Taxation of Flow-Through Entities
Textbook Exam Questions
Course Introduction
This course provides an in-depth examination of the taxation principles and rules applicable to flow-through entities, such as partnerships, S corporations, and limited liability companies. Topics include the formation, operation, and liquidation of these entities, as well as the allocation of income, deductions, losses, and credits to owners. The course also covers basis determination, distributions, the tax consequences of contributions and withdrawals, and compliance issues, with an emphasis on practical tax planning strategies and current developments in flow-through entity taxation.
Recommended Textbook
South Western Federal Taxation 2015 Corporations Partnerships Estates and Trusts 38th Edition
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2
Chapter 1: Understanding and Working With the Federal Tax Law
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Sample Questions
Q1) The Federal tax law allows a taxpayer to claim a deduction for state and local income taxes.
A)True
B)False
Answer: True
Q2) Explain the Golsen doctrine.
Answer: Because the Tax Court is a national court, it decides cases from all parts of the country. For many years, the Tax Court followed a policy of deciding cases based on what it thought the result should be, even though its decision might be appealed to a U.S. Circuit Court of Appeals that had previously decided a similar case differently. A number of years ago this policy was changed in the Golsen decision. Now the Tax Court will decide a case as it feels the law should be applied only if the Circuit Court of Appeals of appropriate jurisdiction has not yet passed on the issue or has previously decided a similar case in accord with the Tax Court's decision. If the Circuit Court of Appeals of appropriate jurisdiction has previously held otherwise, the Tax Court will conform under the Golsen rule even though it disagrees with the holding.
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Page 3
Chapter 2: Corporations: Introduction and Operating Rules
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Sample Questions
Q1) Juanita owns 60% of the stock in a C corporation that had a profit of $200,000 in 2013. 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. Which of the following statements relating to 2013 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.
Answer: A
Q2) 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.
A)True
B)False
Answer: True
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Chapter 3: Corporations: Special Situations
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Sample Questions
Q1) If QPAI cannot be used in any one year due to the TI limitation, it can be carried over for 3 years.
A)True
B)False
Answer: False
Q2) DPGR cannot include the cost of an embedded service that is part of in the sale of a manufactured product.
A)True
B)False
Answer: False
Q3) Intangible drilling costs are a tax preference item only for integrated oil companies.
A)True
B)False
Answer: True
Q4) In the case of an individual, modified AGI is substituted for taxable income in the DPAD formula.
A)True
B)False Answer: True
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Chapter 4: Corporations: Organization and Capital Structure
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Sample Questions
Q1) George transfers cash of $150,000 to Finch Corporation, a newly formed corporation, for 100% of the stock in Finch worth $80,000 and debt in the amount of $70,000, payable in equal annual installments of $7,000 plus interest at the rate of 9% per annum. In the first year of operation, Finch has net taxable income of $40,000. If Finch pays George interest of $6,300 and $7,000 principal payment on the note:
A) George has dividend income of $13,300.
B) Finch Corporation does not have a tax deduction with respect to the payment.
C) George has dividend income of $7,000.
D) Finch Corporation has an interest expense deduction of $6,300.
E) None of the above.
Q2) How is the transfer of liabilities in a property transaction generally treated for tax purposes? How is a transfer of liabilities generally treated in a § 351 transaction? What exceptions could arise to this usual treatment in a § 351 setting?
Q3) For transfers falling under § 351, what are the holding period rules for stock received by the shareholder and for the assets transferred to the corporation?
Q4) What is the rationale underlying the tax deferral treatment available under § 351?
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Page 6
Chapter 5: Corporations: Earnings Profits and Dividend
Distributions
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Sample Questions
Q1) When computing E & P, taxable income is not adjusted for § 179 expense.
A)True
B)False
Q2) The tax treatment of corporate distributions at the shareholder level does not depend on:
A) The character of the property being distributed.
B) The earnings and profits of the corporation.
C) The basis of stock in the hands of the shareholder.
D) Whether the distributed property is received by an individual or a corporation.
E) None of the above.
Q3) During the year, Blue Corporation distributes land to its sole shareholder. If the fair market value of the land is less than its adjusted basis, Blue will not be able to recognize a loss on the distribution.
A)True
B)False
Q4) Briefly describe the rationale for the reduced tax rate on dividends for individual taxpayers.
Q5) Intangible drilling costs deducted currently.
Q6) How does the payment of a property dividend affect E & P?
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Chapter 6: Corporations: Redemptions and Liquidations
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Sample Questions
Q1) Connie sold 400 shares of § 306 stock (basis of $20,000) in Blackbird Corporation to Larry (an unrelated individual) for $50,000. When the § 306 stock was issued to Connie, the stock had a value of $50,000, and Blackbird had E & P of $500,000. At the time the § 306 stock is sold, Blackbird's E & P is $550,000. At the time of the sale, Connie owned 900 shares of common stock (basis of $210,000) in Blackbird. With respect to the sale of the § 306 stock by Connie:
A) Connie has $50,000 of ordinary income.
