Pearson’s Federal Taxation 2022: Corporations, Partnerships, Estates, and Trusts, 35e

(Anderson et al.)
Chapter C8: Consolidated Tax Returns

LO1: Definition of an Affiliated Group

1) To be an affiliated group, the parent corporation must directly own at least 80% of another
group member.
Answer: TRUE
Explanation: To be an affiliated group, the parent corporation must directly own at least 80% of
another group member.
Page Ref.: C:8-2
Objective: 1

2) Brother-sister controlled groups can elect to file a consolidated tax return.

Answer: FALSE
Explanation: Lacking a parent
Page Ref.: C:8-4
Objective: 1

3) Identify which of the following statements is true.

A) To be part of an affiliated group, a corporation must be at least 80% directly owned by
another group member.
B) Only common stock is considered when determining if the 80% ownership test is met for
affiliated group eligibility.
C) An affiliated group electing to file a consolidated return may be composed of as few as two
corporations.
D) All of the above are false.
Answer: C
Explanation: An affiliated group electing to file a consolidated return may be composed of as
few as two corporations.
Page Ref.: C:8-2 and C:8-3
Objective: 1

4) Which of the following corporations is an includible corporation for purposes of filing a

consolidated tax return?
A) insurance companies
B) S corporations
C) car manufacturing corporation
D) foreign corporations
Answer: C
Explanation: Insurance companies, S Corporations and Foreign corporations may not be
included in a consolidated return
Page Ref.: C:8-3
Objective: 1

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5) Diana Corporation owns stock of Tomika Corporation. For Diana and Tomika to qualify for
the filing of consolidated returns, at least what percentage of Tomika's total voting power and
total value of stock must be directly owned by Diana?
A)
Total voting Total Value of
power stock
51% 51%

B)
Total voting Total Value of
power stock
51% 80%

C)
Total voting Total Value of
power stock
80% 51%

D)
Total voting Total Value of
power stock
80% 80%

Answer: D
Explanation: Minimum threshold of 80%
Page Ref.: C:8-3
Objective: 1

6) Ajak Corporation owns 85% of the single class of Utech Corporation stock. Utech
Corporation owns 35% of Tech Corporation. Ajak Corporation also owns 50% of Tech
Corporation, and Tech Corporation owns 75% of Baxter Corporation. What entities are in the
affiliated group?
A) Ajak, Tech, Utech, and Baxter Corporations are an affiliated group.
B) Ajak, Tech, and Baxter Corporations are an affiliated group.
C) Ajak, Tech, and Utech Corporations are an affiliated group.
D) None of the above are correct.
Answer: C
Explanation: Common ownership
Page Ref.: C:8-3
Objective: 1

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7) Which of the following corporations is entitled to join in a consolidated tax return without
making a special election?
A) corporations exempt from tax under Sec. 501
B) real estate investment trusts
C) closely held corporations
D) foreign corporations
Answer: C
Explanation: Greater than 80% ownership
Page Ref.: C:8-3
Objective: 1

8) Identify which of the following statements is true.

A) If 100% of the stock of two corporations is owned by the same individual, the two
corporations are eligible to file a consolidated return.
B) The check-the-box regulations permit partnership and LLCs to elect C corporation tax
treatment.
C) A group of corporations that meets the parent-subsidiary controlled group requirements is
always eligible to file a consolidated return.
D) All of the above are false.
Answer: B
Explanation: The check-the-box regulations permit partnership and LLCs to elect C corporation
tax treatment.
Page Ref.: C:8-4
Objective: 1

9) Jeffrey Corporation owns 85% of Placer Corporation and 25% of Mercer Corporation. Placer
Corporation owns 60% of Mercer Corporation and 45% of Tyson Corporation. Jeffrey
Corporation also owns 85% of Apple Corporation and Apple Corporation owns 30% of Tyson
Corporation. Which of these corporations are members of an affiliated group if all percentages
represent voting power and value held by the respective corporations?
Answer: Jeffrey Corporation is the parent corporation with Placer, Mercer, and Apple
Corporations as members of the affiliated group. The 75% (30% + 45%) ownership of Tyson
Corporation stock does not meet the 80% ownership minimum.
Page Ref.: C:8-3
Objective: 1

10) Toby Corporation owns 85% of James Corporation's single class of stock and 35% of Mony
Corporation's single class of stock. James Corporation owns 45% of Mony's stock. The
remainder of James and Mony's stock is owned by 80 individual shareholders. Are the
corporations part of an affiliated group, and can they elect to file a consolidated tax return?
Answer: Since Toby owns more than 80% of the stock of James and therefore satisfies the direct
ownership requirement, and Toby and James together own 80% (45% + 35%) of Mony's stock,
they are affiliated corporations. The Toby, James, and Mony group can elect to file a
consolidated tax return.
Page Ref.: C:8-3; Example C:8-1
Objective: 1

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11) Toby owns all of the single class of stock of James and Mony Corporations. James
Corporation owns all of Volt Corporation's stock. Mony owns all of Wegnin Corporation. Mony
and Wegnin Corporations are foreign corporations. Toby, James, and Volt are domestic
corporations. Are the corporations part of an affiliated group?
Answer: Toby, James, and Volt constitute the affiliated group. Toby is the common parent.
Mony and Wegnin are not included, as they are foreign corporations.
Page Ref.: C:8-2 and C:8-3; Example C:8-3
Objective: 1

12) Explain the requirements a group of corporations must meet in order to elect to file a
consolidated return.
Answer: The parent corporation must own at least 80% of the total voting power and at least
80% of the total value of all outstanding stock in at least one includible corporation. Each
additional corporation that is included must also meet the two 80% stock ownership rules either
directly or indirectly. Eligible affiliated groups must make a consolidated return election by
filing a timely consolidated tax return.
Page Ref.: C:8-2 and C:8-3
Objective: 1

13) What types of corporations are not includible corporations for purposes of determining
whether or not an affiliated group exists?
Answer: Special tax status corporations are not includible corporations.
• Exempt corporations under Sec. 501
• Insurance companies subject to tax under Sec. 801
• Foreign corporations
• Corporations claiming the Puerto Rico and U.S. possessions tax credit
• Regulated investment companies
• Real estate investment trusts
• Domestic international sales corporations
• S corporations
Page Ref.: C:8-3
Objective: 1

14) What are the differences between a controlled group and an affiliated group?
Answer: Three forms of controlled groups are permitted — brother-sister groups, parent-
subsidiary groups, and combined groups. Only parent-subsidiary groups and the parent-
subsidiary portion of a combined group can elect to file a consolidated tax return. Four primary
differences between a controlled group and an affiliated group exist. First, the two 80% stock
ownership tests must be met to have an affiliated group. Only one of the tests needs to be met to
have a controlled group. Second, the controlled group definition uses certain stock attribution
rules and included and excluded corporation rules that are not used in testing for an affiliated
group. Third, certain special status corporations are excluded from the affiliated group definition
that may be included in a controlled group. Fourth, the controlled group definition is tested only
at December 31. The affiliated group definition must be tested on each day of the year. See
Chapter C3 for further discussion of controlled group topics.
Page Ref.: C:8-4
Objective: 1
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15) What issues determine whether an affiliated group exists?
Answer: In determining whether an affiliated group exists, three questions must be answered.
• Does a corporation (common parent) directly own 80% or more of at least one includible
corporation?
• What are the includible corporations?
• What chains of includible corporations are connected by at least 80% ownership?
Page Ref.: C:8-3
Objective: 1

LO2: Consolidated Tax Return Election

1) A Canadian subsidiary cannot file as part of the consolidated group with its U.S. parent.
Answer: FALSE
Explanation: A Canadian subsidiary can file as part of a consolidated group with its US parent.
Page Ref.: C:8-4
Objective: 2

2) The election to file a consolidated return is made annually.

