Chapter 22 S Corporations True / False Questions S corporations offer the same legal protection to owners as C corporations True False The S corporation rules are less complex for S corporations that have earnings and profits from prior C corporation years than for S corporations that not have earnings and profits from prior C corporation years True False The same exact requirements for forming and contributing property govern S corporations and partnerships True False S corporations may have no more than 50 shareholders, but members of the same family only count as one shareholder True False Differences in voting powers are permissible across shares of S corporation stock as long as the shares have identical distribution and liquidation rights True False Publicly traded corporations cannot be treated as S corporations True False To make an S election effective as of the beginning of the current year, an S corporation must file Form 2553 within 3½ months after the beginning of the year True False Bobby T (95% owner) would like to elect S corporation status for DJ, Inc Dallas (5% owner) does not want to elect S corporation status Bobby T cannot elect S status for DJ, Inc without Dallas' consent True False An S corporation may be voluntarily or involuntarily terminated True False 22-1 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 10 An S corporation can make a voluntary revocation of an S election if shareholders holding more than 25 percent of the S corporation stock (including nonvoting shares) agree True False 11 Bobby T (75% owner) would like to terminate the S corporation status for DJ, Inc Dallas (5% owner) does not want to terminate the S corporation status Bobby T can terminate the S status for DJ, Inc without Dallas' consent True False 12 An S election is terminated if the S corporation has passive investment income in excess of 20 percent of gross receipts for three consecutive years True False 13 If an S corporation never operated as a C corporation, it may earn passive investment income without fear of an involuntary S election termination True False 14 If an S corporation shareholder sells her stock to a nonresident alien, it will automatically terminate the S election True False 15 The specific identification method is a method an S corporation may use to allocate its income across short tax years that result from an involuntary S election termination True False 16 The specific identification method and monthly allocation method are methods an S corporation may use to allocate its income across short tax years that result from an involuntary S election termination True False 17 After terminating or voluntarily revoking S corporation status, a corporation may elect it again, but it generally must wait until the beginning of the third tax year after the tax year in which it terminated the election True False 18 Like partnerships, S corporations determine their accounting periods and make accounting method elections at the entity level True False 19 Like partnerships and C corporations, S corporations face several restrictions on using the cash method of accounting True False 22-2 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 20 An S corporation can use a non-calendar year-end if it can establish a business purpose for an alternative year end True False 21 SoTired, Inc., a C corporation with a June 30 year-end, elects S corporation status this year Assuming no special elections, SoTired, Inc will continue to use a June 30 yearend as an S corporation True False 22 S corporations have considerable flexibility in making special profit and loss allocations True False 23 Separately stated items are tax items that are treated similarly for tax purposes as a shareholder's share of ordinary business income (loss) True False 24 S corporations are not entitled to a dividends received deduction True False 25 An S corporation shareholder calculates his initial basis upon formation of the corporation like C corporation shareholders True False 26 Like partnerships, an S corporation shareholder's basis is dynamic and must be adjusted annually True False 27 Unlike partnerships, adjustments that decrease an S corporation shareholder's basis may reduce it below zero True False 28 In general, an S corporation shareholder makes increasing adjustments to her basis first, followed by adjustments that decrease basis True False 29 S corporation shareholders are not allowed to include any S corporation debt in their stock basis True False 30 For an S corporation shareholder to deduct it, a loss must clear three separate hurdles: (1) tax basis, (2) at-risk amount, and (3) tax-shelter rules True False 22-3 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 31 Losses not deductible due to the basis rules are carried over to future years True False 32 Regarding debt, S corporation shareholders are deemed at risk only for direct loans they make to S corporations True False 33 An S corporation shareholder's allocable share of ordinary business income (loss) is classified as self-employment income for tax purposes True False 34 An S