B) Blackbird Corporation reduces its E & P by $50,000.
C) Connie has a $30,000 capital gain.
D) After the sale, Connie has a $210,000 basis in the common stock.
E) None of the above.
Q2) The Code treats corporate distributions that are a return of a shareholder's investment as sales or exchanges and corporate distributions that are a return from a shareholder's investment as dividends.
A)True
B)False
Q3) What are the requirements that must be satisfied for a distribution to qualify under § 302(b)(2) as a disproportionate redemption?
Q4) When is a redemption to pay death taxes under § 303 most advantageous?
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Chapter 7: Corporations: Reorganizations
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Sample Questions
Q1) Tin Corporation was created 10 years ago. It currently is valued at $1.5 million as follows: Tacks division ($420,000), Safety Pins division ($580,000), Paper Clips division ($450,000) and investment assets ($50,000). Tin currently has three shareholders: Antonio, who was the initial shareholder and now owns 40% of the stock (basis in stock $350,000), and Beth and Chang, who each purchased 30% of Tin two years ago for $435,000.
Tin is having management problems because the shareholders cannot agree on the future of the company. They have determined that it would be best to divide up the company and go their separate ways. Each shareholder feels that the others do not deserve to continue using the Tin Corporation name.
a.
a. Determine what would be the best method to divide the corporation among the shareholders with the least amount of taxes.
b. Draw a diagram of the solution you suggested in part
c. Any investments that should be received by the new entities will be distributed to the shareholders in exchange for their Tin stock. Beth is the only shareholder who has indicated that she prefers to receive some investments. Determine the gain or loss each entity and shareholder will have upon the division.
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Page 9
Chapter 8: Consolidated Tax Returns
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Sample Questions
Q1) In computing consolidated taxable income, the profit/loss from a sale between Subsidiary and Parent is an example of a(n) ____________________ item.
Q2) Member's operating gains/profits
Q3) Which of the following potentially is a disadvantage of electing to file a Federal corporate income tax consolidated return?
A) Increased deduction amounts when computations are made on a group basis.
B) Deferral of gains realized in transactions between group members.
C) Increased basis in the stock of a subsidiary that generates annual taxable income.
D) Additional administrative costs in complying with the election.
Q4) Offsetting gains against other members' losses
Q5) The domestic production activities deduction (DPAD) of the affiliates is an example of an item that is computed on a basis on a Federal corporate income tax consolidated return.
Q6) A tax-exempt charitable trust, created by a U.S. C corporation, can join in a Federal consolidated return.
A)True
B)False
Q7) Compensation deductions
Page 10
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Chapter 9: Taxation of International Transactions
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Sample Questions
Q1) Which of the following statements regarding the taxation of U.S. real property gains recognized by non-U.S. persons not engaged in a U.S. trade or business is false? Gains from the disposition of U.S. real property are:
A) Not taxed to non-U.S. persons because real property gains are specifically exempt from U.S. taxation.
B) Taxed to non-U.S. persons without regard to whether such non-U.S. persons are engaged in a U.S. trade or business.
C) Taxed in the U.S. because such gains are treated as if they are effectively connected to a U.S. trade or business.
D) Taxed to non-U.S. persons notwithstanding the general exemption of capital gains from U.S. taxation.
Q2) Which of the following is a principle used in applying the income-sourcing rules under U.S. tax law?
A) The rules should be acceptable to both countries.
B) The rules should favor the U.S. Treasury.
C) The rules should favor the treasury of the non-U.S. country.
D) The rules should apply to income items only; deductions need not be sourced in this way.
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11
Chapter 10: Partnerships: Formation, Operation, and Basis
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Sample Questions
Q1) Tim, Al, and Pat contributed assets to form the equal TAP Partnership. Tim contributed cash of $40,000 and land with a basis of $80,000 (fair market value of $60,000). Al contributed cash of $60,000 and land with a basis of $50,000 (fair market value of $40,000). Pat contributed cash of $60,000 and a fully depreciated property ($0 basis) valued at $40,000. Which of the following tax treatments is not correct?
A) Tim's basis in his partnership interest is $120,000.
B) Al realizes and recognizes a loss of $10,000.
C) Pat realizes a gain of $40,000 but recognizes $0 gain.
D) TAP has a basis of $80,000, $50,000, and $0 in the land and property (excluding cash) contributed by Tim, Al, and Pat, respectively.
E) All of these statement are correct.
