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Chapter 16 - Corporate Operations

Chapter 16 Corporate Operations SOLUTIONS MANUAL Discussion Questions


1. [LO 1] In general terms, identify the similarities and differences between the corporate ta able income form!la and the indi"id!al ta able income form!la. Similarities: Both start with the gross income (income after exclusions) for the taxable year. Both formulas reduce gross income by deductions to determine taxable income. Both formulas apply tax rates to taxable income to determine the tax liability. Finally, both formulas reduce the tax liability by credits and tax payments to determine taxes due or the refund. Both formulas include are allowed to take deductions for business expenses to come to taxable income. ifferences: !ndi"iduals distinguish deductions between for and from #$! deductions, and they report ad%usted gross income. &orporations don't distinguish deduction types and don't report ad%usted gross income. (his means corporations don't itemi)e deductions nor do they deduct standard deductions. Finally, unlike indi"iduals, corporations don't deduct personal exemptions. #. [LO 1] Is a corporation$s choice of its ta year independent from its year-end for financial acco!nting p!rposes% *o. (he tax year must be the same year as it uses for financial accounting. &. [LO 1] Can ta able corporations !se the cash method of acco!nting% ' plain. (he three types of o"erall accounting methods that are a"ailable to corporations are accrual, cash, and hybrid. $enerally, corporations must use the accrual method of accounting unless it is a small corporation (a"erage gross receipts for the past + years are ,- million or less). For tax purposes, corporations with a"erage gross receipts for the past three years of ,- million or less may use the cash method of accounting. &orporations that ha"e not been in existence for at least three years may compute their a"erage gross receipts o"er the period they ha"e been in existence to determine if they are allowed to use the cash method of accounting. (. [LO #] )riefly describe the process of comp!ting a corporation$s ta able income ass!ming the corporation m!st !se *++, to determine its boo- income. .ow might the process differ for corporations not re/!ired to !se *++, for boo- p!rposes%

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Chapter 16 - Corporate Operations

(o compute taxable income a corporation will start with book income and make book.to.tax ad%ustments for items that are accounted for differently for book and tax purposes. (he end result is taxable income. !n contrast, a corporation that is not re/uired to (and chooses not to) use $##0 for tax purposes could use tax accounting methods to determine book and tax income. !n these situations, the corporations would not report any book.tax differences. 0. [LO #] 1hat role do a corporation$s a!dited financial statements play in determining its ta able income% # corporation will generally start with income from its audited financial statements and then reconcile to taxable income by determining book.tax differences. 6. [LO #] 1hat is the difference between fa"orable and !nfa"orable boo--ta differences% 1Fa"orable2 book.tax differences are subtractions from book income when reconciling to taxable income. !n contrast, unfa"orable book.tax differences are additions to book income when reconciling to taxable income. (hat is, relati"e to book income, fa"orable book.tax differences decrease taxable income (they reduce taxable income and taxes payable so they are fa"orable) and unfa"orable book.tax differences increase it (they increase taxable income and taxes payable so they are unfa"orable). 2. [LO #] 1hat is the difference between permanent and temporary boo--ta differences% 0ermanent book.tax differences arise from items that are income or deductions during the year for either book purposes or for tax purposes but not both. 0ermanent differences do not re"erse o"er time, so o"er the long run the total amount of income or deductions for the items are different for book and tax purposes. !n contrast, temporary book.tax differences are those book. tax differences that re"erse o"er time such that o"er the long.term, corporations recogni)e the same amount of income or deductions for the items on their financial statements as they recogni)e on their tax returns. (emporary book.tax differences arise because the income or deduction items are included in financial accounting income in one year and in taxable income in a different year. 3. [LO #] 1hy is it important to be able to determine whether a partic!lar boo--ta difference is permanent or temporary% 3any corporations are re/uired to disclose their permanent and temporary book.tax differences on their tax returns (on Schedule 3.+). Second, the distinction is useful for those responsible for computing and tracking book.tax differences for tax return purposes and for the use of calculating the income tax expense and effecti"e tax rate to be reported in the financial statements.

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Chapter 16 - Corporate Operations

4. [LO #] 5escribe the relation between the boo--ta differences associated with depreciation e pense and with gain or loss on disposition of depreciable assets. Because tax depreciation methods generally pro"ide for more accelerated depreciation than financial accounting methods, book.tax differences associated with depreciation are usually fa"orable in the early years of an asset's depreciable life. (he difference re"erses later on. 4owe"er, when an asset is disposed of before it is fully depreciated, it is likely that the tax basis of the asset will be lower than the financial accounting basis. &onse/uently, for tax purposes, the corporation likely will recogni)e more gain (or less loss) for tax purposes than for book purposes resulting in an unfa"orable book.tax difference. (he book.tax difference on the sale is a complete re"ersal of the cumulati"e book.tax differences from depreciation. 16. [LO #] 1hen a corporation recei"es a di"idend from another corporation does the di"idend generate a boo--ta difference to the di"idend-recei"ing corporation 7ignore the di"idends recei"ed ded!ction8% ' plain. (he di"idend could generate a book.tax difference depending on the le"el of ownership in the distributing corporation because this is what affects the method of accounting for receipt of di"idends for book purposes. !f the recipient corporation owns less than 567 of the distributing corporation there will generally not be a book tax difference. !f the recei"ing corporation owns 567 or more and less than -67 the book.tax difference will generally be the difference between the amount of the di"idend and the amount of income the corporation recogni)es on its books for its pro.rata share of the distributing corporation's earnings. Book.tax differences when the recipient corporation owns -67 or more of the distributing corporation are beyond the scope of this text. 11. [LO #] 5escribe how goodwill recogni9ed in an asset ac/!isition leads to temporary boo-ta differences. 8hen a corporation ac/uires the assets of another business in a taxable transaction and it allocates part of the purchase price to goodwill (excess purchase price o"er the fair market "alue of identifiable assets ac/uired), the corporation is allowed to amorti)e this purchased goodwill on a straight.line basis o"er 9- years (9:6 months) for tax purposes. For book purposes, corporations ac/uiring the assets of another business also typically allocate part of the purchase price to goodwill but reco"er the cost of goodwill for book purposes only when and only to the extent goodwill is impaired. (hus, to determine the temporary book.tax difference associated with purchased goodwill, corporations need to compare the amount of goodwill they amorti)e for tax purposes with the goodwill impairment expense for book purposes. 1#. [LO #] 5escribe the boo--ta differences that arise from incenti"e stoc- options and non/!alified stoc- options granted before +:C 213 7the codification of ;+: 1#&<8 became effecti"e.

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Before #S& ;9: , no book.tax differences existed for incenti"e stock options because there was no book deduction and no tax deduction associated with the stock options. 4owe"er, a fa"orable, permanent book.tax difference was generated when non/ualified options were exercised. <n exercise, corporations were allowed a tax deduction for the bargain element of the options (the difference between the fair market "alue of the stock and the exercise price on the date the employee exercised the stock options). 4owe"er, they did not deduct any compensation expense for book purposes. 1&. [LO #] 5escribe the boo--ta differences that arise from incenti"e stoc- options granted after +:C 213 7the codification of ;+: 1#&<8 became effecti"e. #fter #S& ;9: , incenti"e stock options now gi"e rise to permanent, unfa"orable book.tax differences. &orporations are not allowed to deduct any compensation expense associated with incenti"e stock options for tax purposes, but for financial accounting purposes, corporations are re/uired to deduct the initial estimated "alue of the stock options x the percentage of the options that "est during that particular year. 1(. [LO #] 5escribe the boo--ta differences that arise from non/!alified stoc- options granted after +:C 213 7the codification of ;+: 1#&<88 became effecti"e. *on/ualified options may generate permanent and=or temporary book.tax differences. &orporations initially recogni)e temporary book.tax differences associated with stock options for the "alue of options that "est during the year but are not exercised during that year. (his initial temporary difference is always unfa"orable because the corporation deducts the "alue of the unexercised options that "est during the year for book purposes but not for tax purposes. (his initial unfa"orable temporary book.tax difference completely re"erses when employees actually exercise the stock options. (he amount of the permanent difference is the difference between the estimated "alue of the stock options exercised (the amount associated with these stock options deducted for book purposes) minus the bargain element of the stock options exercised during the year (the amount that is deducted for tax purposes). !f the estimated "alue of stock options exercised exceeds the bargain element of the stock options exercised, the permanent book.tax difference is unfa"orable, otherwise it is fa"orable. (he permanent book.tax difference is recogni)ed in the year the options are exercised. (he tax benefits related to the excess tax deductions o"er the estimated book amounts are recorded as 1windfall2 benefits in the company's additional paid.in capital.

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Chapter 16 - Corporate Operations

10. [LO #] .ow do corporations acco!nt for capital gains and losses for ta p!rposes% .ow is this different than the way indi"id!als acco!nt for capital gains and losses% For tax purposes, capital gains are taxed at the corporation's ordinary rates, and indi"iduals are taxed on net long.term capital gains at preferential rates (lower than ordinary rates). &orporations are not allowed to deduct net capital losses. (hey carry back net capital losses three years and forward fi"e years to offset capital gains in those years. !ndi"iduals can deduct up to ,+,666 of net capital loss against ordinary income in a year. (hey carry o"er the remainder indefinitely to offset against capital gains in subse/uent years and to deduct up to ,+,666 of net capital loss against ordinary income each year. 16. [LO #] 1hat are the common boo--ta differences relating to acco!nting for capital gains and losses% 5o these differences create fa"orable or !nfa"orable boo--to-ta ad=!stments% (he first common difference arises when a corporation has a net capital loss in a year. (he corporation deducts the net loss for book purposes but is not allowed to deduct it for tax purposes. So, the net capital loss generates an unfa"orable temporary book.tax difference. 8hen the net capital loss is deducted for tax purposes as a carryback or a carryo"er it generates a fa"orable book.tax difference because the carryback or carryo"er is not deductible for book purposes. 12. [LO #] 1hat are the carrybac- and carryo"er periods for a net operating loss% *et operating losses are carried back for two years (the loss must be carried back to two years before the current year first and then to the year %ust prior to the current year. &orporations incurring *<>s in 566: or 566? may elect to carry back the losses for two, three, four, or fi"e years (a carryback to the fifth year may offset only -67 of the income). #ny remaining loss is carried forward for up to 56 years. 8hen a corporation has net operating losses that arise in multiple years, the losses must be used on a F!F< basis. &orporations may elect to wai"e the carryback period, choosing to only carryforward net operating losses. 13. [LO #] Is a corporation allowed to carry a net operating loss forward if it has income in prior years that it co!ld offset with a carrybac-% ' plain. # corporation can elect to forgo the carryback period and instead carry the net operating loss forward.

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14. [LO #] >,lanning? 1hat m!st a decision ma-er consider when deciding whether to carry bac- a net operating loss or to elect to forgo the carrybac-% (he decision maker must e"aluate the marginal tax rate at which the net operating loss carryback or carryo"er will sa"e taxes. !f the rate in the carryback period is lower than the estimated tax rate in early carryo"er periods, it may make sense to carry back the loss. !f the rate is lower in the carryback period, it may be better from a tax perspecti"e to forgo the carryback period. &orporations may also want to consider the time and effort re/uired to file the carryback claim (on Form 99+?) because it is much easier to simply carry the loss forward on the corporation's tax return. #6. [LO #] >,lanning? + corporation hired an acco!nting firm to recalc!late the way it acco!nted for leasing transactions. 1ith the new calc!lations, the corporation was able to file amended ta ret!rns for the past few years that increased the corporation$s net operating loss carryo"er from @&,666,666 to @0,666,666. 1as the corporation wise to pay the acco!ntants for their wor- that led to the increase in the AOL carryo"er% 1hat factors sho!ld be considered in ma-ing this determination% !t depends on how much they paid the accountants, whether or not they will be able to use the *<> to offset income in the pre"ious years, or whether or not they will ha"e income in the future to recei"e a tax benefit from the *<>. (hey should calculate if the present "alue of the tax sa"ings for the *<> is greater than the cost to ha"e the accountants obtain the higher *<>s. !t may be that the business is ne"er going to become profitable and will therefore not e"er recei"e a tax benefit from the increased carryo"er. #1. [LO #] Compare and contrast the general r!le for determining the amo!nt of the charitable contrib!tion if the corporation contrib!tes capital gain property "ers!s ordinary income property. $enerally, corporations are allowed to deduct the amount of money they contribute, the fair market "alue of capital gain property they donate (property that would generate long.term capital gain property if sold), and the ad%usted basis of ordinary income property they donate. ##. [LO #] 1hich limitations might restrict a corporation$s ded!ction for a cash charitable contrib!tion% ' plain how to determine the amo!nt of the limitation. &orporations@ charitable contributions are limited to 967 of their taxable income before any charitable contribution, domestic production acti"ities deduction, di"idends recei"ed deduction, capital loss carrybacks, and *<> carrybacks. #dditionally, an accrual.method corporation may not be allowed to deduct a charitable contribution it accrues in the current year (with appro"al of the board of directors) if it does not pay actual contribution within 5 A months after year end.

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#&. [LO #] ;or ta p!rposes, what happens to a corporation$s charitable contrib!tions that are not ded!cted in the c!rrent year beca!se of the ta able income limitation% &haritable contributions that are restricted by the taxable income limitation are carried forward for fi"e years. 8hen the excess contribution is carried forward it is treated as though it were a contribution in the subse/uent year. 4owe"er, if the contribution is limited in the subse/uent year, the current year contributions are deducted before the carryo"er. #lso, carryo"ers from different years are deducted in a first.in, first.out order. !f the carryo"er is not deducted within fi"e years, it expires without pro"iding any tax benefit. #(. [LO #] 1hat are common boo--ta differences relating to corporate charitable contrib!tions% +re these differences fa"orable or !nfa"orable% (he common book.tax differences related to charitable contributions are based on when the contribution is paid and the o"erall limitation. 8hen paid: !f a company accrues a contribution for book purposes, it is allowed to take the deduction in the year of accrual. For tax purposes, howe"er, a corporation must pay it within 5 A months after year end. # difference here would be a temporary difference that is initially unfa"orable but re"erses as a fa"orable book.tax difference in the subse/uent year. <"erall limitation: For tax purposes, charitable contributions are limited to 967 of charitable contribution limit modified taxable income. For book purposes, the limitation does not apply. &onse/uently, in the year in which the contribution is limited for tax purposes, the book.tax difference will be an unfa"orable temporary difference. 4owe"er, when the carryo"er is deducted it will generate a fa"orable temporary difference that is the re"ersal of the pre"ious unfa"orable ad%ustment. #0. [LO #] 1hy does Congress pro"ide the di"idends recei"ed ded!ction for corporations recei"ing di"idends% (he di"idends recei"ed deduction reduces the extent to which the earnings of a corporation may be sub%ect to more than two le"els of taxation (that is, corporate income technically should only be sub%ect to 1double taxation,2 first at the corporate le"el and then at the shareholder le"el). #6. [LO #] .ow does a corporation determine the percentage for its di"idends recei"ed ded!ction% ' plain. (he percentage is determined based on the actual ownership of the recei"ing corporation in the distributing corporation's stock. !f the ownership is less than 567, the di"idends recei"ed deduction percentage is ;67. !f ownership is at least 567 but less than :67, the di"idends recei"ed deduction is :67. !f the ownership is :67 or more, the di"idends recei"ed deduction percentage is 9667.