corporation shareholder's allocable share of business income that is a passive activity is considered net investment income for purposes of the Net Investment Income tax True False 35 S corporations are treated in part like C corporations and in part like partnerships with respect to tax deductions for qualifying employee fringe benefits True False 36 For S corporations with earnings and profits from prior C corporation years, the taxation of distributions is very similar to the rules for partnerships True False 37 For S corporations without earnings and profits from prior C corporation years, the taxation of distributions is very similar to the rules for partnerships True False 38 Similar to an S corporation shareholder's stock basis, the AAA may not have a negative balance True False 39 Distributions to owners may not cause the AAA to go negative or to become more negative True False 40 When an S corporation distributes appreciated property to its shareholders the S corporation recognizes gain as though it had sold the appreciated property for its fair market value just prior to the distribution True False 22-4 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 41 When an S corporation distributes appreciated property to its shareholders, the shareholders who receive the distributed property recognize their distributive share of the deemed gain True False 42 S corporations recognize gains and losses on distributions of property True False 43 S corporation distributions are not taxable to the extent of stock and debt basis True False 44 During the post-termination transition period, property distributions are tax-free to shareholders to the extent they not exceed the corporation's AAA balance and the individual shareholder's basis in the stock True False 45 S corporations generally recognize gain or loss on each asset they distribute in liquidation True False 46 The built-in gains tax does not apply to S corporations that never operated as C corporations True False 47 Built-in gains recognized fifteen years after a C corporation elects to become an S corporation are subject to the built-in gains tax True False 48 S corporations without earnings and profits from prior C corporation years are not subject to the excess net passive income tax True False 49 C corporations that elect S corporation status and use the FIFO inventory method are subject to the FIFO recapture tax True False 50 The estimated tax rules for S corporations generally follow the rules for C corporations True False 51 S corporations are required to file Form 1120S, U.S Income Tax Return for an S Corporation, with the IRS by the fifteenth day of the fourth month after the S corporation's year end True False 22-5 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Multiple Choice Questions 52 Which of the following is prohibited from being an S corporation shareholder? A Foreign citizens that are U.S residents B U.S citizens C Corporation s D 51 unrelated individuals E None of these 53 Which of the following is not considered a family member for purposes of the S corporation shareholder limit? A brothe r B greatgrandparent C grandchildre n D grandpare nt E None of these 54 Tone Loc and 89 of his biggest fans formed an S corporation, 2hit, Inc., as the original ninety shareholders Tone then transferred some of his stock to his grandfather, four of Tone's cousins, five of Tone's children, three of Tone's grandchildren, and close friends For the S corporation shareholder limit rules, how many shareholders does 2hit, Inc have? A 90 B 92 C 95 D 97 E None of these 22-6 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 55 Which of the following is a requirement to be an S corporation? A be a domestic or foreign corporation B have only one class of stock C have fewer than 75 shareholders D have at least one corporate shareholder E None of these 56 Suppose Hassell formed a C corporation, NewCorp Inc., in 2014 with a calendar tax year and made an S election on April 14, 2014 with the consent of NewCorp Inc.'s shareholders: Hassell, Richie Cunningham, and Arnold's, Inc (a C corporation) When is the S election effective? A January 1, 2014 B April 14, 2014 C January 1, 2015 D April 14, 2015 E Never 57 J D formed Clampett, Inc as a C corporation (calendar tax year) with J D., Granny, and Jethro, Inc (a C corporation) as shareholders On January 15, 2014, Jethro, Inc sold all its shares to Jane Hathaway On February 28, 2014, Clampett, Inc filed an S corporation election, with J D., Granny, and Jane all consenting to the election What is the earliest effective date of the S election? A January 1, 2014 B January 1, 2015 C January 1, 2016 D February 28, 2015 E Never 22-7 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 58 If Annie and Andy (each a 30% shareholder) file a revocation on February 10, 2014 to terminate their S corporation's S election, what is the effective date of the S corporation termination (assuming they not specify one)? A January 1, 2014 B February 10, 2014 C January 1, 2015 D February 10, 2015 E None of these 59 If Annie and Andy (each a 30% shareholder) file