Determine C Corporation Taxable Income - CPA Reg

1. Under Section 248, organizational expenditures incurred in forming a C corporation may be deducted under which of the following rules?
   Answer: The corporation may elect to deduct up to $5,000 of organizational expenditures in the first year, reduced dollar-for-dollar by expenditures exceeding $50,000, with the remainder amortized over 180 months. Under Section 248, a corporation may elect to deduct up to $5,000 of organizational expenditures in the tax year the business begins. This $5,000 immediate deduction is reduced dollar-for-dollar by the amount of organizational expenditures that exceed $50,000. Any remaining organizational expenditures are amortized ratably over 180 months (15 years) beginning with the month the corporation begins business. Answer B is incorrect because immediate full deduction of all organizational costs is not permitted. Answer C is incorrect because the election allows both a current deduction and amortization. Answer D (60 months) was the rule under prior law but has been replaced by the 180-month amortization period.
2. Under the consolidated return rules, affiliated corporations may file a consolidated federal income tax return. Which of the following correctly states the ownership requirement for affiliated group membership?
   Answer: The common parent (directly or through other group members) must own at least 80% of the total voting power and 80% of the total value of each subsidiary's stock. Under Section 1504(a), an affiliated group for consolidated return purposes requires that the common parent directly own at least 80% of the total voting power and 80% of the total value of at least one includible corporation, and each other member is connected through stock ownership meeting the 80% voting/value threshold (directly or through other group members). Answer A (51%) is not the statutory threshold. Answer B (50%, all classes) does not meet the 80% voting and value requirement. Answer D (100%) is not required; 80% is the threshold, and minority interests are permitted.
3. Under Section 165(g), a C corporation may claim a worthless stock deduction when stock in a subsidiary becomes completely worthless. Which of the following correctly describes the character of this loss?
   Answer: If the subsidiary is an affiliated corporation (80% or more owned) and meets the Section 165(g)(3) requirements, the loss is treated as an ordinary loss rather than a capital loss. Under Section 165(g)(3), when a domestic corporation's stock in an affiliated subsidiary (80% or more owned) becomes worthless and the subsidiary is an operating company (deriving more than 90% of its gross receipts from active business sources), the loss is treated as an ordinary loss, not a capital loss. This allows the parent to deduct the full loss against ordinary income. Answer B is incorrect because the Section 165(g)(3) exception converts the loss to ordinary for qualifying affiliated subsidiaries. Answer C is incorrect because worthless stock is not a Section 1231 asset; it is capital unless the ordinary loss election applies. Answer D is incorrect because worthless stock deductions are specifically allowed under Section 165(g).
4. A C corporation has a net operating loss (NOL) generated in 2022. Under post-TCJA NOL rules, how may this NOL be used?
   Answer: The NOL may be carried forward indefinitely but may only offset up to 80% of taxable income in any carryforward year; no carryback is permitted. Under the TCJA (effective for NOLs arising in tax years beginning after December 31, 2017), corporate NOLs have an indefinite carryforward period but are limited to offsetting 80% of taxable income (before the NOL deduction) in any given year. The carryback provision was eliminated for most taxpayers (though a temporary 5-year carryback was allowed for 2018-2020 NOLs under the CARES Act, that provision has expired). Answer A describes pre-TCJA rules. Answer B describes CARES Act rules that are no longer in effect for 2022 NOLs. Answer D describes the old 20-year carryforward rule without the 80% limitation.
5. Cortland Corp, a C corporation, incurs $600,000 of start-up expenditures before beginning business operations on January 1 of Year 1. Under Section 195, how much may Cortland deduct in its first year of business?
   Answer: $40,000; the $5,000 immediate deduction is entirely phased out because costs exceed $50,000 by $550,000, so all $600,000 is amortized over 180 months at $3,333 per month, yielding $40,000 for a full 12-month first year. Under Section 195, a corporation may elect to deduct up to $5,000 of start-up expenditures in the first year, but this is reduced dollar-for-dollar when total start-up costs exceed $50,000. Here, costs of $600,000 exceed $50,000 by $550,000, reducing the immediate deduction to $0 ($5,000 - $550,000). All $600,000 is amortized over 180 months. Because the business began January 1 (a full 12 months), the first-year amortization = $600,000 / 180 x 12 = $40,000. Answer D is correct. Answer A is incorrect because full immediate deduction is not allowed when costs exceed $50,000 by this magnitude. Answer B (60 months) was the old rule. Answer C ($100,000) is not a statutory amount under Section 195.
