CPA TCP Entity tax planning: practice questions with answers

Question 1

The founders of Silverpine Drones want pass-through taxation and plan to raise capital in 2026. Which planned feature would make an S election unavailable, so that an LLC taxed as a partnership would be the better choice?

1. A Issuing voting and nonvoting common shares with identical distribution and liquidation rights
2. B Having 90 shareholders, including six family members who elect to be counted as one
3. C Issuing preferred shares with a liquidation preference to a venture fund that is a partnership
4. D Admitting a shareholder who is a resident alien living and working in the United States

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Answer: C. An S corporation may have no more than 100 shareholders (members of a family may count as one), only eligible shareholders (individuals who are US citizens or residents, estates and certain trusts and exempt organizations; not partnerships or corporations), and one class of stock, although differences in voting rights are allowed (IRC §1361(b), (c)(1), (c)(4)).

Preferred stock with a liquidation preference held by a partnership fund breaks two rules. An LLC taxed as a partnership can offer preferred returns and admit any type of investor.

Question 2

Quarry Lane Builders Inc. has a $1,000,000 NOL carryforward from 2023 and projects 2026 taxable income of $300,000 before any NOL deduction. The corporate rate is 21%, and NOLs arising after 2017 may offset only 80% of taxable income before the NOL deduction. How much 2026 federal income tax does the NOL carryforward save?

1. A $12,600
2. B $50,400
3. C $63,000
4. D $210,000

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Answer: B. NOL deduction = lesser of $1,000,000 or 80% x $300,000 = $240,000 (IRC §172(a)(2))

Tax saved = $240,000 x 21% = $50,400

Tax still due = ($300,000 - $240,000) x 21% = $12,600; $760,000 of NOL carries to 2027.

Question 3

Calderwood Pottery Inc. has 1,000 shares outstanding: Ingeborg Fairweather owns 400, her son Mark Fairweather owns 300, and Kwabena Ofori, who is unrelated, owns 300. Calderwood proposes to redeem 250 of Ingeborg's shares on December 1, 2026, for $200,000; her basis in those shares is $25,000. Calderwood has ample E&P, and Ingeborg will remain a director. How will the redemption be taxed to Ingeborg if it goes ahead?

1. A Long-term capital gain of $175,000: her direct ownership falls from 40% to 20%
2. B Dividend of $175,000: the amount received less her basis in the shares
3. C Long-term capital gain of $175,000: family attribution can be waived for this redemption
4. D Dividend of $200,000: counting Mark's shares, she owns 60% afterwards

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Answer: D. Substantially disproportionate test (IRC §302(b)(2)): after the redemption the shareholder must own less than 50% of the voting stock and less than 80% of her former percentage, counting constructive ownership under §318 (her son's shares are attributed to her).

- Before: (400 + 300) / 1,000 = 70%
- After: (150 + 300) / 750 = 60%

60% is not below 50%, and it exceeds 80% x 70% = 56%, so the test fails. The waiver of family attribution (§302(c)(2)) is available only for a complete termination. The redemption is a §301 distribution: a dividend of $200,000, with her $25,000 basis added to her remaining shares. Without attribution she would have owned 20% (below 32%) and had a $175,000 capital gain.

Question 4

Benedikt Ruhl owns all of Alderbank Webworks Inc., an S corporation. He expects his share of its 2026 ordinary loss to be $90,000, and his stock basis is $20,000 with no debt basis. He materially participates and is at risk for any money he puts in. He does not want to use his own savings. Which proposal lets him deduct the whole $90,000 loss in 2026?

1. A Personally guarantee a $70,000 bank loan made directly to Alderbank.
2. B Have Alderbank borrow $70,000 from the bank, secured by a pledge of his Alderbank shares.
3. C Have a sister company he owns lend Alderbank $70,000 under a written note.
4. D Borrow $70,000 from his bank personally and lend it to Alderbank under a written note.

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Answer: D. §1366(d)(1); Reg. §1.1366-2(a)(2): debt basis arises only from bona fide indebtedness of the S corporation that runs directly to the shareholder. Guarantees, pledges and loans from related entities do not count until the shareholder actually makes a payment or becomes the creditor.

Back-to-back loan: Benedikt borrows $70,000 and lends it to Alderbank, so debt basis is $70,000. Loss limit = $20,000 stock + $70,000 debt = $90,000, all deductible.

Under each other proposal the limit stays at $20,000, and $70,000 is suspended. Later income restores the debt basis before stock basis, and repaying a note with reduced basis gives gain.

Question 5

On March 1, 2026, Cassius contributed investment land with an adjusted basis of $80,000 and a fair market value of $50,000 to Elmstead Partners, owned 50/50 by Cassius and Delia. On November 1, 2026, the partnership sold the land to an unrelated buyer for $44,000. How is the $36,000 tax loss allocated?

1. A Cassius $33,000; Delia $3,000
2. B Cassius $18,000; Delia $18,000
3. C Cassius $36,000; Delia $0
4. D Cassius $30,000; Delia $3,000

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Answer: A. §704(c)(1)(C): for contributed property with a built-in loss, the built-in loss is taken into account only for the contributing partner; for the other partners the partnership's basis is treated as FMV at contribution ($50,000).

- Built-in loss: $80,000 - $50,000 = $30,000, to Cassius only.
- Post-contribution decline: $50,000 - $44,000 = $6,000, shared $3,000 / $3,000.

Cassius = $30,000 + $3,000 = $33,000; Delia = $3,000.

Planning: if Cassius had sold the land himself and contributed cash, he would have recognized the $30,000 loss directly. If he leaves the partnership before the land is sold, the built-in loss does not pass to a buyer of his interest.

Question 6

On March 1, 2022, Anselm contributed land (adjusted basis $40,000, fair market value $100,000) to Greystone Partners. The partnership proposes to distribute the land to another partner, Beatrix, on November 1, 2026, when its fair market value will be $120,000. Nothing has changed the land's basis. Which statement about the proposal is correct?

1. A Anselm recognizes $60,000 of gain on the distribution; waiting until after March 1, 2029, would avoid this.
2. B Anselm recognizes $80,000 of gain on the distribution; waiting until after March 1, 2029, would avoid this.
3. C No one recognizes gain, because property distributions are tax-free under §731 whatever the timing.
4. D Anselm recognizes $60,000 of gain on the distribution; waiting until after March 1, 2027, would avoid this.

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Answer: A. §704(c)(1)(B): if contributed property is distributed to another partner within 7 years of contribution, the contributor recognizes the gain that would have been allocated to him under §704(c)(1)(A) had the property been sold at FMV on the distribution date.

Hypothetical sale at $120,000: gain $80,000; §704(c) precontribution gain to Anselm = $100,000 - $40,000 = $60,000 (the $20,000 balance would be shared).

Anselm's outside basis and the partnership's basis in the land each rise by $60,000 before Beatrix takes the land. The 7-year period ends on March 1, 2029, so a distribution after that date avoids this rule.