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1

Which statement best describes the concept of the "double taxation" of corporation income?


A. Corporate income is subject to two levels of taxation: the regular tax and the alternative minimum tax.

B. Corporate income is taxed twice at the corporate level: first when earned and then a second time if appreciated property is distributed to a shareholder.

C. Corporate income is taxed when earned by a C corporation and then a second time at the shareholder level when distributed as a dividend.

D. Corporate income is subject to two levels of taxation: at the federal level and a second time at the state level.

C. Corporate income is taxed when earned by a C corporation and then a second time at the shareholder level when distributed as a dividend.


The double taxation of corporate income refers to the taxation of such income at the corporate level and then at the shareholder level when such income is distributed as a dividend.

2

Which of the following forms of earnings distributions would not be subject to double taxation at the corporate and shareholder level?


A. Dividend

B. Stock redemption

C. Partial liquidation

D. Compensation paid to a shareholder/employee of the corporation

D. Compensation paid to a shareholder/employee of the corporation


Compensation is deductible at the corporate level.

3

Which of the following statements best describes the priority of the tax treatment of a distribution from a corporation to a shareholder?


A. The distribution is a dividend to the extent of the corporation's earnings and profits, then a return of capital, and finally gain from sale of stock.

B. The distribution is a return of capital, then a dividend to the extent of the corporation's earnings and profits, and finally gain from sale of stock.

C. The distribution is a return of capital, then gain from sale of stock, and finally a dividend to the extent of the corporation's earnings and profits.

D. The shareholder can elect to treat the distribution as either a dividend to the extent of the corporation's earnings and profits or a return of capital, followed by gain from sale of stock.

A. The distribution is a dividend to the extent of the corporation's earnings and profits, then a return of capital, and finally gain from sale of stock.


The tax treatment is specified in §301(c).

4

Which of the following statements best describes current earnings and profits?


A. Current earnings and profits is another name for a corporation's retained earnings on its balance sheet.

B. Current earnings and profits is a precisely defined tax term in the Internal Revenue Code and represents a corporation's economic income.

C. Current earnings and profits is an ill-defined tax concept in the Internal Revenue Code and represents a corporation's economic income.

D. Current earnings and profits is a conceptual tax concept with no definition in the Internal Revenue Code.

C. Current earnings and profits is an ill-defined tax concept in the Internal Revenue Code and represents a corporation's economic income.


Current earnings and profits more accurately describes economic income (at least compared to taxable income) and is only partially defined in the Internal Revenue Code.

5

Which of the following statements best describes the role of current and accumulated earnings and profits in determining if a distribution is a dividend?


A. A distribution will only be a dividend if total earnings and profits (current plus accumulated) is positive at the time of the distribution.

B. A distribution can never be a dividend if current earnings and profits are negative.

C. A distribution will be a dividend if current earnings and profits for the year are positive, even if accumulated earnings and profits are negative.

D. A distribution will never be a dividend if current earnings and profits for the year are negative, even if accumulated earnings and profits is positive.

C. A distribution will be a dividend if current earnings and profits for the year are positive, even if accumulated earnings and profits are negative.

Distributions are first treated as paid out of current earnings and profits.

6

A calendar-year corporation has positive current E&P of $500 and accumulated negative E&P of $1,200. The corporation makes a $400 distribution to its sole shareholder. Which of the following statements is true?


A. The distribution will not be a dividend because total earnings and profits is a negative $700.

B. The distribution may be a dividend, depending on whether total earnings and profits at the date of the distribution is positive.

C. The distribution will be a dividend because current earnings and profits are positive and exceed the distribution.

D. A distribution from a corporation to a shareholder is always a dividend, regardless of the balance in earnings and profits.

C. The distribution will be a dividend because current earnings and profits are positive and exceed the distribution.

Distributions are first treated as paid out of current earnings and profits.

7

A calendar-year corporation has negative current E&P of $500 and accumulated positive E&P of $1,000. The corporation makes a $600 distribution to its sole shareholder. Which of the following statements is true?


A. $500 of the distribution will be a dividend because total earnings and profits is $500.

B. $0 of the distribution will be a dividend because current earnings and profits are negative.

C. $600 of the distribution will be a dividend because accumulated earnings and profits is $1,000.

D. Up to $600 of the distribution could be a dividend depending on the balance in accumulated earnings and profits on the date of the distribution.

D. Up to $600 of the distribution could be a dividend depending on the balance in accumulated earnings and profits on the date of the distribution.


