Chapter11TheCorporateTaxpayer

Chapter 11
Questions and Problems for Discussion
1.

Individuals who perform professional services for clients (doctors, attorneys, CPAs, etc.) cannot
avoid liability for malpractice by operating as shareholder/employees of a corporation. These
individuals remain personally responsible for their actions and can be sued for negligence or
misconduct.

2.

a. The shareholders of a publicly held corporation elect a board of directors to manage the
corporation on their behalf. The board of directors is responsible for hiring the corporate officers
and other key employees. Under this centralized structure, the owners of the business (the
shareholders) do not participate in management decisions.
b. In contrast, the shareholders of a closely held corporation usually serve as the board of directors
and are typically employed to manage the corporate business. In this case, management is not
centralized but is retained by the business owners.

3.

a. Equity stock in publicly held corporations is a highly liquid asset that can be freely bought or sold
through established security markets. These public markets determine the price at which the
stock is traded.
b. Equity stock in closely held corporations is bought or sold through private markets. Transfers of
stock may be infrequent, and the stocks value is not determined by the market but by reference
to the underlying value of the corporate assets. Such stock typically is subject to buy-sell
restrictions that prevent the owners from transferring stock unless the other shareholders agree.
Consequently, the stock may not be freely transferable at all.

4.

The three family corporations form a brother-sister controlled group, but not an affiliated group.
Consequently, the three corporations are ineligible to file a consolidated return.

5.

Although RP legally controls QV, its 59 percent ownership falls far short of the 80 percent required to
form an affiliated group. Consequently, RP and QV are ineligible to file a consolidated return.

6.

Libretto may want to isolate the risk associated with the music video business by operating the
venture through a wholly owned subsidiary. The subsidiary can have a unique management
structure and its own corporate officers who are solely responsible for the success of the subsidiarys
specialized business.

7.

The dividends-received deduction was enacted to mitigate the double tax that would occur when one
corporation subject to federal tax distributes after-tax income as a dividend to a second corporation
also subject to federal tax. If the distributing corporation is a foreign corporation not subject to federal
tax, the problem of double taxation by the United States government doesnt arise, and the
dividends-received deduction is unnecessary.

8.

Congress enacts tax preferences as incentives for all corporations to engage in certain behaviors.
While Congress wants these incentives to work on a macroeconomic level, it does not want any one
corporation to benefit too much from preferences. Consequently, the AMT penalizes overindulgence
in preferences at the microeconomic level.

9.

Because the 20 percent AMT rate is so much less than the 34 or 35 percent regular corporate tax
rate, AMTI must be significantly greater than taxable income before a corporation owes an AMT.
Evidently, Corporation V routinely has insignificant AMT adjustments and preferences, but not
enough to trigger the AMT.

11-1

Chapter11TheCorporateTaxpayer
10. A corporation is merely a form in which people (owners, employees, suppliers, customers)
participate in a business activity. Any tax levied on the activity necessarily reduces the after-tax value
of the activity to some group of participants.
Application Problems
1.

Alpha is the parent corporation of an affiliated group consisting of Alpha and Beta.

2.

Grommet, Staple, and Binder are eligible to file a consolidated return.

3.

a.

Corporation Ps
Separate Return

Separate Return
Ordinary operating income (loss)
Capital gain
Section 1231 gain (loss)
Capital loss (deductible to extent of
capital and Section 1231 gain
Taxable income (NOL)
b.
Return

$(200,000)
6,000
5,000

-0$499,000

-0$(189,000)

$300,000
6,000
4,000
(8,300)
$301,700

Napa Corporations dividends-received deduction is $158,500.

KLP dividend $55,000 70%
Gamma dividend $120,000 100%

5.

$500,000
-0(1,000)

Consolidated

Ordinary operating income

Capital gain
Net Section 1231 gain
Deductible capital loss
Taxable income
4.

Corporation Ts

$38,500
120,000
$158,500

GHJs dividends-received deduction is $76,750.

BP dividend $17,300 70%
MN dividend $80,800 80%

$12,110
64,640
$76,750

GHJ is not entitled to a dividends-received deduction for the AB dividend because AB is a foreign
corporation.
6.

