624 MODULE 36 TAXES: CORPORATE
before the dividends received and net operating loss deduc-
tions, the dividends received deduction will not be a recon-
ciling item on Schedule M-I. In this case, Farve Corp.'s
$80,000 of book income would be increased by the $18,000
of federal income tax, $6,000 of net capital loss, and 50% of
the $4,000 of business meals which were deducted per
books, but are not deductible for tax purposes. Book income
would be reduced by the $5,000 of municipal bond interest
that is tax -exempt. ,
67. (c) The requirement is to determine Starke Corp.'s
taxable income as reconciled on Schedule M-I of Form
1120. Schedule M-I provides a reconciliation of a corpora-
tion's book income with its taxable income before the divi-
dends received and net operating loss deductions. Starke
reported book income of $380,000 that included $50,000 of
municipal bond interest income, and deductions for
$170,000 of federal income tax expense and $2,000 of in-
terest expense incurred to carry the municipal bonds. Since
municipal bond interest is tax-exempt, the $50,000 of inter-
est income must be subtracted from book income, and the
$2,000 of interest expense incurred to carry the municipal
bonds is not deductible and must be added back to book
income. Similarly, the $170,000 of federal income tax ex-
pense is not deductible and must be added back to book in-
come. Thus, Starke's taxable income is $380,000 - $50,000
+ $2,000 + $170,000 = $502,000.
68. (d) The requirement is to determine whether lodging
expenses for out-of-town travel and the deduction of a net
capital loss would be reported on Schedule M-I of the US
corporate income tax return (Form 1120). Schedule M-I
generally provides a reconciliation of a corporation's income'
per books with the corporation's taxable income before the
NOL and dividends received deductions. Since a net capital
loss deducted per books would not be deductible for tax
purposes, the net capital loss would be added back to book
income on Schedule M-I. However, since out-of-town
lodging expenses are deductible for both book and tax pur-
poses, the expenses would riot appear on Schedule M-I.
69. (c) The reconciliation of income per books with
income per return is accomplished on Schedule M-I of Form
1120. Both temporary differences (e.g., accelerated depre-
ciation on tax return and straight-line on books) and perma-
nent differences (e.g., tax-exempt interest) must be consid-
ered to convert book income to taxable income.
70. (a) The requirement is to determine Media Corpora-
tion's net M-I adjustment on its 2009 Form 1120. Gener-
ally, items of income and deduction whose book and tax
treatment differ result in Schedule M-I adjustments that
reconcile income reported per books with taxable income.
Media reported book income that included $6,000 in mu-
nicipal bond interest income, and deductions that included
$1,500 of interest expense incurred on debt to carry the mu-
nicipal bonds, and $8,000 in advertising expense. Since
municipal bond interest is tax-exempt, the $6,000 of interest
income must be subtracted from book income. Additionally,
since the $1,500 of interest expense to carry the municipal
bonds is an expense incurred in the production of exempt
income, it is not tax deductible and must be added back to
book income. On the other hand, the $8,000 of advertising
expense is deductible for book as well as taxable income
purposes, and no Schedule M-I adjustment is necessary.
Thus, Media's net Schedule M-I adjustment t~ reconcile
book income to taxable income is $1,500 - $6,000 =
($4,500).
C.6.d. Schedule M-2
7L (d) The requirement is to determine the amount to
be shown on Schedule M-2 of Form 1120 as Barbaro's re-
tained earnings at December 31, 2009. Beginning with the
balance at January 1, 2009, the end of year balance would be
computed as follows: .
Balance, 111/09 $600,000
Net income for year + 274,900
Federal income tax refund + 26,000
Cash dividends - 150000
Balance, 12/31109 $750,900
,72. (a) The requirement is to determine the amount that
should appear on the last line of Schedule M-2 of Form
1120. Schedule M-2 is an "Analysis of Unappropriated
Retained Earnings Per Books." Its first line is the balance at
the beginning of the year and its last line is the balance at the
end of the year. The end-of-year balance would be com-
puted as follows:
Retained earnings, beginning $ 50,000
Net income for year
Contingency reserve + 70,000
Cash dividends
Retained earnings, end of year -10,000
- ---.8...QQQ
D. Affiliated and Controlled Corporations
$lO2,000
7~.. (d) The requirement is to determine the
'}mount of
dividend revenue to be reported on Bank Corp.'s consoli-
dated tax return for the $48,000 of dividends received from
Bank Corp.ls 80%-owned subsidiary, Shore Corp. Instead
of filing separate tax returns, an affiliated group of corpora-
tions (i.e., corporations connected through 80% or more
stock-ownership) can elect to file a consolidated tax return.
If a consolidated return is filed, dividends received from
affiliated group members are eliminated in the consolidation
process, and are not reported on the consolidated tax return.
74. (d) The requirement is to determine the amount of
net dividend income received from an affiliated corporation
that should be included in Portal Corporation's 2009 con-
solidated tax return. When dividends are received from an
affiliated corporation (i.e., at least 80%-owned subsidiary)
during a consolidated return year, the intercompany divi- ,
dends are eliminated in the consolidation process and are not
included in gross income.
75. (d) The requirement is to determine the amount of
gain to be reported in the 2009 and 2008 consolidated tax
returns. Generally, gains and losses on intercompany trans-
actions during consolidated return years are deferred and
reported in subsequent years when a restoration event oc-
curs. Since Potter and Sly filed a consolidated tax return for
2008, Potter's gain on the sale of land to Sly in 2008 is de-
ferred and will be reported when Sly sells the land outside of
the affiliated group in 2009. Thus, the 2008 consolidated
return will report no gain with regard to the land, while the
2009 consolidated return will report the aggregate amount of
gain, $125,000 - $60,000 = $65,000.
76. (b) The requirement is to determine the correct
statement regarding an affiliated group of includible corpo-
rations filing a consolidated return. One of the advantages
of filing a consolidated return is that operating losses of one
member of the group offset operating profits of other mem-