Chapter 2-3-4 Exam

True/False
Indicate whether the sentence or statement is true or false.

____ 1. The tax form used to file an extension to file a corporate tax return is form 7004.

____ 2. From the shareholders perspective, distributions received from the corporation are treated as
ordinary income, capital gain, or a nontaxable recovery of capital.

____ 3. Partridge Corporation is a C corporation with net income of $200,000 during 2003. If Partridge paid
dividends of $70,000 to its shareholders, the corporation must still pay tax on $200,000 of net income.
Shareholders must pay tax on the $70,000 dividends.

____ 4. Compensation that is determined to be unreasonable by the IRS is usually treated as a constructive dividend
to the shareholder and is not deductible by the corporation.

____ 5. On December 30, 2005, Debbie, a cash basis sole proprietor, pledged to make a $10,000 charitable
contribution in 2006 on or before January 15th. Green Corporation made a similar pledge on the same date,
and the contribution was authorized by Green's board of directors. Debbie and Green Corporation, both
calendar year taxpayers, can deduct these contributions in 2005.

____ 6. The Dial Food Corporation donated canned goods worth $75,000 to various charities in town. The basis of the
property was $50,000, and Dial had held it for fourteen months as inventory. Dial may deduct $75,000 as a
charitable contribution.

____ 7. A cash basis corporation that incurs (but does not pay) qualifying organizational expenditures in its first year
of operations may include such expenses in the amortization computation.

____ 8. Schedule M-1 is used to reconcile net income as computed for financial accounting purposes with taxable
income reported on the corporation's income tax return.

Multiple Choice
Identify the letter of the choice that best completes the statement or answers the question.

____ 9. Mary is a 40% owner in the Alpha Corporation, a C-corporation. The corporation had taxable
income of $100,000 and made no distributions during the year. How much does Mary report as
taxable income?
a. $40,000
b. $None
c. $34,000
d. $3,000
____ 10. Chip and Dale formed a corporation to which Chip transferred a patent right that had a fair market
value of $25,000 and a zero adjusted basis. Dale transferred a building that had a fair market value of
$100,000 and an adjusted basis to him of $75,000. In return, Chip received 200 shares and Dale 800
shares of the corporation's 1,000 outstanding shares of its only class of stock. As a result of this
transaction, Dale should report:
a. Neither a gain nor a loss
b. A capital gain of $25,000
c. A Section 1250 gain of $25,000
d. An ordinary gain of $25,000

____ 11. The Alpha Omega Bugging Whip Corporation has a tax year end of December 31, 2005. What is the
tax return due date?
a. April 15, 2006
b. December 31, 2005
c. March 15, 2006
d. None of the above

____ 12. Laura, an attorney, performed legal services valued at $2,000 for Fine Corporation, a newly formed
corporation, in exchange for 1% of the issued and outstanding stock. The fair market value of the
shares received was $2,000. Laura would recognize:
a. No income until the stock is sold.
b. $2,000 as ordinary income ratable over 60 months.
c. Compensation of $2,000
d. A short term capital gain of $2,000

____ 13. University Inc. had taxable income of $85,000. Compute the tax.
a. $28,900 (34% x 85,000)
b. $13,750
c. $17,150
d. None of the above

____ 14. Mary, Harry and Sally formed a new corporation. Mary contributed her sole proprietorship business
with a basis of $20,000 and FMV of $80,000. Harry contributed $80,000 in cash. Sally contributed
assets with a FMV of $110,000 and a basis of $80,000. They all made these contributions in
exchange for stock in the corporation.
a. Mary will have a recognized gain and Sally a recognized loss as this a sale or exchange
which is taxable.
b. Mary and Sally will defer recognizing any income or loss until they sell their stock.
c. Because Harry contributed cash, Section 351 will not apply
d. Corporations can only be formed with cash contributions.

