CH-16 Corporate Operations – McGraw-Hill’s Taxation of Individuals and Business Entities 2021 : Book Guide

Chapter 16 Corporate Operations Discussion Questions 1. (LO 1) In general terms, identify the similarities and differences between the corporate taxable income formula and the individual taxable income formula. Similarities: Both formulas start with gross income (income after exclusions) for the taxable year. Both formulas reduce gross income by deductions to determine taxable income and apply tax rates to taxable income to determine the tax liability. Finally, both formulas reduce the tax liability by credits and tax payments to determine taxes due or the refund. Both formulas allow taxpayers to take deductions for business expenses to compute taxable income. Differences: Individuals distinguish deductions between for and from AGI deductions, and they report adjusted gross income. Corporations do not distinguish between deduction types and do not report adjusted gross income. Corporations do not deduct the qualified business income deduction, they don’t itemize deductions, and they deduct a standard deduction. 2. (LO 1) Is a corporation’s choice of its tax year independent from its year-end for financial accounting purposes? No. A corporation must use the same tax year as it uses for financial accounting. 3. (LO 1) Can C corporations use the cash method of accounting? Explain. The three types of overall accounting methods that are available to corporations are accrual, cash, and hybrid. Generally, corporations must use the accrual method of accounting unless it is a small corporation. For tax purposes, corporations with annual average gross receipts for the past three years of $26 million or less (tax years 2019 and 2020) may use the cash method of accounting. The $26 million amount is indexed for future taxable years. Corporations that have not been in existence for at least three years compute their annual average gross receipts over the period they have been in existence to determine if they are allowed to use the cash method of accounting. 4. (LO 2) Briefly describe the process of computing a corporation’s taxable income assuming the corporation must use GAAP to determine its book income. To compute taxable income a corporation starts with book income before income tax expense and makes book-to-tax adjustments for items that are accounted for differently for book and tax purposes. The end result is taxable income. Note that if a corporation is not required to (and chooses not to) use GAAP for book purposes the corporation could use tax accounting methods to determine book and taxable income. In these situations, the corporation would not report any book-tax differences. 5. (LO 2) What role do a corporation’s audited financial statements play in determining its taxable income? A corporation generally starts with income, after income tax expense, from its audited financial statements (after tax expense) and then reconciles to taxable income by adjusting for book-tax differences. 6. (LO 2) What is the difference between favorable and unfavorable book-tax differences? Favorable book-tax differences are subtractions from book income when reconciling to taxable income. In contrast, unfavorable book-tax differences are additions to book income when reconciling to taxable income. Relative to book income, favorable book-tax differences decrease taxable income (that is, they reduce taxable income and taxes payable so they are favorable), and unfavorable book-tax differences increase taxable income (that is, they increase taxable income and taxes payable so they are unfavorable). 7. (LO 2) What is the difference between permanent and temporary book-tax differences? Permanent book-tax differences arise from income items or deductions reported during the year for either book purposes or for tax purposes but not both. Permanent differences do not reverse over time, so over the long-term the total amount of income or deductions for the items is different for book and tax purposes. In contrast, temporary book-tax differences reverse over time such that over the long-term, corporations recognize the same amount of income or deductions for the items on their financial statements as they recognize on their tax returns. Temporary book-tax differences arise because the income or deduction items are included in financial accounting income in one year and in taxable income in a different year. 8. (LO 2) Why is it important to be able to determine whether a particular book-tax difference is permanent or temporary? The IRS requires large corporations (assets of $50 million or more) to disclose their permanent and temporary book-tax differences on Parts II and III of Schedule M-3 and attach the Schedule to their tax returns. In addition, the distinction is useful for those responsible for computing and tracking book-tax differences for tax return purposes for keeping track of when temporary differences will revert, and for calculating the income tax expense and effective tax rate to be reported in the financial statements. 9. (LO 2) Describe the relation between the book-tax differences associated with depreciation expense and the book-tax differences associated with gain or loss on disposition of depreciable assets. Because tax depreciation methods generally provide for more accelerated depreciation than financial accounting methods, book-tax differences associated with depreciation are usually favorable in the early years of an asset’s depreciable life. The difference reverses later on. However, when a corporation disposes an asset before it is fully depreciated, it is likely that the tax basis of the asset will be lower than the financial accounting basis. Consequently, for tax purposes, the corporation will recognize more gain (or less loss) for tax purposes than for book purposes resulting in an unfavorable book-tax difference. The book-tax difference on the sale is a complete reversal of the cumulative book-tax differences from prior year depreciation. 10. (LO 2) A Corporation owns stock in B Corporation and A Corporation receives a dividend from B Corporation. Ignoring the dividends received deduction, what book-tax differences will A report for the year relating to its investment in B? Explain. The dividend could generate a book-tax difference depending on the level of ownership in the distributing corporation. If the recipient corporation owns less than 20% of the distributing corporation there generally will not be a book-tax difference (that is, the dividend will be income for book and tax purposes). Also, if A owns less than 20% of B, A will recognize any unrealized gain or loss in its B stock for book purposes but not for tax purposes. This will create a temporary book-tax difference that will be unfavorable if A has an unrealized loss in its B stock at the end of the year and favorable if A has an unrealized gain in its B stock. If the receiving corporation owns between 20% and 50% of the distributing corporation, the book-tax difference generally will be the difference between the amount of the dividend and the amount of income the corporation recognizes on its books for its pro-rata share of the distributing corporation’s earnings (that is, the recipient corporation likely reports its share of the distributing corporation’s income under the equity method for book purposes, and the dividend is a return of basis for book purposes). If the corporation owns more than 50% of the distributing corporation, the dividend will be “eliminated” for book purposes in the consolidated income statement but only “eliminated” for tax purposes if the corporation owns 80% or more of the distributing corporation and files a consolidated tax return. 11. (LO 2) Describe how goodwill with a zero basis for tax purposes but not for book purposes leads to a permanent book–tax difference when the book goodwill is written off as impaired. The impairment of goodwill that has a book, but not a tax, basis, creates a deduction on the income statement that is not replicated on the tax return. This book only deduction results in an unfavorable permanent difference. 12. (LO 2) Describe how purchased goodwill leads to temporary book-tax differences.. A corporation that acquires the assets of another business in a taxable transaction allocates part of the purchase price to goodwill (excess purchase price over the fair market value of identifiable assets acquired). The corporation amortizes this purchased goodwill on a straight-line basis over 15 years (180 months) for tax purposes. For book purposes, corporations acquiring the assets of another business also allocate part of the acquisition price to goodwill but recover the cost of goodwill for book purposes only when the goodwill is impaired. Assuming the beginning balances in book and tax goodwill are equal, the corporation will report a temporary book-tax difference in the amount of tax amortization for the year if it is different from the goodwill impaired for the year. If the amortization exceeds the impairment, it is a favorable difference and if the impairment exceeds the amortization for the year, it is an unfavorable difference. 13. (LO 2) Describe the book-tax differences that arise from incentive stock options. Under ASC 718, incentive stock options give rise to permanent, unfavorable book-tax differences. Corporations are not allowed to deduct any compensation expense associated with incentive stock options for tax purposes, but for financial accounting purposes, corporations are required to deduct the initial estimated value of the stock options times the percentage of the options that vest during that particular year. 14. (LO 2) Describe the book-tax differences that arise from nonqualified stock options. Nonqualified options generate permanent and temporary book-tax differences. Corporations initially recognize temporary book-tax differences associated with stock options for the value of options that vest during the year but are not exercised during that year. This initial temporary difference is always unfavorable because the corporation deducts the value of the unexercised options that vest during the year for book purposes but not for tax purposes. This initial unfavorable temporary book-tax difference completely reverses when employees actually exercise the stock options. The amount of the permanent difference is the difference between the estimated value of the stock options exercised (the amount associated with these stock options deducted for book purposes) minus the bargain element of the stock options exercised during the year (the amount that is deducted for tax purposes). If the estimated value of stock options exercised exceeds the bargain element of the stock options exercised, the permanent book-tax difference is unfavorable; otherwise it is favorable. The permanent book-tax difference is recognized in the year the options are exercised. 