Taxation of Business Entities
Which of the following is NOT a decrease to basis in a partnership interest?
An increase in the partner's share of the debt of the partnership Rationale: An increase in the partner's share of debt of the partnership increases the basis of a partnership interest.
How does a partnership adopt an overall method of accounting for tax purposes?
By filing a tax return
Which of the following is NOT a flow-through entity?
C corporation Rationale: C corporations are taxed at the entity level.
Partnerships with ______ as partners are generally not eligible to use the cash method of accounting for tax purposes.
C corporations
Which of the following BEST describes the calculation of realized gain or loss on the sale of a partnership interest?
Cash and market value of property received plus debt relief less the outside basis in the partnership interest
Which of the following is NOT an increase to a partner's adjusted basis in a partnership interest?
Cash distributions paid from the partnership to the partner
A partner selling his or her partnership interest includes which of the following in the amount realized? (Check all that apply.)
Cash received Debt relief Fair market value of property received
Purchase
Cost basis + debt allocated
deferred income tax expense
Deferred tax expenses are the tax effects of temporary differences in the book and tax basis of assets and liabilities.
Loss not recognized
Fair market value of distributed property is less than its adjusted basis
True or false: A company must consider ONLY negative evidence in determining whether a valuation allowance is needed.
False----a company needs to consider negative and positive evidence in determining whether a valuation allowance is needed.
True or false: Operating distributions from a partnership ALWAYS result in a gain or loss to the partner.
False--Generally, operating distributions do NOT result in a gain or loss.
Ack Corp. acquires all the assets and liabilities of Targ Corp for $200,000 cash. Targ has two assets at the time of acquisition: land valued at $120,000 (basis = $50,000) and inventory valued at $40,000 (basis = $40,000) and no liabilities. What amount of gain or loss does Targ recognize on the sale?
Gain recognized = $110,000 Rationale: The purchase price is allocated to the assets based on FMV and the remainder ($40,000) to goodwill. Thus, the gain on the land is $120,000 - $50,000 = $70,000. The gain on inventory is $0 and the gain on goodwill is $40,000. Total gain = $110,000.
Andre receives 50 shares of stock with a fair market value of $200,000 plus $50,000 cash in exchange for his contribution of machinery, land and inventory valued at $40,000, $150,000 and $60,000, respectively. How does Andre allocate the boot for purposes of calculating gain recognized?
Machinery $8,000; land $30,000; inventory $12,000 Rationale: Allocate the boot of $50,000 based on relative FMV: Machinery 40/250 = 16% x $50,000 = $8,000; land 150/250 = 60% x $50,000 = $30,000; Inventory 60/250 = 24% x $12,000.
Which of the following are recognized by the partner on the contribution of property to a partnership by a partner?
Neither built-in gains nor losses Rationale: Partners do not generally recognize gain or loss when they contribute property to a partnership.
Brendan transfers a building with a value of $300,000 (adjusted basis = $120,000) to Fours Corp. in exchange for stock worth $100,000. As part of the transfer, Fours assumes the $200,000 mortgage on the building. What is Brendan's gain realized, gain recognized, and basis in Fours stock?
Realized gain = $180,000; recognized gain = $80,000; basis in stock = $0 Rationale: Realized gain = $300,000 - $120,000 = $180,000. Gain recognized = $200,000 liabilities less $120,000 adj. basis = $80,000. Basis of stock = $120,000 + $80,000 gain recognized - $200,000 liability = $0.
Which of the following are generally flow-through entities? (Check all that apply.)
S corporation Limited liability company Limited partnership
S corporation
S corporations are corporations that make an election to flow through the income to the shareholders.
Which of the following is NOT a separately stated item?
Sales revenue less costs of goods sold Rationale: Sales less COGS is a component of ordinary business income.
Which of the following Type A mergers does NOT result in the creation of a stand-alone subsidiary?
Statutory Type A merger
Which of the following items are adjustments to taxable income to calculate current E&P? (Check all that apply.)
Tax-exempt income, such as municipal bond interest Penalties and fines Federal income taxes paid
True or false: Contributions of property to a partnership generally result in the same type of deferral available to a sole shareholder's contribution of property to a corporation.
True
In which type of merger will the exchange of cash for the stock of the target corporation taint the tax deferral of the reorganization?
Type B Rationale: A Type B merger requires a solely stock for stock exchange.
Glenda Goodwich contributes property with a basis of $20,000 and a fair market value of $100,000 to form WOZ Corporation in exchange for 100 shares of WOZ common stock with a fair market value of $80,000 and $20,000 cash. This contribution will result in
gain recognition.---Glenda has a realized gain and the boot (cash) received triggers gain recognition.
In order for a stock distribution to be non-taxable, it must be: (Check all that apply.)
made with respect to the corporation's common stock. made pro-rata with respect to all shareholders.
Clark is preparing to contribute property with a value of $5,000 and basis of $20,000 to a partnership. A better tax alternative is to:
sell the property, recognize the loss and contribute the cash from the sale Rationale: Clark will be able to recognize the loss by selling the property rather than contributing property with a built-in loss to a partnership.
Guaranteed payments are
separately stated items and deducted from ordinary business income or loss.
The tax basis of stock received in a tax-deferred Section 351 transaction is typically a(n) basis (that is, it is the same basis as the property transferred).
substituted
Under an exception to the general rule, a liability transferred to a corporation in a Section 351 transaction will NOT be treated as boot unless the purpose of the transaction is____________ ____________ . (Enter one word per blank)
tax-avoidance
Alberto transfers all of the assets of his proprietorship, including a building with a basis of $135,000 and a value of $200,000 to form Fonseca Corp. in exchange for 40 shares of stock in a tax-deferred 351 transaction. Fonseca assumed the $50,000 mortgage against the building. How much gain will Alberto recognize?
$0 Rationale: The liabilities are not treated as boot and thus no gain is recognized.
A corporation will be required to file Schedule UTP if assets exceed
$10 million
Eddie contributes property worth $50,000 (adjusted basis = $30,000) to Lindy Corp. Eddie is already the sole shareholder of Lindy and receives nothing in return for his transfer. What is Lindy's basis in the property?
$30,000 Rationale: On a contribution to capital, the basis of the property remains the carryover basis.
Which of the following are inventory when defining hot assets? (Check all that apply.)
