ACC 460 Exam 3

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Ben purchased 100 of the 300 outstanding shares of stock of an S corporation on December 1 of the current year. The corporation reported $365,000 ordinary income for the entire calendar year. There were no other ownership changes. What is Ben's share of the current year's ordinary income? A. $121,667 B. $10,000 C. $30,000 D. $15,000

Corporation Basis

Basis in Assets = Shareholder's transferred basis + Gain recognized by shareholder Tax Attributes (holding period, depreciation computation, recaptures, etc) transfer --> Corp continues were shareholders left off. Ch12/13

Alien Corporation owns 60% of the stock of Blackbird Corporation and 10% of the stock of Dannin Corporation. Both corporations are U.S. corporations. Alien has taxable income before the dividends-received deduction of $200,000, and has received the following dividends: Blackbird $ 10,000 Dannin 15,000 The dividends-received deduction for Alien Corporation would be A. $16,250 B. $12,500 C. $7,500 D. $14,000

A corporation may alternate between S corporation and C corporation status each year, depending on which results in more tax savings.

Fakse

Losses on 1244 Stock

Ordinarily loss treatment up to $50,000 (single) or $100,000 (joint/married) on the sale or worthlessness of small business stock. Small Business requirements: --> Total paid in capital at purchase < $1,000,000 --> >50% of gross receipts from active business income. CH12/13

Property Dividends - Depreciated Property

1. Corp does NOT recognize loss 2. Corp reduces E&P by BASIS 3. Shareholder has a taxable dividend = FMV 4. Shareholder basis = FMV CH12/13

When an employee/shareholder receives an ordinary income allocation (i.e., the flow-through income) from an S corporation, what taxes apply to the ordinary income allocation? A. Income tax only. B. Self-employment tax (social security) only. C. Both Income and self-employment tax. D. None of the above. This income will never be taxed.

Gray is a 50% partner in Fabco Partnership. Gray's tax basis in Fabco on January 1, 2019, was $5,000. Fabco made no distributions to the partners during year 4 and recorded the following. Ordinary income $20,000 Tax-exempt income 8,000 Portfolio income 4,000 What is Gray's tax basis in Fabco on December 31, 2019? A) $21,000 B) $16,000 C) $12,000 D) $10,000

Jimmy is the sole owner of Coral, Inc. and Reef, Inc. For the current year, Coral, a regular C corporation, reported $80,000 in income and paid $20,000 in dividends to Jimmy. Reef, an electing S corporation, reported $30,000 of income and paid $5,000 in dividends to Jimmy. What is Jimmy's qualified business income (QBI) deduction? A) $6,000 B) $22,000 C) $10,000 D)$5,000

Fred and Ethel form Mertz Corporation. Fred transfers equipment (FMV = $950,000, basis = $200,000) and $50,000 in cash to Mertz Corporation for 50% of its stock. Ethel transfers a building and land (FMV = $1,050,000, basis = $400,000) for 50% of the stock in Mertz plus a $50,000 note payable from Mertz due in 10 years. A) Fred will not recognize gain; Ethel will recognize gain of $50,000. B) Fred will not recognize gain; Ethel will recognize gain of $650,000. C) Neither Fred nor Ethel will recognize gain. D)Fred will recognize a gain of $750,000; Ethel will recognize gain of $650,000.

A. Over 80%, however there is debt of 50k that the corp is taking over (gain is limited to debt)

Sale of Partnership interest

Capital gain or loss on sale/ exchange. Liabilities effect amount realized and basis. Section 751 (hot assets) are exception to capital character. CH14

Partnership Basis in Assets Received

Carryover of everything: Basis, holding period, MACRS schedule, depreciation recapture potential. Tainted property - 724 taint CH14

Which of the following does not adjust a partner's basis? A. Ordinary business income (loss)B. Change in amount of partnership debt C.Tax-exempt income D.All of the above adjust a partner's basis

Lili transfers property (basis of $300,000 and fair market value of $500,000) to Koi Corporation for 100% of its stock (worth $400,000) and a long-term note (worth $100,000), executed by Koi Corporation and made payable to Lili. As a result of the transfer: A. Lili recognizes no gain. B. Lili recognizes a gain of $200,000. C. Lili recognizes a gain of $40,000. D.Lili recognizes a gain of $100,000.

Sam owns a 25% in Spade, LLC. In 2019, Spade reports $100,000 or ordinary income. What is Sam's qualified business income (QBI) deduction? A) $0, because Spade is operated as an LLC B) $5,250 C) $4,000 D)$5,000

T/F: An expense that is deducted in computing net income per books but not deductible in computing taxable income is a subtraction item on Schedule M-1.

False A Schedule M-1 adjustment that is deducted from net income but not a deductible expense in computing taxable income results in an increase on the Schedule M-1. CQ12

Dividend Received Deduction (DRD)

GAAP --> Cost method = Dividend Income Deduction for dividends received for stock held more than 45 hays based on ownership % <20% ownership = 50% deduction rate = 50% taxed 20 - under 80% = 65% deduction rate = 35% taxed > or equal 80% = 100% deduction rate = 0% taxed EXCEPTION: If NOL is created taxable income limit does not apply. Deduction rate % of dividend Income is used. Dividend Received Deduction = Smaller of: 1. Deduction rate % of Dividend Income or 2. Deduction rate % of Taxable Income CH12/13

Partnership - ending basis / tax basis

Initial basis + Increase in Debt + Share of partnership Income + Tax exempt income + LTCG - Distributions + ordinary Income CH14

Outside Basis

Partners' basis and their ownership CH14

Basis in Assets =

Shareholder's transferred basis + Gain recognized by shareholder

Earnings and Profits

Tax versions of Retained Earnings Uses conservative accounting methods (accelerated income, defers expense) No decrease for nontaxable stock dividend Ch12/13

Constructive Dividends

Unreasonable compensation, rent, interest Below Market loans Bargain sales Advances Personal use of corporate property CH12/13

Section 751 - Hot Assets

are exception to capital character when partnership interest is sold. Effect is to reclassify what would be capital gain from the sale of a partnership into ordinary income. Types of assets: 1. Unrealized receivables. --> Cash basis receivables (have a basis of $0) --> 1245 and 1250 recapture potential 2. Appreciated Inventory 3. Equipment (MACRS) CH14

Rick, a cash basis taxpayer, incorporates his sole proprietorship. He transfers the following items to newly created Orange Corporation. Adjusted Basis : Fair MarketValue Cash $ 10,000 : $ 10,000 Building 120,000 : 175,000 Mortgage payable (secured by the building and heldfor 15 years) 100,000 : 100,000 With respect to this transaction: A.Rick's basis in the Orange stock is $30,000 B.Orange Corporation's basis in the building is $175,000. C.Rick has a recognized gain of $100,000 D.Rick has a recognized gain of $75,000

A. Rick's basis in the Orange stock is $30,000 CQ12

T/F: Ashley purchased her partnership interest from Lindsey on the first day of the current year for $40,000 cash. The partnership had no liabilities at that time. Ashley received a $10,000 cash distribution from the partnership during the year, and her share of partnership income is $15,000. Her share of partnership liabilities on the last day of the partnership year is $20,000. Ashley's outside basis for her partnership interest at the end of the year is $45,000.

False Ashley's adjusted basis at the end of the year is $65,000, determined as follows: $40,000 cash (paid to acquire interest) + $15,000 (share of income) + $20,000 (share of partnership liabilities) - $10,000 (cash distribution). CQ14

T/F: Laura is a real estate developer and owns property that is treated as a capital asset) in her business.She contributes a parcel of this land (basis of $15,000) to a partnership, to be held as inventory. The fair marketvalue of the property is $12,000 at the contribution date. After three years, the partnership sells the land for $10,000.The partnership will recognize a $5,000 ordinary loss on sale of the property.

False CQ14

T/F: Regardless of any deficit in current E & P, distributions during the year are taxed as dividends to the extent of accumulated E & P.

False Distributions are taxed as dividends to the extent that any positive balance in accumulated E & P exceeds the current E & P deficit at the date of distribution. CQ13

T/F: A distribution in excess of E & P is treated as capital gain by shareholders.

False Distributions in excess of both current and accumulated E & P are treated as a tax-free recovery of capital to the extent of stock basis. Distributions in excess of basis trigger capital gain. CQ13

T/F: George received a fully vested 10% interest in partnership capital and a 20% interest in future partnership profits in exchange for services rendered to the GHP, LLC (not a publicly traded partnership interest). The future profits of the partnership are subject to normal operating risks. George will report ordinary income equal to the fair market value of the profits interest, but the capital interest will not be currently taxed to him.

False George will recognize ordinary income equal to the fair market value of the capital interest (i.e., his share of the liquidation value of the partnership). The fair market value of the profits interest is not reasonably ensured and is, therefore, indeterminable. The profits interest will be taxed to George as the partnership's profits are earned. CQ14

T/F: Morgan and Kristen formed an equal partnership on August 1 of the current year. Morgan contributed $60,000 cash and land with a basis of $18,000 and a fair market value of $40,000. Kristen contributed equipment with a basis of $42,000 and a value of $100,000. Kristen and Morgan both have a basis of $100,000 in their partnership interests.

False Morgan's basis includes the $18,000 substituted basis for the contributed land plus $60,000 cash, for a total of $78,000. Kristen's basis is $42,000, a substituted basis from the contributed equipment. CQ14

T/F: A taxpayer transfers assets and liabilities to a corporation in return for its stock. If the liabilities exceed the basis of the assets transferred, the taxpayer will have a negative basis in the stock.

False The result is precluded by compelling the transferor to recognize gain on the excess of the liabilities over the basis of the assets. CQ12

T/F: When current E & P is positive and accumulated E & P has a deficit balance, the two accounts are netted for dividend determination purposes.

False The two accounts are not netted against each other. Instead, any distribution is a taxable dividend to the extent of the positive current E & P balance. CQ13

Luciana, Jon, and Clyde incorporate their respective businesses and form Starling Corporation. On March 1 of the current year, Luciana exchanges her property (basis of $50,000 and fair market value of $150,000) for 150 shares in Starling Corporation. On April 15, Jon exchanges his property (basis of $70,000 and fair market value of $500,000) for 500 shares in Starling. On May 10, Clyde transfers his property (basis of $90,000 and fair market value of $350,000) for 350 shares in Starling. a. If the three exchanges are part of a pre-arranged plan, who will recognize a gain on the exchanges? b. Now assume that Luciana and Jon exchanged their property for stock four years ago, while Clyde transfers his property for 350 shares in the current year. Clyde's transfer is not part of a pre-arranged plan with Luciana and Jon to incorporate their businesses. What gain will Clyde recognize on the transfer? Clyde will recognize a gain of ______________ on the transfer. c. Returning to the original facts, assume the property that Clyde contributes has a basis of $490,000 (instead of $90,000). Why would it be better from a tax perspective for Clyde to wait to transfer his property rather than be a part of Luciana's and Jon's transfers?

a) Answer: None of the parties. For the transaction to qualify as nontaxable under § 351, the property transferors must be in control of the corporation immediately after the exchange. Control means that the person or persons transferring the property must have at least an 80 percent stock ownership in the corporation. Immediately after the exchange, the property transferors must control the corporation. Control can apply to a single person or to several taxpayers if they are all parties to an integrated transaction. When more than one person is involved, the exchange does not necessarily require simultaneous exchanges by those persons. However, the rights of those transferring property to the corporation must be previously set out and determined as in a pre-arranged plan. Also, the agreement to transfer property should be executed "with an expedition consistent with orderly procedure." Therefore, if two or more persons transfer property to a corporation for stock and want to defer gain, it is helpful if the transfers occur close together in time and are made in accordance with an agreement among the parties. None of the three individuals will recognize gain in this case. The nonrecognition provisions of § 351 apply to all the exchanges. b) Answer: $260,000. Clyde will have a taxable gain of $260,000 on the transfer because he does not have control of the corporation after his transfer and because his transaction cannot be integrated with Luciana's and Jon's transfer for purposes of the control requirement. Clyde will recognize gain of $260,000 on the exchange, computed as follows: $350,000 fair market value of property - $90,000 basis of property. c) To allow the recognition of a loss by Clyde. Since the same principles govern the nonrecognition of gain or loss under § 351, Clyde would be well advised to avoid having his transfer treated as a part of an integrated plan that also includes Luciana's and Jon's transfers. If his transfer is considered independent, it will not fall under the mandatory nonrecognition treatment for gains and losses. Not only will Luciana and Jon be able to benefit from § 351 (i.e., realized gains would not be recognized), Clyde's loss of $140,000 ($350,000 - $490,000) will be recognized. HW12a

Dan Knight and Patricia Chen form Crane Corporation. Dan transfers land (worth $200,000, basis of $60,000) for 50% of the stock in Crane. Patricia transfers machinery (worth $150,000, adjusted basis of $30,000) and provides services worth $50,000 for 50% of the stock. a. Will the transfers qualify under § 351? _______, because _______ of Patricia's stock is counted in determining control since the property she transferred has ____________ than a nominal value in comparison to the value of the services rendered. b. What are the tax consequences to Dan and Patricia? Dan recognizes ________________ on the transfer of the land. His basis in the Crane stock is ____________________. Patricia recognizes __________ of _______________ on the transfer. Patricia has a basis of __________ in her Crane stock. c. What is Crane Corporation's basis in the land and the machinery?Crane Corporation has a basis of ________ in the land and a basis of ______________ in the machinery. In addition, Crane either has ______________ of _______________ for the services provided by Patricia, or it will capitalize the ______________ as _______________ .

a) Answers: Yes; all; more. A person who receives stock in exchange for services and for property transferred may be treated as a member of the transferring group for purposes of the control test. When this is the case, the person is taxed on the value of the stock issued for services but not on the stock issued for property, assuming the property transferors control the corporation. In this case, all stock received by the person transferring both property and services is counted in determining whether the transferors acquired control of the corporation. To be a member of the group and to aid in qualifying all transferors under the 80 percent control test, the person contributing services must transfer property having more than a "relatively small value" compared to the services performed. The Regulations provide that stock issued for property whose value is relatively small compared to the value of the stock already owned (or to be received for services rendered) will not be treated as issued in return for property. This will be the result when the primary purpose of the transfer is to qualify the transaction under § 351 for concurrent transferors. In summary, the transfers will qualify under § 351. Patricia's stock is counted in determining control for purposes of § 351; thus, the property transferors own 100% of the stock in Crane. All of Patricia's stock, not just the shares received for the machinery, is counted in determining control because property she transferred has more than a nominal value in comparison to the value of the services rendered (i.e., at least 10% of the value of the services provided). b) Answers: no gain or loss; $60,000; compensation income; $50,000; $80,000. The Code specifically excludes services rendered from the definition of property. Services are not considered to be property under § 351 for a critical reason. A taxpayer must report as income the fair market value of any consideration received as compensation for services rendered. Consequently, when a taxpayer receives stock in a corporation as consideration for rendering services to the corporation, taxable income results. In this case, the amount of income recognized by the taxpayer is equal to the fair market value of the stock received. The taxpayer's basis in the stock received is its fair market value. For a taxpayer transferring property to a corporation in a § 351 transaction, the stock received in the transaction is given a substituted basis. Essentially, the stock's basis is the same as the basis the taxpayer had in the property transferred, increased by any gain recognized on the exchange of property and decreased by boot received. Dan recognizes no gain on the transfer of the land. His basis in the Crane stock is $60,000, his basis in the land. Patricia recognizes compensation income of $50,000 on the transfer. Even though the transfer of the machinery qualifies under § 351, her transfer of services for stock does not. Patricia has a basis of $80,000 in her Crane stock [$30,000 (basis of the machinery) + $50,000 (value of her services) - $0 (boot received)]. c) Answers: $60,000; $30,000; a deduction; $50,000; $50,000; organizational costs. The basis of property received by the corporation generally is determined under a carryover basis rule. This rule provides that the property's basis to the corporation is equal to the basis in the hands of the transferor increased by the amount of any gain recognized on the transfer by the transferor-shareholder. A transfer of stock for services is not a taxable transaction to a corporation. But another issue arises: Can a corporation deduct as a business expense the fair market value of the stock it issues in consideration of services? Yes, unless the services are such that the payment is characterized as a capital expenditure. Crane Corporation has a basis of $60,000 in the land and a basis of $30,000 in the machinery. Crane either has a deduction of $50,000 for the services provided by Patricia or has $50,000 to capitalize as organizational costs. HW12a

