C:3-63 Knoxville Musical Sales, Inc. is located at 5500 Kingston Pike, Knoxville, 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) $110,000
June 15, 2006 221,000
September 15, 2006 265,000
December 15, 2006 265,000
Taxable income in 2005 was $1,500,000, and the 2005 tax was $510,000. 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% $277,500
John Willis 783-97-9105 100% 25% 170,000
Chris Parker 465-34-2245 100% 25% 170,000
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 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 No 11 Do not check box
4 a No 12 Not applicable
4b yes; omit Schedule G 13-14 No
5 No 15a no 15b Not applicable
(a) (b) (c) (d) (f)
Knoxville Musical Sales, Inc.â€”Book Balance Sheet Information
January 1, 2006 December 31, 2006
Account Debit Credit Debit Credit
Cash $ 193,116 / $ 226,823
Accounts receivable 441,180/ $513,000
Allowance for doubtful accounts [CREDIT] $ 22,059 / $ 25,650
Inventory 2,3750,000 / $ 3,325,000
Investment in corporate stock $265,000 110,000
Investment in municipal bonds $32,000 32,000
Net current deferred tax asset $10,220 / $8,721
Cash surrender value of insurance policy 42,000 / 54,000
Land 300,000 / 300,000
Buildings 1,400,000 / 1,400,000
Accumulated depreciationâ€”Buildings [CREDIT] 70,000 / 98,000
Equipment 960,000 / 2,640,000
Accumulated depreciationâ€”Equipment [CREDIT] 160,000 / 249,333
Trucks 250,000 / 250,000
All accounts below are [CREDIT] side
Accumulated depreciationâ€”Trucks 75,000 / 125,000
Accounts payable 300,000 / 270,000
Notes payable (short-term) 610,000 / 488,000
Accrued payroll taxes 14,250 / 17,812
Accrued state income taxes 8,550 / 14,250
Accrued federal income taxes 0 / 116,693
Bonds payable (long-term) 2,000,000 / 2,300,000
Net noncurrent Deferred tax liability 158,657 / 284,588
Capital stockâ€”Common 950,000 / 950,000
Retain earningsâ€”Unappropriated 1,900,000 / 3,920,218
Totals $6,268,516 / $6,268,516 // $8,859,544 / $8,859,544
3-62 Corporations ? Chapter 3
The corporation incurred $11,000 of organizational expenditures on January 2, 2003. For
book 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 monthâ€™s amortization taken for January 2003. The corporation reports this amortization in Part VI of Form 4562 and includes it in â€œOther Deductionsâ€ 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. The
corporation 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. 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-yearâ€™s depreciation in
the year of acquisition and the year of disposition and assumes no salvage value. The
Knoxville Musical Sales, Inc.â€”Book Income Statement 2006
Sales $ 9,500,000
Net sales $ 9,262,500
Beginning inventory $2,375,000
Ending inventory (3,325,000)
Cost of goods sold (4,275,000)
Gross profit $ 4,987,500
Amortization $ â€“0â€“
General insurance 52,250
Premiumâ€“Officersâ€™ life insurance (net of cash buildup) 42,750
Officerâ€™s compensation 617,500
Other salaries 380,000
Legal and accounting fees 47,500
Charitable contributions 28,500
Employment tax 59,375
Bad debts 41,591
Total expenses (1,834,059)
Gain on sale of equipment 104,000
Interest on municipal bonds 4,750
Net gain on stock sales 18,000
Dividend income 11,400
Net income before FIT expense $ 3,291,591
Federal income tax (FIT) expense $(1,105,123)
State income tax expense ($71,250)
Net income per books $ 2,115,218
The Corporate Income Tax ? Corporations 3-63
book financial statements in Tables C:3-3 and C:3-4 reflect these calculations. The designation
â€œoldâ€ refers to property placed in service before 2006, and the designation â€œnewâ€
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 $1.4 million and placed it in service on
January 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 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 $106,246
Equipment 1 180,064
Equipment 2 360,128
On November 16, 2006, the corporation sold for $350,000 Equipment 1 that originally
cost $320,000 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 $2 million. 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.
Where applicable, use published IRS depreciation tables to compute 2006 depreciation
(reproduced in Appendix C of this text).
â€¢ The corporationâ€™s activities do not qualify for the U.S. production activities deduction.
â€¢ Ignore the AMT and accumulated earnings tax.
â€¢ The corporation received dividends (see table 3-4) from taxable, domestic corporations,
the stock of which Knoxville Musical Sales, Inc. owns less than 20%.
â€¢ The corporation paid $95,000 in cash dividends to its shareholders during the year
and charged the payment directly to retained earnings.
â€¢ The corporation is not entitled any credits.
â€¢ The state income tax in table c 3-4 is the exact amount of such taxes incurred during the year.
â€¢ 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. along
with 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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