Answer: FALSE
Explanation: Once made election is binding.
Page Ref.: C:8-5
Objective: 2

3) A separate return year is a corporation's tax year for which it files a separate tax return or files
a consolidated tax return with another affiliated group.
Answer: TRUE
Explanation: A separate return year is a corporation's tax year for which it files a separate tax
return or files a consolidated tax return with another affiliated group.
Page Ref.: C:8-5
Objective: 2

4) Cardinal and Bluebird Corporations both use a calendar year as their tax year. At the close of
business on June 30, Cardinal Corporation buys all of Bluebird Corporation's stock. If the two
corporations file a consolidated return and both corporations earn their income evenly throughout
the year, what portion of Cardinal's income will be included in the consolidated return? (Assume
all months have 30 days.)
A) 100%
B) 50%
C) 0%
D) none of the above
Answer: A
Explanation: Consolidated return - Cardinal is parent.
Page Ref.: C:8-5; Example C:8-6
Objective: 2

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5) Cardinal and Bluebird Corporations both use a calendar year as their tax year. At the close of
business on June 30, Cardinal Corporation buys all of Bluebird Corporation's stock. If the two
corporations file a consolidated return and both corporations earn their income evenly throughout
the year, what portion of Bluebird's income will be included in the consolidated return? (Assume
all months have 30 days.)
A) 100%
B) 50%
C) 0%
D) none of the above
Answer: B
Explanation: Consolidated return Bluebird is subsidiary, only owned for half of the year
Page Ref.: C:8-5; Example C:8-6
Objective: 2

6) Parent Corporation owns all of the stock of Richards and Smith Corporations on January 1.
The three corporations have filed consolidated tax returns for a number of calendar years. Parent
sells all of the stock of Richards Corporation on June 1. Parent purchases all of the stock of
Taylor Corporation on September 1. Parent sells all of the stock of Smith Corporation on
November 1. When does the affiliated group terminate?
A) June 1
B) September 1
C) November 1
D) The original affiliated group does not terminate.
Answer: D
Explanation: A least one subsidiary still exists
Page Ref.: C:8-5
Objective: 2

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7) Alto and Bass Corporations have filed consolidated tax returns for several calendar years. At
the close of business on September 30, Alto Corporation sells all of the Bass Corporation stock.
What portion of Alto's and Bass's income for the current year will be included in the
consolidated return, assuming its income is earned evenly throughout the year and all months
have 30 days?
A)
Alto Bass
100% 100%

B)
Alto Bass
100% 75%

C)
Alto Bass
75% 75%

D) none of the above

Answer: B
Explanation: Owned 75% of the year
Page Ref.: C:8-5
Objective: 2

LO3: Consolidated Taxable Income

1) Identify which of the following statements is true.

A) When a new corporation joins an affiliated group, all of its income and expense items for the
tax year, including the acquisition date, must be allocated between the separate tax return and
consolidated tax return that are to be filed based on the number of days included in each of the
two tax years.
B) A consolidated return election may be revoked after 5 years.
C) All members of a consolidated group must use the same tax year.
D) All of the above are false.
Answer: C
Explanation: Members of consolidated group must use same tax year
Page Ref.: C:8-6 through C:8-8
Objective: 3

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2) Identify which of the following statements is true.
A) Corporations that join in a consolidated return must adopt the same tax year as the parent
corporation.
B) Permission to discontinue the filing of consolidated tax returns is sometimes granted by the
IRS.
C) Additional administrative costs may be incurred when filing a consolidated tax return.
D) All of the above are true.
Answer: D
Explanation: See page C:8-6
Page Ref.: C:8-6 through C:8-8
Objective: 3

3) Identify which of the following statements is true.

A) A corporation may be required to file a separate return and file with an affiliated group in the
same calendar year.
B) When a corporation joins in filing a consolidated return, taxable income of the member is
combined with other members' taxable income prior to any adjustments.
C) If a corporation becomes a member of an affiliated group within the first thirty days of the
corporation's tax year, the corporation can elect not to file a short-period tax return.
D) All of the above are false.
Answer: A
Explanation: A corporation may be required to file a separate return and file with an affiliated
group in the same calendar year.
Page Ref.: C:8-6 and C:8-7
Objective: 3

4) Penish and Sagen Corporations have filed consolidated tax returns for several calendar years.
At the close of business on September 30, 2018, Penish Corporation sells all of its Sagen stock to
June. What are the tax consequences to each corporation?
Answer: All of Penish's income is included in the consolidated tax return for 2018. Only nine
months of Sagen Corporation's income is included in the consolidated tax return for 2018. Sagen
must also file a separate tax return for the period October 1 through December 31, 2018.
Page Ref.: C:8-7
Objective: 3

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5) Marietta and Alpharetta Corporation, two accrual method of accounting corporations that use
the calendar year as their tax year, have filed consolidated tax returns for a number of years.
Alpharetta Corporation, a 100% owned subsidiary of Marietta, is transferring a patent,
equipment, and working capital to newly created Georgia Corporation in exchange for 100% of
its stock. In 2018, the corporation will begin to produce parts for the computer industry. Georgia
Corporation expects to incur organizational expenditures of $10,000 and start-up expenditures of
$60,000. What tax issues should Georgia Corporation consider with respect to the selection of its
overall accounting method, inventory method, and tax year, and the proper reporting of its
organizational and start-up expenditures?
Answer:
• What tax year can Georgia Corporation elect?
• What overall method of accounting can Georgia Corporation elect?
• What inventory method can Georgia Corporation elect?
• How does Georgia Corporation treat its organizational expenditures? Its start-up
expenditures?

Georgia Corporation must use the same tax year as the other two corporations in its affiliated
group. In general, Georgia Corporation can elect to use the cash, accrual, or hybrid methods of
accounting. However, since it is producing parts for the computer industry, inventories will be a
material income producing factor, and it must use the accrual method of accounting for its sales-
related activities. It is possible for Georgia Corporation to use the hybrid accounting method, and
if such an election were made, Georgia would not be required to use the accrual method of
accounting for its other income and expense items. It need not use the same accounting methods
as the other two corporations in the affiliated group. Georgia Corporation can elect any of the
inventory methods acceptable under Sec. 471. It does not need to use the same inventory method
as the other two corporations in its affiliated group. Georgia Corporation can elect to amortize its
organizational expenditures and its start-up costs whether or not the other two corporations have
made similar elections. There is no restriction under Code Secs. 195 and 248, or the consolidated
tax return regulations, that similar treatment of such expenditures be followed by all three
corporations.
Page Ref.: C:8-6 through C:8-8
Objective: 3

LO4: Intercompany Transactions

1) P and S are members of an affiliated group that has filed consolidated tax returns for a number
of years. The sale of inventory by P that was acquired from S in an intercompany transaction
outside the affiliated group triggers the recognition of gain by S.
Answer: TRUE
Explanation: P and S are members of an affiliated group that has filed consolidated tax returns
for a number of years. The sale of inventory by P that was acquired from S in an intercompany
transaction outside the affiliated group triggers the recognition of gain by S.
Page Ref.: C:8-18
Objective: 4

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2) Ajax and Brindel Corporations have filed consolidated returns for several calendar years. Ajax
acquires land for $60,000 on January 1 of last year. On September 1 of this year, Ajax sells the
land to Brindel for $90,000. The basis and holding period for the land acquired by Brindel are:
A)
Holding Period Begins
Basis On
$60,000 January 2 of last year

B)
Holding Period Begins
Basis On
$90,000 January 2 of last year

C)
Holding Period Begins
Basis On
$90,000 September 2 of this year

D) none of the above

Answer: C
Explanation: Sale basis of $90,000
Page Ref.: C:8-10 and C:8-11
Objective: 4

3) Which of the following events is an intercompany transaction?

