Entity Tax Exam

Fall 2018
Exam 1
100 points

Question 1 Response:

Question 2 Response:
If the bonus is given as salary than Michelle would pay an additional $27,750 (75,000 x 37%) in
taxes on top of whatever she made during the year. The corporation would be able to deduct the
$27,750 (75,000 x 37%) as a salary deduction. This is more beneficial for the corporation. If the
bonus were disbursed as a dividend than Michelle would only have to pay a dividend tax rate of
20%, which is $15,000. The corporation would not be able to deduct any of the $75,000.
By contrast, declaring $75,000 in dividends is more beneficial for Michelle. Michelle prefers
treating the payment as a dividend, as a preferential tax rate of 15% would apply to the $75,000
and result in only $11,250 of tax. If, instead, the payment was treated as a salary, Michelle
would incur tax of $27,750 [$75,000 (salary) * 37% (marginal tax rate)]. If the payment were
treated as a dividend, none of the $75,000 would deductible by Esther Corp. Thus, Michelle
would save $16,500 of tax if the payment were treated as a dividend instead of salary. Esther
Corporation prefers treating the payment as salary.
Question 3 Response:
Thrush-Dawn C-Corporation

Gross Income $350,000

Individual income 75,000 [Dawn]
Taxable income 275,000
Corporate-level tax [$275,000 * 21%]: (57,750)
Individual level tax [$75,000 * 37%] 27,750
Total taxes paid (85,500)
Swallow-Kirk S-Corporation

Gross Income $350,000

Individual income 75,000 [Kirk]
Taxable income 275,000
Corporate-level tax: [Flow-through]
Individual level tax [$350,000 * 37%]. ($129,500)
Total taxes paid ($129,500)
Dawn
Corporate income is taxed twice. Once at the corporate level and again at the shareholder level
when they receive distributions from the corporation or sell their appreciated stock.
Kirk
Flow-through entity income retains its character and is allocated or “flows through” to entity
owners. The owners generally pay tax on their share of the income as if they had earned it
themselves. Flow-through entity owners are taxed when the income is allocated to them not
when they receive distributions. Flow-through entity owners may qualify the deduction for
qualified business income. This deduction is generally 20 percent of the business income from
nonservice activities generated in the U.S. Flow-through entity income of passive owners is
subject to the 3.8 percent net investment income tax for owners with AGI over a threshold
amount. The flow-through business income of an S corporation is not self-employment income.
The income of a sole proprietorship is self-employment income. Whether the income of an entity
taxed as a partnership is flow-through income depends on the extent to which the owner is
involved in the entity’s business activities.
Question 4 Response:
Income from operations $260,000
Expenses from operations 305,000
Dividends received from Roadrunner Corporation 115,000

a. Coyote owns 5% of Roadrunner Corporation’s stock. How much is Coyote

Corporation’s taxable income (loss) for the year?

For Year Ended December 31, 2017

Gross Income:
Income from operations $260,000
Dividends 115,000
Total gross income: 375,000

Less:
Expenses from operations: ($305,000)
Taxable income before dividends received deduction: 70,000
Dividends received deduction ($115,000 * 70%): (80,500)
Total expense: 385,500
Net operating loss: ($10,500)

For Year Ended December 31, 2018

Gross Income:
Income from operations $260,000
Dividends 115,000
Total gross income: 375,000

Less:
Expenses from operations: ($305,000)
Taxable income before dividends received deduction: 70,000
Dividends received deduction ($115,000 * 50%): 57,500
Taxable Income: $12,500

b. Would your answer change if Coyote owned 25% of Roadrunner Corporation’s

stock?

