Deck 12: Organization, Capital Structure, and Operating Rules

Question 1

Jake, the sole shareholder of Peach Corporation, a C corporation, has the corporation pay him $100,000.For income tax purposes, Jake would prefer to have the payment treated as dividend instead of salary.

Answer 1

True

Question 2

Because of the taxable income limitation, no dividends received deduction is allowed if a corporation has an NOL for the current taxable year.

Answer 2

False

Question 3

Under the "check-the-box" Regulations, a two-owner LLC that fails to elect to be to treated as a corporation will be taxed as a sole proprietorship.

Answer 3

False

Question 4

Donald owns a 45% interest in a partnership that earned $130,000 in the current year.He also owns 45% of the stock in a C corporation that earned $130,000 during the year.Donald received $20,000 in distributions from each of the two entities during the year.With respect to this information, Donald must report $78,500 of income on his individual income tax return for the year.

Question 5

Hornbill Corporation, a cash basis and calendar year C corporation, was formed and began operations on May 1, 2017.Hornbill incurred the following expenses during its first year of operations (May 1 - December 31, 2017): temporary directors meeting expenses of $10,500, state of incorporation fee of $5,000, stock certificate printing expenses of $1,200, and legal fees for drafting corporate charter and bylaws of $7,500.Hornbill Corporation's 2017 deduction for organizational expenditures is $5,800.

Question 6

Eagle Company, a partnership, had a short-term capital loss of $10,000 during the current year.Aaron, who owns 25% of Eagle, will report $2,500 of Eagle's short-term capital loss on his individual tax return.

Question 7

No dividends received deduction is allowed unless the corporation has held the stock for more than 90 days.

Question 8

Thrush Corporation files Form 1120, which reports taxable income of $200,000 in the current year.The corporation's tax is $56,250.

Question 9

Lilac Corporation incurred $4,700 of legal and accounting fees associated with its incorporation.The $4,700 is deductible as startup expenditures on Lilac's tax return for the year in which it begins business.

Question 10

The corporate marginal income tax rates range from 15% to 39%, while the individual marginal income tax rates range from 10% to 39.6%.

Question 11

Rajib is the sole shareholder of Robin Corporation, a calendar year S corporation.In the current year, Robin earned net profit of $350,000 ($520,000 gross income - $170,000 operating expenses) and distributed $80,000 to Rajib.Rajib must report Robin Corporation profit of $350,000 on his Federal income tax return.

Question 12

Double taxation of corporate income results because dividend distributions are included in a shareholder's gross income but are not deductible by the corporation.

Question 13

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 $21,000.

Question 14

Tomas owns a sole proprietorship, and Lucy is the sole shareholder of a C corporation.In the current year both businesses make a net profit of $60,000.Neither business distributes any funds to the owners in the year.For the current year, Tomas must report $60,000 of income on his individual tax return, but Lucy is not required to report any income from the corporation on her individual tax return.

Question 15

Employment taxes apply to all entity forms of operating a business.As a result, employment taxes are a neutral factor in selecting the most tax effective form of operating a business.

Question 16

Don, the sole shareholder of Pastel Corporation (a C corporation), has the corporation pay him a salary of $600,000 in the current year.The Tax Court has held that $200,000 represents unreasonable compensation.Don must report a salary of $400,000 and a dividend of $200,000 on his individual tax return.

Question 17

Carol and Candace are equal partners in Peach Partnership.In the current year, Peach had a net profit of $75,000 ($250,000 gross income - $175,000 operating expenses) and distributed $25,000 to each partner.Peach must pay tax on $75,000 of income.

Question 18

A personal service corporation with taxable income of $100,000 in the current year will have a tax liability of $22,250.

Question 19

Quail Corporation is a C corporation with net income of $125,000 during the current year.If Quail paid dividends of $25,000 to its shareholders, the corporation must pay tax on $100,000 of net income.Shareholders must report the $25,000 of dividends as income.

Question 20

Ed, an individual, incorporates two separate businesses that he owns by establishing two new C corporations.Each corporation generates taxable income of $50,000.As a general rule, each corporation will have a tax liability of $11,125.

Question 21

In a § 351 transfer, a shareholder receives boot of $10,000 but ends up with a realized loss of $3,000.Only $7,000 of the boot will be taxed to the shareholder.

Question 22

A taxpayer may never recognize a loss on the transfer of property in a transaction subject to § 351.

Question 23

Income that is included in net income per books but not included in taxable income is a subtraction item on Schedule M-1.