6. Under Section 1231, a C corporation sells depreciable equipment used in its business for more than its adjusted basis. The equipment was purchased for $200,000, has accumulated depreciation of $120,000, and is sold for $170,000. What is the character of the gain?
   Answer: Section 1245 ordinary income recapture of $90,000. Adjusted basis = $200,000 - $120,000 = $80,000. Amount realized = $170,000. Total gain = $170,000 - $80,000 = $90,000. Under Section 1245, all gain on the sale of depreciable personal property is recaptured as ordinary income to the extent of depreciation taken. Since the total gain ($90,000) is less than the depreciation taken ($120,000), the entire $90,000 gain is recaptured as ordinary income under Section 1245. No Section 1231 gain exists because Section 1245 recapture absorbs the entire gain. Answer A and B are incorrect because Section 1245 recapture overrides Section 1231 treatment for the recaptured amount. Answer D is incorrect because the gain ($90,000) does not exceed the depreciation ($120,000), so there is no unrecaptured portion to treat as Section 1231 gain.
7. Under Section 163(j), the business interest expense deduction is limited for C corporations. Which of the following correctly describes the general limitation?
   Answer: Business interest expense is deductible only up to the sum of business interest income plus floor plan financing interest expense plus 30% of adjusted taxable income (ATI), with disallowed interest carried forward indefinitely. Under Section 163(j), the deduction for business interest expense is limited to the sum of (1) business interest income, (2) floor plan financing interest expense (applicable to dealers in motor vehicles, boats, and farm equipment), and (3) 30% of adjusted taxable income (ATI). For tax years beginning before 2022, ATI was computed before depreciation, amortization, and depletion (similar to EBITDA). For 2022 and beyond, ATI is computed after depreciation (similar to EBIT), making the limitation more restrictive. Disallowed interest carries forward indefinitely. Answer A is correct. Answer B is incorrect because Section 163(j) applies to most C corporations; small businesses with average gross receipts at or below the inflation-adjusted threshold (approximately $31 million for 2024) are exempt. Answer C (50% of taxable income) is not the Section 163(j) formula. Answer D is incorrect because corporations with gross receipts above the threshold are subject to the limitation, not exempt.
8. A C corporation pays a $50,000 penalty to the EPA for violating environmental regulations. Is this penalty deductible as a business expense?
   Answer: No, because Section 162(f) disallows deductions for fines and penalties paid to a government for violation of law. Under Section 162(f), no deduction is allowed for any fine or similar penalty paid to a government (federal, state, local, or foreign) as a result of a violation of law. The EPA penalty constitutes a fine paid to a government entity for a law violation and is therefore not deductible. Answer A is incorrect because the ordinary course of business test does not override Section 162(f)'s specific disallowance for government penalties. Answer C is incorrect because there is no 50% partial deduction for government penalties. Answer D is incorrect because the intent of the violation is irrelevant to the Section 162(f) disallowance.
9. A C corporation's taxable income is computed by subtracting allowable deductions from gross income. Which of the following correctly states the corporate income tax rate under current law?
   Answer: A flat rate of 21% on all taxable income. The Tax Cuts and Jobs Act of 2017 replaced the graduated corporate tax rate schedule with a flat 21% rate on all C corporation taxable income, effective for tax years beginning after December 31, 2017. Answer A describes the pre-TCJA graduated rate schedule. Answer B (28%) and Answer C (35%) were rates that existed under prior law but are no longer applicable.
10. Under the accumulated earnings tax (AET) under Section 531, which of the following correctly describes when the AET applies to a C corporation?
    Answer: The AET applies when a corporation is found to have accumulated earnings and profits beyond the reasonable needs of the business with the purpose of avoiding shareholder-level income tax. The accumulated earnings tax under Section 531 is a penalty tax imposed on C corporations that accumulate earnings beyond the reasonable needs of the business for the purpose of avoiding shareholder-level income tax on dividends. The AET rate is 20%. Corporations may accumulate up to $250,000 (or $150,000 for professional service corporations) without facing a presumption of unreasonable accumulation. Answer A is incorrect because the $250,000 threshold is a safe harbor, not an automatic trigger. Answer B is incorrect because the AET does not apply automatically based on dividend payment history alone; purpose and reasonable business needs are the key factors. Answer D describes the personal holding company (PHC) tax, a different provision.
