xville, TN 37919. The
corporation uses the calendar year and accrual basis for both book and tax purposes. It is
engaged in the sale of musical instruments with an employer identification number (EIN)
of 75-2008006. The company incorporated on December 31, 2002 and began business on
January 2, 2003. Table C:3-3 contains balance sheet information at January 1, 2006, and
December 31, 2006. Table C:3-4 presents an income statement for 2006. These schedules
are presented on a book basis. Other information follows.
Estimated Tax Payments (Form 2220):
The corporation deposited estimated tax payments as follows:
April 17, 2006 (April 15 fell on a Sunday) $118,000
June 15, 2006 243,000
September 15, 2006 285,000
December 15, 2006
Taxable income in 2005 was $2,200,000, and the 2005 tax was $748,000. The corporation
earned its 2006 taxable income evenly throughout the year. Therefore, it does not use
the annualization or seasonal methods.
Inventory and Cost of Goods Sold (Schedule A):
The corporation uses the periodic inventory method and prices its inventory using the
lower of FIFO cost or market. Only beginning inventory, ending inventory, and purchases
should be reflected in Schedule A. No other costs or expenses are allocated to cost
of goods sold. Note: the corporation is exempt from the uniform capitalization (UNICAP)
rules because average gross income for the previous three years was less than $10
Line 9 (a) Check (ii)
(b), (c) (d) Not applicable
(e) (f) No
The Corporate Income Tax ▼ Corporations 3-61
Compensation of Officers (Schedule E):
Mary Travis 345-82-7091 100% 50% $265,000
John Willis 783-97-9105 100% 25% 160,000
Chris Parker 465-34-2245 100% 25%
For tax purposes, the corporation uses the direct writeoff method of deducting bad debts.
For book purposes, the corporation uses an allowance for doubtful accounts. During 2006,
the corporation charged $36,000 to the allowance account, such amount representing actual
writeoffs for 2006.
Additional Information (Schedule K):
1 b Accrual 6-7 No
2 a 451140 8 Do not check box
b Retail sales 9 Fill in the correct amount
c Musical instruments 10 3
3-4 No 11 Do not check box
5 Yes, 50% 12 Not applicable
(a) (b) (c) (d) (f)
Knoxville Musical Sales, Inc.—Book Balance Sheet Information
January 1, 2006 December 31, 2006
Account Debit Credit Debit Credit
Cash $ 254,567 $ 107,357
Accounts receivable 417,960 486,000
Allowance for doubtful accounts $ 35,527 $ 41,310
Inventory 2,250,000 3,150,000
Investment in corporate stock 180,000 37,000
Investment in municipal bonds 30,000 30,000
Cash surrender value of insurance policy 20,000 34,000
Land 500,000 500,000
Buildings 2,500,000 2,500,000
Accumulated depreciation—Buildings 125,000 175,000
Equipment 600,000 840,000
Accumulated depreciation—Equipment 100,000 115,333
Trucks 230,000 145,000
Accumulated depreciation—Trucks 69,000 14,500
Accounts payable 1,500,000 550,000
Notes payable (short-term) 500,000 600,000
Accrued payroll taxes 25,000 28,000
Accrued state income taxes 8,000 11,000
Accrued federal income taxes 126,000
Bonds payable (long-term) 1,800,000 1,400,000
Deferred tax liability 70,000 75,000
Capital stock—Common 1,500,000 1,500,000
Totals $6,982,527 $6,982,527 $7,829,357 $7,829,357
3-62 Corporations ▼ Chapter 3
The corporation incurred $6,000 of organizational expenditures on January 2, 2003. For
book purposes, the corporation expensed the entire expenditure pursuant to Statement of
Position 98-5. For tax purposes, the corporation elected under Sec. 248 to amortize this
amount over 60 months (the rule then in effect), with a full month’s amortization taken
for January 2003. The corporation reports this amortization in Part VI of Form 4562 and
includes it in Other Deductions on Form 1120, Line 26.
Capital Gains and Losses:
The corporation sold 100 shares of PDQ Corp. common stock on March 7, 2006 for
$95,000. The corporation acquired the stock on December 15, 2005 for $65,000. The
corporation also sold 75 shares of JSB Corp. common stock on September 17, 2006 for
$62,000. The corporation acquired this stock on September 18, 2003 for $78,000. The
corporation has an $8,000 capital loss carryover from 2005.