a revocation on March 18, 2014 to terminate their S corporation's S election, what is the effective date of the S corporation termination (assuming they not specify one)? A January 1, 2014 B March 16, 2014 C January 1, 2015 D March 16, 2015 E None of these 60 Which of the following would not result in an S election termination? A Having 120 unrelated shareholders B Having a corporation as a shareholder C Issuing a second class of stock D Having excess passive investment income for two consecutive years E None of these 22-8 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 61 On March 15, 2014, J D sold his Clampett, Inc (an S corporation) shares to Ellie Mae, Inc (a C corporation), terminating Clampett, Inc.'s S election on March 15, 2014 Absent permission from the IRS, what is the earliest date Clampett, Inc may again elect to be taxed as an S corporation? A January 1, 2020 B January 1, 2019 C January 1, 2018 D January 1, 2017 E January 1, 2015 62 The IRS may consent to an early re-election of S corporation status after a termination under which of the following: A The corporation is now owned more than 10 percent by shareholders who were not owners at the time of termination B The corporation is now owned more than 60 percent by shareholders who were owners at the time of termination C The termination was not reasonably within the control of the corporation or shareholders with a substantial interest in the corporation and was not part of a planned termination by the corporation or shareholders D The corporation had only two ineligible shareholders at the termination date E None of these 63 Assume Joe Harry sells his 25% interest in Joe's S Corp Inc to Tyrone on January 29 Using the daily allocation method, how much income does Joe Harry report if Joe's S Corp Inc earned $200,000 from January to January 28 and a total of $1,460,000 from January through December 31 (365 days)? A $28,00 B $50,00 C $112,00 D $200,00 E None of these 22-9 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 64 Assume Joe Harry sells his 25% interest in Joe's S Corp Inc to Tyrone on January 29 Using the specific identification allocation method, how much income does Joe Harry report if Joe's S Corp Inc earned $200,000 from January to January 28 and a total of $1,460,000 from January through December 31 (365 days)? A $28,00 B $50,00 C $112,00 D $200,00 E None of these 65 Which of the following is not a separately stated item for S corporations? A Dividend s B Interest income C Charitable contributions D Investment interest expense E All of these are separately stated items 66 Vanessa contributed $20,000 of cash and land with a fair market value of $100,000 and an adjusted basis of $40,000 to Cook, Inc (an S corporation) when it was formed The land was encumbered by a $30,000 mortgage executed two years before What is Vanessa's tax basis in Cook, Inc after formation? A $20,00 B $30,00 C $60,00 D $80,00 E $120,00 22-10 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Learning Objective: 22-02 Explain the events that terminate the S corporation election Level of Difficulty: Easy Topic: S Corporation terminations 113 XYZ was formed as a calendar-year S corporation with Xavier, Yolinda, and Zach as equal shareholders On September 15, 2014, XYZ's S election was terminated after Zach sold his XYZ shares (one-third of all shares) to his solely owned C Corporation Zach, Inc Absent permission from the IRS, what is the earliest date XYZ may again elect to be taxed as an S corporation? January 1, 2019 Feedback: This is the fifth tax year after 2014, which is the year in which the termination became effective AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-02 Explain the events that terminate the S corporation election Level of Difficulty: Medium Topic: S Corporation terminations 114 CB Corporation was formed as a calendar-year S corporation Casey is a 60% shareholder and Bryant is a 40% shareholder On September 30, 2014, Bryant sold his CB shares to Don CB reported business income for 2014 as follows (assume that there are 365 days in the year): How much 2014 income is allocated to each shareholder if CB corp uses the daily method of allocating income? Casey is allocated $438,000 of income ($730,000 × 60%) Bryant is allocated $218,400 ($730,000/365 × 273 × 40%) and Don is allocated $73,600 ($730,000/365 × 92 × 40%) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-03 Describe operating issues relating to S corporation accounting periods and methods; and explain income and loss allocations and separately stated items Level of Difficulty: Medium Topic: Operating issues 22-93 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 115 CB Corporation was formed as a calendar-year S corporation Casey is a 60% shareholder and Bryant is a 40% shareholder On September 30, 2014, Bryant sold his CB shares to Don CB reported business income for 2014 as follows (assume that there are 365 days in the year): How much 2014 income is allocated to each shareholder if CB uses its normal accounting rules to allocate income to the specific periods in which it