Intermediate Managerial and Tax Accounting, he Choice of Business Entity

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Intermediate Managerial and Tax
Accounting ACCTG 325, Fall 2024
Exercise 8
Chapter 12, The Choice of Business Entity
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1. Delta Partnership has four equal partners. At the beginning of the year, Drew was one of the Delta partners, but on
October 1, he sold his partnership interest to Cody. If Delta’s ordinary income for the year was $476,000, what
portion of this income should be allocated to Drew and what portion should be allocated to Cody?
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2. American Corporation has two equal shareholders, Mr. Freedom and Brave Inc. In addition to their investments in
American stock, both shareholders have made substantial loans to American. During the current year, American
paid $100,000 interest each to Mr. Freedom and Brave Inc. Assume that American and Brave have 21 percent tax
rates and Mr. Freedom’s marginal tax rate on ordinary income is 37 percent.
a. Calculate American’s tax savings from deduction of these interest payments and their after-tax cost.
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b. Calculate Brave’s tax cost and after-tax earnings from its receipt of income from American.
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c. Calculate Mr. Freedom’s tax cost and after-tax earnings from his receipt of income from American.
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d. If an IRS agent concludes that American is thinly capitalized and the shareholder loans should be treated
as equity, explain the impact on American, Brave, and Mr. Freedom.
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e. Recalculate Brave’s tax cost and after-tax earnings assuming its receipt of interest from American is
treated as a constructive dividend.
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f. Recalculate Mr. Freedom’s tax cost and after-tax earnings assuming his receipt of interest from American
is treated as a constructive dividend.
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3. During a recent IRS audit, the revenue agent determined that Level Corporation meets the definition of a personal
holding company. If Level’s undistributed after-tax income last year was $670,000, compute the amount of
personal holding company tax it owes.
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Intermediate Managerial and Tax
Accounting ACCTG 325, Fall 2024
Exercise 8
Chapter 12, The Choice of Business Entity
4. During a recent IRS audit, the revenue agent determined that the Parker family used their closely held corporation
to, Falco, to avoid shareholder tax by accumulating earnings beyond the reasonable needs of the business. Falco’s
taxable income was $900,000, it paid no dividends, and it had no business need to retain income. Falco’s marginal
tax rate in prior years was 34 percent. Compute Falco’s accumulated earnings tax assuming that:
a. It had accumulated $4,000,000 of after-tax income in prior years.
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b. It had accumulated $129,000 of after-tax income in prior years.
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