Chapter C3
The Corporate Income Tax
Discussion Questions
C3-1 Unless High Corporation is an S corporation or a personal service corporation, High
Corporation can select a tax year ending on the last day of any month (i.e., a fiscal year or a calendar
year). pp. C3-2 and C3-3.
C3-2 Port Corporation may change its annual accounting period without prior approval of the IRS
if: (1) the corporation has not changed its annual accounting period within the prior ten years; (2) the
resulting short period does not have an NOL; (3) the corporation's annualized taxable income for the
resulting short period is at least 80% of the corporation's taxable income for the preceding tax year;
(4) the corporation has a special tax status (i.e., personal holding company or exempt status) for the
short period or tax year prior to the short period, it has the same status for both; and (5) the
corporation does not elect S corporation status for the year following the short period (Reg. Sec.
1.442-1(c)). If these requirements are not satisfied, Port Corporation can request approval of a
change in accounting period by filing a Form 1128 on or before the 15th day of the second month
following the close of the short period resulting from the change. p. C3-4.
C3-3 Stan and Susan need to choose an accounting period. They generally can select either a
calendar year or a fiscal year. A fiscal year can permit an income deferral. However, if they elect S
corporation status, they are generally required to use a calendar year. Stan and Susan need to select
an accounting method. They are required to use the accrual method for sales-related items since
inventories are a material income-producing factor, but may want to use the cash method for other
items (i.e., the hybrid method) as long as they are eligible.
Stan and Susan need to select an accounting method for their inventory, i.e., LIFO, FIFO,
LCM, etc. They may want to investigate which method is best for their particular type of inventory.
Since the price of digital circuits has declined in recent years, the LIFO method does not appear to
be a logical choice. Stan and Susan need to determine whether they will make an election to
amortize organizational costs and/or start-up costs. Stan and Susan need to decide what method they
will use to writeoff their research and development expenses - i.e., expense in year incurred or defer
and amortize over 60 months or more. Stan and Susan need to determine whether they want to make
an S election in order to pass through start-up losses. Stan and Susan need to determine if they want
to capitalize the corporation with debt as well as equity, and, if so, how much debt and how much
equity will be used. pp. C3-2 through C3-5.
C3-4 Capital gains and losses are computed in the same way by corporations and by individuals.
However, corporations cannot deduct capital losses from ordinary income. A corporation can carry a
capital loss back three years and forward five years to offset capital gains. Individuals can only carry
such losses forward. Corporations also do not have a maximum tax rate for net capital gains that is
lower than the top ordinary income rate like individuals do. pp. C3-7 and C3-8.
C3-1
C3-5 Section 291 reduces the tax preference given to Sec. 1250 property at the time of sale by
requiring a corporation to recapture as ordinary income 20% of the additional amount of gain that
would have been recaptured as ordinary income if the property had instead been Sec. 1245 property.
pp. C3-8 and C3-9.
C3-6 Organizational expenditures include those outlays that are incident to the creation of a
corporation, chargeable to the corporation's capital account, and of a character that would be
amortizable, if the corporation had a limited life. They must be capitalized. An election can be made
under Sec. 248 to amortize those expenditures incurred in the corporation's first tax year over a
period of 60 months or more starting with the month in which the corporation begins business
operations. pp. C3-9 and C3-10.
C3-7 Start-up expenditures are ordinary and necessary business expenses that are paid or incurred
to investigate the creation or acquisition of an active trade or business, to create an active trade or
business, or to conduct an activity engaged in for profit or the production of income before the time
the activity becomes an active trade or business. An election can be made under Sec. 195 to
amortize these expenditures over a period of 60 months or more starting with the month in which an
active trade or business begins. pp. C3-10 and C3-11.
C3-8 Charitable contributions for corporations differ from those allowed to individuals in three
ways: (1) the timing of the deduction; (2) the amount of the deduction permitted for the contribution
of certain nonmoney properties; and (3) the maximum deduction permitted in any given year.
Accrual method of accounting corporations are able to deduct certain contributions that remain
unpaid at year-end. Such an election is not available to individuals. A corporate taxpayer can deduct
a larger amount for health-related and scientific- research properties that are donated from inventory
than is permitted an individual taxpayer. A corporation's charitable contribution is limited to 10% of
adjusted taxable income, which is different from the series of limits that apply to individuals. pp.
C3-11 through C3-14.
C3-9 Carver Corporation can deduct the contribution in 1998 if it is paid on March 10, 1999.
However, if it is paid on April 20, 1999 (after the March 15, 1999 deadline for a calendar-year
taxpayer), it cannot be deducted in 1998 but must be deducted in 1999. p. C3-11.
C3-10 If the property qualifies as scientific research property under Sec. 170(e)(4), Zero
Corporation's deduction is $2,012 {$1,225 + [0.50 x ($2,800 - $1,225)]} since the tentative
deduction amount is less than twice the property's adjusted basis ($2,450 = $1,225 x 2). Otherwise,
the contribution is $1,225. pp. C3-12 and C3-13.
C3-11 Corporations are allowed a dividends-received deduction to partially or fully mitigate the
effects of multiple taxation of corporate earnings. Dividends received by a domestic corporation
from another domestic corporation (other than S corporations) are eligible for the special 70%, 80%
or 100% deduction. Also ineligible for the dividends-received deduction are distributions that
receive capital gain treatment (e.g., liquidating distributions), most dividends from foreign
C3-2
corporations, dividends on stock held 45 days or less, or stock that is debt-financed. pp. C3-14
through C3-18.
