Chapter 22 S Corporations

Question

62. [LO4] Adam Fleeman, a skilled carpenter, started a home improvement business with Tom Collins, a master plumber. Adam and Tom are concerned about the payroll taxes they will have to pay. Assume they form an S corporation, and each earns a salary of $80,000 from the corporation; in addition, they expect their share of business profits to be $60,000 each. How much Social Security tax and Medicare tax (or self-employment tax) will Adam, Tom, and their corporation have to pay on their salary and profits?

63. [LO4] {Planning} Using the facts in problem 62, could Adam and Tom lower their payroll tax exposure if they operated their business as a partnership? Why or why not?

64. [LO4]) This year, Justin B.’s share of S corporation income includes $4,000 of interest income, $5,000 of dividend income, and $40,000 of net income from the corporation’s professional service business activity.

A. Assume that Justin B. materially participates in the S corporation. How much of his S corporation income is potentially subject to the Net Investment Income tax?

B. Assume that Justin B. does not materially participate in the S corporation. How much of his S corporation income is potentially subject to the Net Investment Income tax?

65. [LO4] Friends Jackie (0.5 percent owner), Jermaine (1 percent owner), Marlon (2 percent owner), Michael (86 percent owner), and Tito (10.5 percent owner) are shareholders in Jackson 5 Inc. (an S corporation). As employees of the company, they each receive health insurance ($10,000 per year benefit), dental insurance ($2,000 per year benefit), and free access to a workout facility located at company headquarters ($500 per year benefit). What are the tax consequences of these benefits for each shareholder and for Jackson 5 Inc.?

66. [LO 5] Maple Corp., a calendar-year corporation, was formed three years ago by its sole shareholder, Brady, who immediately elected S corporation status. On December 31 of the current year, Maple distributed $30,000 cash to Brady. What is the amount and character of gain Brady must recognize on the distribution in each of the following alternative scenarios?

    1. At the time of the distribution, Brady’s basis in his Maple Corp. stock was $35,000.

    1. At the time of the distribution, Brady’s basis in his Maple Corp. stock was $8,000.

c. At the time of the distribution, Brady’s basis in his Maple Corp. stock was $0.

67. [LO 5] Oak Corp., a calendar-year corporation, was formed three years ago by its sole shareholder, Glover, and has always operated as a C corporation. However, at the beginning of this year, Glover made a qualifying S election for Oak Corp., effective January 1. Oak Corp. did not have any C corporation earnings and profits on that date. On June 1, Oak Corp. distributed $15,000 to Glover. What is the amount and character of gain Glover must recognize on the distribution, and what is his basis in his Oak Corp. stock in each of the following alternate scenarios?

a. At the time of the distribution, Glover’s basis in his Oak Corp. stock was $35,000.

b. At the time of the distribution, Glover’s basis in his Oak Corp. stock was $8,000.

c. At the time of the distribution, Glover’s basis in his Oak Corp. stock was $0.

68. [LO 5] Janna has a tax basis of $15,000 in her Mimikaki stock (Mimikaki has been an S corporation since inception). In 2014, Janna was allocated $20,000 of ordinary income from Mimikaki. What is the amount and character of gain she recognizes from end of the year distributions in each of the following alternative scenarios, and what is her stock basis following each distribution?

a. Mimikaki distributes $10,000 to Janna.

).

b. Mimikaki distributes $20,000 to Janna.

.

).

d. Mimikaki distributes $40,000 to Janna.

69. [LO 5] Assume the following year 2 income statement for Johnstone Corporation, which was a C corporation in year 1 and elected to be taxed as an S corporation beginning in year 2. Johnstone’s earnings and profits at the end of year 1 were $10,000. Marcus is Johnstone’s sole shareholder. What is Johnstone’s accumulated adjustments account at the end of year 2, and what amount of dividend income does Marcus recognize on the year 2 distribution in each of the following alternative scenarios?

Johnstone Corporation

Income Statement

December 31, year 2

Year 2

(S corporation)

Sales Revenue

$150,000

Cost of Goods Sold

(35,000)

Salary to owners

(60,000)

Employee Wages

(50,000)

Depreciation Expense

(4,000)

Miscellaneous Expenses

(4,000)

Interest income

10,000

Overall Net Income

$7,000

a. Johnstone distributed $6,000 to Marcus in year 2.

b. Johnstone distributed $10,000 to Marcus in year 2.

c. Johnstone distributed $16,000 to Marcus in year 2.

d. Johnstone distributed $26,000 to Marcus in year 2.

70. [LO 5] At the end of the year, before distributions, Bombay (an S corporation) has an accumulated adjustments account balance of $15,000 and accumulated E&P of $20,000 from a previous year as a C corporation. During the year, Nicolette (a 40 percent shareholder) received a $20,000 distribution (the remaining shareholders received $30,000 in distributions). What is the amount and character of gain Nicolette must recognize from the distribution? What is her basis in her Bombay stock at the end of the year (assume her stock basis is $40,000 after considering her share of Bombay’s income for the year but before considering the effects of the distribution)?