Because Camco had an NOL for its first year, it could not deduct any of its $5,000 contribution but
could only carry the contribution forward to its second year. In the second year, Camcos charitable
contribution deduction is limited to 10 percent of taxable income after the NOL carryforward
deduction. Consequently, Camco is allowed an $11,860 charitable contribution deduction ($10,000
current year contribution + $1,860 carryforward), and its taxable income is $106,740.
Income from operations
NOL carryforward deduction
Taxable income before charitable contribution
Charitable contribution deduction
Taxable income

11-2

$210,600
(92,000)
118,600
(11,860)
$106,740

Chapter11TheCorporateTaxpayer
7.

a. The $100,000 charitable contribution has an after-tax cost of $66,000 ($100,000 $34,000 tax
savings from current deduction at 34 percent).
b. Fig can deduct $49,000 of the contribution this year and $51,000 as a contribution carryforward
next year. The after-tax cost of the contribution is $66,988.
Contribution
$(100,000)
Current tax savings ($49,000 34%)
16,660
Tax savings next year
([$51,000 34%] .943 discount factor
16,352
$(66,988)
c.

Fig can deduct $19,000 of the contribution this year and $13,000 in each of the next five years.
The remaining $16,000 contribution carryforward expires. The after-tax cost of the contribution is
$71,235.
Contribution
$(100,000)
Current tax savings ($19,000 39%)
7,410
NPV of future tax savings
([$13,000 39%] 4.212 discount factor)
21,355
$(71,235)

8.

a. Domestic production activities deduction = $12,000 ($200,000 * 6%)

2007 taxable income = $438,000 ($450,000 - $12,000)
2007 tax liability = $148,920
b. $153,000
c.

9.

Potential tax savings = $4,080. This tax savings may be insufficient to cause the company to
shift future production activities from Canada to the U.S., unless other cost factors also favor
domestic production.

a. Net income from U.S. production activity

U.S. production activities deduction
($429,000 3%)
Net income from Canadian production activity
Investment income
Hallicks taxable income

$429,000

b. Net income from U.S. production activity

Net loss from Canadian production activity
Investment income
Taxable income before deduction
U.S. production activities deduction
($355,700 3%)
Hallicks taxable income

$429,000
(112,700)
39,400
$355,700

(12,870)
343,000
39,400
$798,530

(10,671)
$345,029

10. a. Allowable rehab credit = $800,000 (20% * $4,000,000)

After-tax purchase price of historic building is $6,200,000 ($3,000,000 purchase price +
$4,000,000 rehab costs - $800,000 credit)
b. Landover should acquire the historic building, because its after-tax cost of $6,200,000 is less
than the $6,500,000 cost of the new building.

11-3

Chapter11TheCorporateTaxpayer
c.

If the credit cannot be used immediately, its value is less than $800,000. Depending on the
length of time until Landover expects to be profitable, if the NPV of the credit drops below
$500,000, the decision would change.

11. a. Book income

Less: DRD
Less: excess tax depreciation
Less: muni bond interest
Plus: excess capital loss
Plus: federal income tax

$500,000
(10,500)
(15,000)
(5,000)
2,000
249,000

Taxable income

$720,500

Tax liability

$244,970

b. Schedule M-1:

12. a. EFGs net income per books

U.S. production activities deduction
($314,800 6%)
Tax-exempt income
Bad debt expense per books
$3,700
Bad debt deduction (write-offs)
(4,400)
Nondeductible fine
Book depreciation expense
MACRS depreciation

$479,900
(18,888)
(10,700)
(700)
6,000

$44,200
(31,000)
13,200
(8,800)
(460)
241,589
$701,141
.34
$238,388

Capital loss carryforward deduction

Amortization of organizational costs
Federal tax expense per books
EFGs taxable income
Tax rate
EFGs regular tax

11-4

Chapter11TheCorporateTaxpayer
b. Schedule M-1:

13. a. Corporation ABs tax savings is $750 ($5,000 15%), and Corporation YZs tax savings are
$1,750 ($5,000 35%)
b. The tax savings of a $5,000 credit to both corporations is $5,000.
14. a. $45,650 ($22,250 + [39% $60,000])
b. $56,000 (35% $160,000)
c.