was actually earned? Casey is allocated $438,000 of income ($730,000 × 60%) Bryant is allocated $80,000 ($200,000 × 40%) and Don is allocated $212,000 ($530,000 × 40%) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-03 Describe operating issues relating to S corporation accounting periods and methods; and explain income and loss allocations and separately stated items Level of Difficulty: Easy Topic: Operating issues 22-94 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 116 XYZ Corporation (an S corporation) is owned by Jane and Rebecca who are each 50% shareholders At the beginning of the year, Jane's basis in her XYZ stock was $40,000 XYZ reported the following tax information for 2014 Required: a What amount of ordinary business income is allocated to Jane? b What is the amount and character of separately stated items allocated to Jane? c What is Jane's basis in her XYZ corp stock at the end of the year? Answer to parts a and b: See the following table for the allocations: Answer to part c: Jane's stock basis at the end of the year is $217,000 ($40,000 + 169,000 + 4,000 + 2,500 + 1,500) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-03 Describe operating issues relating to S corporation accounting periods and methods; 22-95 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education and explain income and loss allocations and separately stated items Learning Objective: 22-04 Explain stock-basis calculations; loss limitations; determination of self-employment income; and fringe benefit rules that apply to S corporation shareholders Level of Difficulty: Medium Topic: Operating issues Topic: Shareholder basis 117 At the beginning of the year, Harold, Missy, and Ranae formed HMR Corporation as an S corporation For one-third of the HMR stock, Harold contributed $50,000 cash and land with a fair market value of $75,000 and adjusted tax basis of $60,000 The land was subject to a $45,000 mortgage, which was assumed by HMR on the formation Missy and Ranae each contributed $80,000 cash to HMR for one-third of the HMR stock What is Harold's basis in the HMR stock after the formation? What is Missy's basis in her HMR stock after the formation? Harold's stock basis is $65,000 ($50,000 cash + $60,000 basis of land contributed - $45,000 mortgage relief) Missy's stock basis is $80,000 (this is the amount of cash she contributed) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-04 Explain stock-basis calculations; loss limitations; determination of self-employment income; and fringe benefit rules that apply to S corporation shareholders Level of Difficulty: Medium Topic: Shareholder basis 118 Jackson is the sole owner of JJJ corp (an S corporation) At the beginning of 2014, Jackson's basis in his JJJ stock was $8,000 For 2014, JJJ reported a ($30,000) ordinary business loss (not a passive loss) and $4,000 of long-term capital gains Assuming Jackson's tax basis and his at risk amount are the same, what is Jackson's stock basis at the end of the year and how much of the ordinary business loss is he allowed to deduct in 2014? Jackson's stock basis at the end of the year is $0 ($8,000 + $4,000 long-term capital gain - 12,000 ordinary business loss) and he can deduct $12,000 (his basis and at risk amounts before considering the ordinary loss) of the ordinary business loss in 2014 The remaining $18,000 loss is suspended AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-04 Explain stock-basis calculations; loss limitations; determination of self-employment income; and fringe benefit rules that apply to S corporation shareholders Level of Difficulty: Medium Topic: Shareholder basis 22-96 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 119 Jackson is the sole owner of JJJ corp (an S corporation) At the end of 2014, Jackson's basis in his JJJ stock and his at risk amount was $0 Jackson also had a $10,000 suspended ordinary business loss (suspended at the tax basis and at risk level) JJJ's S election was terminated effective the end of the day on December 31, 2014 If Jackson contributes $6,000 cash to JJJ on July 1, 2015 and $3,000 cash on January 5, 2016, how much of his $10,000 suspended loss will he be allowed to deduct and how much disappears unused? Jackson will be allowed to deduct $6,000 of the ordinary business loss and $4,000 will expire unused Jackson can deduct $6,000 because he created $6,000 additional stock basis in the post termination transition period that begins on January 1, 2015 and ends December 31, 2015 (the later of the extended due date of the final S corporation tax return or one year from the date of the termination) Because the $3,000 contribution is after December 31, 2015 it does not create additional basis that can absorb the suspended loss (it simply creates stock basis in his C corporation stock) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-04 Explain stock-basis calculations; loss limitations; determination of self-employment income; and fringe benefit rules that apply to S corporation shareholders Level of Difficulty: Medium Topic: Shareholder basis 120 Parker is a 100% shareholder