CPA Tcp Quiz: S Corporation Income Loss Distribution Rules

What this quiz covers

This quiz focuses on S Corporation Income Loss Distribution Rules, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA Tcp.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

Question 1

1. The shareholders' capital account balances at year-end.
2. Each shareholder's pro-rata daily share of stock ownership - income and loss items are allocated based on the number of shares owned for each day of the year. (correct answer)
3. The amount of distributions each shareholder received during the year.
4. Special allocations agreed upon by the shareholders in the operating agreement.

Explanation: S corporation items are allocated strictly pro-rata based on shares owned per day - unlike partnerships, S corps cannot make special allocations. Answer B is correct. Capital accounts (A) determine partnership allocations. Distributions (C) affect basis but not income allocation. Special allocations (D) are not permitted for S corps.

Question 2

1. The amount paid for the stock (purchase price or, for founding shareholders, the amount of cash and adjusted basis of property contributed in exchange for the stock). (correct answer)
2. The fair market value of the S corporation on the date of purchase.
3. The S corporation's book value per share on the purchase date.
4. The S corporation's retained earnings attributable to the shareholder's ownership percentage.

Explanation: Stock basis in an S corporation is initially the purchase price or contribution amount - the same as for any corporate stock. Answer A is correct. FMV determines amount realized, not initial tax basis (B). Book value (C) and retained earnings (D) are accounting concepts, not tax basis.

Question 3

1. Distributions received from the corporation.
2. The shareholder's share of corporate losses.
3. The shareholder's pro-rata share of S corporation income (including tax-exempt income) and capital contributions to the corporation. (correct answer)
4. The corporation's total debt outstanding.

Explanation: Basis increases for income pass-throughs (including tax-exempt income) and additional capital contributions. Answer C is correct. Distributions decrease basis (A). Losses decrease basis (B). S corporation debt generally doesn't increase shareholder stock basis (D).

Question 4

1. Their pro-rata ownership percentage of total corporate losses.
2. Their adjusted basis in the S corporation stock plus any basis in loans made to the corporation - losses exceeding this combined basis are suspended until basis is restored. (correct answer)
3. The amount of their capital contributions during the year.
4. Their share of the corporation's total assets.

Explanation: S corp shareholders can deduct losses to the extent of stock basis plus debt basis (loans to the corporation). Excess losses are suspended. Answer B is correct. Loss limitation is based on basis, not ownership percentage (A). Only current-year contributions don't determine the total available basis (C). Asset values are irrelevant to the loss limitation (D).

Question 5

1. A distribution at the fair market value of the property - the S corporation recognizes gain as if it sold the property at FMV, and the shareholder treats the FMV as the distribution amount for basis purposes. (correct answer)
2. A tax-free exchange with no gain recognized at either level.
3. Ordinary income to the shareholder equal to the property's adjusted basis.
4. A deductible expense for the S corporation.

Explanation: Non-cash distributions trigger gain recognition at the corporate level (as if sold at FMV), and the shareholder receives a distribution at FMV for stock basis purposes. Answer A is correct. Gain is recognized (B). FMV is the measure, not adjusted basis (C). Distributions are not deductible by S corps (D).

Question 6

1. First from accumulated E&P, then from AAA.
2. First from paid-in capital, then from AAA.
3. First from the accumulated adjustments account (AAA), then from accumulated E&P (if any), then as a return of capital, and finally as capital gain - the AAA represents post-S election accumulated undistributed income. (correct answer)
4. All distributions treated as dividends from E&P as long as any E&P exists.

Explanation: The distribution ordering for S corps with prior C corp history is: AAA first, then AE&P, then return of capital, then capital gain. Answer C is correct. The ordering is AAA then E&P (A - reversed). Paid-in capital is not the first source (B). E&P doesn't override AAA (D).

Question 7

1. Ordinary income to the extent of the S corporation's accumulated E&P.
2. Capital gain - distributions in excess of stock basis (after AAA has been exhausted and no AE&P exists) are treated as gain from the sale of the S corporation stock. (correct answer)
3. Ordinary income since S corporation distributions are not capital transactions.
4. Tax-free since the excess represents a return of capital to the shareholder.

Explanation: After stock basis is reduced to zero, any excess distribution (from AAA or in the absence of AE&P) is capital gain from the deemed sale of stock. Answer B is correct. Excess over basis creates capital gain, not necessarily ordinary income from E&P (A). Capital gain treatment applies (C). Excess over basis is not tax-free (D).