Blue Corporation has a deficit in accumulated E & P of $300,000 and has current E & P of $225,000. On July 1, Blue distributes $250,000 to its sole shareholder, Sam, who has a basis in his stock of $52,500. As a result of the distribution, Sam has: a.Dividend income of $225,000 and reduces his stock basis to $27,500. b.Dividend income of $52,500 and reduces his stock basis to zero. c.Dividend income of $225,000 and no adjustment to stock basis. d.No dividend income, reduces his stock basis to zero, and has a capital gain of $250,000.

a.Dividend income of $225,000 and reduces his stock basis to $27,500. The corporation has current E & P of $225,000, and to this extent, Sam has a taxable dividend. The remaining $25,000 reduces his stock basis. CQ13

When a partner's share of partnership liabilities increases, that partner's basis in the partnership interest: a.Increases by the partner's share of the liabilities. b.Decreases by the partner's share of the liabilities. c.Decreases, but not to less than zero. d.Is not affected.

a.Increases by the partner's share of the liabilities. When a partner's share of partnership liabilities increases, that partner's basis in the partnership increases by his share of the liabilities. Since the partner has unlimited liability, the partnership liabilities are treated as if the partner personally borrowed the money and then contributed it to the partnership. CQ14

Fox Corp. owned 2,000 shares of Duffy Corp. stock that it bought in year 0 for $9 per share. In year 8, when the fair market value of the Duffy stock was $20 per share, Fox distributed this stock to a noncorporate shareholder. Fox's recognized gain on this distribution was: a.$40,000 b.$22,000 c.$18,000 d.$0

b.$22,000 Rule: A corporation generally must recognize gain when it distributes appreciated property to its shareholders in any ordinary, nonliquidating distribution to the extent that the fair market value of the property exceeds its adjusted basis. Fair market value per share $20 Basis per share (9) Appreciation in value per share $11 Number of shares distributed × 2,000 Recognized gain = $22,000 HW13

Jane is the sole shareholder of Buttons, Inc. Buttons has a deficit of $60,000 in accumulated earnings and profits (E & P) at the beginning of the current year. Current E & P is $35,000. If Buttons pays out a cash distribution to Jane during the current year of $50,000, how much is a taxable dividend to Jane? a.$0 b.$35,000 c.$50,000 d.$85,000

b.$35,000 The cash distribution is only a taxable dividend to the extent of current or accumulated E & P and is first applied against current E & P. That amount here is $35,000. HW13

Use the following information for the next two questions. In February, 2013, Mary and Kay formed the KayMary Company as equal owners. Mary contributed cash of $50,000 and Kay contributed land with an adjusted basis of $40,000 and a fair market value of $50,000 to form a business. In 2018, the land was sold for $60,000. 21. What is Kay's share of the gain from the sale of land if the business is operated as a partnership? $10,000 $15,000 $20,000 $-0- 22. What is Kay's share of the gain from the sale of land if the business is operated as an S corporation? $10,000 $15,000 $20,000 $-0-

21. B 22. A

An S corporation can own stock in a regular C corporation, but a C corporation cannot own stock in an S corporation.

True

An S shareholder's basis is decreased by distributions treated as being paid from AAA.

True

One of the disadvantages of the partnership form is that the partner's share of the partnership's taxable income is taxed to the partner, regardless of whether or not distributed.

True

S corporations offer the same legal protection to owners as C corporations.

True

The same exact requirements for forming and contributing property govern S corporations and C corporations.

True

T/F: Because services are not considered property under § 351, a taxpayer must report as income the fair market value of stock received for such services.

True CQ12

T/F: When current E & P has a deficit and accumulated E & P is positive, the two accounts are netted at the date of the distribution. If a positive balance results, the distribution is a dividend to the extent of the balance.

True CQ13

Rita has been the sole shareholder of Salt Co. since she acquired all its stock in 2009. Salt Co. was originally organized as a C corporation, but Rita converted it to an S corporation upon her acquisition. When Rita's stock basis is $50,000, she receives a distribution from Salt of $10,000. Corporate level accounts are as follows: AAA $ 4,000 Accumulated E&P 11,000 How much of the distribution is taxable to Rita? A. $6,000 B. $10,000 C. $0 D. $4,000

Loss and Deduction Pass Through to Shareholders (S corp)

Allocation of loss: Excess loss could create an NOL for the shareholder and results in a carryback or carryover to the shareholder's other tax years. Shareholder Loss Limitations: Losses (including separately stated deductions) limited to basis in stock plus basis of any indebtedness owed directly by the S corp to the shareholder. CH15

T/F: All cash distributions received from a corporation with a positive balance in accumulated E & P at the beginning of the year will be taxed as dividend income.

False A positive balance in accumulated E & P at the beginning of the year does not guarantee dividend treatment for distributions. If there is a deficit in current E & P during the year, dividend treatment may not result. CQ13

Boot

Includes anything other than stock. However, corporate assumption of debt does not count. EXCEPT when the liabilities transferred > basis. CH12/13

Termination of the Election (S corp)

Methods: 1) Voluntary: (shareholders owning > 50% of the stock on the day of the revocation must consent to the revocation) Retroactive: --> By 3/15 of the current year, retroactive to Jan 1. Prospective: --> Generally, next year. But can be only future date in current year. Cessation of Small Business Stock: --> S corporation election is terminated if the corporation fails one of the small business corp tests. Timely corrections to reinstate S status may be allowed (letter ruling issued) Excess Passive Income: (applied annually) --> A termination will result if more than 25% of the corporation's gross receipts is portfolio income for each of the 3 consecutive years AND the corporation has C corporation earnings and profits. 2) New Election Following a Termination --> Generally, a 5 year wait before making a new election. CH15

Formation of Partnerships - General Consequences

No Gain (loss) for partners or partnership Partner Outside basis = Substitute basis fro property contributed Partnership Inside Basis = carryover fro contributing partners Similar to CH12/13 in services and boot problems CH14

Partner's Basis in Investment - Example

A and B contribute $100,000 cash and $100,000 FMV of property (30,000 basis), respectively as equal partners. A: 0 gain recognized; outside basis = 100,000 B: 0 gain recognized; outside basis = 30,000 AB: Inside Basis = 100,000 and 30,000 B: Built in Gain (B.I.G) of 70,000 --> 100,000 FMV -30,000 basis CH14

On January 1, Bobby and Alicia own equally all of the stock of an electing S corporation called Prairie Dirt Delight. The company has a $60,000 loss for the year (not a leap year). On the 219th day of the year, Bobby sells his half of the stock to his son, Bubba. The loss allocated to Bubba is

Answer: $12,000. Each shareholder is allocated a pro rata portion of nonseparately stated income or loss and all separately stated items. The pro rata allocation method assigns an equal amount of each of the S items to each day of the year. If a shareholder's stock holding changes during the year, this allocation assigns the shareholder a pro rata share of each item for each day the stock is owned. On the date of transfer, the transferor (not the transferee) is considered to own the stock. Bobby owns the stock for 219 days and Bubba for 146 days (365 - 219). Computation: $12,000 ($60,000 x 0.50 x 146/365) HW15

After a corporation's status as an S corporation is revoked or terminated, how many years is the corporation required to wait before making a new S election, in the absence of IRS consent to an earlier election? a.1 b.3 c.5 d.10

Answer: 5. Rule: After a corporation's status as an S corporation is revoked or terminated, the corporation is required to wait 5 years before making a new S election, in the absence of IRS consent to an earlier election. HW15

Smith incorporated a sole proprietorship by exchanging all the proprietorship's assets for the stock of Gnu Co., a new corporation. To qualify for tax-free incorporation, Smith must be in "control" of Gnu immediately after the exchange. What percentage of Gnu's stock must Smith own to qualify as "control" for this purpose? A. 51% B. 66.67% C. 80% D. 50%

What is the maximum number of owners allowable for (1) an S corporation and (2) an LLC? S Corporation : LLC A. No limit : No limit B. 100 : 100 C. 100 : No limit D. No limit : 100

Use the following information for the next two (2) questions: Kirk and Spock formed the Enterprise Company in 2010 as equal owners. Kirk contributed land held an investment ($50,000 basis; $100,000 FMV), and Spock contributed $100,000 cash. The land was used in the business as a parking lot until it was sold this year for $120,000. 28. If Enterprise Company was formed as a partnership, how much of the gain from the sale is taxable to Kirk? A) $10,000 B) $50,000 C) $60,000 D) $35,000 29. If Enterprise Company was formed as an S corporation, how much of the gain from the sale is taxable to Kirk? A) $10,000 B) $50,000 C) $60,000 D)$35,000

C & D

19. The Watkins Group, LLC, had the following items for the current year: Income from clients $200,000 Dividend income 500 Depreciation expense 3,000 Other operating expenses 125,000 Charitable contributions 1,500 Sec. 1231 gain on sale of equipment 1,200 Sec. 1245 gain on sale of equipment 1,000 What is the Watkins Group's ordinary income? A. $70,500 B. $72,700 C. $73,000 D. $73,500

The Mon Partnership reported the following items for the current year: Income from clients $200,000 Short-Term Capital gain 1,200 Interest income 1,500 Cash operating expenses (126,000) Charitable contributions (1,500) Depreciation expense (2,000) What is Mon Partnership's ordinary income? A. $73,500 B. $74,000 C. $72,000 D. $73,200

Which of the following events would cause an existing S corporation to lose its S corporation election? A. The S corporation earned more than 40% of its gross receipts from passive income sources in its first year of operations. B. The S corporation issues long-term debt instruments to a person or entity that is not an eligible shareholder. C. A shareholder transfers half of her stock to a partnership. D. The S corporation purchases more than 80% of the stock in another corporation.

S corp Distribution Example

EX 1) Jan has basis in her S corp stock of $10,000. AAA = 3,000; EAP= 1,000. Jan receives a 5,000 distribution. How is it treated? AAA = 3,000 = Not Taxable EAP = 1,000 = Taxable Dividend Stock Basis = 1,000 = NOT taxable (PLUG) Total = 5,000 = Distribution Jan Basis after distribution? 10,000 original basis - 3,000 AAA - 1,000 Stock basis = 6,000 NEW stock basis EX2) S corp Distributes a property dividend (basis 20,000; FMV 50,000) to Joe, a 50% shareholder. What is the impact to Joe? (assume AAA is sufficient) Key word= FMV 1. S corp must write up asset to FMV (50-20 =30) 30,000 gain 2. 30,000 gain flows through to all shareholders Joe reports 15,000 (50% x 30,000) 3. Distribution is not taxable. Joe: $0 taxable, Asset basis = $50,000 FMV, Stock basis = 0 (15 gain - 50 distribution) CH15

Election of S Corp Status

Election (form 2553) must be made anytime during the proceeding year or by the: 15th day of the 3rd month of the Tax Year of the Election All shareholders must consent to the election and all prior shareholders for the tax year if the election is retroactive. CH15

T/F: The inside basis is defined as a partner's basis in the partnership interest.

False The outside basis is defined as a partner's basis in the partnership interest. CQ14

Key Person Life Insurance

GAAP: Expense, Gain (death is classified as a gain) 1. Corporation owns policy and is beneficiary 2. No deduction allowed for premiums, since proceeds will be excludible. CH12/13

Charitable Contribution

GAAP: Expense, No limit 1. Limit is 10% of taxable income before DRD 2. Excess is carried forward for 5 years, subject to the same limits 3. Accrual basis corporation can deduct in the year accrued if authorized by Board by year end and paid within 2 1/1 months after year-end. 4. Amount of deduction: --> FMV, reduced by any ordinary income hat would be recognized if sold --> Exceptions: Inventory given to organizations for care of ill, needy, or infants and Scientific property given to colleges and research organizations. Reduction is only 1/2 of the application. CH12/13

S Corp Stock Transfer

If stock is transferred, the income must be allocated between the owners on a per share and per day basis. Affected shareholders (buyer and seller) can elect to close the books as of transfer date. EX) Al owns 100% of an S corp. On 10/1 he sells 25% of the stock to Betty. How is each item of income and loss allocated? AL: (1/1 - 10/1 ) 100% x (274 days / 365) = 75% (10/2 - 12/31) (100% - 25% given up = 75%) 75% x (91 days /365) = 18.75% Weighted Average = 93.75% Betty: (1/1 - 10/1) 0% x (274 days /365) = 0% (10/2 - 12/31) 25% x (91/365) = 6.25% Weighted Average = 6.25% CH15

Qualified Business Income (QBI) Deduction

Individual taxpayers get a 20% deduction on income stemming from proprietorships, partnerships and s-corps. QBI = flow through income. Excludes capital gains (losses), dividend income, and interest income. Limited to 20% of TAXPAYER'S taxable ordinary Income. Phase out and limits on QBI: 1. Applies to taxable income > 163,300 (single) or 326,600 (joint/married). 2. QBI rate phases pout for service businesses (Health, Law, Accounting, Financial and Brokerage services) 163,300 - 213,300 (single) 326,600 - 426,600 (married) 3. Non service businesses QBI deduction is limited to the GREATER of: 50% wages in the business OR 25% of wages in the business + 2.5% of unadjusted basis of business property. Located on PARTNER'S individual tax return: Taxable Income before QBI - QBI Deduction CH14

Corporate assumption of liabilities

Not classified as boot for 351 purposes (gain recognition) --> Exception: Liability > basis of assets transferred IN THAT CASE: Liability - Basis of Asset Transferred = Gain recognized --> Exception: Tax avoidance or bona fide business purpose. Is classified as boot for 358 purposes (basis determination) CH12/13

Partner's Basis in Investment - Initial basis from contribution of property

Outside Basis: Basis of property transferred/given up - Boot Received + Share of partnership debt + Gain Recognized/Share of Income CH14

Tainting Property - 724 taint

Partnership's use of the property contributed by the partner is different from the partner's use. EX: Unrealized receivables of partner --> Partner = cash method --> Partnership = ordinary income when collected Inventory to Partner = 1231 Asset to partnership --> Partner= Ordinary --> Partnership = LTCG (potentially) 5 year taint, if partnership sells within 5 years then it's ORDINARY INCOME If partnership sells after 5 years then 1231 (LTCG) Capital Loss property to partner = Inventory to Partnership. 5 year taint, if sold by partnership within 5 years then Capital Loss for the built in loss (loss at contribution). FMV < Basis at contribution Date Excess is ordinary CH14

Equity Section on Balance Sheet (partnerships and s corps)

Partnerships: Partner A's Capital Partner B's Capital Parter C's Capital = Total Partnership Capital S Corp: Common Stock Additional Paid In Capital Retained Earnings = Total Stockholder's equity = Basis CH15

Reconciliation of Book Income to Taxable Income

Schedule M-1 of Form 1120 Book Income (after FIT expense) Permanent Differences: + Nondeductible Expenses (federal income taxes, life insurance premiums, meals & entertainment) - Tax Exempt Income (interest on state and local bonds , life insurance proceeds) Temporary Differences: +/- Timing differences in recognizing revenues (prepaid income received) +/- Timing differences in recognizing deductions (depreciation vs MACRS, Section 179, Bonus Depreciation, all carryforwards (NOL, Capital Loss, Charitable Contribution)) = Taxable Income CH12/13

Shareholder Basis

Stock Basis: Basis of property transferred in - Boot received (includes 358 debt) + Gain recognized Boot Basis = FMV CH12/13

A shareholder's basis in the stock of an S corporation is increased by the shareholder's pro rata share of income from tax-exempt interest income.

TRUE

An S corporation shareholder calculates his initial basis upon formation of the corporation the same as C corporation shareholders

TRUE

One of the disadvantages of an LLC is that a member's share of the LLC's taxable income is taxed to the member, regardless of whether or not distributed

TRUE

Only the salaries paid to shareholder/employees of an S corporation are subject to employment tax (social security & Medicare); the flow-through income is not subject to employment tax.

TRUE

When an S corporation distributes appreciated property to one of its shareholders, the shareholders who did NOT receive the distributed property must ALSO recognize their distributive share of the deemed gain.