Q2) On a corporate Form 1120, Schedule M-1 (or M-3) is used to reconcile book and tax income, and Schedule M-2 reconciles retained earnings to the amounts shown on Schedule L. How are these reconciliations accomplished on a partnership return? What additional information must be provided?
Q3) Schedule K-1
Q4) Required taxable year
Q5) Check the box regulations
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Chapter 11: Partnerships: Distributions, Transfer of Interests, and Terminations
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Sample Questions
Q1) Randi owns a 40% interest in the capital and profits of the RAY Partnership. Immediately before she receives a proportionate nonliquidating distribution from RAY, the basis for her partnership interest is $60,000. The distribution consists of $45,000 in cash and land with a fair market value of $72,000. RAY's adjusted basis in the land immediately before the distribution is $36,000. As a result of the distribution, Randi recognizes a gain of $21,000.
A)True
B)False
Q2) A gain will only arise on a distribution from a partnership of cash that exceeds the partner's basis in the partnership interest. For this purpose, only cash, checks, and credit card charges are treated as cash.
A)True
B)False
Q3) Mandatory step down
Q4) Step up
Q5) Inventory with a basis of $10,000 and a fair market value of $10,500.
Q6) Cash basis accounts receivable.
Page 13
Q7) Installment receivables for sale of a capital asset.
Q8) Unrealized receivable
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Page 14
Chapter 12: S: Corporations
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Sample Questions
Q1) Any excess of S corporation losses or deductions over the shareholder's combined stock and debt basis is suspended until there is a subsequent stock or debt basis.
A)True
B)False
Q2) An S corporation that has total assets of at least $10 million on Schedule L at the end of the tax year must file a Schedule M-3.
A)True B)False
Q3) An S shareholder's basis is decreased by distributions treated as being paid from AAA.
A)True B)False
Q4) An S shareholder's basis is increased by stock purchases and capital contributions. A)True B)False
Q5) Distribution of loss property by an S corporation to a shareholder generally should be .
Q6) Discuss two ways that an S election may be terminated.
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Chapter 13: Comparative Forms of Doing Business
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Sample Questions
Q1) Arthur is the sole shareholder of Purple, Inc. Purple's taxable income before the payment of Arthur's salary is $300,000. Based on this information, Arthur has the corporation pay him a salary of $200,000 and a bonus of $100,000. A reasonable salary and bonus would be $175,000. Which of the following is correct?
A) The taxable income of Purple, Inc., is $0 ($300,000 - $300,000 salary and bonus).
B) The taxable income of Purple, Inc., is $100,000 ($300,000 - $200,000).
C) Arthur has salary and bonus income of $300,000.
D) Arthur has salary and bonus income of $175,000 and dividend income of $125,000.
E) None of the above.
Q2) To which of the following entities does the AMT apply?
-Sole proprietorship.
-General partnership.
-Limited partnership. -LLC.
-S corporation.
-C corporation.
Q3) Technique for minimizing double taxation
Q4) General partnership
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Page 16
Chapter 14: Taxes on the Financial Statements
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Sample Questions
Q1) Healy, Inc., reports an effective tax rate in its income tax footnote of 14%. The only reconciling item with regard to the hypothetical tax at 35% is a valuation allowance reversal of negative 21%. Which of the following statements is true concerning comparing Healy, Inc.'s effective tax rate with its competitors, all of whom have an effective tax rate between 32 and 36%?
A) Healy Inc., is managing its tax burden in a more efficient manner than its competitors. B) Healy Inc., structural effective tax rate is actually quite close to its competitors.
C) Healy Inc., earned more cash profits because of its lower effective tax rate.
D) Healy Inc., is likely to be engaged in tax shelter activities.
Q2) The operations of 80% or more owned domestic subsidiaries can be included in the parent corporation's consolidated tax return, if a proper election is made.
A)True
B)False
Q3) ASC 740 (FIN 48) is the GAAP equivalent of the Form 1120 Schedule UTP. A)True B)False
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Chapter 15: Exempt Entities
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Sample Questions
Q1) Tax on self-dealing
A) Carries on a trade or business for the benefit of an exempt organization, remits its profits to the exempt organization, and is not exempt from Federal income tax.
B) May be subject to some Federal income taxation and classification may adversely affect amount of charitable contributions received.
C) Tax imposed for engaging in transactions with disqualified persons.
D) Enables certain exempt organizations to engage in lobbying activities on a limited basis.
E) Tax imposed on investments that enable a private foundation to control unrelated businesses.
Q2) Form 990
Q3) Help, Inc., a tax-exempt organization, incurs lobbying expenses of $275,000 during the tax year. Help is eligible for and makes the § 501(h) lobbying expenditure election. During the year, Help spends $1,200,000 carrying out its exempt mission.
a. Will the lobbying expense result in Help losing its exempt status?
b. Calculate the amount of any tax that Help must pay associated with its lobbying expenses.
