CPA Regulation (REG) : Special Issues in Corporate Taxation

Study concepts, example questions & explanations for CPA Regulation (REG)

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Example Questions

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Example Question #1 : Liquidating & Non Liquidating Distributions

What is the usual result to the shareholders of a distribution in complete liquidation of a corporation?

Possible Answers:

Capital gain or loss

Ordinary gain or loss

Ordinary gain to the extent of cash received

No taxable effect

Correct answer:

Capital gain or loss

Explanation:

Capital gains and losses are the result of changes in the value of an investment. If there is a liquidation and the assets received in liquidation differ in value from the shareholder’s original investment value (= basis), the difference would result in a capital gain or loss.

Example Question #2 : Liquidating & Non Liquidating Distributions

On January 1 of the current year, Hobbes Corp., an accrual-basis calendar-year C corporation, had $30,000 in accumulated earnings and profits. For the current year, Hobbes had current earnings and profits of $20,000, and made two $40,000 cash distributions to its shareholders, one in March and one in August. What amount of the distributions is classified as dividend income to Hobbes’ shareholders?

Possible Answers:

$80,000

$50,000

$20,000

$0

Correct answer:

$50,000

Explanation:

Distributions from current and accumulated earnings and profits (E&P) qualify as dividend income; distributions in excess of current and accumulated E&P are regarded as returns of capital. Here, there was $50,000 in current and accumulated E&P ($20,000 current, $30,000 accumulated). This is the maximum amount of the $80,000 in distributions that can be classified as dividend income.

Example Question #3 : Liquidating & Non Liquidating Distributions

On January 1, Year 1, Peele Corp., a C corporation, had a $50,000 deficit in earnings and profits. For Year 1, Peele had current earnings and profits of $10,000 and made a $30,000 cash distribution to its stockholders. What amount of the distribution is taxable as dividend income to Peele’s stockholders?

Possible Answers:

$20,000

$10,000

$30,000

$0

Correct answer:

$10,000

Explanation:

Distributions from current and accumulated earnings and profits (E&P) qualify as dividend income; distributions in excess of this are regarded as returns of capital. Here, there was only $10,000 in current E&P, and there was a deficit for accumulated E&P, meaning the $10,000 is the maximum amount of the $30,000 distribution that can be classified as dividend income.

Example Question #4 : Liquidating & Non Liquidating Distributions

Which is the usual result to the shareholders of a distribution in complete liquidation of a corporation?

Possible Answers:

No taxable effect

Ordinary gain or loss

Ordinary gain to the extent of cash received

Capital gain or loss

Correct answer:

Capital gain or loss

Explanation:

Shareholders treat property received in complete liquidation of a corporation as full payment for their stock. Therefore, the shareholder must recognize capital gain or loss equal to the difference between the FMV and the basis.

Example Question #5 : Liquidating & Non Liquidating Distributions

At the beginning of the year, a C Corp had a $50,000 deficit in its earnings and profits account. For the year, the Corp had current earnings and profits of $10,000 and made a $30,000 cash distribution to its stockholders. What amount of the distribution is taxable s dividend income to its shareholders?

Possible Answers:

$0

$20,000

$10,000

$30,000

Correct answer:

$10,000

Explanation:

Taxable dividend income is paid out of a corporation’s current or accumulated earnings and profits. Since the corp had a deficit, only the current earnings and profits of $10,000 are available for dividends.

Example Question #6 : Liquidating & Non Liquidating Distributions

Upon the dissolution of a partnership, the basis of any “in-kind” property distributed to a former partner will be the same as the partner’s _________ in the partnership.

Possible Answers:

Fair market value

Cash account

Ending adjusted basis

Beginning adjusted basis

Correct answer:

Ending adjusted basis

Explanation:

Upon the dissolution of a partnership, the basis of any “in-kind” property distributed to a former partner will be the same as the partner’s adjusted basis in the partnership.

Example Question #1 : Accumulated Earnings Tax

Presto Corp., a calendar year domestic C corporation, is not a personal holding company. For purposes of the accumulated earnings tax, Presto has accumulated taxable income for Year 3. Which step(s) can Presto take to eliminate or reduce any Year 3 accumulated earnings tax?

I.  Demonstrate that the “reasonable needs” of its business require the retention of all or part of the Year 3 accumulated taxable income.

II. Pay dividends by April 15, Year 4.

Possible Answers:

Neither I or II

II only

I only

Both I and II

Correct answer:

Both I and II

Explanation:

To minimize the impact of the accumulated earnings tax, a corporation can argue on the basis of “reasonable needs” of business before the IRS, and provide a specific, definite, and feasible plan for the use of such retained earnings. Additionally, dividends paid by the corporate tax return deadline which reduce accumulated earnings will also reduce or eliminate the tax on those earnings.

Example Question #2 : Accumulated Earnings Tax

The accumulated earnings tax can be imposed:

Possible Answers:

On personal holding companies.

Only on S corporations.

On any entity with more than 100 shareholders.

Regardless of the number of stockholders in a corporation.

Correct answer:

Regardless of the number of stockholders in a corporation.

Explanation:

The accumulated earnings tax is directed primarily at regular C corporations. The number of shareholders is irrelevant. Personal holding companies and S corporations are exempt from this tax.

Example Question #3 : Accumulated Earnings Tax

The accumulated earnings tax is paid at which rate?

Possible Answers:

35%

20%

21%

15%

Correct answer:

20%

Explanation:

The rate for the accumulated earnings tax is the same as the rate individual taxpayers pay on dividends, or 20%. This is because the accumulated earnings tax is directed at regular corporations who hold an excess of retained earnings instead of being distributed as dividends to shareholders.

Example Question #4 : Accumulated Earnings Tax

When a Subchapter S corporation does not have any _________, the amount distributed to a shareholder will decrease that shareholder’s basis in the stock.

Possible Answers:

Tax exempt earnings and profits

Capital gains income

Dividend income

Accumulated earnings and profits

Correct answer:

Accumulated earnings and profits

Explanation:

When an S Corp does not have any accumulated E&P, the distribution to the shareholder will decrease its basis in the company stock.

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