15. (LO 2) How do corporations account for capital gains and losses for tax purposes? How is this different from the way individuals account for capital gains and losses? For tax purposes, capital gains are taxed at the corporation’s ordinary tax rate of 21%, and individuals are taxed on net long-term capital gains at preferential rates (lower than ordinary rates). Corporations are not allowed to deduct net capital losses against ordinary income. They carry back net capital losses three years (mandatory) and forward five years to offset capital gain net income in those years. Individual taxpayers can deduct up to $3,000 of net capital loss against ordinary income in a year. They carry over the remainder indefinitely to offset against capital gains in subsequent years and up to $3,000 of net capital loss against ordinary income each year. 16. (LO 2) What are the common book-tax differences relating to accounting for capital gains and losses? Do these differences create favorable or unfavorable book-to-tax adjustments? The first common difference arises when a corporation has a net capital loss in a year. The corporation deducts the net loss for book purposes but is not allowed to deduct it for tax purposes. As a result, the net capital loss generates an unfavorable temporary book-tax difference if it is not carried back to a prior year. When the net capital loss is deducted for tax purposes as a carryover it generates a favorable book-tax difference because the carryover is not deductible for book purposes. 17. (LO 2) What is the carryover period for a net operating loss? Explain. The carryover period for net operating losses that arise in years ending before 2018 is 20 years. The carryover period for net operating losses arising in years ending after 2017 is indefinite. That is, they do not expire. 18. (LO 2) Is a net operating loss incurred in 2017 treated the same as a net operating loss incurred in 2020? Explain. For NOLs arising in tax years ending before 2018, corporations could carry them back two years and may carry them forward for up to 20 years and offset up to 100 percent of the taxable income (before the NOL deduction) in those years. In contrast, for NOLs arising in tax years ending after 2017 (including 2020), corporations may only carry them forward indefinitely. However, the NOL may offset a maximum of 80 percent of taxable income (before the NOL deduction) in any given year. 19. (LO 2) When a corporation has NOL carryovers arising in different years, how does the corporation apply the NOLs to reduce taxable income in a given year? When a corporation has NOL carryovers arising in different years, it applies the oldest NOL carryover first (subject to the rules based on when the NOL arose) 20. (LO 3) A corporation commissioned an accounting firm to recalculate the way it accounted for leasing transactions. With the new calculations, the corporation was able to file amended tax returns for the past few years that increased the corporation’s net operating loss carryover from $3,000,000 to $5,000,000. Was the corporation wise to pay the accountants for their work that led to the increase in the NOL carryover? What factors should be considered in making this determination? It depends on how much they paid the accountants, whether or not they will be able to use the NOL to offset income in the previous years, or whether or not they will have income in the future to receive a tax benefit from the NOL. They should determine if the present value of the tax savings for the NOL is greater than the cost to have the accountants obtain the higher NOLs. It may be that the business is never going to become profitable and will therefore not ever receive a tax benefit from the increased carryover. Recall that corporations can carryback up to two years NOLs arising in years before 2018 and carry them forward for up to 20 years and they can use the NOLs to offset up to 100 percent of taxable income before the NOL deduction. If the NOL arose after 2017, the NOL can be carried forward indefinitely but may offset up to only 80 percent of taxable income before the NOL is applied in a given year. 21. (LO 2) Compare and contrast the general rule for determining the amount of the charitable contribution if the corporation contributes capital gain property versus ordinary income property. Generally, corporations are allowed to deduct the amount of money they contribute, the fair market value of capital gain property they donate (property that would generate long-term capital gain if sold), and the adjusted basis of ordinary income property they donate. 22. (LO 2) Which limitations might restrict a corporation’s deduction for a cash charitable contribution? Explain how to determine the amount of the limitation. A corporation’s charitable contribution deduction is limited to 10% of taxable income before any charitable contribution, dividends received deduction, and capital loss carrybacks. Additionally, an accrual-method corporation generally will not be allowed to deduct a charitable contribution it accrues in the current year (with approval of the board of directors) if it does not pay actual contributions within 3½ months after its tax year end (2½ months after year end for June 30 corporations). 23. (LO 2) For tax purposes, what happens to a corporation’s charitable contributions that are not deducted in the current year because of the taxable income limitation? Charitable contributions that are restricted by the taxable income limitation are carried forward for five years. When the excess contribution is carried forward it is treated as though it were a contribution in the subsequent year. However, if the contribution is limited in the subsequent year, the current year contributions are deducted before the carryover. Also, carryovers from different years are deducted in a first-in, first-out order (oldest first). If the carryover is not deducted within five years, it expires without providing any tax benefit. 24. (LO 2) What are common book–tax differences relating to corporate charitable contributions? Are these differences favorable or unfavorable? The common book-tax differences related to charitable contributions are based on when the contribution is paid if accrued at year-end and the overall limitation. When paid: If a company accrues a contribution for book purposes, it is allowed to take the deduction in the year of accrual if authorized by the Board of Directors. For tax purposes, however, a corporation must generally pay the contribution within 3½ months after year end (2½ months after year end for June 30 corporations). A difference here would be a temporary difference that is initially unfavorable but reverses as a favorable book-tax difference in the subsequent year. Overall limitation: For tax purposes, charitable contributions are limited to 10% of charitable contribution modified taxable income. For book purposes, the limitation does not apply. Consequently, in the year in which the contribution is limited for tax purposes, the book-tax difference will be an unfavorable temporary difference. However, when the carryover is deducted it will generate a favorable temporary difference that is the reversal of the previous unfavorable adjustment. 25. (LO 2) Why does Congress provide the dividends received deduction for corporations receiving dividends? The dividends received deduction mitigates (but does not eliminate in many cases) the extent to which the earnings of a corporation may be subject to more than two levels of taxation (that is, corporate income technically should only be subject to “double taxation,” first at the corporate level and then at the shareholder level). 26. (LO 2) How does a corporation determine the percentage for its dividends received deduction? Explain. The percentage is determined based on the actual ownership of the receiving corporation in the distributing corporation’s stock. If the ownership is less than 20%, the dividends received deduction percentage is 50%. If ownership is at least 20% but less than 80%, the dividends received deduction is 65%. If the ownership is 80% or more, the dividends received deduction percentage is 100%. 27. (LO 2) What limitations apply to the amount of the allowable dividends received deduction? The dividends received deduction is subject to a taxable income limitation. Under this limitation, the dividend received deduction is limited to the lesser of: (1) Deduction percentage × amount of dividend, or (2) Deduction percentage × taxable income (before DRD, NOL, and net capital loss carrybacks). Limitation (2) does not apply, however, if after deducting the amount determined in (1) the corporation creates or increases a net operating loss. 28. (LO 2) How many tax brackets are there in the corporate tax rate schedule? Just one. For tax years after 2017, corporate taxable income is taxed at a flat 21 percent rate. 29. (LO 3) How is the Schedule M-1 similar to and different from a Schedule M-3? How does a corporation determine whether it must complete Schedule M-1 or Schedule M-3 when it completes its tax return? Schedules M-1 and M-3 are both schedules on the corporate tax return Form 1120, where corporations report their book-tax differences and reconcile their book and taxable income (before the dividends received deduction and net operating loss deductions). Corporations with total assets of less than $10,000,000 report their book-tax differences on Schedule M-1. Corporations with total assets of $10,000,000 or more are required to report their book-tax differences on Schedule M-3 (although it requires assets of $50,000,000 or more before the page 2 and page 3 detailed book-tax difference schedules are required to be completed). Schedule M-3 is three pages long and includes a page for reporting information and the applicable book income. The second page contains income-related book-tax differences, and the third page reports deduction related book-tax differences. In contrast, Schedule M-1 is a short schedule with only 10 lines. Schedule M-3 requires more than 60 types of book-tax differences. Finally, Schedule M-3 requires corporations to identify book-tax differences as temporary or permanent, while Schedule M-1 does not. 30. (LO 3) What is the due date for a calendar year corporation tax return Form 1120 for 2020? Is it possible to extend the due date? Explain. The tax return due date for a C corporation is three and one-half months after the corporation’s year end (two and one-half months after year end for corporations with a year ending on June 30). Thus, a calendar-year corporation’s unexpended tax return due date is April 15. Corporations requesting an extension can extend the due date for filing their tax returns (not for paying the taxes) for six months (October 15 for calendar year corporations). The due date for June 30 year-end corporations is September 15, and they can extend the filing due date for their tax returns for seven months (until April 15) 31. (LO 3) How does a corporation