*A machine purchased and sold within the same tax year *Property held for sale to customers in the ordinary course of business
Partnership income tax returns are due:
15th day of the 3rd month after year end Rationale: The due date is the 15th day of the 3rd month after year end
ASC 740 applies to which of the following tax positions? (Check all that apply.)
A position taken on a previous tax return A position taken on a current tax return A tax position taken with regards to the deductibility of 50% of meals
Which of the following provides an opportunity for a corporation to avoid double taxation on payments to its shareholders?
A reasonable deduction for salaries paid to owner
Which of the following is NOT a passive activity?
A rental real estate business in which the real estate developer works full time Rationale: Although most rental real estate is considered passive, partnership activities such as real estate development can be active if the partner spends sufficient time on them.
Bad debt reserves
An allowance for bad debts is a temporary difference.
A partnership's ordinary business income or loss can be defined as
the partnership's overall income or loss, except for separately stated items.
Consistent with other types of entities, partnerships with gross receipts exceeding a certain threshold must use the accrual method for the purchase and sale of ________________.
inventory
In a 351 transaction, Byron transfers property with a value of $100,000 (adjusted basis = $80,000) to Allen Corp. for stock worth $50,000. Allen assumes the $50,000 mortgage against the property. What is the recognized gain or loss on the transfer?
$0 Rationale: Amount realized = $100,000 less adjusted basis of $80,000 = $20,000 realized gain. However, the liabilities assumed ($50,000) do NOT exceed the adjusted basis of the property, and thus no gain is recognized.
Agatha contributes land valued at $25,000 (basis = $5,000) subject to a mortgage of $15,000 to the Kristy Partnership for a 50% interest. What is Agatha's gain or loss on the contribution?
$0 Rationale: Because the cash deemed to have been received does not exceed Agatha's basis in the partnership interest, she does not recognize gain.
Jesbill Inc. receives property worth $50,000 from the state as a contribution to capital as incentive to build a factory in the state. What is Jesbill's basis in the property?
$0 Rationale: Non-shareholders' contributions to capital take a basis of $0.
Mia has an outside basis of $50,000 in the Brimstone Partnership, including her share of liabilities of $25,000. In a liquidating distribution, she receives cash of $10,000 and inventory worth $8,000 (inside basis to Brimstone of $20,000). What is Mia's recognized gain or loss on the liquidation and basis in the property received?
$0 gain or loss and basis of $10,000 in the cash and $15,000 in the inventory Rationale: Mia's outside basis after adjusting for the debt relief is $25,000. She received cash of $10,000 and inventory with a basis of $20,000 which means she has a required decrease of $5,000 ($30,000 - $25,000). The reduction is allocated to the inventory reducing the basis to $15,000. No gain or loss is recognized.
Candles, Inc. distributes some defective candles to its shareholders. The market value of the candles was $20,000 (adjusted basis = $60,000). What are the tax consequences of the distribution to Candles?
$0 gain or loss recognized (No loss is recognized on the distribution of noncash property by a corporation. E&P is reduced by the E&P basis in the property.)
Lower Texas, Inc. (LTI) took a tax position to treat $100,000 of income as tax-exempt. However, LTI is not certain that the treatment will be sustained. After analyzing the position, LTI determines that the there is a 40% chance that $80,000 will be treated as tax-exempt and a 75% chance that $40,000 will be treated as tax-exempt. Assuming a 35% tax rate, and if the more likely than not threshold is met, what is the uncertain tax liability associated with this position?
$21,000---LTI can recognize $14,000 ($40,000 x 35%) of the benefit as the cumulative probability is greater than 50%; however, the $21,000 (the remaining $60,000 x 35%) is NOT recognizable and must be accrued as an uncertain tax liability.
Gene, a single taxpayer, sells Section 1244 stock for a $35,000 loss. He also earns wages of $75,000 and generates net capital gains of $12,000. What is Gene's ordinary income and capital gain income?
$40,000 ordinary income; $12,000 capital gains Rationale: Ordinary income is $75,000 less $35,000 1244 loss = $40,000. Capital gains remain $12,000.
Amy redeemed all 50 of her shares of Fontaine Corp. in exchange for $46,000. This represented one-half of Fontaine's outstanding stock. Just prior to the redemption, Fontaine has E&P of $80,000. What is Fontaine's E&P after the redemption?
$40,000---In a redemption treated as an exchange, E&P is adjusted by the same percentage as the percentage of stock redeemed, not to exceed the FMV of the property distributed. 50% of stock redeemed x $80,000 =$40,000.
Industry, Inc. recorded $100,000 of depreciation on its books in Year 1 (its first year of business) and $150,000 of tax depreciation in Year 1. What is the cumulative difference in the book and tax basis of the assets?
$50,000 cumulatively favorable Rationale: The $50,000 difference between book and tax represents a current reduction of taxable income, making it favorable.
In order to receive tax deferred treatment for a reorganization, which of the following are typically required? (Check all that apply.)
A continuing ownership interest in the assets Receipt of equity from acquiring corporation A significant business purpose for engaging in the transaction
Acquiring corporation
Asset acquisition with step-up in basis of assets
Place the following in the order in which any partnership loss limitations are considered.
Basic limitations, At-risk limitations, Passive loss limitations
Murtaugh decides he is ready to leave the LW Partnership and sells his interest (basis = $30,000) to Riggs for $75,000. Murtaugh was an original partner in LW when it was formed 5 years ago. LW has no debt. What is Rigg's basis and holding period in his newly acquired LW interest?
Basis = $75,000; holding period begins at date of purchase Rationale: The basis of a purchased partnership interest is the cost + share of debt. The holding period begins on date of purchase.
A(n) ___________ interest represents the share of a partnership's capital that a partner is entitled to receive if the partnership liquidates.
Capital
Generally, what is the character of the gain or loss on the sale of a partnership interest?
Capital Rationale: A partnership interest is a capital asset, and thus would generally be treated as a capital gain or loss.
General Partnership distributes investments that it has held for two years to Major, an individual partner in a liquidating distribution. What is the character of the investments to Major?
Capital Rationale: Generally, the character of distributed property is determined by the manner in which the distributee partner holds the property.
Match the service partner's tax treatment based on the type of partnership interest received in exchange.
Capital interest: Service partner recognizes ordinary income for the liquidation value of the partnership received Profits interest received: Service partner does NOT immediately recognize ordinary income for value of partnership interest received
Old Corp. (target) merges into New Corp (acquiring) in a statutory Type A merger. What will the basis in Old Corp.'s assets be in the hands of New Corp?