C3-12 The dividends-received deduction on debt-financed stock is disallowed to prevent a
corporation from deducting interest paid on money borrowed to purchase the stock, while paying
little or no tax on the dividends received on the stock. pp. C3-17 and C3-18.
C3-13 For tax years beginning before August 5, 1997, Crane Corporation may carry its NOL back
three years and forward to the next 15 years. Alternatively it can forgo the carry back period and just
carry the NOL forward to the next 15 years. The election to forgo the carryback might be utilized if
(1) its income was taxed at a low marginal rate in the carryback period and the corporation
anticipates income being taxed at a higher marginal rate in later years, or (2) it utilized tax credit
carryovers in the earlier year that were about to expire. The NOL carryback and carryover rules are
different for tax years beginning after August 5, 1997 (for example, calendar year 1998). The new
rules permit a two-year carryback and a 20-year carryover. The election to forego the NOL
carryback permits a 20-year carryover. pp. C3-19 through C3-21 and C3-37.
C3-14 Section 267(a)(1) denies a deduction for losses realized on the sale or exchange of property
between a corporation and a shareholder who owns more than 50% (in value) of the corporation's
stock (i.e., a controlling shareholder). The loss can be used at a later date by the purchasing party to
reduce their recognized gain on a subsequent sale or exchange of the property. Section 267(a)(2)
denies a deduction for accrued expenses and interest on certain transactions involving a corporation
and a controlling shareholder that use different accounting methods when the payee will include the
item in gross income at a date that is later than when it is accrued by the payor. The expense is
deducted by the payor at the time it is included in gross income by the payee. pp. C3-20 and C3-21.
C3-15 0.15 x $ 50,000 = $ 7,500
0.25 x 25,000 =
6,250
0.34 x 25,000 =
8,500
0.39 x 100,000 =
39,000
Tax liability
$61,250
pp. C3-22 through C3-24.
C3-16 $75,000 x 0.35 = $26,250. (Note: Personal service corporations are taxed at a flat 35% rate.)
pp. C3-23 and C3-24.
C3-17 Special restrictions are needed on controlled groups of corporations to prevent shareholders
from creating multiple corporations so as to have all of the corporate income taxed at less than the
maximum 35% marginal tax rate. pp. C3-24 and C3-25.
C3-3
C3-18 Three types of controlled groups are brother-sister controlled groups, parent-subsidiary
controlled groups, and combined controlled groups. A group of two or more corporations is a
brother-sister controlled group if five or fewer individuals, trusts, or estates own (1) At least 80% of
the voting power of all classes of voting stock (or at least 80% of the total value of the outstanding
stock) of each corporation, and (2) More than 50% of the voting power of all classes of stock (or
more than 50% of the total value of the outstanding stock) of each corporation, taking into account
only the stock ownership that each person has that is identical with respect to each corporation. A
shareholder's identical ownership is the percentage of stock the shareholder owns in common in each
of the corporations. A parent-subsidiary controlled group is a group of two or more corporations
where one corporation (the parent corporation) owns directly at least 80% of the voting power of all
classes of voting stock, or 80% of the total value of all classes of stock, of a second corporation (the
subsidiary corporation). There can be more than one subsidiary corporation in the group. If the
parent corporation, the subsidiary corporation, or any other members of the controlled group in total
own at least 80% of the voting power of all classes of voting stock, or 80% of the total value of all
classes of stock of another corporation, then that other corporation is included in the parentsubsidiary controlled group. A combined controlled group is a group of three or more corporations
where the following criteria are met: (1) Each corporation is a member of a parent-subsidiary
controlled group or a brother-sister controlled group; and (2) At least one of the corporations is (a)
the parent corporation of a parent-subsidiary controlled group and (b) a member of a brother-sister
controlled group. pp. C3-25 through C3-28.
C3-19 Members of a controlled group are limited to a total of $50,000 being taxed at the 15%
marginal tax rate, $25,000 being taxed at the 25% marginal tax rate, and $10 million being taxed at
the 34% marginal tax rate. Controlled groups must apportion other tax benefits among its members.
Items requiring apportionment include: the $250,000 minimum accumulated earnings credit, the
$40,000 statutory exemption for the AMT, the $17,500 of depreciable assets that can be expensed
annually, the exemption from the 5 percentage point surcharge on taxable income amounts between
$100,000 and $335,000, and the exemption from the 3 percentage point surcharge on taxable income
amounts between $15 million and $18.333 million. pp. C3-28 and C3-29.
C3-20 The advantages of a consolidated tax return are: income of a profitable member can be offset
against losses of another member; capital gains of one member can be offset against capital losses of
another member; and profits or gains reported on intercompany transactions are deferred. The
disadvantages are: the election is binding; losses on intercompany transactions are deferred; Sec.
1231 losses offset Sec. 1231 gains; losses of an unprofitable member may limit deductions or credits
of a profitable member; and additional administrative expenses are incurred in preparing and filing
the consolidated return. pp. C3-29 and C3-30.