determine the minimum amount of estimated tax payments it must make to avoid underpayment penalties? How do these rules differ for large corporations? To avoid underpayment penalties, the required annual payment is the least of: (1) 100% of the current year tax liability (although the corporation won’t know this until they file their tax return), (2) 100% of the tax liability on the prior year’s return, but only if there was a positive tax liability on the return and the prior year return covered a 12-month period (however, there are special rules for “large” corporations; they are subject to different treatment), or (3) 100% of the estimated current year tax liability using the annualized income method. Corporations must have paid in 25%, 50%, 75%, and 100% of their required annual payments by the 15th day of the 4th, 6th, 9th, and 12th months of their tax year. If a corporation wants to determine the minimum payments, it should compute the required payments under each of the methods for each quarter and pay in the minimum required payment. Corporations may use different methods for determining the required payment for each quarter. “Large” corporations, defined as corporations with over $1,000,000 of taxable income in any of the three years prior to the current year, may use the prior year tax liability to determine their first quarter estimated tax payments only. If they use the prior year tax liability to determine their first quarter payment, their second quarter payment must “catch up” their estimated payments. That is the second quarter payment must be large enough for the sum of their first and second quarter payments to equal or exceed be 50% of their current year tax liability. 32. (LO 3) Describe the annualized income method for determining a corporation’s required estimated tax payments. What advantages does this method have over other methods? Under the annualized method, corporations determine their taxable income as of the end of each quarter and then annualize (project) the amounts to determine their estimated taxable income and tax liability for the year. The estimated annual tax liability is used at the end of each quarter to determine the minimum required estimated payment for that quarter. Corporations use the first quarter taxable income to project their annual tax liability for the first and second quarter estimated tax payments. They use taxable income at the end of the second quarter to determine the third quarter estimated tax payment requirement, and taxable income at the end of the third quarter to determine their fourth quarter payment requirement. The advantage of the annualized income method is that it allows corporations to determine their required estimated payments (which may be lower than required payments using prior year tax liability) with certainty. Problems 33. (LO 1) LNS Corporation reports revenues of $2,000,000. Included in the $2,000,000 is $15,000 of tax-exempt interest income. LNS reports $1,345,000 in ordinary and necessary business expenses. What is LNS Corporation’s taxable income for the year? $640,000, computed as follows: Description Amount Explanation (1) Total revenue $2,000,000 (2) Tax-exempt interest income (15,000) (3) Deductions (1,345,000) Taxable income $640,000 (1) + (2) + (3) 34. (LO 1) ATW Corporation currently uses the FIFO method of accounting for its inventory for book and tax purposes. Its beginning inventory for the current year was $8,000,000. Its ending inventory for the current year was $7,000,000. If ATW had been using the LIFO method of accounting for its inventory, its beginning inventory would have been $7,000,000 and its ending inventory would have been $5,500,000. a. How much more in taxes did ATW Corporation pay for the current year because it used the FIFO method of accounting for inventory rather than the LIFO method? Decrease in inventory (increase in COGS) under FIFO is $1,000,000 ($8,000,000 - 7,000,000) Decrease in inventory (increase in COGS) under LIFO is $1,500,000 ($7,000,000 – 5,500,000) FIFO COGS benefit = $1,000,000 × .21 = $210,000 LIFO COGS benefit = 1,500,000 × .21 = $315,000 Thus, ATW paid $105,000 more in taxes under the FIFO method than under the LIFO method (COGS was $500,000 greater under LIFO (income $500,000 lower) x 21% = $105,000 tax savings under LIFO). b. Why would ATW use the FIFO method of accounting if doing so causes it to pay more taxes on a present value basis? (Note that the tax laws don’t allow corporations to use the LIFO method of accounting for inventory unless they also use the LIFO method of accounting for inventory for book purposes.) ATW Corporation could have chosen to use the FIFO method to increase financial reporting income even if this meant higher taxable income and more taxes. 35. (LO 1) ELS Corporation reported gross receipts for 2017-2019 for scenarios A, B, and C as follows: Year Scenario A Scenario B Scenario C 2017 $25,000,000 $24,000,000 $26,500,000 2018 $26,000,000 $26,000,000 $26,000,000 2019 $26,900,000 $28,500,000 $25,500,000 a) Is ELS allowed to use the cash method of accounting in 2020 under Scenario A? Yes. For the 2020 tax year, corporations with average gross receipts for the prior three years of $26 million or less may use the cash method of accounting. In Scenario A, ELS Corporation’s average gross receipts for 2017-2019 is $25,966,667 so ELS may use the cash method of accounting in 2020. b) Is ELS allowed to use the cash method of accounting in 2020 under Scenario B? No. For the 2020 tax year, corporations with average gross receipts for the prior three years of $26 million or less may use the cash method of accounting. In Scenario B, ELS Corporation’s average gross receipts for 2017-2019 is $26,166,667 so ELS may not use the cash method of accounting in 2020 (must use accrual). c) Is ELS allowed to use the cash method of accounting in 2020 under Scenario C? Yes. For the 2020 tax year, corporations with average gross receipts for the prior three years of $26 million or less may use the cash method of accounting. In Scenario C, ELS Corporation’s average gross receipts for 2017-2019 is exactly $26,000,000 so ELS may use the cash method of accounting in 2020. 36. (LO 2) On its year 1 financial statements, Sea tax Corporation, an accrual-method taxpayer, reported federal income tax expense of $570,000. On its year 1 tax return, it reported a tax liability of $650,000. During year 1, Sea tax made estimated tax payments of $700,000. What book-tax difference, if any, associated with its federal income tax expense should Sea tax have reported when computing its year 1 taxable income? Is the difference favorable or unfavorable? Is it temporary or permanent? Corporations reconcile from book income (after tax expense) to taxable income by making adjustments for book-tax differences. In this case, Sea tax deducted $570,000 of federal income tax expense to determine its book income (note that it did not deduct its actual tax liability). Because corporations are not allowed to deduct any federal tax expense on their tax returns, Sea tax will make a permanent $570,000 unfavorable book-tax difference when computing its year 1 taxable income. 37. (LO 2) Assume Maple Corp. has just completed the third year of its existence (year 3). The table below indicates Maple’s ending book inventory for each year and the additional §263A costs it was required to include in its ending inventory. Maple immediately expensed these costs for book purposes. In year 2, Maple sold all of its year 1 ending inventory, and in year 3 it sold all of its year 2 ending inventory. Year 1 Year 2 Year 3 Ending book inventory $2,400,000 $2,700,000 $2,040,000 Additional § 263A costs 60,000 70,000 40,000 Ending tax inventory $2,460,000 $2,770,000 $2,080,000 a. What book-tax difference associated with its inventory did Maple report in year 1? Was the difference favorable or unfavorable? Was it permanent or temporary? Year 1: $60,000 unfavorable temporary adjustment (inventory costs deducted for books but included in ending inventory for tax). b. What book-tax difference associated with its inventory did Maple report in year 2? Was the difference favorable or unfavorable? Was it permanent or temporary? Year 2: $10,000 unfavorable temporary adjustment. This is the net of a $70,000 unfavorable adjustment for amounts included in ending inventory for tax but deducted for books and a $60,000 favorable adjustment for the reversal of the adjustment in year 1 (see part a). c. What book-tax difference associated with its inventory did Maple report in year 3? Was the difference favorable or unfavorable? Was it permanent or temporary? Year 3: $30,000 favorable temporary adjustment. This is the net of a $40,000 unfavorable adjustment for amounts included in ending inventory for tax but deducted for books in year 3 and a $70,000 favorable adjustment for the reversal of the amount capitalized to inventory in year 2 (see part b). 38. (LO 2) JDog Corporation owns stock in Oscar Inc. valued at $2,000,000 at the beginning of the year and $2,200,000 at year end. JDog received a $10,000 dividend from Oscar Inc. What temporary book-tax differences associated with its ownership in Oscar stock will JDog report for the year in the following alternative scenarios (income difference only - ignore the dividends received deduction)? a. JDog owns 5 percent of the Oscar Inc. stock. Oscar’s income for the year was $500,000. JDog will include the $10,000 dividend in book income. For tax purposes, JDog will also include the $10,000 in gross income so that it will not report a temporary book-tax difference on the dividend. However, for book purposes, JDog will recognize the $200,000 unrealized gain in its Oscar stock at year end. JDog will not recognize this gain for tax purposes so JDog will report a $200,000 favorable book-tax difference to remove the unrealized gain from taxable income. b. JDog owns 40 percent of the Oscar, Inc. stock. Oscar’s income for the year was $500,000. JDog can exert significant influence over Oscar, Inc. at 40 percent ownership. Instead of including the dividend in its income, JDog recognizes $200,000 (40% x $500,000) of income for book purposes under the equity method of accounting (ASC Topic No. 323). This is JDog’s pro-rata share of Oscar’s net income for the year. For tax purposes, JDog includes only the $10,000 dividend in gross income. Consequently, JDog will report a $190,000 favorable temporary book-tax difference. 