TRUE

S corp Operations

Taxable Year: (Same as Partnerships) Ordinary Income or Loss (same as partnerships) Special S corp taxes: S corps may be subject to 3 special tax levies. ONLY APPLIES to S corps that were once C corps. 1. Excessive passive investment Income tax 2. Built in gains tax 3. LIFO recapture CH15

Qualified Dividends

Taxed at 15% rate same as LTCGs Stock must be held > 60 days in the 120 day period commencing 60 days prior to the ex-dividend date. CH12/13

Pheasant Corporation, a calendar year taxpayer, has $400,000 of current E & P and a deficit in accumulated E & P of $180,000. If Pheasant pays a $600,000 distribution to its shareholders on July 1, how much dividend income do the shareholders report? a.$220,000 b.$20,000 c.$0 d.$400,000

d.$400,000 When a deficit exists in accumulated E & P and a positive balance exists in current E & P, distributions are regarded as dividends to the extent of current E & P ($400,000). CQ13

Inside Basis

Partnership's basis in its assets CH14

Property Dividends - Property Subject to Debt

1. Corporations recognize gain = to greater of: a. FMV - Basis b. Debt - Basis 2. Corporations reduce E&P by greater of: a. FMV - debt transferred b. Basis - debt transferred 3. Shareholder has a taxable dividend = FMV - Debt 4. Shareholder basis = FMV CH12/13

Order of E&P Distributions

1. Earnings and Profits (taxable as dividend) --> Current (this year's profit) = Taxable Income --> Accumulated (Jan 1 Balance) 2. Return on stock basis (liquidating dividends basis is not taxed) 3. Capital Gain (Excess> Basis) CH12/13

Transfer of Services

1. Income must be recognized by person transferring the services. 2. Person transferring both property and services: If property transfer is at least 10% of the value of the service then, the stock transferred can be counted in the 351 exception (80%) control test. CH12/13

Profits Interest

% allocation of current operations CH14

Capital Interest

% share of net assets at liquidation CH14

Basis adjustments to s corp stock basis

+ Investments - Withdrawals (Dividends, AAA) + Income Items (ordinary, tax exempt, separately stated) - Loss items (ordinary, tax-exempt, separately stated) CH15

Partner's Basis in Investment - Effects of Liabilities Examples

1. A and B contribute $100,000 cash and $100,000 FMV of property (30,000 basis), respectively as equal partners. B's property has a 50,000 recourse debt. A: 0 gain recognized; outside basis = 100,000 basis - 0 boot + 1/2(50,000) debt = 125,000 B: 0 gain recognized; outside basis = 30,000basis - 50,000 boot + 1/2 (50,000) debt = 5,000 AB: Inside Basis = 100,000 and 30,000 B: 0 Gain Recognized BECAUSE. 1/2 (50,000) Debt - 30,000 Basis = Loss 2. A and B contribute $100,000 cash and $100,000 FMV of property (30,000 basis), respectively as equal partners. B's property has a 90,000 recourse debt. A: 0 gain recognized; outside basis = 100,000 basis - 0 boot + 1/2(90,000) debt = 145,000 B: 15,000 gain recognized; outside basis = 30,000basis - 90,000 boot + 1/2 (90,000) debt + 15,000 gain = 0 AB: Inside Basis = 100,000 and 30,000 B: 15,000 Gain Recognized BECAUSE. 1/2 (90,000) Debt - 30,000 Basis = 15,000 CH14

S Corp Distributions

1. AAA: Accumulated Adjustments Accounts: Retained Earnings --> S corp: NOT Taxable 2. E&P: Earnings and Profits: Retained Earnings --> C corp: Taxable 3. OAA: Other Adjustments Account --> Sourced from Nontaxable items: Retained Earnings --> S corp: NOT taxable 4. Stock Basis: Stock Basis Remaining (common stock account): NOT taxable 5. Capital Gain: Excess: Taxable CH15

Overall Loss Limitation Rules

1. After applying at risk and PAL loss limits, individuals have a limit on deducting the overall loss from all flow through entities. 2. Maximum total flow through loss in any year now limited to: (518,000) married/ joint (259,000) single 3. Any amount > maximum amount is treated as a NOL to individual: limited to 80% of taxable income in carryforward year Carryforward period is unlimited. CH14

Property Dividends - Appreciated Property

1. Corp recognized gain (as if sold) 2. Corp reduces E&P by FMV 3. Shareholders have taxable dividend = to FMV 4. Shareholder Basis = FMV Corp rule: Assets in at FMV; Assets out at FMV CH12/13

Adjustments to Basis (subsequent to formation)

1. Profits and Losses (P&L): Profits increase basis; Losses Decrease Character does not matter 2. Recurse Debt: At least 1 partner is personally liable. All those liable share proportionally. 3. Nonrecourse debt: No partners are liable; no one shares this (not at risk) CH14

Dividend Received Deduction (2 Examples)

40% Ownership: Gross Profit 500,000 Operating Expenses -400,000 Dividend Income 250,000 =Taxable Income 350,000 65% Dividends 162,500 65% Taxable Income 227,500 DRD (pick smaller) 162,500 Gross Profit 300,000 Operating Expenses -400,000 =NOL -100,000 Dividend Income 250,000 =Taxable Income 150,000 65% Dividends 162,500 65% Taxable Income 97,500 DRD (NOL so use % of Dividends) 162,500 CH12/13

Partner's Basis in Investment - Sale of property with Built in Gain (Loss)

A contributes $100,000 cash and B contributes $100,000 FMV of property (30,000 basis), as equal partners. Suppose the partnership sells B's asset a few years later. What is the gain allocated? 1. Sales Price = 120,000 120,000 - 30,000 basis = 90,000 gain A: 0 Built in gain + 1/2 (20,000) remaining gain = 10,000 B: 70,000 Built in Gain + 1/2 (20,000) remaining gain = 80,000 B: Built in Gain (B.I.G) of 70,000 --> 100,000 FMV -30,000 basis Remaining gain = 20,000 BECAUSE 90,000 gain - 70,000 built in gain 2. Sales Price = 90,000 90,000 - 30,000 basis = 60,000 gain A: 0 B: 60,000 built in gain B: Built in Gain (B.I.G) of 70,000 --> 100,000 FMV -30,000 basis BUT only 60,000 of the 70,000 gan be allocated CH14

Megan owns 100% of Oxen Corporation, an S corporation. During the year, Oxen reports the following: Ordinary Income $50,000 Long-term capital gain from sale of securities 10,000 Assuming Megan's taxable income is $100,000, what is her QBI deduction? A. $10,000. B. $20,000. C. $12,000. D. $0.

Tim acquired 100% of the stock of an existing calendar year corporation in 2017, and immediately elected the S corporation status for the company. At the end of the current year, Tim's stock basis is $50,000, and he receives a distribution of $15,000. Corporate level accounts are as follows: AAA $13,000 Accumulated E&P 8,000 How is Tim taxed on the $15,000 distribution? A. $2,000 taxable dividend. B. $8,000 taxable dividend. C. $15,000 taxable dividend D. $-0- taxable dividend

Dividend Distributions in General

Any distribution by a corporation to a shareholder is presumed to be a dividend unless proven otherwise. CH12/13

A limited liability company (LLC) will normally be treated as which type of entity for tax purposes? A. Regular (C) corporation B. Partnership C. S corporation- D. An LLC is treated as a separate tax entity and has its own unique tax rate schedule.

To qualify for tax-free incorporation under §351, the transferring shareholders must be in control of the corporation immediately after the transfer of assets. What percentage of stock must be owned to meet this "control" requirement? A. 100% B. 80% C. 66.67% D.51%

Snow Corporation owns a 40% interest in Bowl Corporation, a domestic corporation. For the current year, Snow Corporation had gross receipts of $800,000, operating expenses of $650,000, and dividend income of $100,000 from Bowl Corporation. What is Snow Corporation's dividends-received deduction for the current year? A. $100,000 B. $65,000 C. $50,000 D. $40,000

B Lower of Taxable income or dividends Taxable income = GP 800k - OE 650k + DIV 100k = 250k (more than dividend so use div income) 100k * 65% = 65k

20. Randy and Annie are equal partners in a general partnership. Their partnership agreement calls for a $20,000 guaranteed payment to Annie, with profits and losses divided equally. For the current year, the partnership reports the following: Income from clients $60,000 Office Expenses 25,000 Depreciation 10,000 Employee Wages 15,000 What amount of income does Annie report from the partnership for the year? A) $10,000 B) $15,000 C) $20,000 D)$25,000

After a corporation's status as a S corporation is revoked or terminated, how many years is the corporation required to wait before making a new S election (in the absence of IRS consent to an earlier election). A) 1 year B) 5 years C) 10 years D) never, once the S election is lost, it cannot be reelected

At the beginning of the year, Smith Co. (an S corporation) was owned by 2 equal shareholders, John and Jane. On November 1 (305th day of the year), Jane sold all of her shares to John (i.e., John now owns 100%). Smith Co. has $365,000 of ordinary income for the tax year. What amount of the income is reported by John? A) $365,000 B) $212,500 C) $273,750 D)$305,000

Items that pertain to Pogue Corporation for the current year are presented below: Taxable loss before capital transactions $(25,000) Short-term capital gains 10,000 Long-term capital losses (15,000) For the year, Pogue Corporation has a: A. $30,000 net operating loss (NOL) B. $25,000 NOL and a capital loss carry-back/forward of $5,000 C. $28,000 NOL and a capital loss carry-back/forward of $2,000 D. $15,000 NOL and a capital loss carry-back/forward of $15,000

Tara's 50% interest in the TS Partnership is sold to Seth for $85,000 cash. On the date of the sale, the partnership tax balance sheet and the agreed FMVs were as follows: Adjusted Basis : FMV Cash $80,000 : $80,000 Accounts Receivable -0- : 10,000 Inventory 20,000 : 24,000 Land 50,000 : 56,000 Sub total: $150,000 : $170,000 Tara, Capital $75,000 : $85,000 Sam, Capital 75,000 ; 85,000 Sub total: $150,000 : $170,000 Assume Tara's outside basis in her partnership interest equals her capital account. As a result of the sale, Tara recognizes: A. $10,000 capital gain B. $7,000 ordinary gain; $3,000 capital gain C. $5,000 ordinary gain; $5,000 capital gain D.$17,000 ordinary income; ($7,000) capital loss

Partnership Distributions

Basis No gain (loss) to partnership or partner Reduced outside basis and assign assets distributed Exception: Gain recognition when cash distributed > outside basis All distributions deemed to have occurred on the last day of the partnership tax year. Ex: Partner receives proportionate distribution when outside basis is $15,000. Asset: Partnership Basis: FMV : Basis to Partner Cash: 5,000 : 5,000 : 5,000 Inv : 3,000 : 10,000: 3,000 Land: 6,000 : 10,000: 6,000 Outside Basis remaining: 15 - (5 + 3 + 6) = 1 Asset: Partnership Basis: FMV : Basis to Partner Cash: 20,000 : 20,000 : 20,000 Land: 10,000 : 10,000 : 0 Outside Basis remaining = 0 5 gain with cash only --> 20 basis to partner - 15 outside basis. CH14

Malcomb and Sandra formed Crow Corporation as equal shareholders with investments of $150,000. Two years later, each of them loans Crow $500,000 at the market rate of 6% interest to fund long-term cash needs. At the shareholders' election, the loans may be converted to stock. If the IRS were successful in reclassifying the loan as equity investments, I. the interest payments would not be deductible by Crow, and Malcomb and Sandra would still recognize income. II. repayment of the note principal to Malcomb and Sandra would not qualify for nontaxable return of capital treatment and would most likely result in dividend income treatment for Malcomb and Sandra. A. Only I is correct. B. Only II is correct. C. Both I and II are correct. D.Neither I nor II are correct.

18. Alice, a 50% partner in the GLASS Partnership, sells her interest to Bill for $125,000 at a time when she has a basis in her partnership interest of $55,000. The GLASS Partnership accounts show the following information at the time of sale: Adjusted Basis : FMV Cash $20,000 : $20,000 Accounts Receivable 30,000 : 30,000 Inventory 20,000 : 40,000 Equipment (basis is net of $80,000 MACRS deductions) 10,000 : 70,000 Land 30,000 : 90,000 Totals $110,000 : $250,000 What are the amounts and types of gains that Alice will recognize on this sale? A. $70,000 capital gain $35,000 ordinary income and $35,000 capital gain B. $40,000 ordinary income and $30,000 capital gain C. $10,000 ordinary income and $60,000 capital gain

Molly is a 30% partner in the MAP Partnership. During the current tax year, the partnership reported ordinary income of $200,000 before payment of guaranteed payments and distributions to partners. The partnership paid guaranteed payments to partners Molly, Amber, and Pat of $20,000 each ($60,000 total guaranteed payments). How much will Molly's adjusted gross income increase as a result of the above items? A. $42,000 B. $60,000 C. $62,000 D. $80,000

Which of the following statements is always correct regarding assets acquired by a newly formed partnership? If a partner contributes: A) Depreciable property: the partnership treats the property as newly acquired depreciable property, and may claim 100% bonus depreciation deduction. B) Unrealized (cash-basis) receivables: the partnership will report a capital gain when the receivable is collected. C) Inventory (in the partner's hands): the partnership reports ordinary income if the property is held as a capital asset and sold within 5 years of the contribution date. D)Land (capital asset in partner's hands) valued at less than its basis: the partnership reports an ordinary loss if the property is sold at a loss within 5 years of the contribution date.

Capital Structure issues

Corporation needs money from its owners. Debt vs Stock --> both payable to owners Annual Payment Differences: Note--> Interest Payments. Taxable to the owner. Deducted by the Corp Stock--> Dividend Payments. Taxable to the owner. owner. Not deducted by Corp Redemption Differences: Note--> Redeemed at maturity. Not taxable. Stock--> Treasury stock. Repemption is taxed as a dividend. Thin capitalization Problem: IRS can retroactively reclassify debt as equity (stock) if: 1. Debt held by owners is excessively relative to stock ownership 2. Debt held by owners is proportionate to stock 3. No evidence of notes. 4. Debt is convertible into stock CH12/13

Organizational Expenses

Costs incurred incident to the creation of the corporation (legal and accounting expenses, organizational meetings, but NOT stock issuance costs) Must be incurred before the end of the corporation's 1st tax year Corporations may deduct $5,000 in the first year (subject to phaseout if > $50,000) with the balance amortized over 15 years. --> 5,000 + (remaining balance /15 years) CH12/13

Al and Carla have been equal owners of ABC Company for the past 10 years. This year, Betty contributes assets (basis of $750,000 and FMV of $1,000,000) to ABC Company for a 50% ownership in ABC. What amount of gain (loss) does Betty recognize on her contribution if ABC Company is organized under the following types of entities? LLC : S CORP. A. $250,000 : $250,000 B. $250,000 : $-0- C. $-0- : $-0- D. $-0- : $250,000

Gains on 1202 Stock

Exclusion of 50%/75%/100% of the gain realized on sale of qualified small business corporation stock. Gain eligible for exclusion is limited to the greater of: --> $10 million or --> 10 x the adjusted basis of all qualified stock sold during the year Requirements: 1. The individual must hold the stock at least 5 years 2. The corporation must not have gross assets exceeding $50 million at any time. 3. The corporation must use at least 80% of its assets in the conduct of a qualified trade or business. CH12/13

All LLC and S corporation investments are classified as passive activities.

FALSE

Both LLC members and S corporation shareholders may have a profit (loss)-sharing ratio that differs from the ownership-sharing ratio, depending on the provisions in the ownership agreement.

FALSE

Only the guaranteed payments to general partners of a partnership are subject to employment tax (social security & Medicare); the flow-through income is not subject to employment tax.

FALSE

S corporations are entitled to the same 50%, 65%, or 100% dividends received deduction allowed for C corporations.

FALSE

When partnership liabilities increase, it causes each of the partner's basis in the partnership interest to decrease.

FALSE

Both LLC members and S corporation shareholders may have a profit (loss)-sharing ratio that differs from the ownership-sharing ratio, depending on the provisions in the ownership agreement.

False

Laura owns land that held for investment purposes (a capital asset). She contributes this land (basis = $1,500,000; FMV = $1,200,000) to a partnership, to be held as inventory and developed into a residential subdivision. After three years, the partnership sells the land for $1,000,000. The partnership will recognize a $500,000 ordinary loss on sale of the property.

False

Section 1244 ordinary loss treatment is available to shareholders in a C corporation but not to those in an S corporation.

False

The same exact requirements for forming and contributing property govern S corporations and partnerships.