C3-21 The substitution of fringe benefits for salary permits the owner-employee to exempt these
amounts from personal taxation while obtaining a deduction for the expenditure at the corporate
level. Thus, the owner-employee is able to make certain expenditures out of pre-tax dollars that
might otherwise be nondeductible personal expenditures that must be paid out of after-tax dollars
(e.g., group term life insurance premiums). p. C3-31.
C3-4
C3-22 A determination that part of the compensation paid to an owner-employee is unreasonable in
amount means that the corporation loses its tax deduction for that portion of the payment. Generally
the unreasonable compensation is taxed as a dividend to the owner-employee. (See also hedge
agreements in Chapter C4.) p. C3-31.
C3-23 A special apportionment plan avoids wasting the benefit of the 15%, 25%, and 34% lower
marginal tax rates that results from assigning a ratable share of each bracket to a group member with
little or no taxable income. pp. C3-32 and C3-33.
C3-24 There are two reasons to forgo the NOL carryback: (1) the NOL may offset ordinary income
or capital gains that were taxed at a low tax rate so that the tax refund would be greater if the NOL is
carried forward; (2) the NOL carryback eliminates a tax liability that was offset by a tax credit
carryover that was about to expire and the credit carryover cannot be used in a later year. pp. C3-18
and C3-19 and C3-33.
C3-25 Every corporation must pay estimated taxes. The payments are due April 15th, June 15th,
September 15th, and December 15th for a calendar year corporation. p. C3-34.
C3-26 A nondeductible penalty is assessed if a corporation does not deposit its required estimated
tax installment on or before the due date for that installment. Interest is assessed if any remaining
tax due is not paid by the original due date for the corporate tax return. In addition to interest, a late
payment penalty (failure-to-pay penalty) is assessed if the tax is not paid on time (see Chapter C15).
If an extension was requested, the amount of tax shown on the request for extension (Form 7004) or
the amount of tax paid by the original due date must be at least 90% of the tax shown on its Form
1120 in order to avoid a late payment penalty. pp. C3-35 and C3-36.
C3-27 A corporation must file a tax return each year whether it has any taxable income or not. If the
corporation is no longer in existence, it does not have to file a tax return. If it was only in existence
for a portion of the year, it must file a return for the portion of the year it was in existence. p. C3-37.
C3-28 A corporate tax return is due by the 15th day of the third month following the close of the
corporation's tax year, or March 15 for a calendar-year taxpayer. A corporation can obtain an
automatic six-month extension of time to file its tax return by filing Form 7004 by the original due
date for the return; therefore, the extended due date for a calendar-year taxpayer is September 15. p.
C3-37.
C3-29 1.
Some book income is not taxable.
2.
Some gross income is not included in book income for the current period.
3.
Some financial accounting expenses are not deductible for tax purposes.
4.
Some deductions allowed for tax purposes are not expenses in determining book
income for the current period. p. C3-38.
Issue Identification Problems
C3-5
C3-30 ·
·
·
·
·
·
Is the property that is being received cash or a noncash asset? If a noncash asset, are
any liabilities assumed or acquired by the shareholder?
Does the distribution come from the distributing corporation's E&P?
What is X-Ray's gross income amount?
Is either X-Ray or Yancey a foreign corporation?
What is the appropriate dividends-received deduction percentage?
·
Does the overall dividends-received deduction limitation restrict the
availability of the deduction?
·
Does one of the other special limitations on the dividends-received deduction
apply (e.g., 45-day rule, debt-financed stock, etc.)?
If noncash property is received, what is the basis of the property to X-Ray?
Since X-Ray owns 10% of Yancey Corporation, it is normally entitled to a $70,000 (0.70 x
$100,000) dividends-received deduction. But there are several limitations. If X-Ray's taxable
income before the dividends-received deduction is less than $100,000, but at least $70,000, then it is
limited to 70% of its taxable income before the dividends-received deduction. If X-Ray's taxable
income after the dividends-received deduction is negative (i.e., a NOL), then the dividends-received
deduction limitation does not apply. In addition, if (1) X-Ray has held the Yancey stock for 45 days
or less, (2) the Yancey stock is debt-financed, or (3) Yancey is a foreign corporation, X-Ray will
receive either a reduced or no dividends-received deduction. pp. C3-14 through C3-18.
C3-31 ·
·
·
What is Williams Corporation's realized gain or loss?
What is Williams Corporation's recognized loss?
·
Does the sale of property to a shareholder at a loss trigger the application of
the Sec. 267 related party rules?
·
Is Barbara related to any other Williams Corporation shareholders (e.g.,
spouses, siblings, or other entities) whose attribution of stock ownership
causes her stock ownership to exceed 50% of Williams's outstanding stock?
·
If a loss is disallowed, can the transaction be restructured to permit
recognition of the loss?
What is Barbara's basis for the truck? Does it reflect an adjustment for the
disallowed loss?
The primary issue is whether Barbara is a related party to Williams Corporation under the
Sec. 267 rules. If so, the loss on the sale of the truck is disallowed. In this case, since Barbara does
not own more than 50% of the Williams stock, she is not a related party and Williams may deduct a
$20,000 ($25,000 - $5,000) loss. The loss is a Sec. 1231 loss if the truck was used by Williams in the
conduct of its trade or business. However, if Barbara's spouse, siblings, or other parties or entities
related to her own more than 25% of the stock, Barbara is deemed to own more than 50% of
Williams Corporation and the loss disallowed under Sec. 267. pp. C3-20 and C3-21.