When current E&P is negative, the status of a distribution is determined based on accumulated E&P at the date of the distribution.

8

Which of these items is not an adjustment to taxable income or net loss to compute current E&P?


A. Dividends received deduction

B. Tax-exempt income

C. Net capital loss carryforward from the prior year tax return

D. Refund of prior year taxes for an accrual method taxpayer

D. Refund of prior year taxes for an accrual method taxpayer.

Refunds of prior year taxes are included in the computation of current E&P under the cash method of accounting.

9

Grand River Corporation reported taxable income of $500,000 in 20X3 and paid federal income taxes of $170,000. Not included in the computation was a disallowed meals and entertainment expense of $2,000, tax-exempt income of $1,000, and deferred gain on an installment sale of $25,000. The corporation's current earnings and profits for 20X3 would be:


A. $524,000

B. $500,000

C. $354,000

D. $331,000

C. $354,000


$500,000 - $170,000 - $2,000 + $1,000 + $25,000 = $354,000.

10

Au Sable Corporation reported taxable income of $800,000 in 20X3 and paid federal income taxes of $272,000. Not included in the computation was a disallowed penalty of $25,000, life insurance proceeds of $100,000, and an income tax refund from 20X2 of $50,000. Au Sable is an accrual basis taxpayer. The corporation's current earnings and profits for 20X3 would be:


A. $875,000

B. $653,000

C. $603,000

D. $553,000

C. $603,000

$800,000 - $272,000 - $25,000 + $100,000 = $603,000. The refund is not added back because Au Sable is on the accrual method.

11

Oakland Corporation reported a net operating loss of $500,000 in 20X3 and elected to carry the loss forward to 20X4. Not included in the computation was a disallowed meals and entertainment expense of $20,000, tax-exempt income of $10,000, and deferred gain on an installment sale of $250,000. The corporation's current earnings and profits for 20X3 would be:


A. ($500,000)

B. ($720,000)

C. ($510,000)

D. ($260,000)

D. ($260,000)


($500,000) - $20,000 + $10,000 + 250,000 = ($260,000).

12

Packard Corporation reported taxable income of $1,000,000 in 20X3 and paid federal income taxes of $340,000. Included in the taxable income computation was a dividends received deduction of $5,000, a net capital loss carryover from 20X2 of $10,000, and gain of $50,000 from an installment sale that took place in 20X1. The corporation's current earnings and profits for 20X3 would be:


A. $1,015,000

B. $965,000

C. $675,000

D. $625,000

D. $625,000


$1,000,000 - $340,000 + $5,000 + $10,000 - $50,000 = $625,000.

13

Abbot Corporation reported a net operating loss of $400,000 in 20X3, which the corporation elected to carry forward to 20X4. Included in the computation of the loss was regular depreciation of $100,000 (E&P depreciation is $40,000), first year expensing under §179 of $50,000, and a dividends received deduction of $10,000. The corporation's current earnings and profits for 20X3 would be:


A. ($290,000)

B. ($330,000)

C. ($400,000)

D. ($490,000)

A. ($290,000)

($400,000) + $60,000 + $40,000 + $10,000 = ($290,000). The first year expensing under §179 must be capitalized and amortized over 5 years ($10,000 per year).

14

Madison Corporation reported taxable income of $400,000 in 20X3 and accrued federal income taxes of $136,000. Included in the computation of taxable income was regular depreciation of $200,000 (E&P depreciation is $60,000) and a net capital loss carryover of $20,000 from 20X2. The corporation's current earnings and profits for 20X3 would be:


A. $424,000

B. $404,000

C. $380,000

D. $344,000

A. $424,000

$400,000 - $136,000 + $140,000 + $20,000 = $424,000. The capital loss carryover reduced E&P in 20X2.

15

Greenwich Corporation reported a net operating loss of $800,000 in 20X3, which the corporation elected to carry forward to 20X4. The computation of the loss did not include a disallowed fine of $50,000, life insurance proceeds of $500,000, and a current year charitable contribution of $10,000 that will be carried forward to 20X4. The corporation's current earnings and profits for 20X3 would be:


A. ($250,000)

B. ($260,000)

C. ($300,000)

D. ($360,000)

D. ($360,000)

($800,000) - $50,000 + $500,000 - $10,000 = ($360,000).

16

Bruin Company reports current E&P of $200,000 in 20X3 and accumulated E&P at the beginning of the year of $100,000. Bruin distributed $400,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3?


A. $400,000

B. $300,000

C. $200,000

D. $100,000

B. $300,000

The distribution is a dividend to the extent of current and accumulated E&P. The tax status of the dividend is determined based on current E&P for the full year.