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Page 18
Chapter 16: Multistate Corporate Taxation
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Sample Questions
Q1) Flip Corporation operates in two states, as indicated below. All goods are manufactured in State A. Determine the sales to be assigned to both states to be used in computing Flip's sales factor for the year. Both states follow the UDITPA and the MTC regulations in this regard.
State A State B
Gross sales to purchasers in state $400,000 $350,000
Sales returns 9,000 11,000
Discounts allowed 21,000 31,000
Carrying charges collected back from customers, separately stated 20,000 10,000
Rental income 60,000 * 25,000 **
* Excess warehouse space, seasonal rental to a competitor.
** Land held for speculation.
Q2) In determining taxable income for state income tax purposes, interest income from Federal bonds typically constitutes a(n) modification.
Q3) A garment purchased for resale.
Q4) Typically exempt from the sales/use tax base is the purchase of prescription medicines by an individual.
A)True
B)False
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Chapter 17: Tax Practice and Ethics
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Sample Questions
Q1) In a criminal fraud case, the burden is on the taxpayer to show that he or she was innocent "beyond the shadow of any reasonable doubt."
A)True
B)False
Q2) The IRS can pay an informant's fee of up to % of the recovered tax, interest, and penalty amounts. The reward can be as high as % for information provided by a "whistle blower."
Q3) Quon filed an amended return, claiming a $100,000 refund. The IRS disallowed the refund, and it can assess a penalty if there was no reasonable basis of support for the refund claim, in the amount of % of the disallowed amount.
Q4) Evaluate this statement: the audited taxpayer has more freedom to "trade issues" with the IRS when the dispute progresses to an Appeals conference. Hint: What are the "hazards of litigation?"
Q5) A tax professional needs to know how the IRS is structured and how it works to carry out its mission. Evaluate this statement.
Q6) In taking a dispute to the Appeals Division, a written protest is required of the taxpayer when the proposed deficiency exceeds $____________________.
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Page 20
Chapter 18: The Federal Gift and Estate Taxes
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Sample Questions
Q1) Daniel's will provides that all of his property passes to a trust, life estate to his wife, remainder to charity. If Daniel's executor makes a QTIP election, the use of the alternate valuation date is not possible.
A)True
B)False
Q2) In 1992, Daniel and Mia acquire realty for $2 million, with Daniel furnishing $1.5 million of the purchase price and Mia providing the balance. Title to the property is listed as: "Daniel and Mia, joint tenants with right of survivorship." In 2013, Mia dies first when the realty is worth $4 million. How much is included in her gross estate under the following circumstances?
a. Daniel and Mia are brother and sister.
b. Daniel and Mia are husband and wife.
Q3) After being diagnosed with a terminal illness, Jude (a widower) makes gifts of all of his assets (over $6 million in value) to family members and dies shortly thereafter. Based on these facts, comment on the following assumptions.
a. Because the Federal gift tax is imposed on the donor and Jude has no assets, any gift tax that is due is avoided.
b. Because Jude died without any assets, the Federal estate tax is avoided.
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Chapter 19: Family Tax Planning
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Sample Questions
Q1) Living trusts.
Q2) Sold out-of-state realty.
Q3) In planning for the use of § 6166, what are several steps that can be taken to aid the owner of a small business while he or she is alive? In this connection consider the following.
a. The number of owners and the amount of ownership in the business.
b. The nonqualifying assets held by the owner.
c. Aggregation of qualifying interest.
Q4) Transfer by death of depreciable property.
Q5) In arriving at the value of stock in a closely held business, the IRS frequently imputes goodwill. Comment on how the following independent factors would affect the determination of goodwill.
a. Past profits include a large nonoperating gain.
b. Shareholder-employees have not been receiving adequate compensation for their services.
c. The shareholders have been financing corporate operations with interest-free loans.
Q6) A gift will not cause income tax consequences to the donor.
Q7) Created a living trust.
Q8) Doubles the number of annual exclusions available.
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Chapter 20: Income Taxation of Trusts and Estates
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Q1) Sixty percent of the income received by the Atom Trust this year constituted municipal bond interest. Atom's trustee also made a $100,000 gift to the United Fund, a qualifying charity. The charitable deduction associated with this gift is limited to $60,000.
A)True
B)False
Q2) Does the estate or trust's distributable net income always equal its deduction for distributions to beneficiaries? Are the two amounts ever equal in amount? Answer for estates, simple trusts, and complex trusts.
Q3) An estate's remainder beneficiary generally must wait until the entity is terminated by the executor to receive any distributions.
A)True
B)False
Q4) Tax planning usually dictates that high-income and high-wealth individuals be specified as second-tier beneficiaries of a trust arrangement.
A)True
B)False
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