False

Limit on Business Interest Expense Deduction

GAAP: No limit 1. Applies only on large businesses: --> Large = >$26 million average gross recipts over last 3 years 2. Maximum deduction = (50% x adjusted taxable income) + Interest Income --> Adjusted Taxable Income = EBITDA --> Beginning 2021 = 50% becomes 30% 3. Carryforward (indefinitely) for any interest expense > limit CH12/13

Captal Gains and Losses

GAAP: Other Income/Losses, No Distinction 1. No special rates for LTCGs 2. No $3,000 offset against ordinary income, net CLs are carried back 3 years and forward 5 years. CL carrybacks/forwards are always classified as ST CH12/13

NOLs

GAAP: it doesn't exist 1. Pre-2018 NOLs: 2 year carrybacks and 20 year carryforward 2. 2018-2020 NOLs: 5 year carrybacks and an unlimited carryforward 3. Post 2021: No carrybacks and an unlimited carryforward 4. Carryforwards to 2021 and Later: --> Pre 2018 NOLs are carryforwards have no limit on offset against taxable income --> Post 2017 NOL carryforwards limited to 80% of taxable income in carryover year. CH12/13

Guaranteed Payments

Guaranteed payments paid ro partners without regard to profits. Ex: A and B are equal partners. A has a guaranteed payment of $30,000. How is the total income allocated to each partner? Partnership Income = 50,000 A's Allocation = 30,000 + 1/2 (50,000 - 30,000) = 40,000 B's Allocation = 0 + 1/2 (50,000 - 30,000) = 10,000 CH14

Taxation of the Shareholders (s corps)

Income Allocation Procedures: --> Timing of shareholder reporting is the same as partnerships. --> No Special Allocations Allowed Ex 1) Al contributes $50 an Betty contributes property ($35 basis and FMV 50) in exchange for 50% (each) of S Corp stock. If the S corp sells Betty's property for $75. How is the gain allocated? Selling Price: 75 - Basis: (35) = Gain: 40 20 allocated to Al and 20 allocated to Betty. CH15

separately stated items - separated from ordinary income

Partnership: Capital Gains (Losses) 1231 Gains (Losses) Charitable Contributions Dividend Income Foreign Taxes Tax exempt income (s corp) S-Corp: Tax-exempt income Long-term and short-term capital gains and losses Section 1231 gains and losses Charitable contributions (no grace period) Passive gains, losses, and credits Certain portfolio income Section 179 expense deduction Domestic production gross receipts and deductions Tax preferences and adjustments for the alternative minimum tax Depletion Foreign income or loss Recoveries of tax benefit items Intangible drilling costs Investment interest, income, and expenses If starting at Book Income subtract separately stated items. If starting at sales ignore separately stated items CH14

S corp requirements - Shareholder and Corporate

Shareholder: 1. Limits number of shareholders to 100. 2. Limits type of shareholders to: --> Individuals and their estates --> Trusts (grantor, voting, testamentary, QSST) --> Retirement plan trusts and Charitable organizations NOT ALLOWED: --> Partnerships --> C Corps --> NonResident aliens --> International --> Nondomestic Corporate: 1. Qualified: --> Corporation (must already have formed a corporation) -->Domestic --> Not on the ineligible list (banks, and insurance company's) 2. One class of stock only (no preferred stock) 3. S ownership in C corp is okay (BUT C corp can not own S corp) 4. S ownership in other S corps is okay. --> Parent S corp must own 100% of Subsidiary S corp CH15

Liquidations

Tax consequences of Corporate Liquidation: General rule is to treat the distribution as a sale or exchange. 1. Shareholder: recognizes gain or loss is extent of money and the FMV of the property received exceeds the adjusted basis of the stock 2. Corp: recognizes gain or loss as if the property were sold to the shareholder. CH12/13

Hot Assets example

Troy sells his 1/4 interest in a partnership for $50,000. Assets: Troy Basis (1/4): Basis: FMV: Troy's FMV (1/4) Cash: 10 : 40 : 40 : 10 AR: 0 : 0 : 36 : 9 Inv: 10 : 40 : 92 : 23 Land: 10 : 40 : 32 : 8 Total 30 : 120 : 200 : 50 Step 1: categorize Assets as 751 (hot assets) and non-751 --> 751: AR (cash basis), Inventory ---->751 Amount realized (FMV) = 9 + 23 = 32 ----> 751 Basis = 0 + 10 = 10 --> Non-751: Cash, Land ----> Non 751 Amount relaized (FMV) = 10 + 8 = 18 ----> Non 751 Basis = 10 + 10 =20 Step 2: Compute Gain (Loss) on 751 assets and Non 751 Assets Character : Total: 751 Asset: Non 751 Asset Amount Realized : 50 : 32 : 18 Basis : (30) : (10) : (20) Gain (Loss) : 20 : 22 : (2) 22 ordinary Income (2) capital loss CH14

At the beginning of the tax year, Barnaby's basis in the BBB Partnership was $50,000, including his $5,000 share of partnership debt. At the end of the tax year, his share of the entity's debt was $8,000. Barnaby's share of BBB's ordinary income for the year was $20,000, and he received cash distributions totaling $12,000. In addition, his share of the partnership's tax-exempt income was $1,000. Determine Barnaby's basis at the end of the tax year.

$62,000 Barnaby's basis in the partnership is $62,000 ($50,000 + $3,000 + $20,000 + $1,000 - $12,000) at the end of the tax year. Barnaby's initial $50,000 basis was increased by the $3,000 increase in his share of partnership debt ($8,000 ending − $5,000 beginning), his $20,000 share of partnership income, and his $1,000 share of the partnership's tax-exempt income. In addition, his basis was reduced by the $12,000 cash distribution he received. HW14b

Zebra, Inc., a calendar year S corporation, incurred the following items this year. Sammy is a 40% Zebra shareholder throughout the year. Sales$100,000 Cost of goods sold(40,000) Depreciation expense (MACRS)(10,000) Administrative expenses(5,000) §1231 gain21,000Depreciation recapture income25,000 Short-term capital loss from stock sale(6,000) Long-term capital loss from stock sale(4,000) Long-term capital gain from stock sale15,000 Charitable contributions(4,500) a. Indicate whether the following items are included in nonseparately computed income. Select "Yes or No", whichever is applicable. Sales Cost of goods sold Depreciation expense (MACRS) Administrative expenses §1231 gain Depreciation recapture income Short-term capital loss from stock sale Long-term capital loss from stock sale Long-term capital gain from stock sale Charitable contributions Calculate Sammy's share of Zebra's nonseparately computed income or loss. His share of the nonseparately computed __________ is ________ b. Calculate Sammy's share of Zebra long-term capital gain, if any. c. Calculate Sammy's share of charitable contributions, if any.

A) Answers: Yes; Yes; Yes; Yes; No; Yes; No; No; No; No; income; $28,000. Each year, the S corporation determines nonseparately stated income or loss and separately stated income, deductions, and credits. These items are taxed only once, at the shareholder level. All items are allocated to each shareholder based on average ownership of stock throughout the year. The flow-through of each item of income, deduction, and credit from the corporation to the shareholder is illustrated in Exhibit 15.2. An S corporation's taxable income or loss is determined in a manner similar to the tax rules that apply to partnerships, except that S corporations amortize organizational expenditures under the C corporation rules and must recognize gains, but not losses, on distributions of appreciated property to shareholders. Other special provisions affecting only the computation of C corporation income, such as the dividends received deduction, do not extend to S corporations. Finally, as with partnerships, certain deductions of individuals are not permitted, including alimony payments, personal moving expenses, certain dependent care expenses, the personal exemption, and the standard deduction. In general, S corporation items are divided into (1) nonseparately stated income or loss and (2) separately stated income, losses, deductions, and credits that could affect the tax liability of any shareholder in a different manner, depending on other factors in the shareholder's tax situation. In essence, nonseparate items are aggregated into an undifferentiated amount that constitutes Subchapter S ordinary income or loss. An S corporation's separately stated items are identical to those separately stated by partnerships. These items retain their tax attributes on the shareholder's return. Separately stated items are listed on Schedule K of the 1120S. They include the following: Tax-exempt income. Long-term and short-term capital gains and losses. Section 1231 gains and losses. Charitable contributions (no grace period). Passive gains, losses, and credits. Certain portfolio income. Section 179 expense deduction. Domestic production gross receipts and deductions. Tax preferences and adjustments for the alternative minimum tax. Depletion. Foreign income or loss. Recoveries of tax benefit items. Intangible drilling costs. Investment interest, income, and expenses. B) Answer: $6,000. Each shareholder is allocated a pro rata portion of nonseparately stated income or loss and all separately stated items. The pro rata allocation method assigns an equal amount of each of the S items to each day of the year. If a shareholder's stock holding changes during the year, this allocation assigns the shareholder a pro rata share of each item for each day the stock is owned. On the date of transfer, the transferor (and not the transferee) is considered to own the stock. $15,000 × 40% = $6,000 LTCG to Sammy. C) Answer: $1,800. $4,500 × 40% = $1,800 charitable contributions to Sammy. HW15

The profit and loss statement of Kitsch Ltd., an S corporation, shows $100,000 book income. Kitsch is owned equally by four shareholders. From supplemental data, you obtain the following information about items that are included in book income. Selling expenses($21,200) Tax-exempt interest income3,000 Dividends received9,000 § 1231 gain7,000 Depreciation recapture income11,000 Net income from passive real estate rentals5,000 Long-term capital loss(6,000) Salary paid to owners (each)(12,000) Cost of goods sold(91,000) a. Compute Kitsch's nonseparately stated income or loss for the tax year. The entity's nonseparately stated ___________ is ___________ b. What would be the share of this year's nonseparately stated income or loss items for James Billings, one of the Kitsch shareholders? c. What is James Billings' share of tax-exempt interest income, if any?___________________ Is the income taxable to him this year?

A) Answers: income; $82,000. Each year, the S corporation determines nonseparately stated income or loss and separately stated income, deductions, and credits. These items are taxed only once, at the shareholder level. All items are allocated to each shareholder based on average ownership of stock throughout the year. The flow-through of each item of income, deduction, and credit from the corporation to the shareholder is illustrated in Exhibit 15.2. An S corporation's taxable income or loss is determined in a manner similar to the tax rules that apply to partnerships, except that S corporations amortize organizational expenditures under the C corporation rules and must recognize gains, but not losses, on distributions of appreciated property to shareholders. Other special provisions affecting only the computation of C corporation income, such as the dividends received deduction, do not extend to S corporations. Finally, as with partnerships, certain deductions of individuals are not permitted, including alimony payments, personal moving expenses, certain dependent care expenses, the personal exemption, and the standard deduction. In general, S corporation items are divided into (1) nonseparately stated income or loss and (2) separately stated income, losses, deductions, and credits that could affect the tax liability of any shareholder in a different manner, depending on other factors in the shareholder's tax situation. In essence, nonseparate items are aggregated into an undifferentiated amount that constitutes Subchapter S ordinary income or loss. An S corporation's separately stated items are identical to those separately stated by partnerships. These items retain their tax attributes on the shareholder's return. Separately stated items are listed on Schedule K of the 1120S. They include the following: Tax-exempt income Long-term and short-term capital gains and losses Section 1231 gains and losses Charitable contributions (no grace period) Passive gains, losses, and credits Certain portfolio income Section 179 expense deduction Domestic production gross receipts and deductions Tax preferences and adjustments for the alternative minimum tax Depletion Foreign income or loss Recoveries of tax benefit items Intangible drilling costs Investment interest, income, and expenses B) Answer: $20,500. Each shareholder is allocated a pro rata portion of nonseparately stated income or loss and all separately stated items. The pro rata allocation method assigns an equal amount of each of the S items to each day of the year. If a shareholder's stock holding changes during the year, this allocation assigns the shareholder a pro rata share of each item for each day the stock is owned. On the date of transfer, the transferor (and not the transferee) is considered to own the stock. In summary, each shareholder is allocated a pro rata portion of nonseparately stated income or loss and all separately stated items. $82,000 ÷ 4 = $20,500 C) Answers: $750; Not taxable. Tax exempt income is reported on the Schedule K and a proportionate share of it passes through to the shareholders' tax returns. However, since the interest is tax-exempt, it is not taxable. James' share is $750 ($3,000 ÷ 4). HW15

Village Corp., a calendar year corporation, began business in year 1. Village made a valid S corporation election on December 5, year 4, with the unanimous consent of its shareholders. The eligibility requirements for S status continued to be met throughout year 5. On what date did Village's S status become effective? a.January 1, year 4 b.January 1, year 5 c.December 5, year 4 d.December 5, year 5

Answer: January 1, year 5. Rule: In order to be effective for the current taxable year, the S corporation election must be made by the 15th day of the third month of the taxable year. If the election is made after that date, it becomes effective on the first day of the next taxable year, January 1, Year 5, in this case. HW15

John organized Toucan Corporation 10 years ago. He contributed property worth $1,000,000 (basis of $200,000) for 2,000 shares of stock in Toucan (representing 100% ownership). John later gave each of his children, Julie and Rachel, 500 shares of the stock. In the current year, John transfers property worth $350,000 (basis of $170,000) to Toucan for 1,000 more of its shares. What gain, if any, will John recognize on the transfer?

Answer: $180,000. John must recognize $180,000 of gain on the current-year transfer [$350,000 (value of the shares received) - $170,000 (basis in the property transferred)]. The transfer does not qualify under § 351. Although John originally owned 100% of Toucan Corporation, he only owns 66 ⅔% after the transfer [2,000 (shares originally owned) - 1,000 (shares transferred to Julie and Rachel) + 1,000 (shares acquired in the transfer), or 2,000 shares of a total of 3,000 shares which is 66 ⅔%]. Julie's and Rachel's stock ownership cannot be counted because the stock attribution rules of § 318 do not apply to a § 351 transfer. HW12a

Fox Corp., an S corporation, had an ordinary loss of $36,500 for the year ended December 31, year 2. At January 1, year 2, Duffy owned 50% of Fox's stock. Duffy held the stock for 40 days in year 2 before selling the entire 50% interest to an unrelated third party. Duffy's basis for the stock was $10,000. Duffy was a full-time employee of Fox until the stock was sold. Assume a 365 day year. Duffy's share of Fox's loss was: a.$0 b.$2,000 c.$10,000 d.$18,250

Answer: $2,000. Rule: If ownership interests of an S corporation change within the taxable year, the income and/or loss to be allocated among the various shareholders will be made on a "per share, per day" basis. S corporation loss for the year: $36,500 / 365 days =$ 100(per day) Number of days Duffy was a shareholder 40 Loss allocated to 40 days$ 4,000 Duffy's ownership interest 50% Loss allocated to Duffy for the year$ 2,000 HW15

Ron, David, and Mary formed Widget, Inc. Ron and David each received 40% of the stock, and Mary received the remaining 20%. Ron contributed land with an FMV of $70,000 and an adjusted basis of $20,000. The corporation also assumed a $30,000 liability on the property. David contributed land with an FMV of $30,000 and an adjusted basis of $15,000. David also contributed $10,000 in cash. Mary received her stock for services rendered. She normally would bill $20,000 for these services. What is Mary's basis in the corporate stock received? a.$0 b.$10,000 c.$15,000 d.$20,000

Answer: $20,000. This generally is a nontaxable transaction for Ron and David because together they met the 80% control test. Mary does not count toward the 80% test because she received her stock for services rendered. Mary's basis in the corporate stock received is simply the $20,000 FMV of the services rendered. HW12a

The Haas Corp., a calendar year S corporation, has two equal shareholders. For the year ended December 31, year 6, Haas had net income of $60,000, which included $50,000 from operations and $10,000 from investment interest income. There were no other transactions that year. Each shareholder's basis in the stock of Haas will increase by: a.$50,000 b.$30,000 c.$25,000 d.$0

Answer: $30,000. The basis of a shareholder's stock in an S corporation is increased by any item of income and decreased by any item of loss or deduction that passes through to the shareholder. Each shareholder reports ½ of $60,000. HW15

The Matthew Corporation, an S corporation, is equally owned by three shareholders—Emily, Alejandra, and Kristina. The corporation is on the calendar year basis for tax and financial purposes. On April 1 of the current year, Emily sold her one-third interest in the Matthew Corporation equally to the other two shareholders. For the current year, the corporation had nonseparately stated ordinary income of $900,000. For the current year, how much ordinary income should be allocated to Kristina on her Schedule K-1? Note: use months instead of days in your computations. a.$25,000 b.$75,000 c.$337,500 d.$412,500

Answer: $412,500. Kristina is a 1/3 shareholder for 1/4 of the year and a 1/2 shareholder for 3/4 of the year. Her allocated ordinary income is calculated as follows: Jan 1 - March 31 Allocable Income: $900,000 / 4 = $225,000 Jan 1 - March 31 to Kristina: $225,000 × 1/3 = $75,000 April 1 - Dec 31 Allocable Income: $900,000 - $225,000 = $675,000 April 1 - Dec 31 to Kristina: $675,000 × 1/2 = $337,500 Total Allocated to Kristina: $75,000 + $337,500 = $412,500 HW15

Greiner, Inc., a calendar year S corporation, holds no AEP. During the year, Chad, an individual Greiner shareholder, receives a cash distribution of $30,000 from the entity. Chad's basis in his stock is $25,000. Compute Chad's ordinary income and capital gain from the distribution. What is his stock basis after accounting for the payment? If an amount is zero, enter "0". a. Determine Chad's ordinary income and capital gain, if any, from the distribution.Chad recognizes ordinary income of _____ and a capital gain of _____ b. What is the basis of Chad's Greiner stock after accounting for the distribution?His basis in the stock is _____ after the distribution.

