CPA Practice Test 12
10 free CPA practice questions in the real exam format, covering the official content areas, with an explanation for every answer.
Question 1 of 10
Federal Taxation of Entities (including tax preparation)Tax File — Fenwick Tool & Die, Inc., Form 1120 (current year)
From: Alan Prescott, Tax Partner To: Staff Accountant Date: March 3, Year 2 Subject: Fenwick — Schedule M-1 and taxable income
Fenwick Tool & Die, Inc. is a calendar-year, accrual-method C corporation (not a member of a controlled group). Using the controller's notes, please prepare the key Schedule M-1 lines and carry the result to taxable income. Fenwick's average annual gross receipts exceed the small-business threshold, and the controller says all other book and tax amounts agree.
| Item | Amount |
|---|---|
| Net income per books (after tax) | $540,000 |
| Federal income tax expense per books (current and deferred) | $150,000 |
| Officer compensation (deducted for book and tax) | $310,000 |
| Estimated federal tax payments made during the year | $32,000 |
a. Dividends of $40,000 from Arlo Steel Corp., a domestic C corporation in which Fenwick owns 15%, are included in book income. b. Interest of $18,000 on municipal bonds is included in book income. c. Premiums of $9,000 on life insurance on Fenwick's chief engineer (Fenwick is the beneficiary) were expensed. d. Meals with customers, $14,000, were expensed. e. A golf outing for customers, $5,000, was expensed as entertainment. f. An OSHA fine of $3,000 was expensed. g. Credit-loss expense per books (allowance method) was $22,000; specific accounts written off as worthless during the year totaled $15,000. h. Book depreciation was $80,000; MACRS depreciation is $125,000. i. Fenwick sold marketable securities at a $12,000 capital loss; it had no capital gains this year or in the prior three years. j. On December 28, Fenwick collected $24,000 of rent from a subtenant for January–March of Year 2; books record it as unearned rent. k. Fenwick has a net operating loss carryforward of $600,000 from a prior year (arising after 2017). No other carryforwards or credits.
Authoritative excerpt (paraphrased)
Schedule M-1 reconciles net income per books (line 1) to taxable income before the net operating loss and special deductions (Form 1120 line 28). Line 2 adds federal income tax per books; line 3 adds the excess of capital losses over capital gains; line 4 adds income taxable this year but not recorded on the books; line 5 adds expenses recorded on the books but not deducted on the return; line 7 subtracts book income not taxed this year; line 8 subtracts return deductions not charged against book income.
IRC §1211(a) allows a corporation's capital losses only to the extent of capital gains; §1212(a) carries the excess back 3 years and forward 5. §166 allows bad-debt deductions only for specific debts that become worthless. Prepaid rent is taxable when received (Reg. §1.61-8(b)). §§162(f), 264(a), 274(a) and 274(n) disallow government fines, premiums where the corporation is a beneficiary, entertainment, and 50% of business meals.
§243 allows a 50% dividends-received deduction for dividends from a domestic corporation owned less than 20%. §172(a) limits a deduction for a net operating loss arising after 2017 to 80% of taxable income computed without the NOL deduction itself.
Row 1 — Schedule M-1 line 5. Enter the total of expenses recorded on Fenwick's books this year that are not deducted on the return.