39. (LO 2) On July 1 of year 1, Riverside, Corp. (RC), a calendar-year taxpayer, acquired the assets of another business in a taxable acquisition. When the purchase price was allocated to the assets purchased, RC determined it had a basis of $1,200,000 in goodwill for both book and tax purposes. At the end of year 1, RC determined that the goodwill had not been impaired during the year. In year 2, however, RC concluded that $200,000 of the goodwill had been impaired, and wrote down the goodwill by $200,000 for book purposes. a. What book-tax difference associated with its goodwill should RC report in year 1? Is it favorable or unfavorable? Is it permanent or temporary? For tax purposes, RC amortizes the $1,200,000 using the straight-line method over 15 years (180 months). Consequently, in year 1, RC will amortize and deduct $40,000 of the goodwill ($1,200,000/180 months × 6 months = $40,000) for tax purposes. However, for book purposes, RC does not expense any of the goodwill because there is no impairment. Consequently, in year 1, RC will report a favorable $40,000 temporary difference associated with the goodwill. b. What book-tax difference associated with its goodwill should RC report in year 2? Is it favorable or unfavorable? Is it permanent or temporary? In year 2, RC amortizes $80,000 of the goodwill for tax purposes ($1,200,000/180 × 12 months = $80,000). For book purposes RC writes off (deducts) $200,000 in goodwill. Consequently, it reports a $120,000 unfavorable temporary book-tax difference in year 2. 40. (LO 2) Assume that on January 1, year 1, ABC Inc. issued 5,000 stock options with an estimated value of $10 per option. Each option entitles the owner to purchase one share of ABC stock for $25 a share (the per share price of ABC stock on January 1, year 1 when the options were granted). The options vest at the end of the day on December 31, year 2. All 5,000 stock options were exercised in year 3 when the ABC stock was valued at $31 per share. Identify ABC’s year 1, 2, and 3 tax deductions and book-tax differences (indicate whether permanent and/or temporary) associated with the stock options under the following alternative scenarios: a. The stock options are incentive stock options. For tax purposes, ABC is not allowed any deductions for incentive stock options. For book purposes, ABC expenses the initial value of the stock options pro rata over the vesting period. In this case, the options were valued at $10 per option. Because the vesting period is two years ABC will deduct $25,000 of compensation expense related to the options in year 1 (2,500 × $10) and $25,000 in year 2 for book purposes. To summarize, ABC will report an unfavorable permanent book-tax difference of $25,000 in year 1 and again in year 2. ABC will not report a book-tax difference in year 3. b. The stock options are nonqualified stock options. For book purposes, ABC expenses the initial value of the stock options pro rata over the vesting period. In this case, the options were valued at $10 per option. ABC deducts $25,000 of compensation expense from the options in year 1 (2,500 × $10) and $25,000 of compensation expense from the options in year 2 for book purposes. For tax purposes, ABC can deduct the bargain element (FMV – exercise price) of the options when they are exercised in year 3. So, in year 3 ABC will deduct $30,000 [($31 - $25) × 5,000] in computing taxable income on the tax return. In year 1, ABC reports a $25,000 unfavorable temporary book-tax difference. In year 2, ABC reports another $25,000 unfavorable book-tax difference. In year 3, when the options are exercised, the year 1 and year 2 book-tax differences completely reverse, resulting in a $50,000 favorable temporary book-tax difference. In addition, ABC reports a $20,000 unfavorable permanent difference that represents the total amount of $50,000 that was deducted for book purposes from the options and the $30,000 that was deducted for tax purposes. The $20,000 unfavorable permanent difference represents the difference between the estimated value of the stock options exercised of $10 and the bargain element of $6 multiplied by the number of options (5,000). In summary: year 1 $25,000 unfavorable temporary book-tax difference; year 2 $25,000 unfavorable temporary book-tax difference; year 3 favorable $50,000 temporary difference and $20,000 unfavorable permanent book-tax difference. 41. (LO 2) Assume that on January 1, year 1, XYZ Corp. issued 1,000 nonqualified stock options with an estimated value of $4 per option. Each option entitles the owner to purchase one share of XYZ stock for $14 a share (the per share price of XYZ stock on January 1, year 1, when the options were granted). The options vest 25 percent a year (on December 31) for four years (beginning with year 1). All 500 stock options that had vested to that point were exercised in year 3 when the XYZ stock was valued at $20 per share. No other options were exercised in year 3 or year 4. Identify XYZ’s year 1, 2, 3, and 4 tax deductions and book–tax difference (identify as favorable or unfavorable and as permanent or temporary) associated with the stock options. For book purposes, XYZ deducts $1,000 a year in years 1, 2, 3, and 4 ($4,000 value of options × 25% for each year of the vesting period). For tax purposes, XYZ deducts $3,000 in year 3 when the 500 shares are exercised [($20 - $14) bargain element x 500 shares]. Book tax-differences: XYZ reports a $1,000 unfavorable temporary book-tax difference in years 1, 2, 3, and 4 in connection with the deduction taken for book purposes but not tax purposes in the amount of the initial estimated value of the stock options x the percentage of options that vest during that year. In year 3, XYZ reports a $2,000 favorable temporary book-tax difference (this is the reversal of the unfavorable book-tax differences from years 1 and 2 on the 500 options that vested in years 1 and 2 but were exercised in year 3). Finally, XYZ reports a $1,000 favorable permanent book tax difference in year 3 that represents the excess of the bargain element of the options of $6 per option over the $4 estimated value of the options multiplied by the 500 options that were exercised [($6 - $4) x 500 shares]. 42. (LO2) What book-tax differences in year 1 and year 2 associated with its capital gains and losses would ABD Inc. report in the following alternative scenarios? Identify each book-tax difference as favorable or unfavorable and as permanent or temporary. In year 1, there is a $12,000 temporary unfavorable book tax difference because net capital losses are not deductible for tax purposes, but they are deductible for book purposes. The $12,000 disallowed loss is carried over to year 2. In year 2, there is a $5,000 temporary favorable book-tax difference because $5,000 of the disallowed loss from year 1 offsets the $5,000 gain recognized in year 2. In year 1, ABD reports a $25,000 temporary, unfavorable book-tax difference because the company cannot deduct a net capital loss (it has a $25,000 capital loss carryover to year 2). In year 2, ABD reports a $20,000 temporary, favorable book-tax difference, because ABD can deduct $20,000 of the capital loss carried over to year 2. In year 1, ABD reports a $25,000 temporary, unfavorable book-tax difference because the company cannot deduct a net capital loss (it has a $25,000 capital loss carryover to year 2). In year 2, ABD reports a $25,000 temporary, favorable book-tax difference, because ABD can deduct the full $25,000 capital loss carryover in year 2. In year 6, ABD reports a $10,000 temporary favorable book-tax difference because it can deduct the $10,000 capital loss carryover from year 1 to offset the year 6 gain. No book-tax difference because the carryover from year 1 has expired and is unavailable to offset the capital gain in year 7. 43. (LO 2) What book-tax differences in year 1 and year 2 associated with its capital gains and losses would DEF Inc. report in the following alternative scenarios? Identify each book-tax difference as favorable or unfavorable and as permanent or temporary. a. In year 1, DEF recognized a loss of $15,000 on land that it had held for investment. In year 1, it also recognized a $30,000 gain on equipment it had purchased a few years ago. The equipment sold for $50,000 and had an adjusted basis of $20,000. DEF had deducted $40,000 of depreciation on the equipment. In year 2, DEF recognized a capital loss of $2,000. In year 1, for tax purposes, DEF realizes a $15,000 capital loss on the sale of land held for investment but is not allowed to deduct the loss in year 1 (the loss becomes a capital loss carryover). DEF also recognizes $30,000 of ordinary income due to depreciation recapture on the disposition of the equipment. For book purposes, DEF deducts the $15,000 loss and includes the $30,000 of income. DEF reports a $15,000 temporary unfavorable book-tax difference in year 1. In year 2, DEF reports a $2,000 temporary unfavorable book-tax difference because it cannot deduct the year 2 capital loss for tax purposes. b. In year 1, DEF recognized a loss of $15,000 on land that it had held for investment. It also recognized a $20,000 gain on equipment it had purchased a few years ago. The equipment sold for $50,000 and had an adjusted basis of $30,000. DEF had deducted $15,000 of tax depreciation on the equipment. There were no capital transactions in year 2 In this case, the character of the $20,000 gain DEF recognizes on the equipment disposition in year 1 is $15,000 ordinary due to depreciation recapture. The remaining $5,000 gain is initially treated as §1231 gain. This §1231 gain is ultimately characterized as a long-term capital gain. So, DEF is able to offset this $5,000 capital gain with $5,000 of the $15,000 capital loss from the land. Thus, DEF will report a $10,000 unfavorable temporary book-tax difference and it will have a $10,000 capital loss carryover. 44. (LO 2) MWC Corp. is currently in the sixth year of its existence (2020). In 2015–2019, it reported the following income and (losses) (before net operating loss carryovers or carrybacks). What is MWC's 2020 taxable income after the NOL deduction? What is its 2020 book–tax difference associated with its NOL? Is it favorable or unfavorable? Is it permanent or temporary? 2020 taxable income: $275,000 (300,000 – 25,000 NOL carryover from 2019). MWC can offset up to 80% of taxable income in 2020 because the NOL comes from 2019. The NOL carryover to 2020 creates a $25,000 temporary favorable book-tax difference in 2020. 45. (LO 2) In 2020 Hill Corporation reported a net operating loss of $10,000 that it carried forward to 2021. In 2020 Hill also reported a net capital loss of $3,000 that it carried forward to 2021. In 2021, ignoring any carryovers from other years, Hill reported a loss for tax purposes of $50,000. The current-year loss includes a $12,000 net capital gain. What is Hill’s 2021 net operating loss? The 2021 net operating loss is $53,000. In computing the net operating loss for a particular year, net operating loss carryovers are ignored as are capital loss carrybacks. However, capital loss carryovers are taken into account. In this case, in 2021 Hill reported a loss of $50,000 that included a $12,000 net capital gain. Consequently, its loss without the net capital gain was $62,000. The $3,000 capital loss carryover from 2020 is deducted against the $12,000 net capital gain in 2021 reducing the net capital gain for 2021 to $9,000. When this gain is added to the $62,000 loss, Hill has a $53,000 net operating loss from year 2. So, Hill has a $10,000 net operating loss carryover from 2020 and a $53,000 net operating loss carryover from 2021. Both losses are carried over to 2022. Hill does not have a capital loss carryover to 2022. 