A) a capital contribution
B) accrual of interest on a loan made by one group member to another group member; both
group members use the accrual method of accounting
C) dividend payment received from a subsidiary corporation to its parent corporation; the
subsidiary corporation is not an includible corporation
D) a parent corporation's sale of stock of a subsidiary corporation to a nonmember of the group
Answer: B
Explanation: Accrual of interest on a loan made by one group member to another group
member; both group members use the accrual method of accounting is an intercompany
transaction.
Page Ref.: C:8-10 and C:8-11
Objective: 4

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4) Subsidiary Corporation purchases a used machine from Parent Corporation in an
intercompany transaction. Which of the following events is a corresponding event for the
intercompany transaction?
A) the purchasing group member depreciating the machine
B) the purchasing group member selling the machine for cash to a nonmember of the group
C) the departure of the purchasing group member from the affiliated group when its stock is sold
to a nonmember of the group
D) All of the above are recognition events.
Answer: D
Explanation: See C8-10
Page Ref.: C:8-10 and C:8-11
Objective: 4

5) Which of the following events is an intercompany transaction that requires the deferral and
later recognition of income?
A) accrual of rentals on a lease of real property owned by one group member that is used by
another group member; both group members use the accrual method of accounting
B) cash dividend payment from a subsidiary corporation to its parent corporation
C) sale of inventory from a subsidiary corporation to its parent corporation
D) None of the above transactions require the deferral and later recognition of income.
Answer: C
Explanation: Sales of inventory between a subsidiary and parent corporation is an intercompany
transaction that requires the deferral and later recognition of income when the parent entity sells
the inventory to unrelated 3rd party.
Page Ref.: C:8-9
Objective: 4

6) Identify which of the following statements is false.

A) Inventory sales between group members are an example of an intercompany transaction.
B) The basis to the purchasing member of property acquired in an intercompany transaction is
the amount of cash paid to the selling member.
C) The holding period for property acquired in an intercompany transaction begins when the
corresponding item is reported.
D) In general, buyers and sellers engaging in an intercompany transaction are treated as separate
entities.
Answer: C
Explanation: Holding period carryovers from the source entity.
Page Ref.: C:8-8 through C:8-10
Objective: 4

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7) Identify which of the following statements is true.
A) The basic accounting method elections that are used by the seller in intercompany
transactions do not override the intercompany transaction rules.
B) P and S are members of an affiliated group that has filed consolidated tax returns for a
number of years. The sale of inventory by P, which was acquired from S in an intercompany
transaction, outside the affiliated group triggers the restoration of gain by S.
C) Last year, P, S, and T Corporations have filed consolidated tax returns for a number of years.
Last year P Corporation sold land (a Sec. 1231 asset) to T at a $75,000 profit. The gain was
deferred by P in last year's consolidated tax return. P sold the T stock to Mike on June 1 of this
year. The stock sale will require P to report in its income the gain that was deferred on the land
sale.
D) All of the above are true.
Answer: D
Explanation: See C8-9
Page Ref.: C:8-9 and C:8-10
Objective: 4

8) Parent Corporation sells land (a capital asset) to Subsidiary Corporation in an intercompany

transaction, realizing a $25,000 gain. Subsidiary uses the land for five years in its trade or
business before selling the land to a nonmember of the group in a cash sale in which a $50,000
gain is realized. Which statement is correct?
A) A $25,000 capital gain is included in consolidated taxable income when Parent sells the land
to Subsidiary Corporation. A $50,000 Sec. 1231 gain is included in consolidated taxable income
when Subsidiary sells the land.
B) A $25,000 capital gain and a $50,000 Sec. 1231 gain are included in consolidated taxable
income when Subsidiary sells the land.
C) A $75,000 Sec. 1231 gain ($25,000 from Parent and $50,000 from Subsidiary) is included in
consolidated taxable income in the year Subsidiary sells the land (assuming no recapture of
previously deducted Sec. 1231 losses must occur).
D) None of the above are correct.
Answer: C
Explanation: The recomputed gain is $75,000 of Sec. 1231 gain. $50,000 of gain is reported by
Subsidiary. $25,000 is reported by Parent. Both Sec. 1231 gains are reported in the year of
Subsidiary's sale. The $25,000 amount reported by Parent is a restoration that reflects the fact
that $25,000 was included in Parent's separate taxable income in the year of the original sale to
Subsidiary, which was deferred when determining the group's consolidated taxable income.
Page Ref.: C:8-12
Objective: 4

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9) Apple Corporation and Banana Corporation file consolidated returns. In January 2017, Apple
sold Banana property with a basis of $120,000 for its fair value of $150,000. Banana sold the
property to an unrelated party in April 2018 for $200,000. What amount of gain should be
reported for these transactions in the consolidated returns for 2017 and 2018?
A)
2017 2018
$30,000 $50,000

B)
2017 2018
$0 $50,000

C)
2017 2018
$30,000 $80,000

D)
2017 2018
$0 $80,000

Answer: D
Explanation: Report in year of sale to unrelated party
Page Ref.: C:8-12
Objective: 4

10) Parent Corporation sells land (a capital asset) to Subsidiary Corporation in an intercompany
transaction, recognizing a $25,000 gain. Subsidiary holds the land as an investment for five years
before selling the land to a nonmember of the group on an installment basis in a sale in which a
$50,000 gain is realized. The sales proceeds are collectible in four equal installments with an
appropriate interest amount being charged to the purchaser. Which statement is correct?
A) A $25,000 capital gain is included in consolidated taxable income when Parent sells the land
to Subsidiary Corporation. A $50,000 capital gain is included in consolidated taxable income
when Subsidiary sells the land.
B) A $25,000 capital gain from Parent and a $50,000 capital gain from Subsidiary are included
in consolidated taxable income when Subsidiary sells the land.
C) The $25,000 capital gain from Parent and $50,000 capital gain from Subsidiary are included
ratably in consolidated taxable income, commencing in the year the first installment is received.
D) None of the above are correct.
Answer: D
Explanation: The recomputed gain is $75,000 of capital gain. $15,000 ($75,000/5) of the
recomputed gain is recognized as each installment is collected. $10,000 of this gain is reported
by Subsidiary and $5,000 by Parent as each installment is collected. The $25,000 amount
reported by Parent is a restoration that reflects the fact that $25,000 was included in Parent's
separate taxable income in the year of the original sale to Subsidiary, which was deferred when
determining the group's consolidated taxable income.
Page Ref.: C:8-11; Example C:8-15
Objective: 4
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11) Parent and Subsidiary Corporations have filed calendar-year consolidated tax returns for
several years. Parent Corporation uses the cash method of accounting while Subsidiary
Corporation uses the accrual method of accounting. If Parent lends Subsidiary money
A) the interest expense is deductible when accrued.
B) the interest expense and interest income may be reported in different consolidated return
years.
C) the interest income is reported when the interest expense is accrued by Subsidiary.
D) the interest expense deduction is taken when Parent reports the interest income.
Answer: C
Explanation: Expense must match when income reported
Page Ref.: C:8-16; Example C:8-24
Objective: 4

12) Which of the following is not reported by an affiliated group on a consolidated basis?
A) capital gain
B) section 1231 gain
C) casualty & theft gain
D) All of the above are included.
Answer: D
Explanation: See C8-9
Page Ref.: C:8-9
Objective: 4