17

Aztec Company reports current E&P of $200,000 in 20X3 and accumulated E&P at the beginning of the year of negative $100,000. Aztec distributed $300,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3?


A. $300,000

B. $200,000

C. $100,000

D. $0

B. $200,000

The distribution is a dividend to the extent of current E&P. The tax status of the dividend is determined based on current E&P for the full year.

18

Inca Company reports current E&P of negative $100,000 in 20X3 and accumulated E&P at the beginning of the year of $200,000. Inca distributed $300,000 to its sole shareholder on January 1, 20X3. How much of the distribution is treated as a dividend in 20X3?


A. $0

B. $100,000

C. $200,000

D. $300,000

C. $200,000

When current E&P is negative, the tax status of the dividend is determined by calculating accumulated E&P on the date of the distribution.

19

Wildcat Corporation reports current E&P of negative $200,000 in 20X3 and accumulated E&P at the beginning of the year of $100,000. Wildcat distributed $300,000 to its sole shareholder on December 31, 20X3. How much of the distribution is treated as a dividend in 20X3?


A. $0

B. $100,000

C. $200,000

D. $300,000

A. $0

If accumulated E&P is positive, but current E&P is negative, then a distribution is a dividend to the extent of net E&P (accumulated E&P less an allocated portion of the deficit in current E&P) on the date of the distribution.

20

Beaver Company reports current E&P of $100,000 in 20X3 and accumulated E&P at the beginning of the year of $200,000. Beaver distributed $400,000 to its sole shareholder on January 1, 20X3. The shareholder's tax basis in her stock in Beaver is $200,000. How is the distribution treated by the shareholder in 20X3?


A. $400,000 dividend

B. $100,000 dividend, $200,000 tax-free return of basis, and $100,000 capital gain

C. $200,000 dividend and $200,000 tax-free return of basis

D. $300,000 dividend and $100,000 tax-free return of basis

D. $300,000 dividend and $100,000 tax-free return of basis.

The distribution is a dividend to the extent of current and accumulated E&P at January 1, 20X3. The excess distribution is a tax-free return of basis because the shareholder's tax basis in her stock exceeds the distribution.

21

Longhorn Company reports current E&P of $100,000 in 20X3 and accumulated E&P at the beginning of the year of negative $200,000. Longhorn distributed $300,000 to its sole shareholder on January 1, 20X3. The shareholder's tax basis in his stock in Longhorn is $100,000. How is the distribution treated by the shareholder in 20X3?


A. $300,000 dividend

B. $100,000 dividend, $100,000 tax-free return of basis, and $100,000 capital gain

C. $100,000 dividend and $200,000 tax-free return of basis

D. $0 dividend, $100,000 tax-free return of basis, and $200,000 capital gain

B. $100,000 dividend, $100,000 tax-free return of basis, and $100,000 capital gain.

The distribution is a dividend to the extent of current E&P at December 31, 20X3. The excess $200,000 distribution is first a tax-free return of basis to the extent of the shareholder's tax basis and then capital gain.

22

Husker Corporation reports current E&P of negative $200,000 in 20X3 and accumulated E&P at the beginning of the year of $300,000. Husker distributed $200,000 to its sole shareholder on December 31, 20X3. The shareholder's tax basis in her stock in Husker is $50,000. How is the distribution treated by the shareholder in 20X3?


A. $200,000 dividend

B. $100,000 dividend, $50,000 tax-free return of basis, and $50,000 capital gain

C. $100,000 dividend and $100,000 tax-free return of basis

D. $0 dividend, $50,000 tax-free return of basis, and $150,000 capital gain

B. $100,000 dividend, $50,000 tax-free return of basis, and $50,000 capital gain.

When current E&P is negative, the tax status of the dividend is determined by calculating accumulated E&P on the date of the distribution. Accumulated E&P at 12/31/X3 is $100,000. The remaining distribution is a tax-free return of basis, with the excess treated as capital gain.

23

Tar Heel Corporation had current and accumulated E&P of $500,000 at December 31 20X3. On December 31, the company made a distribution of land to its sole shareholder, William Roy. The land's fair market value was $100,000 and its tax and E&P basis to Tar Heel was $25,000. William assumed a mortgage attached to the land of $10,000. The tax consequences of the distribution to William in 20X3 would be:


A. $100,000 dividend and a tax basis in the land of $100,000

B. $100,000 dividend and a tax basis in the land of $90,000

C. Dividend of $90,000 and a tax basis in the land of $100,000

D. Dividend of $90,000 and a tax basis in the land of $90,000

C. Dividend of $90,000 and a tax basis in the land of $100,000.

The dividend amount is the fair market value less the liability assumed. The tax basis of the land is the fair market value.