Carryover basis Rationale: In a Type A merger, the basis of the assets and liabilities carries over to the surviving entity.
deferred tax assets
Deferred tax assets represent the tax effect of a future recovery.
Belinda receives an operating distribution from the GoGo Partnership. Her basis just prior to the distribution is $100,000. Which of the following distributions is likely to result in a gain to Belinda?
Distribution of $150,000 cash Rationale: Gain will be recognized only when any cash distributed exceeds the partner's outside basis in the partnership immediately prior to the distribution.
Corporate distributions to shareholders are treated in the following order.
Dividend to the extent to E&P included in gross income Non-taxable return of capital that reduces the shareholders basis Gain from sale or exchange of stock
Nadia contributed cash of $20,000 to form the USSR Partnership. At the same time, Elena contributed land worth $20,000 (her basis was $5,000 at the time of contribution). They both received a 50% capital and profits interest. Shortly after the partnership was formed, USSR sold the land for $22,000. How is the gain on the sale of the land allocated to the partners?
Elena $16,000; Nadia $1,000 Rationale: The built-in gain of $15,000 must be allocated to the contributing partner. The remaining gain of $2,000 is shared in accordance with the profit and loss sharing ratios.
Taxable gain to the corporation
Fair market value of distributed property exceeds its adjusted basis
True or false: In a stock redemption, the stock redeemed by the corporation must be immediately canceled.
False The stock acquired by the corporation can be canceled, retired or held in treasury stock.
A §351 deferral is only available when a single shareholder transfers property for a controlling stock interest in a corporation.
False--Property must be exchanged for a controlling stock interest, but one or more shareholders may be involved.
Match the type of partner with self-employment tax treatment.
General partner's guaranteed payment:Always treated as self-employment income Limited partner's share of ordinary income:Not treated as self-employment income LLC managing member's share of ordinary business income:Varies, with some treating as self-employment income and others not
Which of the following are acceptable methods of classifying interest and penalties on uncertain tax liabilities? (Check all that apply.)
Include interest and penalties as income tax expense Classify interest and penalties separately from income tax expense
Gandy is allocated a $10,000 passive loss from his investment in a partnership. Which of the following types of income can be offset by Gandy's passive losses?
Income from Gandy's investment in a limited partnership.
Flip Flop, Inc. treated interest on uncertain tax liabilities as interest expense and penalties as part of selling, general and administrative expenses in the prior year. How can Flip Flop treat interest and penalties this year?
Interest must be treated as interest expense and penalties as S,G and A.--- Interest and penalties related to uncertain tax positions must be treated consistently from year to year.
Net operating loss carryovers
NOL carryovers are a temporary difference.
Bunny provides deductible consulting services worth $40,000 to Egg Partnership and receives a profits interest (no capital interest). What is the tax treatment to Bunny and to Egg?
No income to Bunny and no deduction for Egg Rationale: Services exchanged for a partnership profits interest result in no ordinary income to the contributing service partner and no deduction for the partnership.
General partnership
Partnership income flows through to the owners.
Aztec Corp. is calculating its current E&P and is considering the following items: Federal income taxes paid $50,000 Political contributions to the state governor's race $5,000 Fines and penalties $1,000 Ordinary and necessary business expenses $50,000 Salaries paid to owner/employees $30,000 Which of the items above should Aztec deduct when adjusting its taxable income to get to E&P? (Check all that apply.)
Political contributions Fines and penalties Federal income taxes Ordinary business expenses are deductible for taxable income and should not be deducted when adjusting E&P.
Which of the following are NOT inventory items? (Check all that apply.)
Section 1231 assets Capital assets Cash
Which of the following is NOT a possible loss limitation on partnership losses?
Self-employment tax limitation Rationale: There is a cap on the amount of self-employment income subject to the Social Security portion of FICA taxes, but no such limitation on partnership losses.
Match the steps in the proper order for calculating the gain or loss on the sale of a partnership interest with hot assets.
Step One: Determine the total recognized gain or loss. Step Two: Calculate the partner's share of gain or loss from hot assets as if the partnership sold the assets at FMV. Step Three: Subtract the ordinary portion from the total gain or loss to determine the capital gain or loss.
The basic models of acquisition include a corporation acquiring a target corporation's: (Check all that apply.)
Stock assets
Target corporation
Stock acquisition with tax deferral
Which of the following are non-tax advantages to a cash acquisition with an acquiring corporation? (Check all that apply.)
Target corporation shareholders do NOT join the acquiring corporation's shareholders. Rationale: The target shareholders receive cash and are frequently no longer party to the surviving corporation. No additional stock is issued that dilutes the existing earnings per share. Rationale: No additional shares are issued in exchange for the target's shares, keeping the EPS denominator in tact.
Black & Red Corp. distributes a machine to its sole shareholder, Mike. Black & Red's basis in the machine was $4,000 and the machine was worth $10,000 at the time of the distribution. What are the tax consequences to Black & Red?
Taxable gain of $6,000 and a $4,000 reduction in E&P (Black & Red recognizes a $6,000 gain ($10,000 FMV - $4,000 adjusted basis) and increases E&P by the gain, but then decreases E&P by the FMV ($10,000) resulting in a net decrease of $4,000.)
Entity approach
Taxes the entity separate from the owners
Newly formed Chasbro Partnership is preparing its first tax return. Who makes the election to expense a portion of the partnership's start-up costs?
The partnership
Aggregate approach
Treats the entity as an aggregation of owner's interests
True or false: Owners of a flow through entity are taxed on the entity's business income whether the income is distributed or not.
True--A flow through entity allocates income to its owners in the year the income is recognized by the entity and does not wait until a distribution is made.
Warranty reserves
Warranty reserves accrued for books are a temporary difference.
Van Zandt Partnership distributes money and property other than money to its partners. This distribution ______ be an operating distribution.
can
A partner's interest in a partnership interest is treated as a(n):
capital asset
The expected future tax recovery from a taxable deductible difference is recognized as a:
deferred tax liability
Spiro Partnership holds cash, inventory and unrealized receivables. Josh, a one-third partner, receives a cash only liquidating distribution representing one-third the value of the partnership. This distribution is a:
disproportionate liquidating distribution Rationale: Because the distribution is cash only from a partnership that holds inventory and unrealized receivables, it is disproportionate.