13) Gee Corporation purchased land from an unrelated corporation several years ago for
$105,000. The land was used by Gee as a storage lot for company trucks. Gee sold the land to
Wilkers, its 85%-owned subsidiary corporation, last year (July 3) for $115,000. The land was
also used in Wilkers' trade or business. Wilkers Corporation sold the land for cash this year
(August 22) for $130,000 to a corporation that was not a member of the affiliated group. What
gains and losses are recognized, deferred, or restored by Gee and Wilkers Corporations?
Answer: Gee Corporation must report the $10,000 Sec. 1231 gain recognized on the sale of the
land last year to Wilkers in its separate taxable income. The gain is deferred by the affiliated
group in determining consolidated taxable income until the year the property is sold outside the
group. The recomputed gain is $25,000. Wilkers recognizes a $15,000 Sec. 1231 gain in the
current year when it sells the land for cash to a nonmember of the group. The group then restores
the $10,000 balance of the recomputed gain as a Sec. 1231 gain.
Page Ref.: C:8-18
Objective: 4

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14) Gee Corporation purchased land from an unrelated corporation several years ago for
$105,000. The land was used by Gee as a storage lot for company trucks. Gee sold the land to
Wilkers, its 85%-owned subsidiary corporation, last year (July 3) for $115,000. The land was
also used in Wilkers' trade or business. Wilkers Corporation sold the land this year (August 22)
for $130,000 to a corporation that was not a member of the affiliated group. The $130,000
purchase price is to be collected in five equal, annual installments, commencing with the current
year's sale date. What gains and losses are recognized, deferred, or restored by Gee and Wilkers
Corporations?
Answer: Gee Corporation must report the $10,000 Sec. 1231 gain recognized on the sale of the
land last year to Wilkers in its separate taxable income. The gain is deferred by the affiliated
group in determining consolidated taxable income until the year the property is sold outside the
group. The recomputed gain is $25,000. Wilkers recognizes a $3,000 gain Sec. 1231 gain
($15,000 × 0.20) in the current year when it sells the land to a nonmember of the group and
collects the first installment. The group then restores the $10,000 balance of the recomputed gain
as a Sec. 1231 gain ratably as the five installments are collected. $2,000 ($10,000 × 1/5) of gain
is restored when each of the five payments is received. A similar amount of gain is recognized
when each subsequent installment is collected.
Page Ref.: C:8-13
Objective: 4

15) Parent Corporation purchases a machine (a five-year property) for $20,000. It claims $4,000
of depreciation under the MACRS rules in the first year it owns the property. At the close of
business on the last day of the first year, Parent sells the machine to a 100%-owned corporation
(Subsidiary) for $18,000. Subsidiary immediately commences depreciating the machine as a
five-year property using the regular MACRS rules. What depreciation can be claimed by
Subsidiary Corporation in the first year it uses the machine?
Answer: The basis of the machine to Parent on the sale date is $16,000 ($20,000 - $4,000). This
basis and the MACRS depreciation rules carry over to Subsidiary from Parent for this portion of
the acquisition cost. Parent recognizes a $2,000 gain ($18,000 - $16,000), which is deferred
when the consolidated tax return is filed. Subsidiary steps up its basis for the asset by the $2,000
amount, thereby providing a total basis of $18,000. The basis increase is treated as a new asset
by Subsidiary under the MACRS rules. Subsidiary's depreciation calculation is:
Carryover basis: $20,000 × 0.32 = $6,400
Basis increase: $ 2,000 × 0.20 = 400
Total depreciation $6,800
Page Ref.: C:8-15; Example C:8-21
Objective: 4

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16) Parent Corporation purchases a machine (a five-year property) for $20,000. It claims $4,000
of depreciation under the MACRS rules in the first year it owns the property. At the close of
business on the last day of the first year, Parent sells the machine to a 100%-owned corporation
(Subsidiary) for $18,000. Subsidiary immediately commences depreciating the machine as a
five-year property using the regular MACRS rules.

What gain is reported by Parent Corporation in the first year that Subsidiary Corporation
depreciates the machine?
Answer: The restored gain equals the depreciation taken ($400) by Subsidiary Corporation on
the step-up in basis. The gain is ordinary income under Sec. 1245. The basis of the machine to
Parent on the sale date is $16,000 ($20,000 - $4,000). This basis and the MACRS depreciation
rules carry over to Subsidiary from Parent for this portion of the acquisition cost. Parent
recognizes a $2,000 gain ($18,000 - $16,000), which is deferred when the consolidated tax return
is filed. Subsidiary steps up its basis for the asset by the $2,000 amount, thereby providing a total
basis of $18,000. The basis increase is treated as a new asset by Subsidiary under the MACRS
rules. Basis increase: $2,000 × .20 = 400
Page Ref.: C:8-15; Example C:8-21
Objective: 4

17) Why are other intercompany transactions not given any special treatment?
Answer: Since both sides of the transaction are reported in the same consolidated return, they
simply net each other out. If, due to accounting methods, the items would be reported in different
tax periods, both the income and deduction must be reported in the later of the two tax years.
Page Ref.: C:8-9
Objective: 4

18) Define intercompany transactions and explain the two types of transactions.
Answer: An intercompany transaction takes place during a consolidated return year between
corporations that are members of the same affiliated group immediately after the transaction. The
two types of intercompany transactions are property and other intercompany transactions.
Intercompany property transaction gains or losses are deferred until a corresponding event
occurs. Other intercompany transactions income or expense is reported in the year in which the
corresponding event occurs.
Page Ref.: C:8-9
Objective: 4

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19) What are the five steps in calculating consolidated taxable income?
Answer: Generally, the five steps are:
1) Compute each group member's taxable income (or loss) based on the member's own
accounting methods as if the corporation were filing its own separate tax return.
2) Make adjustments to each group member's taxable income for certain intercompany
transactions, inventory adjustments, dividends received, excess loss (negative investment basis)
accounts, and built-in deductions.
3) Remove certain gains, losses, and deductions from each member's taxable income since they
must be computed on a consolidated basis (e.g., NOLs, capital gains and losses, Sec. 1231 gains
and losses, charitable contribution deductions, dividends-received deduction, percentage
depletion under Sec. 613A).
4) Steps 1 through 3 result in the member's separate taxable income. Combine these amounts to
equal the group's combined taxable income.
5) Adjust the group's combined taxable income for items reported on a consolidated basis to
equal the consolidated taxable income.
Page Ref.: C:8-9; Table C:8-1
Objective: 4

LO5: Items Computed on a Consolidated Basis

1) Intercompany dividends and undistributed subsidiary earnings do not create temporary

differences for affiliated companies filing a consolidated return.
Answer: TRUE
Explanation: Intercompany dividends and undistributed subsidiary earnings do not create
temporary differences for affiliated companies filing a consolidated return.
Page Ref.: C:8-19
Objective: 5

2) The treatment of capital loss carrybacks and carryovers is similar to NOLs.

Answer: TRUE
Explanation: The treatment of capital loss carrybacks and carryovers is similar to NOLs.
Page Ref.: C:8-22
Objective: 5

3) Which of the following statements is true?

A) A consolidated group determines its general business credit on a consolidated basis.
B) The general business credit can be carried back 3 years and forward 15 years.
C) The general business credit can be carried forward indefinitely.
D) The general business credit cannot be carried forward or backward.
Answer: A
Explanation: A consolidated group determines its general business credit on a consolidated
basis.
Page Ref.: C:8-25
Objective: 5

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4) The Alpha-Beta affiliated group has consolidated taxable income of $400,000 and tentative
general business credit of $80,000 in the current year. The maximum general business credit that
can be used on the consolidated return is
A) $69,250.
B) $14,750.
C) $80,000.
D) $64,000.
Answer: A
Explanation: Tax on $400,000 * 21% = $84,000
$84,000 - (25% ($84,000-$25,000) = $69,250
Page Ref.: C:8-25; Example C:8-34
Objective: 5

5) Identify which of the following statements is false.

