contributing partner’s share of the contributed liability. Sam is contributing property with a basis of $130,000, subject to a liability of $120,000, for a 25% interest in the partnership. As a result, Sam would have a basis in his partnership interest equal to the $130,000 basis in the contributed property, less the $120,000 liability assumed by the partnership, plus Sam’s $30,000 share of the liability (25% x $120,000), or $40,000. Under these facts, Sam would not recognize any gain on the contribution.
Q 22. Prairie partnership has four equal partners, Dodd, Crank, Pick, and Mack. Each of the partners had a tax basis of $320,000 as of January 1, Year 1. Prairie’s Year 1 ordinary business income was $152,000 before deducting any guaranteed payments made to the partners. During Year 1, Prairie paid Mack guaranteed payments of $4,000 for deductible services rendered. During Year 1, each of the four partners took a distribution of $50,000. What amount from Prairie should be included on Dodd’s Year 1 tax return
Correct! The guaranteed payment of $4,000 to Mack reduced Prairie’s allocable ordinary business
income from $152,000 to $148,000. Each of the three partners other than Mack will report ordinary income of $148,000/4, or $37,000, while Mack will report ordinary income of $37,000 + $4,000, or $41,000. Because the $50,000 cash distributions were not in excess of the partners’ tax basis in their interests, the cash distributions were not taxable to the partners.
Q 23. Preakness Partnership makes an operating distribution to Prasad consisting of $30,000 in cash, land with a fair market value of $50,000 ($55,000 partnership basis), and inventory with a fair market value of $8,000 ($3,000 partnership basis). Immediately prior to the distribution, Prasad’s outside basis in the partnership was $35,000. What amount of gain, if any, will Prasad recognize on the distribution, and what is Prasad’s resulting basis in the land?
Correct! In accounting for the distribution, Prasad will account for the cash of $30,000, reducing
Prasad’s basis from $35,000 to $5,000. The inventory will be recognized at the partnership’s basis of $3,000, leaving Prasad a basis of $2,000, which will be the basis in the land. Gain would only be recognized if the amount of cash distributed exceeded Prasad’s basis in the partnership.
Q 24. Each of the following generates a permanent difference between book and taxable income, except
Correct! In reconciling book income to taxable income on Schedule M-1 or M-3, all differences
between book and taxable income are identified. Temporary differences are those that will ultimately be the same for tax and book purposes but in different periods, such as Section 179 depreciation, taken in the year of acquisition for tax and spread out over the life of the asset for book purposes. Permanent differences are items that are deducted or added in for tax purposes but not for book purposes, or vice versa. This would include political contributions, which are not deductible for tax purposes but are expensed for financial reporting purposes; the DPAD, which is deductible
for tax purposes but is not an expense for financial reporting purposes; and tax credits, which are reductions in tax as a result of the operation of tax law but do not represent either income or expense for financial reporting purposes.
Q 25. Pelican Partnership makes an operating distribution to Prabakhar consisting of $30,000 in cash and capital assets worth $10,000 (partnership basis $8,000). Immediately prior to the distribution, Prabhakar’s outside basis in the partnership was $35,000. What amount of gain, if any, will Prabhakar recognize on the distribution, and what is Prabhakar’s resulting outside basis in the partnership?
Correct! In accounting for the distribution, Prabakhar will account for the cash of $30,000, reducing
Prabakhar’s basis from $35,000 to $5,000. The capital assets will have a basis to Prabakhar equal to the remaining basis in the partnership, $5,000, leaving a basis in the partnership of $0. No gain would be recognized; gain would only be recognized if the amount of cash distributed exceeded Prabakhar’s basis in the partnership.
A partnership makes an operating distribution consisting of cash, hot assets, and land. The distribute partner’s outside basis just prior to the distribution (the “prior basis”) is less than the total basis of all the distributed property but more than the combined amount of cash and the partnership’s basis in the hot assets. Which of the following choices best describes the computation of the amount of the partner’s recognized gain and basis in the land received?
Correct! In an operating distribution, a partner will first re duce the partner’s basis in the partnership
by the total of cash and the basis of any hot assets (such as marketable securities, inventories and accounts receivable) distributed. If the partnership’s basis in the remaining property distributed exceeds the partner’s remaining basis in the partnership, the distributed asset will have a basis equal to the partner’s remaining basis in the partnership. Gain would only be recognized if the amount of cash distributed exceeded the partner’s basis in the partnershi p.
Hubert Hanson owns 40% of Calico Corp.’s outstanding shares; Hanson’s spouse owns 20%. In a qualifying stock redemption, Calico exchanges $100,000 cash for half of Hubert Hanson’s stock. At the time of the redemption, Hubert’s adjusted basis in the Calico stock was $300,000. Additionally, just prior to the redemption, Calico Corp. had accumulated earnings and profits (E&P) of $(20,000) and current E&P of $25,000. What amount of income, gain or loss, if any, will Hanson recognize as a result of the redemption?
Correct! Hubert’s transaction will be treated as an exchange under IRC §302, because he meets
both of the following requirements: (1) he owns less than 50% of the all voting stock after the redemption, including indirect ownership attributed to him from his spouse; and (2) he owns less than 80% of the percentage of voting stock and total fair market value that he previously owned. Including the stock owned by Hubert’s wife, Hanson is considered to own 60% of Calico before the redemption. Hubert meets the first test since, after the redemption, Hubert owns 40% (i.e., 40% – 50% sold = 20% owned directly + 20% owned indirectly). Hubert also meets the second test since his now 40% ownership is less than 80% of what he used to own (i.e., 60% previous ownership × 80% = 48% threshold). However, since the transaction resulted in a loss of $50,000 [i.e., $100,000 cash – ($300,000 basis × 50%)] and Hubert was a related party at the time of the transaction (i.e., more than 50% ownership), his $50,000 loss is disallowed under the IRC §267 related-party loss rules.
Explanation Correct! The
income of a C corporation does not pass-through to its shareholders. That is, it is not a pass-through entity. A pass-through entity is one that is an entity responsible for filing its own tax return but not subject to tax. Instead, its ordinary income and each category of its special income, deductions, gains, and losses are included in, or passed through to, the tax returns of the owners.
Which of the following statements correctly describes a tax implication of a foreign subsidiary versus a foreign branch?
The following chart shows ownership percentages of Devon Corp. in X, Y and Z Corporations, and dividends received by Devon from these corporations in Year 4. OK by ED