C3-32 ·
What is the tax liability for Pencil Corporation? For Eraser Corporation?
C3-6
·
·
·
·
·
Are Pencil and Eraser Corporations C corporations? S corporations?
Are Pencil and Eraser Corporations members of a controlled group?
Are Mary and Don related parties for purposes of the controlled group stock
ownership tests?
·
What effect does being a member of the controlled group have on the reduced
tax rate benefits of each corporation?
·
Are Pencil and Eraser Corporations personal service corporations?
What monies are being paid by Pencil and Eraser Corporations to Don and Mary?
·
Have the taxpayers divided up the money between the three entities (Pencil,
Eraser, and the joint return) to minimize their tax liabilities?
·
Can the taxpayers adjust their salaries and/or fringe benefits to reduce their
total tax costs?
If Pencil and/or Eraser Corporations are C corporations, would an S election be
advisable?
The primary issue is the appropriate corporation classification for Pencil and Eraser
Corporations. If both corporations are C corporations, then they constitute a controlled group and
they must share the tax benefits of the reduced 15, 25% and 34% tax brackets. Two other important
issues are: (1) can either one of the corporations benefit from an S election; and (2) what amount of
salaries and fringe benefits should be withdrawn from each of the two corporations to maximize the
corporate and shareholder benefits. The last two points are too complicated to arrive at a definitive
answer with the limited facts that are given here. pp. C3-22 through C3-29, and C3-32 and C3-33.
C3-33 ·
·
·
What carryovers and carrybacks are available for Rugby's current year NOL?
What tax benefit can be obtained by carrying the NOL back to the third preceding
year? Are any other tax benefits lost?
·
How does Rugby carry the loss back to a preceding tax year? How does it
obtain the refund?
What tax benefit can be obtained by carrying the NOL forward?
·
How is the election to forgo the carryback made?
·
What effect does the carryover have on Rugby's estimated tax payments in
the next year?
The primary issue is whether Rugby should carry $25,000 of its loss back to the second and
first preceding tax years. If it does, it will receive a refund of $3,750 ($25,000 x 0.15) for each year.
This amount does not take into account any other tax benefits that might be lost. However, if it
forgoes the carryback and carries the loss to the next year, it may get a much higher refund. Since its
taxable income exceeds $335,000, the tax savings in the next year equals $17,000 (0.34 x $50,000).
The carryforward reduces Rugby's estimated tax payments in the next year. The election is made by
checking the appropriate box on the Form 1120. pp. C3-18 through C3-20, and C3-33.
C3-7
Problems
C3-34 Land:
Sales price
Minus: Basis (original cost)
Sec. 1231 gain on land
$ 50,000
( 25,000)
$ 25,000
Building:
Sales price
Minus: Basis (original cost)
Minus: Depreciation
Recognized gain
Recapture amount on building:
Lesser of:
$50,000 (Depreciation claimed)
or
$75,000 (Recognized gain)
Times: Sec. 291 percentage
Ordinary income under Sec. 291
$225,000
$200,000
( 50,000)
(150,000)
$ 75,000
$ 50,000
x 0.20
$ 10,000
Sec. 1231 gain on building:
Recognized gain
Minus: Ordinary income on building
Sec. 1231 gain on building
$ 75,000
( 10,000)
$ 65,000
Summary:
Asset
Land
Building
Total
Sec. 1231
$25,000
65,000
$90,000
Type of Gain
Ordinary
$10,000
$10,000
Total
$ 25,000
75,000
$100,000
pp. C3-8 and C3-9.
C3-35 a.
Delta Corporation can elect to amortize organizational expenditures under Sec. 248
over 60 months (or more). Delta Corporation can also elect to amortize start-up expenditures under
Sec. 195 over 60 months (or more).
Date
1/30
5/15
5/30
5/30
Expense
Travel expense
Legal expense
Commission to stockbroker
Director's fees
C3-8
Amount
Treatment
$2,000 Start-up expense
2,500
Organizational expense
4,000
Reduction of capital
2,500
Organizational expense
6/5
6/10
6/15
7/15
Accounting fees
Training expense
Rent expense
Rent expense
1,500
5,000
1,000
1,000
Organizational expense
Start-up expense
Start-up expense
Sec. 162 expense
b.
Organizational expenditures total $6,500 or $108.33 ($6,500/60) per month if
amortized over 60 months. Delta can amortize $433.33 ($108.33 x 4 months) in the first year for the
period July 1 through October 31. pp. C3-9 through C3-11.
C3-36 a.
Yellow Corporation's charitable contribution deduction is determined as follows:
Deduction
Property
Basis
FMV
Amount
ABC stock (capital gain property)
$18,000
$25,000
$25,000
Inventory (scientific research
property) {$17,000 + [0.50 x
($22,000 - $17,000)]}
17,000
22,000
19,500
Antique vase (capital gain property-tangible personal property)
10,000
18,000
10,000
Total
$54,500
Deduction limited to $250,000 x 0.10 = $25,000
b.
Yellow Corporation's contribution carryover is determined as follows:
Total contribution allowable before limitation
$54,500
Minus: Amount deducted in current year
(25,000)
Contribution carryover
$29,500
pp. C3-11 through C3-14.