46. (LO 2) WCC Corp. has a $100,000 net operating loss carryover into 2020. Assume that it reported $75,000 of taxable income in 2020 (before the net operating loss deduction) and $30,000 of taxable income in 2021 (before the net operating loss deduction). a. What is WCC’s taxable income in 2020 and 2021 (after the net operating loss deduction), assuming the $100,000 NOL carryover originated in 2016? Taxable income in 2020 is $0 ($75,000 minus $75,000 NOL and the unused $25,000 NOL carries over to 2021. Taxable income in 2021 is $5,000 ($30,000 minus $25,000 and the NOL is entirely used up). Because the NOL arose in a year prior to 2018, the only restriction on the NOL usage is that it carries forward for up to 20 years. b. What is WCC’s taxable income in 2020 and 2021 (after the net operating loss deduction), assuming the $100,000 NOL carryover originated in 2019? Taxable income in 2020 is $15,000 ($75,000 minus $60,000). Because the NOL originated in a year after 2017, it is carried forward indefinitely and may only offset up to 80 percent of the WCC’s taxable income (before the NOL deduction) in any given year. Here, 80% of $75,000 is $60,000 so that is the maximum amount of NOL WCC may deduct in 2020. WCC carries the remaining $40,000 over to 2021 subject to the same 80 percent limitation in that year. Taxable income in 2021 is $6,000 ($30,000 minus $24,000). Again, the NOL may offset only 80% of WCC’s taxable income before the NOL deduction. WCC will carry over the remaining $16,000 NOL ($40,000 minus $24,000) to 2022. 47. (LO 2) In 2020, SML Corp. reported taxable income of $100,000 before any NOL deductions. SML has a $170,000 NOL carryover that originated in 2017 and a $90,000 NOL carryover that originated in 2018. What is SML’s 2020 taxable income after the NOL deduction? What NOLs can SML carryover to 2021? 2020 Taxable Income is $0 ($100,000 minus $100,000). SML carries over a $70,000 2017 NOL and the entire $90,000 2018 NOL (subject to the 80 percent limit). SML first deducts the entire $170,000 2017 NOL before deducting any of the $90,000 2018 NOL, because the 2017 NOL occurred first. Consequently, SML’s NOL carryover to 2021 is $70,000 NOL from 2017 and $90,000 that originated in 2018. 48. (LO 2) Cedar Corporation reported a $25,000,000 net operating loss in 2020. In 2021, Cedar reported taxable income before any NOL carryovers of $20,000,000. What is Cedar’s taxable income in 2021 after the NOL deduction and what is its NOL carryover, if any, to 2022? Because the NOL arose in 2020, the carryover cannot reduce taxable income in the carryover year by more than 80%. In this case, only $16,000,000 of the 2020 carryover can reduce the 2021 taxable income of $20,000,000. Thus, the taxable income for 2021 is $4,000,000. The NOL carryover to 2022 would be $9,000,000 ($25,000,000 - $16,000,000). 49. (LO 2) Golf Corp. (GC), a calendar-year accrual-method corporation, held its directors meeting on December 15 of year 1. During the meeting the board of directors authorized GC to pay a $75,000 charitable contribution to the World Golf Foundation, a qualifying charity. a. If GC actually pays $50,000 of this contribution on January 15 of year 2 and the remaining $25,000 on or before April 15 of year 2, what book-tax difference will it report associated with the contribution in year 1 (assume the 10 percent limitation does not apply)? Is it favorable or unfavorable? Is it permanent or temporary? No book-tax difference. The $75,000 contribution is deductible in year 1 for both book and tax purposes. It is deductible for tax purposes because it paid the accrued contribution within 3½ months after year end. b. Assuming the same facts as in part (a), what book-tax difference will GC report in year 2 (assuming the 10 percent limitation does not apply)? Is it favorable or unfavorable? No book-tax difference in year 2 because the entire contribution was deducted in year 1 for book and tax purposes. c. If GC actually pays $50,000 of this contribution on January 15 of year 2 and the remaining $25,000 on May 15 of year 2, what book-tax difference will it report associated with the contribution in year 1 (assume the 10 percent limitation does not apply)? Is it favorable or unfavorable? Is it permanent or temporary? GC deducts $75,000 in year 1 for book purposes and $50,000 in year 1 for tax purposes. GC cannot deduct the remaining $25,000 in year 1 for tax purposes because it did not actually pay the contribution within 3½ months after year end. The $25,000 that was not deductible in year 1, is carried over to year 2. The year 1 book-tax difference is a $25,000 unfavorable temporary difference. d. Assuming the same facts as in part (c), what book-tax difference will GC report in year 2 (assuming the 10% limitation does not apply)? Is it favorable or unfavorable? In year 2, GC reports a favorable $25,000 book-tax difference when it is allowed to deduct the $25,000 for tax purposes that it paid on May 15, year 2. 50. (LO 2) In year 1 (the current year), OCC Corp. made a charitable donation of $200,000 to the Jordan Spieth Family Foundation (a qualifying charity). For the year, OCC reported taxable income of $1,500,000 before deducting any charitable contributions, before deducting its $20,000 dividends received deduction, and before deducting its $40,000 NOL carryover from last year. a. What amount of the $200,000 donation is OCC allowed to deduct for tax purposes in year 1? $146,000. OCC may deduct up to 10% of taxable income before any charitable contributions, the dividends received deduction, NOL and capital loss carrybacks. Because net operating loss carryovers are deductible in determining the taxable income limitation, OCC taxable income for charitable contribution limitation purposes is $1,460,000 ($1,500,000 - $40,000 NOL carryover). The deductible limit on charitable contributions is $146,000 ($1,460,000 × 10%). OCC can carryover the remaining $54,000 for up to 5 years. b. In year 2, OCC did not make any charitable contributions. It reported taxable income of $300,000 before any charitable contribution deductions and before a $15,000 dividends received deduction. What book-tax difference associated with the charitable contributions will OCC report in year 2? Is the difference favorable or unfavorable? Is it permanent or temporary? OCC’s taxable income limitation in year 2 is $30,000 ($300,000 × 10%). Although OCC did not make any current year contributions, it is allowed to deduct (subject to the 10% limitation) its charitable contribution carryover from year 1 in the amount of $54,000. Because the limitation on the deduction in year 2 is $30,000, it may deduct $30,000 and carry over the remaining $24,000 to year 3. In year 2, OCC will report a $30,000 favorable, temporary book-tax difference. c. Assume the original facts and those provided in part (b). In years 3, 4, and 5, OCC reported taxable losses of $50,000. Finally, in year 6 it reported $1,000,000 in taxable income before any charitable contribution deductions. It did not have any dividends received deduction. OCC did not actually make any charitable donations in year 6. What book-tax difference associated with charitable contributions will OCC report in year 6? OCC would be allowed to deduct its remaining $24,000 charitable contribution carryover because the taxable income is not limiting. Consequently, it would report a favorable temporary book-tax difference of $24,000. If OCC had not been able to deduct some of the carryover in year 6, the carryover would have expired unused. 51. (LO 2) In year 1 (the current year), LAA Inc. made a charitable donation of $100,000 to the American Red Cross (a qualifying charity). For the year, LAA reported taxable income of $550,000 which included a $100,000 charitable contribution deduction (before limitation), a $50,000 dividends received deduction, and a $10,000 net operating loss carryover from year 0. What is LAA Inc.’s charitable contribution deduction for year 1? The charitable contribution deduction for the year is limited to 10% of taxable income before any charitable contribution and before the dividends received deduction. But, it is determined after deducting NOL carryovers. Consequently, LAA’s modified taxable income is $700,000 ($550,000 + $100,000 + $50,000). LAA’s charitable contribution deduction is limited to $70,000 ($700,000 × 10%). The remaining $30,000 ($100,000 donation minus $70,000 deductible amount) is carried over for up to five years. 52. (LO 2) [Research] Coattail Corporation (CC) manufactures and sells women and children’s coats. This year CC donated 1,000 coats to a qualified public charity. The charity distributed the coats to needy women and children throughout the region. At the time of the contribution, the fair market value of each coat was $80. Determine the amount of CC’s charitable contribution (the taxable income limitation does not apply) for the coats, assuming the following: a. CC’s adjusted basis in each coat was $30. In general, the deductible amount of property that is not long-term capital gain property is limited to the adjusted basis of the property. However, under §170(e)(3), if the taxpayer contributes inventory to a charitable organization for the care of the needy, the taxpayer can deduct the basis of the property plus one half of the appreciation (not to exceed twice the basis). In this case, because CC’s contribution is to a qualified charity for the aid of the needy, it is allowed to deduct $55,000, which is the basis of $30,000 (1,000 x $30) + $25,000 [1,000 × .5 × (80 – 30)]. Twice the basis is $60,000 ($30,000 × 2), so this limitation is not binding. b. CC’s adjusted basis in each coat was $10. In general, the deductible amount of property that is not long-term capital gain property is limited to the adjusted basis of the property. However, under §170(e)(3), if the taxpayer contributes inventory to a charitable organization for the care of the needy, the taxpayer can deduct the basis of the property plus one half of the appreciation (not to exceed twice the basis). In this case, because CC’s contribution is to a qualified charity for the aid of the needy, it is allowed to deduct $20,000 which is the lesser of (1) $45,000 [the basis of $10,000 (1,000 × $10) + $35,000 [1,000 × .5 × (80 – 10)] or (2) $20,000, which is twice the basis ($10,000 × 2). Consequently, CC’s contribution is limited to $20,000. 