Answers: $0; $5,000; $0. If the S corporation has never been a C corporation or if it has no C corporation AEP, the distribution is a tax-free recovery of capital to the extent that it does not exceed the shareholder's basis in the stock of the S corporation. When the amount of the distribution exceeds the basis of the stock, the excess is treated as a gain from the sale or exchange of property (capital gain in most cases). The vast majority of S corporations fall into this favorable category. Since the distribution exceeds Chad's basis in the stock, he recognizes a capital gain of $5,000, the excess of the distribution over the stock basis ($30,000 - $25,000). The remaining $25,000 is tax-free, but it reduces Chad's basis in his stock to zero. HW15

Adam transfers property with an adjusted basis of $50,000 (fair market value of $400,000) to Swift Corporation for 90% of the stock. The property is subject to a liability of $60,000, which Swift assumes. a. What is the basis of the Swift stock to Adam?Adam recognizes a gain of _____________ and the basis of the Swift stock to Adam is $___________

Answers: $10,000; $0. Section 357(a) provides, however, that when the acquiring corporation assumes a liability in a § 351 transaction, the liability is not treated as boot received for gain recognition purposes. The general rule of § 357(a) has two exceptions: § 357(b) provides that if the principal purpose of the assumption of the liabilities is to avoid tax or if there is no bona fide business purpose behind the exchange, the liabilities are treated as boot. § 357(c) provides that if the sum of the liabilities exceeds the adjusted basis of the properties transferred, the excess is taxable gain. Without this provision, when liabilities exceed the basis in property exchanged, a taxpayer would have a negative basis in the stock received in the controlled corporation. For a taxpayer transferring property to a corporation in a § 351 transaction, the stock received in the transaction is given a substituted basis. Essentially, the stock's basis is the same as the basis the taxpayer had in the property transferred, increased by any gain recognized on the exchange of property and decreased by boot received. Click here to view Exhibit 12.2, Shareholder's Basis of Stock Received in Exchange for Property. Adam recognizes a gain of $10,000 on the transaction under § 357(c) [$60,000 (liability) - $50,000 (basis in the transferred property)]. Adam has a zero basis in the stock in Swift Corporation, computed as follows: $50,000 (basis in the property transferred to Swift Corporation) + $10,000 (gain recognized by Adam) - $60,000 (liability assumed by Swift treated as Boot Received for purposes of Shareholder's Basis in Stock Received). HW12a

Polly has been the sole shareholder of a calendar year S corporation since its inception. Polly's stock basis is $15,500, and she receives a distribution of $19,000. Corporate-level accounts indicate a $6,000 balance in AAA and a $500 balance in AEP. Determine Polly's tax treatment of the distribution: Tax-free amount Taxed as a dividend Taxed as capital gains What is her stock basis after the distribution?

Answers: $15,500; $500; $3,000; $0. The tax treatment of distributions differs, depending upon whether the S corporation has AEP. If AEP (accumulated E & P) exists, distributions are tax-free to the extent of the accumulated adjustments account (AAA). Next, AEP is distributed as taxable dividends (i.e., as payments from AEP). Remaining amounts of the distribution are received tax-free to the extent of the shareholder's remaining stock basis, with any excess being treated typically as capital gain. The distribution is accounted for as follows: To extent of AAA, tax-free $6,000 To extent of AEP, taxable dividend $500 These two distributions reduce the stock basis to $9,500 ($15,500 - $6,000). Next, the distribution is treated as a return of capital (tax-free) to the extent of stock basis ($9,500). The remaining $3,000 of the distribution ($19,000 - $6,500 - $9,500) is accounted for as a capital gain. Recap: Tax-free (AAA and reduced basis of stock)$15,500 Taxed as dividends (AEP)500 Balance taxed as capital gain 3,000 Total $19,000 HW15

Tiger, Inc., a calendar year S corporation, is owned equally by four shareholders: Ann, Becky, Chris, and David. Tiger owns investment land that was purchased for $160,000 four years ago. On September 14 of the current year when the land is worth $240,000, it is distributed to David. Assume that David's basis in his S corporation stock is $270,000 on the distribution date. Complete the statement below that outlines what the Federal income tax ramifications are. Ignore the QBI deduction. A _____ of _____ is reported at the corporate level, and each shareholder includes a flow-through of _____. David's basis in the S corporation becomes _____.

Answers: A capital gain; $80,000; $20,000; $50,000. An S corporation recognizes a gain on any liquidating or nonliquidating distribution of appreciated property in the same manner as if the asset were sold to the shareholder at its fair market value. The corporate gain is passed through to the shareholders. The character of the gain-capital gain or ordinary income- depends upon the type of asset being distributed. There is an important reason for this gain recognition rule. Without it, property might be distributed tax-free (other than for certain recapture items) and later sold without income recognition to the shareholder because the shareholder's basis in the property equals the asset's fair market value. The S corporation does not recognize a loss when distributing assets that are worth less than their basis. As with gain property, the shareholder's basis is equal to the asset's fair market value. Thus, the potential loss is postponed until the shareholder sells the stock of the S corporation. Because loss property receives a step-down in basis without any loss recognition by the S corporation, distributions of loss property should be avoided. A capital gain of $80,000 ($240,000 - $160,000) is reported at the corporate level, and each shareholder includes a flow-through of $20,000 ($80,000 / 4). David's stock basis is reduced to $50,000 ($270,000 + $20,000 - $240,000). HW15

Emerald Corporation, a calendar year and accrual method taxpayer, provides the following information and asks you to prepare Schedule M-1 for 2020: Net income per books (after-tax) $268,200 Federal income tax per books 31,500 Tax-exempt interest income 15,000 Life insurance proceeds received as a result of death of corporate president 150,000 Interest on loan to purchase tax-exempt bonds 1,500 Excess of capital losses over capital gains 6,000 Premiums paid on life insurance policy on life of Emerald's president 7,800 a. Classify each item as being "Added" or "Deducted" on the M-1 schedule. 1• Federal income tax per books 2• Tax-exempt interest income 3• Life insurance proceeds received as a result of death of corporate president 4• Interest on loan to purchase tax-exempt bonds 5• Excess of capital losses over capital gains 6• Premiums paid on life insurance policy on life of Emerald's president b. What is the taxable income after the M-1 adjustments are made?

Answers: Added; Deducted; Deducted; Added; Added; Added; $150,000 1. Added. If a company takes an expense for Federal income taxes in their book income, this would be added back as Federal income taxes is not an allowable expense when computing taxable income. 2. Deducted. Although included in book income, tax-exempt interest income are not taxable; thus not included in taxable income. 3. Deducted. Although included in book income, life insurance proceeds are not taxable; thus not included in taxable income. 4. Added. Interest on loan to purchase tax-exempt bonds are deducted for financial accounting purposes but not deductible by corporations for income tax purposes and therefore, added back to book income. 5. Added. The excess of capital losses over capital gains (deducted for financial accounting purposes but not deductible by corporations for income tax purposes) would be added back to book income. 6. Added. Although an expense taken per book income, the premiums paid on life insurance policies of executives where the corporation is the beneficiary is not deductible for tax purposes. This expense would be added back to book income. b. $150,000 HW12b

Boot Basis =

FMV

For each of the following independent statements, select either "Increase", "Decrease" or "No Effect" to indicate whether the transaction will increase, decrease, or have no effect on the adjusted basis of a shareholder's stock in an S corporation. a. Expenses related to tax-exempt income b. Short-term capital gain c. Nonseparately computed loss d. Section 1231 gain e. Depletion not in excess of basis f. Separately computed income g. Nontaxable return-of-capital distribution by the corporation h. Advertising expenses i. Business gifts in excess of $25 j. Depreciation recapture income k. Dividends received by the S corporation l. LIFO recapture tax paid m. Long-term capital loss n. Cash distribution to shareholder out of AAA (with positive stock basis)

Answers: Decrease; Increase; Decrease; Increase; Decrease; Increase; Decrease; Decrease; Decrease; Increase; Increase; Decrease; Decrease; Decrease. a. Decrease. Basis is reduced (but not below zero) by distributions not reported as income by the shareholder (e.g., tax-exempt income) and nondeductible expenses (e.g., expenses related to tax-exempt income). b. Increase. Operations during the year resulting in separately stated income items (e.g., short-term capital gains) cause an upward adjustment to basis. c. Decrease. A shareholder can deduct an NOL for the year in which the S corporation's tax year ends. The corporation does not deduct the NOL. A shareholder's basis in the stock is reduced to the extent of any pass-through of the NOL, and the entity's AAA is reduced by the same deductible amount. d. Increase. Operations during the year resulting in separately stated income items (e.g., Section 1231 gain) cause an upward adjustment to basis e. Decrease. Operations during the year resulting in separately and nonseparately stated expense items cause an downward adjustment to basis. If depletion is in excess of basis, it would cause an upward adjustments. f. Increase. Operations during the year resulting in separately computed income items (e.g., interest income, dividend income) cause an upward adjustment to basis. g. Decrease. Basis is reduced by distributions not reported as income by the shareholder (e.g., an AAA distribution). h. Decrease. Operations during the year resulting in nonseparately stated expense items cause an downward adjustment to basis. i. Decrease. Nondeductible expenses of the corporation (e.g., fines, penalties, and illegal kickbacks) cause an downward adjustment to basis. j. Increase. Operations during the year resulting in nonseparately stated income items (e.g., Depreciation recapture income) cause an upward adjustment to basis. k. Increase. Operations during the year resulting in separately stated income items cause an upward adjustment to basis. l. Decrease. To preclude deferral of gain recognition by a C corporation that is electing S status, any LIFO recapture amount at the time of the S election is subject to a corporate level tax. The taxable LIFO recapture amount equals the excess of the inventory's value under FIFO over the LIFO value. No negative adjustment is allowed if the LIFO value is higher than the FIFO value. m. Decrease. Basis is reduced (but not below zero) by distributions that are stated separately by the shareholder (e.g., long-term capital losses). n. Decrease. Basis is reduced (but not below zero) by distributions not reported by the shareholder (e.g., an AAA distribution). HW15

Indicate whether the following statements are "True" or "False" regarding the requirements for S corporation status. a. S corporations are subject to sales and capitalization restrictions. b. S corporations may only issue one class of stock. c. S corporations are limited to a theoretical maximum of 100 shareholders. d. S corporations may be U.S. (domestic) or non-U.S. corporations. e. S corporations shareholders may only be individuals, estates, and certain trusts and exempt organizations. f. Nonresident alien shareholders are not allowed for S corporations.

Answers: False; True; True; False; True; True. a. False. Unlike other provisions in the tax law (e.g., § 1244), no maximum or minimum dollar sales or capitalization restrictions apply to small business corporations. b. True. A small business corporation may have only one class of stock issued and outstanding. This restriction permits differences in voting rights, but not differences in distribution or liquidation rights. c. True. A small business corporation theoretically is limited to 100 shareholders. If shares of stock are owned jointly by two individuals, they will generally be treated as separate shareholders. d. False. Small business corporation status is not permitted for non-U.S. corporations nor for certain banks and insurance companies. e. True. Small business corporation shareholders may be resident individuals, estates, certain trusts, and certain tax-exempt organizations. Charitable organizations, employee benefit trusts exempt from taxation, and a one-person LLC also can qualify as shareholders of an S corporation. This limitation prevents partnerships, corporations, limited liability partnerships, most LLCs, and most IRAs and Roth IRAs from owning S corporation stock. f. True. Nonresident aliens cannot own stock in a small business corporation. That is, individuals who are not U.S. citizens must live in the United States to own S corporation stock. Therefore, shareholders with nonresident alien spouses in community property states cannot own S corporation stock because the nonresident alien spouse would be treated as owning half of the community property. HW15

Indicate whether the following items are treated as "Separately stated item" or "Nonseparately stated item" stated item for a S corporation. a. Tax-exempt income b. Trade or business expenses c. Ordinary income d. Long-term and short-term capital gains and losses e. Charitable contributions f. Depreciation recapture

Answers: Separately stated item; Nonseparately stated item; Nonseparately stated item; Separately stated item; Separately stated item; Nonseparately stated item. An S corporation's taxable income or loss is determined in a manner similar to the tax rules that apply to partnerships, except that S corporations amortize organizational expenditures under the C corporation rules and must recognize gains, but not losses, on distributions of appreciated property to shareholders. Other special provisions affecting only the computation of C corporation income, such as the dividends received deduction, do not extend to S corporations. Finally, as with partnerships, certain deductions of individuals are not permitted, including alimony payments, personal moving expenses, certain dependent care expenses, the personal exemption, and the standard deduction. In general, S corporation items are divided into (1) nonseparately stated income or loss and (2) separately stated income, losses, deductions, and credits that could affect the tax liability of any shareholder in a different manner, depending on other factors in the shareholder's tax situation. In essence, nonseparate items are aggregated into an undifferentiated amount that constitutes Subchapter S ordinary income or loss. An S corporation's separately stated items are identical to those separately stated by partnerships. These items retain their tax attributes on the shareholder's return. Separately stated items are listed on Schedule K of the 1120S. They include the following:• Tax-exempt income.• Long-term and short-term capital gains and losses.• Section 1231 gains and losses.• Charitable contributions (no grace period).• Passive gains, losses, and credits.• Certain portfolio income.• Section 179 expense deduction.• Domestic production gross receipts and deductions.• Tax preferences and adjustments for the alternative minimum tax.• Depletion.• Foreign income or loss.• Recoveries of tax benefit items.• Intangible drilling costs.• Investment interest, income, and expenses HW15

The following information for 2020 relates to Sparrow Corporation, a calendar year, accrual method taxpayer. Net income per books (after-tax) $205,050 Federal income tax per books 55,650 Tax-exempt interest income 4,500 MACRS depreciation in excess of straight-line depreciation used for financial accounting purposes 7,200 Excess of capital losses over capital gains 9,400 Nondeductible meals and entertainment 5,500 Interest on loan to purchase tax-exempt bonds 1,100 a. Regarding items that would be added back on the M-1 schedule, label either "Yes" (it would be added back to net income per books) or "No" (it would not be). 1• Federal income tax per books 2• Excess of capital loss over capital gains 3• Tax-exempt interest income 4• Excess of MACRS over book depreciation 5• Interest on loan to purchase tax-exempt bonds 6• Nondeductible meals and entertainment b. Sparrow's taxable income for 2020 is

Answers: Yes; Yes; No; No; Yes; Yes; $265,000. 1. Yes. If a company takes an expense for Federal income taxes in their book income, this would be added back as Federal income taxes is not an allowable expense when computing taxable income. 2. Yes. The excess of capital losses over capital gains (deducted for financial accounting purposes but not deductible by corporations for income tax purposes) would be added back to book income. 3. No. Although included in book income, tax-exempt interest income is not taxable; thus not included in taxable income. 4. No. Many assets are depreciated quicker for tax than for book purposes. Consequently, an additional expense (a subtraction from / reduction in) in book income adjustment is necessary. 5. Yes. Interest on loan to purchase tax-exempt bonds is deducted for financial accounting purposes but not deductible by corporations for income tax purposes and therefore, added back to book income. 6. Yes. Although an expense for meals and entertainment is taken per book income, the nondeductible portion of meals and entertainment is not deductible for tax purposes. This expense would be added back to book income. b. $265,000. HW12b

Vogel, Inc., an S corporation for five years, distributes a tract of land held as an investment to Jamari, its majority shareholder. The land was purchased for $45,000 ten years ago and is currently worth $120,000. a. As a result of the distribution, what is Vogel's recognized capital gain? How much is reported as a distribution to shareholders? Vogel recognizes a _____ of _____ which is reported on Schedule K, and a _____ Jamari would take a _____ basis in the land. b. What is the net effect of the distribution on Vogel's AAA? There is a net _____ of _____ to Vogel's AAA. c. Assume instead that the land had been purchased for $120,000 and was currently worth $45,000. How much would Vogel recognize as a loss? What would be the net effect on Vogel's AAA? What would be Jamari's basis in the land? Vogel recognizes a loss _____ and the net effect on Vogel's AAA is _____ of _____. Jamari would take a _____ basis in the land.