C3-37 Blue Corporation’s charitable contribution deduction is determined as follows:
Property
Basis
XYZ stock (capital gain property)
$25,000
Computer equipment (Sec. 170(e)(6) property)
{$16,000 + [0.50 x ($50,000 - $16,000)]
limited to 2 x $16,000 basis}
16,000
PQR Stock (Short-term capital gain)
12,000
Total contribution amount
FMV
$16,000
50,000
18,000
Deduction
$16,000
32,000
12,000
$60,000
The charitable contribution deduction is limited to $40,000 ($400,000 x 0.10).
C3-9
Blue Corporation’s contribution carryover is determined as follows:
Total contribution allowable before limitation
Minus: Amount deducted in current year
Contribution carryover to next 5 years
C3-38 a.
b.
C3-39 a.
b.
$60,000
(40,000)
$20,000
1998: Contribution limitation: = $180,000 x 0.10 = $18,000
Carryover to 1999: $20,000 - $18,000 = $2,000
1999: Contribution limitation: $125,000 x 0.10 = $12,500
1999 contribution consists of $12,000 (1999 contribution) and
$500 (carryover from 1998)
Carryover to 2000: 1998 contribution
Amount used in 1998
Carryover used in 1999
Carryover to 2000
The entire carryover is from 1998. p. C3-15.
Charitable contribution limitation:
Gross profit on sales
Dividends from less than 20%
owned corporations
Gross income
Minus: Operating expenses
Adjusted taxable income
Contribution limitation: 0.10 x $70,000 =
Contribution carryover: $10,000 - $7,000 = $3,000.
Taxable income:
Adjusted taxable income
Minus: Charitable contribution deduction
Dividends-received deduction
(0.70 x $50,000)
Taxable income
$100,000
50,000
$150,000
( 80,000)
$ 70,000
$ 7,000
$ 70,000
( 7,000)
( 35,000)
$ 28,000
The dividends-received deduction limit does not apply.
pp. C3-11 through C3-14.
C3-40
Gross profit on sales
Dividends
Gross income
Minus: Operating expenses
Part a Part b
$220,000
100,000
$320,000
(218,000)
C3-10
Part c
$220,000
100,000
$320,000
(234,000)
$20,000
(18,000)
( 500)
$ 1,500
$220,000
100,000
$320,000
(252,000)
Income for dividendsreceived deduction purposes $102,000
$
Dividends-received deductiona
( 70,000)
Taxable income
$ 32,000
86,000
( 60,200)
$ 25,800
$ 68,000
( 70,000)
$ (2,000)b
a
Dividends-received
deduction: lesser of:
(1) 70% of dividends or
$ 70,000
$ 70,000
(2) 70% of income for
dividends-received
deduction purposes
71,400
60,200
b
Income limitation does not apply since an NOL is created.
$
70,000
N/A
pp. C3-14 through C3-18.
C3-41 Beta has dividend income of $10,000 but gets no dividends-received deduction because the
stock was held 45 days or less. Beta also has a short-term capital loss of $10,000 ($190,000 $200,000). p. C3-17.
C3-42 a.
Cheers may deduct all of the interest paid on the loan.
b.
Cheers must include all $40,000 of dividends received from Beer in its income. Its
regular dividends-received deduction is $28,000 ($40,000 x 0.70). The dividends-received deduction
is reduced by 80% because the purchase of the stock was 80% debt-financed. The actual dividendsreceived deduction is $5,600 ($28,000 x 0.20). pp. C3-17 and C3-18.
C3-43 a.
b.
Gross income from operations
Dividends
Gross income
Minus: Operating expenses
NOL before dividends-received deduction
Minus: Dividends-received deduction
NOL for 1998
1996 taxable income
Minus: 1998 NOL carryback
1996 taxable income recomputed
$150,000
50,000
$200,000
(220,000)
$(20,000)
( 35,000)
$(55,000)
$ 75,000
(55,000)
$ 20,000
Taxes originally paid in 1996
Minus: Tax on $20,000 ($20,000 x 0.15)
Refund of 1996 taxes
a
($50,000 x 0.15) + ($25,000 x 0.25) = $13,750.
$ 13,750a
(3,000)
$ 10,750
C3-11
c.
Ace Corporation could elect to relinquish the carryback period entirely and instead
carry the loss forward to 1999. If Ace earns taxable income (before any NOL) of $400,000 in 1999,
Ace Corporation will save $18,700 (0.34 x $55,000) in 1999 by using the NOL as a carryforward.
Therefore, by electing to forego the carryback period, Ace will increase its tax refund by $7,950
($18,700 - $10,750). pp. C3-18 through C3-20, and C3-38.
C3-44 a.
Gross income from operations
$180,000
Dividends from less than 20%-owned corporations
100,000
Gross income
$280,000
Minus: Operating expenses
(150,000)
Taxable income before NOL, dividends-received, or
charitable contribution deductions
$130,000
Minus: Charitable contribution deduction
( 8,000)a
Dividends-received deduction
( 70,000)b
NOL deduction
( 50,000)
Taxable income
$ 2,000
a
Charitable contribution deduction limitation: {0.10 x [$280,000 - ($150,000 +
$50,000)] = $8,000}. Deduction is lesser of $20,000 contribution or $8,000 limit.
b
Dividends-received deduction: $100,000 x 0.70 = $70,000 tentative deduction.
Limitation = 0.70 x ($130,000 - $8,000) = $85,400. Deduction is lesser of $70,000
or $85,400 limitation.
b.
