Pearson’s Federal Taxation 2019 Corporations Partnerships Estates & Trusts 32nd Edition by Timothy J. Rupert -Test Bank

1) The accumulated adjustments account is the cumulative total of ordinary income or loss and separately stated items (excluding tax-exempt income and expenses) for the most recent continuous period during which the corporation has been an S corporation.
Answer: TRUE
Page Ref.: C:11-27 through C:11-29
Objective: 7

2) Identify which of the following statements is false.
A) The AAA balance can be negative, but the shareholder’s basis in the S corporation stock cannot be less than zero.
B) The AAA represents the cumulative income/loss recognized in post-1982 S corporation years.
C) Nonmoney property distributions made by an S corporation having accumulated E&P are treated differently when determining the corporate-level gain recognized under Sec. 311 than are property distributions made by an S corporation without accumulated E&P.
D) Tax-exempt income does not increase the AAA but increases the basis of the S corporation stock.
Answer: C
Page Ref.: C:11-27 through C:11-29
Objective: 7

3) Pressley Corporation was incorporated on January 1, 2004. The corporation made its S election on March 1, 2008. The corporation retains an E&P balance from its C corporation days. During the current year, it made a cash distribution to its sole shareholder Robert Pressley. What is the proper sequence in reducing the corporate earnings accounts for the distribution?
A) AAA; E&P
B) AAA; OAA; E&P
C) E&P; AAA
D) AAA; PTI; E&P
Answer: A
Explanation: The OAA is not a separate accumulated earnings account even though it is reported on page 4 of the Form 1120S. The tax-exempt income otherwise included in OAA becomes part of the S corporation’s stock basis for distribution purposes.
Page Ref.: C:11-30
Objective: 7

4) Dixon Corporation was incorporated on January 1, 2005. The corporation made its S election on April 1, 2008. The corporation retains an E&P balance from its C corporation days. Which one of the following current-year income and expense items is not included in Dixon Corporation’s Accumulated Adjustments Account?
A) ordinary income or loss
B) tax-exempt bond interest income
C) long-term capital gains and losses
D) amortization of organizational expenditures
Answer: B
Explanation: The tax-exempt bond interest income is included in the Other Adjustments Account.
Page Ref.: C:11-30
Objective: 7

5) Rocky Corporation, an S corporation, reports the following results for the current year:

Ordinary income $70,000
Long-term capital gain 20,000
Municipal bond interest income 10,000
Domestic corporate dividends 6,000
Charitable contributions 16,000

Rocky’s AAA and accumulated E&P balances at the beginning of the year are $80,000 and $50,000, respectively. Rocky makes a $100,000 cash distribution to its sole shareholder on June 1 and a second $100,000 cash distribution on December 1. The shareholder’s basis for Rocky stock on January 1 was $120,000. Discuss the tax consequences of these transactions.
Answer: The basis of the shareholder’s stock is increased to $210,000 ($120,000 + $70,000 + $20,000 + $10,000 + $6,000 – $16,000) by Rocky’s current year operations.

Rocky’s AAA balance before any current year distributions is $160,000 ($80,000 + $70,000 + $20,000 + $6,000 – $16,000). $80,000 {[$100,000/($100,000 + $100,000)] × $160,000 = $80,000} of each distribution comes from Rocky’s AAA and is tax-free because the $160,000 amount coming from AAA is less than the $210,000 basis of the Rocky stock.

The remaining $20,000 of each distribution comes from Rocky’s accumulated E&P and is a taxable dividend. This portion of the distribution does not reduce the basis of the stock. The year-end accumulated E&P is $10,000.

In addition, Rocky has a $10,000 balance in its Other Adjustments Account from the current year tax-exempt income. This amount is not a separate earnings pool for distribution purposes, but is reflected in the shareholder’s stock basis.

The basis of the Rocky stock is $50,000 at year-end ($210,000 – $160,000).
Page Ref.: C:11-27 through C:11-29
Objective: 7

6) Zebra Corporation has always been an S corporation and is 100% owned by Paul. Paul has a basis of $40,000 in his Zebra stock at the beginning of the year. During the year, Zebra has an ordinary loss of $20,000 and a long-term capital gain of $10,000. In addition, Zebra Corporation distributed $55,000 in cash to Paul on December 1. Will the distribution cause Paul to recognize a gain? If so, what are its amount and character?
Answer: Basis adjustments for distributions made by an S corporation during the tax year are taken into account before applying the loss limitation. Distributions reduce the adjusted basis for determining the allowable loss, but the loss does not reduce the adjusted basis for determining the tax status of distributions.

Basis $40,000
Long-term capital gain 10,000
Minus: distribution (50,000)*
Postdistribution basis $ 0

*Distributions cannot reduce basis below zero. The $5,000 excess distribution is a long-term capital gain.
Page Ref.: C:11-29
Objective: 7

7) Caravan Corporation has always been an S corporation. Caravan Corporation is 100% owned by Alan Merten. On January 1, Alan has an adjusted basis of $50,000 in his Caravan stock. During the year, Caravan reports ordinary income of $60,000, a long-term capital gain of $10,000, and a charitable contribution of $5,000. Alan receives a $20,000 cash distribution from Caravan on December 1. What income does Alan recognize from the distribution, and what is his basis in the Caravan stock at year-end?
Answer: Basis = $50,000 + $60,000 + $10,000 – $5,000 – $20,000 = $95,000. The distribution is tax-free since the $115,000 predistribution basis exceeds the amount distributed.
Page Ref.: C:11-27
Objective: 7