A) A corresponding item includes the income, gain, deduction, or loss amount reported by the
buyer from an intercompany transaction, or from property acquired in an intercompany
transaction.
B) Affiliated groups of corporations filing a consolidated tax return are not eligible for the small
corporation exemption from the corporate alternative minimum tax.
C) An intercompany transaction generally results in the selling member and buying member in a
property transaction being treated as divisions of a single corporation.
D) Intercompany dividends and undistributed subsidiary earnings do not create temporary
differences for affiliated companies filing a consolidated return.
Answer: B
Explanation: Affiliated groups of corporations filing a consolidated tax return are eligible for the
small corporation exemption from the corporate alternative minimum tax.
Page Ref.: C:8-24
Objective: 5

6) Identify which of the following statements is false.

A) Unused general business credit carryforwards, which originate in a consolidated return year,
are absorbed in a FIFO manner, beginning with the earliest ending tax year.
B) An intercompany transaction is a transaction that takes place between two corporations that
are members of the same affiliated group immediately after the transaction.
C) An intercompany item includes income reported by the seller on the providing of services by
one group member to another group member and the gain/loss reported by the seller on the sale
of property to another group member.
D) All of the above are false.
Answer: C
Explanation: An intercompany item does not include income reported by the seller on the
providing of services by one group member to another group member and the gain/loss reported
by the seller on the sale of property to another group member.
Page Ref.: C:8-25
Objective: 5

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7) Identify which of the following statements is true.
A) P Corporation receives a dividend from its 100%-owned subsidiary corporation S. P and S
have filed consolidated tax returns for a number of years. The dividend payment is out of S's
earnings and profits and reduces P's investment in S. The dividend is an intercompany
transaction and excluded from P's gross income.
B) The consolidated dividends-received deduction percentage for dividends received by one
affiliated group member from another affiliated group member is always 100%.
C) The dividends-received deduction claimed when a $50,000 dividend is received from a 100%-
owned nonconsolidated life insurance company is $35,000 (ignoring any dividends-received
deduction limitations).
D) All of the above are false.
Answer: A
Explanation: P Corporation receives a dividend from its 100%-owned subsidiary corporation S.
P and S have filed consolidated tax returns for a number of years. The dividend payment is out of
S's earnings and profits and reduces P's investment in S. The dividend is an intercompany
transaction and excluded from P's gross income.
Page Ref.: C:8-22
Objective: 5

8) Identify which of the following statements is true.

A) The basic dividends-received deduction rules generally do not apply to the calculation of the
consolidated dividends-received deduction.
B) A member of an affiliated group can elect to carry back its own separate return losses from a
consolidated return year to one of its earlier profitable separate return years.
C) A consolidated NOL is computed in part by including the consolidated capital gain in taxable
income.
D) All of the above are false.
Answer: C
Explanation: A consolidated NOL is computed in part by including the consolidated capital gain
in taxable income.
Page Ref.: C:8-22
Objective: 5

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9) Identify which of the following statements is true.
A) A shareholder corporation that receives a nondividend distribution from an affiliated group
member is not required to recognize a gain when the distribution amount exceeds the
shareholder's basis in the distributing corporation's stock.
B) The dividends-received deduction limitation for dividends received by members of an
affiliated group from nonmembers is applied to the separate taxable income of each group
member.
C) The dividends-received deduction cannot be taken in full on a consolidated return if the
deduction amount creates or increases a consolidated NOL.
D) All of the above are false.
Answer: A
Explanation: A shareholder corporation that receives a nondividend distribution from an
affiliated group member is not required to recognize a gain when the distribution amount exceeds
the shareholder's basis in the distributing corporation's stock.
Page Ref.: C:8-22
Objective: 5

10) Identify which of the following statements is true.

A) The charitable contribution deduction is calculated on a separate return basis for each group
member, and the separate company deductions of the individual group members are totaled to
arrive at the consolidated deduction.
B) An affiliated group member cannot carry over any unused charitable contribution deduction
from a consolidated return year to a separate return year if the member leaves the group prior to
the end of the current consolidated return year.
C) Charitable contributions, which cannot be deducted in a consolidated return due to the 10%
deduction limitation, can be carried forward indefinitely by the affiliated group.
D) All of the above are false.
Answer: D
Explanation: See C8-21
Page Ref.: C:8-21
Objective: 5

11) Identify which of the following statements is true.

A) Rules for carryforward and carryback of a consolidated net capital loss and a consolidated
NOL are the same with the exception of the carryforward period.
B) Capital loss carrybacks and carryforwards are all treated as short-term capital losses.
C) A member leaving an affiliated group cannot use capital loss carryovers that originated in one
of its previous separate return years.
D) All of the above are false.
Answer: B
Explanation: Capital loss carrybacks and carryforwards are all treated as short-term capital
losses.
Page Ref.: C:8-21
Objective: 5

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12) Blair and Cannon Corporations are the two members of an affiliated group. No prior net Sec.
1231 losses have been reported by any group member. The two corporations report consolidated
ordinary income of $100,000 and gains and losses from property transactions as follows:

Sec. 1231
Corporation STCG/STCL LTCG/LTCL
Gains and Losses
Blair ($5,000) $6,000 $3,000
Cannon 6,000 (7,000) (3,000)

Included in the above totals is $6,000 of long-term capital losses recognized by Cannon on an
intercompany transaction. Excluded from the above is a $4,000 Sec. 1231 gain originally
deferred by Cannon that must be reported by the group in the current year.

Which one of the following statements is incorrect?

A) The consolidated group must report a net long-term capital gain of $9,000 and a net short-
term capital gain of $1,000.
B) Cannon Corporation's separate return reports a $6,000 net long-term capital gain.
C) The affiliated group reports a $4,000 net Sec. 1231 gain.
D) None of the above statements are incorrect.
Answer: B
Explanation: Statement A is correct because the group reports a $1,000 net short-term capital
gain [($5,000) + $6,000]. The group reports a $5,000 [($6,000 - $7,000) + $6,000 deferred loss]
net long-term capital gain before taking into account the Sec. 1231 gains and losses. The group
reports a $4,000 [$3,000 - $3,000 + $4,000 restored gain] net Sec. 1231 gain that is taxed as a
long-term capital gain. The total is a $9,000 net long-term capital gain. Statement B is incorrect
because Cannon Corporation reports $6,000 of short-term capital gains, $1,000 of long-term
capital losses, and $1,000 of Sec. 1231 gains, or a net $6,000 short-term (and not long-term)
capital gain. Statement C is correct because the affiliated group reports a $4,000 net Sec. 1231
gain ($3,000 from Blair and $1,000 from Cannon after adding in the restored gain).
Page Ref.: C:8-21 and C:8-22
Objective: 5

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13) Roland, Shedrick, and Tyrone Corporations formed an affiliated group a number of years
ago, which has since filed consolidated tax returns. No prior Sec. 1231 losses have been reported
by any group member. The group had a consolidated capital loss carryover last year. For the
current year, the group reports the following results:

Ordinary Sec. 1231

Corporation STCG/STCL LTCG/LTCL
Income Gains and Losses
Roland $25,000 $4,000 ($2,000) ($5,000)
Shedrick 30,000 (2,000) 14,000 ( 2,000)
Tyrone 20,000 (3,000) 8,000 ( 3,000)

Which of following statements is incorrect?

A) No Sec. 1231 recapture can occur this year.
B) The net capital gain is taxed at the regular corporate tax rates.
C) The Sec. 1231 loss is treated as an ordinary loss.
D) The net capital gain is $20,000.
Answer: D
Explanation: The net capital gain is $19,000 ($20,000 - $1,000).
Page Ref.: C:8-21 and C:8-22; Example C:8-30
Objective: 5

14) Blair and Cannon Corporations are members of an affiliated group. No prior net Sec. 1231
losses have been reported by any group member. The two corporations report consolidated
ordinary income of $100,000 and gains and losses from property transactions as follows.