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#2. [LO #] 1hat limitations apply to the amo!nt of the allowable di"idends recei"ed ded!ction% (he di"idends recei"ed deduction is sub%ect to a taxable income limitation. Bnder this limitation, the di"idend recei"ed deduction is limited to the lesser of (9) eduction percentage x amount of di"idend or (5) eduction percentage x taxable income (before C , *<>, 0# , and capital loss carrybacks) (5) does not apply howe"er if after deducting the amount determined in (9) the corporation reports a loss. #3. [LO #] 1hy do the marginal rates in the corporate ta rate sched!le increase and then decrease before increasing again% 8hen the apparent marginal rate increases to +?7, the marginal tax rate is really +D7, but the tax laws impose a -7 add.on tax that is designed to eliminate the benefit of the rates lower than +D7 (9-7 and 5-7). &onse/uently, by the time the marginal rate from the schedule drops back down to +D7 at ,++-,666 of taxable income, the entire amount of taxable income is taxed at a flat +D7 rate. (herefore, taxable income between ,++-,666 and ,96,666,666, is taxed at a flat +D7 rate. (he marginal rate then %umps to +-7 and then to +:7. (he +7 increase from +-7 to +:7 is also an add.on tax designed to phase.out the benefit of the +D7 tax rate relati"e to the +-7 rate. #s a result, by the time taxable income hits ,9:,+++,+++, a corporation's taxable income is taxed at a flat +-7 tax rate. #4. [LO #] ' plain the controlled gro!p r!les in "ery general terms and indicate what type of beha"ior the r!les are attempting to pre"ent in terms of comp!ting a corporation$s ta liability. # controlled group is a group of corporations that is owned or controlled by the same (small) group of taxpayers. # controlled group of corporations may use only one 9-7 tax bracket and one 5-7 tax bracket among all the corporations in the group. (hat is, the controlled group is treated as one corporation for purposes of using the tax rate schedules. !n general, the tax pro"isions associated with controlled groups are designed to eliminate the benefit of splitting large corporations into smaller entities to take ad"antage of multiple tax benefits allowable to smaller corporations because the controlled group rules treat the entire group as though it is one entity. (he controlled group pro"isions re/uire corporations in the group to share other tax benefits such as the #3( exemption. # potential benefit of ha"ing a parent.subsidiary controlled group is that if the group files a consolidated tax return, the losses of one corporation in the group can offset income from other corporation's in the group

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&6. [LO #] 5escribe the three types of controlled gro!ps. # controlled group is a group of corporations that is controlled or owned by the same taxpayer or group of taxpayers. # controlled group could be a parent.subsidiary controlled group, a brother.sister controlled group, or a combined group. # parent.subsidiary controlled group in"ol"es a corporation (the parent) that owns at least :67 of the "oting power or stock "alue of another corporation (the subsidiary) on the last day of the year. # brother.sister controlled group consists of two or more corporations of which fi"e or fewer persons collecti"ely own more than -67 of the "oting power or stock "alue of each corporation on the last day of the year. # combined group is three or more corporations, each of which is a member of either a parent.subsidiary or brother.sister controlled group, and one of the corporations is the parent in the parent.subsidiary controlled group and also is in a brother. sister controlled group. &1. [LO &]. .ow is the :ched!le B-1 similar to and different from a :ched!le B-&% .ow does a corporation determine whether it m!st complete :ched!le B-1 or :ched!le B-& when it completes its ta ret!rn% Schedules 3.9 and 3.+ are both schedules on the corporate tax return Form 9956, where corporations report their book.tax differences and reconcile their book and taxable income (before the di"idends recei"ed deduction and net operating loss deductions). &orporations with total assets of less than ,96,666,666 report their book.tax differences on Schedule 3.9. &orporations with total assets of ,96,666,666 or more are re/uired to report their book.tax differences on Schedule 3.+. Schedule 3.+ is three pages long and includes a page for reporting information and the applicable book income. (he second page contains income. related book.tax differences, while the third page reports deduction related book.tax differences. !n contrast, Schedule 3.9 is a short schedule with only 96 lines. Schedule 3.+ re/uires more than E6 types of book.tax differences. Finally, Schedule 3.+ re/uires corporations to identify book.tax differences as temporary or permanent while Schedule 3.9 does not. &#. [LO &] 1hat is the d!e date for the corporation ta ret!rn ;orm 11#6% Is it possible to e tend the d!e date% ' plain. (he tax return due date for a taxable corporation is two and one.half months after the corporation's year end. (hus, a calendar.year corporation's unextended tax return due date is 3arch 9-. &orporations re/uesting an extension can extend the due date for filing their tax returns (not for paying the taxes) for six months (September 9- for calendar year corporations).

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&&. [LO &] .ow does a corporation determine the minim!m amo!nt of estimated ta payments it m!st ma-e to a"oid !nderpayment penalties% .ow are these r!les different for large corporations than they are for other corporations% (o a"oid underpayment penalties, the re/uired annual payment is the least of (9) 9667 of the current year tax liability (although they won't know this until they file their tax return), (5) 9667 of the tax liability on the prior year's return, but only if there was a positi"e tax liability on the return and the prior year return co"ered a 95.month period (howe"er, there are special rules for 1large2 corporationsF they are sub%ect to different treatment), or (+) 9667 of the estimated current year tax liability using the annuali)ed income method. &orporations must ha"e paid in 5-7, -67, ;-7, and 9667 of their re/uired annual payments by the 9-th day of the Dth, Eth, ?th, and 95th months of their tax year. !f a corporation wants to determine the minimum payments, it should compute the re/uired payments under each of the methods for each /uarter and pay in the minimum re/uired payment. &orporations may use different methods for determining the re/uired payment for each /uarter. 1>arge2 corporations, defined as corporations with o"er ,9,666,666 of taxable income in any of the three years prior to the current year, may use the prior year tax liability to determine their first /uarter estimated tax payments only. !f they use the prior year tax liability to determine their first /uarter payment, their second /uarter payment must 1catch up2 their estimated payments. (hat is the second /uarter payment must be large enough for the sum of their first and second /uarter payments to e/ual or exceed be -67 of their current year tax liability. &(. [LO &] 5escribe the ann!ali9ed income method for determining a corporation$s re/!ired estimated ta payments. 1hat ad"antages does this method ha"e o"er other methods% Bnder the annuali)ed method, corporations determine their taxable income as of the end of each /uarter and then annuali)e (pro%ect) the amounts to determine their estimated taxable income and tax liability for the year. (he estimated annual tax liability is used at the end of each /uarter to determine the minimum re/uired estimated payment for that /uarter. &orporations use the first /uarter taxable income to pro%ect their annual tax liability for the first and second /uarter estimated tax payments. (hey use taxable income at the end of the second /uarter to determine the third /uarter estimated tax payment re/uirement, and taxable income at the end of the third /uarter to determine their fourth /uarter payment re/uirement. (he ad"antage of the annuali)ed income method is that it allows corporations to determine their re/uired estimated payments (which may be lower than re/uired payments using prior year tax liability) with certainty.

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&0. [LO (] +re any corporations e empt from the +BC% )riefly e plain. Ges, small corporations are exempt from the #3(. Small corporations are those with a"erage annual gross receipts less than ,;.- million for the three years prior to the current year. *ew corporations are exempt from the #3( in their first year of existence, and they are exempt from their first three years of existence as long as their a"erage annual gross receipts are below ,-3 during the three.year period. *ote howe"er that !CS publication -D5 1&orporations2 and the instructions to Form DE5E indicate that (9) all corporations are exempt from the #3( in their first year of existence, (5) a corporation is exempt from the #3( in its second year of existence if the gross receipts from its first year are under ,-,666,666, and (+) a corporation is exempt from the #3( if its a"erage gross receipts for the +.year period (or portion thereof during which the corporation was in existence) ending before its current tax year did not exceed ,;,-66,666. <nce a corporation fails the #3( gross receipts test (,;.-3 or ,-3), it is no longer exempt from the #3(. &6. [LO (] )riefly describe the process of comp!ting a corporation$s +BC. (he starting point for computing corporate #3( is regular taxable income before the *<> deduction. (axable income is then increased by preference items and then either increased or decreased by ad%ustments to come to alternati"e minimum taxable income (#3(!). From #3(! the corporation subtracts the exemption amount (to the extent it is not phase.out) to come to the #3( tax base. (he tax base is multiplied by 567 to get the tentati"e minimum tax. (he #3( is the excess of the tentati"e minimum tax o"er the regular tax liability. (his is summari)ed in the following formula: #3( F<C3B># (axable income or loss before *<> deduction #dd: 0reference items #dd or subtract: #d%ustments #lternati"e minimum taxable income (#3(!) Subtract: Hxemption #3( base x 567 (entati"e minimum tax Subtract: Cegular income tax #lternati"e minimum tax if positi"e

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&2. [LO (] 1hat is the concept!al difference between ad=!stments and preference items for +BC p!rposes% (he difference between an ad%ustment and a preference item is that preference items are always added back to taxable income while ad%ustments can be either added or subtracted. !n this sense, ad%ustments are more like timing differences between regular taxable income and #3(!, and preferences are permanent unfa"orable differences between regular taxable income and #3(!. &3. [LO (] 1hat does the +C' ad=!stment attempt to capt!re% .ow does a corporation determine its +C' ad=!stment% (he #&H ad%ustment attempts to capture economic income that is not otherwise included in the #3( tax base. (o compute the #&H ad%ustment, a corporation would determine the items that are accounted for differently for #3( purposes and for #&H purposes (see Hxhibit 9E.9D in text) and sum (or net) the differences (some may be positi"e (unfa"orable differences) and others may be negati"e (fa"orable differences)). (he #&H ad%ustment is ;-7 of the sum of the indi"idual differences. *ote that the #&H ad%ustment can be positi"e or negati"e. 4owe"er, any negati"e ad%ustment is limited to the cumulati"e positi"e ad%ustments in prior years. &4. [LO (] 1hat is the corporate +BC e emption% Is it a"ailable to all corporations% )riefly e plain. (he corporate #3( exemption is a fixed amount that a corporation can deduct in determining its #3(!. (he exemption amount is ,D6,666. 4owe"er, the exemption is only a"ailable for smaller corporations because it is phased out by 5-7 for each dollar that #3(! exceeds ,9-6,666. So the exemption is completely eliminated for corporations with #3(! o"er ,+96,666. (6. [LO (] .ow is it possible that a corporation$s marginal +BC rate is greater than #6 percent if the stated +BC rate is #6 percent% # corporation's marginal #3( rate can be greater than 567 if it is in the exemption phase.out range. For corporations in the phase.out range, each dollar of income increases #3(! by ,9.5-. &onse/uently, each dollar of income in this range increases the #3( by .5- (,9.5- x 567) which is a 5-7 marginal tax rate. (1. [LO (] 5oes a corporation pay the +BC in addition to or instead of the reg!lar ta % )riefly e plain. # corporation pays the #3( in addition to the regular tax. (here is no #3( unless the tentati"e minimum tax is greater than the regular income tax. (he #3( is the excess of the tentati"e minimum tax in excess of the regular tax.

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(#. [LO (] .ow does a corporation comp!te its minim!m ta credit% .ow does a minim!m ta credit benefit a corporation% # corporation recei"es a minimum tax credit for any #3( it pays for the year. (he credit can be used to reduce regular tax liability in future years, but only to the extent that the regular tax is greater than the tentati"e minimum tax. (he minimum tax credit is carried o"er indefinitely. (he credit only benefits corporations in years when they don't owe the alternati"e minimum tax. (&. [LO (] >,lanning? 1hat basic ta planning strategies might a corporation that is e pected to owe +BC this year b!t not ne t year engage in% .ow wo!ld those strategies change if the corporation e pected to be in +BC ne t year b!t not in the c!rrent year% Because the #3( rate is low relati"e to the regular tax rates, a corporation that is expected to owe #3( this year but not next year may be ser"ed best by accelerating income into the #3( year (or defer deductions to the non #3( year) and ha"ing it taxed at the lower #3( rate. !n contrast, if a corporation expects to be in #3( next year but not this year, the corporation may want to defer income to next year or accelerate deductions into this year to take ad"antage of the rate differential between the two years.

Problems
((. [LO 1] LA: corporation reports boo- income of @#,666,666. Incl!ded in the @#,666,666 is @10,666 of ta -e empt interest income. LA: reports @1,&(0,666 in ordinary and necessary b!siness e penses. 1hat is LA: corporation$s ta able income for the year% ,ED6,666, computed as follows: Description (9) Book income (5) (ax.exempt interest income (+) eductions (axable income Amount Explanation ,5,666,666 (9-,666) (9,+D-,666) $640,000 (9) I (5) I (+)

(0. [LO 1] +C1 corporation c!rrently !ses the ;I;O method of acco!nting for its in"entory for boo- and ta p!rposes. Its beginning in"entory for the c!rrent year was @3,666,666. Its ending in"entory for the c!rrent year was @2,666,666. If +C1 had been !sing the LI;O method of acco!nting for its in"entory, its beginning in"entory wo!ld ha"e been @2,666,666 and its ending in"entory wo!ld ha"e been @0,066,666. +ss!me +C1 corporation$s marginal ta rate is &( percent.

16-1&

Chapter 16 - Corporate Operations

a. .ow m!ch more in ta es did +C1 corporation pay for the c!rrent year beca!se it !sed the ;I;O method of acco!nting for in"entory than it wo!ld ha"e paid if it had !sed the LI;O method% ecrease in in"entory (increase in &<$S) under F!F< is ,9,666,666 (,:,666,666 . ;,666,666) ecrease in in"entory (increase in &<$S) under >!F< is ,9,-66,666 (,;,666,666 J -,-66,666) F!F< &<$S benefit K ,9,666,666 L .+D K ,+D6,666 >!F< &<$S benefit K 9,-66,666 L .+D K ,-96,666 (hus #(8 paid ,9;6,666 more in taxes under the F!F< method than under the >!F< method (&<$S was ,-66,666 greater under >!F< (income ,-66,666 lower) x +D7 K ,9;6,666 tax sa"ings under >!F<). b. 1hy wo!ld +C1 !se the ;I;O method of acco!nting if doing so ca!ses them to pay more ta es on a present "al!e basis% 7Aote that the ta laws don$t allow corporations to !se the LI;O method of acco!nting for in"entory !nless they also !se the LI;O method of acco!nting for in"entory for boo- p!rposes.8 #(8 &orporation may ha"e chosen to use the F!F< method to increase financial reporting income e"en if this meant higher taxable income and more taxes. (6. [LO 1] 'L: corporation is abo!t to begin its si th year of e istence. +ss!me that 'L: reported gross receipts for each of its first fi"e years of e istence for scenarios +, ), and C as followsD Year of Existence 1 # & ( 0 Scenario A @(,666,666 @0,666,666 @0,466,666 @6,666,666 @(,066,666 Scenario B @&,666,666 @0,666,666 @2,066,666 @6,666,666 @(,066,666 Scenario C @0,066,666 @0,666,666 @(,206,666 @0,666,666 @0,#06,666

a. In what years is 'L: allowed to !se the cash method of acco!nting !nder :cenario +% For tax purposes, corporations with a"erage gross receipts for the past three years of ,- million or less may use the cash method of accounting. &orporations that ha"e not been in existence for at least three years may compute their a"erage gross receipts o"er the period they ha"e been in existence to determine if they are allowed to use the cash method of accounting H>S is allowed to use

16-1(

Chapter 16 - Corporate Operations

Year of Existence 9 5 + D E

Scenario A Ges: *o gross receipts in prior year. Ges, a"erage gross receipts through year one of ,D,666,666 M ,-,666,666 Ges, a"erage gross receipts through year two of ,D,-66,666 M ,-,666,666 Ges: a"erage gross receipts through year three of ,D,?EE,EE; M ,-,666,666 *o: a"erage gross receipts from years two through four of ,-,E++,+++ N ,-,666,666 *o: a"erage gross receipts from years three through fi"e of ,-,DEE,EE; N ,-,666,666

b. In what years is 'L: allowed to !se the cash method of acco!nting !nder :cenario )% Year of Existence 9 5 + D E

Scenario B Ges, no gross receipts in prior year. Ges, a"erage gross receipts through year one of ,+,666,666 M ,-,666,666 Ges, a"erage gross receipts through year two of ,D,666,666 M ,-,666,666 *o: a"erage gross receipts through year three of ,-,9EE,EE; N ,-,666,666 *o: a"erage gross receipts from years two through four of ,E,9EE,EE; N ,-,666,666 *o: a"erage gross receipts from three through fi"e of ,E,666,666 N ,-,666,666

c. In what years is 'L: allowed to !se the cash method of acco!nting !nder :cenario C%

16-10

Chapter 16 - Corporate Operations

Year of Existence 9 5 + D E

Scenario C Ges, no gross receipts in prior year. *o, a"erage gross receipts through year one of ,-,-66,666 N ,-,666,666 *o, a"erage gross receipts through year two of ,-,5-6,666 N ,-,666,666 *o: a"erage gross receipts through year three of ,-,6:+,+++ N ,-,666,666 Ges: a"erage gross receipts from years two through four of ,D,?9E,EE; M ,-,666,666 Ges: a"erage gross receipts from three through fi"e of ,-,666,666 K ,-,666,666

(2. [LO #]. On its year 1 financial statements, :eata Corporation, an accr!al-method ta payer, reported federal income ta e pense of @026,666. On its year 1 ta ret!rn, it reported a ta liability of @606,666. 5!ring year 1, :eata made estimated ta payments of @266,666. 1hat boo--ta difference, if any, associated with its federal income ta e pense sho!ld :eata ha"e reported when comp!ting its year 1 ta able income% Is the difference fa"orable or !nfa"orable% Is it temporary or permanent% &orporations reconcile from book income to taxable income by making ad%ustments for book.tax differences. !n this case, Seatax deducted ,-;6,666 of federal income tax expense to determine its book income (note that it did not deduct its actual tax liability). Because corporations are not allowed to deduct any federal tax expense on their tax returns, Seatax will make a permanent ,-;6,666 unfa"orable book.tax difference when computing its year 9 taxable income. (3. [LO #] +ss!me Baple Corp. has =!st completed the third year of its e istence 7year &8. Che table below indicates Baple$s ending boo- in"entory for each year and the additional E#6&+ costs it was re/!ired to incl!de in its ending in"entory. Baple immediately e pensed these costs for boo- p!rposes. In year #, Baple sold all of its year 1 ending in"entory, and in year & it sold all of its year # ending in"entory. 'nding boo- in"entory +dditional E #6&+ costs 'nding ta in"entory Year 1 @#,(66,666 66,666 @#,(66,666 Year 2 @#,266,666 26,666 @#,226,666 Year 3 @#,6(6,666 (6,666 @#,636,666

a. 1hat boo--ta difference associated with its in"entory did Baple report in year 1% 1as the difference fa"orable or !nfa"orable% 1as it permanent or temporary% Gear 9: ,E6,666 unfa"orable temporary ad%ustment (in"entory costs deducted for books but included in ending in"entory for tax).