Yes, the answer would change because here, Coyote owns more than 20% of Roadrunner
Corporation. Therefore, Coyote would either be eligible for 80 percent dividends received
deduction for its tax year that began after 2017, or 65 percent dividends received deduction
for its tax year that began after 2018.
 For Year Ended December 31, 2017

Gross Income:
Income from operations $260,000
Dividends 115,000
Total gross income: 375,000

Less:
Expenses from operations: ($305,000)
Taxable income before dividends received deduction: 70,000
Dividends received deduction ($115,000 * 80%): (92,000)
Net operating loss: ($22,000)

For Year Ended December 31, 2018

Gross Income:
Income from operations $260,000
Dividends + 115,000
Total gross income: 375,000

Less:
Expenses from operations: ($305,000)
Taxable income before dividends received: 70,000
Dividends received deduction ($115,000 * 65%): (74,750)
Net operating loss: ($4,750)
Question 5 Response:
During the current year, Quartz Corporation (a calendar year C corporation) has the following
transactions:

Income from operations $350,000

Expenses from operations 370,000
Dividends received from ABC Corporation 50,000

Quartz owns 25% of ABC Corporation’s stock. How much is Quartz Corporation’s taxable
income (loss) for the year?

For Year Ended December 31, 2017

Gross Income:
Income from operations $350,000
Dividends 50,000
Total gross income: 400,000

Less:
Expenses from operations: ($370,000)
Taxable income before dividends received deduction: 30,000
Dividends received deduction ($50,000 * 80%): ($40,000)
Net operating loss: ($10,000)

For Year Ended December 31, 2018

Gross Income:
Income from operations $350,000
Dividends 50,000
Total gross income: 400,000

Less:
Expenses from operations: ($370,000)
Taxable income before dividends received deduction: 30,000
Dividends received deduction ($50,000 * 65%): ($32,500)
Net operating loss: ($2,500)
Question 6 Response:
Orange Corporation exchanges a warehouse located in Michigan (adjusted basis of $560,000) for
a warehouse located in Ohio (adjusted basis of $450,000; fair market value of $525,000).
Indicate the amount of gain or loss that is recognized by Orange Corporation on the exchange,
and the basis of the warehouse acquired.

a. Orange Corporation exchanges a warehouse located in Michigan (adjusted basis of

$560,000) for a warehouse located in Ohio (adjusted basis of $450,000; fair market
value of $525,000). Indicate the amount of gain or loss that is recognized by Orange
Corporation on the exchange, and the basis of the warehouse acquired.

Amount realized $525,000

Adjusted basis (560,000)
Capital loss realized ($35,000)

Orange recognized $35,000 in ordinary §1231 capital losses.

The new basis in the warehouse is $525,000, which is the fair-market value and carry-
over basis of the asset (Ohio warehouse) received.

b. Assume that in addition to the warehouse Orange Corporation also received

$100,000 in cash. Indicate the amount of gain or loss that is recognized by Orange
Corporation on the exchange, and the basis of the warehouse acquired.

Amount realized $625,000 [$525,000 + $100,000]

Adjusted basis (560,000)
Capital gain realized ($65,000)

Orange recognized $65,000 in ordinary §1231 capital gain.

The new basis in the warehouse is $525,000, which is the fair-market value and carry-
over basis of the asset (Ohio warehouse) received.

c. How would your answer in b. change if instead of receiving $100,000 in cash, the
other party assumed Orange’s $100,000 mortgage on the Michigan warehouse?

Nothing would change, and this transaction results in same answer as part (b). On these
facts nothing would change from part (b) because the other party discharged the
indebtedness of Orange Corporation by assuming $100,000 of its mortgage debt. This
discharge of indebtedness is boot. Hence, the same tax treatment results as in part (b)
when Orange Corporation received $100,000 in cash.
Question 7 Response:

Part a

Merle

Amount realized on sale $25,000

Basis in stock 40,000
Loss realized on sale (15,000)
Loss recognized 0 [I.R.C. § 267]

Ned
Amount realized on sale $26,000
Basis in stock 25,000
Loss realized on sale (1,000)
Loss recognized 0 [Ned must sell his stock interest for over $41,000]

Part b

Yes, Ned would realize and recognize $1,000 of capital gain.