For the current taxable year, Starke Corp., an accrual basis calendar-year corporation, reported book income of $380,000. Included in that amount was $50,000 municipal bond interest income, $170,000 for federal income tax expense, and $2,000 interest expense on the debt incurred to carry the municipal bonds. What amount should Starke’s taxable income be as reconciled on Starke’s Schedule M-1 of Form 1120, US Corporation Income Tax Return?
a. $330,000
b. $500,000
c. $502,000
d. $550,000
Answer:C
The requirement is to determine Starke Corp.’s taxable income as reconciled on Schedule M-1 of Form 1120. Schedule M-1 provides a reconciliation of a corporation’s book income with its taxable income before the dividends received and net operating loss deductions. Starke reported book income of $380,000 that included $50,000 of municipal bond interest income, and deductions for $170,000 of federal income tax expense and $2,000 of interest expense incurred to carry the municipal bonds. Since municipal bond interest is tax-exempt, the $50,000 of interest income must be subtracted from book income, and the $2,000 of interest expense incurred to carry the municipal bonds is not deductible and must be added back to book income. Similarly, the $170,000 of federal income tax expense is not deductible and must be added back to book income. Thus, Starke’s taxable income is $380,000 – $50,000 + $2,000 + $170,000 = $502,000.