____ 15. Delta Egma, Inc has a valid tax year of October 31, 2005. What is the tax return due date?
a. November 15, 2005
b. April 15, 2006
 c. January 15, 2006
d. March 15, 2006

____ 16. Corporations may carryback capital losses to ____ preceding tax years and forward ____years.
a. Back 2, forward 20
b. Back 3, forward 5
c. Back 5 forward 3
d. Forward only, indefinitely

____ 17. The Left Coast Surfing Corporation received dividends from a less than 20% owned U.S.
corporations in the amount of $80,000. What is the dollar amount that gets reported on line 4, page
1, of Form 1120?
a. $64,000
b. $56,000
c. $80,000
d. $60,000

____ 18. For net operating losses of a corporation, the carryback period is ___ years and forward ___ years.
a. Carryback 3 and forward 5
b. Carryback 2 and forward 20
c. No carryback, Forward 20
d. Carryback 3, forward 20

____ 19. Mary had invested $45,000 in the stock of MAR, Inc. Recently MAR, Inc. declared bankruptcy.
What code section will allow Mary to deduct the $45,000 as an ordinary loss?
a. Section 165 (g)
b. Section 1244
c. Section 1031
d. None of the above, such losses are always capital losses.

____ 20. POM, Inc. has land with a basis of $20,000 and FMV of $50,000 that it has owned for three years.
To save cash it paid a dividend by distributing the land to its shareholder. This is considered a
$50,000 property dividend by the corporation. What is the tax effect and amount to POM, Inc.
a. $30,000 gain
b. $50,000 gain
c. No gain or loss as this is a dividends, no assets were sold
d. $30,000 loss

____ 21. Kerri formed a corporation by contributing $10,000 of accounting services in exchange for stock.
a. The $10,000 is not taxable to Kerri in the year of incorporation.
b. Corporations cannot be formed unless property or cash is contributed for the stock.
c. Kerri doesnt pay tax on the amount as he didnt receive a cash payment.
d. Services exchanged for stock do not qualify under Section 351 causing this
transaction to be taxable to Kerri.
____ 22. Sparrow Company had operating income of $270,000 and operating expenses of $225,000 in 2005 (the year it
was formed). In addition, Sparrow had a long-term capital loss of $3,000. Robert, the sole proprietor of
Sparrow Company, withdraws $25,000 from Sparrow during the year. How does Robert report this
information on his individual tax return for 2005?
a. Robert reports $25,000 income.
b. Robert reports $25,000 income and a $3,000 long-term capital loss.
c. Robert reports $45,000 income and a $3,000 long-term capital loss.
d. Robert reports $42,000 income on Schedule C of Form 1040.
e. None of the above.

____ 23. On December 31, 2005, Peregrine Corporation, a calendar year taxpayer, accrues a performance bonus of
$50,000 to Charles, a cash basis, calendar year taxpayer who is president and sole shareholder of the
corporation. When can Peregrine deduct the bonus?
a. In 2005 if the bonus was authorized by the Board of Directors and payment was made by
March 15, 2006.
b. In 2005 if payment was made on or before March 15, 2006.
c. In 2006 if payment was made at any time during that year.
d. In 2006, but only if payment was made on or before March 15, 2006.
e. None of the above.

____ 24. Lavender Corporation is an accrual method C corporation with two unrelated shareholders. Ann owns 45%,
and Art owns 55%, of the stock. Both shareholders use the cash method of accounting and the calendar year.
At the end of the current year, the corporation has accrued salary to Ann of $20,000 and accrued salary to Art
of $10,000. How much may the corporation claim as a deduction in the current year?
a. $0
b. $10,000
c. $20,000
d. $30,000
e. $30,000

____ 25. Blue Corporation owns stock in Orange Corporation and has net operating income of $250,000 for the year.
Orange Corporation pays Blue a dividend of $50,000. What amount of dividends received deduction may
Blue claim if it owns 15% of Orange stock (assuming Blue's dividends received deduction is not limited by its
taxable income)?
a. $0
b. $35,000
c. $40,000
d. $50,000
e. None of the above
Chapter 2-3-4 Exam
Answer Section

TRUE/FALSE

1. ANS: T
Form 7004 Pg 2-25
2. ANS: T
Distributions are taxed as ordinary income up to the corporations earnings and profits; nontaxable recovery of
capital to the extent of the shareholders basis; then capital gain for amounts in excess of basis.