16-16

Chapter 16 - Corporate Operations

b. 1hat boo--ta difference associated with its in"entory did Baple report in year #% 1as the difference fa"orable or !nfa"orable% 1as it permanent or temporary% Gear 5: ,96,666 unfa"orable temporary ad%ustment. (his is the net of a ,;6,666 unfa"orable ad%ustment for amounts included in ending in"entory for tax but deducted for books and a ,E6,666 fa"orable ad%ustment for the re"ersal of the ad%ustment in year 9 (see part a). c. 1hat boo--ta difference associated with its in"entory did Baple report in year &% 1as the difference fa"orable or !nfa"orable% 1as it permanent or temporary% Gear +: ,+6,666 fa"orable temporary ad%ustment. (his is the net of a ,D6,666 unfa"orable ad%ustment for amounts included in ending in"entory for tax but deducted for books in year + and a ,;6,666 fa"orable ad%ustment for the re"ersal of the amount capitali)ed to in"entory in year 5 (see part b). (4. [LO #] F5og corporation owns stoc- in Oscar, Inc. F5og recei"ed a @16,666 di"idend from Oscar, Inc. 1hat temporary boo--ta difference associated with the di"idend will F5og report for the year in the following alternati"e scenarios 7for part a., ignore the di"idends recei"ed ded!ction8% a. F5og owns 0 percent of the Oscar, Inc. stoc-. Oscar$s income for the year was @066,666. O og will include the ,96,666 di"idend in book income. For tax purposes, O og will also include the ,96,666 in gross income so that it will not report a temporary book.tax difference on the di"idend. *ote that O og is also entitled to a di"idends recei"ed deduction that will result in a permanent fa"orable book.tax difference. b. F5og owns (6 percent of the Oscar, Inc. stoc-. Oscar$s income for the year was @066,666. O og can exert significant influence o"er <scar, !nc. at D6 percent ownership., !nstead of including the di"idend in its income, O og recogni)es ,566,666 (D67 x ,-66,666) of income for book purposes under the e/uity method. (his is O og's pro.rata share of <scar's net income for the year. For tax purposes, O og includes only the ,96,666 di"idend in gross income. &onse/uently, O og will report a ,9?6,666 fa"orable temporary book.tax difference. *ote that O og will also report a permanent fa"orable book.tax difference in the amount of the di"idends recei"ed deduction.

16-12

Chapter 16 - Corporate Operations

06. [LO #] On F!ly 1 of year 1, <i"erside, Corp. 7<C8, a calendar-year ta payer, ac/!ired the assets of another b!siness in a ta able ac/!isition. 1hen the p!rchase price was allocated to the assets p!rchased, <C determined it had p!rchased @1,#66,666 of goodwill for both boo- and ta p!rposes. +t the end of year 1, the a!ditors for <C determined that the goodwill had not been impaired d!ring the year. In year #, howe"er, the a!ditors concl!ded that @#66,666 of the goodwill had been impaired, and they re/!ired <C to write down the goodwill by @#66,666 for boo- p!rposes. a. 1hat boo--ta difference associated with its goodwill sho!ld <C report in year 1% Is it fa"orable or !nfa"orable% Is it permanent or temporary% For tax purposes, C& amorti)es the ,9,566,666 using the straight line method o"er 9- years (9:6 months). &onse/uently, in year 9, it will amorti)e and expense ,D6,666 of the goodwill (,9,566,666=9:6 months x E months K ,D6,666) for tax purposes. 4owe"er, for book purposes, it does not deduct any of the goodwill since there is no impairment. &onse/uently, in year 9, C& will report a fa"orable ,D6,666 temporary difference associated with the goodwill. b. 1hat boo--ta difference associated with its goodwill sho!ld <C report in year #% Is it fa"orable or !nfa"orable% Is it permanent or temporary% !n year 5, C& amorti)es ,:6,666 of the goodwill for tax purposes (,9,566,666=9:6 x 95 K ,:6,666). For book purposes it writes off (deducts) ,566,666 in goodwill. &onse/uently, it reports a ,956,666 unfa"orable temporary book.tax difference in year 5. 01. [LO #]. +ss!me that on Fan!ary 1, year 1, +)C, Inc. iss!ed 0,666 stoc- options with an estimated "al!e of @16 per option. 'ach option entitles the owner to p!rchase one share of +)C stoc- for @#0 a share 7the per share price of +)C stoc- on Fan!ary 1, year 1 when the options were granted8. Che options "est 06 percent at the end of the day on 5ecember &1, year 1, and 06 percent at the end of the day on 5ecember &1, year #. +ll 0,666 stoc- options were e ercised in year & when the +)C stoc- was "al!ed at @&1 per share. Identify +)C$s year 1, #, and & ta ded!ctions and boo--ta differences 7indicate whether permanent andGor temporary8 associated with the stoc- options !nder the following alternati"e scenariosD a. Che stoc- options are incenti"e stoc- options and +:C 213 7the codification of ;+: 1#&<8 does not apply to the options. Bnless #S& ;9: applies, #B& will not deduct any compensation expense for the options for book purposes. Further, for tax purposes, #B& is not allowed any deductions related to incenti"e stock options. &onse/uently, there are no book.tax differences associated with the stock options in years 9, 5, or +. b. Che stoc- options are non/!alified stoc- options and +:C 213 does not apply to the options.

16-13

Chapter 16 - Corporate Operations

8ithout the application of #S& ;9:, there is no book deduction for non/ualified stock options. 4owe"er, for tax purposes, #B& can deduct the bargain element (F3P J exercise price) of the options when they are exercised in year +. (hus, there are no book. tax differences for years 9 and 5, but a ,+6,666 Q(,+9 . ,5-) x -,666R fa"orable, permanent book.tax difference in year +. c. Che stoc- options are incenti"e stoc- options and +:C 213 applies to the options. For tax purposes, #B& is not allowed any deductions for incenti"e stock options. 4owe"er, under #S& ;9:, for book purposes, #B& expenses the initial "alue of the stock options as the options "est. !n this case, the options were "alued at ,96 per option. !n year 9, 5,-66 options "est. So, #B& will deduct ,5-,666 of compensation expense from the options in year 9 (5,-66 x ,96). !n year 5, 5,-66 more options "est. #B& will deduct ,5-,666 of compensation expense from the options in year 5 (5,-66 x ,96) for book purposes. (o summari)e, #B& will report an unfa"orable permanent book.tax difference of ,5-,666 in year 9 and again in year 5. !t will not report a book.tax difference in year +. d. Che stoc- options are non/!alified stoc- options and +:C 213 applies to the options. Bnder #S& ;9:, for book purposes, #B& expenses the initial "alue of the stock options as the options "est. !n this case, the options were "alued at ,96 per option. !n year 9, 5,-66 options "est. So, #B& will deduct ,5-,666 of compensation expense from the options in year 9 (5,-66 L ,96) for book purposes. !n year 5, 5,-66 more options "est. #B& will deduct ,5-,666 of compensation expense from the options in year 5 (5,-66 x ,96) for book purposes. For tax purposes, #B& can deduct the bargain element (F3P J exercise price) of the options when they are exercised in year +. So, in year + it will deduct ,+6,666 Q(,+9 . ,5-) L -,666Rin computing taxable income on the tax return. !n year 9, then, #B& will report a ,5-,666 unfa"orable temporary book.tax difference. !n year 5, it will report another ,5-,666 unfa"orable book.tax difference. !n year +, when the options are exercised, the year 9 and year 5 book.tax differences completely re"erse, resulting in a ,-6,666 fa"orable temporary book.tax difference. !n addition, #B& will report a ,56,666 unfa"orable permanent difference that represents the total amount of ,-6,666 that was deducted for book purposes from the options and the ,+6,666 that was deducted for tax purposes. (he ,56,666 unfa"orable permanent difference represents the difference between the estimated "alue of the stock options exercised of ,96 and the bargain element of ,E multiplied by the number of options (-,666). !n summary: year 9 ,5-,666 unfa"orable temporary book.tax differenceF year 5 ,5-,666 unfa"orable temporary book.tax differenceF year + fa"orable ,-6,666 temporary difference and ,56,666 unfa"orable permanent book.tax difference.

16-14

Chapter 16 - Corporate Operations

0#. [LO #]. +ss!me that on Fan!ary 1, year 1, HIJ Corp. iss!ed 1,666 non/!alified stocoptions with an estimated "al!e of @( per option. 'ach option entitles the owner to p!rchase one share of HIJ stoc- for @1( a share 7the per share price of HIJ stoc- on Fan!ary 1, year 1 when the options were granted8. Che options "est #0 percent a year 7on 5ecember &18 for fo!r years 7beginning with year 18. +ll 066 stoc- options that had "ested to that point were e ercised in year & when the HIJ stoc- was "al!ed at @#6 per share. Ao other options were e ercised in year & or year (. Identify HIJ$s year 1, #, &, and ( ta ded!ctions and boo--ta difference 7identify as permanent andGor temporary8 associated with the stoc- options !nder the following alternati"e scenariosD a. +:C 213 7formerly ;+: 1#&<8 does not apply to the stoc- options. 8ithout applying #S& ;9:, SGT has no book expenses associated with the stock options. 4owe"er, for tax purposes, it is allowed to deduct the bargain element of the options exercised in year +. &onse/uently, SGT reports a ,+,666 Q(,56 J ,9D) x ,-66R tax deduction for the stock options in year +. (his creates a ,+,666 permanent fa"orable book.tax difference in year + (,+,666 tax deductionF ,6 book deduction). (here is no book.tax difference associated with the stock options in year 9, 5, or D. b. +:C 213 applies to the stoc- options. For book purposes, SGT will deduct ,9,666 a year in years 9, 5, +, and D (,D,666 "alue of options x 5-7 for each year of the "esting period). For tax purposes, SGT will deduct ,+,666 in year + when the -66 shares are exercised. Book tax.differences: SGT will report a ,9,666 unfa"orable temporary book.tax difference in years 9, 5, +, and D in connection with the deduction taken for book purposes but not tax purposes in the amount of the initial estimated "alue of the stock options x the percentage of options that "est during that year. !n year +, it will also report a ,5,666 fa"orable temporary book.tax difference (this is the re"ersal of the unfa"orable book.tax differences from years 9 and 5 on the -66 options that "ested in years 9 and 5 but were exercised in year +). Finally, SGT will report a ,9,666 fa"orable permanent book tax difference in year + that represents the excess of the bargain element of the options of ,E per option o"er the ,D estimated "alue of the options multiplied by the -66 options that were exercised Q(,E . ,D) x -66 sharesR.

16-#6

Chapter 16 - Corporate Operations

0&. 7LO#8 1hat boo--ta differences in year 1 and year # associated with its capital gains and losses wo!ld +)5 Inc. report in the following alternati"e scenarios% Identify each boo--ta difference as fa"orable or !nfa"orable and as permanent or temporary. a. Capital gains Capital losses Iear 1 @#6,666 3,666 Iear # @0,666 6

*o book.tax differences in either year. b. Capital gains Capital losses Iear 1 @ 3,666 #6,666 Iear # @0,666 6

!n year 9, there is a ,95,666 temporary unfa"orable ad%ustment because net capital losses are not deductible for tax purposes, but they are deductible for book purposes. (he ,95,666 disallowed loss is carried o"er to year 5. So, in year 5, there is a ,-,666 temporary fa"orable book.tax difference because ,-,666 of the disallowed loss from year 9 offsets the ,-,666 gain recogni)ed in year 5. c. Capital gains Capital losses @ Iear 1 6 #0,666 Iear # @06,666 &6,666

In year 1, ABD reports a $25,000 temporary, unfavorable book-tax differen e be ause it annot dedu t a net apital loss !it "as a $25,000 apital loss arryover to year 2#$ In year 2, ABD reports a $20,000 temporary, favorable book-tax differen e, be ause ABD an dedu t $20,000 of t"e apital loss arried over to year 2$ d. Capital gains Capital losses Iear 1 @ 6 #0,666 Iear # @(6,666 6

In year 1, ABD reports a $25,000 temporary, unfavorable book-tax differen e be ause it annot dedu t a net apital loss !it "as a $25,000 apital loss arryover to year 2#$ In year 2, ABD reports a $25,000 temporary, favorable book-tax differen e, be ause ABD an dedu t t"e full $25,000 apital loss arryover in year 2$

16-#1

Chapter 16 - Corporate Operations

e.

+nswer for year 6 only. Capital gains Capital losses Iear 1 @ 6 16,666 Iears # - 0 @ 6 6 Iear 6 @10,666 6

In year %, ABD &ould report a $10,000 temporary favorable book-tax differen e be ause it an dedu t t"e $10,000 apital loss arryover from year 1 to offset t"e year % 'ain$ f. +nswer for year 2 only. Capital gains Capital losses Iear 1 @ 6 16,666 Iears # - 6 @ 6 6 Iear 2 @10,666 6

*o book.tax difference because the carryo"er from year 9 has expired and is una"ailable to offset the capital gain in year ;.

0(. [LO #] 1hat boo--ta differences in year 1 and year # associated with its capital gains and losses wo!ld 5'; Inc. report in the following alternati"e scenarios% Identify each boo--ta difference as fa"orable or !nfa"orable and as permanent or temporary. a. In year 1, 5'; recogni9ed a loss of @10,666 on land that it had held for in"estment. In year 1, it also recogni9ed a @&6,666 gain on e/!ipment it had p!rchased a few years ago. Che e/!ipment sold for @06,666 and had an ad=!sted basis of @#6,666. 5'; had ded!cted @(6,666 of depreciation on the e/!ipment. In year #, 5'; recogni9ed a capital loss of @#,666. !n year 9, for tax purposes, HF reali)es a (,9-,666) capital loss on the sale of land held for in"estment, but it is not allowed to deduct the loss in year 9 (the loss becomes a capital loss carryo"er). !t also recogni)es ,+6,666 of ordinary income due to depreciation recapture on the disposition of the e/uipment. For book purposes, it deducts the (,9-,666) loss and it includes the ,+6,666 of income. So, HF reports a (,9-,666) temporary unfa"orable book.tax difference in year 9. !n year 5, HF reports a ,5,666 temporary unfa"orable book.tax difference because it cannot deduct the year 5 capital loss for tax purposes. b. In year 1, 5'; recogni9ed a loss of @10,666 on land that it had held for in"estment. It also recogni9ed a @#6,666 gain on e/!ipment it had p!rchased a few years ago. Che e/!ipment sold for @06,666 and had an ad=!sted basis of @&6,666. 5'; had ded!cted @10,666 of ta depreciation on the e/!ipment.