11. Under Section 267, losses on sales between related parties are disallowed. Which of the following correctly identifies a related party transaction subject to Section 267?
    Answer: A sale of property between a corporation and a shareholder who owns more than 50% of the corporation's stock. Under Section 267(b)(2), a corporation and an individual who owns more than 50% in value of its outstanding stock are related parties. Losses on sales between related parties are disallowed, and the gain on a later sale by the buyer is reduced by the disallowed loss. Answer B is incorrect because unrelated corporations are not related parties under Section 267. Answer C is incorrect because the threshold is more than 50%, not 50% exactly. Answer D is incorrect because a non-stockholder employee is not a related party under Section 267 solely by virtue of employment.
12. Stanton Corp, a C corporation, owns 15% of Verdant Corp, another domestic corporation. Stanton receives $200,000 in dividends from Verdant. What is Stanton's DRD?
    Answer: $100,000 (50% DRD) Under post-TCJA Section 243, the DRD for a corporation owning less than 20% of the distributing corporation is 50%. Stanton owns 15% of Verdant, which is less than 20%, so the 50% DRD applies. DRD = $200,000 x 50% = $100,000. Answer A (65%) applies when ownership is 20% or more but less than 80%. Answer C (100%) applies for affiliated group members with 80% or more ownership. Answer D is incorrect because the DRD is available at 50% for all eligible corporate shareholders, not only those with 20% or more ownership.
13. Parkview Corp, a calendar-year C corporation, has taxable income of $500,000 before considering a charitable contribution of $80,000 made during the year. What is the maximum charitable contribution deduction Parkview may claim?
    Answer: $50,000, limited to 10% of taxable income computed before the deduction. Under Section 170(b)(2), a C corporation's charitable contribution deduction is limited to 10% of taxable income computed before the charitable deduction, certain other deductions, and any NOL carryback or capital loss carryback. Pre-contribution taxable income = $500,000. Maximum deduction = 10% x $500,000 = $50,000. The remaining $30,000 may be carried forward for up to five years. Answer A is incorrect because the 10% limitation caps the current-year deduction. Answer C (5%) is not the corporate charitable contribution limit. Answer D (20%) is not the applicable rate for C corporations.
14. A C corporation contributes appreciated property (adjusted basis $30,000, FMV $80,000) to a qualifying charity. What is the corporation's charitable contribution deduction for the donated property?
    Answer: $80,000 if the property is capital gain property; $30,000 if it is ordinary income property. When a C corporation donates capital gain property (property that would produce long-term capital gain if sold), the deduction is the fair market value ($80,000). When a corporation donates ordinary income property (property that would produce ordinary income or short-term capital gain if sold), the deduction is limited to the property's adjusted basis ($30,000). The character of the gain that would have been recognized on a hypothetical sale determines whether the deduction is FMV or basis. Answer A (adjusted basis only) applies only to ordinary income property. Answer B (FMV for all property) is correct only for capital gain property. Answer C ($55,000) has no basis in the Code.
15. Dunmore Corp accrues a bonus payable to its employees at year-end December 31. Under the accrual method, when must the bonus be paid for Dunmore to deduct it in the current year?
    Answer: By March 15 of the following year (2.5 months after year-end) for a calendar-year corporation. Under Section 404(a)(11) and the recurring item exception, accrual-method corporations may deduct bonuses accrued at year-end if the liability is fixed by year-end and the bonuses are paid within 2.5 months after year-end (by March 15 for a calendar-year corporation). This is the 2.5-month rule for deferred compensation. Answer A is incorrect because the deduction is allowed even if paid after year-end, provided the 2.5-month window is met. Answer C (April 15) is too late for the 2.5-month rule. Answer D (end of following year) does not meet the requirement for current-year deductibility under the 2.5-month rule.
16. A C corporation's dividends-received deduction (DRD) is subject to a taxable income limitation. Under Section 246(b), how does this limitation apply?