Fixed Assets and Depreciation:
For book purposes: The corporation uses straight-line depreciation over the useful lives of
assets as follows: Store building, 50 years; Equipment, 15 years (old) and ten years (new);
and Trucks, five years (old and new). The corporation takes a half-year’s depreciation in
the year of acquisition and the year of disposition and assumes no salvage value. The
Knoxville Musical Sales, Inc.—Book Income Statement 2006
Sales $ 9,000,000
Net sales $ 8,775,000
Beginning inventory $2,250,000
Ending inventory )
Cost of goods sold )
Gross profit $ 4,725,000
Amortization $ -0-
General insurance 49,500
Premium-Officers’ life insurance (net of cash buildup) 40,500
Officer’s compensation 585,000
Other salaries 360,000
Legal and accounting fees 45,000
Charitable contributions 27,000
Employment tax 56,250
State tax 67,500
Total expenses (1,731,087)
Loss on exchange of trucks (18,000)
Gain on sale of equipment 90,000
Interest on municipal bonds 4,500
Net gain on stock sales 14,000
Net income before FIT expense $ 3,095,213
Federal income tax (FIT) expense )
Net income per books $ 2,032,213
The Corporate Income Tax ▼ Corporations 3-63
book financial statements in Tables C:3-3 and C:3-4 reflect these calculations. The designation
old refers to property placed in service before 2006, and the designation new
refers to property placed in service in 2006.
For tax purposes: All assets are MACRS property as follows: Store building, 39-year nonresidential
real property; Equipment, seven-year property; and Trucks, five-year property.
The corporation acquired the store building for $2.5 million and placed it in service on
January 2, 2003. The corporation acquired two pieces of equipment for $200,000
(Equipment 1) and $400,000 (Equipment 2) and placed them in service on January 2,
2003. The corporation acquired the old trucks for $230,000 and placed them in service
on July 18, 2004. The corporation did not make the expensing election under Sec. 179 on
any property acquired before 2006 and elected not to claim bonus depreciation. Also, the
corporation did not elect the straight-line option or the alternative depreciation system
(ADS) under MACRS. Accumulated tax depreciation through December 31, 2005 on
these properties is as follows:
Store building $189,725
Equipment 1 112,540
Equipment 2 225,080
On November 16, 2006, the corporation sold for $250,000 Equipment 1 that originally
cost $200,000 on January 2, 2003. The corporation had no Sec. 1231 losses from
prior years. In a separate transaction on November 17, 2006, the corporation acquired
and placed in service a piece of equipment costing $440,000. These two transactions do
not qualify as a like-kind exchange under Reg. Sec. 1.1031(k)-1(a). The new equipment is
seven-year property. The corporation made the Sec. 179 expensing election with regard to
the new equipment. The corporation relies on Sec. 179(d)(3) and Reg. Sec. 1.179-4(d) to
determine the cost of its Sec. 179 property.
On May 15, 2006, the corporation exchanged its entire fleet of delivery trucks, which
cost $230,000 on July 18, 2004 for similar trucks. On the date of exchange, the old trucks
had a $120,000 FMV, and the new trucks had a $145,000 FMV. As part of the exchange,
the corporation paid $25,000 cash in addition to the old trucks. For tax purposes,
the exchange qualifies as a like-kind exchange. The new trucks are five-year property.
Assume that neither the old nor new trucks are listed property according to Reg.
Sec. 1.280F-6(c)(3)(iii) and Temp. Reg. Sec. 1.274-5T(k). The corporation relies on Temp.
Reg. Sec. 1.168(i)-6T(e) to compute depreciation on the new trucks.
Where applicable, use published IRS depreciation tables to compute 2006 depreciation
(reproduced in Appendix C of this text).
• The corporation’s activities do not qualify for the U.S. production activities deduction.
• Ignore the AMT and accumulated earnings tax.
• The corporation received the $10,800 in dividends from taxable, domestic corporations,
the stock of which Knoxville Musical Sales, Inc. owns less than 20%.
• The corporation paid $90,000 in cash dividends to its shareholders during the year
and charged the payment directly to retained earnings.
• The corporation issued the bonds payable at par. Thus, no premium or discount need
• The corporation is not entitled any credits.
Required: Prepare the 2006 corporate tax return for Knoxville Musical Sales, Inc. along
with any necessary supporting schedules. Also, prepare Schedule M-3 as well as Schedule
M-1 even though the IRS does not require both schedules.