16-##

Chapter 16 - Corporate Operations

!n this case, the character of the ,56,666 gain HF recogni)es on the e/uipment disposition in year 9 is ,9-,666 ordinary due to depreciation recapture. (he remaining ,-,666 gain is initially treated as U95+9 gain. (his U95+9 gain is ultimately characteri)ed as a long.term capital gain. So, HF is able to offset this ,-,666 capital gain with (,-,666) of the (,9-,666) capital loss from the land. (hus, HF will report a (,96,666) unfa"orable temporary book.tax difference and it will ha"e a (,96,666) capital loss carryo"er. 00. [LO #] B1C Corp. is c!rrently in the si th year of its e istence 7#6118. In #666K #616, it reported the following income and 7losses8 7before net operating loss carryo"ers or carrybac-s8. #666D #662D #663D #664D #616D #611D 7@ 26,6668 7@ &6,6668 @ 66,666 @1(6,666 7@ #0,6668 @&66,666 a. +ss!ming the original facts and that B1C elects to not carry bac- AOLs, what was B1C$s year #664 ta able income% ,966,666 taxable income. # ,D6,666 *<> carryo"er is deducted in 566?. (he *<> carryo"er is comprised of ,96,666 from 566E and ,+6,666 from 566;. b. If B1C does not elect to forgo any AOL carrybac-s, what is its #611 ta able income after the AOL ded!ction% ,+66,666 taxable income. (he ,5-,666 *<> from 5696 is used up when it is carried back to 566?. So, there is no *<> carryo"er to 5699. c. If B1C always elects to forgo AOL carrybac-s, what is its #611 ta able income after the AOL ded!ction% 1hat is its #611 boo--ta difference associated with its AOL% Is it fa"orable or !nfa"orable% Is it permanent or temporary% 5699 taxable income: ,5;-,666 (+66,666 J 5-,666 *<> carryo"er from 5696). (he *<> carryo"er to 5699 creates a ,5-,666 temporary fa"orable book.tax difference.

16-#&

Chapter 16 - Corporate Operations

06. [LO #] >,lanning? 1CC, Inc. has a c!rrent year 7#6118 net operating loss of @166,666. It is trying to determine whether it sho!ld carry bac- the loss or whether it sho!ld elect to forgo the carrybac-. .ow wo!ld yo! ad"ise 1CC in each of the following alternati"e sit!ations 7ignore time "al!e of money in yo!r comp!tations8.% a. Ca able income #664 @ &6,666 #616 @ 6 #61# @&66,666

If ()) ele ts to arry ba k t"e loss it &ill offset $*0,000 of in ome t"at &as taxed at a 15+ so it &ould save $,,500 in taxes !$*0,000 x 15+#$ If instead it for'oes t"e arryba k and arries t"e loss over to 2012, it &ill offset $*0,000 of in ome t"at &ould "ave ot"er&ise been taxed at *,+, so its tax savin's &ould be $10,200$ In t"is s enario, t"e taxpayer &ill save an additional $5,-00 in taxes by arryin' t"e loss over to t"e next year$ !.ee orporate tax rate s "edule$# b. Ca able income #664 @466,666 #616 @66,666 #61# @166,666

If ()) arries ba k t"e loss, it must first arry it ba k to t&o years a'o and offset $100,000 of in ome t"at &ould ot"er&ise "ave been taxed at *,+ savin' it $*,,000 in tax !$100,000 x *,+#$ If ()) for'oes t"e arryba k and arries t"e loss over to 2012 it &ill offset in ome t"at &ould ot"er&ise 'enerate a $22,250 tax liability !tax on first $100,000 of taxable in ome#$ /"us, ()) &ould be better off to arry t"e loss ba k$ !.ee orporate tax rate s "edule#$ c. Ca able income #664 @466,666 #616 @66,666 #61# @0,666,666

If it arries t"e loss ba k it &ill save $*,,000 in taxes !see solution to part a#$ If it arries t"e loss over it &ill redu e in ome t"at &ould ot"er&ise be taxed at *,+, so it &ould also save $*,,000 in taxes$ Be ause t"e $*,,000 arryba k results in an immediate refund and it is a sure t"in', ()) s"ould arry t"e loss ba k$ d. Ca able income #664 @ 06,666 #616 @#6,666 #61# @#,666,666

By carrying the loss back, 8&& will offset income that was taxed at 9-7 both in 566? and 5696. (hus carrying the loss back will sa"e it ,96,-66 in taxes. !f it forgoes the carryback and carries

16-#(

Chapter 16 - Corporate Operations

the loss forward, it will offset ,96,666 of income that would ha"e otherwise been taxed at 9-7 and ,?6,666 of income that would otherwise ha"e been taxed at +D7 so it would sa"e ,+5,966 Q,96,666 x 9-7 I ,?6,666 x +D7R of tax. So, it appears that 8&& should elect to forgo the carryback.

16-#0

Chapter 16 - Corporate Operations

02. [LO #] +ss!me that in year 1 .ill Corporation reported a net operating loss of @16,666 that it carried forward to year #. In year 1, .ill also reported a net capital loss of @&,666 that it carried forward to year #. In year #, ignoring any carryo"ers from other years, .ill reported a loss for ta p!rposes of @06,666. Che c!rrent year loss incl!des a @1#,666 net capital gain. 1hat is .ill$s year # net operating loss% (he year 5 net operating loss is ,-+,666. !n computing the net operating loss for a particular year, net operating loss carrybacks and carryo"ers are ignored as are capital loss carrybacks. 4owe"er, capital loss carryo"ers are taken into account. !n this case, in year 5 4ill reported a loss of ,-6,666 that included a ,95,666 net capital gain. &onse/uently, its loss without the net capital gain was ,E5,666. (he ,+,666 capital loss carryo"er from year 9 is deducted against the ,95,666 net capital gain in year 5 reducing the net capital gain for year 5 to ,?,666. 8hen this gain is added to the ,E5,666 loss, 4ill has a ,-+,666 net operating loss from year 5. So, 4ill has a ,96,666 net operating loss carryo"er from year 9 and a ,-+,666 net operating loss carryo"er from year 5. Both losses are carried o"er to year +. 4ill does not ha"e a capital loss carryo"er to year +. 03. [LO #]. *olf Corp. 7*C8, a calendar-year accr!al-method corporation, held its directors meeting on 5ecember 10 of year 1. 5!ring the meeting the board of directors a!thori9ed *C to pay a @20,666 charitable contrib!tion to the Ciger 1oods ;o!ndation, a /!alifying charity. a. If *C act!ally pays @06,666 of this contrib!tion on Fan!ary 10 of year # and the remaining @#0,666 on Barch 10 of year #, what boo--ta difference will it report associated with the contrib!tion in year 1 7ass!me the 16 percent limitation does not apply8% Is it fa"orable or !nfa"orable% Is it permanent or temporary% *o book.tax difference. (he ,;-,666 contribution is deductible in year 9 for both book and tax purposes. !t is deductible for tax purposes because it paid the accrued contribution by 5 A months after year end. b. +ss!ming the same facts as in part a., what boo--ta difference will *C report in year # 7ass!ming the 16 percent limitation does not apply8% Is it fa"orable or !nfa"orable% *o book.tax difference in year 5 because the entire contribution was deducted in year 9 for both book and tax purposes. c. If *C act!ally pays @06,666 of this contrib!tion on Fan!ary 10 of year # and the remaining @#0,666 on +pril 10 of year #, what boo--ta difference will it report associated with the contrib!tion in year 1 7ass!me the 16 percent limitation does not apply8% Is it fa"orable or !nfa"orable% Is it permanent or temporary%

16-#6

Chapter 16 - Corporate Operations

$& will deduct ,;-,666 in year 9 for book purposes and ,-6,666 in year 9 for tax purposes. !t cannot deduct the remaining ,5-,666 in year 9 for tax purposes because it did not actually pay the contribution within 5 A months after year end. (he ,5-,666 that was not deductible in year 9, is carried o"er to year 5. (he year 9 book.tax difference is a ,5-,666 unfa"orable temporary difference. d. +ss!ming the same facts as in part c., what boo--ta difference will *C report in year # 7ass!ming the 16L limitation does not apply8% Is it fa"orable or !nfa"orable% !n year 5, $& will report a fa"orable ,5-,666 book.tax difference when it is allowed to deduct the ,5-,666 for tax purposes that it paid on #pril 9-, year 5. 04. [LO #] In year 1 7the c!rrent year8, OCC Corp. made a charitable donation of @#66,666 to the ,hil and +my Bic-elson ;o!ndation 7a /!alifying charity8. ;or the year, OCC reported ta able income of @1,066,666 before ded!cting any charitable contrib!tions, before ded!cting its @#6,666 di"idends recei"ed ded!ction, and before ded!cting its @(6,666 AOL carryo"er from last year. a. 1hat amo!nt of the @#66,666 donation is OCC allowed to ded!ct for ta p!rposes in year 1% ,9DE,666. <&& may deduct up to 967 of taxable income before any charitable contributions, the di"idends recei"ed deduction, and *<> and capital loss carrybacks. Because net operating loss carryo"ers are deductible in determining the taxable income limitation, <&& taxable income for charitable contribution limitation purposes is ,9,DE6,666 (,9,-66,666 . ,D6,666 *<> carryo"er). So, its deductible limit on charitable contributions is ,9DE,666 (,9,DE6,666 x 967). b. In year #, OCC did not ma-e any charitable contrib!tions. It reported ta able income of @&66,666 before any charitable contrib!tion ded!ctions and before a @10,666 di"idends recei"ed ded!ction. 1hat boo--ta difference associated with the charitable contrib!tions will OCC report in year #% Is the difference fa"orable or !nfa"orable% Is it permanent or temporary% <&&'s taxable income limitation in year 5 is ,+6,666 (,+66,666 x 967). #lthough <&& did not make any current year contributions, it is allowed to deduct (sub%ect to the 967 limitation) its charitable contribution carryo"er from year 9 in the amount of ,-D,666. Because the limitation on the deduction in year 5 is ,+6,666, it may deduct ,+6,666 and carry o"er the remaining ,5D,666 to year +. !n year 5, <&& will therefore report a ,+6,666 fa"orable, temporary book.tax difference.

16-#2

Chapter 16 - Corporate Operations

c. +ss!me the original facts and those pro"ided in part b. In years &, (, and 0, OCC reported ta able losses of @06,666. ;inally, in year 6 it reported @1,666,666 in ta able income before any charitable contrib!tion ded!ctions. It did not ha"e any di"idends recei"ed ded!ction. OCC did not act!ally ma-e any charitable donations in year 6. 1hat boo--ta difference associated with charitable contrib!tions will OCC report in year 6% <&& would be allowed to deduct its remaining ,5D,666 charitable contribution carryo"er because the taxable income is not limiting. &onse/uently, it would report a fa"orable temporary book.tax difference of ,5D,666. !f <&& had not been able to deduct some of the carryo"er in year E, the carryo"er would ha"e expired unused. 66. [LO #] In year 1 7the c!rrent year8, L++ Inc. made a charitable donation of @166,666 to the +merican <ed Cross 7a /!alifying charity8. ;or the year, L++ reported ta able income of @006,666 which incl!ded a @166,666 charitable contrib!tion ded!ction 7before limitation8, a @06,666 di"idends recei"ed ded!ction, a @#6,666 domestic prod!ction acti"ities ded!ction, and a @16,666 net operating loss carryo"er from year 6. 1hat is L++ Inc.$s charitable contrib!tion ded!ction for year 1% (he charitable contribution deduction for the year is limited to 967 of taxable income before any charitable contribution, before the di"idends recei"ed deduction, and the domestic production acti"ities deduction. But, it is determined after deducting *<> carryo"ers (but not *<> carrybacks). &onse/uently, >##'s modified taxable income is ,;56,666 (,--6,666 I ,966,666 I ,-6,666 I,56,666). >##'s charitable contribution deduction is limited to ,;5,666 (,;56,666 x 967). (he remaining ,5:,666 (,966,666 donation minus ,;5,666 deductible amount) is carried o"er for up to fi"e years. 61. [LO #] ><esearch? Coattail Corporation 7CC8 man!fact!res and sells women and children$s coats. Chis year CC donated 1,666 coats to a /!alified p!blic charity. Che charity distrib!ted the coats to needy women and children thro!gho!t the region. +t the time of the contrib!tion, the fair mar-et "al!e of each coat was @36. 5etermine the amo!nt of CC$s charitable contrib!tion 7the ta able income limitation does not apply8 for the coats ass!ming the followingD a. CC$s ad=!sted basis in each coat was @&6. !n general, the deductible amount of property that is not long.term capital gain property is limited to the ad%usted basis of the property. 4owe"er, under U9;6(e)(+), if the taxpayer contributes in"entory to a charitable organi)ation for the care of the needy, the taxpayer can deduct the basis of the property plus one half of the appreciation (not to exceed twice the basis). !n this case, because &&'s contribution is to a /ualified charity for the aid of the needy, it is allowed to deduct ,--,666, which is the basis of ,+6,666 (9,666 x ,+6) I ,5-,666 Q9,666 x .- x (:6 J +6)R. (wice the basis is ,E6,666 (,+6,666 x 5), so this limitation is not binding. b. CC$s ad=!sted basis in each coat was @16.

16-#3

Chapter 16 - Corporate Operations

!n general, the deductible amount of property that is not long.term capital gain property is limited to the ad%usted basis of the property. 4owe"er, under U9;6(e)(+), if the taxpayer contributes in"entory to a charitable organi)ation for the care of the needy, the taxpayer can deduct the basis of the property plus one half of the appreciation (not to exceed twice the basis). !n this case, because &&'s contribution is to a /ualified charity for the aid of the needy, it is allowed to deduct ,56,666 which is the lesser of (9) ,D-,666 Qthe basis of ,96,666 (9,666 x ,96) I ,+-,666 Q9,666 x .- x (:6 J 96)R or (5) ,56,666, which is twice the basis (,96,666 x 5). &onse/uently, &&'s contribution is limited to ,56,666. 6#. [LO #] ><esearch? Baple Corp. owns se"eral pieces of highly "al!ed paintings that are on display in the corporation$s head/!arters. Chis year, it donated one of the paintings "al!ed at @166,666 7ad=!sted basis of @#0,6668 to a local m!se!m for the m!se!m to display. 1hat is the amo!nt of Baple Corp.$s charitable contrib!tion ded!ction for the painting 7ass!ming income limitations do not apply8% 1hat wo!ld be Baple$s ded!ction if the m!se!m sold the painting one month after it recei"ed it from Baple 7+ss!me Baple corporation had prior -nowledge of the m!se!m$s intention to sell the painting after it recei"ed it8% !f the taxpayer contributes tangible personal property to a tax.exempt organi)ation, and the organi)ation uses the property in a manner related to its tax.exempt purpose Qsee U9;6(e)(9)(B) (i)R, the taxpayer is allowed to deduct the fair market "alue of the property if the property would ha"e generated long.term capital gain if it were sold. !n this case, the painting was long.term capital gain property to 3aple &orp. and the museum used the painting to display which is its tax.exempt purpose. So, 3aple is allowed to deduct the ,966,666 fair market "alue of the painting. !f the museum sold the painting, it would be using the property in a manner unrelated to its tax exempt purpose. !n this case, according to Ceg. U9.9;6#.D(b)(+)(ii)(b), 3aple's deduction would be limited to the ,5-,666 basis of the property unless at the time of the contribution, it is reasonable to anticipate that the property would not be put to an unrelated use by the donee. Further, the regulation explains that 1in the case of a contribution of tangible personal property to or for the use of a museum, if the ob%ect donated is of a general type normally retained by such museum or other museums for museum purposes, it will be reasonable for the donor to anticipate, unless he has actual knowledge to the contrary, that the ob%ect will not be put to an unrelated use by the donee, whether or not the ob%ect is later sold or exchanged by the donee.2 &onse/uently, if 3aple had prior knowledge that the museum would sell the property, it would be allowed to deduct only the ,5-,666 basis of the property. 6&. [LO #] <i"erbend Inc. recei"ed a @#66,666 di"idend from stoc- it held in .obble Corporation. <i"erbend$s ta able income is @#,166,666 before ded!cting the di"idends recei"ed ded!ction 75<58, a @(6,666 AOL carryo"er, a @16,666 domestic prod!ction acti"ities ded!ction, and a @166,666 charitable contrib!tion. a. 1hat is <i"erbend$s ded!ctible 5<5 ass!ming it owns 16 percent of .obble Corporation%

16-#4

Chapter 16 - Corporate Operations

Because Ci"erbend owns less than 56 percent of 4obble, its C percentage is ;67. So, its full C is ,9D6,666 (.; x ,566,666). Ci"erbend's modified taxable income for the taxable income limitation is ,5,666,666 (,5,966,666 minus ,966,666 charitable contribution). (hus, the taxable income limit is ,9,D66,666 (,5,666,666 x ;67). Because the full ,9D6,666 C is less than the taxable income limit, Ci"erbend may deduct the entire ,9D6,666 C . b. +ss!ming the facts in part a, what is <i"erbend$s marginal ta rate on the di"idend% 96.57. Based on its le"el of taxable income, Ci"erbend's marginal tax rate is +D7. So, its marginal tax rate on the di"idend after taking the C into account is computed as follows: Q(,566,666 . ,9D6,666) x .+DR=,566,666 K 96.57 c. 1hat is <i"erbend$s 5<5 ass!ming it owns 66 percent of .obble Corporation% Because Ci"erbend owns 56 percent or more but less than :67 of 4obble, its C percentage is :67. So, its full C is ,9E6,666 (.: x ,566,666). Ci"erbend's modified taxable income for the taxable income limitation is ,5,666,666 (,5,966,666 minus ,966,666 charitable contribution). (hus, the taxable income limit is ,9,E66,666 (,5,666,666 x :67). Because the full ,9E6,666 C is less than the taxable income limit, Ci"erbend may deduct the entire ,9E6,666 C . d. +ss!ming the facts in part c, what is <i"erbend$s marginal ta rate on the di"idend% E.:7. Based on its le"el of taxable income, Ci"erbend's marginal tax rate is +D7. So, its marginal tax rate on the di"idend after taking the C into account is computed as follows: Q(,566,666 . ,9E6,666) x .+DR=,566,666 K E.:7 e. 1hat is <i"erbend$s 5<5 ass!ming it owns 30L of .obble Corporation 7and is part of the same affiliated gro!p8% ,566,666. Because it owns :67 or more of 4obble &orp., Ci"erbend is entitled to a 9667 C .

