HARVARD UNIVERSITY
FACULTY OF ARTS AND SCIENCES - EXTENSION SCHOOL
TAX FACTORS IN BUSINESS DECISIONS
ACCOUNTING E-140
SPRING TERM 2008 – EXAMINATION #1
NAME: ______
The examination consists of twenty four (24) multiple choice questions and 7 short problems. The grading will be approximately balanced between the multiple choice and the problems. Please use the attached grading sheet by marking your selection with an “X”. The short problems should be answered directly in the space below each problem. Please email your grading sheet only (Please do not email the multiple choice questions) and your solutions to the seven (7) problems to me no later than Wednesday, March 26, 2008 at 9:30 pm. Alternatively, you may either deliver or mail the examination to me at Baker Library at the address on the Syllabus.
1. What is George’s gross income if he has the following: Salary = $78,000; Dividends = $4,000; interest on city of San Francisco bonds = $2,000; a gain of $14,000 on a stock sale and a $4,000 loss on a small sole proprietorship that he owns.
a. / $78,000 / c. / $92,000b. / $84,000 / d. / $96,000
2. Jason purchased a 20 percent interest in JKL Partnership for $20,000 at the beginning of the year. At year-end, the partnership reported net income of $15,000 and distributed $2,000 to Jason. What is Jason’s year-end basis?
a. / $20,000 / c. / $23,000b. / $21,000 / d. / $33,000
3. Ted owns 20% of Genco (a C corporation) that had taxable income of $100,000 and paid a total of $50,000 in dividends to its shareholders. Ted also owns a 10% of Subco (an S corporation) that had $100,000 of taxable income and distributed a total of $60,000 to its shareholders. How much must Ted include in his gross income as a result of being a shareholder in these two corporations?
a. / $16,000 / c. / $26,000b. / $20,000 / d. / $30,000
4. Wesley invested $100,000 in Hollywood (a C corporation) for a 10% interest and also invested $50,000 in Cage (an S corporation) for a 25% interest. For the current year, Hollywood had a taxable loss of $120,000 and Cage had a taxable loss of $75,000. No distributions were made. If Wesley is in the 25% marginal tax bracket, how much will he be able to save in taxes in the current year as a result of these corporate losses? (Round up your calculations)
a. / $18,750 / d. / $4,688b. / $12,500 / e. / None of the above.
c. / $7,000
5. Crystal invested $8,000 cash in CRK Partnership for a 30% general partnership interest. In its first year of operations, CRK lost $15,000. In its second year of operations, CRK lost an additional $14,000. How much of the second year’s losses can Crystal deduct?
a. / $700 / c. / $3,500b. / $2,400 / d. / $4,200
6. Hoku Corporation (a C corporation) had the following history of income and loss:
Year / Income (Loss)2005 / $70,000
2006 / $40,000
2007 / ($10,000)
How much of a tax refund can Hoku Corporation receive by carrying back its 2007 loss?
a. / $1,500 / c. / $3,500b. / $2,500 / d. / None; it cannot carry its loss back
7. How much income tax must the Benton Trust pay if its taxable income (after all deductions) is $4,600?
a. / $460 / c. / $935b. / $690 / d. / $1,150
8. Coral Corporation (a C corporation) sold $100,000 of merchandise for which it paid $40,000. It also paid $35,000 of other expenses. All transactions were in cash. What is Coral Corporation’s after-tax net cash inflow?
a. / $100,000 / c. / $25,000b. / $60,000 / d. / $21,250
9. Merced Company has invested $200,000 in a project. It had before tax net income of $100,000 in year 1, $150,000 in year 2, and $125,000 in year 3. What is the net present value of this project’s after-tax net cash flow if Merced’s discount rate is 8 percent and its marginal tax rate is 34 percent in all years?
a. / $11,464 / c. / $211,464b. / $120,000 / d. / $320,400
10. Crispen Corporation can invest in a project that costs $400,000. The project is expected to have an after-tax return of $250,000 in each of years 1 and 2. Crispen normally uses a 10 percent discount rate to evaluate projects but feels it should use 12 percent to compensate for inflation. How much difference does the rate make in the after-tax net present value of the project?
a. / $50,000 / c. / $20,000b. / $22,500 / d. / $11,250
11. Which of the following is not a requirement to qualify for innocent spouse relief?
a. / The individual electing innocent spouse relief must have been abandoned by her spouse for more than 6 months.b. / The individual establishes that she did not know and had no reason to know that there was an understatement
c. / It would be inequitable to hold the individual liable for the deficiency attributable to the understatement when all facts and circumstances are considered
d. / The individual elects innocent spouse relief no later than 2 years after collection activities against the person seeking relief have begun.
