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XYZ is a calendar-year corporation that began business on January 1, 2017. For 2017, it reported the following information in its current-year audited income statement. Notes with important tax information are provided below.
| XYZ corp. | Book Income |
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| Income statement | |||||||||||||||||||
| For current year | |||||||||||||||||||
| 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 | 300,000 | 1 | |||||||||||||||||
| Interest income | 20,000 | 2 | |||||||||||||||||
| Capital gains (losses) | (4,000 | ) | |||||||||||||||||
| Gain or loss from disposition of fixed assets | 3,000 | 3 | |||||||||||||||||
| 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 and entertainment | (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 | (720,000 | )13 | |||||||||||||||||
| Net Income after taxes | $ | 1,259,000 | 14 | ||||||||||||||||
| Notes:
XYZ owns 30 percent 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. Of the $20,000 interest income, $5,000 was from a City of Seattle bond issued in 2014 that was used to fund public activities, $7,000 was from a Tacoma City bond issued in 2014 used to fund private activities (a private activity bond), $6,000 was from a fully taxable corporate bond, and the remaining $2,000 was from a money market account. This gain is from equipment that XYZ purchased in February and sold in December (i.e., it does not qualify as §1231 gain). This includes total officer compensation of $2,500,000 (no one officer received more than $1,000,000 compensation). This amount is the portion of incentive stock option compensation that was expensed during the year (recipients are officers). XYZ actually wrote off $27,000 of its accounts receivable as uncollectible. Regular tax depreciation was $1,900,000 and AMT (and ACE) depreciation was $1,700,000. In the current year, XYZ did not make any actual payments on warranties it provided to customers. XYZ made $500,000 of cash contributions to qualified charities during the year. 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. XYZ expensed all of its organizational expenditures for book purposes. XYZ expensed the maximum amount of organizational expenditures allowed for tax purposes. The other expenses do not contain any items with book-tax differences. This is an estimated tax provision (federal tax expense) for the year. Assume that XYZ is not subject to state income taxes. XYZ calculated that its domestic production activities deduction (DPAD) is $90,000. This amount is not included on the audited income statement numbers. Estimated tax information: XYZ made four equal estimated tax payments totaling $480,000. For purposes of estimated tax liabilities, assume XYZ was in existence in 2016 and it reported a tax liability of $800,000. During 2017, XYZ determined its taxable income at the end of each of the four quarters as follows:
Finally, assume that XYZ is not a large corporation for purposes of estimated tax calculations. (Do not round intermediate calculations. Round your answers to the nearest dollar amount.) Comprehensive Problem 16-87 Part a a. Compute XYZ’s taxable income.
b. Compute XYZ’s regular income tax liability. (Use Corporate Tax Rate Schedule.)
c. Complete XYZ’s Schedule M-1. (Enter all amounts as positive numbers.)
e. Compute XYZ’s alternative minimum tax, if any.
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Expert Answer
| 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 and entertainment | (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 | (720,000) | 720,000 [P] | 0 | |
| Total expenses before charitable contribution, NOL, DRD, and DPAD deduction | (11,610,000) | (11,040,600) | ||
| Income before charitable contribution, DRD, and DPAD | $1,759,000 | $2,220,400 | ||
| Charitable contributions | (500,000) | 277,960 [T] | (222,040)7 | |
| Taxable income before DRD and DPAD | $1,998,360 | |||
| Dividends received deduction (DRD) | (160,000) [P] | (160,000) | ||
| Domestic production activities deduction | (90,000) [P] | (90,000) | ||
| Book/Taxable income | $1,259,000 | (862,000) | 1,351,360 | $1,748,360 |
*[T] reflects temporary book-tax differences and [P] reflects permanent book-tax differences.
- Using the equity method, XYZ accounts for $100,000 of income for book purposes ($1,000,000 x .3).
- 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.
- Warranty expense is deductible for tax purposes when paid.
- For tax purposes, XYZ is allowed to amortize goodwill acquired in an asset acquisition on a straight-line basis over 180 months. In 2011, 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 ($30,000/180 months x 6 months). So, the Schedule M-1 adjustment is $20,000 unfavorable.
- 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)].
- The charitable contribution deduction is limited to $222,040 which is 10% of taxable income before the charitable contribution, DRD, or DMD ($2,220,400 x 10%).
- Because XYZ owns 30% of HC, it is entitled to an 80% DRD. Its DRD is $160,000 ($200,000 dividend x 80%).
b. XYZ’s regular income tax liability is $594,442 ($1,748,360 x 34%).
c. XYZ’s Schedule M-1 is as follows:
| Schedule M-1 | ||
| 1 | Net income per books | $1,259,000 |
| 2 | Federal income tax provision | 720,000 |
| 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. Travel and entertainment | 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 | ||
| Domestic production activities deduction | 90,000 | |
| 9 | Add lines 7 and 8 | 702,000 |
| 10 | Income (line 28, page 1) – line 6 less line 9 | $1,908,360 |
Note that line 10 does not reconcile to XYZ’s taxable income. It reconciles to taxable income before the dividends received deduction of $160,000. XYZ’s taxable income is $1,748,360 ($1,908,360 -160,000).
. XYZ’s alternative minimum tax liability is $0, computed as follows:
| AMT Calculation | ||
| Category | Item/Calculation | Amount |
| Taxable income or loss before NOL deduction | $1,748,360 | |
| Preference items | Private activity bond | 7,000 |
| Adjustments | Depreciation | 200,000 |
| ACE adjustment | 9,450 | |
| Alternative minimum taxable income (AMTI) | $1,964,810 | |
| Subtract: Exemption (completely phased-out) | (0) | |
| AMT base | $1,964,810 | |
| x 20% | .2 | |
| Tentative minimum tax | $392,962 | |
| Subtract:
Regular income tax ($1,748,360 x 34%) |
$594,442 | |
| Alternative minimum tax
if positive. |
$0 | |
| ACE Adjustment | |
| Description | Modification to AMTI |
| Tax-exempt interest income from tax exempt bond that funds a public activity (as opposed to private activity) | +$5,000 |
| Organizational expenditures that were expensed during the year | +7,600 |
| Total | 12,600 |
| ACE Adjustment ($12,600 total x 75%) | $9,450 |