16-&6

Chapter 16 - Corporate Operations

f. +ss!ming the facts in part e, what is <i"erbend$s marginal ta rate on the di"idend% 67. Ci"erbend does not pay any tax on the di"idend. 6(. [LO #] 1asatch Corp. 71C8 recei"ed a @#66,666 di"idend from Cager Corporation 7CC8. 1C owns 10 percent of the CC stoc-. Comp!te 1C$s ded!ctible 5<5 in each of the following sit!ationsD a. 1C$s ta able income 7loss8 witho!t the di"idend income or the 5<5 is @16,666. ,9D6,666. Because 8asatch owns less than 56 percent of (ager, its C is percentage is ;67. So, its full C is ,9D6,666 (.; x ,566,666). 8asatch's modified taxable income for the taxable income limitation is ,596,666 (,96,666 I ,566,666 di"idend). (hus, the taxable income limit is ,9D;,666 (,596,666 x ;67). Because the full ,9D6,666 C is less than the taxable income limit, 8asatch may deduct the entire ,9D6,666 C . b. 1C$s ta able income 7loss8 witho!t the di"idend income or the 5<5 is 7@16,6668. ,9++,666. Because 8asatch owns less than 56 percent of (ager, its C is percentage is ;67. So, its full C is ,9D6,666 (.; x ,566,666). 8asatch's modified taxable income for the taxable income limitation is ,9?6,666 Q(,96,666) I ,566,666 di"idendR. (hus, the taxable income limit is ,9++,666 (,9?6,666 x ;67). Because the taxable income limitation of ,9++,666 is less than the full C of ,9D6,666 and because deducting the full C does not lea"e 8asatch in a loss position (,9?6,666 . ,9D6,666 N ,6,) 8asatch's C is limited to ,9++,666. c. 1C$s ta able income 7loss8 witho!t the di"idend income or the 5<5 is 7@04,6668. ,?:,;66. Because 8asatch owns less than 56 percent of (ager, its C is percentage is ;67. So, its full C is ,9D6,666 (.; x ,566,666). 8asatch's modified taxable income for the taxable income limitation is ,9D9,666 Q(,-?,666) I ,566,666 di"idendR. (hus, the taxable income limit is ,?:,;66 (,9D9,666 x ;67). !n this case the taxable income limitation of ,?:,;66 is less than the full C of ,9D6,666 and because deducting the full C does not lea"e 8asatch in a loss position (,9D9,666 . ,9D6,666 N ,6), 8asatch's C is limited to ,?:,;66.

16-&1

Chapter 16 - Corporate Operations

d. 1C$s ta able income 7loss8 witho!t the di"idend income or the 5<5 is 7@61,6668. ,9D6,666. Because 8asatch owns less than 56 percent of (ager, its C is percentage is ;67. So, its full C is ,9D6,666 (.; x ,566,666). 8asatch's modified taxable income for the taxable income limitation is ,9+?,666 Q(,E9,666) I ,566,666 di"idendR. (hus, the taxable income limit is ,?;,+66 (,9+?,666 x ;67). !n this case the taxable income limitation of ,?;,+66 is less than the full C of ,9D6,666, howe"er, because deducting the full C lea"es 8asatch in a loss position (,9+?,666 . ,9D6,666 M ,6), 8asatch's C is not limited by the taxable income limitation. So, it is allowed to deduct the full ,9D6,666 C . e. 1C$s ta able income 7loss8 witho!t the di"idend income or the 5<5 is 7@066,6668. ,9D6,666. Because 8asatch owns less than 56 percent of (ager, its C is percentage is ;67. So, its full C is ,9D6,666 (.; x ,566,666). 8asatch's modified taxable income for the taxable income limitation is (,+66,666) Q(,-66,666) I ,566,666 di"idendR. Because 8asatch is in a loss position before deducting the C , the taxable income limitation does not apply and 8asatch may deduct the full C of ,9D6,666. f. 1hat is 1C$s boo--ta difference associated with its 5<5 in part a% Is the difference fa"orable or !nfa"orable% Is it permanent or temporary% (he C creates a ,9D6,666 permanent, fa"orable book.tax difference. 60. [LO #] Comp!te :1M Inc.$s ta liability for each of the following scenariosD a. :1M$s ta able income is @66,666. ,;,-66 (,-6,666 x 9-7) I ,5,-66 (,96,666 L .5-) K ,10,000 b. :1M$s ta able income is @#20,666. ,55,5-6 (-6,666 x 9-7 I 5-,666 x 5-7 I 5-,666 x +D7) I ,E:,5-6 (,9;-,666 L .+?) K $90, 00 c. :1M$s ta able income is @10,066,666. ,-,9-6,666 (96,666,666 x +D7 I -,666,666 L +-7) I ,9?6,666 (-66,666 x +:7) K $ ,!40,000

16-&#

Chapter 16 - Corporate Operations

d. :1M$s ta able income for the year is @06,666,666. ,-6,666,666 L .+- K $1", 00,000 66. [LO #] +)C$s ta able income for the year is @#66,666 and C)+$s ta able income for the year is @(66,666. Comp!te the combined ta liability of the two corporations ass!ming the followingD a. +manda, Fermaine, and O$Aeil each own one-third of the stoc- of +)C and C)+. ,56D,666. Because #B& and &B# meet the definition of a brother.sister controlled group, the combined tax liability is computed as though both corporations were one corporation. (he tax on their combined ,E66,666 of taxable income (,566,666 I ,D66,666) is ,56D,666 (,E66,666 L +D7). b. +manda, Fermaine, and O$Aeil each own one-third of the stoc- of +)C and +manda and 5!stin each own 06 percent of the stoc- of C)+. ,9?;,5-6. Because #B& and &B# are not a controlled group (the same group of taxpayers doesn't own more than -67 of both corporations), each corporation computes its tax liability separately. #B&'s tax liability is ,E9,5-6 Q,55,5-6 I (,566,666 . ,966,666) x .+?R. &B#'s tax liability is ,9+E,666 (,D66,666 x +D7). So, the combined tax liability of the corporations is ,9?;,5-6. c. +)C owns 30 percent of C)+$s stoc- on the last day of the year. +)C and C)+ file separate 7as opposed to consolidated8 ta ret!rns. ,56D,666 Because #B& and &B# form a parent subsidiary controlled group, as in a, both corporations are treated as one for tax liability computation purposes. So, their combined tax liability is ,56D,666 (see a abo"e).

16-&&

Chapter 16 - Corporate Operations

62. [LO #] +)C$s ta able income for the year is @#0,666 and C)+$s ta able income for the year is @16,666,666. Comp!te the combined ta liability of the two corporations ass!ming the followingD a. +manda, Fermaine, and O$Aeil each own one-third of the stoc- of +)C and C)+. ,+,D6:,;-6. Because #B& and &B# meet the definition of a brother.sister controlled group, the combined tax liability is computed as though both corporations were one corporation. (he tax on their combined ,96,65-,666 of taxable income (,96,666,666 I ,5-,666) is ,+,D6:,;-6 (,96,666,666 x +D7 I ,5-,666 x +-7). b. +manda, Fermaine, and O$Aeil each own one-third of the stoc- of +)C and +manda and 5!stin each own 06 percent of the stoc- of C)+. ,+,D6+,;-6. Because #B& and &B# are not a controlled group (the same group of taxpayers doesn't own more than -67 of both corporations), each corporation computes its tax liability separately. #B&'s tax liability is ,+,;-6 (,5-,666 x 9-7). &B#'s tax liability is ,+,D66,666 (,96,666,666 x +D7). So, the combined tax liability of the corporations is ,+,D6+,;-6. 63. [LO &] Last year, C)+ Corporation, a calendar-year ta payer, reported a ta liability of @166,666. C)+ confidently anticipates a c!rrent year ta liability of @#(6,666. 1hat minim!m estimated ta payments sho!ld C)+ ma-e for the first, second, third, and fo!rth /!arters respecti"ely 7ignore the ann!ali9ed income method8 ass!ming the followingD a. C)+ is not considered to be a large corporation for estimated ta p!rposes. ,5-,666 each /uarter. (B#'s re/uired annual payment is ,966,666 which is the lesser of its ,966,666 prior year tax liability and its current year ,5D6,666 tax liability (assuming it pro"es to be no more than this). (B# must pay in 5-7, -67, ;-7, and 9667 of its first, second, third, and fourth /uarter estimated tax payments respecti"ely. !n this case, its re/uired payment for each /uarter is ,5-,666 which is one./uarter of the re/uired annual payment. b. C)+ is considered to be a large corporation for estimated ta p!rposes.

16-&(

Chapter 16 - Corporate Operations

#s a large corporation, (B# is allowed to use the prior year tax liability to compute its first /uarter estimated tax payment only. #fter that, it must use the current year tax liability (excluding the annuali)ed income method) to determine its re/uired payments. (hus, (B#'s re/uired estimated tax payments by /uarter are as follows:' 3inimum payment Vuarter 9: ,5-,666 Vuarter 5: ,?-,666 Vuarter +: ,E6,666 Vuarter D: ,E6,666 Hxplanation (5-7 of ,966,666 prior year tax liability) ,956,666 J 5-,666 (prior payments). 3ust ha"e paid in total (/. 9 I /. 5 payments) ,956,666 which is -67 of the current year tax liability of ,5D6,666. ,9:6,666 J 956,666 (prior payments). 3ust ha"e paid in total (/. 9 I /. 5 I /. + payments) ,9:6,666 which is ;-7 of the current year tax liability of ,5D6,666. ,5D6,666 J 9:6,666 (prior payments). 3ust ha"e paid in total (/. 9 I /. 5 I /. + I /. D payments) ,5D6,666 which is 9667 of the current year tax liability.

64. [LO &] Last year, )C+ Corporation, a calendar-year ta payer, reported a net operating loss of 7@16,6668 and a @6 ta liability. )C+ confidently anticipates a c!rrent year ta liability of @#(6,666. 1hat minim!m estimated ta payments sho!ld )C+ ma-e for the first, second, third, and fo!rth /!arters respecti"ely 7ignore the ann!ali9ed income method8 ass!ming the followingD a. )C+ is not considered to be a large corporation for estimated ta p!rposes. ,E6,666 each /uarter. Because B(# did not owe a tax liability last year, it must use the current year tax liability to determine its minimum estimated tax payments (ignoring the annuali)ed income method). !n this case, the current year tax liability is expected to be ,5D6,666 so B(#'s /uarterly estimated tax payments would be ,E6,666 (5-7 x ,5D6,666). b. )C+ is considered to be a large corporation for estimated ta p!rposes. ,E6,666 each /uarter. Same answer as a because B(# can't use the prior year tax exception for any /uarter.

16-&0

Chapter 16 - Corporate Operations

26. [LO &] ;or the c!rrent year, LA: corporation reported the following ta able income at the end of its first, second, and third /!arters. 1hat are LA:$s minim!m first, second, third, and fo!rth /!arter estimated ta payments determined !sing the ann!ali9ed income method% N!arter-end ;irst :econd Chird C!m!lati"e ta able income @1,666,666 @1,666,666 @#,(66,666

First and second /uarters: ,+D6,666F third /uarter ,9+E,666F fourth /uarter ,5;5,666, computed as follows: #nnual estimated taxable income (9) (5) #nnuali)ation (axable income Factor ,9,666,666 ,9,666,666 ,9,E66,666 ,5,D66,666
(9) #nnual estimated taxable income (5) (ax on estimated taxable income (flat +D7) ,9,+E6,666 ,9,+E6,666 ,9,6::,666 ,9,6::,666

!nstallment 9st /uarter 5nd /uarter +rd /uarter Dth /uarter

95=+ K D 95=+ K D 95=E K 5 95=? K 9.++++


(+) (9) x (5) 0ercentage of tax re/uired to be paid 5-7 -67 ;-7 9667 (D) (5) x (+) Ce/uired cumulati"e payment ,+D6,666 ,E:6,666 ,:9E,666 ,9,6::,666

(9) x (5) #nnual Hstimated taxable income $4,000,000 $4,000,000 $!,#00,000 $!,#00,000
(-) 0rior cumulati"e payments 6 ,+D6,666 ,E:6,666 ,:9E,666 (D) J (-) Ce/uired estimated tax payment $!40,000 $!40,000 $1!6,000 $#"#,000

!nstallment

9st /uarter 5nd /uarter +rd /uarter Dth /uarter

,D,666,666 ,D,666,666 ,+,566,666 ,+,566,666

16-&6

Chapter 16 - Corporate Operations

21. [LO &] >,lanning? Last year, FL Corporation$s ta liability was @466,666. ;or the c!rrent year, FL Corporation reported the following ta able income at the end of its first, second, and third /!arters 7see table below8. 1hat are FL$s minim!m re/!ired first, second, third, and fo!rth /!arter estimated ta payments 7ignore the act!al c!rrent year ta safe harbor8% N!arter-end ;irst :econd Chird C!m!lati"e ta able income @066,666 @1,#06,666 @#,#06,666

!gnoring the actual current year tax liability safe harbor, the minimum re/uired estimated tax payments for each /uarter is the lesser of the payment re/uired under the prior year tax liability exception and the payment re/uired by the annuali)ed income method. Bnder this approach, the minimum estimated tax payments are as follows: Vuarter 9: ,9;6,666 Vuarter 5: ,9;6,666 Vuarter +: ,5?;,-66 Vuarter D: ,5E5,-66 Qfourth /uarter based on re/uired annual payment under the prior year tax method (,?66,666)R #nnual estimated taxable income (5) #nnuali)ation (axable income Factor (9) ,-66,666 ,-66,666 ,9,5-6,666 ,5,5-6,666 95=+ K D 95=+ K D 95=E K 5 95=? K 9.++++ (9) x (5) #nnual Hstimated taxable income $#,000,000 $#,000,000 $#, 00,000 $!,000,000

!nstallment 9st /uarter 5nd /uarter +rd /uarter Dth /uarter

16-&2

Chapter 16 - Corporate Operations

3inimum re/uired estimated tax payments using annuali)ed income method and prior year tax method.
!nstallment (9) #nnual estimated taxable income ,5,666,666 ,5,666,666 ,5,-66,666 ,+,666,666 (5) (ax on estimated taxable income (flat +D7) ,E:6,666 ,E:6,666 ,:-6,666 ,9,656,666 (+) (9) x (5) 0ercentage of tax re/uired to be paid 5-7 -67 ;-7 9667 (D) (5) x (+) Ce/uired cumulati"e payment ,9;6,666 (,55-,666)W ,+D6,666 (,D-6,666)W ,E+;,-66 (,E;-,666)W ,9,656,666 (,?66,666)W (-) 0rior cumulati"e payments 6 ,9;6,666 ,+D6,666 ,E+;,-66 (D) J (-) Ce/uired estimated tax payment $1"0,000 $1"0,000 $#9", 00 $#6#, 00$$

