Taxation of Business Entities
Exam Answer Key
Course Introduction
Taxation of Business Entities explores the federal tax laws and regulations as they apply to various business structures, including partnerships, corporations (C and S corporations), and limited liability companies. The course examines the process of entity formation, operation, distributions, transfers, and liquidations with a focus on the tax consequences for both the entities and their owners. Topics include income determination, deductions, tax planning opportunities, and compliance issues unique to each entity type. Through real-world examples and case studies, students develop analytical skills needed to advise businesses on tax-efficient structures and transactions within the framework of current tax law.
Recommended Textbook
South Western Federal Taxation 2012 Corporations Partnerships Estates and Trusts Professional
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Chapter 1: Understanding and Working With the Federal Tax Law
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Q1) Many states have balanced budgets because laws or constitutional amendments preclude deficit spending.
A)True
B)False
Answer: True
Q2) Which of the following sources has the highest tax validity?
A) Treasury Regulation.
B) Revenue Ruling.
C) Internal Revenue Code.
D) Proposed Regulation.
E) All of the above have same weight.
Answer: C
Q3) The corporate tax rate of 34 percent applies only to taxable income in excess of $75,000.
A)True
B)False
Answer: True
Q4) What are the key components of tax planning?
Answer: 11ea8545_ae9e_50e5_9aec_4da30f95ffb2_TB4127_00
Page 3
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Chapter 2: Corporations: Introduction and Operating Rules
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Q1) Patrick, an attorney, is the sole shareholder of Gander Corporation. Gander is a personal service corporation with a fiscal year ending September 30. The corporation paid Patrick a salary of $294,000 during its fiscal year ending September 30, 2011. How much salary must Gander pay Patrick during the period October 1 through December 31, 2011, to permit the corporation to continue to use its fiscal year without negative tax effects?
A) $0.
B) $73,500.
C) $220,500.
D) $294,000.
E) None of the above.
Answer: B
Q2) For a corporation in 2011, the domestic production activities deduction is equal to 9% of the higher of (1) qualified production activities income or (2) taxable income. However, the deduction cannot exceed 50% of the W-2 wages related to qualified production activities income.
A)True
B)False
Answer: False
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Chapter 3: Corporations: Special Situations
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Sample Questions
Q1) In the case of an individual, modified AGI is substituted for QPAI in the DPAD formula.
A)True
B)False
Answer: False
Q2) Staff, Inc., has taxable income of $14 million in 2011. What is the maximum DPAD tax savings for this C corporation?
A) None.
B) $204,000.
C) $210,000.
D) $428,400.
E) $441,000.
Answer: E
Q3) Stacey, an advertising executive, pays a contractor to build a lodge on property she owns in Colorado. If Stacey sells the lodge, the proceeds (less the cost of the land) will be DPGR.
A)True
B)False
Answer: False
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Chapter 4: Corporations: Organization and Capital Structure
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Q1) A shareholder's holding period for stock received under § 351 includes the holding period of the property transferred to the corporation.
A)True
B)False
Q2) Lark City donates land worth $300,000 and cash of $100,000 to Orange Corporation as an inducement to locate in the city. Four months later, Orange purchases additional land and a building at a cost of $500,000 and moves its operations to Lark City. Ann, the sole shareholder, contributes equipment (basis of $70,000 and fair market value of $200,000) to help Orange in its new operations. What are the tax consequences of these transfers to Orange Corporation?
Q3) 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.
A)True
B)False
Q4) In a § 351 transfer, the receipt of boot is not taxed if the shareholder has a realized loss.
A)True
B)False
Page 6
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Chapter 5: Corporations: Earnings Profits and Dividend
Distributions
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Q1) The rules used to determine the taxability of stock dividends also apply to distributions of stock rights.
A)True
B)False
Q2) Use of MACRS cost recovery when computing taxable income does not require an E & P adjustment.
A)True
B)False
Q3) If a stock dividend is taxable, the shareholder's basis in the newly received shares is equal to the fair market value of the shares received in the distribution.
Q4) Cash distributions received from a corporation with a positive balance in accumulated E & P at the beginning of the year will be taxed as dividend income.
A)True
B)False
Q5) Constructive dividends do not need to satisfy the legal requirements for a dividend as set forth by applicable state law.