    Answer: The DRD is limited to the applicable DRD percentage (50% or 65%) of taxable income computed before the DRD, unless taking the full DRD would create or increase a net operating loss; the 100% DRD for affiliated group members is not subject to this taxable income limitation. Under Section 246(b), the DRD is limited to the applicable percentage of the corporation's taxable income computed before the DRD and before any NOL deduction. This taxable income limitation applies only to the 50% and 65% DRD tiers; the 100% DRD available to members of an affiliated group filing a consolidated return is not subject to the taxable income limitation. Additionally, the taxable income limitation does not apply to the 50% or 65% DRD if taking the full DRD would create or increase a net operating loss for the year. Answer D is correct. Answer A is incorrect because the limitation percentage matches the DRD percentage (65% or 50%), not a flat 50% cap. Answer B is incorrect because the limitation is based on taxable income, not simply the amount of dividends. Answer C reverses the rule; the taxable income limitation does not apply precisely when the DRD creates or increases an NOL.
17. A C corporation pays a $200,000 salary to its sole shareholder-employee. The IRS determines that $80,000 of this salary is unreasonably high and reclassifies it as a constructive dividend. What are the tax consequences to the corporation?
    Answer: The corporation loses the deduction for the $80,000 reclassified as a dividend, because dividends are not deductible; only the $120,000 reasonable compensation remains deductible. Under Section 162, compensation is deductible only to the extent it is reasonable. When the IRS reclassifies excess compensation as a constructive dividend, the corporation loses the deduction for that portion because dividends paid by a C corporation are not deductible. The corporation may deduct only the $120,000 that constitutes reasonable compensation. Answer A is incorrect because the IRS has disallowed $80,000 as unreasonable. Answer B is incorrect because only the unreasonable $80,000 is disallowed; the remaining $120,000 is still deductible. Answer D is incorrect because there is no 20% excise tax on constructive dividends (that applies to Section 4960 excess compensation at tax-exempt organizations).
18. Westbrook Corp, a C corporation, receives $100,000 in dividends from a domestic corporation in which it owns 25% of the voting stock. What is Westbrook's dividends-received deduction (DRD) percentage and deduction amount?
    Answer: 65% DRD; $65,000 deduction. Under Section 243 (post-TCJA), the dividends-received deduction for a C corporation that owns 20% or more but less than 80% of the distributing corporation is 65%. Since Westbrook owns 25% of the stock, it qualifies for the 65% DRD. DRD = $100,000 x 65% = $65,000. Answer D is correct. Answer A (50%) applies to ownership below 20% under current law. Answer B (80%) is not a valid DRD percentage; 80% is the ownership threshold for the 100% DRD tier, not a DRD rate. Answer C (100%) applies when ownership is 80% or more and the corporations are part of an affiliated group.
19. Which of the following items is specifically disallowed as a deduction for a C corporation under the Internal Revenue Code?
    Answer: Dividends paid to shareholders. C corporations may not deduct dividends paid to shareholders. Unlike interest (which is deductible) or compensation (which is deductible), dividends are a return of profits to equity holders and are not deductible under Section 162. This non-deductibility of dividends, combined with shareholder-level taxation on dividend receipts, creates the double taxation of C corporation earnings. Answer B is incorrect because business interest is generally deductible (subject to Section 163(j) limitations). Answer C is incorrect because reasonable compensation to employees is deductible under Section 162. Answer D is incorrect because depreciation on business property is a specifically allowed deduction under Sections 167 and 168.
20. Ridgeline Corp, a C corporation, sells a capital asset held for three years at a $40,000 loss. The corporation has no capital gains in the current year. Which of the following correctly describes the treatment of this capital loss?
    Answer: The $40,000 capital loss may be carried back 3 years and forward 5 years to offset capital gains; it cannot offset ordinary income. C corporations may only deduct capital losses against capital gains. Unlike individuals, corporations have no $3,000 ordinary income offset for capital losses. If a C corporation has a net capital loss, it may carry the loss back 3 years and forward 5 years to offset capital gains in those years. When carried back or forward, the loss is treated as a short-term capital loss. Answer A is incorrect because corporations cannot deduct capital losses against ordinary income. Answer B describes the individual capital loss rule ($3,000 annual deduction), which does not apply to C corporations. Answer D is incorrect because the loss is not permanently disallowed; it carries over to other years.

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