Sec. 1231
Corporation STCG/STCL LTCG/LTCL
Gains and Losses
Blair ($5,000) $6,000 $3,000
Cannon 6,000 (7,000) (3,000)

Which of the following statements is correct?

A) The consolidated group reports a net short-term capital gain of $1,000.
B) Blair Corporation's separate return reports a $4,000 net long-term capital gain.
C) Cannon Corporation's separate return reports a $1,000 net long-term capital loss.
D) All three of the above are correct.
Answer: D
Explanation: See C8-21
Page Ref.: C:8-21 and C:8-22; Example C:8-30
Objective: 5

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15) Boxcar Corporation and Sidecar Corporation, an affiliated group, reports the following
results for the current year:

Ordinary
Corporation STCG/STCL LTCG/LTCL
Income
Boxcar $10,000 $10,000 ($ 5,000)
Sidecar 30,000 (12,000) 16,000

The affiliated group's consolidated taxable income is

A) $40,000.
B) $49,000.
C) $51,000.
D) $52,000.
Answer: B
Explanation: ($40,000 - $2,000 + $11,000)
Page Ref.: C:8-21 and C:8-22; Example C:8-30
Objective: 5

16) Boxcar Corporation and Sidecar Corporation, an affiliated group, reports the following
results for the current year:

Ordinary
Corporation STCG/STCL LTCG/LTCL
Income
Boxcar $10,000 $10,000 ($ 5,000)
Sidecar 30,000 (12,000) 16,000

What is the affiliated group's consolidated regular tax liability?

A) $7,700
B) $10,290
C) $11,000
D) $49,000
Answer: B
Explanation:
Ordinary income $40,000
Net STCL ( 2,000)
Net LTCG 11,000
Taxable income $49,000
Times: tax rate × 0.21
Tax liability $ 10,290

Page Ref.: C:8-21 and C:8-22; Example C:8-30

Objective: 5

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17) Identify which of the following statements is true.
A) When applying the large corporation rules for purposes of determining underpayments, each
member of an affiliated group is considered separately.
B) The entire consolidated tax liability cannot be collected from one group member.
C) Once consolidated tax returns have been filed for two consecutive years, the affiliated group
must pay estimated taxes on a consolidated basis.
D) All of the above are false.
Answer: C
Explanation: Once consolidated tax returns have been filed for two consecutive years, the
affiliated group must pay estimated taxes on a consolidated basis.
Page Ref.: C:8-26
Objective: 5

18) The Alto-Baxter affiliated group filed a consolidated return for the first time last year. The
group does not come under the "large" corporation rules. For last year, the group reports a tax
liability of $60,000. Cooper Corporation has a $30,000 tax liability last year. This year, the Alto-
Baxter affiliated group purchased all of the Cooper stock. This year, the Alto-Baxter-Cooper
group reports a $110,000 consolidated tax liability. To avoid penalties for the current year, the
group must make timely estimated tax payments of how much during the year?
A) $60,000
B) $90,000
C) $110,000
D) No estimated tax payments are required.
Answer: A
Explanation: 100% of last year
Page Ref.: C:8-26
Objective: 5

19) Jason and Jon Corporations are members of an affiliated group whose taxable incomes
(before dividends) are $90,000 and $100,000, respectively. Jason Corporation owns all of the Jon
stock. Jon Corporation received a dividend from a less-than-20%-owned corporation of $10,000
and $25,000 from a 100%-owned nonconsolidated insurance company. Jon Corporation
distributed a $40,000 dividend to Jason Corporation. Jason Corporation also received dividends
from a 25%-owned corporation of $20,000. The consolidated dividends-received deduction for
federal income tax purposes is what?
Answer: [(0.50 × $10,000) + (0.65 × $20,000) + (1.00 × $25,000)] = $43,000. The $40,000
dividend is excluded from Jason Corporation's gross income in preparing the consolidated return.
Page Ref.: C:8-22
Objective: 5

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20) Parent and Subsidiary Corporations are members of an affiliated group. Their separate
taxable incomes (before taking into account any dividends) are $75,000 and $85,000,
respectively. Subsidiary Corporation receives a dividend from a less-than-20%-owned
corporation of $8,000 and from an affiliated 100%-owned nonconsolidated insurance subsidiary
of $40,000. Subsidiary distributes a dividend of $35,000 to Parent Corporation who also receives
dividends of $6,000 from a less-than-20%-owned corporation. The consolidated dividends-
received deduction is what?
Answer:
50% deduction: Consolidated deduction:
0.50 × $6,000 = $3,000 100% dividends-received deduction $40,000
0.50 × $8,000 = 4,000 70% dividends-received deduction 7,000
Total $7,000 Total $47,000

Page Ref.: C:8-23; Example C:8-32

Objective: 5

21) How do intercompany transactions affect the calculation of capital gains/losses?

Answer: Deferred intercompany gains/losses are included in the netting of capital gains/losses
only when a corresponding item triggers the recognition of the intercompany item.
Page Ref.: C:8-21
Objective: 5

LO6: Net Operating Losses (NOLs)

1) A member's portion of a consolidated NOL may be carried back against that member's taxable
income from the preceding two separate return years.
Answer: TRUE
Explanation: A member's portion of a consolidated NOL may be carried back against that
member's taxable income from the preceding two separate return years.
Page Ref.: C:8-26 through C:8-28
Objective: 6

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2) Parent and Subsidiary Corporations form an affiliated group. In Year 1, the initial year of
operation, Parent and Subsidiary filed separate returns. In Year 2, the group files a consolidated
tax return. The results for Year 1 and and Year 2 are:

Taxable Income
Year 1 Year 2
Parent ($10,000) $50,000
Subsidiary 30,000 (25,000)

How much of Subsidiary's loss can be carried back to Year 1?

A) $0
B) $20,000
C) $25,000
D) none of the above
Answer: C
Explanation: Profitable previous year
Page Ref.: C:8-29; Example C:8-38
Objective: 6

3) Parent and Subsidiary Corporations form an affiliated group. In Year 1, the initial year of
operation, Parent and Subsidiary filed separate returns. In Year 2, the group files a consolidated
return.

Taxable Income
Year 1 Year 2
Parent ($16,000) $20,000
Subsidiary 10,000 (21,000)

How much of the Subsidiary loss can be carried back to Year 1?

A) $0
B) $1,000
C) $10,000
D) none of the above
Answer: A
Explanation: The Year 2 loss exceeds income
Page Ref.: C:8-29; Example C:8-38
Objective: 6

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4) P and S comprise an affiliated group that filed consolidated returns in Years 1, 2 and 3. They
report the following for Year 1, 2, and 3.
Taxable Income
Year 1 Year 2 Year 3
Parent 100 200 200
Subsidiary (500) 100 100

How much of the Subsidiary Year 1 loss can be utilized against consolidated net income in Year
1?
A) $240
B) $400
C) $300
D) $80
Answer: D
Explanation: Year 1 Subsidiary Income 100 * 80% = 80
Page Ref.: C:8-28 through C:8-30
Objective: 6

5) Mako and Snufco Corporations are affiliated and have filed consolidated returns for the first
time in Year 2 Mako acquired 100% of Zebco stock on January 1 of Year 2, the date of Zebco's
formation. Mako, Snufco, and Zebco, report the following taxable incomes for Year 1 and Year
2

Taxable Income Taxable Income

Corporation
Year 1 Year 2
Mako $18,000 $ 12,000
Snufco 9,000 8,000
Zebco (25,000) 15,000