9st /uarter 5nd /uarter +rd /uarter Dth /uarter

W*umbers in parentheses represent re/uired cumulati"e payment under the prior year method of determining estimated tax payments. WW(he fourth /uarter is the only /uarter in which the re/uired cumulati"e payment is less under the prior year tax method than under the annuali)ed income method. (hat is why the fourth /uarter payment is based on the prior year tax method. 2#. [LO &] Last year, Co!gar Corp. 7CC8 reported a net operating loss of @#0,666. In the c!rrent year, CC e pected its c!rrent year ta liability to be @((6,666 so it made fo!r e/!al estimated ta payments of @116,666 each. Co!gar closed its boo-s at the end of each /!arter. Che following sched!le reports CC$s ta able income at the end of each /!arterD C!m!lati"e ta able income @&66,666 @266,666 @1,666,666 @1,(26,033

N!arter-end ;irst :econd Chird ;o!rth

CC$s c!rrent year ta liability on @1,(26,033 of ta able income is @(36,666. 5oes CC owe !nderpayment penalties on its estimated ta payments% If so, for which /!arters does it owe the penalty%

16-&3

Chapter 16 - Corporate Operations

&& is not allowed to rely on the prior year tax to determine its minimum estimated tax payments. && made estimated tax payments of ,996,666 each /uarter for a total of ,DD6,666. 4owe"er, because its actual tax liability was ,D:6,666, && would be sub%ect to estimated tax penalties for each /uarter under the current year tax liability method. && could a"oid penalties if it made the minimum payments under the annuali)ed income method computed below: #nnual estimated taxable income (9) (5) #nnuali)ation (axable income Factor ,+66,666 ,+66,666 ,;66,666 ,9,666,666
(9) #nnual estimated taxable income ,9,566,666 ,9,566,666 ,9,D66,666 ,9,+++,+++ (5) (ax on estimated taxable income (flat +D7) ,D6:,666 ,D6:,666 ,D;E,666 ,D-+,+++

!nstallment 9st /uarter 5nd /uarter +rd /uarter Dth /uarter

95=+ K D 95=+ K D 95=E K 5 95=? K 9.++++


(+) (9) x (5) 0ercentage of tax re/uired to be paid 5-7 -67 ;-7 9667

(9) x (5) #nnual Hstimated taxable income $1,#00,000 $1,#00,000 $1,400,000 $1,!!!,!!!
(-) 0rior cumulati"e payments 6 ,996,666 ,556,666 ,++6,666 (D) J (-) Ce/uired estimated tax payment $10#,000 $94,000 $1!",000 $1#!,!!!

!nstallment

(D) (5) x (+) Ce/uired cumulati"e payment ,965,666 ,56D,666 ,+-;,666 ,D-+,+++

9st /uarter 5nd /uarter +rd /uarter Dth /uarter

CC owes !nderpayment penalties for the third and fo!rth /!arters. Chis is s!mmari9ed as followsD (9) Ce/uired cumulati"e payment (all based on annul ,965,666 (956,666 current year)W ,56D,666 (,5D6,666 current year) ,+-;,666 (,+E6,666 current year) ,D-+,+++ (,D:6,666 current year) (5) #ctual payment ,996,666 ,556,666 ,++6,666 ,DD6,666 (5) J (9) #mount (under) o"er paid ,:,666 ,9E,666 (,5;,666) (,9+,+++) *o *o Ges Ges

Vuarte r 9 5 + D

0enaltyX

16-&4

Chapter 16 - Corporate Operations

W(he re/uired cumulati"e payment under the annuali)ed method is less than re/uired payment under the current year method (in parentheses). So, the annuali)ed method is used to determine whether penalties apply.

16-(6

Chapter 16 - Corporate Operations

&& owes underpayment penalties for the third and fourth /uarters. 2&. [LO#, LO (] ;or the c!rrent year, CC,, Inc. recei"ed the following interest incomeD @1#,666 interest from Ir"ine City bondsD )onds iss!ed in #666 and proceeds !sed to f!nd p!blic schools. @#6,666 interest from ;l!or Corporation bonds. @3,666 interest from Bission Oie=o CityD )onds iss!ed in #663 and proceeds !sed to l!re new b!siness to the area. @6,666 interest from P.:. Creas!ry notes. a. 1hat amo!nt of this interest income is ta able to CC,% ,5E,666. (he ,56,666 interest from the Fluor &orporation bonds and the ,E,666 interest from the B.S. (reasury notes are taxable interest. b. 1hat amo!nt of interest sho!ld CC, report as a preference item when calc!lating its alternati"e minim!m ta liability% ,:,666 interest from 3ission Pie%o &ity bonds (0ri"ate acti"ity bonds issued before 566?)) 2(. [LO (] On Fan!ary # of year 1, HIJ Corp. ac/!ired a piece of machinery for @06,666. Che asset reco"ery period for the assets is se"en years for both reg!lar ta and +BC p!rposes. HIJ !ses the do!ble declining balance method to comp!te its ta depreciation on this asset and it !ses 106 percent declining balance to determine its depreciation for +BC p!rposes. Che following sched!le pro=ects the ta and +BC depreciation on the asset !ntil it is f!lly depreciatedD Ca
Iear 1 # & ( 0 6 2 3 5epreciation @2,1(0 @1#,#(0 @3,2(0 @6,#(0 @(,(60 @(,(66 @(,(60 @#,#&6 )asis at end of year @(#,300 @&6,616 @#1,360 @10,6#6 @11,100 @6,640 @#,#&6 @6 5epreciation @0,&00 @4,060 @2,010 @6,1#0 @6,1#0 @6,1#0 @6,1#0 @&,660

+BC
)asis at end of year @((,6(0 @&0,636 @#2,060 @#1,((6 @10,&10 @4,146 @&,660 @6

16-(1

Chapter 16 - Corporate Operations

a. 1hat +BC ad=!stment relating to depreciation on the e/!ipment will HIJ ma-e for year 1% Is the ad=!stment positi"e 7!nfa"orable8 or negati"e 7fa"orable8% ,9,;?6 unfa"orable ad%ustment (,;,9D- . ,-,+--) in calculation of alternati"e minimum taxable income (#3(!) b. 1hat +BC ad=!stment relating to depreciation on the e/!ipment will HIJ ma-e for year 0% Is the ad=!stment positi"e or negati"e% (,9,EE6) fa"orable ad%ustment (,D,DE- . ,E,95-) in calculation of #3(! c. If HIJ sells the e/!ipment for @&6,666 at the beginning of year &, what +BC ad=!stment will it ma-e in year & to reflect the difference in the gain or loss for reg!lar ta and for +BC p!rposes on the sale 7ass!me no year & depreciation8% Is the ad=!stment positi"e or negati"e% #3( >oss: (,-,6:6) ,+6,666 J (,-6,666 J -,+-- J ?,-E-) (ax >oss: ( ,E96) ,+6,666 J (,-6,666 J ;,9D- J 95,5D-) (,D,D;6) fa"orable ad%ustment in calculation of #3(! 20. [LO (] 5!ring the c!rrent year, C<: Inc. reported the following ta -related informationD @16,666 ta -e empt interest from p!blic acti"ity bonds iss!ed before #664. @16,666 ta -e empt interest from pri"ate acti"ity bonds iss!ed before #664. @106,666 death benefit from life ins!rance policies on officer$s li"es. @6,666 26 percent di"idends recei"ed ded!ction. @1#,666 36 percent di"idends recei"ed ded!ction. @06,666 bad debt e pense. @#6,666 amorti9ation e pense relating to organi9ational e pendit!res. @36,666 gain incl!ded in ta able income !nder the installment method 7sale occ!rred in prior year8.

16-(#

Chapter 16 - Corporate Operations

1hat is C<:$s c!rrent year +C' ad=!stment% @24,066 positi"e ad=!stment, comp!ted as followsD Description (ax.exempt interest income from tax.exempt bond that funds a public acti"ity (as opposed to pri"ate acti"ity) issued before 566? ifference between #3( depreciation and #&H depreciation ifference between #3( and #&H gain or loss on asset disposition eath benefit from life insurance contracts ;67 di"idends recei"ed deduction (not the :67 or 9667 deduction) <rgani)ational expenditures that were expensed during the year !nstallment method not allowed for #&H purposes. So, for #&H purposes, the gain was included in #&H in a pre"ious year (the year of the sale) and should not be included in #&H this year. (otal #3(! J #&H differences ACE Ad)ustment *&otal x " +, A%&' ( ACE difference I96,666 6 6 I9-6,666 IE,666 I56,666 .:6,666 ,96E,666 $"9, 00

26 [LO (]. 5!ring the c!rrent year, 'L: Corporation reported the following ta -related informationD @0,666 ta e empt interest from p!blic acti"ity bonds iss!ed in #663. @(0,666 gain incl!ded in ta able income !nder the installment method. Che installment sale occ!rred two years ago. a. 1hat is 'L: Corp.$s c!rrent year +C' ad=!stment ass!ming its c!m!lati"e +C' ad=!stment as of the beginning of the year is a positi"e @1#,666% *egati"e ,95,666, determined as follows: Q,-,666 I (,D-,666)R x .;- K (,+6,666) negati"e ad%ustment. 4owe"er, a negati"e ad%ustment for the year is limited to prior cumulati"e positi"e ad%ustments (,95,666 in this case). (herefore, H>S's #&H ad%ustment for the year is (,95,666). b. 1hat is 'L: Corp.$s c!rrent year +C' ad=!stment ass!ming its c!m!lati"e +C' ad=!stment as of the beginning of the year is a positi"e @36,666% *egati"e ,+6,666, determined as follows: Q,-,666 I (,D-,666)R x .;- K (,+6,666) negati"e ad%ustment. 8hile a negati"e ad%ustment for the year is limited to prior cumulati"e positi"e ad%ustments (,:6,666 in this case), the negati"e ad%ustment does not exceed the prior cumulati"e positi"e ad%ustments. (herefore, H>S's #&H ad%ustment for the year is (,+6,666).

16-(&

Chapter 16 - Corporate Operations

22 [LO (] 5!ring the c!rrent year, ;C, Corporation reported reg!lar ta able income of @066,666. ;C, !sed the following information in its ta -related comp!tationsD @1#,666 interest from Ir"ine City bondsD )onds iss!ed in #662 and proceeds !sed to f!nd p!blic schools. @#6,666 interest from ;l!or Corporation bonds. @3,666 interest from Bission Oie=o CityD )onds iss!ed in #666 and proceeds !sed to l!re new b!siness to the area. @6,666 interest from P.:. Creas!ry notes. @&6,666 di"idends recei"ed from *eneral 'lectric Corporation 7;C, owns less than 1 percent of *' stoc-8. @16,666 di"idends recei"ed from .obble Inc. 7;C, owns #0 percent of .obble Inc.8 @#0,666 charitable contrib!tion to the ,hil and +my Bic-elson ;o!ndation. @66,666 +BC depreciation 7reg!lar ta depreciation was @26,6668. @06,666 +C' depreciation. @2,666 +BC gain on disposition of assets 7reg!lar ta gain on disposition of assets was @3,6668. @0,666 +C' gain on disposition of assets. a. 1hat is ;C,$s +C' ad=!stment for the c!rrent year% Is it positi"e or negati"e% 0ositi"e ,+6,;-6 #&H ad%ustment, computed as follows: ,95,666 (!r"ine &ity Bonds) I ,59,666 ( C on $H Stock) I ,96,666 (depreciation) I (,5,666) (gain on disposition of assets) K ,D9,666 x ;-7 K ,+6,;-6 #&H ad%ustment. b. 1hat is ;C,$s alternati"e minim!m ta base% 'tem (9) (axable !ncome -reference 'tems (5) !nterest for 3ission Pie%o Bonds Ad)ustment 'tems (+) epreciation (D) $ain (-) #&H #d%ustment (E) #3(! (;) Hxemption A%& Base Amount ,-66,666 I :,666 I 96,666 . 9,666 I+6,;-6 ,-D;,;-6 6 $ 4"," 0 ;6,666 J E6,666 ;,666 J :,666 See part a. Sum of (9) through (-) &ompletely phased out * , ( *6, Calculation

16-((

Chapter 16 - Corporate Operations

c. 1hat is ;C,$s alternati"e minim!m ta liability, if any% #3( K ,6. F(0's tentati"e minimum tax is ,96?,--6 (,-D;,;-6 x .5). !ts regular tax liability is ,9;6,666 (,-66,666 x +D7). (hus, because F(0's regular tax is greater than the minimum tax, it does not owe #3(. 23 [LO (] 1hat is 1:: Corporation$s +BC base in each of the following scenarios% a. 1::$s +BCI is @06,666. #3( Base K ,96,666 (,-6,666 J ,D6,666 exemption) 8SS deducts full exemption amount. b. 1::$s +BCI is @120,666. #3( Base K ,9D9,5-6, calculated as follows: ,9;-,666 J QD6,666 J (9;-,666 . 9-6,666) L .5-R 8SS's exemption is partially phased out. c. 1::$s +BCI is @&66,666. #3( Base K ,5?;,-66, calculated as follows: ,+66,666 J QD6,666 J (+66,666 . 9-6,666) L .5-R d. 1::$s +BCI is @1,666,666. #3( Base K ,9,666,666. Hxemption is entirely phased out for #3(! o"er ,+96,666. 24 [LO (] >,lanning? +ss!me C5+ corporation m!st pay the +BC for the c!rrent year. It is considering entering into a transaction that will generate @#6,666 of income for the c!rrent year. 1hat is C5+$s after-ta benefit of recei"ing this income in each of the following alternati"e scenarios% a. C5+$s +BCI before the transaction is @06,666. #fter.tax benefit K ,9E,666 (,56,666 income minus ,D,666 #3( on additional income), computed as follows: 8ith ,56,666 of additional income: ,-6,666 I ,56,666 K ,;6,666 . ,D6,666 exemption K ,+6,666 x .56 K ,E,666 #3( 8ithout ,56,666 of income: ,-6,666 . ,D6,666 exemption K ,96,666 x .56 K ,5,666 #3(

16-(0

Chapter 16 - Corporate Operations

,E,666 #3( with extra ,56,666 and ,5,666 without it. (hus, & # reports a ,D,666 additional #3( liability with the additional income (,E,666 J 5,666). b. C5+$s +BCI before the transaction is @1(6,666. #fter.tax benefit is ,9-,-66 (,56,666 additional income . ,D,-66 additional #3(). 8ith additional ,56,666 of income: #3(! K ,9E6,666 (,9D6,666 I ,56,666). Because #3(! exceeds ,9-6,666, exemption amount is partially phased out. Hxemption K ,D6,666 J Q(,9E6,666 J 9-6,666) W .5-R K ,+;,-66. #3( with additional income is ,5D,-66 (,9E6,666 . ,+;,-66 exemption K ,955,-66 W . 56). #3( without ,56,666 of income: #3( base K ,9D6,666 (#3(!) J ,D6,666 exemption K ,966,666 x .56 K ,56,666. & # must pay an additional ,D,-66 of #3( with the additional income (,5D,-66 . ,56,666). c. C5+$s +BCI before the transaction is @#66,666. #fter.tax benefit is ,9-,666 (,56,666 additional income . ,-,666 additional #3(). 8ith additional ,56,666 of income: #3(! K ,556,666 (,566,666 I ,56,666). Because #3(! exceeds ,9-6,666, exemption amount is partially phased out. Hxemption K ,D6,666 J Q(,556,666 J 9-6,666) W .5-R K ,55,-66. #3( with additional income is ,+?,-66 (,556,666 #3(! . ,55,-66 exemption K ,9?;,-66 W .56) #3( without ,56,666 of income: Because #3(! exceeds ,9-6,666, exemption amount is partially phased out. Hxemption K ,D6,666 J Q(,566,666 J 9-6,666) W .5-R K ,5;,-66. So, #3( without additional income is ,+D,-66 (,566,666 . ,5;,-66 exemption K ,9;5,-66 x .56). & # must pay an additional ,-,666 of #3( with the additional income (,+?,-66 . ,+D,-66). d. C5+$s +BCI before the transaction is @1,666,666.