When current E&P is positive, but accumulated E&P is negative,:
distributions are deemed to come from current E&P first
When a corporation pays a distribution that is characterized as a dividend, the corporation _______ the dividend from taxable income.
does NOT deduct
Because a corporation pays tax at the entity level and corporate dividends are NOT deductible, corporate income suffers______ taxation.
double
A measure of a corporation's economic profits is known as_________ and__________ .
earnings, profits
Deferred tax assets and liabilities are calculated using the ______ tax rate that is expected to apply when the temporary difference is received or settled.
enacted
The current income tax expense is calculated using the______ tax law.
enacted
When noncash property subject to liabilities is distributed by a corporation to shareholders, the amount of the distribution is
equal to the FMV of the property minus the liability assumed by the shareholder
Partners are informed of their share of a partnership's income by:
examining the information return (Schedule K-1) that the partnership prepares for them
Mick receives a cash distribution from the Stones Partnership in which he has a 10% interest. As a result of the distribution, Mick's ownership interest decreases to 7%. This is a(n) ______ distribution.
operating Rationale: Although Mick's ownership interest decreases, he remains in the partnership, making this an operating distribution.
A partner contributes property or services in exchange for the general ownership interest called a(n)_________ __________ .
partnership interest
Stump Grinders Partnership holds cash and inventory (basis $50,000, market value = $55,000) and makes a liquidating distribution of only cash to Ginny. This distribution is a
proportionate distribution. Rationale: The inventory is NOT more than 120% appreciated; therefore, Ginny did not receive less than her fair share of hot assets (not substantially appreciated) and the distribution is proportionate.
Schedule UTP of the IRS forms requires certain companies to: (Check all that apply.)
rank uncertain tax positions by size. report any uncertain tax positions. identify the code section that relates to the uncertain tax position.
The two steps in the process to determine if a tax benefit can be recognized are (in order):
recognition and measurement
If a transfer of property or cash in exchange for corporate stock does not meet the requirements of Section 351, the taxpayer must any gain on the transfer.
recognize
Limited liability company
LLC income flows through to the members.
ASC requires a two-step process to evaluate tax positions. Select the first of those two steps.
Determine if it is more likely than not as to whether the position will be sustained
Contribution of property
Outside basis = basis of contributed property - debt relief + debt allocated + gain recognized
Which of the following qualify as property under Section 351? (Check all that apply.)
Trademarks Cash Real property
Which of the following methods is an acceptable way for partners to allocate income or loss when their interests change during the year? (Check all that apply.)
Treat the change in interest as an interim closing of the books Prorate income or loss based on the partners' varying interests
True or false: If a partnership has debt, the debt generally serves to increase the partner's outside basis.
True Rationale: Debt is generally allocated in some way to partners to include in their tax basis.
When the basis of property contributed carries over to the corporation in a tax-deferred 351 transaction, the depreciation schedule:
also carries over from the shareholder
Once the more-likely-than-not recognition threshold has been met, ASC 740 requires that the tax position benefit be measured as the:
amount of tax benefit greater than 50% likely to be realized (ASC 740 requires that a company measure the cumulative probability of all outcomes and recognize the amount that has a greater than 50% probability of being sustained.)
The amount of tax benefit NOT recognized on an uncertain tax position is treated as a(n):
non-current liability
Under family attribution, stock ownership by which of the following family members would be attributed to the shareholder? (Check all that apply.)
parent, children, spouse
When an individual (filing single) shareholder sells Section 1244 stock at a loss, the shareholder will
recognize an ordinary loss up to $50,000. **Married filing jointly is eligible for a $100,000 ordinary Section 1244 loss.
Joshuantic, Inc. has cumulative unfavorable temporary differences of $80,000 and, thus, records a $16,800 deferred tax asset. However, Joshuantic believes that it may NOT be able to realize that asset. As a result, Joshuantic will
record a gross deferred tax asset and a valuation allowance as a contra account.
Fleck Corporation redeemed stock from a shareholder in exchange for $20,000. The redemption qualified as a dividend. As a result, Fleck will:
reduce E&P by $20,000----A corporation must reduce E&P by the cash plus the fair market value of property distributed in a redemption treated as a dividend.
Individuals prefer exchange treatment for redemptions due to the: (Check all that apply.)
reduction in the amount of income for the adjusted basis. increased ability to deduct capital losses.
Guenther Corporation has two shareholders: Gene and Asami. Guenther distributes a stock dividend to Asami only. The stock dividend is:
taxable Stock dividends that are NOT pro-rata are taxable.
When depreciable property is transferred to a corporation in exchange for stock in a tax-deferred Section 351 transaction, the depreciable basis of the property to the corporation is:
typically the carryover basis
The application of enacted tax law against the taxable income for the year is the:
current income tax expense---
Current E&P and accumulated E&P are both positive. The order in which a distribution is deemed to come from E&P is:
current, accumulated
Watermelon Partnership distributes unrealized receivables to William in a liquidating distribution. William does NOT collect on these receivables for over five years. What is the character of the income to William?
Ordinary Rationale: The character of unrealized receivables remains ordinary, regardless of the holding period.
Mia has an outside basis of $50,000 in the Brimstone Partnership, including her share of liabilities of $25,000. In a liquidating distribution, she receives cash of $15,000, inventory of part A worth $8,000 (inside basis to Brimstone of $20,000) and inventory of part B worth $4,000 (inside basis = $4,000). What is Mia's recognized gain or loss on the liquidation and basis in the property received?
$0 gain or loss and basis of $15,000 in the cash and $6,667 in Inventory A and $3,333 in inventory B Rationale: Mia allocates her outside basis first to the $25,000 of deemed cash she receives from debt relief and the $15,000 of actual cash she receives. Her remaining outside basis of $10,000 is less than the total $24,000 inside basis of inventory distributed, requiring a $14,000 reduction in the basis of inventory. The first $12,000 of reduction is allocated to Part A inventory reducing its basis down to its FMV of $8,000. The remaining $2,000 reduction is allocated to Part A and Part B inventory pro-rata according to the basis assigned thus far to each class of inventory. Part A: $8,000/$12,000 x ($2,000) = ($1,333) (result is $6,667). Part B: $4,000/$12,000 x ($2,000) = ($667) (result is $3,333). No gain or loss is recognized.