12. Sheryl sold 100 shares of ABC stock for $2,100 and 300 shares of XYZ stock for $8,900. She purchased the ABC stock four years ago for $1,200 and the XYZ stock two years ago for $9,100. What is the net effect of these sales on Sheryl’s income?
a. / $200 net gain / c. / $900 net gainb. / $700 net gain / d. / $1,100 net gain
13. George can invest $10,000 in a tax-exempt bond paying 6 percent interest or a $10,000 corporate bond paying 8 percent interest. What is the lowest marginal tax rate at which George will be better off investing in the tax-exempt bond?
a. / 15% / c. / 28%b. / 25% / d. / 33%
14. Clayton Corporation receives $100,000 to provide garbage service for the next four years:
a. / Clayton must recognize income over the four years for both tax and accounting purposes.b. / Clayton can include the entire $100,000 in income currently for both tax and accounting purposes.
c. / The $100,000 creates a permanent difference between tax and accounting income.
d. / The $100,000 creates a timing difference between tax and accounting income.
15. Bigtown Advertising Agency, a calendar-year, accrual basis taxpayer, was paid $60,000 for a three-year advertising contract on July 1, 2007, and $36,000 for a 12-month contract on December 1, 2007. How much income must Bigtown recognize for these contracts in years 2007 and 2008, respectively?
a. / $96,000, 0 / c. / $63,000, $33,000b. / $13,000, $83,000 / d. / $13,000, $53,000
16. George and Georgette divorced last year. George was ordered to pay (and does pay) Georgette $600 per month alimony and $800 per month child support. In addition, George transferred title to his half of their stock to Georgette last year. The stock had a basis of $120,000 and a fair market value of $260,000 at the date of the transfer. This year Georgette sells the stock for $280,000. What is Georgette’s income for this year if she has no other income items?
a. / $7,200 / c. / $159,200b. / $19,200 / d. / $167,200
17. Myra retired last year from Whiplash Company after working there for 30 years. She elects to take her retirement benefits in the form of a lifetime annuity. Her retirement balance consists of $40,000 of employer contributions, $80,000 of her before-tax contributions, $20,000 of her after-tax contributions, and $60,000 of investment income. The plan will pay her $1,500 per month based on her life expectancy of 22 years. In 2007, Myra receives twelve $1,500 payments. What is her taxable income?
a. / $18,000 / c. / $14,364b. / $17,091 / d. / $13,455
18. Tomohiro Corporation loans $50,000 interest-free for one year to Matt, a shareholder. Matt uses the loan to pay for personal debts. Assume that the applicable federal rate is 4 percent. What are the tax consequences of this loan to Tomohiro and to Matt?
a. / No tax consequences to either Tomohiro or Mattb. / No income to Matt, $2,000 deduction for Tomohiro
c. / $2,000 income to Matt, no income to Tomohiro
d. / $2,000 income to Matt and $2,000 deduction for Tomohiro
e. / $2,000 income to Matt and $2,000 income to Tomohiro
19. Howard is a cash-basis, calendar-year taxpayer. He works for Clyde Corporation, an accrual-basis, calendar-year corporation. Clyde authorizes a $10,000 bonus for Howard on December 20, year 1. It pays the bonus on March 31 of year 2. Which of the following is correct?
a. / Howard recognizes income in year 1 and Clyde takes a deduction in year 1b. / Howard recognizes income in year 1 and Clyde takes a deduction in year 2
c. / Howard recognizes income in year 2 and Clyde takes a deduction in year 1
d. / Howard recognizes income in year 2 and Clyde takes a deduction in year 2
20. Carol owns a small curio shop that is incorporated as an S corporation. Her three children, Sara, age 16, Mark, age 19, and Corey, age 22, all help in the shop. Which of the children’s wages are subject to FICA taxes?
a. / None of the wages are subject to FICA taxes.b. / Corey’s wages only
c. / Mark and Corey’s wages only.
d. / All their wages are subject to FICA taxes.
21. Tom, a calendar-year taxpayer, worked in Kuwait from July 1, 2006 through June 30, 2007. He earns $60,000 in 2006 and $70,000 in 2007 while in Kuwait. Which of the following statements is true?
a. / None of the income can be excluded in 2006 or 2007.b. / $60,000 can be excluded in 2006 and $70,000 in 2007.
c. / $65,000 is the maximum that can be excluded in each year.
d. / $42,850 can be excluded in 2007.