How much of the Year 1 Zebco NOL be used to offset CTI in Year 2?
A) $15,000
B) $20,000
C) $12,000
D) $0
Answer: C
Explanation: $15,000 * 80% = $12,000
Page Ref.: C:8-29; Example C:8-38
Objective: 6

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6) Pants and Skirt Corporations are affiliated and have filed consolidated tax returns for the past
three years. Pants acquires 100% of Zipper stock on January 1 of Year 3. Zipper Corporation
filed separate returns previously. Pants, Skirt, and Zipper filed a consolidated return for Year 3
are reported the following taxable incomes:

Taxable Income Taxable Income

Corporation
Year 2 Year 3
Pants $18,000 $ 12,000
Skirt 9,000 8,000
Zipper (17,000) 20,000

How much of the Year 1 Zipper NOL be used to offset CTI in Year 2?
A) $20,000
B) $17,000
C) $16,000
D) $0
Answer: C
Explanation: 20,000 * 80% = 16,000
Page Ref.: C:8-29; Example C:8-38
Objective: 6

7) Key and Glass Corporations were organized in Year 1. They became an affiliated group and
filed separate tax returns. In Year 2, the corporations begin filing a consolidated tax return. Key
and Glass report the following results:

Income (loss) Income (loss)

Consolidated
Year 1 Year 2
Key ($30,000) $50,000
Glass 10,000 (35,000)

Which of the following statements is not correct?

A) Key's last year NOL cannot offset Glass's last year profits.
B) Key's last year NOL cannot offset this year's consolidated taxable income.
C) Key's current year income must first be offset by Glass's current year loss.
D) All of the above are correct.
Answer: B
Explanation: Key can offset its last year NOL against the current year consolidated taxable
income.
Page Ref.: C:8-30
Objective: 6

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8) Jackson and Tanker Corporations are members of an affiliated group. The two corporations
have been affiliated since they were formed last year. Both corporations have always used a
calendar year as their tax year. Tanker, the subsidiary, has a separate return year NOL of $14,000
from last year. Jackson Corporation has a separate return year NOL of $16,000 from last year.
Commencing this year, the two corporations filed a consolidated tax return. The NOLs can be
carried over
A) to a consolidated return year and both are SRLY (separate return limitation year) losses.
B) to a consolidated return year and Tanker's loss is a SRLY loss.
C) to a consolidated return year without limit.
D) to a consolidated return year and Jackson's loss is a SRLY loss.
Answer: C
Explanation: Since the corporations were affiliated since inception, the SRLY loss limitation
does not apply.
Page Ref.: C:8-31
Objective: 6

9) Identify which of the following statements is true.

A) A built-in deduction accrues in a separate return year, but is not recognized in a consolidated
return year.
B) Section 382 adopts a single-entity approach in determining ownership changes.
C) The 50-percentage-point minimum stock ownership change that triggers the Sec. 382 loss
limitation rules will not occur in acquisitive transactions involving a group of corporations filing
consolidated returns.
D) All of the above are false.
Answer: B
Explanation: Section 382 adopts a single-entity approach in determining ownership changes.
Page Ref.: C:8-33
Objective: 6

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10) Blue and Gold Corporations are members of the Blue-Gold affiliated group, which filed a
consolidated tax return for last year, reporting a $200,000 consolidated NOL. Small taxable
income amounts were reported by Blue and Gold in separate tax returns filed in years prior to
last year. Early in the current year, 100% of Blue's stock is purchased by Robert Martin who
contributes additional funds to Blue Corporation sufficient to acquire all of Green Corporation's
stock. For the current year, the affiliated group reports the following results (excluding the
consolidated NOL deduction):

Corporation Taxable Income

Blue $150,000
Gold ( 25,000)
Green (since acquisition) 100,000

Which of the following statements is correct?

A) Last year's NOL cannot be carried back.
B) The portion of last year's NOL that is not used as a carryback can be carried over the current
year but is only used against Blue's taxable income.
C) The portion of last year's NOL that is not used as a carryback can be carried over against the
current consolidated taxable income, but is subject to the Sec. 382 limitation.
D) The portion of last year's NOL that is not used as a carryback can be carried over, but is used
only against the Blue's and Gold's taxable income.
Answer: C
Explanation: The portion of last year's NOL that is not used as a carryback can be carried over
against the current consolidated taxable income, but is subject to the Sec. 382 limitation.
Page Ref.: C:8-31 through C:8-33
Objective: 6

11) Mariano owns all of Alpha Corporation, which owns 100% of Beta Corporation's single class
of stock. On January 1, Alpha and Beta Corporations report a consolidated NOL carryover from
prior years. What is the maximum percentage of Alpha Corporation's single class of stock that
Mariano can sell to a single shareholder without triggering the Sec. 382 loss limitation?
A) 0%
B) 50%
C) 75%
D) 80%
Answer: B
Explanation: Limitation is 50%
Page Ref.: C:8-33
Objective: 6

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12) Last year, Trix Corporation acquired 100% of Track Corporation. The acquisition occurred
on July 1, which was five months after Track's creation. The corporations filed separate returns
that year and have filed consolidated returns since then. The group results for the years,
excluding the NOL deduction, are shown below.

Taxable Income Taxable Income

Corporation
Last year Current year
Trix
($12,000) $34,000
Track
( 10,000) ( 2,000)
Consolidated Taxable
($22,000) $32,000
Income

Which of the following statements is incorrect?

A) Last year is an SRLY (separate return limitation year) with respect to Track Corporation.
B) Track's last year loss is offset against the consolidated current taxable income.
C) Track's last year loss can be used to offset the current year's consolidated taxable income.
D) None of Track's last year's loss can be used to offset the current year's consolidated taxable
income.
Answer: C
Explanation: Track is the subsidiary
Page Ref.: C:8-33
Objective: 6

13) A consolidated Year 1 NOL carryover is $36,000 at the beginning of Year 2 is exists. Of the
Year 1 NOL, 25% of the loss is allocable to Duke Corporation. Duke Corporation leaves the
group in the middle of the affiliated group's tax year. Before Duke's departure, it had earnings of
$15,000 for the year, and the remainder of the affiliated group earned a total of $25,000, or
$40,000 of taxable income for the group, excluding any NOL carryover. Following its departure
from the affiliated group, Duke earned $8,000 in its first separate return. How much of the
$36,000 NOL can Duke use on its first separate return?
Answer: $ 15,000 Duke contribution to current year CTI
25,000 Plus: other members' contribution to current-year CTI
$ 40,000 Current-year CTI
$40,000 * 80% = 32,000 limitation

Year 1 NOL 36,000 - $32,000 limitation = balance $4,000

$4,000 balance * Duke's percentage 25% = $1,000

Duke can use $1,000 against its first year separate return.
Page Ref.: C:8-29; Example C:8-37
Objective: 6

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14) What is the consequence of having losses subject to the SRLY limitations?
Answer: The effect of having a loss tainted as an SRLY loss is that it can be used only to offset
taxable income of the subsidiary member (or possibly loss subgroup) that created the NOL.
Page Ref.: C:8-31
Objective: 6

15) Blitzer Corporation is the parent corporation of a 10-member group that has filed
consolidated tax returns for a number of years. Last year, the group sold all the stock of Wolf
Corporation to Jerry Jensen. This year, Wolf Corporation reported a $300,000 NOL. Wolf's
taxable income while a group member averaged $200,000 annually for the past five years but is
expected to be only $50,000 next year due to start-up costs that will be incurred with the
introduction of a new product line. Profits are expected to increase in each succeeding year.
What issues should Blitzer have considered when trying to value Wolf's NOL prior to its sale?
What tax issues should Wolf now consider when deciding how to use its NOL?
Answer:
• What alternatives exist for using the NOL?
• Can the separate-return NOL of Wolf be carried back to a consolidated tax year of the Blitzer
affiliated group?
• If so, what special limitations (if any) is the NOL subject to?
• What is the projected tax refund if the NOL is carried back to a prior consolidated return
year?
• Who files for the tax refund? Who receives the refund from the IRS?
• Was any provision made for Wolf receiving the NOL refund payment from the Blitzer
affiliated group in the stock purchase agreement should a separate NOL be carried back?
• What is the projected taxable income of Wolf Corporation in the future?
• What is the projected tax refund if the NOL is carried forward to a separate return year(s)?
• What special limitations (if any) is the NOL subject to (e.g., Sec. 382 restrictions following a
change in ownership)?
• How is the election to forgo the NOL carryback made?
• What effect does the low taxable income in the future years and the Sec. 382 limitation have
on the valuation of the NOL? The company?

