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624 MODULE 36 TAXES: CORPORATE

before the dividends received and net operating loss deduc- book income to taxable income is $1,500 - $6,000 =
tions, the dividends received deduction will not be a recon- ($4,500).
ciling item on Schedule M-I. In this case, Farve Corp.'s
$80,000 of book income would be increased by the $18,000 C.6.d. Schedule M-2
of federal income tax, $6,000 of net capital loss, and 50% of
the $4,000 of business meals which were deducted per 7L (d) The requirement is to determine the amount to
books, but are not deductible for tax purposes. Book income be shown on Schedule M-2 of Form 1120 as Barbaro's re-
would be reduced by the $5,000 of municipal bond interest tained earnings at December 31, 2009. Beginning with the
that is tax -exempt. , balance at January 1, 2009, the end of year balance would be
computed as follows: .
67. (c) The requirement is to determine Starke Corp.'s Balance, 111/09 $600,000
taxable income as reconciled on Schedule M-I of Form Net income for year + 274,900
1120. Schedule M-I provides a reconciliation of a corpora- Federal income tax refund + 26,000
tion's book income with its taxable income before the divi- Cash dividends - 150000
dends received and net operating loss deductions. Starke Balance, 12/31109 $750,900
reported book income of $380,000 that included $50,000 of ,72. (a) The requirement is to determine the amount that
municipal bond interest income, and deductions for should appear on the last line of Schedule M-2 of Form
$170,000 of federal income tax expense and $2,000 of in- 1120. Schedule M-2 is an "Analysis of Unappropriated
terest expense incurred to carry the municipal bonds. Since Retained Earnings Per Books." Its first line is the balance at
municipal bond interest is tax-exempt, the $50,000 of inter- the beginning of the year and its last line is the balance at the
est income must be subtracted from book income, and the end of the year. The end-of-year balance would be com-
$2,000 of interest expense incurred to carry the municipal puted as follows:
bonds is not deductible and must be added back to book Retained earnings, beginning $ 50,000
income. Similarly, the $170,000 of federal income tax ex- Net income for year
pense is not deductible and must be added back to book in- Contingency reserve + 70,000
come. Thus, Starke's taxable income is $380,000 - $50,000 Cash dividends
+ $2,000 + $170,000 = $502,000. Retained earnings, end of year -10,000
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D. Affiliated and Controlled Corporations
68. (d) The requirement is to determine whether lodging $lO2,000
expenses for out-of-town travel and the deduction of a net 7~.. (d) The requirement is to determine the
capital loss would be reported on Schedule M-I of the US '}mount of
corporate income tax return (Form 1120). Schedule M-I dividend revenue to be reported on Bank Corp.'s consoli-
generally provides a reconciliation of a corporation's income' dated tax return for the $48,000 of dividends received from
per books with the corporation's taxable income before the Bank Corp.ls 80%-owned subsidiary, Shore Corp. Instead
NOL and dividends received deductions. Since a net capital of filing separate tax returns, an affiliated group of corpora-
loss deducted per books would not be deductible for tax tions (i.e., corporations connected through 80% or more
purposes, the net capital loss would be added back to book stock-ownership) can elect to file a consolidated tax return.
income on Schedule M-I. However, since out-of-town If a consolidated return is filed, dividends received from
lodging expenses are deductible for both book and tax pur- affiliated group members are eliminated in the consolidation
poses, the expenses would riot appear on Schedule M-I. process, and are not reported on the consolidated tax return.
69. (c) The reconciliation of income per books with 74. (d) The requirement is to determine the amount of
income per return is accomplished on Schedule M-I of Form net dividend income received from an affiliated corporation
1120. Both temporary differences (e.g., accelerated depre- that should be included in Portal Corporation's 2009 con-
ciation on tax return and straight-line on books) and perma- solidated tax return. When dividends are received from an
nent differences (e.g., tax-exempt interest) must be consid- affiliated corporation (i.e., at least 80%-owned subsidiary)
ered to convert book income to taxable income. during a consolidated return year, the intercompany divi- ,
dends are eliminated in the consolidation process and are not
70. (a) The requirement is to determine Media Corpora- included in gross income.
tion's net M-I adjustment on its 2009 Form 1120. Gener-
ally, items of income and deduction whose book and tax 75. (d) The requirement is to determine the amount of
treatment differ result in Schedule M-I adjustments that gain to be reported in the 2009 and 2008 consolidated tax
reconcile income reported per books with taxable income. returns. Generally, gains and losses on intercompany trans-
Media reported book income that included $6,000 in mu- actions during consolidated return years are deferred and
nicipal bond interest income, and deductions that included reported in subsequent years when a restoration event oc-
$1,500 of interest expense incurred on debt to carry the mu- curs. Since Potter and Sly filed a consolidated tax return for
nicipal bonds, and $8,000 in advertising expense. Since 2008, Potter's gain on the sale of land to Sly in 2008 is de-
municipal bond interest is tax-exempt, the $6,000 of interest ferred and will be reported when Sly sells the land outside of
income must be subtracted from book income. Additionally, the affiliated group in 2009. Thus, the 2008 consolidated
since the $1,500 of interest expense to carry the municipal return will report no gain with regard to the land, while the
bonds is an expense incurred in the production of exempt 2009 consolidated return will report the aggregate amount of
income, it is not tax deductible and must be added back to gain, $125,000 - $60,000 = $65,000.
book income. On the other hand, the $8,000 of advertising 76. (b) The requirement is to determine the correct
expense is deductible for book as well as taxable income statement regarding an affiliated group of includible corpo-
purposes, and no Schedule M-I adjustment is necessary. rations filing a consolidated return. One of the advantages
Thus, Media's net Schedule M-I adjustment t~ reconcile of filing a consolidated return is that operating losses of one
member of the group offset operating profits of other mem-