Beta has a $12,000 ($20,000 - $8,000) charitable contribution deduction carryover to
the next five years. pp. C3-19 and C3-20.
C3-45 a.
Union's realized loss: $18,000 - $24,000 = $6,000. The loss is not recognized
because Jane is the controlling shareholder of Union Corporation.
b.
Jane's realized gain: $25,000 - ($18,000 - $5,000) = $12,000. Jane's recognized gain:
$12,000 - $6,000 disallowed loss from part a = $6,000.
c.
Jane's realized and recognized loss is: $8,000 - ($18,000 - $5,000) = ($5,000). The
$6,000 loss that was disallowed in part a is permanently lost. p. C3-21.
C3-46 a.
Regardless of whether Value pays the bonus on March 13 or March 16, Value cannot
deduct the payment until the year it is paid (and included in Brett's gross income) since Brett is a
cash method of accounting taxpayer and a controlling shareholder [Sec. 267(a)(2)]. Thus, the
payment is deductible in 1999 in both cases.
b.
Value's payment to Brett on March 13, 1999 can be accrued and deducted by Value
Corporation in 1998 since it is made within 2½ months of the end of the corporation's tax year. A
payment made on March 16, 1999 cannot be deducted until it is paid in 1998 since the Sec. 404
deferred compensation rules apply because the payment is made more than 2½ months after the
corporation's year-end. p. C3-21.
C3-12
C3-47 a.
North Corporation's taxable income:
Gross profits
Net capital gain
Gross income
Minus: Operating expenses
Taxable income
$100,000
3,000a
$103,000
( 32,000)
$ 71,000
a
($10,000 - $5,000) + ($3,000 - $5,000) = $3,000.
North Corporation's regular tax liability:
$50,000 x 0.15 =
$21,000 x 0.25 =
Regular tax liability
b.
North Corporation’s taxable income:a
Gross profits
Minus: Operating expenses
Taxable income
$
7,500
5,250
$ 12,750
$100,000
( 32,000)
$ 68,000
a
North has a net capital loss of $7,000 ($10,000 - $5,000) + ($3,000 - $15,000). This loss may be
carried back three years and forward five years.
North Corporation’s regular tax liability:
$50,000 x 0.15 =
$18,000 x 0.25 =
Regular tax liability
$
pp. C3-7 and C3-8, and C3-22 and C3-23.
C3-48 a.
b.
(i)
(ii)
(iii)
(i)
(ii)
(iii)
(0.15 x $50,000) + (0.25 x $25,000) + (0.34 x $25,000) = $22,250
(0.15 x $50,000) + (0.25 x $25,000) + (0.34 x $150,000) +
(0.05 x $125,000) = $71,000
0.34 x $500,000 = $170,000
0.35 x $100,000 = $ 35,000
0.35 x $225,000 = $ 78,750
0.35 x $500,000 = $175,000
pp. C3-22 through C3-24.
C3-13
7,500
4,500
$ 12,000
C3-49 a.
$50,000 x 0.15
$25,000 x 0.25
=
=
$
$
7,500
6,250
13,750
b.
Tax on first $10,000,000
Plus: $3,500,000 x 0.35
=
=
$3,400,000
1,225,000
$4,625,000
c.
Tax on first $15 million
Plus: $2,500,000 x 0.38
=
=
$5,150,000
950,000
$6,100,000
d.
$33,500,000 x 0.35 = $11,725,000.
pp. C3-22 through C3-24.
C3-50 a.
Pace Corporation's taxable income:
Gross profits
Dividends (more than 20%-owned corporations)
Gross income
Minus: Operating expenses
Adjusted taxable income
Minus: Charitable contribution deduction (0.10 x $85,000)
Minus: Dividends-received deduction
(0.80 x $30,000)
Taxable income
$120,000
30,000
$150,000
( 65,000)
$ 85,000
( 8,500)
$ 76,500
( 24,000)
$ 52,500
Pace Corporation's regular tax liability:
$50,000 x 0.15 =
$ 7,500
$2,500 x 0.25 =
625
Regular tax liability
$ 8,125
b.
Pace Corporation has a $1,500 ($10,000 - $8,500) charitable contribution carryover to
the next five years. Pace also has a $15,000 ($10,000 + $5,000) capital loss that can be carried back
three years and forward five years as a short-term capital loss. pp. C3-7 and C3-8, C3-12 through
C3-14, and C3-22 through C3-24.
C3-51 Roper Corporation's taxable income:
Gross profits on sales
Capital gain net income ($40,000 + $25,000)
Dividends from more than 20%-owned corporation
Gross income
Minus: Operating expenses
C3-14
$ 80,000
65,000
10,000
$155,000
( 45,000)
Dividends-received deduction (0.80 x $10,000)
NOL carryover from the preceding year
Taxable income
( 8,000)
( 8,000)
$ 94,000
Roper Corporation's regular tax liability:
$50,000 x 0.15 =
$25,000 x 0.25 =
($94,000 - $75,000) x 0.34 =
Regular tax liability
$ 7,500
6,250
6,460
$ 20,210
pp. C3-22 through C3-24.
C3-52 a.
Yes, it is a brother-sister group.
b.
Not a controlled group because the 80% test is failed since Mary owns no stock in
Kane Corporation.
c.
Yes, it is a parent-subsidiary group. Link Corporation is the parent of Model and
Name Corporations. Link and Model together own 90% of Name.
d.