Answers: a capital gain; $75,000; a proportionate share of it passes through to the shareholders; $120,000; decrease; $45,000; $0; a decrease; $120,000; $45,000. An S corporation recognizes a gain on any distribution of appreciated property in the same manner as if the asset were sold to the shareholder at its fair market value. The corporate gain is passed through to the shareholders. The character of the gain—capital gain or ordinary income—depends upon the type of asset being distributed. The S corporation does not recognize a loss when distributing assets that are worth less than their basis. As with gain property, the shareholder's basis is equal to the asset's fair market value. Thus, the potential loss is postponed until the shareholder sells the stock of the S corporation. Because loss property receives a step-down in basis without any loss recognition by the S corporation, distributions of loss property should be avoided. a. Vogel recognizes a capital gain of $75,000 ($120,000 - $45,000), which increases the AAA by $75,000. The gain appears on Vogel's Schedule K, and a proportionate share of it passes through to the shareholders' tax returns. Jamari reports receiving a distribution of $120,000 and his basis in the property equals its fair market value ($120,000). b. The property distribution reduces the AAA by $120,000 (the fair market value). Therefore, the net effect on AAA is a $45,000 decrease ($75,000 gain - $120,000 distribution). The tax consequences are the same for appreciated property, whether it is distributed to the shareholders and they dispose of it or the corporation sells the property and distributes the proceeds to the shareholders. c. If the land had been purchased for $120,000 and was currently worth $45,000, Jamari would take a $45,000 basis (fair market value) in the land. The $75,000 realized loss is not recognized at the corporate level. The loss reduces Vogel's AAA. Therefore, the effect on AAA is a decrease of $120,000 ($75,000 realized loss + $45,000 FMV of land). In addition, Jamari has a $45,000 basis in the property received. Only when the S corporation sells the asset does it recognize the loss and reduce AAA. HW15

Chaz transfers cash of $60,000 to a newly formed corporation for 100% of the stock. In its initial year, the corporation has net income of $15,000. The income is credited to its earnings and profits account. The corporation distributes $5,000 to Chaz. a. Chaz has a ________ of ____ and the corporation has a deduction of _____ b. Assume, instead, that Chaz transfers to the corporation cash of $30,000 for stock and cash of $30,000 for a note of the same amount. The note is payable in equal annual installments of $3,000 and bears interest at the rate of 6%. At the end of the year, the corporation pays an amount to meet this obligation. Chaz has interest of ____ and a note repayment of ____of which ____ is taxable to Chaz. The corporation has a deduction of ____

Answers: taxable dividend; $5,000; $0; $1,800; $3,000; $1,800; $1,800. Significant tax differences exist between debt and equity in the capital structure. The advantages of issuing long-term debt instead of stock are numerous. Interest on debt is deductible by the corporation, while dividend payments are not. Further, loan repayments are not taxable to investors unless the repayments exceed basis. A shareholder's receipt of property from a corporation, however, cannot be tax-free as long as the corporation has earnings and profits (see Chapter 5). Such distributions will be taxed as dividends to the extent of earnings and profits of the distributing corporation. Another distinction between debt and equity relates to the taxation of dividend and interest income. Dividend income on equity holdings is taxed to individual investors at low capital gains rates, while interest income on debt is taxed at higher ordinary income rates. a. If the corporation distributes $5,000 to Chaz, the distribution is a taxable dividend to Chaz with no corresponding deduction to the corporation. b. If Chaz transfers to the corporation cash of $30,000 for stock and cash of $30,000 for a note of the same amount, at the end of the year, the corporation pays Chaz interest of $1,800 ($30,000 x 6%) and a note repayment of $3,000. The interest payment is a deductible expense to the corporation and taxable to Chaz. The $3,000 principal repayment on the note is neither deducted by the corporation nor taxed to Chaz. HW12a

Strom acquired a 25% interest in Ace Partnership by contributing land having an adjusted basis of $16,000 and a fair market value of $50,000. The land was subject to a $24,000 mortgage, which was assumed by Ace. No other liabilities existed at the time of the contribution. What was Strom's basis in Ace? A.$16,000 B.$0 C.$32,000 D.$26,000

B.$0 CQ14

Stock Basis =

Basis of Property Transferred in - Boot Received (358 Debt) + Gain Recognized CH 12/13

Fargo Corporation holds $5,000,000 in accumulated E & P. It distributes to Leilei, one of its shareholders, land worth $310,000; basis of the land to Fargo is $260,000. Determine the Federal income tax consequences of the distribution to Fargo. Fargo Corporation recognizes a gain of $. The net decrease to Fargo's E & P is $. The shareholder has dividend income of $

Fargo Corporation recognizes a gain of $50,000. The net decrease to Fargo's E & P is $260,000. The shareholder has dividend income of $310,000 When a corporation distributes property (rather than cash) to a shareholder, the amount distributed is measured by the fair market value of the property on the date of distribution. All distributions of appreciated property generate gain to the distributing corporation (and will increase E & P). Corporate noncash property distributions reduce E & P by the greater of the fair market value or the adjusted basis of property distributed, less the amount of any liability on the property. Fargo Corporation recognizes a gain of $50,000. Fargo's E & P is increased by the $50,000 gain and decreased by the $310,000 fair market value of the distribution. The result is a net decrease of $260,000 ($310,000 - $50,000). The shareholder has dividend income of $310,000 (presuming sufficient E & P). HW13

351 Exception

No Gain or Loss recognized on the transfer of property in exchange for stock if these are met: 1. Property is transferred 2. Solely in exchange for stock 3. The transferors are in control of 80% or more of the corporation. EXCEPTION: If boot is received then any realized gain is recognized up to the amount of boot received CH12/13

At the start of the current year, Blue Corporation (a calendar year taxpayer) holds accumulated E & P of $100,000. Blue's current E & P is $60,000. At the end of the year, it distributes $200,000 ($100,000 each) to its equal shareholders, Pam and Jon. Their basis in the stock is $11,000 for Pam and $26,000 for Jon. How is the distribution treated for tax purposes? Pam has the following: Dividend income: $ Capital gain: $ Stock basis after distribution: $ Jon has the following: Dividend income: $ Capital gain: $ Stock basis after distribution: $

Pam has the following: Dividend income: $80,000 ((100k + 60k)/2) Capital gain: $9,000 Stock basis after distribution: $0 Jon has the following: Dividend income: $80,000 ((100k + 60k)/2) Capital gain: $0 Stock basis after distribution: $6,000 Distributions not treated as dividends (because of insufficient E & P) are nontaxable to the extent of the shareholder's stock basis, which is reduced accordingly. The excess of the distribution over the shareholder's basis is treated as a gain from sale or exchange of the stock. Jon and Pam each have dividend income of $80,000 {[$100,000 (accumulated E & P) + $60,000 (current E & P)] ÷ 2}. The dividend income will be subject to the reduced tax rate on dividends available to all individuals. The remaining $40,000 of the $200,000 distribution reduces the basis ($20,000 each) in the shareholders' stock with any excess treated as a capital gain. Pam has a reduction in stock basis from $11,000 to zero and a capital gain of $9,000. Jon has a reduction in stock basis from $26,000 to $6,000 (and no capital gain). HW13

T/F: A deficit in current E & P is treated as occurring ratably during the year unless the taxpayer can show otherwise.

True Any loss in current E & P is usually treated as occurring ratably during the year. However, if the taxpayer can demonstrate that an identifiable event causes the loss (e.g., a capital loss from the sale of a particular stock), the loss may be fixed as of that time. CQ13

T/F: Basis of appreciated property transferred minus boot received (including liabilities transferred) plus gain recognized equals basis of stock received in a § 351 transfer.

True CQ12

T/F: The control requirement under § 351 requires that the person or persons transferring property to the corporation immediately after the transfer own stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation.

True CQ12

T/F: Corporate distributions are presumed to be paid out of E & P and are treated as dividends unless the parties to the transaction can show otherwise.

True CQ13

T/F: Emma's basis in her BBDE LLC interest is $60,000 at the beginning of the tax year. Her allocable share of LLC items are as follows: $20,000 of ordinary income, $2,000 tax-exempt interest income, and a $6,000 long-term capital gain. In addition, the LLC distributed $12,000 of cash to Emma during the year. Assuming that the LLC had no liabilities at the beginning or the end of the year, Emma's ending basis in her LLC interest is $76,000.

True Emma's initial basis is increased by her share of ordinary income, tax-exempt income, and long-term capital gain. Her basis is decreased by the distribution. Her basis at the end of the year is $76,000 ($60,000 initial basis + $20,000 ordinary income + $2,000 tax-exempt interest income + $6,000 long-term capital gain - $12,000 distribution). CQ14

T/F: Blaine contributes property valued at $50,000 (basis of $40,000) in exchange for a 25% interest in the BIKE Partnership. If the property is later sold for $70,000, gain of $15,000 will be allocated to Blaine.

True If appreciated property is contributed to a partnership, any recognized precontribution gain must be allocated to the partner that contributed the property. This applies only to the appreciation at the contribution date. Any appreciation after that date is allocated proportionately to the partners (or in accordance with the partnership agreement). In this case, the precontribution gain of $10,000 must be allocated to Blaine, plus $5,000 [25% × ($70,000 - $50,000)] of the gain arising since the property was contributed. CQ14

T/F: Under Federal tax law, a bias for corporate issuers exists in favor of debt as compared to equity when financing the operations of a corporation.

True Included in the advantages of issuing long-term debt instead of stock is the fact that interest on debt is deductible by the corporation while dividend payments are not. Further, loan repayments are not taxable to investors unless the repayments exceed basis. CQ12

T/F: In the current year, Azul Corporation, a calendar year C corporation, received a dividend of $30,000 from Naranja Corporation. Azul owns 25% of the Naranja Corporation stock. Assuming it is not subject to the taxable income limitation, Azul's dividends received deduction is $19,500.

True The dividends received deduction percentage for a 25% ownership is 65%. Thus, the dividends received deduction would be $19,500 ($30,000 × 65%). CQ12

T/F: One of the disadvantages of the partnership form is that the partner's share of the partnership's taxable income is taxed to the partner even if it is not distributed.

True The partnership's income (or loss) is allocated and reported to the partners each year on Schedule K-1; the partners report this income (or loss) regardless of whether the partnership distributes any cash to the partners during the year. CQ14

Indicate whether the following statements are "True" or "False" regarding the tax techniques that are available for eliminating or at least reducing the second layer of taxation. a. Transferring funds to the shareholders that are not deductible to the corporation. b. Not making distributions to the shareholders. c. Making distributions that qualify for return of capital treatment at the shareholder level. d. Making the S corporation election.

a. False b. True c. True d. True HW18

Bill and Mary filed a joint Federal income tax return this year. Mary owns a 30% interest in MAJIC Partnership, a women's dress boutique. Mary's share of the partnership's net income is $280,000. Her shares of the partnership's W-2 wages and unadjusted basis of depreciable property are $100,000 and $300,000, respectively. a. What is Bill and Mary's maximum QBI deduction if their total taxable income is $300,000? b. What is the maximum QBI deduction if Bill and Mary's total taxable income is $450,000? c. What is the maximum QBI deduction if MAJIC's income was from qualified services and Bill and Mary's total taxable income was $450,000?

a. $56,000 b. $50,000 c. 0 HW14b

Franco owns a 60% interest in the Dulera LLC. On December 31 of the current tax year, his basis in the LLC interest is $128,000. The fair market value of the interest is $140,000. Dulera then distributes to Franco $30,000 cash and equipment with an adjusted basis of $5,000 and a fair market value of $8,000. a. Compute Franco's basis in Dulera after the distribution.$ b. Compute Franco's basis in the equipment he received from Dulera.$

a. $93,000 b. $5,000 In general, neither the partner nor the partnership recognizes gain or loss when a proportionate current distribution occurs. The partner usually takes a carryover basis for the assets distributed. The distributee partner's outside basis is reduced (but not below zero) by the amount of cash and the adjusted basis of property distributed to the partner by the partnership. a. & b. The distribution is not taxable to Franco (or the LLC). The distribution reduces Franco's adjusted basis in Dulera LLC is $93,000 ($128,000 - $30,000 - $5,000). He takes a carryover basis of $5,000 in the equipment. HW14b

Emmy contributes $40,000 to MeldCo in exchange for a 30% ownership interest. During the first year of operations, MeldCo earns a profit of $200,000. At the end of that year, MeldCo holds liabilities of $75,000. Calculate Emmy's basis for her ownership interest if the entity is (a) a C corporation, (b) an S corporation, and (c) a partnership. a. If the entity is a C corporation, Emmy's ownership interest (basis) is ________ b. If the entity is an S corporation, Emmy's ownership interest (basis) is ________ c. If the entity is a partnership, Emmy's ownership interest (basis) is ________

a. 40,000 b. 100,000 c. 122,500 HW18

Carlota and Dave formed an S corporation; Carlota owns 75% of the out-standing shares, and Dave owns the rest. When the entity's AAA balance is $1,000,000, it distributes an asset to each shareholder; the basis of each asset to the corporation is $45,000. Carlota's asset is worth $90,000, and Dave's is worth $50,000. a. How much gain, if any, does the the corporation recognize as a result of the distribution? b. By how much, if any, does the distribution increase Dave's gross income? c. By how much, if any, does the distribution increase Carlota's gross income?

a. 50,000 b. 12,500 c. 37,500 HW18

Enerico contributes $100,000 cash in exchange for a 40% interest in the calendar year ABC LLC. This year ABC generates $80,000 of ordinary taxable income and has no separately stated items. Enerico withdraws $10,000 cash from the partnership at the end of the tax year. a. Compute Enerico's gross income from ABC's ordinary income for the tax year.$ b. Compute Enerico's gross income from the LLC's cash distribution.$

a. Compute Enerico's gross income from ABC's ordinary income for the tax year.$32,800 b. Compute Enerico's gross income from the LLC's cash distribution.$0 a. Enerico is allocated 40% of the $80,000 of partnership income, or $32,000. This is the income on which tax will be paid. b. In this situation, the distribution is not separately taxable. The distributions reduce the partner's basis but not below zero. HW14a

Wozniacki and Wilcox form Jewel LLC, with each investor receiving a one-half interest in the capital and profits of the LLC. Wozniacki receives his one-half interest as compensation for tax planning services that he rendered prior to the formation of the LLC. Wilcox contributes $50,000 cash. The value of a one-half capital interest in the LLC (for each of the parties) is $50,000. a. Compute Wozniacki's realized and recognized gain from joining Jewel.Wozniacki recognizes $ as compensation income b. Compute Wozniacki's basis in his interest in Jewel.His basis is $ c. How does Jewel treat the services that Wozniacki has rendered? The partnership has a business deduction .

a. Compute Wozniacki's realized and recognized gain from joining Jewel.Wozniacki recognizes $50,000 as compensation income b. Compute Wozniacki's basis in his interest in Jewel.His basis is $50,000 When a partner receives a fully vested interest in partnership capital (i.e., unrestricted liquidation rights) in exchange for services, the value of the interest is generally taxable to the partner as ordinary compensation income. Services are not treated as "property" that can be transferred to a partnership on a tax-free basis. Generally, the partner's ordinary income equals the amount the partner would receive if the partnership was liquidated immediately following the contribution of services, less any amount the partner paid for the interest. However, if the interest is subject to a "substantial risk of forfeiture" (as defined under § 83), the liquidation value would be $0; so the partner would not recognize any income. In the case of a transfer of either an interest in partnership profits or capital, the partnership may deduct any amount included in the service partner's income if the services are of a deductible nature. If the services are not deductible by the partnership, they must be capitalized. For example, the cost of architectural plans created by a partner are capitalized and included in the basis of the structure built with those plans. Alternatively, day-to-day management services performed by a partner for the partnership are usually deductible by the partnership. Any deduction related to the service partners' interest is generally allocated to the other partners in the partnership. Wozniacki recognizes $50,000 of compensation income, and he has a $50,000 basis in his LLC interest. The same result would occur if the LLC had paid Wozniacki and Wilcox $50,000 for his services and he immediately contributed that amount to the entity for a one-half ownership interest. The LLC will treat the $50,000 as a startup expense under § 195. HW14a

Burgundy, Inc., and Violet Gomez are equal partners in the calendar year BV LLC. Burgundy uses a fiscal year ending April 30, and Violet uses a calendar year. Burgundy receives an annual guaranteed payment of $100,000 for use of capital contributed by Burgundy. BV's taxable income (after deducting Burgundy's guaranteed payment) is $80,000 for 2021 and $90,000 for 2022. a. How much income from BV must Burgundy report for its tax year ending April 30, 2022?$ b. How much income from BV must Violet report for her tax year ending December 31, 2022?$

a. How much income from BV must Burgundy report for its tax year ending April 30, 2022?$140,000 b. How much income from BV must Violet report for her tax year ending December 31, 2022?$45,000 In its April 30, 2022, tax return, Burgundy, Inc., must report income from BV, LLC of $140,000. This includes Burgundy's $100,000 guaranteed payment, and its 50% distributive share of the partnership's $80,000 of taxable income for the tax year ended December 31, 2021. Violet does not receive a guaranteed payment. In her December 31, 2022, tax return, Violet must report income from BV of $45,000. This is her 50% share of the partnership's $90,000 of taxable income for the tax year ended December 31, 2022. HW14b