$1,329,400 (34% $3,910,000)

d. $5,834,000 ($5,150,000 + [38% $1,800,000])

e. $19,950,000 (35% $57,000,000)
15. a. Marginal tax rate 39%; average tax rate 28.53%
b. Marginal tax rate 35%; average tax rate 35%.
c.

Marginal tax rate 34%; average tax rate 34%.

d. Marginal tax rate 38%; average tax rate 34.73%.

e. Marginal tax rate 35%; average tax rate 35%.
16. Myamo is exempt from the AMT only for 2005 (its first taxable year). Myamos first test year is 2006,
and the testing period for that year is 2005. Because Myamos 2005 gross receipts exceeded
$5,000,000, Myamo is not exempt from the AMT for 2006 or any subsequent taxable year.
17. Northup is exempt from the AMT for 2002 (its first taxable year) and for 2003, 2004, and 2005.
Northups average annual gross receipts for the 2003 testing period were $4,282,000, which is less
than the $5,000,000 limit for the first test year.
Northups average annual gross receipts for the 2004 and 2005 testing periods were $6,350,000
([$4,282,000 + $8,418,000] 2 years) and $6,567,333 ([$4,282,000 + $8,418,000 + $7,002,000] 3
years), which were less than the $7,500,000 limit for all subsequent test years.
Northups average annual gross receipts for the 2006 testing period were $8,362,667 ([$8,418,000 +
$7,002,000 + $9,668,000] 3 years). Consequently, Northup is not exempt from the AMT for 2006 or
any subsequent taxable year.

11-5

Chapter11TheCorporateTaxpayer
18. Perkins taxable income
AMT adjustments
AMT tax preference
AMTI before exemption
Exemption
($40,000 [25% $17,000 excess AMTI])

$100,000
45,000
22,000
$167,000
(35,750)
$131,250
.20
$26,250
(22,250)
$4,000

AMT rate
Tentative minimum tax
Regular tax
AMT
19. Raises taxable income
AMT adjustments
AMT tax preferences
AMTI before exemption
Exemption
AMT rate
Tentative minimum tax
Regular tax
AMT

$3,590,000
980,000
315,000
$4,885,000
-0$4,885,000
.20
$977,000
(1,220,600)
-0-

20. Grands taxable income before NOL deduction

AMT adjustments
AMT tax preferences
AMTI before NOL deduction and exemption
Exemption
NOL deduction (90% AMTI before deduction)
AMT rate
Tentative minimum tax
Regular tax*
AMT

$1,250,000
-0-0$1,250,000
-0$1,250,000
(1,125,000)
$125,000
.20
$25,000
-0$25,000

* Grand has no taxable income after the NOL deduction

11-6

Chapter11TheCorporateTaxpayer
21. a.

b. Regular taxable income

AMT preferences & adjustments
AMTI
Rate
Tentative minimum tax
Regular tax
AMT
Final tax due

$6,965,000
2,000,000
$8,965,000
20%
$1,793,000
$2,368,100
$0
$2,368,100

22.
Minimum Tax Credit
Generated
Minimum Tax Credit
Used
Final Tax
Liability
Minimum Tax Credit
Carryforward

Year 1
$40,000

Year 2
$0

Year 3
$0

$0

$20,000

$20,000

$150,000

$130,000

$130,000

$40,000

$20,000

$0

23. a. Halls tax for 2005 was $200,000; for 2006 was $900,000 (including $30,000 AMT); and for 2007
was $1,820,000 (including $320,000 AMT).
b. Halls 2008 AMTI
AMT rate
Tentative minimum tax
Regular tax ($9,000,000 34%)
Minimum tax credit
Halls 2008 tax
c.

Halls 2008 AMTI

AMT rate
Tentative minimum tax
Regular tax ($9,000,000 34%)
Minimum tax credit (excess of regular
tax over tentative minimum tax)
Halls 2008 tax

$11,000,000
.20
$2,200,000
$3,060,000
(350,000)
$2,710,000
$14,800,000
.20
$2,960,000
$3,060,000
(100,000)
$2,960,000

11-7

Chapter11TheCorporateTaxpayer
24. a. To avoid an underpayment penalty, NBs required installment payments of 2008 tax must equal
or exceed $201,620 ($50,405 per installment). The total equals 100 percent of NBs 2008 tax.
b. To avoid an underpayment penalty, NBs required installment payments of 2008 tax must equal
or exceed $242,000 ($60,500 per installment). The total equals 100 percent of NBs 2007 tax.
c.