Yes, it is a combined-controlled group. Oat and Peach Corporations are brother-sister
corporations. Oat Corporation is the parent of Rye Corporation. Seed Corporation is a group
member since Oat and Rye together own 90% of Seed. Therefore, the Oat-Rye-Seed group is a
parent-subsidiary group. Since Oat belongs to both groups, all four corporations are a combined
controlled group. pp. C3-24 through C3-29.
C3-53 a.
No apportionment plan:
Corporation Taxable Income
Eta
$ 40,000
Theta
Phi
Gamma
$(25,000)
$ 50,000
$ 10,000
Tax owed
$12,500 x 0.15
$ 6,250 x 0.25
$21,250 x 0.34 =
$12,500 x 0.15
$ 6,250 x 0.25
$31,250 x 0.34 =
$10,000 x 0.15 =
$10,662.50
-0-
14,062.50
1,500.00
$26,225.00
The total taxable income for the controlled group is $75,000 ($40,000 + $50,000 + $10,000 $25,000). The 39% rate bracket is not used to recapture the $11,750 tax savings on the first
$100,000 of taxable income until the group's total taxable income exceeds $100,000. Our group's
total taxable income is only $75,000, therefore, the top tax rate for the group is 34%.
C3-15
b. One possible special apportionment plan is to apportion the entire 15% tax bracket to Phi and
the entire 25% tax bracket to Eta.
Corporation Taxable Income
Tax owed
Eta
$ 40,000
$25,000 x 0.25
$15,000 x 0.34 =
$611,350.00
Theta
$(25,000)
-0Phi
$ 50,000
$50,000 x 0.15
7,500.00
Gamma
$ 10,000
$10,000 x 0.34
3,400.00
$ 22,250.00
The special apportionment plan provides a $3,975 ($26,225 - $22,250) savings. The $22,250 can be
verified as the lowest possible tax liability because the group's total positive taxable income is
$100,000, and the tax liability on $100,000 is $22,250. The group's tax liability could be reduced
even further by filing a consolidated tax return so that Theta's losses could be used to offset the
profits of the other group members. pp. C3-24 through C3-29, and C3-32 through C3-33.
C3-54 a.
Total
Income
$400,000
400,000
400,000
400,000
400,000
Salary
Retained by
Paid to Marilyn Bell Corporation
$ -0$400,000
100,000a
300,000
b
200,000
200,000
300,000c
100,000
d
400,000
-0-
Tax Liability
Marilyn
Bell Corporation
$ -0$136,000
17,483e
100,250
49,651
61,250
89,250
22,250
129,192
-0-
Total
$136,000
117,733
110,901
111,500
129,192
Gross Std.
Pers.
Tax.
Income
Ded.
Ex.
Inc.
a
$100,000 - $7,100 - $10,800 = $ 82,100
b
$200,000 - $7,100 - $ 9,504 = $183,396
c
$300,000 - $7,100 - $ 864 = $292,036
d
$400,000 - $7,100 - $
0 = $392,900
e
At 1998 tax rates, standard deduction, and personal exemption amounts with the personal exemption
being phased-out when AGI is between $186,800 and $309,300. The personal exemptions are
completely phased-out when AGI is $309,300.
b.
The highest tax liability occurs when all of the income ($400,000) is taxed to the C
corporation since none of the income is taxed at the lower individual tax rates. The lowest tax
liability of any of the five alternatives ($200,000 to Marilyn and $200,000 to Bell) takes advantage of
the lower tax rates available to both the individual and corporate taxpayers. (Author's Note: A
difference in the results would arise if one included employment taxes in the analysis.) The
$400,000 salary alternative tax liability is identical to the making of an S election (see Chapter C11)
when one ignores employment taxes. This alternative does not produce the lowest tax liability since
the 15%, 25%, and 34% corporate tax rates available in the other alternatives are not available here
C3-16
and substantial amounts of income are taxed at the 36% and 39.6% marginal tax rate applicable to
Marilyn.
c.
The payment of a dividend by Bell Corporation out of its retained earnings is taxable
as ordinary income to Marilyn and is not deductible by Bell. This alternative is less attractive than
paying the monies out as salary. Alternatively, an S election might be considered which would
permit the retained earnings to be distributed to the shareholder tax-free. pp. C3-30 and C3-32.
C3-55 The savings associated with the $3,000 of tax-free fringe benefits equals $3,000 times
Marilyn's marginal tax rate. The fringe benefit has a second tax advantage in that it also reduces
Marilyn's AGI which decreases the personal exemption phase-out. The disadvantage of paying
fringe benefits is that they generally cannot be restricted to key personnel or shareholder-employees,
but must cover virtually all employees. Since Marilyn is the sole shareholder of Bell Corporation, it
may be less expensive for her to pay the cost of the fringe benefit personally. Some of the cost of her
fringe benefit may be deductible on her personal tax return (e.g., part of the premium paid for
medical insurance that is in excess of 7.5% of her adjusted gross income should she itemize). p. C332.
C3-56 a.
The minimum estimated tax payment for each quarter of 1998 will be $170,000
($680,000  4). Since Zeta Corporation is a large corporation, its estimated tax payments other
than its first payment for the year cannot be based on the prior year's tax liability. If Zeta uses
the special election for the first payment, only $127,500 ($510,000  4) will be due on April 15,
1998. The second payment will need to be $212,500 [$170,000 + ($170,000 - $127,500)] in order
to make up the shortfall in the first payment. A smaller estimated tax payment might be
possible if the annualized income or seasonal exceptions can be used.
b.