Larry, the sole shareholder of Brown Corporation, sold his stock to Ed on July 30 for $270,000. Larry's basis in the stock was $200,000 at the beginning of the year. Brown had accumulated E & P of $120,000 on January 1 and current E & P of $240,000. During the year, Brown made the following distributions: $450,000 cash to Larry on July 1 and $150,000 cash to Ed on December 30. a. How will Larry and Ed be taxed on the distributions? Larry will have the following: Dividend income: $ Return of capital: $ Capital gain: $ Ed will have the following: Dividend income: $ Return of capital: $ Capital gain: $ b. How much gain will Larry recognize on the sale of his stock to Ed? Larry recognizes a capital gain of $ on the sale of the stock.

a. How will Larry and Ed be taxed on the distributions? Larry will have the following: Dividend income: $300,000 Return of capital: $150,000 Capital gain: $0 Ed will have the following: Dividend income: $60,000 Return of capital: $90,000 Capital gain: $0 b. How much gain will Larry recognize on the sale of his stock to Ed? Larry recognizes a capital gain of $220,000 on the sale of the stock. a. Brown Corporation has $240,000 in current E & P, and this amount is allocated on a pro rata basis to the two distributions made during the year (based on the total distributions made during the tax year). Thus, $180,000 of current E & P is allocated to Larry's distribution [$240,000 current E & P x ($450,000 distribution to Larry/$600,000 total distributions)] and $60,000 is allocated to Ed's distribution [$240,000 current E & P x ($150,000 distribution to Ed/$600,000 total distributions)]. Accumulated E & P is applied in chronological order beginning with the earliest distribution. When Brown Corporation distributes $450,000 to Larry on July 1, its dividend-paying capacity is $300,000 (the entire accumulated E & P balance of $120,000 + $180,000 from current E & P). As a result, $300,000 of Larry's July 1 distribution is treated as dividend income. The remaining $150,000 of the distribution reduces Larry's stock basis to $50,000 ($200,000 basis - $150,000 return of capital). Of the $150,000 distributed to Ed, $60,000 is treated as a dividend and the remaining $90,000 reduces his stock basis to $180,000 [$270,000 (original cost) - $90,000 (reduction in basis from the distribution)]. b. Larry recognizes a $220,000 capital gain on the sale of his stock to Ed [$270,000 (sales price) - $50,000 (remaining stock basis)]. HW13

Raven Corporation owns three machines that it uses in its business. It no longer needs two of these machines and is considering distributing them to its two shareholders as a property dividend. The machines have a fair market value of $20,000 each. Their basis is as follows: A, $27,000; B, $20,000; and C, $12,000. Raven has asked you for advice. Complete each of the parts below, first isolating the gain (loss) for each machine and ending (part d) with your recommendation. I f there is no gain or loss, enter "0" as the amount. a. If Raven distributes Machine A, the result will be a nondeductible loss of $ b. If Raven distributes Machine B, the result will be no gain or loss of $ c. If Raven distributes Machine C, the result will be a taxable gain of $ d. Therefore, to preserve the loss on Machine A, Raven should consider selling Machine A. Raven should consider distributing Machine B because there will be no recognized gain or loss on the distribution. To avoid recognizing the gain on Machine C, Raven should consider neither selling nor distributing Machine C.

a. If Raven distributes Machine A, the result will be a nondeductible loss of $-7,000 b. If Raven distributes Machine B, the result will be no gain or loss of $0 c. If Raven distributes Machine C, the result will be a taxable gain of $8,000 Property distributions have the same impact as distributions of cash except for effects attributable to any difference between the basis and the fair market value of the distributed property. In most situations, distributed property is appreciated, so its sale would result in a gain to the corporation. All distributions of appreciated property generate gain to the distributing corporation. In effect, a corporation that distributes gain property is treated as if it had sold the property to the shareholder for its fair market value. However, the distributing corporation does not recognize loss on distributions of property. Distributing Machine A would produce a nondeductible loss of $7,000 ($20,000 - $27,000), distributing Machine B would generate no gain or loss ($20,000 - $20,000), and distributing Machine C would trigger a taxable gain of $8,000 ($20,000 - $12,000) for Raven Corporation. To preserve the loss on Machine A, Raven should sell Machine A and then distribute the cash to one of the shareholders. Raven can distribute Machine B to the other shareholder because there will be no gain on the distribution and no nondeductible loss. It would, therefore, be best to sell Machine A (and distribute the cash to one shareholder) and distribute Machine B to the other shareholder. Raven would retain Machine C (the machine with the embedded gain). HW13

Lee, Brad, and Rick form the LBR Partnership on January 1 of the current year. In return for a 25% interest, Lee transfers property (basis of $15,000, fair market value of $17,500) subject to a nonrecourse liability of $10,000. The liability is assumed by the partnership. Brad transfers property (basis of $16,000, fair market value of $7,500) for a 25% interest, and Rick transfers cash of $15,000 for the remaining 50% interest. a. Lee recognizes no gain or loss on the transfer. b. After the contribution, Lee's basis in his interest in the partnership is $ c. Brad recognizes no loss on the transfer. d. Brad's basis in his interest in the partnership is $ e. Rick's basis in his interest in the partnership is $ f. The LBR Partnership takes a basis of $ in the property transferred by Lee. g. The partnership's basis in the property transferred by Brad is $

a. Lee recognizes no gain or loss on the transfer. b. After the contribution, Lee's basis in his interest in the partnership is $7,500 c. Brad recognizes no loss on the transfer. d. Brad's basis in his interest in the partnership is $18,500 e. Rick's basis in his interest in the partnership is $20,000 f. The LBR Partnership takes a basis of $15,000 in the property transferred by Lee. g. The partnership's basis in the property transferred by Brad is $16,000 HW14a

Lee, Brad, and Rick form the LBR partnership on January 1 of the current year. In return for a 25% interest, Lee transfers property (basis of $15,000, FMV of $27,500) subject to a recourse liability of $20,000. The liability is assumed by the partnership. Brad transfers property (basis of $16,000, FMV of $7,500) for a 25% interest, and Rick transfers cash of $15,000 for the remaining 50% interest. a. Lee's basis in his partnership interest is $ b. Lee recognizes gain of $ on the transfer. c. Brad's basis in his partnership interest is $. d. Ricks's basis in his partnership interest is $

a. Lee's basis in his partnership interest is $0 b. Lee recognizes gain of $0 on the transfer. c. Brad's basis in his partnership interest is $21,000 d. Ricks's basis in his partnership interest is $25,000 Lee's outside basis is computed as follows: 15,000 - 20,000 debt + 25%(20,000 total p'ship debt) + 0 gain. Brad's outside basis is computed as follows: 16,000 - 0 + 25%(20,000) + 0 gain. Rick's outside basis is computed as: 15,000 - 0 + 50%(20,000) + 0 gain. HW14a

Liz and John formed the equal LJ Partnership on January 1 of the current year. Liz contributed $80,000 of cash and land with a fair market value of $90,000 and an adjusted basis of $75,000. John contributed equipment with a fair market value of $170,000 and an adjusted basis of $20,000. John previously used the equipment in his sole proprietorship. a. How much gain or loss will Liz, John, and LJ realize? Liz realizes a gain of $ on contribution of the land. John realizes a gain of $ on contribution of the equipment. The partnership realizes a gain equal to the value of the property it receives . b. How much gain or loss will Liz, John, and LJ recognize? Liz recognizes $ John recognizes $. The partnership recognizes $. c. What bases will Liz and John take in their partnership interests? Liz's basis in the partnership is $, and John's basis is $ in his partnership interest. d. What bases will the partnership take in the assets it receives? The partnership will take a $ carryover basis in all the assets it receives. e. How will LJ depreciate any assets it receives from the partners? Select "Yes" or "No", whichever is applicable. The partnership will "step into John's shoes" in determining its depreciation expense. The partnership may choose its own useful life and depreciation method

a. Liz realizes a gain of $15,000 on contribution of the land. John realizes a gain of $150,000 on contribution of the equipment. b. Liz recognizes $0 John recognizes $0 The partnership recognizes $0 c. Liz's basis in the partnership is $155,000, and John's basis is $20,000 in his partnership interest d. The partnership will take a $175,000 carryover basis in all the assets it receives. e. The partnership will "step into John's shoes" in determining its depreciation expense. - YES The partnership may choose its own useful life and depreciation method - NO

Using the legend provided, indicate which form of business entity each of the following characteristics describes. Some of the characteristics may apply to more than one form of business entity. LegendP= Applies to partnership and LLCS= Applies to S corporationC= Applies to C corporation The basis for an ownership interest is: a. Basis for an ownership interest is increased by an investment by the owner b. Basis for an ownership interest is decreased by a distribution to the owner c. Basis for an ownership interest is increased by entity profits d. Basis for an ownership interest is decreased by entity losses e. Basis for an ownership interest is increased as the entity's liabilities increase f. Basis for an ownership interest is decreased as the entity's liabilities decrease

a. P, S, C b. P, S, C c. P, S d. P, S e. P f. P HW18

Rover Corporation would like to transfer excess cash to its sole shareholder, Aleshia, who is also an employee. Aleshia is in the 24% tax bracket, and Rover is in the 21% bracket. Because Aleshia's contribution to Rover's profit is substantial, Rover believes that a $25,000 bonus in the current year is reasonable compensation and should be deductible in full. However, Rover is considering paying Aleshia a $25,000 dividend because Aleshia's tax rate on dividends is lower than the corporate tax rate on compensation. Answer the following questions to determine whether Rover is correct in believing that a dividend is the better choice. a. Regarding taxes, which would benefit Aleshia the most? The $25,000 dividend because after taxes she would have $ from the dividend and $ from the bonus. b. Regarding taxes, which would benefit Rover Corporation the most? The $25,000 bonus because it would save Rover $ in taxes. c. Considering the two parties together, which alternative would provide the most overall tax savings? The $25,000 bonus because when the overall effect to both the corporation and the shareholder are considered the net tax savings is $.

a. Regarding taxes, which would benefit Aleshia the most? The $25,000 dividend because after taxes she would have $21,250 from the dividend and $19,000 from the bonus. b. Regarding taxes, which would benefit Rover Corporation the most? The $25,000 bonus because it would save Rover $5,250 in taxes. c. Considering the two parties together, which alternative would provide the most overall tax savings? The $25,000 bonus because when the overall effect to both the corporation and the shareholder are considered the net tax savings is $3,000. a. Aleshia would prefer a dividend because she would have $21,250 after taxes [$25,000 dividend - ($25,000 × 15% tax rate)]. If she were paid a bonus, she would have only $19,000 after taxes [$25,000 bonus - ($25,000 × 24% tax rate)]. b. The effect of the payments to Rover Corporation must be consider. If Rover Corporation paid Aleshia a deductible bonus, it would save $5,250 in taxes ($25,000 × 21% tax rate). There are no tax savings should Rover pay a dividend to Aleshia. c. Because Aleshia is $2,250 better off with a dividend ($21,250 after tax from a dividend - $19,000 after tax with a bonus) and Rover Corporation is $5,250 better off with a bonus, the overall effect to both the corporation and the shareholder must be considered. Taken together, Rover Corporation and Aleshia are $3,000 better off with a bonus ($5,250 benefit from bonus for Rover Corporation - $2,250 benefit from a dividend for Aleshia). Because Aleshia is the sole shareholder of Rover Corporation, she should choose the bonus alternative. HW13

Using the legend provided, indicate which form of business entity each of the following characteristics describes. Some of the characteristics may apply to more than one form of business entity. SP=Applies to sole proprietorship P=Applies to partnership L=Applies to LLC S=Applies to S corporation C=Applies to C corporation N=Applies to none a. Has limited liability. b. Greatest ability to raise capital c. Subject to double taxation. d. Limit on types and number of shareholders. e. Has unlimited liability. f. Sale of the business can be subject to double taxation. g. Contribution of property to the entity in exchange for an ownership interest can result in the nonrecognition of realized gain. h. Profits and losses affect the basis for an ownership interest. i. Entity liabilities affect the basis for an ownership interest. j. Distributions of earnings are taxed as dividend income to the owners. k. Total invested capital cannot exceed $1,000,000. l. Accumulated Adjustments Account (AAA) is an account that relates to this entity.

a. S, C, and L b. C c. C d. S e. SP and P f. C g. P, S, C, and L h. P, S, and L i. P j. C k. N l. S HW18

When Padgett Properties LLC was formed, Nova contributed land (value of $200,000 and basis of $50,000) and $100,000 cash, and Oscar contributed cash of $300,000. Both partners received a 50% interest in partnership profits and capital. a. What is Padgett's tax basis in the land? $ b. If Padgett sells the land several years later for $300,000, how much tax gain will Nova and Oscar report? Nova reports $ and Oscar reports $

a. What is Padgett's tax basis in the land? $50,000 b. If Padgett sells the land several years later for $300,000, how much tax gain will Nova and Oscar report? Nova reports $200,000 and Oscar reports $50,000 HW14a

The JM Partnership was formed to acquire land and subdivide it as residential housing lots. On March 1, 2020, Jessica contributed land valued at $600,000 to the partnership in exchange for a 50% interest. She had purchased the land in 2012 for $420,000 and held it for investment purposes (capital asset). The partnership holds the land as inventory. On the same date, Matt contributed land valued at $600,000 that he had purchased in 2010 for $720,000. He became a 50% owner. Matt is a real estate developer, but he held this land personally for investment purposes. The partnership holds this land as inventory. In 2021, the partnership sells the land contributed by Jessica for $620,000. In 2022, the partnership sells the real estate contributed by Matt for $580,000. a. What is each partner's initial basis in his or her partnership interest? Jessica's initial basis is $. Matt's initial basis is $ b. What is the amount of gain or loss recognized on the sale of the land contributed by Jessica? What is the character of this gain or loss? The amount of the gain recognized on the sale of the land contributed by Jessica is $, and the type is ordinary income . c. What is the amount of gain or loss recognized on the sale of the land contributed by Matt? What is the character of this gain or loss? The amount of the loss recognized on the sale of the land contributed by Matt is $, and the type is part capital loss and part ordinary loss . d. How would your answer in (c) change if the property was sold in 2027? The amount of the loss recognized on the sale of the land contributed by Matt is $, and the type is ordinary loss .

a. What is each partner's initial basis in his or her partnership interest? Jessica's initial basis is $420,000. Matt's initial basis is $720,000 b. What is the amount of gain or loss recognized on the sale of the land contributed by Jessica? What is the character of this gain or loss? The amount of the gain recognized on the sale of the land contributed by Jessica is $200,000, and the type is ordinary income . c. What is the amount of gain or loss recognized on the sale of the land contributed by Matt? What is the character of this gain or loss? The amount of the loss recognized on the sale of the land contributed by Matt is $140,000, and the type is part capital loss and part ordinary loss . d. How would your answer in (c) change if the property was sold in 2027? The amount of the loss recognized on the sale of the land contributed by Matt is $140,000, and the type is ordinary loss . HW14a

Indicate whether the following statements are factors to be considered in resolving the thin capitalization issue. Select "Yes, a factor" or "No, not a factor", whichever is applicable. a. Whether funds loaned to the corporation are used to finance initial operations or capital asset acquisitions. b. Whether the corporation has a high ratio of current assets to current liabilities. c. Whether holdings of debt and stock are proportionate (e.g., each shareholder owns the same percentage of debt as stock). d. Whether payment is contingent upon earnings. e. Whether the debt instrument bears a reasonable rate of interest and has a definite maturity date.

a. Yes, a factor. Funds used to finance initial operations or to acquire capital assets the corporation needs are generally obtained through equity investments. b. No, not a factor. Whether the corporation has a high ratio of shareholder debt to shareholder equity is a factor. Thin capitalization indicates that the corporation lacks reserves to pay interest and principal on debt when corporate income is insufficient to meet current needs. In determining a corporation's debt-equity ratio, courts look at the relation of the debt both to the book value of the corporation's assets and to their actual fair market value. c. Yes, a factor. When debt and equity obligations are held in the same proportion, shareholders are, apart from tax considerations, indifferent as to whether corporate distributions are in the form of interest or dividends. d. Yes, a factor. A lender ordinarily will not advance funds that are likely to be repaid only if the venture is successful. e. Yes, a factor. When a shareholder advance does not provide for interest, the return expected may appear to be a share of the profits or an increase in the value of the shares. Likewise, a lender unrelated to the corporation will usually be unwilling to commit funds to the corporation without a definite due date. HW12a

Ann transferred land worth $200,000 with a tax basis of $40,000 to Brown Corporation, an existing entity, for 100 shares of its stock. Brown Corporation has two other shareholders, Bill and Bob, each of whom holds 100 shares. With respect to the transfer: a.Ann has a basis of $200,000 in her 100 shares in Brown Corporation. b.Ann has no recognized gain. c.Ann has a basis of $40,000 in her 100 shares in Brown Corporation. d.Brown Corporation has a basis of $160,000 in the land.