71. [LO 5] Pine Corp., a calendar-year corporation, was formed three years ago by its sole shareholder, Connor, who has always operated it as a C corporation. However, at the beginning of this year, Connor made a qualifying S election for Pine Corp., effective January 1. Pine Corp. reported $70,000 of C corporation earnings and profits on the effective date of the S election. This year (its first S corporation year), Pine reported business income of $50,000. Connor’s basis in his Pine Corp. stock at the beginning of the year was $15,000. What is the amount and character of gain Connor must recognize on the following alternative distributions, and what is his basis in his Pine Corp. stock at the end of the year?

a. Connor received a $40,000 distribution from Pine Corp. at the end of the year.

b. Connor received a $60,000 distribution from Pine Corp. at the end of the year.

c. Connor received a $130,000 distribution from Pine Corp. at the end of the year.

d. Connor received a $150,000 distribution from Pine Corp. at the end of the year.

72. [LO 5] Carolina Corporation, an S corporation, has no corporate E&P from its years as a C corporation. At the end of the year, it distributes a small parcel of land to its sole shareholder Shadiya. The fair market value of the parcel is $70,000 and its tax basis is $40,000. Shadiya’s basis in her stock is $14,000. Assume Carolina Corporation reported zero taxable income before considering the tax consequences of the distribution.

a. What amount of gain or loss, if any, does Carolina Corporation recognize on the distribution?

b. How much gain must Shadiya recognize (if any) as a result of the distribution, what is her basis in her Carolina Corporation stock after the distribution, and what is her basis in the land?

c. What is your answer to (a) if the fair market value of the land is $25,000 rather than $70,000?

d. What is your answer to (b) if the fair market value of the land is $25,000 rather than $70,000?

73. [LO5] Last year, Miley decided to terminate the S corporation election of her solely owned corporation on October 17,2013 (effective immediately), in preparation for taking it public. At the time of the election, the corporation had an accumulated adjustments account balance of $150,000 and $450,000 of accumulated E&P from prior C corporation years, and Miley had a basis in her S corporation stock of $135,000. During 2014, Miley’s corporation reported $0 taxable income or loss. Also, during 2014 the corporation made distributions to Miley of $80,000 and $60,000. How are these distributions taxed to Miley assuming the following?

a. Both distributions are in cash, and the first was paid on June 15 and the second on November 15.

.

b. Both distributions are in cash, and the first was paid on June 15 and the second on September 30.

c. The same facts in (b) except the June 15 distribution was a property (noncash) distribution (fair market value of distributed property equal to basis).

.

74. [LO 5] Alabama Corporation, an S corporation, liquidates this year by distributing a parcel of land to its sole shareholder Mark Ingram. The fair market value of the parcel is $50,000 and its tax basis is $30,000. Mark’s basis in his stock is $25,000.

a. What amount of gain or loss, if any, does Alabama Corporation recognize on the distribution?

b. How much gain must Mark recognize (if any) as a result of the distribution and what is his basis in the land?

c. What is your answer to (a) if the fair market value of the land is $20,000 rather than $50,000?

d. What is your answer to (b) if the fair market value of the land is $20,000 rather than $50,000?

75. [LO 6] Rivendell Corporation uses the accrual method of accounting and has the following assets as of the end of 2013. Rivendell converted to an S corporation on January 1, 2014.

Asset

Adjusted basis

FMV

Cash

$40,000

$40,000

Accounts receivable

30,000

30,000

Inventory

130,000

60,000

Land

100,000

125,000

Totals

$300,000

$255,000

a. What is Rivendell’s net unrealized built-in gain at the time it converted to an S corporation?

b. Assuming the land was valued at $200,000, what would be Rivendell’s net unrealized gain at the time it converted to an S corporation?

c. Assuming the original land value but that the inventory was valued at $85,000, what would be Rivendell’s net unrealized gain at the time it converted to an S corporation?

76. [LO 6] Virginia Corporation is a calendar year corporation. At the beginning of 2014, its election to be taxed as an S corporation became effective. Virginia Corp.’s balance sheet at the end of 2013 reflected the following assets (it did not have any earnings and profits from its prior years as a C corporation).

Asset

Adjusted basis

FMV

Cash

$20,000

$20,000

Accounts receivable

40,000

40,000

Inventory

90,000

200,000

Land

150,000

175,000

Totals

$300,000

$435,000

In 2014, Virginia reported business income of $50,000 (this would have been its taxable income if it were still a C corporation). What is Virginia’s built-in gains tax in each of the following alternative scenarios?

a. During 2014, Virginia sold inventory it owned at the beginning of the year for $100,000. The basis of the inventory sold was $55,000.

b. Assume the same facts as (a) except Virginia had a net operating loss carryover of $24,000 from its time as a C corporation.

c. Assume that same facts as (a) except that if Virginia were a C corporation, its taxable income would have been $1,500.

