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Knoxville Musical Sales, Inc Tax problem




Question;TAX FORM/RETURN PREPARATION PROBLEMC:3-63 Knoxville Musical Sales, Inc. is located at 5500 Kingston Pike, Knoxville, TN 37919. Thecorporation uses the calendar year and accrual basis for both book and tax purposes. It isengaged 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 onJanuary 2, 2003. Table C:3-3 contains balance sheet information at January 1, 2006, andDecember 31, 2006. Table C:3-4 presents an income statement for 2006. These schedulesare 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) $110,000June 15, 2006 221,000September 15, 2006 265,000December 15, 2006 265,000Total 861,000Taxable income in 2005 was $1,500,000, and the 2005 tax was $510,000. The corporationearned its 2006 taxable income evenly throughout the year. Therefore, it does not usethe annualization or seasonal methods.Inventory and Cost of Goods Sold (Schedule A):The corporation uses the periodic inventory method and prices its inventory using thelower of FIFO cost or market. Only beginning inventory, ending inventory, and purchasesshould be reflected in Schedule A. No other costs or expenses are allocated to costof 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 $10million.Line 9 (a) Check (ii)(b), (c) & (d) Not applicable(e) & (f) NoThe Corporate Income Tax? Corporations 3-61Compensation of Officers (Schedule E):Mary Travis 345-82-7091 100% 50% $277,500John Willis 783-97-9105 100% 25% 170,000Chris Parker 465-34-2245 100% 25% 170,000Total 617,500Bad Debts: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 $38,000 to the allowance account, such amount representing actualwriteoffs for 2006.Additional Information (Schedule K):1 b Accrual 6-7 No2 a 451140 8 Do not check boxb Retail sales 9 Fill in the correct amountc Musical instruments 10 33 No 11 Do not check box4 a No 12 Not applicable4b yes, omit Schedule G 13-14 No5 No 15a no 15b Not applicable16-18 No(a) (b) (c) (d) (f)TABLE C:3-3Knoxville Musical Sales, Inc.?Book Balance Sheet InformationJanuary 1, 2006 December 31, 2006Account Debit Credit Debit CreditCash $ 193,116 / $ 226,823Accounts receivable 441,180/ $513,000Allowance for doubtful accounts [CREDIT] $ 22,059 / $ 25,650Inventory 2,3750,000 / $ 3,325,000Investment in corporate stock $265,000 110,000Investment in municipal bonds $32,000 32,000Net current deferred tax asset $10,220 / $8,721Cash surrender value of insurance policy 42,000 / 54,000Land 300,000 / 300,000Buildings 1,400,000 / 1,400,000Accumulated depreciation?Buildings [CREDIT] 70,000 / 98,000Equipment 960,000 / 2,640,000Accumulated depreciation?Equipment [CREDIT] 160,000 / 249,333Trucks 250,000 / 250,000All accounts below are [CREDIT] sideAccumulated depreciation?Trucks 75,000 / 125,000Accounts payable 300,000 / 270,000Notes payable (short-term) 610,000 / 488,000Accrued payroll taxes 14,250 / 17,812Accrued state income taxes 8,550 / 14,250Accrued federal income taxes 0 / 116,693Bonds payable (long-term) 2,000,000 / 2,300,000Net noncurrent Deferred tax liability 158,657 / 284,588Capital stock?Common 950,000 / 950,000Retain earnings?Unappropriated 1,900,000 / 3,920,218Totals $6,268,516 / $6,268,516 // $8,859,544 / $8,859,5443-62 Corporations? Chapter 3Organizational Expenditures:The corporation incurred $11,000 of organizational expenditures on January 2, 2003. Forbook purposes, the corporation expensed the entire expenditure. For tax purposes, the corporation elected under Sec. 248 to deduct $5,000 in 2003 and amortize the remaining $6,000 amount over 180 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 October 8, 2006 for$105,000. The corporation acquired the stock on December 25, 2005 for $75,000. Thecorporation also sold 75 shares of JSB Corp. common stock on June 18, 2006 for$68,000. The corporation acquired this stock on September 18, 2003 for $80,000. Thecorporation 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 ofassets 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 inthe year of acquisition and the year of disposition and assumes no salvage value. TheTABLE C:3-4Knoxville Musical Sales, Inc.?Book Income Statement 2006Sales $ 9,500,000Returns)Net sales $ 9,262,500Beginning inventory $2,375,000Purchases 5,225,000Ending inventory (3,325,000)Cost of goods sold (4,275,000)Gross profit $ 4,987,500Expenses:Amortization $ ?0?Depreciation 231,333Repairs 19,760General insurance 52,250Premium?Officers? life insurance (net of cash buildup) 42,750Officer?s compensation 617,500Other salaries 380,000Utilities 68,400Advertising 45,600Legal and accounting fees 47,500Charitable contributions 28,500Employment tax 59,375Interest 199,500Bad debts 41,591Total expenses (1,834,059)Gain on sale of equipment 104,000Interest on municipal bonds 4,750Net gain on stock sales 18,000Dividend income 11,400Net income before FIT expense $ 3,291,591Federal income tax (FIT) expense $(1,105,123)State income tax expense ($71,250)Net income per books $ 2,115,218The Corporate Income Tax? Corporations 3-63book 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 nonresidentialreal property, Equipment, seven-year property, and Trucks, five-year property.The corporation acquired the store building for $1.4 million and placed it in service onJanuary 2, 2003. The corporation acquired two pieces of equipment for $320,000(Equipment 1) and $640,000 (Equipment 2) and placed them in service on January 2,2003. The corporation acquired the old trucks for $250,000 and placed them in serviceon July 18, 2004. The corporation did not make the expensing election under Sec. 179 onany property acquired before 2006 and elected not to claim bonus depreciation. Also, thecorporation did not elect the straight-line option or the alternative depreciation system(ADS) under MACRS. Accumulated tax depreciation through December 31, 2005 onthese properties is as follows:Store building $106,246Equipment 1 180,064Equipment 2 360,128Trucks 130,000On November 16, 2006, the corporation sold for $350,000 Equipment 1 that originallycost $320,000 on January 2, 2003. The corporation had no Sec. 1231 losses fromprior years. In a separate transaction on November 17, 2006, the corporation acquiredand placed in service a piece of equipment costing $2 million. These two transactions donot qualify as a like-kind exchange under Reg. Sec. 1.1031(k)-1(a). The new equipment isseven-year property. The corporation made the Sec. 179 expensing election with regard tothe new equipment. The corporation relies on Sec. 179(d)(3) and Reg. Sec. 1.179-4(d) todetermine the cost of its Sec. 179 property.Where applicable, use published IRS depreciation tables to compute 2006 depreciation(reproduced in Appendix C of this text).Other Information:? The corporation?s activities do not qualify for the U.S. production activities deduction.? Ignore the AMT and accumulated earnings tax.? The corporation received dividends (see table 3-4) from taxable, domestic corporations,the stock of which Knoxville Musical Sales, Inc. owns less than 20%.? The corporation paid $95,000 in cash dividends to its shareholders during the yearand charged the payment directly to retained earnings.? The corporation is not entitled any credits.? The state income tax in table c 3-4 is the exact amount of such taxes incurred during the year.? Ignore the financial statement impact of any under payment penalties incurred on the tax return.Required: Prepare the 2006 corporate tax return for Knoxville Musical Sales, Inc. alongwith any necessary supporting schedules. Also, prepare Schedule M-3 (omit schedule B) as well as Schedule M-1 even though the IRS does not require both schedules.


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