Pg 4-2 & 4-3

3. ANS: T
Partridge Corporation must pay tax on the $200,000 of corporate net income. Shareholders must pay tax on
the $70,000 of dividends received from the corporation. This is commonly referred to as double taxation.
Example 3
4. ANS: T
Unreasonable compensation is treated as a constructive dividend to the shareholder and is not deductible by
the corporation. See Examples 5 and 6 and related discussion.
5. ANS: F
Individuals cannot deduct contributions until they are actually made. Therefore, Debbie must wait until 2006
to deduct the contribution, assuming she honors the pledge. Green Corporation, whose board of directors
authorized the contribution in 2005, can deduct the contribution in 2005, assuming the pledge is paid on or
before March 15, 2006. p. 2-13 and Example 15
6. ANS: F
The canned goods are ordinary income property (inventory in this case). A corporate donor is allowed to
deduct basis plus one-half of the appreciation.

The deduction is $62,500 [$50,000 plus 50%($75,000 - $50,000)]. p. 2-15

7. ANS: T
As long as they are incurred, such expenses do not have to be paid in the first year. p. 2-18
8. ANS: T
p. 2-27

MULTIPLE CHOICE

9. ANS: B
A Corporation is a separate legal entity and pays its own tax. Since the corporations income does not pass
through to the shareholders she reports no taxable income from the corporation.

Pg 2-3
10. ANS: A
Section 351 is mandatory--Has 80% control. Pg 3-4
11. ANS: C
15th day of the third month following the end of the tax year. 2-25
12. ANS: C
Stock for services is compensation. Pg 3-5
13. ANS: C
85,000 - 75,000 = 10,000
 34% x 10,000 = 3,400
3,400 + 13,750 = 17,150

Pg 2-5
14. ANS: B
This transaction qualifies for Section 351. They all contributed property (cash is property in this
definition) in exchange for stock. They have control after forming the corporation. pp 3-2 through 3-
8
15. ANS: C
15th day of the third month following the end of the tax year. Pg 2-25
16. ANS: B
Carry back 3 years and forward 5. Pg 2-12
17. ANS: C
$80,000-Report gross on line 4, then take deduction on Sch C and line 29b. Pg 2-16 & 2-32
18. ANS: B
Carried back 2 and forward 20. The carryover rules for capital losses and NOLs are different. Pg 2-16
19. ANS: B
Section 1244, which must be elected upon incorporation. Pg 3-20
20. ANS: A
Treated as a deemed sale, creating a $30,000 gain. Page 4-11 Ex 14
21. ANS: D
Services exchanged for stock do not qualify under Section 351. Contributing services is always
taxable. pp 3-7
22. ANS: C
A proprietorship is not a separate taxable entity. The proprietor reports profit or loss on his or her individual
return. Because Sparrow is a proprietorship, Robert will report net profit of $45,000 ($270,000 - $225,000)
and a long-term capital loss of $3,000 on his individual tax return. pp. 2-2 and 2-3
23. ANS: C
Because Charles is a related party, Peregrine must wait until he includes the bonus in gross income. Charles,
who is a cash basis, calendar year taxpayer, will include the payment in gross income in the year he receives it
from Peregrine. Therefore, if Peregrine pays Charles the bonus anytime in 2006, the corporation can deduct
the bonus in 2006. Example 11
24. ANS: C
$20,000. The accrued salary to Art is not deductible because he is a related party (cash basis) and the
corporation is on the accrual basis. p. 2-11 and Example 11
25. ANS: B
The dividends received deduction depends upon the percentage of ownership by the corporate shareholder. If
Blue Corporation owns 15% (less than 20%) of Orange Corporation, Blue would qualify for a 70% deduction,
or $35,000 in this case. p. 2-17