To avoid an underpayment penalty, NBs required installment payments of 2008 tax must equal
or exceed $476,000 ($119,000 per installment). The total equals 100 percent of NBs 2008 tax
because it is ineligible to make a safe harbor estimate.

25. a. James tax on the $100,000 dividend is $15,000 ($100,000 15%).

b. The $100,000 dividend consists of after-tax dollars. Consequently, JJ had to earn $151,515 of
before-tax income to generate the $100,000 dividend ($151,515 [$151,515 34%]), and the
corporate tax with respect to the dividend is $51,515. James must recognize a $151,515
grossed up dividend on which his precredit tax is $22,727 ($151,515 15%). Because he
receives a credit for the $51,515 corporate tax, his individual tax on the dividend is reduced to
zero.
26. a. The shareholders who own Shine stock bear the incidence of the corporate tax increase.
b. In this case, Shines employees bear the incidence of the corporate tax in the form of reduced
compensation (no more on-site day care).
Issue Recognition Problems
1.

Would the foundations profits from sales of a newsletter be unrelated business income subject to
the corporate tax? Can Greentown Foundation undertake the for-profit newsletter activity and
maintain its tax-exempt status?

2.

Can TK accrue and deduct the $375 original issue discount as interest expense over the five-year
life of the bonds?

3.

Can Bandera deduct the $16,800 fee as an ordinary and necessary business expense? Is the
consulting fee considered part of Banderas nondeductible dividend payment?

4.

Is M&M allowed a deduction for a charitable contribution of its own common stock? Is the amount of
the contribution equal to the stocks FMV even though M&M has no basis in the stock?

5.

Can Chemco deduct the $950,000 payment as a charitable contribution? Will the IRS disallow the
deduction because the payment is in lieu of a nondeductible government fine?

6.

Is the difference between the gain realized using the MACRS adjusted basis and the gain realized
using the AMT adjusted basis an AMT adjustment this year? Is Ferris entitled to a $122,000 negative
AMT adjustment (excess of gain realized for regular tax purposes over AMT gain realized) this year?

7.

Will the limitation on the NOL carryforward deduction for AMT purposes trigger an AMT liability in the
next three years?

8.

Will Wiggins owe an underpayment penalty because of the substantial unpaid tax liability triggered
by the sale of the land in the last month of the year? Can Wiggins avoid underpayment penalty on its
first three installment payments because these payments were based on corporate income earned
through the date of payment?

11-8

Chapter11TheCorporateTaxpayer
Research Problems
1

According to Section 118(a), Connor did not recognize income on receipt of the land because
Augusta County contributed the land to corporate capital. According to Section 362(c)(1), Connors
initial basis in the contributed land was zero because Augusta County was not a shareholder. Connor
was required to capitalize the $17,560 expenditure for the title search, survey, and water wells to the
basis of the land. (See Reg. Sec. 1.263(a)-2(c), Wacker, TC Memo 1968-173, and Tidwell, TC Memo
1961-162).
Section 165(a) and Reg. Sec.1.165-2 allow a taxpayer to recognize an ordinary loss on the
abandonment of nondepreciable business property. The dollar amount of the loss is the propertys
adjusted basis. Therefore, Connor recognized a $17,560 ordinary abandonment loss in 2008 when it
renounced any legal claim to the land.