Question 8

1. $30,000 - the combined stock basis ($20,000) plus debt basis ($10,000). The remaining$5,000 is suspended. (correct answer)
2. $35,000 - the full loss since the shareholder is an active participant.
3. $20,000 - only stock basis is available for loss deductions.
4. $0 - losses must be separately substantiated before deduction.

Explanation: S corp losses are deductible to the extent of stock basis plus debt basis: $20,000 +$10,000 = $30,000. The$5,000 excess is suspended. Answer A is correct. Full $35,000 (B) exceeds available basis. Debt basis also supports deductions (C). Losses are deductible up to basis (D).

Question 9

1. First restores stock basis, then debt basis.
2. Increases both stock basis and debt basis proportionally.
3. First restores debt basis to its original amount before increasing stock basis - the income allocation first replenishes the reduced debt basis, then any remaining income increases stock basis. (correct answer)
4. Has no effect on debt basis - debt basis is fixed at the loan amount.

Explanation: Income allocations first restore debt basis (reduced by prior losses) before increasing stock basis. Answer C is correct. Stock basis is restored after debt basis (A - reversed). Income doesn't split between them proportionally (B). Debt basis fluctuates with losses and income (D).

Question 10

1. Was formerly a C corporation and sells appreciated assets within the recognition period (5 years after the S election) - the tax is imposed at the highest corporate rate (21%) on net recognized built-in gains. (correct answer)
2. Has accumulated E&P from its C corporation years and makes distributions.
3. Has passive investment income exceeding 25% of gross receipts for 3 consecutive years.
4. Converts from an S corporation to a C corporation.

Explanation: The BIG tax prevents S corporations from avoiding corporate-level tax on pre-conversion appreciation by electing S status. Answer A is correct. AE&P triggers different S corp issues (B). 25% passive income triggers a different provision (C). Conversion from S to C has different rules (D).

Question 11

1. The passive activity rules only - at-risk rules don't apply to S corporations.
2. The basis limitation only - once basis is available, all losses are fully deductible.
3. The basis limitation (stock + debt basis), then the at-risk rules (Section 465), and then the passive activity rules (Section 469) - losses must clear all three hurdles in sequence. (correct answer)
4. The corporate alternative minimum tax computed at the shareholder level.

Explanation: S corp losses face a three-tier limitation: basis, at-risk, and passive activity - each must be cleared before the loss can be deducted. Answer C is correct. Both at-risk and passive rules apply (A). Multiple limitations apply beyond basis (B). The corporate AMT doesn't apply at the shareholder level (D).

Question 12

1. Distributions increase stock basis and decrease debt basis simultaneously.
2. Distributions to shareholders create deductions for the S corporation.
3. Reducing debt basis first would prevent future interest income on intra-company loans.
4. If a distribution reduces stock basis to zero and no remaining stock basis is available, further distributions are capital gain - distributions do not reduce debt basis. (correct answer)

Explanation: Only losses (not distributions) reduce debt basis - distributions reduce stock basis and then create capital gain once basis is exhausted. Debt basis is only reduced by loss pass-throughs. Answer D is correct. Distributions only affect stock basis (A). S corp distributions are not deductible (B). Debt basis rules are about loss deductions, not distributions (C).

Question 13

1. Passive income is always subject to the built-in gains tax.
2. If passive investment income exceeds 25% of gross receipts for 3 consecutive years, the S election terminates at the end of the third year - and an excise tax (tax on excess passive net income) may be imposed annually during those years. (correct answer)
3. Passive income is automatically characterized as dividends from the C corporation years.
4. Passive income cannot flow through to S corporation shareholders.

Explanation: Excess passive investment income (over 25% of gross receipts for 3 years when E&P exists) terminates the S election and an excise tax applies annually. Answer B is correct. The BIG tax and passive income tax are separate (A). Passive income retains its character for shareholders (C). Passive income does flow through (D).

Question 14

1. When the shareholder directly lends money or property to the S corporation - the shareholder's direct loans create debt basis, but guarantees of third-party loans do not. (correct answer)
2. When the S corporation borrows from a third-party lender and the shareholder personally guarantees the debt.
3. When the S corporation has outstanding bank loans regardless of who made the loans.
4. When the shareholder owns more than 50% of the S corporation's stock.