16-(6

Chapter 16 - Corporate Operations

#fter.tax benefit is ,9E,666 (,56,666 additional income . ,D,666 additional #3(). Hxemption amount is fully phased.out so additional ,56,666 income generates an additional #3(! and #3( base of ,D,666. 36 [LO (] >,lanning? +ss!me FF Inc. m!st pay the +BC for the c!rrent year. Aear the end of the year, FF is considering ma-ing a charitable contrib!tion of @#6,666. 1hat is its after-ta cost of the contrib!tion !nder each of the following alternati"e scenarios% a. FF$s +BCI before the transaction is @06,666. #fter tax cost is ,9E,666 (,56,666 before tax cost minus ,D,666 tax sa"ings). (he charitable contribution will reduce #3(! by ,56,666. Because OO is not in the exemption phase.out range, the ,56,666 charitable deduction will reduce OO's #3( base by ,56,666 and conse/uently reduce its #3( liability by ,D,666 (,56,666 x 567). b. FF$s +BCI before the transaction is @166,666. #fter.tax cost is ,9-,-66 (,56,666 before.tax cost of contribution minus ,D,-66 tax sa"ings). 8ithout the charitable contribution OO's #3( is ,5D,-66 (,9E6,666 . ,+;,-66 exemption K ,955,-66 #3( base x .56) Because #3(! exceeds ,9-6,666, exemption amount is partially phased out. Hxemption K ,D6,666 J Q(,9E6,666 J 9-6,666) W .5-R K ,+;,-66. 8ith the charitable contribution OO's #3(! is reduced to ,9D6,666. !ts #3( is ,56,666 Q(,9D6,666 J D6,666) x 567R. (*o exemption phase.out, #3(! is below ,9-6,666.) (he charitable contribution reduces OO's #3( by ,D,-66 (,5D,-66 minus ,56,666). c. FF$s +BCI before the transaction is @#66,666. #fter.tax cost is ,9-,666 (,56,666 before.tax cost of contribution minus ,-,666 tax sa"ings). 8ithout ,56,666 charitable contribution OO owes ,+D,-66 of #3(, computed as follows: Q,566,666 #3(! J ,5;,-66 exemption K ,9;5,-66 #3( base x .56R Hxemption: ,D6,666 J Q(,566,666 J 9-6,666) W .5-R K ,5;,-66.

16-(2

Chapter 16 - Corporate Operations

8ith ,56,666 charitable contribution OO owes ,5?,-66 of #3(, computed as follows: ,9:6,666 #3(! . ,+5,-66 exemption K ,9D;,-66 #3( base x .56. Hxemption: ,D6,666 J Q(,9:6,666 J 9-6,666) x .5-R K ,5?,-66. (he charitable contribution reduces OO's #3( by ,-,666 (,+D,-66 minus ,5?,-66). d. FF$s +BCI before the transaction is @1,666,666. #fter tax cost is ,9E,666 (,56,666 before.tax cost minus ,D,666 tax sa"ings). !n this case, the exemption is completely phased.out before and after the contribution. So the tax sa"ing from the contribution is ,D,666 (,56,666 contribution x 567). 31 [LO (] Comp!te +CC, Inc.$s tentati"e minim!m ta 7CBC8, alternati"e minim!m ta 7+BC8, and minim!m ta credit 7BCC8 in each of the following alternati"e scenariosD a. +CC$s alternati"e minim!m ta base is @066,666 and its reg!lar ta liability is @36,666. (3( K ,-66,666 x .5 K ,966,666 #3( K ,56,666 (,966,666 (3( minus ,:6,666 regular tax liability) 3(& K ,56,666 (amount of #3() b. +CC$s alternati"e minim!m ta base is @&66,666 and its reg!lar ta liability is @36,666. (3( K ,+66,666 x .5 K ,E6,666 #3( K ,6 (,E6,666 (3( minus ,:6,666 regular tax liability J not below ,6). 3(& K ,6 (no #3( so no 3(& generated). c. +CC$s alternati"e minim!m ta base is @1,666,666 and its reg!lar ta liability is @#06,666. (3( K ,9,666,666 x .5 K ,566,666 #3( K ,6 (,566,666 (3( minus ,5-6,666 regular tax liabilityYnot below ,6). 3(& K ,6 (no #3( so not 3(& generated).

16-(3

Chapter 16 - Corporate Operations

3# [LO (] In year 1, *:L Corp.$s alternati"e minim!m ta base was @#,666,666 and its reg!lar ta liability is @&06,666. a. 1hat is *:L$s total ta liability for years 1, #, &, and ( 7by year8 ass!ming the following% Iear #D +BC base @666,666Q <eg!lar ta liability @166,666. Iear &D +BC base @066,666Q <eg!lar ta liability @166,666. Iear (D +BC base @1,666,666Q <eg!lar ta liability @106,666. Gear 9: $S> will owe ,D66,666 in taxes (,-6,666 of #3( and ,+-6,666 of regular tax liability). (3( K ,D66,666 (,5,666,666 #3( base x 567). #3( K ,-6,666 (,D66,666 (3( minus ,+-6,666 regular tax liability). 3(& K ,-6,666 (#mount of #3( paid in year 9). Gear 5: $S> will owe ,956,666 in taxes (,956,666 (3( minus ,966,666 regular tax liability). (3( K ,956,666 (,E66,666 x 567). #3( K ,56,666 (,956,666 (3( minus ,966,666 regular tax liability). 3(& K ,56,666 current year (amount of #3() 3(& carryo"er K ,;6,666 (,-6,666 prior year I ,56,666 current year). Gear +: $S> will owe ,966,666 in taxes (regular tax liability minus ,E6,666 3(& carryo"er from year 5. Cegular tax liability cannot be reduced below (3( by 3(&). (3( K ,966,666 (,-66,666 x 567). #3( K ,6 (Cegular tax liability exceeds (3(). 3(& carryo"er K ,96,666 (,;6,666 carryo"er from prior year minus ,E6,666 utili)ed in year +).

16-(4

Chapter 16 - Corporate Operations

Gear D: $S> will owe ,566,666 in taxes (,-6,666 #3( I ,9-6,666 regular tax) (3( K ,566,666 (,9,666,666 x 567). #3( K ,-6,666 (,566,666 (3( minus ,9-6,666 regular tax liability). 3(& K ,-6,666 current year 3(& carryo"er to year - K ,E6,666 (,96,666 carryo"er from prior year I ,-6,666 current year). b. 1hat, if any, minim!m ta credit does *:L ha"e at the end of year (% ,E6,666 see calculation abo"e. 3& [LO (]. ><esearch? In year 1, La9y corporation reported a @066,666 net operating loss for reg!lar ta p!rposes and a @(06,666 net operating loss for alternati"e minim!m ta p!rposes 7called an alternati"e tax net operating loss8. In year #, La9y reported @(06,666 of ta able income before ded!cting its net operating loss carryo"er from year 1 7it elected to forgo the net operating loss carry bac-8. It also reported @(06,666 of alternati"e minim!m ta able income before ta-ing the alternati"e ta net operating loss carryo"er into acco!nt 7it did not report any preference or ad=!stments in year #8. 7Aote that, s!b=ect to certain limitations, alternati"e ta AOLs are ded!cted from +BCI in the process of determining the alternati"e minim!m ta .8 1hat is La9y Corporation$s year # ta liability% +ss!me La9y did not ha"e any BCC carryo"er from a prior year. >a)y will owe ,?,666 of taxes (,?,666 #3( I ,6 regular tax). >a)y will not owe any regular tax because its regular taxable income before the *<> carryo"er of ,D-6,666 is completely offset by its regular tax *<>. (hat is, regular taxable income is reduced to ,6 by the *<> carryo"er (,D-6,666 J D-6,666). 4owe"er, under U-E(d)(9)(#)(i), >a)y may only offset ?67 of its #3(! with its alternati"e tax net operating loss. So, its #3(! (and #3( base) is ,D-,666 Q,D-6,666 . ,D6-,666 (?67 x ,-6,666)R and its (3( is ,?,666 (,D-,666 x 567). Because its regular tax liability is ,6, >a)y must pay ,?,666 of #3(.

16-06

Chapter 16 - Corporate Operations

Comprehensi e Problems
3( Comp!te BO, Corp.$s #611 ta able income gi"en the following information relating to its year 1 acti"ities. +lso, comp!te BO$s :ched!le B-1 ass!ming that BO$s federal income ta e pense for boo- p!rposes is @166,666. *ross profit from in"entory sales of @066,666 7no boo--ta differences8. 5i"idends BO recei"ed from #0 percent owned corporation of @166,666. ' penses other than 5<5, charitable contrib!tion 7CC8, net operating loss 7AOL8, and domestic prod!ction acti"ities ded!ction 75,+58 are @&06,666 7no boo--ta differences8. AOL carryforward from prior year of @16,666. Cash charitable contrib!tion of @1#6,666. 5omestic prod!ction acti"ities ded!ction of @0,666 7wage limitation does not apply8.

3P &orp.'s year 9 taxable income is ,9+9,666, computed as follows:


Description 1ross profit 2t3er income4 i"idend income 1ross 'ncome Expenses4 Business expenses other than C , &&, *<>, and 0# Federal income tax expense (otal expenses before charitable contribution, *<>, C , and 0# deduction !ncome before charitable contribution, *<>, C , and 0# *<> carryo"er from prior year (axable income for charitable contribution limitation purposes &haritable contributions (limited to 967 of ,5D6,666) (axable income before C and 0# i"idends recei"ed deduction ( C ) (:67 C F taxable income limitation does not apply) omestic production acti"ities deduction ( 0# ) (limitations on wages and taxable income do not apply) Boo.5&axa0le income Boo. 'ncome *Dr, Cr ,-66,666 966,666 ,E66,666 Boo./tax ad)ustments *Dr, Cr &axa0le 'ncome *Dr, Cr ,-66,666 966,666 ,E66,666

(+-6,666) (966,666) (D-6,666) ,9-6,666 (96,666)

966,666

(+-6,666) 6 (+-6,666) ,5-6,666 (96,666) ,5D6,666

(956,666)

?E,666

(5D,666) ,59E,666 (:6,666) (-,666) $1!1,000

(:6,666) (-,666) *$9 ,000,

$!0,000

$196,000

16-01

Chapter 16 - Corporate Operations

16-0#

Chapter 16 - Corporate Operations

3P's Schedule 3.9 from Form 9956 is as follows:

*ote that line 96 reconciles to taxable income before the net operating loss deduction and the di"idends recei"ed deduction. Starting with ,559,666 of income on line 96 and then subtracting the ,:6,666 di"idends recei"ed deduction and the ,96,666 net operating loss carryo"er yields taxable income of ,9+9,666 (,559,666 J :6,666 J 96,666). 30. Comp!te .C Inc.$s c!rrent year ta able income gi"en the following information relating to its #611 acti"ities. +lso, comp!te .C$s :ched!le B-1 ass!ming that .C$s federal income ta e pense for boo- p!rposes is @&6,666. *ross profit from in"entory sales of @&16,666 7no boo--ta differences8. 5i"idends .C recei"ed from #3 percent-owned corporation of @1#6,666. ' penses other than 5<5, charitable contrib!tion 7CC8, net operating loss 7AOL8, and domestic prod!ction acti"ities ded!ction 75,+58 are @&66,666 7no boo--ta differences8. AOL carryo"er from prior year of @1#,666. Cash charitable contrib!tion of @06,666. 5omestic prod!ction acti"ities ded!ction of @(,666 7wage limitation does not apply8.

16-0&

Chapter 16 - Corporate Operations

4&, !nc.'s taxable income is ,;,ED6, computed as follows:


Description 1ross profit 2t3er income4 i"idend income 1ross 'ncome Expenses4 Business expenses other than C , &&, *<>, and 0# Federal income tax expense (otal expenses before charitable contribution, *<>, C , and 0# deduction !ncome before charitable contribution, *<>, C , and 0# *<> carryo"er from prior year (axable income for charitable contribution limitation purposes &haritable contributions (axable income before C and 0# i"idends recei"ed deduction ( C ) (taxable income limitation applies)W omestic production acti"ities deduction ( 0# ) (*ot limited by income or wages) Boo.5&axa0le income Boo. 'ncome *Dr, Cr ,+96,666 956,666 ,D+6,666 Boo./tax ad)ustments *Dr, Cr &axa0le 'ncome *Dr, Cr ,+96,666 956,666 ,D+6,666

(+66,666) (+6,666) (++6,666) ,966,666 (95,666)

+6,666

(+66,666) 6 (+66,666) ,9+6,666 (95,666) ,99:,666 (99,:66) ,96E,566 (?D,-E6) (D,666) $",640

(-6,666)

+:,566

(?D,-E6) (D,666) *$110, 60,

$ 0,000

$66,#00

W eduction is the lesser of (9) full di"idends recei"ed deduction of ,?E,666 (,956,666 x :67) or (5) ,?D,-E6 Q:67 x (,96E,566 I 95,666 *<> carryo"erR taxable income before the C , *<>, and 0# ).

16-0(

Chapter 16 - Corporate Operations

4&'s Schedule 3.9 from Form 9956 is as follows:

*ote that line 96 reconciles to taxable income before the net operating loss deduction and the di"idends recei"ed deduction. Starting with ,99D,566 of income on line 96 and then subtracting the ,?D,-E6 di"idends recei"ed deduction and the ,95,666 net operating loss carryo"er yields taxable income of ,;,ED6 (,99D,566 J ?D,-E6 J 95,666). 36 Cimpanogos Inc. is an accr!al-method calendar-year corporation. ;or #611, it reported financial statement income after ta es of @1,1(4,666. Cimpanogos pro"ided the following information relating to its #611 acti"itiesD Life ins!rance proceeds as a res!lt of C'O$s death <e"en!e from sales 7for boo- and ta p!rposes8 ,remi!ms paid on the -ey-person life ins!rance policies. Che policies ha"e no cash s!rrender "al!e. Charitable contrib!tions O"erhead costs that were e pensed for boo- p!rposes b!t are incl!ded in ending in"entory for ta p!rposes !nder E #6&+. O"erhead costs that were e pensed for boo- p!rposes in #616 b!t were incl!ded in #616 ending in"entory for ta p!rposes !nder E#6&+. +ll #616 ending in"entory was sold in #611. Cost of goods sold for boo- p!rposes @#66,666 #,666,666 #1,666 136,666 06,666

66,666 &66,666

16-00

Chapter 16 - Corporate Operations

Interest income on pri"ate acti"ity ta -e empt bonds iss!ed in #66( Interest paid on loan obtained to p!rchase ta -e empt bonds <ental income payments recei"ed and earned in #611 <ental income payments recei"ed in #616 b!t earned in #611 <ental income payments recei"ed in #611 b!t not earned by year end B+C<: depreciation )oo- 5epreciation +lternati"e minim!m ta depreciation Aet capital loss ;ederal income ta e pense for boo-s in #611

(6,666 (0,666 10,666 16,666 &6,666 00,666 #0,666 06,666 (0,666 066,666

Cimpanogos did not /!alify for the domestic prod!ction acti"ities ded!ction. <e/!iredD a. <econcile boo- income to ta able income for Cimpanogos Inc. )e s!re to start with booincome and identify all of the ad=!stments necessary to arri"e at ta able income. b. Identify each boo--ta difference as either permanent or temporary. c. Complete :ched!le B-1 for Cimpanogos. d. Comp!te Cimpanogos, Inc.$s reg!lar ta liability for #611. e. 5etermine Cimpanogos$s alternati"e minim!m ta , if any.

16-06

Chapter 16 - Corporate Operations

(impanogos's taxable income is ,9,-95,666, computed as follows:


Description Ce"enue from sales &ost of $oods Sold 1ross profit 2t3er income4 >ife insurance proceeds from &H<'s death !nterest income on tax.exempt bonds Cental income 1ross 'ncome Expenses4 !nterest paid to obtain tax.exempt bonds *et capital loss &haritable contributions epreciation >ife insurance premiums Federal income tax expense (otal expenses before charitable contribution, *<>, C , and 0# deduction !ncome before charitable contribution, *<>, C , and 0# *<> carryo"er from prior year (axable income for charitable contribution limitation purposes &haritable contributions Boo.5&axa0le income Boo. 'ncome *Dr, Cr ,5,666,666 (+66,666) ,9,;66,666 Boo./tax ad)ustments$ *Dr, Cr (E6,666) Q(R -6,666 Q(R &axa0le 'ncome *Dr, Cr ,5,666,666 (+96,666) ,9,E?6,666

566,666 D6,666 5-,666 ,9,?E-,666 (D-,666) (D-,666)


3o"ed below

(566,666) Q0R (D6,666) Q0R (96,666) Q(R

+6,666 Q(R

6 6 D-,666 ,9,;+-,666 6 6 (--,666) 6 6 (--,666) ,9,E:6,666 (6) ,9,E:6,666 (9E:,666) $1, 1#,000

D-,666 Q0R D-,666 Q(R (+6,666) Q(R 59,666 Q0R -66,666 Q0R

(5-,666) (59,666) (-66,666) (E+E,666) ,9,+5?,666 (6)

(9:6,666) $1,149,000

*!40,000,

95,666 Q(R "0!,000

WQ(R reflects temporary book.tax differences and Q0R reflects permanent book.tax differences (see re/uirement b).

