Taxation of Pass-Through Entities Solved
Exam Questions
Course Introduction
This course provides a comprehensive examination of the federal income tax rules applicable to pass-through entities, including partnerships, S corporations, and limited liability companies (LLCs). Students will explore the formation, operation, and dissolution of these entities, focusing on allocation of income, loss, deductions, and credits among owners. Key topics include basis computations, distributions, self-employment tax considerations, and special elections. Practical examples and problem-solving exercises will be utilized to illustrate complex concepts and enhance understanding of compliance and planning strategies for pass-through entities in various business contexts.
Recommended Textbook McGraw Hills Taxation of Business Entities 2019 Edition 10th Edition by Brian C. Spilker
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Chapter 1: Business Income, Deductions, and Accounting Methods
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Sample Questions
Q1) Colby Motors uses the accrual method and reports on a calendar year. In December of last year, Colby acquired auto repair equipment. As part of the acquisition, Colby purchased a warranty agreement that requires the seller of the equipment to provide repairs on the equipment for three years. Colby paid the cost of the warranty, $15,000, in January of this year. What can Colby deduct for the cost of the warranty on the tax return for last year?
Answer: Zero. The warranty cost is only deductible when paid, this year. Warranties provided to the taxpayer are payment liabilities. Consequently, Colby is not allowed to deduct the $15,000 cost of the warranty last year. He will deduct it this year when the warranty is paid for.
Q2) Ralph borrowed $4 million and used the proceeds in his internet business. The interest on this debt is not subject to an interest limitation if Ralph's business has average annual gross receipts of $25 million or less for the prior three taxable years.
A)True
B)False
Answer: True
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Chapter 2: Property Acquisition and Cost Recovery
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Q1) If a business mistakenly claims too little depreciation, the business must only reduce the asset's basis by the depreciation actually taken rather than the amount of the allowable depreciation.
A)True
B)False Answer: False
Q2) To increase their depreciation deduction on automobiles, taxpayers should elect §179 expense.
A)True
B)False Answer: False
Q3) Real property is always depreciated using the straight-line method.
A)True
B)False Answer: True
Q4) Used property is eligible for bonus depreciation.
A)True
B)False Answer: True
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Chapter 3: Property Dispositions
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Q1) For corporations, §291 recaptures 20 percent of the lesser of depreciation taken or the realized gain as ordinary income.
A)True
B)False
Answer: True
Q2) Buzz Corporation sold an office building that it used in its business for $500,000. Buzz bought the building ten years ago for $650,000 and has claimed $200,000 of depreciation expense. What is the amount and character of Buzz's gain or loss?
Answer: $10,000 ordinary and $40,000 §1231 gain.
For corporations, §291 recaptures 20 percent of the lesser of depreciation taken or the recognized gain as ordinary income. The remaining gain is §1231.
Q3) Which of the following is not True regarding an asset's adjusted basis?
A) Tax adjusted basis is usually greater than book adjusted basis.
B) Tax adjusted basis is usually less than book adjusted basis.
C) Adjusted basis is cost basis less cost recovery deductions.
D) Tax adjusted basis may change over time.
Answer: A
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Page 5
Chapter 4: Entities Overview
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Q1) If C corporations retain their after-tax earnings, when will their shareholders who are individuals be taxed on the retained earnings?
A) Shareholders will be taxed when they sell their shares at a gain.
B) Shareholders will be taxed in the year they elect to be taxed on undistributed retained earnings.
C) Shareholders will be taxed on undistributed retained earnings in the year the corporation files its tax return.
D) None of the choices are correct.
Q2) S corporation shareholders who work for the S corporation receive compensation in the form of a guaranteed payment.
A)True
B)False
Q3) Business income allocations to owners from an LLC that is taxed as a partnership are subject to self-employment tax if the owners are significantly involved in the entity's business activities.
A)True B)False
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Chapter 5: Corporate Operations
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Q1) Most corporations use the annualized income method to determine their required annual payment for purposes of making quarterly estimated payments.
A)True
B)False
Q2) Both Schedules M-1 and M-3 require taxpayers to identify book-tax differences as either temporary or permanent.
A)True B)False
Q3) Taxable income of the all C corporations is subject to a flat 21% tax rate.
A)True B)False
Q4) Bingo Corporation incurred a $10 million net operating loss in 2019. Bingo reported taxable income of $12 million in 2020. Bingo can offset the entire $10 million NOL carryover against taxable income in 2020.