22. What is the maximum deductible contribution that Erick (age 32 and single) can make in 2007 to an Individual Retirement Account(s) if he earns $55,000 and is not covered by an employer-sponsored retirement plan?
a. / $5,000 ($4,000 plus an extra $1000 catch-up contribution) to a traditional IRA and zero to a Roth IRAb. / $4,000 to a traditional IRA but only an additional $2,000 to a Roth IRA
c. / $4,000 to a traditional IRA
d. / $2,000 to a traditional IRA due to the income limitation
23. Five years ago, Devin Corporation granted Laura nonqualified stock options to buy 1,000 shares of Devin stock at $22 per share exercisable for six years. At the date of grant, the stock was selling for $19 per share. Laura exercised the options this year when the market price was $28 per share. How much income must Laura recognize from the exercise of the options?
a. / zero / d. / $22,000b. / $3,000 / e. / $28,000
c. / $6,000
24. Henry, age 45, is an employee of Argus Corporation. His fringe benefits for the current year included:
· / $2,500 contributed by Argus to his qualified deferred compensation retirement plan. This year, the retirement plan earned $600 in interest and dividend income. Henry received no distributions from this plan· / A $100,000 face value group term life insurance policy for which Argus paid premiums of $650. Henry is a key employee and it is a discriminatory plan.
· / The use of a company-owned automobile. The annual lease value of this car is $15,000. Henry used it 70% of the time (and miles) for personal use and 30% for business use.
· / Free parking in the company parking lot (valued at $100 per month)
How much must Henry include in gross income?
a. / zero / d. / $11,190b. / $10,590 / e. / $15,450
c. / $11,150
Name ______
A B C D E
1. ( ) ( ) ( ) ( ) ( )
2. ( ) ( ) ( ) ( ) ( )
3. ( ) ( ) ( ) ( ) ( )
4. ( ) ( ) ( ) ( ) ( )
5. ( ) ( ) ( ) ( ) ( )
6. ( ) ( ) ( ) ( ) ( )
7. ( ) ( ) ( ) ( ) ( )
8. ( ) ( ) ( ) ( ) ( )
9. ( ) ( ) ( ) ( ) ( )
10. ( ) ( ) ( ) ( ) ( )
11. ( ) ( ) ( ) ( ) ( )
12. ( ) ( ) ( ) ( ) ( )
13. ( ) ( ) ( ) ( ) ( )
14. ( ) ( ) ( ) ( ) ( )
15. ( ) ( ) ( ) ( ) ( )
16. ( ) ( ) ( ) ( ) ( )
17. ( ) ( ) ( ) ( ) ( )
18. ( ) ( ) ( ) ( ) ( )
19. ( ) ( ) ( ) ( ) ( )
20. ( ) ( ) ( ) ( ) ( )
21. ( ) ( ) ( ) ( ) ( )
22. ( ) ( ) ( ) ( ) ( )
23. ( ) ( ) ( ) ( ) ( )
24. ( ) ( ) ( ) ( ) ( )
Seven Short Problems. Please complete all work in the space directly below the problem.
1. Darden Corporation has taxable income of $420,000. It if distributes all of its after-tax income to its sole shareholder who is in the 35 percent marginal tax bracket, what is the total tax burden on this $420,000 of income?
2. Berman Corporation can accept only one of two projects. The revenue and expenses for each of the projects is shown below. Which project should Berman accept if the corporation has a 10 percent cost of capital and a 34 percent marginal tax rate?
Project A / Project BYear 1 / Revenue / $800,000 / $700,000
Expenses / 525,000 / 500,000
Year 2 / Revenue / 600,000 / 700,000
Expenses / 425,000 / 550,000
3. Shelly runs a small business as a sole proprietorship. The business has average annual income of $60,000 and Shelly takes $30,000 out of the business for living expenses each year. If her marginal tax rate is 25 percent due to other income, what is the net income tax effect if she incorporates her business and takes the $30,000 as salary? (Ignore employment taxes.)
4. In 2007, Potrus, an accrual basis corporate taxpayer, received a $40,000 advance for a series of eight lectures by various employees for the Art Institute. After delivering five lectures, the series was cancelled for poor attendance. Potrus refused to return any of the advance payment, so the Art Institute sued. In 2008, Potrus was ordered by the court to repay $15,000. Potrus’s net income was $426,000 in 2007 and $298,000 in 2008. How should Potrus treat the repayment to obtain the best tax result?