CPA Regulation (REG) : Special Issues in Taxation of Organizations
Study concepts, example questions & explanations for CPA Regulation (REG)
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Example Questions
Example Question #1 : Consolidated Tax Returns
Rigg, Steele, and Urco Corps., all accrual-basis, calendar-year C corporations, have only voting common stock outstanding. Rigg owns 85 percent of Steele and 40 percent of Urco. Steele owns 50 percent of Urco. Which group of corporations qualifies as an affiliated group and may join in the filing of a consolidated federal income tax return?
Urco and Steele
Rigg, Steele, and Urco
An affiliated group does not exist
Rigg and Urco
Rigg, Steele, and Urco
For tax purposes, entities may file as a consolidated group if the parent company owns at least 80% of all entities in the group. Here, Rigg owns 85% of Steele which qualifies for consolidation. Rigg owns 40% of Urco directly, and another 50% indirectly through Steele, which means Urco also qualifies for consolidation.
Example Question #2 : Consolidated Tax Returns
Sunshine Corp., a wholly owned subsidiary of Pierpoint Corp., purchased land from Pierpoint for its fair market value of $10,000 on January 1 of the previous tax year. Pierpoint's adjusted basis of the land on the date of sale was $8,000. During the current tax year, Sunshine sold the land for $9,000 to an unrelated taxpayer. What gain or loss will be reported on a consolidated tax return filed by Sunshine and Pierpoint for the current tax year?
$0
($1,000)
$1,000
$2,000
$1,000
Related party transfers of property are disregarded for tax purposes, and as a result the basis of the parent company is retained by the subsidiary. Only when the property leaves the consolidated group is a gain or loss recognized, again from the parent’s (original owner’s) basis. Since the parent’s basis is $8,000, when the subsidiary sells the property for $9,000, a $1,000 gain is recognized.
Example Question #3 : Consolidated Tax Returns
Which of the following statements regarding the election to file a consolidated tax return is correct?
Intercompany gains are eliminated.
The election may be revoked by the parent of the group at any time.
Net operating losses arising after the election must first offset their income from separate return years.
Each member of the consolidated group is liable only for its own tax liability.
Intercompany gains are eliminated.
One feature of consolidated tax returns is that intercompany gains and losses are deferred for tax purposes. All parties must agree to the initial filing as a group, but the election is binding until the group is disbanded (e.g., the parent sells its stake in the subsidiary). The group as a whole is responsible for the tax liability, and no rules about NOL application within the group exist.
Example Question #4 : Consolidated Tax Returns
Of the following, which groups may elect to file a consolidated corporate return?
A parent corporation and all more than 10% controlled partnerships
Members of an affiliated group
A brother sister controlled group
A parent corporation and all more than 50% controlled subsidiaries
Members of an affiliated group
An affiliated group of corporations may file a consolidated return. Not all corporations have the privilege of filing a consolidated return.
Example Question #2 : Consolidated Tax Returns
In a consolidated income tax return of a corp and its wholly owned subsidiary, what percent of cash dividends paid by the sub to the parent is tax free?
100%
0%
50%
65%
100%
The DRD is increased to 100% of qualifying dividends received from a consolidated affiliated group of a common parent who owns at least 80% of the includible corporations if elected.
Example Question #4 : Consolidated Tax Returns
Under consolidation rules between a corporation and a 100% owned subsidiary, the Dividends Received Deduction percentage would be:
0%
100%
50%
33%
100%
When a company is wholly owned, the distribution of dividends from one to another can be viewed as a cash transfer among the same entity, thus eliminating the tax.
Example Question #1 : Book/Tax Differences
Vital Corp. is an accrual-basis, calendar-year C corporation. Its year 2 reported book income before federal income taxes was $500,000. Included in that amount were the following items:
- Year 1 state franchise tax refund: $50,000
- Municipal bond interest income: 7,500
What should be the amount of Vital's year 2 taxable income as reconciled on Vital's Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return?
$492,500
$450,000
$442,500
$500,000
$492,500
Municipal bond interest income is not taxable, and so must be deducted from book income to determine taxable income. The state tax refund, however, is treated the same for book and tax purposes. As a result, to arrive at tax income, only the bond interest must be removed: $500,000 - $7,500 = $492,500.
Example Question #2 : Book/Tax Differences
Which of the following items should be included on Schedule M-1, Reconciliation of Income (Loss) per Books with Income per Return, of Form 1120, U.S. Corporation Income Tax Return, to reconcile book income to taxable income?
Corporate bond interest
Ending balance of retained earnings
Premiums paid on key-person life insurance policy
Cash distributions to shareholders
Premiums paid on key-person life insurance policy
Life insurance expenses paid on key individuals in the corporation are not treated as expenses for tax purposes, and as a result must be included on Schedule M-1. The rest of the options are all either treated the same for book and tax purposes or are non-taxable transactions.
Example Question #3 : Book/Tax Differences
Taxi Co. reported book income of $140,000. Included in that amount was $50,000 for meal expenses and $40,000 for federal income tax expense. In Taxi’s Schedule M-1 of Form 1120, which reconciles book income and taxable income, what amount should be reported as taxable income?
$150,000
$140,000
$205,000
$190,000
$205,000
To calculate taxable income from book income, income tax expense must be added back before reconciling. Additionally, meal expenses are 50% deductible for tax purposes, meaning half of the expense must be removed to arrive at tax income. So, to calculate taxable income:
$140,000 + $40,000 + ($50,000 * 50%) = $205,000
Example Question #4 : Book/Tax Differences
Of the following items, which should be included on Schedule M1 of form 1120 to reconcile book income to taxable income?
Ending balance of retained earnings
Cash distributions to shareholders
Corporate bond interest
Premiums paid on key person life insurance policy
Premiums paid on key person life insurance policy
Of the following items, only premiums paid on key person’s life insurance policy is a difference between book and tax.
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