of Johnson Corp (an S corporation) At the beginning of 2014, Parker's basis in his Johnson Corp stock was $14,000 During 2014, Parker loaned $20,000 to Johnson Corp and Johnson Corp reported a $25,000 ordinary business loss and no separately stated items In 2015, Johnson Corp reported $8,000 of ordinary business income a How much of the $25,000 ordinary loss allocated to Parker clears the tax basis hurdle for deductibility in 2014? b What is Parker's stock and debt basis at the end of 2014? c What is Parker's stock and debt basis at the end of 2015? Answer to parts a and b: All $25,000 of the ordinary loss clears the tax basis hurdle for deductibility The first $14,000 of the loss reduces his stock basis to $0 at the end of 2014 and the remaining $11,000 reduces his debt basis to $9,000 ($20,000 - $11,000) Answer to part c: The $8,000 of ordinary income restores a portion of his Parker's debt basis So, at the end of 2015, Parker's stock basis is $0 and his debt basis is $17,000 ($9,000 + $8,000) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-04 Explain stock-basis calculations; loss limitations; determination of self-employment income; and fringe benefit rules that apply to S corporation shareholders 22-97 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Level of Difficulty: Medium Topic: Shareholder basis 121 Lamont is a 100% owner of JKL Corporation JKL has been an S corporation since its inception in 2014 During 2016, JKL distributed $20,000 to Lamont During 2016, JKL reported $5,000 of business income and no separately stated items What is the amount and character of the gain, if any, Lamont must recognize in each of the following alternative scenarios? Also, what is Lamont's stock basis at the end of 2016 in each of the following scenarios? a Lamont's stock basis at the beginning of the year was $30,000 b Lamont's stock basis at the beginning of the year was $4,000 Answer to part a: Lamont does not recognize any gain on the distribution and his stock basis at the end of the year is $15,000 ($30,000 initial basis + $5,000 business income allocation - $20,000 distribution) Answer to part b: Lamont recognizes $11,000 of long-term capital gain ($4,000 basis at beginning of year + $5,000 income allocation - $20,000 distribution) The distribution in excess of basis is a long-term capital gain because the Lamont's stock in JKL is a capital asset and Lamont held the stock for more than a year Lamont's stock basis at the end of the year is AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-04 Explain stock-basis calculations; loss limitations; determination of self-employment income; and fringe benefit rules that apply to S corporation shareholders Level of Difficulty: Medium Topic: Shareholder basis 22-98 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 122 Hector formed H Corporation as a C corporation at the beginning of 2014 Hector was the sole shareholder of H Corporation H Corp reported 2014 taxable income (and earnings and profits) of $200,000 At the beginning of 2015, H Corp elected S corporation status During 2015, H Corp had a rough year, reporting an ordinary business loss of $70,000, $4,000 of dividend income, and $3,000 of interest income H Corp also distributed $15,000 to Hector What is the amount and character of gain/income Hector must recognize on the distribution (if any)? What is the balance in H Corporation's accumulated adjustments account (AAA) at the end of 2015? Hector must recognize $15,000 of dividend income and the balance in H Corporation's AAA at the end of 2015 is ($63,000) The entire distribution is a dividend to Hector because H Corp did not have a positive balance in its AAA account It began the year with a zero balance Because the current year adjustment to AAA is a net negative adjustment [($63,000) = ($0 + (70,000) loss + $4,000 dividend + $3,000 interest)], the distribution comes before the net negative adjustment However, because the AAA balance before the net negative adjustment is $0, the distribution does not come from AAA and is therefore entirely from E&P (there is sufficient E&P to absorb the distribution) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-05 Apply the tax rules for S corporation operating distributions and liquidating distributions Level of Difficulty: Medium Topic: Distributions 123 Hazel is the sole shareholder of Maple Corp In 2014 Maple operated as a C corporation and reported $15,000 of taxable income (and earnings and profits) In 2014, Maple elected S corporation status During 2015 Maple reported $12,000 of ordinary business income and no separately stated items It also distributed $25,000 to Hazel What is the amount and character of income Hazel must recognize on the distribution? What is Hazel's stock basis at the end of 2015 (after accounting for the distribution) if her basis at the beginning of the year was $5,000? The first $12,000 of the distribution comes from Maple Corp.'s AAA and reduces the AAA balance to zero ($0 beginning balance + $12,000 income - $12,000 distribution = $0) This portion of the distribution reduces Hazel's stock basis