Module 1- Ethics, Professional Responsibilities, and Federal Tax Procedures

Question 1

While reviewing a new client’s prior-year tax returns, a CPA became aware that the client did not properly file all required federal income tax returns. Under Treasury Circular 230, what should the CPA do in this situation?

Notify the AICPA of the situation and request a ruling of continuance.

Notify the Internal Revenue Service of the client’s noncompliance.

Resign from the engagement.

Advise the client of the consequences of the noncompliance.

Answer 1

Advise the client of the consequences of the noncompliance.

Correct! Circular 230 requires that the tax accountant promptly inform the client of this error. The decision regarding how to respond to the error is the client’s.

Question 2

When preparing a client’s Form 1040, U.S. Individual Income Tax Return, a CPA determined that there was documentation supporting only $12,000 of the $20,000 travel expenses claimed by the client. Which of the following courses of action taken by the CPA would be in compliance with Treasury Circular 230?

The CPA makes reasonable inquiries to obtain the needed documentation if the information as furnished appears to be incorrect or incomplete.

The CPA deducts the $20,000 of expenses since there is a small likelihood that the IRS will audit the tax return.

The CPA relies in good faith, without verification, on information furnished by the client in deducting the expenses.

The CPA deducts the $20,000 of expenses as long as the client agrees to disclose on the return that $8,000 of the expenses are undocumented.

Answer 2

The CPA makes reasonable inquiries to obtain the needed documentation if the information as furnished appears to be incorrect or incomplete.

Correct! It is important that practitioners ensure that positions taken have a reasonable basis.

Question 3

Under Circular 230, it is proper to delay as long as possible in fulfilling an IRS request for records or information if:

You have investigated and believe in good faith that the information is privileged.

It would benefit your client strategically in his tax dispute with the IRS.

A and B

None of the above.

Answer 3

You have investigated and believe in good faith that the information is privileged.

Section 10.20 requires prompt compliance with an IRS request for information or records unless the practitioner believes in good faith and on reasonable grounds that they are privileged.

Question 4

If you learn that the tax return that you prepared for your client last year contained a material error, you should:

Promptly inform your client.

Inform the IRS even before informing your client.

A and B.

None of the above.

Answer 4

Promptly inform your client.

Like the AICPA Code of Professional Conduct, Circular 230 requires the tax practitioner to promptly inform a client of such a material error.

Question 5

Pursuant to Treasury Circular 230, which of the following statements about the return of a client’s records is correct?

The client’s records are to be destroyed upon the submission of a tax return.

The practitioner may retain copies of the client’s records.

The existence of a dispute over fees generally relieves the practitioner of responsibility to return the client’s records.

The practitioner does not need to return any client records that are necessary for the client to comply with the client’s federal tax returns.

Answer 5

The practitioner may retain copies of the client’s records.

The IRS allows tax practitioners to retain copies of the client’s records.

Question 6

Under Treasury Circular 230, which of the following actions of a CPA tax advisor is characteristic of a best practice in rendering tax advice?

Requesting written evidence from a client that the fee proposal for tax advice has been approved by the board of directors.

Recommending to the client that the advisor’s tax advice be made orally instead of in a written memorandum.

Establishing relevant facts, evaluating the reasonableness of assumptions and representations, and arriving at a conclusion supported by the law and facts in a tax memorandum.

Requiring the client to supply a written representation, signed under penalties of perjury, concerning the facts and statements provided to the CPA for preparing a tax memorandum.

Answer 6

Establishing relevant facts, evaluating the reasonableness of assumptions and representations, and arriving at a conclusion supported by the law and facts in a tax memorandum.

Circular 230’s section 10.33 recommends these steps as “best practices” for federal tax advisors.

Question 7

Under Circular 230, which of the following describes improper activity by a CPA giving federal tax advice?

The CPA takes into account the possibility that a tax return will not be audited.

The CPA reasonably relies upon representations of the client.

The CPA considers all relevant facts that are known.

The CPA takes into consideration assumptions about future events related to the relevant facts.

Answer 7

The CPA takes into account the possibility that a tax return will not be audited.

A CPA should never give tax advice turning upon the possibility that the IRS might not audit the client’s tax return.

Question 8

While preparing a tax return for a new client and reviewing the client’s prior-year return, a CPA noticed an error made by the client’s former tax preparer. According to Treasury Department Circular 230, which of the following is the CPA specifically required to do in this case?

Contact the tax preparer who made the error and suggest that an amended return be prepared for the client.

Inform the client of the error and insist that the return be amended.