Question 24

A corporation with $5 million or more in assets must file Schedule M-3 (instead of Schedule M-1).

Question 25

Tina incorporates her sole proprietorship with assets having a fair market value of $100,000 and an adjusted basis of $110,000.Even though § 351 applies, Tina may recognize her realized loss of $10,000.

Question 26

Schedule M-3 is similar to Schedule M-1 in that the form is designed to reconcile net income per books with taxable income.However, an objective of Schedule M-3 is more transparency between financial statements and tax returns than that provided by Schedule M-1.

Question 27

Schedule M-2 is used to reconcile unappropriated retained earnings at the beginning of the year with unappropriated retained earnings at the end of the year.

Question 28

If a transaction qualifies under § 351, any recognized gain is equal to the value of the boot received.

Question 29

On December 31, 2017, Flamingo, Inc., a calendar year, accrual method C corporation, accrues a bonus of $50,000 to its president (a cash basis taxpayer), who owns 75% of the corporation's outstanding stock.The $50,000 bonus is paid to the president on February 2, 2018.For Flamingo's 2017 Form 1120, the $50,000 bonus will be a subtraction item on Schedule M-1.

Question 30

A corporation must file a Federal income tax return even if it has no taxable income for the year.

Question 31

Allen transfers marketable securities with an adjusted basis of $120,000, fair market value of $300,000, for 85% of the stock of Heron Corporation.In addition, he receives cash of $40,000.Allen recognizes a capital gain of $40,000 on the transfer.

Question 32

The transfer of an installment obligation in a transaction qualifying under § 351 is a disposition of the obligation that causes gain to be recognized by the transferor.

Question 33

Similar to the like-kind exchange provision, § 351 can be partly justified under the wherewithal to pay concept.

Question 34

Similar to like-kind exchanges, the receipt of "boot" under § 351 can cause loss to be recognized.

Question 35

A calendar year C corporation can receive an automatic 9-month extension to file its corporate return (Form 1120) by timely filing a Form 7004 for the tax year.

Question 36

Schedule M-1 is used to reconcile net income as computed for financial accounting purposes with taxable income reported on the corporation's income tax return.

Question 37

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.

Question 38

For purposes of the estimated tax payment rules, a "large corporation" is defined as a corporation that had taxable income of $1 million or more in any of the three preceding years.

Question 39

When consideration is transferred to a corporation in return for stock, the definition of "property" is important because tax deferral treatment of § 351 is available only to taxpayers who transfer property.

Question 40

Gabriella and Maria form Luster Corporation with each receiving 50 shares of its stock.Gabriella transfers cash of $50,000, while Maria transfers a proprietary formula (basis of $0; fair market value of $50,000).Neither Gabriella nor Maria will recognize gain on the transfer.

Question 41

In determining whether § 357(c) applies, assess whether the liabilities involved exceed the bases of all assets a shareholder transfers to the corporation.

Question 42

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.

Question 43

When incorporating her sole proprietorship, Samantha transfers all of its assets and liabilities.Included in the $30,000 of liabilities assumed by the corporation is $500 that relates to a personal expenditure.Under these circumstances, the entire $30,000 will be treated as boot.

Question 44

Carl and Ben form Eagle Corporation.Carl transfers cash of $50,000 for 50 shares of stock of Eagle.Ben transfers proprietary information with a tax basis of zero and a fair market value of $50,000 for the remaining 50 shares in Eagle.Carl will have a tax basis of $50,000 in his stock in Eagle Corporation and Ben's basis in his stock will be zero.

Question 45

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

Question 46

The receipt of nonqualified preferred stock in exchange for the transfer of appreciated property to a controlled corporation results in recognition of gain to the transferor.

Question 47

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

Question 48

The use of § 351 is not limited to the initial formation of a corporation, and it can apply to later transfers as well.

Question 49

Because boot is generated under § 357(b) (i.e., the liability is not supported by a bona fide business purpose), the transferor shareholder will always have to recognize gain.

Question 50

If both §§ 357(b) and (c) apply to the same transfer (i.e., the liability is not supported by a bona fide business purpose and also exceeds the basis of the properties transferred), § 357(c) predominates.

Question 51

When a taxpayer transfers property subject to a mortgage to a controlled corporation in an exchange qualifying under § 351, the transferor shareholder's basis in stock received in the transferee corporation is increased by the amount of the mortgage on the property.

Question 52

Ruth transfers property worth $200,000 (basis of $60,000) to Goldfinch Corporation.In return, she receives 80% of its stock (worth $180,000) and a long-term note, executed by Goldfinch and made payable to Ruth (worth $20,000).Ruth will recognize no gain on the transfer.