Zeta Corporation's current year tax return is due on March 15, 1999.
c.
All of the remaining taxes are due on March 15, 1999. No additional taxes
should be owed when the return is filed. Estimated tax payments of $680,000 should exactly
equal the $680,000 tax liability.
d.
Zeta Corporation may obtain an automatic extension of time to file until
September 15, 1999. This does not extend the time for the payment of the tax which is still due
on March 15, 1999. pp. C3-34 through C3-37.
C3-57 a.
Wright Corporation's minimum estimated tax payments are the lesser of:
(1) $22,250 (1997 tax)  4 = $5,562.50 each quarter.
or
(2) $170,000 (1998 tax)  4 = $42,500 each quarter.
Since Wright Corporation is not a large corporation, quarterly payments of $5,562.50 on April
15, June 15, September 15, and December 15 of 1998 are sufficient to avoid any penalties.
b.
Wright Corporation's 1998 tax return is due on March 15, 1999.
c.
All remaining taxes are due on March 15, 1999. The additional taxes that are
owed will be $147,750 ($170,000 - $22,250).
C3-17
d.
25% of 1997's tax now becomes $50,000 ($200,000 x 0.25), therefore,
Wright Corporation will now pay estimated tax payments, based on its estimated 1998 tax, of
$42,500 on each quarterly payment date. If the forecast is accurate, then no additional taxes
will be owed when the return is filed. pp. C3-34 through C3-37.
C3-58
Rocket, Inc.
Worksheet to Convert Book Income to Taxable Income
For the Year ended December 31
Book Income
Account Title
Sales
Dividends
Interest (a)
Gain on stock sale
Life ins. proc. (b)
Cost of sales
Salaries and wages
Bad debts
Payroll taxes
Interest (c)
Contributions (d)
Depreciation
Other expenses (e)
Fed. inc. taxes (f)
NI/TI b/4 spec.
ded.
Totals
(a)
(b)
(c)
(d)
Dr.
Adjustments
Cr.
3,000,000
8,000
18,000
5,000
100,000
2,000,000
500,000
13,000
62,000
12,000
50,000
60,000
40,000
96,000
298,000
3,131,000
Dr.
Taxable Income
(before special
deductions)
Cr.
3,000
100,000
25,000
5,000
96,000
128,000
Cr.
3,000,000
8,000
15,000
5,000
0
1,000
17,800
3,131,000
Dr.
8,200
128,000
2,000,000
500,000
13,000
62,000
11,000
32,200
85,000
35,000
0
289,800
3,028,000
0
3,028,000
Interest earned on municipal bonds is excluded from taxable income.
Life-insurance proceeds are excluded from taxable income if paid by reason of the death of
the insured.
Interest on debt incurred to carry tax-free obligations is not deductible.
Allowable contribution deduction:
Gross income
$3,028,000
Minus: Deductions
(2,706,000)
Taxable income before contributions and base for
calculation of charitable contribution limitation
$ 322,000
Times: 10% allowable deduction
x
.10
Charitable contribution deduction limitation
$ 32,200
Rocket Corporation has a $17,800 ($50,000 actual contributions - $32,200 limitation)
charitable contribution carryover.
C3-18
(e)
Life insurance premiums are not deductible if the corporation is the beneficiary.
(f)
Federal income taxes are not deductible when determining taxable income.
pp. C3-37 through C3-39.
C3-59 Schedule M-1 (Numbers refer to lines of schedule):
1.
Net income per books
2.
Federal income taxes
3.
Excess capital losses
4.
Income subject to tax
not recorded on books
5.
Expenses recorded on books
not deducted in this return:
a. Depreciation
b. Contributions carryover
c. Interest on loan to
purchase tax exempt bonds
d. Insurance premium
6. Total of lines 1 through 5
7. Income on books not in this
return:
a. Tax-exempt interest
8. Deductions in this return not on books:
a. Depreciation
9. Total of lines 7 and 8
10. Income (line 28, page 1) [Line 6 less line 9]
$ 33,000
12,000
5,000
-0-
-0$ 2,500
10,000
8,000
20,500
$ 70,500
$ 6,000
3,000
$ 9,000
$ 61,500
pp. C3-42 through C3-44.
C3-60 Schedule M-2 (Numbers refer to lines of schedule):
1. Balance at beginning of year
2. Net income per books
3. Other increases
4. Total of lines 1, 2, and 3
5. Distributions: a. Cash
b. Stock
c. Property
6. Other decreases:
Contingency reserve
7. Total of lines 5 and 6
8. Balance at end of year (line 4 less line 7)
pp. C3-44 and C3-45.
C3-19
$246,500
259,574
-0$506,074
$23,000
-0-060,000
( 83,000)
$423,074
Tax Form/Return Preparation Problem
C3-61 (See Instructor's Guide)
Case Study Problems
C3-62 (See Instructor's Guide)
C3-63 (See Instructor's Guide)
C3-64 (See Instructor's Guide)
Tax Research Problems
C3-65 (See Instructor's Guide)
C3-66 (See Instructor's Guide)
C3-67 (See Instructor’s Guide)
C3-20