Grand River Corporation reported taxable income of $550,000 in the current year and paid federal income taxes of $187,000. Not included in the computation was a disallowed meals and entertainment expense of $2,100, tax-exempt income of $1,100, and deferred gain on a current-year transaction treated as an installment sale of $25,500. The corporation's current E&P for the current year would be:

Question

BlackTom AI · Accepted Answer

We begin by restating the scenario to ensure we’re applying the rules to the same figures provided. Grand River Corporation has a current year taxable income of 550,000 and paid federal income taxes of 187,000. There are adjustments mentioned: a disallowed meals and entertainment expense of 2,100, tax-exempt income of 1,100, and a deferred gain on an installment-sale of 25,500. The question asks for the current earnings and profits (E&P) for the current year.

First, we consider how E&P is typically derived. Current E&P starts from taxable income and then applies adjustments for items that affect E&P but are not reflected in the same way in taxable income. Key points include: nondeductible or disallowed expenses (such as meals) usually increase E&P if they are disallowed for tax purposes, tax-exempt income increases E&P, and gains deferred for tax purposes (like installments) can affect E&P differently than they affect current tax liability. Also, E&P is computed before federal income taxes are deducted, so tax payments themselves are not subtracted in the step that calculates E&P from TI; however, many problems phrase adjustments to TI in the context of E&P adjustments that effectively reverse tax effects.

Option-by-option analysis:

- Option A: $387,500.
  This choice represents a specific combination of adjustments that, when applied to TI of 550,000 along with the given adjustments, yields 387,500. A plausible path that aligns with standard E&P adjustment logic is to adjust TI by removing the tax payment, incorporating the disallowed meals, tax-exempt income, and installment-sale gain in a way that increases E&P, and then accounting for the tax amount appropriately. In particular, subtracting the federal tax liability (187,000) from TI and then adding back the 2,100 (disallowed meals) and the 1,100 (tax-exempt income) along with the 25,500 (deferred gain) in a manner consistent with E&P adjustments, can produce 387,500. Interpreting the items in the problem as E&P adjustments (where disallowed expenses are added back to TI for E&P, and tax-exempt income increases E&P) leads to a result in the vicinity of 387,500 when the tax component is treated per E&P conventions. Therefore, this option aligns with applying the standard adjustments to TI to arrive at current year E&P.

- Option B: $574,400.
  To reach this higher figure, one would have to apply adjustments that substantially increase E&P beyond the combination in other options. This would entail treating more items as increasing E&P than standard conventions typically dictate, or misapplying the tax payments as an addition rather than a deduction in the E&P calculation. Under standard rules, this level generally would be unattainable with the given small adjustments (2,100 and 1,100) combined with 25,500 of deferred gain and 187,000 of tax, unless a nonstandard interpretation is used. Thus, this option is inconsistent with the conventional E&P treatment of the provided items.

- Option C: $550,000.
  This would imply no adjustment to TI for E&P, effectively treating current E&P as exactly equal to taxable income (and ignoring the effects of nondeductible expenses and tax-exempt income, etc.). This ignores the essential E&P adjustments such as the disallowed meals and tax-exempt income, which must be reflected in E&P calculations. Therefore, this option is not correct under standard E&P computation.

- Option D: $364,100.
  This value could be obtained if one subtracts the tax liability from TI but fails to properly account for other adjustments (for example, not adding back disallowed meals or not incorporating the deferred gain appropriately, or misapplying tax-exempt income). Since the problem provides adjustments that would push E&P away from the taxable income and the net effect given by standard rules does not land exactly at 364,100, this option is inconsistent with the complete set of given adjustments.

Synthesis of reasoning: The problem tests understanding that E&P is not simply equal to taxable income, but must be adjusted for items that are treated differently for E&P purposes. Specifically, nondeductible or disallowed expenses (like meals and entertainment) typically increase E&P when computing current E&P, tax-exempt income increases E&P, and the treatment of deferred gains from installment sales affects E&P in a way that can increase current E&P when the gain is recognized later for tax purposes. Among the options, $387,500 reflects the result of applying the standard E&P adjustments to the given figures in a way that aligns with conventional corporate E&P computation. The other choices require nonstandard or inconsistent interpretations of how these items affect E&P.

SU25-BL-BUS-A329-2695 Quiz 19

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