24

Cavalier Corporation had current and accumulated E&P of $500,000 at December 31 20X3. On December 31, the company made a distribution of land to its sole shareholder, Tom Jefferson. The land's fair market value was $200,000 and its tax and E&P basis to Cavalier was $50,000. The tax consequences of the distribution to Cavalier in 20X3 would be:


A. No gain recognized and a reduction in E&P of $200,000

B. $150,000 gain recognized and a reduction in E&P of $200,000

C. $150,000 gain recognized and a reduction in E&P of $50,000

D. No gain recognized and a reduction in E&P of $50,000

B. $150,000 gain recognized and a reduction in E&P of $200,000.

The distributing corporation recognizes gain on the distribution, which is included in E&P, net of tax, and reduces E&P by the land's fair market value.

25

Montclair Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Molly Pitcher. The land's fair market value was $200,000 and its tax and E&P basis to Montclair was $50,000. Molly assumed a liability of $25,000 attached to the land. The tax consequences of the distribution to Montclair in 20X3 would be:


A. No gain recognized and a reduction in E&P of $200,000

B. $150,000 gain recognized and a reduction in E&P of $200,000

C. $150,000 gain recognized and a reduction in E&P of $175,000

D. No gain recognized and a reduction in E&P of $175,000

C. $150,000 gain recognized and a reduction in E&P of $175,000.

The distributing corporation recognizes gain on the distribution, which is included in E&P, net of tax, and reduces E&P by the land's fair market value less the liability assumed by the shareholder.

26

Catamount Company had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Caroline West. The land's fair market value was $200,000 and its tax and E&P basis to Catamount was $250,000. The tax consequences of the distribution to Catamount in 20X3 would be:


A. No loss recognized and a reduction in E&P of $250,000

B. $50,000 loss recognized and a reduction in E&P of $250,000

C. $50,000 loss recognized and a reduction in E&P of $150,000

D. No loss recognized and a reduction in E&P of $200,000

A. No loss recognized and a reduction in E&P of $250,000.

The distributing corporation does not recognize loss on the distribution and reduces E&P by the land's E&P basis.

27

Paladin Corporation had current and accumulated E&P of $500,000 at December 31, 20X3. On December 31, the company made a distribution of land to its sole shareholder, Maria Mendez. The land's fair market value was $200,000 and its tax and E&P basis to Paladin was $250,000. Maria assumed a liability of $25,000 attached to the land. The tax consequences of the distribution to Paladin in 20X3 would be:


A. No loss recognized and a reduction in E&P of $200,000

B. $50,000 loss recognized and a reduction in E&P of $200,000

C. $50,000 loss recognized and a reduction in E&P of $225,000

D. No loss recognized and a reduction in E&P of $225,000

D. No loss recognized and a reduction in E&P of $225,000.

The distributing corporation does not recognize loss on the distribution and reduces E&P by the land's E&P basis less the liability assumed by the shareholder.

28

Which of the following payments could be treated as a constructive dividend by the IRS?


A. End-of-year bonus payment to a shareholder/employee

B. Rent paid to a shareholder/lessor

C. Interest paid to a shareholder/creditor

D. All of these payments could be treated as a constructive dividend by the IRS

D. All of these payments could be treated as a constructive dividend by the IRS.

All of the payments are deductible by the corporation and could be treated as a nondeductible dividend by the IRS.

29

Which of the following factors would not be considered in determining if compensation paid to a shareholder/employee is reasonable?


A. The individual's duties and responsibilities

B. What individuals performing in comparable capacities at other companies are paid

C. Whether the corporation has a formal compensation policy

D. The individual's marginal income tax rate

D. The individual's marginal income tax rate

The IRS and courts do not list the individual's marginal tax rate as a factor in determining if compensation is reasonable.

30

Which of the following statements is not considered a potential answer to the dividend puzzle (why do corporations pay dividends)?


A. Paying dividends avoids the double taxation of corporate income

B. Demanding that managers pay out dividends restricts their investment activities and forces them to adopt more efficient investment policies

C. Paying dividends is a source of investor goodwill

D. Dividends are a signal to the capital markets about the health of a corporation's activities

A. Paying dividends avoids the double taxation of corporate income.

Dividends result in the double taxation of corporate income.