77. [LO 6] Tempe Corporation is a calendar-year corporation. At the beginning of 2014, its election to be taxed as an S corporation became effective. Tempe Corp.’s balance sheet at the end of 2013 reflected the following assets (it did not have any earnings and profits from its prior years as a C corporation):

Asset

Adjusted basis

FMV

Cash

$20,000

$20,000

Accounts receivable

40,000

40,000

Inventory

160,000

200,000

Land

150,000

120,000

Totals

$370,000

$380,000

Tempe’s business income for the year was $40,000 (this would have been its taxable income if it were a C corporation).

a. During 2014, Tempe sold all of the inventory it owned at the beginning of the year for $210,000. What is its built-in gains tax in 2014?

b. Assume the same facts as in (a) except that if Tempe were a C corporation, its taxable income would have been $7,000. What is its built-in gains tax in 2014?

c. Assume the original facts except the land was valued at $140,000 instead of $120,000. What is Tempe’s built-in gains tax in 2014?

78. [LO 6] Wood Corporation was a C corporation in 2013 but elected to be taxed as an S corporation in 2014. At the end of 2013, its earnings and profits were $15,500. The following table reports Wood’s (taxable) income for 2014 (its first year as an S corporation).

Wood Corporation

Income Statement

December 31, 2014

Sales Revenue

$150,000

Cost of Goods Sold

(35,000)

Salary to owners

(60,000)

Employee Wages

(50,000)

Depreciation Expense

(4,000)

Miscellaneous Expenses

(4,000)

Interest income

8,000

Dividend Income

2,000

Overall Net Income

$7,000

What is Wood Corporation’s excess net passive income tax for 2014?

79. [LO 6] Calculate Anaheim Corporation’s excess net passive income tax in each of the following alternative scenarios.

a. Passive investment income, $100,000; expenses associated with passive investment income, $40,000; gross receipts, $120,000; taxable income if C corporation, $40,000; corporate E&P, $30,000.

b. Passive investment income, $100,000; expenses associated with passive investment income, $70,000; gross receipts, $120,000; taxable income if C corporation, $1,200; corporate E&P, $30,000.

c. Passive investment income, $100,000; expenses associated with passive investment income, $40,000; gross receipts, $120,000; taxable income if C corporation, $40,000; corporate E&P, $0.

80. [LO 5, 6] {Planning; Research} Mark is the sole shareholder of Tex Corporation. Mark first formed Tex as a C corporation. However, in an attempt to avoid having Tex’s income double taxed, Mark elected S corporation status for Tex several years ago. On December 31, 2014, Tex reports $5,000 of earnings and profits from its years as a C corporation and $50,000 in its accumulated adjustments account from its activities as an S corporation (including its 2014 activities). Mark discovered that for the first time Tex was going to have to pay the excess net passive income tax. Mark wanted to avoid having to pay the tax but he determined the only way to avoid the tax was to eliminate Tex’s E&P by the end of 2014. He determined that, because of the distribution ordering rules (AAA first), he would need to have Tex immediately (in 2014) distribute $55,000 to him. This would clear out Tex’s accumulated adjustments account first and then eliminate Tex’s C corporation earnings and profits in time to avoid the excess net passive income tax. Mark was not sure Tex could come up with $55,000 of cash or property in time to accomplish his objective. Does Mark have any other options to eliminate Tex’s earnings and profits without first distributing the balance in Tex’s accumulated adjustments account?

81. [LO 6] {Planning} Farve Inc. recently elected S corporation status. At the time of the election, the company had $10,000 of accumulated earnings and profits, and a net unrealized gain of $1,000,000 associated with land it had invested in (although some parcels had an unrealized loss). In the next couple of years, most of the income the company expects to generate will be in the form of interest and dividends (approximately $200,000 per year). However, in the future, the company will want to liquidate some of its current holdings in land and possibly reinvest in other parcels. What strategies can you recommend for Farve Inc. to help reduce its potential tax liability as an S corporation?

82. [LO 6] Until the end of year 0, Magic Carpets (MC) was a C corporation with a calendar year. At the beginning of year 1 it elected to be taxed as an S corporation. MC uses the LIFO method to value its inventory. At the end of year 0, under the LIFO method, its inventory of rugs was valued at $150,000. Under the FIFO method, the rugs would have been valued at $170,000. How much LIFO recapture tax must MC pay, and what is the due date of the first payment under the following alternative scenarios?

a. Magic Carpets’ regular taxable income in year 0 was $65,000.

b. Magic Carpets’ regular taxable income in year 0 was $200,000.

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