by $12,000 but is not taxable Her stock basis at the end of the year is $5,000 ($5,000 basis at beginning of year + $12,000 ordinary income - $12,000 of the distribution out of AAA) The remaining $13,000 of the distribution comes from Maple Corp.'s earnings and profits ($15,000 beginning balance - $13,000 distribution = $2,000 end of year balance) Hazel must recognize $13,000 of dividend income on the distribution from earnings and profits AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking 22-99 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Blooms: Apply Learning Objective: 22-05 Apply the tax rules for S corporation operating distributions and liquidating distributions Level of Difficulty: Medium Topic: Distributions 124 Vanessa is the sole shareholder of V Corporation V Corporation was formerly a C corporation but is currently an S corporation At the end of 2014, before considering distributions, V Corporation's accumulated adjustments account (AAA) balance was $35,000 and its accumulated E&P from its years as a C corporation was $10,000 On July 1, V Corporation distributed $60,000 to Vanessa What is the amount and character of income Vanessa must recognize on the distribution if her stock basis before considering the distribution was $60,000? What is Vanessa's stock basis after accounting for the distribution? Vanessa must recognize $10,000 of dividend income The first $35,000 of the distribution is deemed to be paid from V Corp.'s AAA and is nontaxable to Vanessa (it reduces her stock basis to $25,000) The next $10,000 is a dividend from V Corp.'s E&P The remaining $15,000 of the distribution reduces Vanessa's stock basis and is not taxable to her At the end of the year, Vanessa's stock basis is $10,000 ($25,000 - 15,000) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-05 Apply the tax rules for S corporation operating distributions and liquidating distributions Level of Difficulty: Medium Topic: Distributions 125 During 2014, CDE Corporation (an S corporation since its inception in 2012) distributed a parcel of land to its sole shareholder Clark The fair market value of the land at the time of the distribution was $80,000 and CDE's tax basis in the property was $30,000 Before considering the effects of the distribution, Clark's basis in his CDE stock was $10,000 What amount of gain, if any, does CDE recognize on the distribution? What amount of income, if any, does Clark recognize on the distribution and what is Clark's basis in his CDE stock after accounting for the distribution? CDE recognizes $50,000 of gain on the distribution ($80,000 fair market value $30,000 basis), which is allocated (and taxable) to Clark Clark must also recognize a $20,000 long-term capital gain on the distribution because the $80,000 distribution exceeds his basis in the stock by $20,000 ($10,000 beginning stock basis + $50,000 taxable income allocated from CDE - $80,000 distribution) This excess distribution is a treated as a long-term capital gain because Clark has held his CDE stock for more than a year Clark's stock basis in his CDE stock is $0 after accounting for the distribution AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking 22-100 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Blooms: Apply Learning Objective: 22-05 Apply the tax rules for S corporation operating distributions and liquidating distributions Level of Difficulty: Hard Topic: Distributions 126 During 2014, CDE Corporation (an S corporation since its inception in 2012) liquidates this year by distributing a parcel of land to its sole shareholder Clark The fair market value of the land at the time of the distribution was $100,000 and CDE's tax basis in the property was $130,000 Before considering the effects of the distribution, Clark's basis in his CDE stock was $40,000 What amount of loss, if any, does CDE recognize on the distribution? What amount of income, if any, does Clark recognize on the distribution and what is his basis in the land? CDE recognizes $30,000 of loss on the distribution ($100,000 fair market value $130,000 basis), which is allocated (and deductible) to Clark Clark must also recognize a $90,000 long-term capital gain on the distribution because the $100,000 distribution exceeds his basis in the stock by $90,000 ($40,000 beginning stock basis - $30,000 loss allocated from CDE - $100,000 distribution) This excess distribution is a treated as a long-term capital gain because Clark has held his CDE stock for more than a year Clark's basis in the land is its fair market value, $100,000 AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-05 Apply the tax rules for S corporation operating distributions and liquidating distributions Level of Difficulty: Hard Topic: Distributions 127 During 2014, CDE Corporation (an S corporation since its inception in 2012) liquidates this year by distributing a parcel of land to its sole shareholder Clark The fair market value of the land at the time of the distribution was $100,000 and CDE's tax basis in the property was $30,000 Before considering the effects of the distribution, Clark's