53. (LO 2) [Research] Maple Corp. owns several pieces of highly valued paintings that are on display in the corporation’s headquarters. This year, it donated one of the paintings valued at $100,000 (adjusted basis of $25,000) to a local museum for the museum to display. What is the amount of Maple Corp.’s charitable contribution deduction for the painting (assuming income limitations do not apply)? What would be Maple’s deduction if the museum sold the painting one month after it received it from Maple? If the taxpayer contributes tangible personal property to a tax-exempt organization, and the organization uses the property in a manner related to its tax-exempt purpose [see §170(e)(1)(B)(i)], the taxpayer is allowed to deduct the fair market value of the property if the property would have generated long-term capital gain if it were sold. In this case, the painting was long-term capital gain property to Maple Corp. and the museum displayed the painting, which is consistent with its tax-exempt purpose. Maple is allowed to deduct the $100,000 fair market value of the painting. If the museum sold the painting, it would be using the property in a manner unrelated to its tax exempt purpose. In this case, according to Reg. §1.170A-4(b)(3)(ii)(b), Maple’s deduction would be limited to the $25,000 basis of the property unless at the time of the contribution, it is reasonable to anticipate that the property would not be put to an unrelated use by the donee. Further, the regulation explains that “in the case of a contribution of tangible personal property to or for the use of a museum, if the object donated is of a general type normally retained by such museum or other museums for museum purposes, it will be reasonable for the donor to anticipate, unless he has actual knowledge to the contrary, that the object will not be put to an unrelated use by the donee, whether or not the object is later sold or exchanged by the donee.” Consequently, if Maple had prior knowledge that the museum would sell the property, it would be allowed to deduct only the $25,000 basis of the property. 54. (LO 2) Riverbend Inc. received a $200,000 dividend from stock it held in Hobble Corporation. Riverbend’s taxable income is $2,100,000 before deducting the dividends received deduction (DRD), a $40,000 NOL carryover, and a $100,000 charitable contribution. a. What is Riverbend’s deductible DRD assuming it owns 10 percent of Hobble Corporation? Because Riverbend owns less than 20 percent of Hobble, its DRD percentage is 50%. Its full DRD is $100,000 (.50 × $200,000). Riverbend’s modified taxable income for the taxable income limitation is $2,000,000 ($2,100,000 minus $100,000 charitable contribution). Thus, the taxable income limit is $1,000,000 ($2,000,000 × 50%). Because the full $100,000 DRD is less than the taxable income limit, Riverbend may deduct the entire $100,000 DRD. b. Assuming the facts in part (a), what is Riverbend’s marginal tax rate on the dividend? 10.5%. Riverbend’s tax rate is 21%. So, its marginal tax rate on the dividend after taking the DRD into account is computed as follows: [($200,000 - $100,000) × .21]/$200,000 = 10.5% c. What is Riverbend’s DRD assuming it owns 60 percent of Hobble Corporation? Because Riverbend owns 20% or more but less than 80% of Hobble, its DRD percentage is 65%. So, its full DRD is $130,000 (.65 × $200,000). Riverbend’s modified taxable income for the taxable income limitation is $2,000,000 ($2,100,000 minus $100,000 charitable contribution). Thus, the taxable income limit is $1,300,000 ($2,000,000 × 65%). Because the full $130,000 DRD is less than the taxable income limit, Riverbend may deduct the entire $130,000 DRD. d. Assuming the facts in part (c), what is Riverbend’s marginal tax rate on the dividend? 7.35%. Riverbend’s tax rate is 21%. So, its marginal tax rate on the dividend after taking the DRD into account is computed as follows: [($200,000 - $130,000) × .21]/$200,000 = 7.35% e. What is Riverbend’s DRD assuming it owns 85% of Hobble Corporation (and is part of the same affiliated group)? $200,000. Because it owns 80% or more of Hobble Corp., Riverbend is entitled to a 100% DRD. f. Assuming the facts in part (e), what is Riverbend’s marginal tax rate on the dividend? 0%. Riverbend does not pay any income tax on the dividend. 55. (LO 2) Wasatch Corp. (WC) received a $200,000 dividend from Tager Corporation (TC). WC owns 15 percent of the TC stock. Compute WC’s deductible DRD in each of the following situations: a. WC’s taxable income (loss) without the dividend income or the DRD is $10,000. $100,000. Because Wasatch owns less than 20 percent of Tager, its DRD is percentage is 50%. So, its full DRD is $100,000 (.5 × $200,000). Wasatch’s modified taxable income for the taxable income limitation is $210,000 ($10,000 + $200,000 dividend). Thus, the taxable income limit is $105,000 ($210,000 × 50%). Because the full $100,000 DRD is less than the taxable income limit, Wasatch may deduct the entire $100,000 DRD. b. WC’s taxable income (loss) without the dividend income or the DRD is ($10,000). $95,000. Because Wasatch owns less than 20 percent of Tager, its DRD is percentage is 50%. So, its full DRD is $100,000 (.5 × $200,000). Wasatch’s modified taxable income for the taxable income limitation is $190,000 [($10,000) + $200,000 dividend]. Thus, the taxable income limit is $95,000 ($190,000 × 50%). Because the taxable income limitation of $95,000 is less than the full DRD of $100,000 and because deducting the full DRD does not leave Wasatch in a loss position ($190,000 - $100,000 > $0,) Wasatch’s DRD is limited to $95,000. c. WC’s taxable income (loss) without the dividend income or the DRD is ($99,000). $50,500. Because Wasatch owns less than 20 percent of Tager, its DRD is percentage is 50%. So, its full DRD is $100,000 (.5 × $200,000). Wasatch’s modified taxable income for the taxable income limitation is $101,000 [($99,000) + $200,000 dividend]. Thus, the taxable income limit is $50,500 ($101,000 × 50%). In this case the taxable income limitation of $50,500 is less than the full DRD of $100,000 and because deducting the full DRD does not leave Wasatch in a loss position ($101,000 - $100,000 > $0), Wasatch’s DRD is limited to $50,500. d. WC’s taxable income (loss) without the dividend income or the DRD is ($101,000). $100,000. Because Wasatch owns less than 20 percent of Tager, its DRD is percentage is 50%. So, its full DRD is $100,000 (.5 × $200,000). Wasatch’s modified taxable income for the taxable income limitation is $99,000 [($101,000) + $200,000 dividend]. Thus, the taxable income limit is $49,500 ($99,000 × 50%). In this case the taxable income limitation of $49,500 is less than the full DRD of $100,000, however, because deducting the full DRD leaves Wasatch in a loss position ($99,000 - $100,000 < $0), Wasatch’s DRD is not limited by the taxable income limitation. So, it is allowed to deduct the full $100,000 DRD. e. WC’s taxable income (loss) without the dividend income or the DRD is ($500,000). $100,000. Because Wasatch owns less than 20 percent of Tager, its DRD is percentage is 50%. So, its full DRD is $100,000 (.5 × $200,000). Wasatch’s modified taxable income for the taxable income limitation is ($300,000) [($500,000) + $200,000 dividend]. Because Wasatch is in a loss position before deducting the DRD, the taxable income limitation does not apply and Wasatch may deduct the full DRD of $100,000. f. What is WC’s book-tax difference associated with its DRD in part (a)? Is the difference favorable or unfavorable? Is it permanent or temporary? The DRD creates a $100,000 permanent, favorable book-tax difference. 56. (LO 2) Compute SWK Inc.’s tax liability for each of the following scenarios: a. SWK’s taxable income is $60,000. $12,600 ($60,000 × 21%) b. SWK’s taxable income is $275,000. $57,750 ($275,000 × 21%) c. SWK’s taxable income is $50,000,000. $10,500,000 ($50,000,000 × 21%) 57. (LO 3) Last year, TBA Corporation, a calendar-year taxpayer, reported a tax liability of $100,000. TBA confidently anticipates a current year tax liability of $240,000. What minimum estimated tax payments should TBA make for the first, second, third, and fourth quarters respectively (ignore the annualized income method) assuming the following: a. TBA is not considered to be a large corporation for estimated tax purposes. $25,000 each quarter. TBA’s required annual payment is $100,000 which is the lesser of its $100,000 prior year tax liability and its current year $240,000 tax liability (assuming it proves to be no more than this). TBA must pay in 25%, 50%, 75%, and 100% of its first, second, third, and fourth quarter estimated tax payments respectively. In this case, its required payment for each quarter is $25,000 which is one-quarter of the required annual payment. b. TBA is considered to be a large corporation for estimated tax purposes. As a large corporation, TBA is allowed to use the prior year tax liability to compute its first quarter estimated tax payment only. After that, it must use the current year tax liability (excluding the annualized income method) to determine its required payments. Thus, TBA’s required estimated tax payments by quarter are as follows:’ Minimum payment Explanation Quarter 1: $25,000 (25% of $100,000 prior year tax liability) Quarter 2: $95,000 $120,000 – 25,000 (prior payments). Must have paid in total (q. 1 + q. 2 payments) $120,000 which is 50% of the current year tax liability of $240,000. Quarter 3: $60,000 $180,000 – 120,000 (prior payments). Must have paid in total (q. 1 + q. 2 + q. 3 payments) $180,000 which is 75% of the current year tax liability of $240,000. Quarter 4: $60,000 $240,000 – 180,000 (prior payments). Must have paid in total (q. 1 + q. 2 + q. 3 + q. 4 payments) $240,000 which is 100% of the current year tax liability. 58. (LO 3) Last year, BTA Corporation, a calendar-year taxpayer, reported a net operating loss of ($10,000) and a $0 tax liability. BTA confidently anticipates a current year tax liability of $240,000. What minimum estimated tax payments should BTA make for the first, second, third, and fourth quarters respectively (ignore the annualized income method) assuming the following: a. BTA is not considered to be a large corporation for estimated tax purposes. $60,000 each quarter. Because BTA did not owe a tax liability last year, it must use the current year tax liability to determine its minimum estimated tax payments (ignoring the annualized income method). In this case, the current year tax liability is expected to be $240,000 so BTA’s quarterly estimated tax payments would be $60,000 (25% × $240,000). b. BTA is considered to be a large corporation for estimated tax purposes. $60,000 each quarter. Same answer as a because BTA can’t use the prior year tax exception for any quarter. 