A)True
B)False
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Chapter 6: Corporations: Redemptions and Liquidations
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Q1) Three years ago, Darlene received preferred (§ 306) stock pursuant to a nontaxable stock dividend from Grackle Corporation. In the current year, Darlene gives the Grackle preferred stock to her sister, Nancy. The Grackle preferred stock is not § 306 stock with regards to Nancy.
A)True
B)False
Q2) One difference between the tax treatment accorded nonliquidating and liquidating distributions is with respect to the recognition of losses by the distributing corporation. As a general rule, a corporation recognizes losses on liquidating distributions of depreciated property (fair market value less than basis) but not on nonliquidating distributions of such property.
A)True
B)False
Q3) In a not essentially equivalent redemption [§ 302(b)(1)], the meaningful reduction test is an objective safe harbor rule that taxpayers can rely upon for sale or exchange treatment.
A)True
B)False
Q4) Describe the requirements for and tax consequences of a § 338 election.
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Chapter 7: Corporations: Reorganizations
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Q1) Discuss the influence of step transaction, sound business purpose, continuity of business enterprise, and continuity of interest doctrines on tax-free corporate reorganizations.
Q2) One of the tenets of U.S. tax policy is to encourage business development. Which of the following Code sections does not support this tenet?
A) Section 351, which allows entities to incorporate tax-free.
B) Section 1031, which allows the exchange of stock of one corporation for stock of another.
C) Section 368, which allows for tax-favorable corporate restructuring through mergers and acquisitions.
D) Section 381, which allows the target corporation's tax benefits to carryover to the successor corporation.
E) All of the above provisions support the tenet.
Q3) When substantially all of the assets of the target corporation are received in exchange for voting stock and selected liabilities, the restructuring can qualify as a "Type C" reorganization.
A)True
B)False
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Chapter 8: Consolidated Tax Returns
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Q1) How do the members of a consolidated group split among themselves the benefits of the lower tax brackets on the first $75,000 of taxable income?
A) According to their relative net asset holdings.
B) According to an internal tax-sharing agreement.
C) According to an internal tax-sharing agreement, which may be modified by the IRS upon audit.
D) According to a tax-sharing agreement that must be approved by the IRS by the end of the first quarter of the tax year.
Q2) In terms of the consolidated return rules, Akron Manufacturing LLC is a(n) ____________________ entity.
Q3) Outline the major advantages and disadvantages of filing Federal corporate income tax returns on a consolidated basis. Limit your comments to the income tax effects of the election.
Q4) In computing consolidated E & P, dividends paid to the parent by group members are ignored.
A)True
B)False
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Chapter 9: Taxation of International Transactions
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Q1) A non-U.S. individual's "green card" remains in effect until:
A) The individual discards it.
B) The individual leaves the United States
C) The individual remains outside the United States for two years.
D) The card has been revoked or the individual has abandoned lawful permanent residency in the U.S.
Q2) The § 367 cross-border transfer rules seem to counteract other favorable tax provisions that allow the taxpayer to defer gross income, e.g. §§ 351 and 368. What is the rationale for eliminating this deferral? Provide two examples of transactions to which § 367 would apply.
Q3) Which of the following situations requires the filing of an information return with the U.S. government?
A) A domestic corporation that is 25% or more foreign owned.
B) A foreign corporation carrying on a trade or business in the United States.
C) U.S. persons who acquire or dispose of an interest in a foreign partnership.
D) All of the above.
E) None of the above.
Q4) Subpart F income includes portfolio income like dividends and interest.
A)True
B)False
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Chapter 10: Partnerships: Formation, Operation, and Basis
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Q1) Katherine invested $80,000 this year to purchase a 30% interest in the KLM Partnership. The partnership reported $200,000 of net income from operations, a $2,000 short-term capital loss, and a $10,000 charitable contribution. In addition, the partnership distributed $20,000 to Katherine and $10,000 each to partners Lauren and Missy. Assuming the partnership has no beginning or ending liabilities, what is Katherine's basis in her partnership interest at the end of the year?
Q2) Section 721 provides that no gain or loss is recognized on contribution of property to a partnership in exchange for an interest in the partnership. A disguised sale is an exception to nonrecognition of gain or loss under § 721.
A)True
B)False
Q3) Henry contributes property valued at $60,000 (basis $50,000) in exchange for a 25% interest in the HIKE Partnership. If the property is later sold for $80,000, gain of $7,500 will be allocated to Henry.