Contribution of services
Outside basis = liquidation value of capital interest + debt allocated
In 20X1, Waters LLC generates ordinary business income of $40,000 and makes no distributions to its partners. In 20X2, Waters recognizes $0 ordinary income, but makes a $20,000 total cash distribution to its partners. Pink, a 25% member in Waters, has an outside basis in Waters of over $200,000 when 20X1 begins. What amount of income will Pink recognize in 20X1 and 20X2?
$10,000 in 20X1 and $0 in 20X2 Rationale: Pink is allocated $10,000 ($40,000 x 25%) of income in 20X1. In 20X2, Pink is allocated $0 income, as distributions are generally NOT taxable if they do not exceed basis.
Jimbo buys a partnership interest from Fisher for $100,000. Fisher's outside basis in the partnership was $60,000 at the time of sale, and Fisher's share of the inside basis of the assets in the partnership (his tax capital account) was $40,000. The partnership has no debt. What is Jimbo's outside basis in the partnership interest?
$100,000 Rationale: A new investor in a partnership will generally take an outside basis equal to his or her cost of the interest.
Topham, Inc. has pretax income of $100,000 for the current year. Included in that amount is $3,000 of tax-exempt income, $8,000 of meals expenses, and $10,000 of depreciation expense (depreciation is $15,000 under tax rules). Topham also paid $21,000 in estimated income tax payments during the year. After adjusting for permanent items (only), Topham's taxable income is:
$101,000---Pretax income $100,000 - $3,000 (tax-exempt income included for book) + $4,000 (50% add-back of non-deductible meals) = $101,000.
Jimbo buys a 40% partnership interest from Fisher for $100,000. Fisher's outside basis in the partnership was $60,000 at the time of sale, and Fisher's share of the inside basis of the assets in the partnership (his tax capital account) was $40,000. The partnership has $20,000 of debt. What is Jimbo's outside basis in the partnership interest?
$108,000 Rationale: A new investor in a partnership will generally take an outside basis equal to his or her cost of the interest plus his or her share of partnership debt.
Gerald's interest (outside basis = $75,000) in the Nixon Partnership is liquidated, and Nixon distributes $62,000 cash to Gerald. What is Gerald's gain or loss (if any) on the liquidating distribution?
$13,000 loss Rationale: Because Gerald receives only money and his outside basis ($75,000) exceeds the sum of the adjusted bases of distributed assets ($62,000), Gerald recognizes a capital loss of $13,000 ($75,000 - $62,000).
WBG Partnership holds only two assets: Cash of $10,000 and Equipment (placed in service 3 years ago): FMV = $50,000; original cost= $50,000; adjusted basis = $35,000 What amount of WBG's assets are considered hot assets?
$15,000 Rationale: The recapture on the equipment is considered a hot asset.
Mia has an outside basis of $50,000 in the Brimstone Partnership, including her share of liabilities of $25,000. In a liquidating distribution, she receives cash of $40,000. What is Mia's recognized gain or loss on the liquidation?
$15,000 capital gain. Rationale: Mia's basis after adjusting for the debt relief is $25,000. She received cash of $40,000 generating a $15,000 gain.
Vebos, Inc. distributes $10,000 cash and a machine with a fair market value of $5,000 (adjusted basis to Vebos was $200) at time of distribution to its shareholder Jody. Vebos had current E&P of $100,000 at the distribution. What is the amount and character of the distribution to Jody?
$15,000 dividend ($10,000 cash + $5,000 FMV of property is all paid from E&P).
Chuck sold his 50% interest in Taylor LLC for a gain of $50,000. Taylor held only one hot asset with a FMV of $30,000 and a tax basis of $0. What is the amount and character of Chuck's gain/loss on the sale?
$15,000 ordinary gain; $35,000 capital gain Rationale: The ordinary portion is 50% x $30,000 or $15,000, leaving $35,000 as capital gain.
Joshua receives Dee Corp. stock worth $135,000 and $15,000 cash in a Section 351 transaction where he transfers property worth $150,000 (adjusted basis = $170,000). What is Dee Corp.'s basis in the property received?
$150,000 Rationale: Joshua does NOT recognize any of his realized loss ($150,000 - $170,000). The aggregate FMV of the property exceeds its basis, thus the basis is the FMV.
Cougar, Inc. has correctly computed the following information for tax purposes: Taxable income $200,000 Federal income taxes $60,000 Cougar's income includes: Dividends received deduction $5,000 Meals $4,000 (8,000 x 50% limit) $3,000 business fine Cougar did not include $10,000 of municipal bond interest and deferred gain from an installment sale of $20,000. What is Cougar's current E&P for the year?
$168,000---$200,000 - $60,000 (taxes) + $5,000 (DRD) - $4,000 (other 50% of meals) + $10,000 (tax-exempt income) + $20,000 (def gain on installment sale) - $3,000 (non-deductible fine) = $168,000.
Rebellion, Inc. distributes property worth $20,000 (adjusted basis = $5,000) to its shareholder, Jerry. Rebellion's current E&P was $100,000 at the time of distribution. What is Jerry's basis in the property received?
$20,000 The basis in the property received is the fair market value.
Sadek contributes cash of $10,000, land with a value of $400,000 (basis = $200,000), and equipment with a value of $20,000 (basis = $0) to a corporation in a tax-defered Section 351 transaction. What is Sadek's basis in the new corporation stock?
$210,000 Rationale: $10,000 cash + $200,000 basis in land + $0 basis in equipment = $210,000
Steven is a member in Manyou LLC. As part of his ownership in Manyou, he also personally guaranteed a portion of Manyou's debts and is considered the managing member of the company (basically he signs all the contracts and checks). Manyou paid Steven a guaranteed payment of $5,000 and allocated business loss of ($2,000) to him in the current year. What is Steven's self-employment income/loss from Manyou?
$3,000 Rationale: Steven includes both the guaranteed payment (all guaranteed payments are self-employment income) and the share of the Manyou loss, since he has a high level of involvement with the LLC and guarantees its debt. $5,000 - $2,000 = $3,000.
On January 1, 20X1, the Blueberry Partnership liquidates Mario's interest by distributing cash of $26,000 and inventory with an inside basis of $13,000 (FMV = $30,000). Mario's outside basis before the distribution was $60,000 including his share of liabilities of $18,000. What is the amount of Mario's gain or loss on the liquidation?