Question 53

In a § 351 transaction, if a transferor receives consideration other than stock, the transaction can be taxable.

Question 54

Beth forms Lark Corporation with a transfer of appreciated property in exchange for all of its shares.Shortly thereafter, she transfers half her shares to her son, Ted.The later transfer to Ted could cause the original transfer to be taxable.

Question 55

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.

Question 56

In general, the basis of property to a corporation in a transfer that qualifies as a nontaxable exchange under § 351 is the basis in the hands of the transferor shareholder decreased by the amount of any gain recognized on the transfer.

Question 57

A person who performs services for a corporation in exchange for stock cannot be treated as a member of the transferring group even if that person also transfers some property to the corporation.

Question 58

In return for legal services worth $60,000 rendered incident to its formation, Crimson Corporation issues stock to Greta, an attorney.Crimson cannot immediately deduct the value of any of this stock but instead must capitalize it as an organizational expenditure.

Question 59

In order to retain the services of Eve, a key employee in Ted's sole proprietorship, Ted contracts with Eve to make her a 30% owner.Ted incorporates the business receiving in return 100% of the stock.Three days later, Ted transfers 30% of the stock to Eve.Under these circumstances, § 351 will not apply to the incorporation of Ted's business.

Question 60

For § 351 purposes, stock rights and stock warrants are included in the definition of "stock."

Question 61

A city contributes $500,000 to a corporation as an inducement to locate in the city.Within the next 12 months, the corporation uses the money to purchase property.The corporation has income of $500,000 and must reduce its tax basis in the property by the same amount.

Question 62

Rachel is the sole member of an LLC, and Jordan is the sole shareholder of a C corporation.Both businesses were started in the current year, and each business has a long-term capital gain of $10,000 for the year.Neither business made any distributions during the year.With respect to this information, which of the following statements is correct?

A)The C corporation receives a preferential tax rate on the LTCG of $10,000.
B)The LLC must pay corporate tax on taxable income of $10,000.
C)Jordan must report $10,000 of LTCG on his tax return.
D)Rachel must report $10,000 of LTCG on her tax return.
E)None of the above.

Question 63

In structuring the capitalization of a corporation, the tax law is neutral for the investor as to debt versus equity financing.

Question 64

Elk, a C corporation, has $370,000 operating income and $290,000 operating expenses during the current year.In addition, Elk has a $10,000 long-term capital gain and a $17,000 short-term capital loss.Elk's taxable income is:

A)$63,000.
B)$73,000.
C)$80,000.
D)$90,000.
E)None of the above.

Question 65

A shareholder's holding period for stock received under § 351 can include the holding period of the property transferred to the corporation.

Question 66

Kim, a real estate dealer, and others form Eagle Corporation under § 351.Kim contributes inventory (land held for resale) in return for Eagle stock.The holding period for the stock includes the holding period of the inventory.

Question 67

Flycatcher Corporation, a C corporation, has two equal individual shareholders, Nancy and Pasqual.In the current year, Flycatcher earned $100,000 net profit and paid a dividend of $10,000 to each shareholder.Regardless of any tax consequences resulting from their interests in Flycatcher, Nancy is in the 33% marginal tax bracket and Pasqual is in the 15% marginal tax bracket.With respect to the current year, which of the following statements is incorrect?

A)Flycatcher cannot avoid the corporate tax altogether by distributing all $100,000 of net profit as dividends to the shareholders.
B)Nancy incurs income tax of $1,500 on her dividend income.
C)Pasqual incurs income tax of $1,500 on his dividend income.
D)Flycatcher pays corporate tax of $22,250.
E)None of the above.

Question 68

A shareholder transfers a capital asset to Red Corporation for its stock.If the transfer qualifies under § 351, Red's holding period for the asset begins on the day of the exchange.

Question 69

Red Corporation, which owns stock in Blue Corporation, had net operating income of $200,000 for the year.Blue pays Red a dividend of $40,000.Red takes a dividends received deduction of $28,000.Which of the following statements is correct?

A)Red owns 80% of Blue Corporation.
B)Red owns 20% or more, but less than 80% of Blue Corporation.
C)Red owns 80% or more of Blue Corporation.
D)Red owns less than 20% of Blue Corporation.
E)None of the above.