A)True
B)False
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Page 12
Chapter 11: Partnerships: Distributions, Transfer of Interests, and Terminations
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Q1) A disproportionate distribution arises when the partnership distributes a share of partnership hot assets to one or more partners that is not the same as the partner's ownership interest in the partnership.
A)True
B)False
Q2) Which of the following is not true regarding a limited liability company?
A) The Code does not specifically provide for the taxation of limited liability companies. Therefore, an LLC that is taxed as a partnership must rely primarily on the tax provisions that apply to partnerships.
B) An LLC is effectively treated as a limited partnership with no limited partners.
C) An LLC offers several advantages over the S corporation, including not making the managing member of the LLC liable for self-employment taxes on his or her share of LLC income.
D) In general, an LLC member is not personally liable for LLC debts.
E) Any member of an LLC can participate in the management of the LLC if the operating agreement so permits.
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Chapter 12: S: Corporations
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Sample Questions
Q1) A distribution from OAA is taxable.
A)True
B)False
Q2) Identify a disadvantage of S corporation status.
A) Most trusts can be shareholders.
B) Losses flow through to the shareholders.
C) The ACE adjustment is avoided.
D) Tax-exempt income flows through to the shareholders.
E) None of the above is a disadvantage of the S election.
Q3) On January 1, Bobby and Alice own equally all of the stock of an electing S corporation called Prairie Dirt Delight. The dirt company has a $60,000 loss for a non-leap year. On the 200th day of the year, Bobby sells his one-half of the stock to his son, Saul. How much of the $60,000 loss, if any, is allocated to Bobby?
A) $0.
B) $13,562.
C) $16,438.
D) $32,877.
E) None of the above.
Q4) An S corporation may have ____________________ class(es) of stock.
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Chapter 13: Comparative Forms of Doing Business
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Q1) Austin is the sole shareholder of Purple, Inc. Purple's accumulated E & P at the beginning of the year is $700,000. Purple's taxable income after paying a salary and bonus to Austin of $100,000 is $500,000. Assume the salary and bonus payment are reasonable. Purple's maximum exposure in calculating accumulated taxable income for purposes of the accumulated earnings tax for the current tax year is:
A) $330,000.
B) $500,000.
C) $600,000.
D) $1,300,000.
E) None of the above.
Q2) The accumulated earnings tax rate in 2011 is the same as the highest tax rate for a C corporation.
A)True
B)False
Q3) A corporation can avoid the accumulated earnings tax by demonstrating that it has plans to distribute earnings at a later date.
A)True
B)False
Q4) Why are S corporations not subject to the accumulated earnings tax?
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Chapter 14: Taxes on the Financial Statements
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Q1) How does an auditor determine whether a valuation allowance is needed against an entity's deferred tax asset? List some of the factors than an auditor will consider in this regard.
Q2) A corporation's taxable income almost never is the same as its GAAP financial accounting income. Explain why this occurs. Use the terms permanent and temporary book-tax differences in your answer. Give examples of each.
Temporary differences are caused by income and expenses appearing in both the financial statement and tax return, but in different periods (i.e., a timing difference). Permanent differences are caused by items appearing in the financial statement or the tax return, but not both. Temporary differences do not affect the book total tax expense. Temporary differences merely shift tax expense (benefit) between the current and deferred accounts. Permanent differences do affect the total book tax expense and are identified in the tax footnote rate reconciliation.
Q3) Under GAAP, a corporation can defer a disclosure of the future U.S. tax expense related to the earnings of foreign subsidiaries, by taking into account its repatriation plans for these earnings.
A)True
B)False
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Chapter 15: Exempt Entities
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Q1) Which of the following is not an excise tax that may be imposed on a private foundation?
A) Tax on jeopardizing investments.
B) Tax on self-dealing.
C) Tax on excessive foundation manager compensation.
D) Tax on excess business holdings.
E) All of these taxes may be imposed on a private foundation.
Q2) Define a private foundation.
Q3) The due date for both Form 990 (Return of Organization Exempt from Income Tax) and Form 990-PF (Return of Private Foundation) is the fifteenth day of the fifth month after the end of the taxable year.
A)True
B)False
Q4) The tax consequences to a donor of making a charitable contribution to an exempt organization classified as a private foundation may be less favorable than the tax consequences to a donor of making a charitable contribution to an exempt organization that is not classified as a private foundation.