$3,000 capital loss Rationale: Mario's outside basis after considering the debt relief is $42,000 ($60,000 - $18,000). Since the basis of the property distributed is $39,000 which is less than Mario's basis, he may recognize a loss (only cash and hot assets distributed) of $3,000.
Cameron Corp. distributes cash and property to its shareholders (all non-corporate) pro rata in a complete liquidation. The value of the property was $40,000 and Cameron's basis was $10,000. What is the amount of gain or loss recognized by Cameron Corp. on the liquidation?
$30,000 recognized gain Rationale: In a taxable distribution of property in a complete liquidation, the liquidating corporation recognizes all gains and losses.
Miguel received a guaranteed payment of $14,000 from Yorba Linda Partnership, a business partnership in which he is a general partner. In addition, he was allocated $18,000 of ordinary business income from Yorba Linda. Miguel also has an ownership interest in Calexico LLC. Calexico paid Miguel a guaranteed payment of $3,000 and allocated $0 of ordinary business income to Miguel. How much self-employment income does Miguel have in total from Yorba Linda and Calexico?
$35,000 Rationale: Guaranteed payments are always treated as self-employment income and the allocation of business income to a general partner is typically treated as self-employment income, thus $14,000 + $18,000 + $3,000 = $35,000.
Van Persey decides to sell his 40% partnership interest to Drogba for $100,000. Van Persey's outside basis was $80,000 and the partnership held debt of $40,000. What is Van Persey's realized gain or loss?
$36,000 gain Rationale: Amount realized = $100,000 + $16,000 (debt relief of $40,000 x 40%) = $116,000, less the adjusted basis of $80,000, equals a gain of $36,000.
Marcie and her husband, Franklin, each own 50 shares of Chestnut, Inc. Sally, Marcie's old high school friend, owns the remaining 50 shares (150 total shares outstanding). Chestnut redeems 40 of Marcie's shares for $38,000 (her adjusted basis was $5,000). What is the tax treatment of the redemption to Marcie?
$38,000 dividend--As her spouse, Franklin's shares are attributed to Marcie. Thus Marcie owns 60 (her remaining 10 + Franklin's 50) shares of Chestnut's total 110 (150 - 40) outstanding. Because 60/110 > 50%, Marcie fails the 50% test and the redemption is treated as a dividend.
Joshua Corp. distributes land to its shareholder, Eddie. The land has a fair market value of $25,000 and is subject to a mortgage of $40,000. Joshua Corp.'s basis in the land is $1,000. How much gain does Joshua Corp recognize on the distribution of the land?
$39,000 (Because the liability assumed with the land exceeds its fair market value, the amount of the distribution is assumed to be the liability ($40,000) less $1,000 (adjusted basis) = $39,000.)
Robert sells his 30% interest in Kashmir Partnership on July 1 to Jimmy for $80,000. Robert's outside basis in Kashmir was $50,000 at the start of the year. Kashmir recognizes an ordinary loss of $30,000 for the entire calendar year. The partnership agreements calls for Kashmir to allocate income or loss using the proration method. How much loss is allocated to Robert and what is his basis at the time of sale?
$4,500 loss and basis of $45,500 Rationale: $30,000 loss x 1/2 year x 30% = $4,500. This amount reduces Roberts basis from $50,000 to $45,500.
Gopher Inc. has current E&P of $40,000 and accumulated E&P of negative $100,000. Gopher makes a $60,000 distribution. What is the character of the distribution?
$40,000 dividend, $20,000 return of capital to the extent of basis (The distribution first comes out of current E&P.)
Zelda Partnership holds cash of $30,000 and inventory worth $60,000 (basis equals $42,000). Zelda makes a $30,000 cash liquidating distribution to Link, a one-third partner with an outside basis of $24,000. How much gain or loss, if any, does Link recognize?
$6,000 ordinary gain Rationale: Because Zelda held substantially appreciated inventory ($60,000/$42,000 > 120%), but distributed only cash, Link must treat his distribution as if he sold his share of the hot assets. One-third of the $18,000 of appreciation is treated as ordinary gain to Link.
Macadamia Corp. redeems 60 shares of common stock from Patty in exchange for $50,000. Patty held 100 shares of the 150 total outstanding shares in Macadamia for the past 5 years. Patty's basis in the 60 redeemed shares was $10,000. Assuming Patty has a 15% tax rate on both dividends and long-term capital gains, what is Patty's tax liability from this redemption?
$6,000----After the exchange Patty owns 40/90 shares (44%) which is less than 50% and also less than 80% of her ownership percentage before the redemption. As a result, her redemption qualifies as an exchange. $50,000 less $10,000 basis = $40,000 x 15% = $6,000.
SAN Partnership has three 33% partners: Diego, Onofre, and Clemente. All have tax capital accounts of $60,000. Diego sells his interest to Francisco for $80,000. What is the balance in Francisco's tax capital account after the sale?
$60,000 Rationale: The tax capital account carries over to the new partner.
Gopher, Inc. has current E&P of $40,000 and accumulated E&P of $100,000. Gopher makes a $60,000 cash distribution. What is the character of the distribution?
$60,000 dividend (Distributions are dividends to the extent of E&P. The first $40,000 comes from current E&P and the next $20,000 ($60,000 less $40,000) comes from accumulated E&P.)
Shirin contributes cash of $10,000, a computer with a market value of $1,000 (her basis is $500), and land with a market value of $80,000 (her basis is $20,000) to a corporation in exchange for stock that qualifies under Section 351. How much gain or loss did Shirin realized and recognize?
$60,500 gain realized; $0 gain recognized Shirin realizes a gain of $500 on the computer and $60,000 ($80,000 - $20,000) on the land. Under Section 351, she defers all the gain
Milly transfers a building worth $100,000 (adjusted basis = $80,000) and land worth $50,000 (adjusted basis = $10,000) to EE Corp. in exchange for EE Corp. stock worth $126,000 and $24,000 cash in a Section 351 transaction. What is EE Corp.'s depreciable basis for the building that that it received from Milly? What is the depreciable basis of the land?
$80,000 for the building and $0 for the land Rationale: Only the carryover portion of the basis remains on the existing depreciation schedule. The basis attributable to the gain starts a new depreciation schedule. Land is NOT depreciable.