2. Section 170(a)(1) allows a deduction for charitable contributions paid within the taxable year.
However, Section 170(a)(2) provides that accrual basis corporations can elect to take a deduction in
the year in which the board of directors authorizes a charitable contribution on the condition that the
contribution is paid on or before the fifteenth day of the third month following the close of the year.
Because Wilkie failed to transfer the Gydo stock before March 15, 2006, it cannot elect to take the
deduction in 2005 but can take it only in 2006. According to Reg. Sec. 1.170A-1(c)(1), the amount of
a contribution of property is the propertys FMV at date of contribution. This amount is not reduced
under Section 170(e)(1) because the sale of the stock would have resulted in long-term capital gain to
Wilkie. Consequently, Wilkies deduction equals the $100,000 FMV of the donated shares.
3. According to Section 311(b), if a corporation distributes property to a shareholder as a dividend and
the FMV of such property exceeds the corporations adjusted in the property, the distributing
corporation must recognize gain as if such property were sold to the shareholder at FMV. Because of
this recognition rule, Echo Valley must recognize a $209,000 gain ($420,000 FMV $211,000 basis)
on the distribution of tract D6 to Barry and Lynette Majors. If it held the land as an investment, the
gain is capital gain. If it used the land in a corporate business, the gain is a Section 1231 gain.
According to Section 301(b) and (c), the amount of the corporate distribution equals tract D6s
$420,000 FMV, and the Majors must recognize a $420,000 dividend (assuming that Echo Valley has
sufficient earnings and profits). According to Section 301(d), the couples basis in the tract is its
$420,000 FMV.
4.

Under the general computational rule, Prewer is entitled to a $112,000 dividends-received deduction
(70% $160,000) with respect to its TKS dividend. However, Section 246(b)(1) limits the DRD to 70
percent of Prewers taxable income before the DRD. This subparagraph specifies that taxable
income is computed without regard to any NOL deduction for the year. Consequently, Prewers DRD
and taxable income are computed as follows.
Dividend income
Operating loss
Taxable income before DRD or NOL deduction
Limited DRD

$160,000
(43,500)
$116,500
.70
$81,550

Taxable income before DRD or NOL deduction

DRD
NOL deduction
Taxable income

$116,500
(81,550)
(31,300)
$3,650

11-9

Chapter11TheCorporateTaxpayer

Tax Planning Cases

1.

a. An $80,000 deduction is worth $27,200 ($80,000 34%) to TMM Corporation. Because the
corporations precredit tax on $500,000 income is $170,000, it can use its entire credit ($80,000
50%) to save $40,000 in tax. Therefore, TMM should elect the credit.
b. TMMs precredit tax on $70,000 income is $12,500. The corporation can reduce its current year
tax to zero by electing the credit. If the corporation deducts the $80,000 cost of the program, it
has a $10,000 net operating loss, which it can carry back or forward as a deduction against past
or future income. In this case, TMM has no current year tax plus a valuable NOL deduction.
Therefore, TMM should deduct the programs cost.

2.

A&Zs before-tax and after-tax cost of the nondeductible dividend payments on the preferred stock
would be $28,000 (5.6% $500,000). The corporations after-tax cost of the debt would be $29,700
($45,000 before-tax cost [9% $500,000] $15,300 tax savings from $45,000 interest deduction).
Consequently, the preferred stock option minimizes A&Zs after-tax cost of new capital.

3.

The cost of the $129,300 AMT payment in NPV terms is $20,688.

2006 AMT payment
NPV of 2009 minimum tax credit
($129,300 .840 discount factor at 6%)
NPV

$(129,300)
108,612
$(20,688)

4. a. Because interest from the bonds is exempt from regular tax, after-tax cash flow equals the
$400,000 before-tax interest received.
b. Because of the DRD, only $120,000 of the dividend is taxed ($400,000 - $280,000 DRD [70%
$400,000]). Consequently, after-tax cash flow is $359,200 ($400,000 dividend received - $40,800
regular tax [34% regular rate $120,000]).
c.

The tax-exempt interest is included in book income and also in ACE. Wingos ACE adjustment
increases by $300,000 (75% $400,000), and its AMT increases by $60,000 (20% AMT rate
$300,000). Consequently, after-tax cash flow is $340,000 ($400,000 interest received - $60,000
AMT).

d. Wingos regular tax with respect to the dividend is $40,800 (see the answer to b.). The entire
dividend is included in book income and also in ACE. Wingos ACE adjustment increases by
$210,000 (75% $280,000 DRD), and its AMT increases by $42,000 (20% AMT rate
$210,000). Consequently, after-tax cash flow is $317,200 ($400,000 dividend received - $40,800
regular tax - $42,000 AMT).

11-10