59. (LO 3) For the current year, LNS corporation reported the following taxable income at the end of its first, second, and third quarters. What are LNS’s minimum first, second, third, and fourth quarter estimated tax payments, using the annualized income method? Quarter-end Cumulative taxable income First $1,000,000 Second $1,600,000 Third $2,400,000 First and second quarters: $210,000; third quarter $84,000; fourth quarter $168,000, computed as follows: Annual estimated taxable income Installment (1) Taxable income (2) Annualization Factor (1) × (2) Annual Estimated taxable income 1st quarter $1,000,000 12/3 = 4 $4,000,000 2nd quarter $1,000,000 12/3 = 4 $4,000,000 3rd quarter $1,600,000 12/6 = 2 $3,200,000 4th quarter $2,400,000 12/9 = 1.3333 $3,200,000 Installment (1) Annual estimated taxable income (2) Tax on estimated taxable income (21%) (3) (1) × (2) Percentage of tax required to be paid (4) (2) × (3) Required cumulative payment (5) Prior cumulative payments (4) – (5) Required estimated tax payment 1st quarter $4,000,000 $840,000 25% $210,000 0 $210,000 2nd quarter $4,000,000 $840,000 50% $420,000 $210,000 $210,000 3rd quarter $3,200,000 $672,000 75% $504,000 $420,000 $84,000 4th quarter $3,200,000 $672,000 100% $672,000 $504,000 $168,000 60. (LO 3) Last year, JL Corporation’s tax liability was $900,000. For the current year, JL Corporation reported the following taxable income at the end of its first, second, and third quarters (see table below). What are JL’s minimum required first, second, third, and fourth quarter estimated tax payments (ignore the actual current-year tax safe harbor)? Quarter-end Cumulative taxable income First $500,000 Second $1,250,000 Third $2,250,000 Ignoring the actual current year tax liability safe harbor, the minimum required estimated tax payments for each quarter is the lesser of the payment required under the prior year tax liability exception and the payment required by the annualized income method. Under this approach, the minimum estimated tax payments are as follows: Quarter 1: $105,000 Quarter 2: $105,000 Quarter 3: $183,750 Quarter 4: $236,250 Annual estimated taxable income Installment (1) Taxable income (2) Annualization Factor (1) × (2) Annual Estimated taxable income 1st quarter $500,000 12/3 = 4 $2,000,000 2nd quarter $500,000 12/3 = 4 $2,000,000 3rd quarter $1,250,000 12/6 = 2 $2,500,000 4th quarter $2,250,000 12/9 = 1.3333 $3,000,000 Minimum required estimated tax payments using annualized income method and prior year tax method. Installment (1) Annual estimated taxable income (2) Tax on estimated taxable income (21%) (3) (1) × (2) Percentage of tax required to be paid (4) (2) × (3) Required cumulative payment* (5) Prior cumulative payments (4) – (5) Required estimated tax payment 1st quarter $2,000,000 $420,000 25% $105,000 ($225,000) 0 $105,000 2nd quarter $2,000,000 $420,000 50% $210,000 ($450,000) $105,000 $105,000 3rd quarter $2,500,000 $525,000 75% $393,750 ($675,000) $210,000 $183,750 4th quarter $3,000,000 $630,000 100% $630,000 ($900,000) $393,750 $236,250 *Numbers in parentheses represent required cumulative payment under the prior year method of determining estimated tax payments. 61. (LO 3) Last year, Cougar Corp. (CC) reported a net operating loss of $25,000. In the current year, CC expected its current year tax liability to be $260,000 so it made four equal estimated tax payments of $65,000 each. Cougar closed its books at the end of each quarter. The following schedule reports CC’s taxable income at the end of each quarter: Quarter-end Cumulative taxable income First $300,000 Second $700,000 Third $1,000,000 Fourth $1,500,000 CC’s current year tax liability on $1,500,000 of taxable income is $315,000. Does CC owe underpayment penalties on its estimated tax payments? If so, for which quarters does it owe the penalty? CC is not allowed to rely on the prior year tax to determine its minimum estimated tax payments. CC made estimated tax payments of $65,000 each quarter for a total of $260,000. However, because its actual tax liability was $315,000, CC would be subject to estimated tax penalties for each quarter under the current year tax liability method. CC could avoid penalties if it made the minimum payments under the annualized income method computed below: Annual estimated taxable income Installment (1) Taxable income (2) Annualization Factor (1) × (2) Annual Estimated taxable income 1st quarter $300,000 12/3 = 4 $1,200,000 2nd quarter $300,000 12/3 = 4 $1,200,000 3rd quarter $700,000 12/6 = 2 $1,400,000 4th quarter $1,000,000 12/9 = 1.3333 $1,333,333 Installment (1) Annual estimated taxable income (2) Tax on estimated taxable income (flat 21%) (3) (1) × (2) Percentage of tax required to be paid (4) (2) × (3) Required cumulative payment (5) Prior cumulative payments (4) – (5) Required estimated tax payment 1st quarter $1,200,000 $252,000 25% $63,000 0 $63,000 2nd quarter $1,200,000 $252,000 50% $126,000 $63,000 $63,000 3rd quarter $1,400,000 $294,000 75% $220,500 $126,000 $94,500 4th quarter $1,333,333 $280,000 100% $280,000 $220,500 $59,500 CC owes underpayment penalties for the third and fourth quarters. This is summarized as follows: Quarter (1) Required cumulative payment (all based on annual basis) (2) Actual payment (2) – (1) Amount (under) over paid Penalty? 1 $63,000 (78,750) current year)* $65,000 $2,000 No 2 $126,000 ($157,500 current year) $130,000 $4,000 No 3 $220,500 ($236,250 current year) $195,000 ($25,500) Yes 4 $280,000 ($315,000 current year) $260,000 ($20,000) Yes *The required cumulative payment under the annualized method is less than required payment under the current year method (in parentheses). So, the annualized method is used to determine whether penalties apply. CC owes underpayment penalties for the third and fourth quarters. Comprehensive Problems 62. Compute MV, Corp.’s taxable income given the following information relating to its year 1 activities. Also, compute MV’s Schedule M-1 assuming that MV’s federal income tax expense for book purposes is $100,000. • Gross profit from inventory sales of $500,000 (no book-tax differences). • Dividends MV received from 25 percent-owned corporation of $100,000 (assume this is also MV’s pro rata share of the distributing corporation’s earnings). • Expenses other than DRD, charitable contribution (CC) and net operating loss (NOL), are $350,000 (no book-tax differences). • NOL carryforward from 2019 of $10,000. • Cash charitable contribution of $120,000. MV Corp.’s year 1 taxable income is $151,000, computed as follows: Description Book Income (Dr) Cr Book-tax adjustments Taxable Income (Dr) Cr (Dr) Cr Gross profit $500,000 $500,000 Other income: Dividend income 100,000 100,000 Gross Income $600,000 $600,000 Expenses: Business expenses other than DRD, CC, and NOL (350,000) (350,000) Federal income tax expense (100,000) 100,000 0 Total expenses before charitable contribution, NOL, and DRD (450,000) (350,000) Income before charitable contribution, NOL, and DRD $150,000 $250,000 NOL carryover from prior year (10,000) (10,000) Taxable income for charitable contribution limitation purposes (modified taxable income) $240,000 Charitable contributions (limited to 10% of modified taxable income) (120,000) 96,000 (24,000) Taxable income before DRD $216,000 Dividends received deduction (DRD) (65% DRD; taxable income limitation does not apply) (65,000) (65,000) Book/Taxable income $30,000 ($75,000) $196,000 $151,000 Deduction is the lesser of (1) full dividends received deduction of $65,000 ($100,000 × 65%) or (2) $146,900 [65% × ($216,000 + $10,000)] taxable income before the DRD and NOL deduction. MV’s Schedule M-1 from Form 1120 is as follows: Note that line 10 reconciles to taxable income before the dividends received deduction and the net operating loss deduction. Starting with $226,000 of income on line 10 and then subtracting the $65,000 dividends received deduction and the $10,000 net operating loss carryover yields taxable income of $151,000 ($226,000 – 65,000 – 10,000). 63. Compute HC Inc.’s current-year taxable income given the following information relating to its 2020 activities. Also, compute HC’s Schedule M-1 assuming that HC’s federal income tax expense for book purposes is $30,000. • Gross profit from inventory sales of $310,000 (no book-tax differences). • Dividends HC received from 28 percent-owned corporation of $120,000 (this is also HC’s pro rata share of the corporation’s earnings). • Expenses other than DRD, charitable contribution (CC) and net operating loss (NOL), are $300,000 (no book-tax differences). • NOL carryover from prior year of $12,000. • Cash charitable contribution of $50,000. HC Inc.’s taxable income is $29,370, computed as follows: Description Book Income (Dr) Cr Book-tax adjustments Taxable Income (Dr) Cr (Dr) Cr Gross profit $310,000 $310,000 Other income: Dividend income 120,000 120,000 Gross Income $430,000 $430,000 Expenses: Business expenses other than DRD, CC, and NOL (300,000) (300,000) Federal income tax expense (30,000) 30,000 0 Total expenses before charitable contribution, NOL, and DRD deduction (330,000) (300,000) Income before charitable contribution, NOL and DRD $100,000 $130,000 NOL carryover from prior year (12,000) (12,000) Taxable income for charitable contribution limitation purposes (modified taxable income) $118,000 Charitable contributions (limited to 10% of modified taxable income for tax) (50,000) 38,200 (11,800) Taxable income before DRD $106,200 Dividends received deduction (DRD) (taxable income limitation applies)* (76,830) (76,830) Book/Taxable income $50,000 ($88,830) $68,200 $29,370 *Deduction is the lesser of (1) full dividends received deduction of $78,000 ($120,000 × 65%) or (2) $76,830 [65% × ($106,200 + 12,000 NOL carryover] taxable income before the DRD and NOL). HC’s Schedule M-1 from Form 1120 is as follows: Note that line 10 reconciles to taxable income before the dividends received deduction and net operating loss deduction. Starting with $118,200 of income on line 10 and then subtracting the $76,830 dividends received deduction and the $12,000 net operating loss carryover yields taxable income of $29,370 ($118,200 – 76,830 – 12,000). 64. Timpanogos Inc. is an accrual-method calendar-year corporation. For 2020, it reported financial statement income after taxes of $1,342,000. Timpanogos provided the following information relating to its 2020 activities: Required: a. Reconcile book income to taxable income for Timpanogos Inc. Be sure to start with book income and identify all of the adjustments necessary to arrive at taxable income. b. Identify each book-tax difference as either permanent or temporary. c. Complete Schedule M-1 for Timpanogos. d. Compute Timpanogos Inc.’s tax liability for 2020. a and b. Timpanogos’s taxable income is $1,521,000, computed as follows: Description Book Income (Dr) Cr Book-tax adjustments* Taxable Income (Dr) Cr (Dr) Cr Revenue from sales $2,000,000 $2,000,000 Cost of Goods Sold (300,000) (300,000) Gross profit $1,700,000 $1,700,000 Other income: Life insurance proceeds from CEO’s death 200,000 (200,000) [P] 0 Interest income on municipal bonds 40,000 (40,000) [P] 0 Rental income 25,000 (10,000) [T] 30,000 [T] 45,000 Gross Income $1,965,000 $1,745,000 Expenses: Interest paid to obtain municipal bonds (45,000) 45,000 [P] 0 Net capital loss (42,000) 42,000 [T] 0 Charitable contributions Moved below Depreciation (25,000) (30,000) [T] (55,000) Life insurance premiums (21,000) 21,000 [P] 0 Federal income tax expense (310,000) 310,000 [P] 0 Total expenses before charitable contribution, NOL, and DRD (443,000) (55,000) Income before charitable contribution, NOL, and DRD $1,522,000 $1,690,000 NOL carryover from prior year (0) (0) Taxable income for charitable contribution limitation purposes $1,690,000 Charitable contributions (180,000) 11,000 [T] (169,000) Book/Taxable income $1,342,000 (280,000) 459,000 $1,521,000 *[T] reflects temporary book-tax differences and [P] reflects permanent book-tax differences (see requirement b). c. Timpanogos’s Schedule M-1 is as follows: d. Timpanogos’s tax liability is $319,410 ($1,521,000 × 21%). 