a.Ann has a basis of $200,000 in her 100 shares in Brown Corporation. The transfer does not qualify under § 351 because Ann has only a 1/3 interest in Brown Corporation. The requirements of § 351 apply to transfers to an existing corporation, as well as to a newly formed corporation. CQ12

Parrott, Inc., a C corporation, is owned by Alfonso (60%) and Deanna (40%). Alfonso is the president, and Deanna is the vice president for sales. Parrott, Alfonso, and Deanna are cash basis taxpayers. Parrott encounters working capital difficulties, so Alfonso loans the corporation $810,000, and Deanna loans the corporation $540,000. Each loan uses a 5% note that is due in five years with interest payable annually. Determine the tax consequences to Parrott, Alfonso, and Deanna if the notes are classified as (a) debt and (b) equity. a. If the notes are classified as debt, Parrott, Inc., will _____ of _____. Alfonso will report _____ of _____, and Deanna will report _____ of _____ each year. b. If the notes are classified as equity, Parrott, Inc., will report _____ of _____. Alfonso will report _____ of _____. Deanna will report _____ of _____ each year. When the loan is repaid in five years, assuming adequate earnings and profits, Alfonso will report _____ of _____ and Deanna will report _____ of _______.

a. deduct interest expense; 67,500; interest income; 40,500; interest income; 27,000 b. Dividends deemed to be paid; 67,500; dividend income; 40,500; dividend income; 27,000; dividend income; 810,000; dividend income; 540,000 HW18

BC Corp. paid two cash distributions during year 5. The first was $42,000, and the second was $33,000. Accumulated earnings and profits (E & P) at the end of year 4 were $80,000. Current E & P for year 5 is $30,000. How will the second distribution be allocated between current E & P and accumulated E & P? Current E & P : Accumulated E & P a.$13,200 : $19,800 b.$16,500 : $16,500 c.$19,800 : $13,200 d.$30,000 : $30,000

a.$13,200 : $19,800 Current E & P is allocated to the distributions on a pro rata basis. Then accumulated E & P is applied to the distributions in chronological order. Total distributions are $75,000 ($42,000 + $33,000). Current E & P is allocated to the second distribution at 44% ($33,000/$75,000 = 44%). $13,200 ($30,000 × 44%) of current E & P is allocated to the first distribution. The remaining $19,800 ($33,000 - $13,200) is applied to accumulated E & P. HW13

Gray is a 50% partner in Fabco Partnership. Gray's tax basis in Fabco on January 1, year 4, was $5,000. Fabco made no distributions to the partners during year 4 and recorded the following. Ordinary income $20,000 Tax-exempt income 8,000 Portfolio income 4,000 What is Gray's tax basis in Fabco on December 31, year 4? a.$21,000 b.$16,000 c.$12,000 d.$10,000

a.$21,000 A partner's basis in a partnership is increased by the partner's share of partnership ordinary income, separately stated income, and tax exempt income. $5,000 + 50% × ($20,000 + $8,000 + $4,000) = $21,000. HW14b

As of January 1, Cassowary Corporation has a deficit in accumulated E & P of $100,000. For the tax year, current E & P (accrued ratably) is $240,000 (prior to any distributions). On July 1, Cassowary Corporation distributes $275,000 to its sole shareholder. The amount of the distribution that is a dividend is: a.$240,000. b.$140,000. c.$275,000. d.$20,000.

a.$240,000. The distribution is taxed to the extent of current E & P ($240,000). CQ13

Peter, a 25% partner in Gold & Stein Partnership, received a $20,000 guaranteed payment in the current year for deductible services rendered to the partnership. Guaranteed payments were not made to any other partner. Gold & Stein's current-year partnership income consisted of: Net business income before guaranteed payments$80,000 Net long-term capital gains 10,000 What amount of income should Peter report from Gold & Stein Partnership on his current-year tax return? (Disregard the character of the income and just calculate the total increase to Peter's income.) a.$37,500 b.$27,500 c.$22,500 d.$20,000

a.$37,500 Peter's income from Gold & Stein is $37,500, calculated as follows: Partnership income before guaranteed payment to Peter $80,000 Deductible guaranteed payment to Peter (20,000) Net taxable partnership income = 60,000 Peter's share of partnership income x25% Peter's amount of partnership income = 15,000 Peter's 25% share of Gold & Stein's $10,000 capital gain 2,500 Peter's guaranteed payment from Gold & Stein 20,000 Current year Gold & Stein income reportable on Peter's return = $37,500 HW14b

Eagle Corporation, a calendar year C corporation, owns stock in Hawk Corporation and has taxable income of $100,000 for the year before considering the dividends received deduction. In the current year, Hawk Corporation pays Eagle a dividend of $130,000, which was considered in calculating the $100,000. What amount of dividends received deduction may Eagle claim if it owns 15% of Hawk's stock? a.$84,500 b.$50,000 c.$65,000 d.$0

b.$50,000 The dividends received deduction depends upon the percentage of ownership by the corporate shareholder. Because Eagle Corporation owns 15% of Hawk Corporation, Eagle would qualify for a 50% deduction, calculated as shown below. 1.Multiply the dividends received by the deduction percentage ($130,000 × 50% = $65,000). 2.Multiply the taxable income before the dividends received deduction by the deduction percentage ($100,000 × 50% = $50,000). 3.Limit the deduction to the lesser of step 1 or step 2, unless subtracting the amount derived in step 1 ($65,000) from taxable income before the dividends received deduction ($100,000) generates an NOL ($100,000 - $65,000 = $35,000 taxable income). If so, use the amount derived in step 1 ($65,000). In this case, the NOL exception to the taxable income limitation does not apply, and the deduction equals $50,000. CQ12

Hart's adjusted basis of his interest in a partnership was $30,000. He received a nonliquidating distribution of $24,000 cash plus a parcel of land with a fair market value and partnership basis of $9,000. Hart's basis for the land is: a.$9,000 b.$6,000 c.$3,000 d.$0

b.$6,000 Partnership interest adjusted prior to distribution$30,000 Amount of cash distributed (24,000) Remaining basis after cash distribution = 6,000 Distribution of land with basis of $9,000 (6,000) Remaining partnership interest = $ 0 HW14b

Molly is a 30% partner in the MAP Partnership. During the current tax year, the partnership reported ordinary income of $200,000 before any permitted deduction for guaranteed payments and distributions to partners. The partnership made an ordinary cash distribution of $20,000 to Molly and made guaranteed payments to partners Molly, Amber, and Pat of $20,000 each ($60,000 total guaranteed payments). How much will Molly's adjusted gross income increase as a result of these items? a.$42,000 b.$62,000 c.$60,000 d.$36,000

b.$62,000 MAP reports ordinary income of $140,000 ($200,000 less the $60,000 of guaranteed payments). The distribution to Molly is not deducted by the partnership and is not taxable to her. Molly's share of partnership income is $42,000 (30% × $140,000). In addition, she will pay tax on the $20,000 guaranteed payment she received. CQ14

Navy Corporation has E & P of $240,000. It distributes land with a fair market value of $70,000 (adjusted basis of $25,000) to its sole shareholder, Troy. The land is subject to a liability of $55,000 that Troy assumes. Troy has: a.A basis in the machinery of $55,000. b.A taxable dividend of $15,000. c.A taxable dividend of $25,000. d.A taxable dividend of $70,000.

b.A taxable dividend of $15,000. Troy's dividend income is $15,000 measured by the fair market value of the property ($70,000) less the liability on the property ($55,000). Troy has a basis in the land of $70,000 (fair market value). CQ13

Jane is the sole shareholder of Buttons, Inc. Buttons has accumulated earnings and profits (E & P) of $65,000 at the beginning of the current year. The current E & P is $35,000. Buttons pays out a property distribution to Jane during the current year with an FMV of $150,000 and an adjusted basis of $130,000. How much is a taxable dividend to Jane? a.$35,000 b.$100,000 c.$120,000 d.$150,000

c.$120,000 The FMV of the property distribution is only a taxable dividend to the extent of current and accumulated E & P. That amount appears to be $100,000 ($65,000 + $35,000). However, the distribution will result in the recognition of a $20,000 gain ($150,000 FMV - $130,000) on adjusted basis to Buttons. The $20,000 gain will increase total E & P to $120,000 ($100,000 + $20,000), so the entire $120,000 of the distribution is a taxable dividend. The remaining $30,000 is a nontaxable return of capital until basis is exhausted, and then it is a capital gain distribution. HW13

Mark and Addison formed a partnership. Mark received a 25% interest in partnership capital and profits in exchange for land with a basis of $40,000 and a fair market value of $60,000. Addison received a 75% interest in partnership capital and profits in exchange for $180,000 of cash. Three years after the contribution date, the land contributed by Mark is sold by the partnership to a third party for $76,000. How much taxable gain will Mark recognize from the sale? a.$9,000 b.$16,000 c.$24,000 d.$0

c.$24,000 Any precontribution gain must be allocated entirely to Mark. Therefore, Mark is allocated the $20,000 precontribution (built-in) gain and 25% ($4,000) of the $16,000 postcontribution gain. CQ14

On January 2 of the current year, Black acquired a 50% interest in New Partnership by contributing property with an adjusted basis of $7,000 and a fair market value of $9,000, subject to a mortgage of $3,000. What was Black's basis in New at January 2 of the current year? a.$3,500 b.$4,000 c.$5,500 d.$7,500

c.$5,500 The partner takes a substituted basis in the partnership interest. This means that the partner's basis in the contributed assets transfers over to become the partner's outside basis in the partnership interest. Black's basis is reduced by the $3,000 mortgage assumed by the partnership and then increased by his share of share of the partnership's liability. $5,500 = $7,000 - $3,000 + (50% x $3,000). HW14a

On January 1, year 5, Olinto Corp., an accrual basis, calendar year C corporation, had $35,000 in accumulated earnings and profits. For year 5, Olinto had current earnings and profits of $15,000 and made two $40,000 cash distributions to its shareholders, one in April and one in September of year 5. What amount of the year 5 distributions is classified as dividend income to Olinto's shareholders? a.$15,000 b.$35,000 c.$50,000 d.$80,000

c.$50,000 Dividends are distributions of a corporation's earnings and profits, including accumulated (prior year) and current-year E & P. Because the corporation had both accumulated E & P of $35,000 and current E & P of $15,000, the total amount of distributions classified as dividends is $50,000 HW13

On January 1, Eagle Corporation (a calendar year taxpayer) has accumulated E & P of $300,000. During the year, Eagle incurs a net loss of $420,000 from operations that accrues ratably. On June 30, Eagle distributes $180,000 to Libby, its sole shareholder, who has a basis in her stock of $112,500. How much of the $180,000 is a dividend to Libby? a.$0 b.$180,000 c.$90,000 d.$112,500

c.$90,000 The deficit in current E & P equals $210,000 on June 30, the date of distribution. Subtracting this from accumulated E & P yields a net accumulated E & P balance on June 30 of $90,000 ($300,000 accumulated E & P at the beginning of the year - $210,000 current E & P deficit on June 30). Of the $180,000 distribution, $90,000 will be taxed as a dividend to Libby. CQ13

Ridge Corp., a calendar year C corporation, made a nonliquidating cash distribution to its shareholders of $1,000,000 with respect to its stock. At that time, Ridge's current and accumulated earnings and profits totaled $750,000 and its total paid-in capital for tax purposes was $10,000,000. Ridge had no corporate shareholders. Ridge's cash distribution: Which of the following statements are correct? I. Was taxable as $750,000 in dividend income to its shareholders. II. Reduced its shareholders' adjusted bases in Ridge stock by $250,000. a.I only b.II only c.Both I and II d.Neither I nor II

c.Both I and II Distributions out of current and accumulated earnings and profits are taxable as dividend income to non-corporate shareholders. Any distribution from a corporation that exceeds its earnings and profits reduces its shareholders' basis in their shares by the amount of the excess; any amount beyond that required to reduce the basis to zero is treated as received on the sale or exchange of the stock and is capital gain. Assuming all of Ridge's shareholders had enough basis to absorb their proportionate part of the $250,000 excess over the distribution of earnings and profits, it would all be treated as a reduction of shareholders' basis. HW13

Xena and Xavier form the XX LLC. Xena contributes cash of $20,000, land (basis = $40,000; fair market value = $25,000), equipment (basis = $0; fair market value = $35,000), and inventory (basis = $30,000; fair market value = $40,000). Xavier contributed $120,000 of cash. How much is the partnership's basis in the land, equipment, and inventory, and how much is Xena's basis in the partnership interest? a.$40,000 land, $35,000 equipment, $40,000 inventory; $135,000 partnership interest. b.$25,000 land, $0 equipment, $30,000 inventory; $55,000 partnership interest. c.$25,000 land, $35,000 equipment, $30,000 inventory; $105,000 partnership interest. d.$40,000 land, $0 equipment, $30,000 inventory; $90,000 partnership interest.

d.$40,000 land, $0 equipment, $30,000 inventory; $90,000 partnership interest. The partnership takes a carryover basis in the assets it receives; Xena takes a substituted basis in the partnership interest. The partnership's basis in assets is the same as Xena's basis: $20,000 basis in cash, $40,000 basis in land, $0 basis in equipment, and $30,000 basis in inventory. This is the same as Xena's basis in the partnership interest of $90,000 ($20,000 + $40,000 + $0 + $30,000). CQ14

Jane transfers property (basis of $180,000 and fair market value of $500,000) to Green Corporation for 80% of its stock (worth $425,000) and a long-term note (worth $75,000) executed by Green Corporation and made payable to Jane. As a result of the transfer: a.Jane recognizes no gain. b.Jane recognizes a gain of $270,000. c.Jane recognizes a gain of $320,000. d.Jane recognizes a gain of $75,000.

d.Jane recognizes a gain of $75,000. A long-term note is treated as "boot." Thus, Jane is taxed on the value of the note received because the boot is less than the realized gain on the exchange. CQ12

At partnership inception, Black acquires a 50% interest in Decorators Partnership by contributing property with an adjusted basis of $250,000. Black recognizes a gain if: I. The fair market value of the contributed property exceeds its adjusted basis. II. The property is encumbered by a mortgage with a balance of $100,000. a.I only b.II only c.Both I and II d.Neither I nor II

d.Neither I nor II The fair market value of property (high or low) is irrelevant in determining Black's basis in Decorators. The partner's adjusted basis is used. Because 50% of the mortgage does not exceed Black's basis in the property, he will not recognize a gain on the contribution of the encumbered property to Decorators. HW14a

Mitchell and Powell form Green Corporation. Mitchell transfers property (basis of $105,000 and fair market value of $90,000) while Powell transfers land (basis of $8,000 and fair market value of $75,000) and $15,000 of cash. Each receives 50% of Green Corporation's stock (total value of $180,000). As a result of these transfers: a.Mitchell has a recognized loss of $15,000, and Powell has a recognized gain of $67,000. b.Green Corporation will have a basis in the land of $23,000. c.Mitchell has no recognized loss, but Powell has a recognized gain of $15,000. d.Neither Mitchell nor Powell has any recognized gain or loss.

d.Neither Mitchell nor Powell has any recognized gain or loss. As § 351 applies, Mitchell cannot recognize the realized loss of $15,000 ("Mitchell has a recognized loss of $15,000, and Powell has a recognized gain of $67,000"). Although cash was involved, it was given, not received by Powell ("Mitchell has no recognized loss, but Powell has a recognized gain of $15,000"). Therefore, it is not boot within the meaning of § 351(b). Green Corporation will have a basis of $105,000 in the property transferred by Mitchell and $8,000 in the land (not $23,000 as in "Green Corporation will have a basis in the land of $23,000"). CQ12

Generally, in a direct distribution of assets to the shareholders that results in a complete corporate liquidation: a.There is no taxable event. b.The corporation recognizes no gain or loss because it transfers the assets to the shareholders at the corporation's basis immediately before the distribution. c.The shareholders recognize dividend income in the amount of the fair market value of property received. d.The shareholders recognize gain or loss to the extent the fair market value of the distributed assets differs from the adjusted basis of the stock.

d.The shareholders recognize gain or loss to the extent the fair market value of the distributed assets differs from the adjusted basis of the stock. In a complete corporate liquidation, when a corporation directly distributes assets to its shareholders, the corporation recognizes gain or loss as if it had sold the assets for the fair market value. Further, the shareholders recognize capital gain or loss to the extent the fair market value of the assets differs from the shareholders' adjusted basis in the stock of the corporation. This occurs because shareholders must treat property received in a complete liquidation of a corporation as full payment for their stock. HW13

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