Explanation: S corporation debt basis arises only from direct loans from the shareholder to the corporation - loan guarantees do not create basis unless the shareholder actually makes payment on the guarantee. Answer A is correct. Guarantees alone don't create basis (B). Third-party loans don't create shareholder basis (C). Ownership percentage doesn't determine debt basis (D).

Question 15

1. $0 - the distribution exceeded the beginning basis.
2. $20,000 - beginning basis plus income.
3. $10,000 - no change since income and distribution cancel out.
4. $20,000 - beginning basis ($10,000) + income ($30,000) - distribution ($20,000) = $20,000. (correct answer)

Explanation: Year-end basis = $10,000 (beginning) +$30,000 (income) - $20,000 (distribution) =$20,000. Answer D is correct. The basis doesn't go to zero (A). Income is added and distributions reduce (B - correct number but wrong formula). They don't cancel (C).

Question 16

1. A full year's pro-rata share since the shareholder is a owner at year-end.
2. A negotiated amount agreed upon by all shareholders.
3. The prior shareholder's share of income through the date of transfer.
4. A daily pro-rata allocation from the date of acquisition through year-end - or alternatively, under the 'closing of the books' election, items through the date of transfer are allocated to the seller and items after the transfer date to the buyer. (correct answer)

Explanation: S corporations may use either daily proration or, by consent, the closing-of-the-books method for the year of transfer. Answer D is correct. Not a full year for a mid-year purchaser (A). No negotiated allocation allowed (B). The new shareholder gets their share from acquisition forward (C - this is the seller's share, not the new shareholder's).

Question 17

1. All S corporation items are aggregated into a single net income or loss figure on the K-1.
2. Separately stated items (such as long-term capital gains, charitable contributions, Section 1231 gains, and tax-exempt income) retain their specific character and are reported separately on the K-1, while non-separately stated items are combined into ordinary income or loss. (correct answer)
3. All S corporation items are converted to ordinary income at the corporate level.
4. Capital gains are converted to ordinary income since S corporations are treated as ordinary businesses.

Explanation: The conduit principle applies - separately stated items retain their character for the shareholder, while ordinary income items are combined. Answer B is correct. Separately stated items are not aggregated (A). Items retain their character (C, D).

Question 18

1. The S corporation's current year taxable income.
2. Amounts the S corporation pays as salaries to non-shareholder employees.
3. The FMV of distributions received that exceed the shareholder's basis.
4. Distributions from the corporation, the shareholder's pro-rata share of losses and deductions, and the shareholder's pro-rata share of non-deductible expenses (in that order). (correct answer)

Explanation: Stock basis is reduced by: (1) distributions, (2) loss/deduction items, and (3) non-deductible expenses - but cannot go below zero. Answer D is correct. Income increases basis (A). Employee salaries don't affect shareholder basis (B). Distributions are basis reducers, not excess distribution gains (C - the gain is recognized when distributions exceed basis).

Question 19

1. The sum of all shareholder capital contributions to the S corporation.
2. The S corporation's retained earnings for financial accounting purposes.
3. The total distributions made by the S corporation during its existence.
4. The cumulative undistributed income (net of losses) that has been taxed at the shareholder level during the S corporation's existence - it tracks the amount that can be distributed tax-free after previously taxed post-S election income. (correct answer)

Explanation: The AAA tracks the post-S election income that has already been taxed to shareholders but not yet distributed - distributions from AAA are tax-free (return of previously taxed income). Answer D is correct. Capital contributions (A) are separate. Book retained earnings (B) differ from AAA. Cumulative distributions reduce AAA (C).

Question 20

1. Immediately recognize all LIFO reserves as income.
2. Eliminate the LIFO method and switch to FIFO.
3. Include in income in the final C corporation tax year (the year before the S election becomes effective) the LIFO reserve - the amount by which inventory would be higher under FIFO than under LIFO, paid over 4 years. (correct answer)
4. Report LIFO reserves as AE&P available for distribution.

Explanation: The LIFO recapture rule requires recognition of the LIFO reserve in the last C corporation year, paid in 4 installments, to prevent permanent avoidance of the LIFO tax benefit through an S election. Answer C is correct. Not immediate but 4-year spread (A). LIFO method doesn't need to be abandoned (B). LIFO reserves are not AE&P (D).