A)True B)False
Q5) A C corporation reports its taxable income or loss on Form 1065. A)True B)False
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Chapter 6: Accounting for Income Taxes
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Sample Questions
Q1) Oriole Company reported pretax net income from continuing operations of $1,000,000 and taxable income of $1,200,000. The unfavorable book-tax difference of $200,000 was due to a $200,000 favorable temporary difference relating to depreciation, an unfavorable temporary difference of $300,000 due to an increase in the reserve for bad debts, and a $100,000 unfavorable permanent difference from the disallowance of compensation expense related to the exercise of incentive stock options.
a. Compute Oriole's current income tax expense.
b. Compute Oriole's deferred income tax expense or benefit.
c. Compute Oriole's effective tax rate.
d. Provide a reconciliation of Oriole's effective tax rate with its hypothetical tax rate of 21%.
Q2) Which of the following items would likely not be included in the computation of a company's structural effective tax rate?
A) Tax effects of international operations.
B) Tax effects of state and local operations.
C) Tax effects from the R&D credit.
D) Tax effects from goodwill impairment.
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Chapter 7: Corporate Taxation: Nonliquidating Distributions
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Q1) Houghton Company reports negative current E&P of ($500,000) and negative accumulated E&P of ($800,000). Houghton distributed $100,000 to its sole shareholder, Blossom Applegate, on December 31, 20X3. Blossom's tax basis in her Houghton stock is $50,000. What is the tax treatment of the distribution to Blossom and what is her tax basis in Houghton stock after the distribution?
Q2) Buckeye Company is owned equally by James and his brother Terrelle, each of whom own 500 shares in the company. Terrelle wants to reduce his ownership in the company, and it was decided that the company will redeem 200 of his shares for $5,000 per share on December 31, 20X3. Terrelle's income tax basis in each share is $1,000. Buckeye has current E&P of $10,000,000 and accumulated E&P of $20,000,000. What is the amount and character (capital gain or dividend) recognized by Terrelle because of the stock redemption?
Q3) Sunapee Corporation reported taxable income of $700,000 from operations for 20X3. During the year, the company made a distribution of land to its sole shareholder, Jean McCarthy. The land's fair market value was $125,000 and its tax and E&P basis to Sunapee was $75,000. Jean assumed a mortgage attached to the land of $25,000. Sunapee's tax rate is 21%. Compute Sunapee's total taxable income and federal income tax paid because of the distribution. Using your solution, compute Sunapee's current E&P for 20X3.
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Page 9
Chapter 8: Corporate Formation, Reorganization, and Liquidation
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Q1) Which of the following statements best describes the concept of control as it applies to a section 351 transaction?
A) Control is defined as the ownership of 80 percent or more of a corporation's voting stock.
B) Control is defined as the ownership of 80 percent or more of the fair market value of a corporation's stock.
C) Control is defined as the ownership of 80 percent or more of a corporation's voting stock and 80 percent or more of the fair market value of a corporation's stock.
D) Control is defined as the ownership of 80 percent or more of a corporation's voting stock and 80 percent or more of the total number of shares of each class of nonvoting stock.
Q2) Which of the following statements best describes the impact of receiving boot in a section 351 transaction?
A) Boot received has no impact on the recognition of gain or loss realized in a section 351 transaction.
B) Boot received causes gain realized to be recognized, but not loss realized.
C) Boot received causes loss realized to be recognized, but not gain realized.
D) Boot received causes gain or loss realized to be recognized.
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Chapter 9: Forming and Operating Partnerships
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Sample Questions
Q1) How does a partnership make a tax election for the current year?
A) Partnerships make certain elections automatically by simply filing their returns.
B) Partnerships make certain tax elections by filing a separate form with the IRS.
C) Partnerships do not need to file anything to make a tax election.
D) Partnerships do not make tax elections. Partners must make tax elections separately.
E) Both Partnerships make certain elections automatically by simply filing their returns and Partnerships make certain tax elections by filing a separate form with the IRS.
Q2) The term "outside basis" refers to the partnership's basis in its assets; whereas, the term "inside basis" refers an individual partner's basis in her partnership interest.
A)True B)False
Q3) Income earned by flow-through entities is usually taxed only once at the entity level.