Victoria contributes cash of $20,000 in exchange for a partnership interest. In the first year, her share of dividends, tax-exempt income and ordinary business loss are $2,000, $1,000 and ($4,000), respectively. The partnership also makes a cash distribution to her of $10,000. What is Victoria's adjusted basis at the end of the year?
$9,000 Rationale: $20,000 + $2,000 + $1,000 - $10,000 - $4,000 = $9,000
When a corporation makes a distribution, the distribution is deemed paid out of _____ E&P first, then ____ E&P.
current; accumulated
During the current year, Jason received guaranteed payments of $12,000, $1,000 and $0 from his ownership interest in a partnership (he is a general partner), an LLC, and a limited partnership (he is a limited partner), respectively. The partnership, LLC, and limited partnership also allocated ordinary income (loss) to Jason of ($4,000), $2,000, and $6,000, respectively. Assuming Jason provided limited services to the LLC but is NOT involved in the management, what is Jason's self-employment income/loss for the current year?
$9,000 Rationale: All guaranteed payments are treated as self-employment income. The ordinary loss from the general partnership is considered self-employment income. Since Jason is NOT a managing member of the LLC, he does not include the business income from the LLC. Limited partnership income is not considered self-employment income. $13,000 - $4,000 = $9,000
Greg transfers property worth $100,000 (basis = $5,000) to a corporation and receives a note from the corporation valued at $100,000. Greg's realized gain or loss on this transaction is
$95,000. Rationale: Greg will recognize his entire gain of $95,000 ($100,000 - $5,000), as this represents a taxable sale.
Which of the following represent potential alternative tax consequences of a corporate distribution of property to a shareholder? (Check all that apply.)
*A gain from the sale of stock (A corporate distribution can be a dividend, return of capital or gain.) *A dividend included in the income of the shareholder *A non-taxable return of the shareholder's capital
Which of the following allow a partnership that has elected Section 754 to make a special basis adjustment? (Check all that apply.)
*A partner recognizes a gain or loss on a distribution. *A partner takes a basis in distributed property that differs from the partnership's inside basis in the property. *A new investor purchases a partnership interest from an existing partner.
Which of the following items qualify as boot in a Section 351 transaction? (Check all that apply.)
*Cash Rationale: If the corporation transfers cash to the shareholder as part of the exchange, that is considered boot. *Fair market value of property received Rationale: The fair market value of any property received with stock in the exchange is considered boot. ***The stock of the corporation that the Section 351 transaction applies to is NOT considered boot.
Mitt redeems his entire ownership of stock in Dawn Key Corp. However, Mitt's sons, Rick and Newt, own all of the remaining shares of Dawn Key Corp. after the redemption. What are the requirements that Mitt must meet to waive the family attribution rules for this redemption? (Check all that apply.)
*Mitt must notify the IRS if he acquires a prohibited interest within 10 years of the redemptions. *Mitt may NOT serve as a shareholder, director, officer or consultant for Dawn Key.
Under which of the following circumstances MUST a partnership make a special basis adjustment? (Check all that apply.)
*The partnership has a substantial basis reduction as a result of a distribution. *The partnership has a substantial built-in loss at the time of the sale of a partnership interest.
Partnership allocations of income and loss should: (Check all that apply.)
*be defined in the partnership agreement. *have substantial economic effect.
Passive losses can be: (Check all that apply.)
*considered only after the basis and at-risk limitations are considered. *offset against ordinary income when the passive activity is disposed. *offset against passive income.
In order to qualify as Section 1244 stock, the: (Check all that apply.)
*corporation must have been primarily engaged in an active trade or business for the five years preceding the sale of the stock. *issuing corporation must have issued no more than $1 million of stock. *shareholder must be the original recipient.
A liquidating corporation will NOT recognize losses if loss property: (Check all that apply.)
*is distributed to a related party and the distribution is not pro rata. *was acquired by the liquidating corporation in a tax-deferred 351 transaction in the last 5 years and distributed to a related party.
A shareholder can treat a stock redemption as an exchange if the: (Check all that apply.)
*redemption is substantially disproportionate with respect to the shareholder. *redemption is NOT essentially equivalent to a dividend. *redemption is a complete redemption of the all the shareholder's stock in the corporation.
In order to qualify for exchange treatment as a redemption that is NOT essentially equivalent to a dividend, the redemption must: (Check all that apply.)
*result in a meaningful reduction of the shareholder's proportionate interest in the corporation. *result in the shareholder's voting power being below 50%.
A sale of a partnership interest will trigger ordinary (not capital) gain if any gain on the sale is attributable to: (Check all that apply.)
*unrealized receivables. Rationale: Unrealized receivables are hot assets and can trigger ordinary gains *inventory. Rationale: Inventory is a hot asset and can trigger ordinary gains.
For purposes of control for Section 351, ownership of ______% or more of the voting stock is required.
80
Which of the following BEST describes a guaranteed payment?
A payment made by a partnership to a partner whether the partnership generates income or losses
Qiang Corporation acquires the assets of Kween Corporation in a cash transaction. Which of the following BEST represents the likely tax treatment for Qiang and Kween?
Kween will recognize a gain or loss on the sale of its assets. Qiang will take a new tax basis in the assets. Rationale: In a taxable asset sale (where cash is received), the target recognizes gains and losses on the sale of assets but the acquiring corporation receives a step up in basis.
In which of the following scenarios will Billy meet the material participation test?
Billy participates in the activity for 120 hours. Mandy, his only other partner, participates for only 80 hours.
Winkin contributes property with a value of $45,000 and Blinkin contributes property with a value of $90,000 to form Boat Corp in exchange for 25 and 50 shares of Boat, respectively. Which shareholder qualifies for Section 351 deferral of any gain or loss?
Both Winkin and Blinkin Rationale: Since Winkin and Blinkin made the contributions in exchange solely for stock at the same time, the cumulative control of both shareholders is examined. Immediately after, Winkin owns 33% (25/75) and Blinkin owns 67% (50/75), which means they own collectively 100% (more than 80% control.)
Macrohard Partnership distributes some of its software inventory to partner Jill in a liquidating distribution. Jill intends to use the software for personal use and does so for seven years. After that time, Jill sells the software at a gain. What is the character of the gain to Jill?
Capital Rationale: Because Jill uses the software as a capital asset for more than five years, the taint of ordinary treatment is lifted.
Which of the following are reorganizations for tax purposes? (Check all that apply.)
Disposition of a subsidiary's stock Change of corporate name Change in corporate capital structure
Which of the following items is a permanent difference?