16-02

Chapter 16 - Corporate Operations

c. (impanogos's Schedule 3.9 is as follows:

d. (impanogos's regular tax liability is ,-9D,6:6 (,9,-95,666 x +D7). e. (impanogos does not ha"e an alternati"e minimum tax liability. See following computation: Cate7or8 (axable income or loss before *<> deduction 0reference items: A%& Calculation 'tem5Calculation Amount ,9,-95,666 D6,666 (D-,666)W -,666 9+D,5-6 ,9,EDE,5-6 (6) ,9,EDE,5-6 .5 ,+5?,5-6

0ri"ate acti"ity bond !nterest expense on loan to ac/uire pri"ate acti"ity bonds. epreciation #&H ad%ustment

#d%ustments: #lternati"e minimum taxable income (#3(!) Subtract: Hxemption (completely phased.out) #3( base x 567 (entati"e minimum tax

16-03

Chapter 16 - Corporate Operations

Subtract: Cegular income tax Alternati9e minimum tax if positi9e

(9,-95,666 J ++-,666) x . +D I 99+,?66

(-9D,6:6) $0

W!nterest expense is deductible for #3( because it generated income that is includible in #3(!. ACE Ad)ustment %odification to Description A%&' eath benefit from life insurance contract ,566,666 >ife insurance premiums (generate tax.exempt income) .59,666WW (otal 9;?,666 ACE Ad)ustment *total x " +, $1!4,# 0 WW0remiums are deductible for #&H purposes because premiums generated income (death benefit) that is included in #&H. 32 HIJ is a calendar-year corporation that began b!siness on Fan!ary 1, #611. ;or #611, it reported the following information in its c!rrent year a!dited income statement. Aotes with important ta information are pro"ided below. <e/!iredD a. <econcile boo- income to ta able income and identify each boo--ta difference as temporary or permanent. b. Comp!te HIJ$s reg!lar income ta liability. c. Complete HIJ$s :ched!le B-1. d. Complete HIJ$s ;orm 11#6, page 1 7!se #616 form if #611 form is !na"ailable8. Ignore estimated ta penalties when completing the form. e. Comp!te HIJ$s alternati"e minim!m ta , if any. f. Complete a ;orm (6#6 for HIJ 7!se #616 "ersion if #611 is !na"ailable8. g. 5etermine the /!arters for which HIJ is s!b=ect to !nderpayment of estimated ta es penalties 7see estimated ta information below8.

16-04

Chapter 16 - Corporate Operations

HIJ corp. Income statement ;or c!rrent year <e"en!e from sales Cost of *oods :old Gross profit Other income: Income from in"estment in corporate stocInterest income Capital gains 7losses8 *ain or loss from disposition of fi ed assets Biscellaneo!s income *ross Income Expenses: Compensation :toc- option compensation +d"ertising <epairs and Baintenance <ent )ad 5ebt e pense 5epreciation 1arranty e penses Charitable donations Beals and entertainment

)ooIncome @(6,666,666 7#2,666,6668 @1&,666,666 &66,6661 #6,666# 7(,6668 &,666& 06,666 @1&,&64,666 72,066,6668( 7#66,66680 71,&06,6668 720,6668 7##,6668 7(1,66686 71,(66,66682 726,66683 7066,66684 713,6668

)oo- to Ca +d=!stments 75r.8 Cr.

Ca able Income

16-66

Chapter 16 - Corporate Operations

*oodwill impairment Organi9ational e pendit!res Other e penses Cotal e penses Income before ta es ,ro"ision for income ta es Aet Income after ta es

7&6,666816 7((,6668 11 71(6,66681# 7@11,&46,6668 @1,424,666 72#6,66681& @1,#04,6661(

Notes: 1. HIJ owns &6L of the o!tstanding .obble Corp. 7.C8 stoc-. .obble Corp. reported @1,666,666 of income for the year. HIJ acco!nted for its in"estment in .C !nder the e/!ity method and it recorded its pro rata share of .C$s earnings for the year. .C also distrib!ted a @#66,666 di"idend to HIJ. #. Of the @#6,666 interest income, @0,666 was from a City of :eattle bond 7iss!ed in #6628 that was !sed to f!nd p!blic acti"ities, @2,666 was from a Cacoma City bond 7iss!ed in #6638 !sed to f!nd pri"ate acti"ities, @6,666 was from a f!lly ta able corporate bond, and the remaining @#,666 was from a money mar-et acco!nt. &. Chis gain is from e/!ipment that HIJ p!rchased in ;ebr!ary and sold in 5ecember 7that is, it does not /!alify as E1#&1 gain8. (. Chis incl!des total officer compensation of @#,066,666 7no one officer recei"ed more than @1,666,666 compensation8. 0. Chis amo!nt is the portion of incenti"e stoc- option compensation that "ested d!ring the year 7recipients are officers8. 6. HIJ act!ally wrote off @#2,666 of its acco!nts recei"able as !ncollectible. 2. <eg!lar ta depreciation was @1,466,666 and +BC 7and +C'8 depreciation was @1,266,666. 3. In the c!rrent year, HIJ did not ma-e any act!al payments on warranties it pro"ided to c!stomers. 4. HIJ made @066,666 of cash contrib!tions to /!alified charities d!ring the year. 16. On F!ly 1 of this year HIJ ac/!ired the assets of another b!siness. In the process it ac/!ired @&66,666 of goodwill. +t the end of the year, HIJ wrote off @&6,666 of the goodwill as impaired. 11. HIJ e pensed all of its organi9ational e pendit!res for boo- p!rposes. It e pensed the ma im!m amo!nt of organi9ational e pendit!res allowed for ta p!rposes. 1#. Che other e penses do not contain any items with boo--ta differences. 1&. Chis is an estimated ta pro"ision 7federal ta e pense8 for the year. +ss!me that HIJ is not s!b=ect to state income ta es. 1(. HIJ calc!lated that its domestic prod!ction acti"ities ded!ction 75,+58 is @46,666. Chis amo!nt is not incl!ded on the a!dited income statement n!mbers.

16-61

Chapter 16 - Corporate Operations

Estimated tax informationD HIJ made fo!r e/!al estimated ta payments totaling @(36,666. +ss!me for p!rposes of estimated ta penalties, HIJ was in e istence in #616 and it reported a ta liability of @366,666. 5!ring #611, HIJ determined its ta able income at the end of each of the fo!r /!arters as followsD C!m!lati"e ta able income 7loss8 @&06,666 @366,666 @1,666,666

N!arter-end ;irst :econd Chird

;inally, ass!me that HIJ is not a large corporation for p!rposes of estimated ta calc!lations. a.
Description Ce"enue from sales &ost of $oods Sold 1ross profit 2t3er income4 !ncome from in"estment in corporate stock !nterest income &apital gains (losses) $ain on fixed asset dispositions 3iscellaneous income 1ross 'ncome Expenses4 &ompensation Stock option compensation #d"ertising Cepairs and 3aintenance Cent Bad debt expense epreciation 8arranty expenses &haritable contributions 3eals and entertainment Boo. 'ncome *Dr, Cr ,D6,666,666 (5;,666,666) ,9+,666,666 Boo./tax ad)ustments$ *Dr, Cr &axa0le 'ncome *Dr, Cr ,D6,666,666 (5;,666,666) ,9+,666,666

+66,6669 56,666 (D,666) +,666 -6,666 ,9+,+E?,666 (;,-66,666) (566,666) (9,+-6,666) (;-,666) (55,666) (D9,666) (9,D66,666) (;6,666)
3o"ed below

(966,666) Q(R (95,666) Q0R D,666 Q(R

566,666 :,666 6 +,6665 -6,666 ,9+,5E9,666 (;,-66,666) 6 (9,+-6,666) (;-,666) (55,666) (5;,666) (9,?66,666) 6+ (?,666)

566,666 Q0R

9D,666 Q(R (-66,666) Q(R ;6,666 Q(R ?,666 Q0R

(9:,666)

16-6#

Chapter 16 - Corporate Operations

$oodwill impairment <rgani)ational expenditures <ther expenses Federal income tax expense (otal expenses before charitable contribution, *<>, C , and 0# deduction !ncome before charitable contribution, C , and 0# &haritable contributions (axable income before C and 0# i"idends recei"ed deduction ( C ) omestic production acti"ities deduction Boo.5&axa0le income

(+6,666) (DD,666) (9D6,666) (;56,666) (99,E96,666) ,9,;-?,666 (-66,666) (9E6,666) Q0R (?6,666) Q0R *66#,000,

56,666 Q(R +E,D66 Q(R ;56,666 Q0R

(96,666)D (;,E66)(9D6,666) 6 (99,6D6,E66) ,5,556,D66 (555,6D6); ,9,??:,+E6 (9E6,666) (?6,666) $1,"46,!60

5;;,?E6 Q(R

$1,# 9,000

1,! 1,!60

WQ(R reflects temporary book.tax differences and Q0R reflects permanent book.tax differences. 9. Bsing the e/uity method, SGT accounts for ,966,666 of income for book purposes (,9,666,666 x .+). 5. (his is ordinary income for tax purposes (used in trade or business held for less than a year) so it is not netted with the capital loss. +. 8arranty expense is deductible for tax purposes when paid. D. For tax purposes, SGT is allowed to amorti)e goodwill ac/uired in an asset ac/uisition on a straight.line basis o"er 9:6 months. !n 5699, it is allowed to amorti)e goodwill for E months because the goodwill was ac/uired in Ouly. !ts deductible amorti)ation expense for goodwill is ,96,666 (,+6,666=9:6 months x E months). So, the Schedule 3.9 ad%ustment is ,56,666 unfa"orable. -. Because SGT reported less than ,-6,666 in organi)ation expenditures it is allowed to immediately expense ,-,666 and amorti)e the remaining costs ,+?,666 (,DD,666 J -,666) o"er 9:6 months (9- years). Because SGT began business in Oanuary, it is allowed to deduct a full year's worth of amorti)ation. !n total, its SGT's deductible amorti)ation is ,;,E66 Q,-,666 I 5,E66 (,+?,666=9-)R. E. (he charitable contribution deduction is limited to ,555,6D6 which is 967 of taxable income before the charitable contribution, C , or 3 (,5,556,D66 x 967). ;. Because SGT owns +67 of 4&, it is entitled to an :67 C . !ts C is ,9E6,666 (,566,666 di"idend x :67).

16-6&

Chapter 16 - Corporate Operations

b. SGT's regular income tax liability is ,-?D,DD5 (,9,;D:,+E6 x +D7). c. SGT's Schedule 3.9 is as follows:

Sc3edule %/1
9 5 + D *et income per books Federal income tax pro"ision Hxcess of capital losses o"er capital gains !ncome sub%ect to tax not recorded on books this year (itemi)e) ,9,5-?,666 ;56,666 D,666

- Hxpenses recorded on books this year not deducted on this return a. epreciation b. &ontributions carryo"er c. (ra"el and entertainment Stock option compensation (incenti"e stock options) Bad debt expense 8arranty expense $oodwill impairment <rgani)ational expenditures E #dd lines 9 through ; !ncome recorded on books this year not included on this return a. (ax exempt interest !ncome from in"estment in corporate stock : eductions on this return not charged against book income this year a. epreciation b. &ontributions carryo"er omestic production acti"ities deduction

5;;,?E6 ?,666 566,666 9D,666 ;6,666 56,666 +E,D66 ,5,E96,+E6 95,666 966,666

-66,666 ?6,666

? #dd lines ; and : 96 !ncome (line 5:, page 9) J line E less line ?

;65,666 ,9,?6:,+E6

*ote that line 96 does not reconcile to SGT's taxable income. !t reconciles to taxable income before the di"idends recei"ed deduction of ,9E6,666. SGT's taxable income is ,9,;D:,+E6 (,9,?6:,+E6 .9E6,666).

16-6(

Chapter 16 - Corporate Operations

d. (he front page of SGT's Form 9956 is as follows: QCeplace with 5696 filled in formR

16-60

Chapter 16 - Corporate Operations

Other e pensesD Beals and entertainment *oodwill amorti9ation Organi9ational e pendit!res Other

@4,666 16,666 2,666 1(6,666 @166,666

e. SGT's alternati"e minimum tax liability is ,6, computed as follows: Cate7or8 (axable income or loss before *<> deduction 0reference items #d%ustments #lternati"e minimum taxable income (#3(!) Subtract: Hxemption (completely phased.out) #3( base x 567 (entati"e minimum tax Subtract: Cegular income tax
(,9,;D:,+E6 x +D7)

A%& Calculation 'tem5Calculation

Amount ,9,;D:,+E6 ;,666 566,666 ?,D-6 ,9,?ED,:96 (6) ,9,?ED,:96 .5 ,+?5,?E5 ,-?D,DD5 ,6

0ri"ate acti"ity bond epreciation #&H ad%ustment

#lternati"e minimum tax if positi"e. ACE Ad)ustment Description (ax.exempt interest income from tax exempt bond that funds a public acti"ity (as opposed to pri"ate acti"ity) <rgani)ational expenditures that were expensed during the year (otal ACE Ad)ustment *$1#,600 total x " +,

%odification to A%&' I,-,666 I;,E66 95,E66 $9,4 0

16-66

Chapter 16 - Corporate Operations

f. SGT's Form DE5E is as follows: Qreplace with 5696 filled in formR

16-62

Chapter 16 - Corporate Operations

g. !n this part of the problem, we assume that SGT filed a tax return last year (5696) and reported a tax liability of ,:66,666. (his year, SGT's actual tax liability is ,-?D,DD5 and it made ,D:6,666 in estimated tax payments.
718 Installment 1st /!arter #nd /!arter &rd /!arter (th /!arter Ca able income @&06,666 @&06,666 @366,666 @1,666,666 7#8 +nn!ali9ation ;actor 1#G& R ( 1#G& R ( 1#G6 R # 1#G4 R 1.&&& 718 7#8 +nn!al 'stimated ta able income $1, !!,!!! $1, !!,!!! $1,"!!,!!! $1,333,333

!nstallment 9st /uarter 5nd /uarter +rd /uarter Dth /uarter

:e;uired Estimated &ax -a8ments under annuali<ed met3od (9) (5) (+) (D) #nnual (ax on (9) x (5) (5) x (+) estimated estimated 0ercentage of Ce/uired taxable taxable tax re/uired to cumulati"e income income be paid payment 9,D66,666 D;E,666 5-7 99?,6666 9,D66,666 D;E,6666 -67 5+:,6666 9,E66,666 -DD,666 ;-7 D6:,666 9,+++,+++ D-+,+++ 9667 D-+,+++

Installment

1st /!arter #nd /!arter &rd /!arter (th /!arter

718 <e/!ired c!m!lati"e payment !nder prior year ta method 7@666,666G( per /!arter8 @106,666 @&66,666 @(06,666 @666,666

7#8 'stimated ta payment !nder ann!ali9ed method

7&8 <e/!ired payment based on c!rrent year ta liability @1(6,2(4 @#4&,(43 @((6,#(2 @036,446

7&8 <e/!ired c!m!lati"e payment Least of 718, 7#8, and 7&8]

7(8 +ct!al payments

Pnderpayment penalty Ies if 7(8 S 7&8

@114,666 @#&3,666 @(63,666 @(0&,&&&

@114,666 @#&3,666 @(63,666 @(0&,&&&

@1#6,666 @#(6,666 @&66,666 @(36,666

No No Yes No

SGT is sub%ect to an underpayment penalty based on a ,D:,666 underpayment during for the third /uarter. (he penalty is applied on the underpayment at the federal short term rate plus +7 for the number of days between the due date of the third /uarter payment and the date of the fourth /uarter payment.

16-63