Question 70

Norma formed Hyacinth Enterprises, a proprietorship, in the current year.During the year, Hyacinth had operating income of $400,000 and operating expenses of $240,000.In addition, Hyacinth had a long-term capital loss of $10,000.Norma withdrew $75,000 from Hyacinth during the year.Assuming Norma has no other capital gains or losses, and ignoring any self-employment taxes, how does this information affect her adjusted gross income for the year?

A)Increases Norma's adjusted gross income by $157,000 ($160,000 ordinary business income - $3,000 long-term capital loss).
B)Increases Norma's adjusted gross income by $150,000 ($160,000 ordinary business income - $10,000 long-term capital loss).
C)Increases Norma's adjusted gross income by $75,000.
D)Increases Norma's adjusted gross income by $160,000.
E)None of the above.

Question 71

Copper Corporation owns stock in Bronze Corporation and has net operating income of $900,000 for the year.Bronze Corporation pays Copper a dividend of $150,000.What amount of dividends received deduction may Copper claim if it owns 85% of Bronze stock (assuming Copper's dividends received deduction is not limited by its taxable income)?

A)$97,500
B)$105,000
C)$120,000
D)$150,000
E)None of the above

Question 72

Which of the following statements is incorrect about LLCs and the check-the-box Regulations?

A)If a limited liability company with more than one owner does not make an election, the entity is taxed as a corporation.
B)All 50 states have passed laws that allow LLCs.
C)An entity with more than one owner and formed as a corporation cannot elect to be taxed as a partnership.
D)If a limited liability company with one owner does not make an election, the entity is taxed as a sole proprietorship.
E)A limited liability company with one owner can elect to be taxed as a corporation.

Question 73

In order to encourage the development of an industrial park, a county donates land to Ecru Corporation.The donation does not result in gross income to Ecru.

Question 74

To ease a liquidity problem, all of the shareholders of Osprey Corporation contribute additional cash to its capital.Osprey has no tax consequences from the contribution.

Question 75

When depreciable property is transferred to a controlled corporation under § 351, any recapture potential disappears and does not carry over to the corporation.

Question 76

Lucinda is a 60% shareholder in Rhea Corporation, a calendar year S corporation.During the current year, Rhea Corporation had gross income of $550,000 and operating expenses of $380,000.In addition, the corporation sold land that had been held for investment purposes for a short-term capital gain of $30,000.During the year, Rhea Corporation distributed $50,000 to Lucinda.With respect to this information, which of the following statements is correct?

A)Rhea Corporation will pay tax on taxable income of $200,000.
B)Lucinda reports ordinary income of $50,000.
C)Lucinda reports ordinary income of $120,000.
D)Lucinda reports ordinary income of $102,000 and a short-term capital gain of $18,000.
E)None of the above.

Question 77

A shareholder contributes land to his wholly owned corporation but receives no stock in return.The corporation has a zero basis in the land.

Question 78

Juanita owns 60% of the stock in a C corporation that had a profit of $200,000 in the current year.Carlos owns a 60% interest in a partnership that had a profit of $200,000 during the year.The corporation distributed $45,000 to Juanita, and the partnership distributed $45,000 to Carlos.With respect to this information, which of the following statements is incorrect?

A)Juanita must report $120,000 of income from the corporation.
B)The corporation must pay corporate tax on $200,000 of income.
C)Carlos must report $120,000 of income from the partnership.
D)The partnership is not subject to a Federal entity-level income tax.
E)None of the above.

Question 79

Bjorn owns a 60% interest in an S corporation that earned $150,000 in the current year.He also owns 60% of the stock in a C corporation that earned $150,000 during the year.The S corporation distributed $30,000 to Bjorn and the C corporation paid dividends of $30,000 to Bjorn.How much income must Bjorn report from these businesses?

A)$0 income from the S corporation and $30,000 income from the C corporation.
B)$30,000 income from the S corporation and $30,000 of dividend income from the C corporation.
C)$90,000 income from the S corporation and $0 income from the C corporation.
D)$90,000 income from the S corporation and $30,000 income from the C corporation.
E)None of the above.

Question 80

Pablo, a sole proprietor, sold stock held as an investment for a $40,000 long-term capital gain.Pablo's marginal tax rate is 33%.Loon Corporation, a C corporation, sold stock held as an investment for a $40,000 long-term capital gain.Loon's marginal tax rate is 35%.What tax rates are applicable to these capital gains?

A)15% rate applies to Pablo and 35% rate applies to Loon.
B)15% rate applies to Loon and 33% rate applies to Pablo.
C)35% rate applies to Loon and 33% rate applies to Pablo.
D)15% rate applies to both Pablo and Loon.
E)None of the above.