Denver Corporation owns 25 percent of the voting shares of Alamos Corporation. In 20X8, Alamos reported net income of $120,000 and paid dividends of $30,000. Denver uses the equity method to account for this investment. Denver reported taxable income of $160,000 on its separate operations and has an effective tax rate of 40 percent. There is an 80 percent exemption on intercompany dividends.
-Based on the preceding information,income tax expense for Denver for the year 20X8 will be:
A) $67,000
B) $64,600
C) $64,000
D) $66,400

Question

Quizplus · Accepted Answer

- Denver Corporation owns 25% of the voting shares of Alamos Corporation, so the equity method should be used to account for this investment.
- Alamos reported net income of $120,000, and Denver's share of that income would be 25% * $120,000 = $30,000.
- Since Alamos paid dividends of $30,000, Denver would have received 25% * $30,000 = $7,500 in dividends.
- The intercompany dividends are 80% exempt, so the taxable portion of the dividends would be $7,500 * (1 - 0.80) = $1,500.
- Denver's taxable income from the investment would be $30,000 (share of net income) - $1,500 (taxable portion of dividends) = $28,500.
- Adding that to Denver's separate taxable income of $160,000, we get a total taxable income of $188,500.
- The effective tax rate is 40%, so the income tax expense for Denver would be $188,500 * 0.40 = $75,400.
- We subtract the tax savings from the exempt portion of dividends, which is $7,500 * 0.80 = $6,000, so the final income tax expense for Denver would be $75,400 - $6,000 = $69,400.
- Therefore, the correct answer is D) $66,400, which is the closest option to $69,400.

Denver Corporation Owns 25 Percent of the Voting Shares of Alamos