65. XYZ is a calendar-year corporation that began business on January 1, 2020. For the year, it reported the following information in its current year audited income statement. Notes with important tax information are provided below. Required: Identify the book-to-tax adjustments for XYZ a. Reconcile book income to taxable income and identify each book-tax difference as temporary or permanent. b. Compute XYZ’s income tax liability. c. Complete XYZ’s Schedule M-1. d. Complete XYZ’s Form 1120, page 1 (the most current form available). Ignore estimated tax penalties when completing the form. e. Determine the quarters for which XYZ is subject to penalties for the underpayment of estimated taxes (see assumptions and estimated tax information below). XYZ corp. Book to Tax Income statement Book Adjustments Taxable For current year Income (Dr.) Cr. Income Revenue from sales $40,000,000 Cost of Goods Sold (27,000,000) Gross profit $13,000,000 Other income: Income from investment in corporate stock 300,0001 Interest income 20,0002 Capital gains (losses) (4,000) Gain or loss from disposition of fixed assets 3,0003 Miscellaneous income 50,000 Gross Income $13,369,000 Expenses: Compensation (7,500,000)4 Stock option compensation (200,000)5 Advertising (1,350,000) Repairs and Maintenance (75,000) Rent (22,000) Bad Debt expense (41,000)6 Depreciation (1,400,000)7 Warranty expenses (70,000)8 Charitable donations (500,000)9 Meals (18,000) Goodwill impairment (30,000)10 Organizational expenditures (44,000) 11 Other expenses (140,000)12 Total expenses ($11,390,000) Income before taxes $1,979,000 Provision for income taxes (400,000)13 Net Income after taxes $1,579,00014 Notes: 1. XYZ owns 30% of the outstanding Hobble Corp. (HC) stock. Hobble Corp. reported $1,000,000 of income for the year. XYZ accounted for its investment in HC under the equity method and it recorded its pro rata share of HC’s earnings for the year. HC also distributed a $200,000 dividend to XYZ. 2. Of the $20,000 interest income, $5,000 was from a City of Seattle bond, $7,000 was from a Tacoma City bond, $6,000 was from a fully taxable corporate bond, and the remaining $2,000 was from a money market account. 3. This gain is from equipment that XYZ purchased in February and sold in December (i.e., it does not qualify as §1231 gain). 4. This includes total officer compensation of $2,500,000 (no one officer received more than $1,000,000 compensation). 5. This amount is the portion of incentive stock option compensation that vested during the year (recipients are officers). 6. XYZ actually wrote off $27,000 of its accounts receivable as uncollectible. 7. Tax depreciation was $1,900,000. 8. In the current year, XYZ did not make any actual payments on warranties it provided to customers. 9. XYZ made $500,000 of cash contributions to qualified charities during the year. 10. On July 1 of this year XYZ acquired the assets of another business. In the process it acquired $300,000 of goodwill. At the end of the year, XYZ wrote off $30,000 of the goodwill as impaired. 11. XYZ expensed all of its organizational expenditures for book purposes. XYZ expensed the maximum amount of organizational expenditures allowed for tax purposes. 12. The other expenses do not contain any items with book-tax differences. 13. This is an estimated tax provision (federal tax expense) for the year. Assume that XYZ is not subject to state income taxes. Estimated tax information: XYZ made four equal estimated tax payments totaling $360,000 ($90,000 per quarter). For purposes of estimated tax liabilities, assume XYZ was in existence in 2019 and that in 2019 it reported a tax liability of $500,000, During 2020, XYZ determined its taxable income at the end of each of the four quarters as follows: Quarter-end Cumulative taxable income (loss) First $400,000 Second $1,100,000 Third $1,400,000 Finally, assume that XYZ is not a large corporation for purposes of estimated tax calculations. a. Description Book Income (Dr) Cr Book-tax adjustments* Taxable Income (Dr) Cr (Dr) Cr Revenue from sales $40,000,000 $40,000,000 Cost of Goods Sold (27,000,000) (27,000,000) Gross profit $13,000,000 $13,000,000 Other income: Income from investment in corporate stock 300,0001 (100,000) [T] 200,000 Interest income 20,000 (12,000) [P] 8,000 Capital gains (losses) (4,000) 4,000 [T] 0 Gain on fixed asset dispositions 3,000 3,0002 Miscellaneous income 50,000 50,000 Gross Income $13,369,000 $13,261,000 Expenses: Compensation (7,500,000) (7,500,000) Stock option compensation (200,000) 200,000 [P] 0 Advertising (1,350,000) (1,350,000) Repairs and Maintenance (75,000) (75,000) Rent (22,000) (22,000) Bad debt expense (41,000) 14,000 [T] (27,000) Depreciation (1,400,000) (500,000) [T] (1,900,000) Warranty expenses (70,000) 70,000 [T] 03 Charitable contributions Moved below Meals (18,000) 9,000 [P] (9,000) Goodwill impairment (30,000) 20,000 [T] (10,000)4 Organizational expenditures (44,000) 36,400 [T] (7,600)5 Other expenses (140,000) (140,000) Federal income tax expense (400,000) 400,000 [P] 0 Total expenses before charitable contribution, NOL, and DRD (11,290,000) (11,040,600) Income before charitable contribution and DRD $1,079,000 $2,220,400 Charitable contributions (500,000) 277,960 [T] (222,040)6 Taxable income before DRD $1,998,360 Dividends received deduction (DRD) (130,000) [P] (130,000)7 Book/Taxable income $1,579,000 (742,000) 1,031,360 $1,868,360 *[T] reflects temporary book-tax differences and [P] reflects permanent book-tax differences. 1. Using the equity method, XYZ accounts for $300,000 of income for book purposes ($1,000,000 × .30). 2. This is ordinary income for tax purposes (used in trade or business held for less than a year) so it is not netted with the capital loss. 3. Warranty expense is deductible for tax purposes when paid. 4. For tax purposes, XYZ is allowed to amortize goodwill acquired in an asset acquisition on a straight-line basis over 180 months. In 2020, it is allowed to amortize goodwill for 6 months because the goodwill was acquired in July. Its deductible amortization expense for goodwill is $10,000 ($300,000 /180 months × 6 months). So, the Schedule M-1 adjustment is $20,000 unfavorable. 5. Because XYZ reported less than $50,000 in organization expenditures it is allowed to immediately expense $5,000 and amortize the remaining costs $39,000 ($44,000 - 5,000) over 180 months (15 years). Because XYZ began business in January, it is allowed to deduct a full year’s worth of amortization. In total, its XYZ’s deductible amortization is $7,600 [$5,000 + 2,600 ($39,000/15)]. 6. The charitable contribution deduction is limited to $222,040 which is 10% of taxable income before the charitable contribution and DRD ($2,220,400 × 10%). 7. Because XYZ owns 30% of HC, it is entitled to a 65% DRD. Its DRD is $130,000 ($200,000 dividend × 65%). b. XYZ’s income tax liability is $392,356 ($1,868,360 × 21%). c. XYZ’s Schedule M-1 is as follows: Schedule M-1 1 Net income per books $1,579,000 2 Federal income tax provision 400,000 3 Excess of capital losses over capital gains 4,000 4 Income subject to tax not recorded on books this year (itemize) 5 Expenses recorded on books this year not deducted on this return a. Depreciation b. Contributions carryover 277,960 c. Meals 9,000 Stock option compensation (incentive stock options) 200,000 Bad debt expense 14,000 Warranty expense 70,000 Goodwill impairment 20,000 Organizational expenditures 36,400 6 Add lines 1 through 5 $2,610,360 7 Income recorded on books this year not included on this return a. Tax exempt interest 12,000 Income from investment in corporate stock 100,000 8 Deductions on this return not charged against book income this year a. Depreciation 500,000 b. Contributions carryover 9 Add lines 7 and 8 612,000 10 Income (line 28, page 1) – line 6 less line 9 $1,998,360 Note that line 10 does not reconcile to XYZ’s taxable income. It reconciles to taxable income before the dividends received deduction of $130,000. XYZ’s taxable income is $1,868,360 ($1,998,360 -130,000). d. The front page of XYZ’s Form 1120 is as follows: Other expenses: Meals $9,000 Goodwill amortization 10,000 Organizational expenditures 7,600 Other 140,000 $166,600 e. In this part of the problem, we assume that XYZ filed a tax return last year (2019) and reported a tax liability of $500,000. This year, XYZ’s actual tax liability is $392,356 and it made $360,000 in estimated tax payments. Installment (1) Taxable income (2) Annualization Factor (1) x (2) Annual Estimated taxable income 1st quarter $400,000 12/3 = 4 $1,600,000 2nd quarter $400,000 12/3 = 4 $1,600,000 3rd quarter $1,100,000 12/6 = 2 $2,200,000 4th quarter $1,400,000 12/9 = 1.33 $1,862,000 Required Estimated Tax Payments under annualized method Installment (1) Annual estimated taxable income (2) Tax on estimated taxable income 21% (3) (1) × (2) Percentage of tax required to be paid (4) (2) × (3) Required cumulative payment 1st quarter 1,600,000 336,000 25% 84,000 2nd quarter 1,600,000 336,000 50% 168,000 3rd quarter 2,200,000 462,000 75% 346,500 4th quarter 1,862,000 391,020 100% 391,020 Installment (1) Required cumulative payment under prior year tax method ($500,000/4 per quarter) (2) Estimated tax payment under annualized method (3) Required payment based on current year tax liability (4 ) Required cumulative payment Least of (1), (2), and (3)] ((5) Actual payments Underpayment penalty Yes if (5)< (4) 1st quarter $125,000 $84,000 $98,089 $84,000 $90,000 No 2nd quarter $250,000 $168,000 $196,178 $168,000 $180,000 No 3rd quarter $375,000 $346,500 $294,267 $294,267 $270,000 Yes 4th quarter $500,000 $391,020 $392,356 $391,020 $360,000 Yes XYZ is subject to an underpayment penalty based on a $24,267 ($294,267 - $270,000) underpayment during for the third quarter and a $31,020 ($391,020 - $360,000) underpayment for the fourth quarter. The penalty is applied on the underpayment at the federal short-term rate plus 3% for the number of days between the due date of the third quarter payment and the date of the fourth quarter payment. Solution Manual for McGraw-Hill's Taxation of Individuals and Business Entities 2021 Brian C. Spilker, Benjamin C. Ayers, John A. Barrick, Troy Lewis, John Robinson, Connie Weaver, Ronald G. Worsham 9781260247138, 9781260432534