A)True
B)False
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Chapter 16: Multistate Corporate Taxation
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Q1) The corporate income tax provides about 5 percent of the annual tax revenues for the typical U.S. state.
A)True
B)False
Q2) The model law relating to the assignment of income among the states for corporations is:
A) The Multistate Tax Treaty.
B) The Uniform Division of Income for Tax Purposes Act (UDITPA).
C) Public Law 86-272.
D) The Multistate Tax Commission (MTC).
Q3) Typically, a sales/use tax is applied to a retail sale of ____________________ property.
Q4) An ad valorem property tax is based on the asset's current ____________________.
Q5) State Q has adopted sales-factor-only apportionment for its corporate income tax. As a result, a ____________________ (larger/smaller) percentage of an out-of-state corporation's income is assigned to tax in the state.
Q6) P.L. 86-272 ____________________ (does/does not) create nexus when the seller runs a booth with inventory samples, at a one-week trade show in the state.
Page 18
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Chapter 17: Tax Practice and Ethics
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Q1) IRS computers use document matching programs for both individuals and business taxpayers to keep the audit rate low.
A)True
B)False
Q2) Maria's AGI last year was $195,000. To avoid a penalty, her estimated tax payments and withholdings for this year must equal the lesser of ____________________ percent of last year's taxes or ____________________ percent of this year's taxes. or
Q3) In a letter ruling, the IRS responds to a taxpayer request concerning the tax treatment of a proposed transaction.
A)True
B)False
Q4) When the IRS issues a notice of tax due, the taxpayer has 30 days to either pay the tax or file a petition with the Tax Court. This is conveyed in the "thirty-day letter."
A)True
B)False
Q5) The ____________________, a presidential appointee, is the "IRS attorney."
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Chapter 18: The Federal Gift and Estate Taxes
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Q1) At the time of her death in 2011, Emma still owed $36,000 on her church pledge for the year. Even if church pledges are not an enforceable obligation in the state where Emma resided, her estate can claim a deduction for the $36,000 it later pays.
A)True
B)False
Q2) The U.S. has death tax conventions (i.e., treaties) with most of the countries of the world.
A)True
B)False
Q3) For estate tax purposes, a surviving spouse's share of the community property is handled in the same manner as a surviving spouse's dower interest.
A)True
B)False
Q4) In 2010 and with $100,000, Ronald establishes a joint savings account with his cousin, Allison. In 2011, Allison withdraws the $100,000 and disappears. Ronald made a gift to Allison in 2011.
A)True
B)False
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Chapter 19: Family Tax Planning
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Q1) Walt owns an insurance policy on his life with Doris as the designated beneficiary. On Walt's prior death, the proceeds of the policy are part of his probate estate.
A)True
B)False
Q2) A disclaimer by a surviving spouse will generate additional estate tax since it reduces the amount of marital deduction allowed.
A)True B)False
Q3) Barney creates a trust, income payable to Chloe for five years, remainder to Emma. Emma is Barney's daughter (and a single parent), and Chloe is his 19-year old granddaughter. What might be the justification for this type of trust?
Q4) Doug inherited his mother's bedroom furniture worth $3,000. For sentimental reasons, Martha, the daughter, pays Doug $3,500 for the furniture. The furniture should be included in the mother's gross estate at $3,500.
A)True B)False
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Chapter 20: Income Taxation of Trusts and Estates
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Q1) To reduce trustee commissions, the Sigrid Trust is operated as though it were two trusts (i.e., with 70-year-old Grandma and 7-year old Skippy each holding equal shares). This year the trust generated distributable net income (DNI) of $80,000. The Sigrid trustee distributed $100,000 to Grandma this year: $40,000 as her one-half share of the entity's income, and $60,000 as a distribution of principal. Skippy received no distribution. How much of the year's distributable net income is assigned to Grandma?
A) $40,000.
B) $50,000.
C) $80,000.
D) $100,000.
Q2) Which of the following taxpayers use a Schedule K and K-1 to pass through income, loss, and credit amounts to the owners or beneficiaries?
A) Complex trust.
B) Partnership.
C) S corporation.
D) All of the above taxpayers use Schedule K and K-1.
Q3) Is a trust subject to the alternative minimum tax? Or does the trust "pass through" AMT items to its grantor and beneficiaries?
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