Dividends received deducions---The DRD is an artificial tax deduction that is NOT recorded for book.
Match the type of income with its basket.
Dividends:Portfolio Wages:Active Income from limited partnership:Passive
True or false: The statutory language regarding corporate reorganizations is stated clearly and simply in the Internal Revenue Code.
False Rationale: The statutory language regarding corporate reorganizations in the Code is sparse, and thus a great deal of the tax law has come through administrative rulings and judicial tax law.
True or false: A corporation that receives property in exchange for its stock in a Section 351 transfer recognizes gain or loss realized on the transfer.
False Rationale: The transferee corporation does NOT recognize gain or loss on the transfer.
Match the federal tax form with the description.
Form 1065-Entity level return reporting partnership income Form 7004-Form to request 6-month extension to file Form 1065 Schedule K-Part of Form 1065 that lists ordinary income and all separately stated items at the entity level
Match the liquidating distribution condition with the tax result.
Gain: Partnership distribution of money exceeds partner's outside basis Loss: Partnership distributes only money or hot assets and the partner's outside basis is greater than the bases of the distributed property
Greta contributes property to form Unity Corp. and receives all 100 shares of Unity. A year later, Bjorn contributes property and receives 20 shares of Unity (total 120 shares of Unity outstanding). Which shareholder will receive deferral treatment under Section 351?
Greta only Rationale: Immediately after Greta's contribution she is in control of 80% or more (she controls 100%). Bjorn only controls 16.67% (20/120) after his transfer and may not include his with Greta's as a single transfer.
Snap Inc. and Crackle Corp. own a capital and profits interest in the Cereal Bowl Partnership of 20% and 25%, respectively. There are another 35 partners, all with interests of less than 5%. Snap and Crackle have a June 30 year-end and the 35 other partners have various fiscal year ends. What year end must Cereal Bowl use?
June 30 Rationale: No partners with the same year-end own a majority interest. However, the principal partners have the same year-end of June 30.
A varying interest in a partnership is:
when a partner's interest in the partnership increases and/or decreases during the year
Billy contributes equipment used in a trade or business that he has held for more than 1 year to a partnership in exchange for a partnership interest. What is Billy's holding period immediately after the transfer and one year plus one day later?
Long-term immediately and long term after the year Rationale: The holding period of the partnership interest tacks on the previous holding period of 1231 property contributed.
Andre receives 50 shares of stock with a fair market value of $200,000 plus $50,000 cash in exchange for his contribution of machinery, land and inventory valued at (adjusted basis of) $40,000 ($10,000), $150,000 ($180,000) and $60,000 ($50,000), respectively. How much gain does Andre recognize?
Machinery $8,000 gain; land $0 gain; inventory $10,000 gain Rationale: Allocate the boot of $50,000 based on FMV: machinery 40/250 = 16% x $50,000 = $8,000; land 150/250 = 60% x $50,000 = $30,000; inventory 60/250 = 24% x $12,000. Recognized gain is lesser of realized gain or boot. Machinery gain ($30,000) is greater than boot ($8,000), so recognize boot. Land is realized loss, so no recognition. Inventory gain ($10,000) is less than boot ($12,000) so recognize gain ($10,000).
Taylor Partnership is a general partnership with 3 equal partners. In the current year, Taylor generated taxable business income of $3,000 and made $0 distributions to its partners. How will the $3,000 be taxed for Federal income tax purposes?
No tax at the partnership level and all $3,000 taxed at the partner level. Rationale: Partnerships are taxed as a flow-through and thus the income is taxed at the partner level whether distributions are made or not.
Jon, Stewart, and Stephen decide to form Daily, Inc. Jon and Stewart both contribute cash and property in exchange for a total 67% of the voting stock of the corporation. Stephen contributes services in exchange for the remaining 33%. All three make the contribution at the same time. Which shareholder's contributions will qualify for deferral under Section 351?
None of the shareholders qualify Rationale: The cumulative control test applies only to shareholders contributing property (not services) and thus Jon and Stewart, with only 67% control, do not meet the 80% test. Stephen's contribution of services results in taxable compensation to Stephen.
Hunda Corp. exchanges its voting stock for all of the shares of Kneesawn Corp., held by its sole shareholder, Chevy, in a reorganization. Chevy's basis in his Kneeswan stock was $30,000 and the fair market value of the Hunda stock Chevy received was $100,000. What is Chevy's realized gain, recognized gain and basis in his Hunda shares?
Realized gain = $70,000; Recognized gain = $0; Basis = $30,000 Rationale: Chevy realizes a $70,000 gain, but none is recognized in a Type B merger. His basis in Hunda stock is the carryover basis of the Kneesawn stock he transferred (or $30,000.)
Match the three possible partnership year-ends with the order in which the steps must be examined.
Step 1: Majority interest tax year Step 2: Principal partners Step 3: Least aggregate deferral
Which of the following is NOT a principle that underlies tax-deferred reorganizations?
The acquiring corporation may NOT sell any of the pre-acquisition businesses that were historically held by it. Rationale: The continuity of business does NOT apply to the assets held by the acquiring corporation prior to the acquisition.
Brenda is entitled to a 10% share of the net assets of the GTC Partnership if it were to liquidate. Brenda's right can be described as:
capital interest Rationale: A capital interest is a partner's share of the net assets of a partnership at liquidation.
Partnerships are taxed under:
both the entity and aggregate approach
A partnership interest represents a(n):
bundle of rights granted to partners through a partnership agreement
When determining whether a tax position will be sustained upon examination, a company ______ consider the likelihood that the taxing jurisdiction will examine the position.
cannot---A company must assume that the position will be examined with full knowledge of all relevant information
The right to receive a share of the partnership net assets if the partnership is liquidated is called a(n) _________interest.
capital
A complete redemption of all the stock of the corporation owned by a shareholder is always treated as a(n):
exchange
The amount of a corporate distribution to a shareholder of property, other than cash, is determined by its:
fair market value
True or false: Under no circumstances will a shareholder who has shares redeemed be able to treat the stock redemption as an exchange unless the shareholder meets the bright line change-in-stock-ownership tests.
false---The not essentially equivalent to a dividend test is still available.
Abby contributes property to a corporation in exchange for stock that results in a deferred loss of $4,000. Abby is going to__________ her basis in the stock by the deferred loss.
increase