A)True B)False
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11
Chapter 10: Dispositions of Partnership Interests and Partnership Distributions
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Q1) Randolph is a 30% partner in the RD Partnership. On January 1, RD distributes $15,000 cash, an investment with a fair value of $20,000 (inside basis of $10,000), and a parcel of land with a fair value of $10,000 (inside basis of $5,000) to Randolph in complete liquidation of his interest. RD has no liabilities at the date of the distribution. Randolph's basis in his RD partnership interest is $48,000. What is Randolph's basis in the distributed investment and land?
A) $10,000 investment, $5,000 land.
B) $22,000 investment, $11,000 land.
C) $20,000 investment, $10,000 land.
D) $20,000 investment, $13,000 land.
Q2) Locke is a 50% partner in the LS Partnership. Locke has a basis in his partnership interest of $84,000 at the end of the current year, prior to any distribution. On December 31, Locke receives an operating distribution of $30,000 cash. LS has no debt or hot assets. What is the amount and character of Locke's recognized gain or loss? What is Locke's ending basis in his partnership interest?
Q3) Cash distributions include decreases in a partner's share of partnership liabilities. A)True B)False
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Chapter 11: S Corporations
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Q1) Assume that at the end of 2018, Clampett, Inc. (an S corporation) distributes property (fair market value of $40,000, basis of $5,000) to each of its four equal shareholders (aggregate distribution of $160,000). At the time of the distribution, Clampett, Inc. has no corporate E&P and J. D. has a basis of $50,000 in his Clampett, Inc. stock. How much income does J. D. recognize as a result of the distribution?
A) $0.
B) $5,000.
C) $35,000.
D) $40,000.
E) None of the choices are correct.
Q2) For S corporations without earnings and profits from prior C corporation years, the taxation of cash distributions to the shareholder is very similar to the rules for partnerships.
A)True
B)False
Q3) If an S corporation shareholder sells her stock to a nonresident alien, it will automatically terminate the S election.
A)True
B)False
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Page 13
Chapter 12: State and Local Taxes
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Sample Questions
Q1) Mighty Manny, Incorporated manufactures and services deli machinery and distributes them across the United States. Mighty Manny is incorporated and headquartered in New Jersey. It has product sales in all 50 states. Mighty Manny service employees work in Connecticut, New Jersey, New York, Pennsylvania, and Rhode Island. Mighty Manny also has an executive training seminar each year in South Carolina. Determine the states in which Mighty Manny has sales tax nexus.
Q2) Delivery of tangible personal property through common carrier is a protected activity.
A)True
B)False
Q3) A unitary return includes only companies included in the federal consolidated tax return filing.
A)True
B)False
Q4) Which of the following is incorrect regarding nondomiciliary businesses?
A) Subject to tax only where income tax nexus exists.
B) A business cannot be nondomiciliary where headquartered.
C) A business can be nondomiciliary in only one jurisdiction.
D) Subject to tax only where a sufficient connection exists.
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Chapter 13: The US Taxation of Multinational Transactions
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Q1) Which of the following items of foreign source income is classified as passive category income for foreign tax credit purposes?
A) Dividend received from a 5 percent owned foreign corporation, all of the income of which is derived from an active business.
B) Dividend received from a 20 percent owned foreign corporation, all of the income of which is derived from an active business.
C) Dividend received from a 100 percent owned foreign corporation, all of the income of which is derived from an active business.
D) None of the dividends in the scenarios listed above are classified as passive category income.
Q2) Under the book value method of allocating and apportioning interest expense for FTC purposes, assets are characterized as being either U.S. or non-U.S. based on their geographic location.
A)True
B)False
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Chapter 14: Transfer Taxes and Wealth Planning
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Q1) Property is included in the gross estate at the value a willing buyer would pay a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of the relevant facts.
A)True
B)False
Q2) A gift tax return does not need to be filed unless the taxpayer has made current gifts in excess of the applicable credit.
A)True
B)False
Q3) This year Nicholas earned $500,000 and used it to purchase land in joint tenancy with a right of survivorship with Nevaeh. Has Nicholas made a taxable gift to Nevaeh and, if so, in what amount?
Q4) A future interest is a right to receive income or property in the future.
A)True
B)False
Q5) For the holidays, Samuel gave a necklace worth $35,000 to Jennifer and jewelry worth $44,000 to Savannah. Samuel is married to Wendy and they live in a community property state. Has Samuel made any taxable gifts and, if so, in what amounts?
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