basis in his CDE stock was $40,000 What amount of gain (loss), if any, does CDE recognize on the distribution? What amount of income or loss, if any, does Clark recognize on the distribution and what is his basis in the land? CDE recognizes $70,000 of gain on the distribution ($100,000 fair market value $30,000 basis), which is allocated (and taxable) to Clark Clark also recognizes a $10,000 long-term capital loss on the distribution because his $110,000 basis in the stock exceeds the $100,000 liquidating distribution by $10,000 ($40,000 beginning stock basis + $70,000 gain allocated from CDE - $100,000 distribution) The loss on the distribution is a treated as a long-term capital loss because Clark has held his CDE stock for more than a year Clark's basis in the land is its fair market value, $100,000 AACSB: Analytic AACSB: Reflective Thinking 22-101 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-05 Apply the tax rules for S corporation operating distributions and liquidating distributions Level of Difficulty: Hard Topic: Distributions 128 MWC is a C corporation that uses the accrual method of accounting MWC made an S election, effective January, of 2014 The following assets were owned by MWC on December 31, 2013 What is MWC's net unrealized built-in gain when it converts to an S corporation on January 1, 2014? $20,000 The ($5,000) built-in loss on the inventory is netted against the $25,000 built-in gain on the land AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-06 Describe the taxes that apply to S corporations; estimated tax requirements; and tax return filing requirements Level of Difficulty: Easy Topic: S Corporation taxes and filing requirements 22-102 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 129 SEC Corporation has been operating as a C corporation since 2011 It elected to become an S corporation, effective January 1, 2014 On December 31, 2013, SEC reported a net unrealized built in gain of $60,000 In addition to other transactions in 2014, SEC sold inventory it owned at the beginning of 2014 (it did not sell any other assets it owned at the beginning of 2014) At the beginning of the year, the inventory it sold had a fair market value of $30,000 and a FIFO tax basis of $10,000 SEC sold the inventory for $35,000 If SEC had been a C corporation in 2014, its taxable income would have been $100,000 How much built-in gains tax must SEC pay in 2014? It must pay $7,000 ($20,000 × 35%) in built-in gain tax SEC must pay a 35 percent tax on the least of (a) $20,000 (recognized built-in gain on inventory), (b) $60,000 (initial net unrealized gain), and (c) $100,000 (taxable income computed as if SEC was a C corporation for 2014) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-06 Describe the taxes that apply to S corporations; estimated tax requirements; and tax return filing requirements Level of Difficulty: Medium Topic: S Corporation taxes and filing requirements 130 SEC Corporation has been operating as a C corporation since 2011 It elected to become an S corporation, effective January 1, 2014 On December 31, 2013, SEC reported a net unrealized built in gain of $10,000 In addition to other transactions in 2014, SEC sold inventory it owned at the beginning of 2014 (it did not sell any other assets it owned at the beginning of 2013) At the beginning of the year, the inventory it sold had a fair market value of $40,000 and a FIFO tax basis of $15,000 SEC sold the inventory for $28,000 If SEC had been a C corporation in 2013, its taxable income would have been $40,000 How much built-in gains tax must SEC pay in 2014? It must pay $3,500 ($10,000 × 35%) in built-in gains tax SEC must pay a 35 percent tax on the least of (a) $13,000 (recognized built-in gain on inventory), (b) $10,000 (initial net unrealized gain), and (c) $40,000 (taxable income computed as if SEC was a C corporation for 2014) AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-06 Describe the taxes that apply to S corporations; estimated tax requirements; and tax return filing requirements Level of Difficulty: Medium Topic: S Corporation taxes and filing requirements 22-103 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 131 RGD Corporation was a C corporation from its inception in 2010 through 2013 However, it elected S corporation status effective January 1, 2014 RGD had $50,000 of earnings and profits at the end of 2013 RGD reported the following information for its 2014 tax year What amount of excess net passive income tax is RGD liable for in 2014? (Round your answer for excess net passive income to the nearest thousand) $10,500 (35% × $30,000) Passive investment income is $73,000 ($6,000 municipal bond interest + $42,000 interest income + $25,000 dividend income); Gross receipts of $172,000 ($99,000 consulting revenue + $6,000 municipal bond interest + 42,000 interest income + 25,000 dividend income); Expenses in producing passive investment income are $0 Excess net passive income is $30,000 computed as $73,000 × [73,000 - (25% × 172,000)]/73,000 Consequently, the excess net passive income tax is $10,500 = 35% × $30,000 AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-06 Describe the taxes that apply to S corporations; estimated tax requirements; and tax return filing requirements Level of Difficulty: Hard Topic: S Corporation taxes and filing requirements 22-104 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 132 RGD Corporation was a C corporation from its inception in 2010 through 2013 However, it elected S corporation status effective January 1, 2014 RGD had $50,000 of earnings and profits at the end of 2013 RGD reported the following information for its 2014 tax year What amount of excess net passive income tax is RGD liable for in 2014? (Round your answer for excess net passive income to the nearest thousand) $12,250 (35% × $35,000) Passive investment income is $90,000 ($50,000 interest income + $40,000 dividend income); Gross receipts of $220,000 ($120,000 consulting revenue + $10,000 long-term capital gains + 50,000 interest income + 40,000 dividend income); Expenses in producing passive investment income are $0 Excess net passive income is $35,000 computed as $90,000 × [90,000 - (25% × 220,000)]/90,000 Consequently, the excess net passive income tax is $12,250 = 35% × $35,000 AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-06 Describe the taxes that apply to S corporations; estimated tax requirements; and tax return filing requirements Level of Difficulty: Hard Topic: S Corporation taxes and filing requirements 22-105 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 133 During 2013, MVC operated as a C corporation However, it made an election to be taxed as an S corporation effective January 1, 2014 MVC uses the accrual method of accounting and uses the LIFO method of accounting for its inventory At the end of 2013 its inventory basis under the LIFO method was $63,000 If MVC had used the FIFO method of accounting for its inventory, it would have had a $70,000 basis in its inventory Finally, MVC's regular taxable income in 2013 was $80,000 What amount of LIFO recapture tax must MVC pay? When must it pay the tax? MVC must pay $2,380 [($70,000 FIFO inventory basis - $63,000 LIFO inventory basis) × 34 percent] The 34 percent tax rate is the marginal rate at which the additional $7,000 of income would have been taxed in 2013 under the corporate tax rate schedule (the income increases its taxable income from $80,000 to $87,000) MVC must pay the tax in four equal installments beginning on the unextended due date of its 2013 tax return and each year thereafter (by March 15) for the following three years Consequently, MVC must pay $595 ($2,380 × 25%) by March 15, 2014; $595 by March 15, 2015; $595 by March 15, 2016; and $595 by March 15, 2017 AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-06 Describe the taxes that apply to S corporations; estimated tax requirements; and tax return filing requirements Level of Difficulty: Medium Topic: S Corporation taxes and filing requirements 134 During 2013, MVC operated as a C corporation However, it made an election to be taxed as an S corporation effective January 1, 2014 MVC uses the accrual method of accounting and uses the LIFO method of accounting for its inventory At the end of 2013 its inventory basis under the LIFO method was $80,000 If MVC had used the FIFO method of accounting for its inventory, it would have had a $100,000 basis in its inventory Finally, MVC's regular taxable income in 2013 was $5,000 What amount of LIFO recapture tax must MVC pay? When must it pay the tax? MVC must pay $3,000 [($100,000 FIFO inventory basis - $80,000 LIFO inventory basis) × 15 percent] The 15 percent tax rate is the marginal rate at which the additional $20,000 of income would have been taxed in 2013 under the corporate tax rate schedule (the income increases MVC's taxable income from $5,000 to $25,000) MVC must pay the tax in four equal installments beginning on the unextended due date of its 2013 tax return and each year thereafter (by March 15) for the following three years Consequently, MVC must pay $750 ($3,000 × 25%) by March 15, 2014; $750 by March 15, 2015; $750 by March 15, 2016; and $750 by March 15, 2017 AACSB: Analytic AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 22-06 Describe the taxes that apply to S corporations; estimated tax requirements; and tax return filing requirements 22-106 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Level of Difficulty: Medium Topic: S Corporation taxes and filing requirements 22-107 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education ... remaining stock basis, prior C corporation earnings and profit, the AAA account B shareholder's remaining stock basis, the AAA account, prior C corporation earnings and profit C prior C corporation... partnerships and C corporations, S corporations face several restrictions on using the cash method of accounting True False 22-2 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction... consent of McGraw-Hill Education 85 Clampett, Inc has been an S corporation since its inception On July 15, 2015, Clampett, Inc distributed $50,000 to J D His basis in his Clampett, Inc stock