A larger tax refund should be available to Wolf Corporation by carrying the NOL back to the
prior tax years of Blitzer Corporation. The marginal tax rate for the earlier tax years appears to
be 39% while Wolf has a 15% rate for the near future. The separate-return NOL is an SRLY loss
when carried back, and its use is subject to the SRLY limitations. The entire loss carryback
should be absorbed within the two-year carryback period since Wolf reported separate-return
profits of $200,000 annually when part of the affiliated group, Wolf files for the refund based on
the carryback. A carryover of the NOL is likely subject to the Sec. 382 loss limitations. We do
not know enough about Wolf's new owners to be able to reach a definite conclusion about the
Sec. 382 issue. The tax refund from an NOL carryback will be paid to Blitzer. As such, Blitzer
may be reluctant to pay the refund to Wolf unless such an event was agreed upon at the time of
the sale. From Wolf's perspective, the sales agreement should include a provision requiring
Blitzer to pay the refund to Wolf Corporation.
Page Ref.: C:8-27 through C:8-33
Objective: 6

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LO7: Stock Basis Adjustments

1) On January 1, Alpha Corporation purchases 100% of the stock of Omega Corporation for $2
million. During the year, Omega Corporation earns $300,000 of taxable income, $30,000 of tax-
exempt income, and distributes $150,000 in dividends. Each company paid its own tax liability.
What basis adjustment must Alpha Corporation make at year-end?
Answer: Alpha Corporation's initial basis for the Omega Corporation stock is its $2,000,000
purchase price. The $300,000 of taxable income and $30,000 of tax-exempt interest income
earned in the current year increase the stock basis. The $63,000 ($300,000 × 0.21) federal
income tax liability decreases the stock basis, as does the $150,000 distribution to the parent
corporation (Alpha). The year-end basis is $2,117,000 ($2,000,000 + $300,000 + $30,000 -
$63,000 - $150,000). The year-end basis for the Omega Corporation stock is $117,000 ($300,000
+ $30,000 - $63,000 - $150,000) higher than its $2,000,000 acquisition cost.
Page Ref.: C:8-34 and C:8-35
Objective: 7

LO8: Tax Planning Considerations

1) An advantage of filing a consolidated return is that losses of one affiliated group member may
be offset against the taxable income of other group members in the same tax year.
Answer: TRUE
Explanation: An advantage of filing a consolidated return is that losses of one affiliated group
member may be offset against the taxable income of other group members in the same tax year.
Page Ref.: C:8-36
Objective: 8

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2) All of the stock of Hartz and Ryder Corporations is owned by Morgen. Hartz Corporation has
been reporting $150,000 of taxable income for each of the past five years. Ryder Corporation has
been reporting $30,000 in NOLs for the same period, which totals $150,000. Approximately one-
third of Hartz's profits come from sales to Ryder. Intercompany sales between Hartz and Ryder
have increased during each of the last five years. What tax issues should Morgen consider with
respect to his investments in Hartz and Ryder Corporations?
Answer:
• What advantages would accrue if the Hartz-Ryder affiliated group elected to file a
consolidated tax return?
• Can the profits earned by Hartz Corporation on an intercompany inventory sale to Ryder
Corporation be deferred for tax purposes?
• Can the current-year losses of Ryder Corporation offset the current-year profits of Hartz
Corporation? Are there any restrictions or limitations on deducting the losses?
• Can the preaffiliation losses of Ryder Corporation offset the consolidated taxable income?
Are there any restrictions or limitations on deducting the losses?
• What disadvantages would accrue if the Hartz-Ryder affiliated group elected to file a
consolidated tax return?
• Is additional recordkeeping involved in filing a consolidated return instead of two separate
tax returns?
• What types of corporate groups can file a consolidated tax return?
• What are the stock ownership and includible corporation requirements for an affiliated
group?
• Do Hartz and Ryder Corporations as brother-sister corporations satisfy these requirements?
• If an affiliated group does not exist, what changes to the corporate structure must be made to
create an affiliated group?

The current brother-sister relationship for Hartz and Ryder Corporations does not permit the
filing of a consolidated tax return. If a parent-subsidiary relationship were established (e.g., by
Morgen's capital contribution of the Ryder stock to Hartz Corporation), a consolidated tax return
could be filed. Postchange NOLs for Ryder Corporation could offset the profits of Hartz
Corporation in the consolidated tax return. The prechange NOLs are SRLY losses and can be
used by the affiliated group only to the extent that Ryder subsequently earned profits. An
adjustment to the transfer price charged for the product produced by Ryder might permit
additional profits to be earned by Ryder and accelerate the use of the SRLY losses. Profits
earned on the intercompany inventory sales are deferred under the consolidated return rules. Too
large of a transfer price change may be indicative of tax avoidance and cause the IRS to apply
Sec. 482 to the intragroup transfers. These deferrals have increased annually over the last five
years. Depending on the inventory method employed (e.g., LIFO or FIFO), the tax deferral could
either be short-term or long-term. Two drawbacks to the filing of a consolidated return are the
additional recordkeeping involved in maintaining the records and preparing the tax returns, and
the smaller deduction and credit limits faced by the group over what Hartz Corporation would
have on a separate return basis.
Page Ref.: C:8-36 and C:8-37
Objective: 8

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LO9: Compliance and Procedural Considerations

1) The IRS can attempt to collect taxes owed on a consolidated return from any of the members
of the consolidated group.
Answer: TRUE
Explanation: The IRS can attempt to collect taxes owed on a consolidated return from any of the
members of the consolidated group.
Page Ref.: C:8-39
Objective: 9

2) An affiliated group elects the use of the consolidated method for filing its tax return by
A) filing Form 1120.
B) filing a consent to the election from each member of the affiliated group in the initial year.
C) filing an affiliations schedule.
D) All of the above are necessary for the election.
Answer: D
Explanation: See C8-37
Page Ref.: C:8-37 and C:8-38
Objective: 9

3) A consolidated return's tax liability is owed by

A) all group members in equal portions.
B) the group member responsible for that portion of the tax liability.
C) all group members who are severely liable.
D) the parent corporation.
Answer: C
Explanation: All members are jointly and severely liable.
Page Ref.: C:8-39
Objective: 9

LO10: Financial Statement Implications

1) Intercompany sales between members of an affiliated group filing separate returns cause
deferred tax assets to be recognized by both buyer and seller.
Answer: FALSE
Explanation: Intercompany sales between members of an affiliated group filing separate returns
do not cause deferred tax assets to be recognized by both buyer and seller.
Page Ref.: C:8-39 and C:8-40
Objective: 10

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2) Which of the following intercompany transactions creates temporary book/tax differences
when a parent corporation owns 100% of a subsidiary's stock and the companies file a
consolidated return?
A) intercompany dividends
B) undistributed subsidiary earnings
C) intercompany sale
D) None of the above items create temporary differences.
Answer: D
Explanation: See C8-39
Page Ref.: C:8-39 through C:8-41
Objective: 10

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