Question

Problem 5-28 (LO. 1, 2) In each of the following independent situations, indicate the effect on taxable income and E & P, stating the amount of any increase (or decrease) in each as a result of the transaction. Assume that E & P has already been increased by taxable income. Enter a decrease as a negative number by using the minus sign. If there is no effect, enter "o". Taxable Income Increase (Decrease) E & P Increase (Decrease) Transaction C. a. Realized gain of $80,000 on involuntary conversion of building ($10,000 of gain is recognized). b. Mining exploration costs incurred on May 1 of current year; $24,000 is deductible from current-year taxable income. Sale of equipment to unrelated third party for $240,000; basis is $120,000 (no election out of installment method; no payments are received in current year). d. Dividends of $20,000 received from 5% owned corporation, together with dividends received deduction (assume that taxable income limit does not apply). Additional first-year (bonus) depreciation of $45,000 claimed in current year. OUTDOO e. f. Section 179 expense deduction of $25,000 in current year. g. Impact of current-year 179 expense deduction in succeeding year.

Answer 1

Answer:-

     Taxable Income                         E & P Increase

    Increase (Decrease)                        (Decrease)

a.                                               $ 10,000                                No effect

b.                                              ($24,000)                                 $ 22,400*

c.                                              No effect                                $120,000

d.                                                 $ 6,000                                 $ 14,000**

e.                                              ($ 45,000)                                $ 45,000

f.                                              ($25,000)                               $ 20,000***

g.                                              No effect                                ($ 20,000)†

h.                                             ($ 80,000)                                ($ 10,000)††

i.                                               No effect                                ($ 80,000)

*Although mining exploration costs are deductible in full under the income tax, they must be amortized over 120 months when computing E & P. Since $200 per month is amortizable ($24,000/120 months), $1,600 is currently deductible for E & P purposes ($200 × 8 months). Thus, of the $24,000 income tax deduction, $22,400 is added back to E & P ($24,000 – $1,600 deduction allowed).

**The receipt of a $20,000 dividend will generate a dividends received deduction of $14,000. The net effect on taxable income is an increase of $6,000. For E & P purposes, the dividends received deduction is added back.

***Only 20% of current-year § 179 expense is allowed for E & P purposes. Thus, 80% of the amount deducted for income tax purposes is added back. †In each of the four succeeding years, 20% of the § 179 expense is allowed as a deduction for E & P purposes.

††ADS straight-line depreciation is allowed for E & P purposes; thus, E & P is decreased by $10,000 (the excess of ADS depreciation over the amount allowed under MACRS).