Inform the client of the error and advise of the consequences.

Advise the client to contact the tax preparer of the prior-year return.

Answer 8

Inform the client of the error and advise of the consequences.

CORRECT! Both Circular 230 and the Code of Professional Conduct tells CPAs who learn of such errors to inform the client of the error and advise the client of the consequences so that the client can make an informed decision regarding how to proceed.

Question 9

Under Treasury Circular 230, the IRS requires that certain records be returned to a client by the tax practitioner even though no payment for services has been received. Records of the client for this purpose do not include

Materials prepared by a client’s actuary and provided to the practitioner with respect to tax preparation.

A schedule prepared by the practitioner that provides mathematical details of a particular amount included in a client’s tax return.

Electronic materials provided to the practitioner that existed before the client retained the practitioner.

Written records given to the practitioner at the beginning of the engagement.

Answer 9

A schedule prepared by the practitioner that provides mathematical details of a particular amount included in a client’s tax return.

Correct! This is a document prepared by the practitioner and therefore is not included in the notion of “records of the client.”

Question 10

With respect to any given tax return, which of the following statements is correct?

More than one person may be deemed to be a preparer of a tax return.

The final reviewer of a tax return is automatically considered the preparer of the return.

Only one person may be deemed to be a preparer of a tax return.

The two individuals who have done the most work in preparing the return will be deemed to be the only preparers.

Answer 10

More than one person may be deemed to be a preparer of a tax return.

Correct! More than one person may be deemed a TRP.

Question 11

A tax preparer filed a return for a taxpayer and used the taxpayer’s detailed check register containing both business and personal expenses. If the tax preparer knowingly included personal expenses as deductible business expenses on the taxpayer’s business, then the

Tax preparer will be liable only for penalties for taking an unreasonable position that led to an understatement.

Taxpayer will be liable for penalties for taking an unreasonable position that led to an understatement.

Tax preparer will be liable for penalties arising from an understatement due to willful or reckless conduct.

Taxpayer will be liable for penalties attributable to transactions lacking economic substance.

Answer 11

Tax preparer will be liable for penalties arising from an understatement due to willful or reckless conduct.

Correct! This appears to be willful misconduct. At a minimum, it was reckless, so the more severe penalties that go with tax understatement will apply.

Question 12

Which of the following will not get CPA Sandy in trouble with the IRS?

Failing to furnish copies of returns to her clients.

Failing to sign returns she prepares and files.

Failure to furnish her preparer’s identifying number to her clients.

Failure to keep copies of the returns she prepares.

Answer 12

Failure to furnish her preparer’s identifying number to her clients.

Under current rules, Sandy must furnish the preparer’s identifying number to the IRS but not to her clients.

Question 13

Pak worked for EPS marketing trusts and other asset protection devices through a nationwide multi-level marketing network of financial planners. The IRS labeled the trusts illicit tax shelters. EPS then started calling the trusts by new names but continued to market them. Pak was EPS’s executive vice president, spoke at its public events, and received sales overrides from agents he recruited as sales representatives for EPS. As Pak explained them, the trusts allowed clients to transfer all their income to a “donor-directed” trust from which they could spend the money on anything they wanted, without paying taxes on it. The IRS brought an action against Pak, seeking to fine him for promoting an abusive tax shelter in violation of 26 U.S.C. 6700. Which of the following is true?

Pak is probably liable.

Pak is probably not liable, because he did not organize or participate in sale of the shelters.

Pak is probably not liable, because he did not make any materially false statements that affect tax liability.

B and C.

Answer 13

Pak is probably liable.

Pak meets the requirements for violating Section 6700 in that he participated in the sale of a tax shelter (in his role as executive vice president of EPS, speaker at its events, etc.) and he made materially false statements because this device is obviously bogus.

Question 14

Under which of the following scenarios will Jenny be in trouble under Section 6713’s confidentiality provisions?

When she sells a celebrity client’s confidential tax information to a tabloid newspaper.

When she discloses a rich client’s confidential tax information pursuant to court order.

When she shows several of her clients’ tax returns to another accountant performing a peer review of Jenny’s firm.

All of the above.

Answer 14

When she sells a celebrity client’s confidential tax information to a tabloid newspaper.

This is an improper disclosure of the client’s confidential information and will violate 6713 (as well as 7216).

Question 15

CPA Monrew induced several rich tax clients to invest in a domesticated beaver tax shelter device. When the IRS sought to audit one of Monrew’s clients, he realized that among other difficulties, he had not had the client sign proper documentation. While an IRS agent sat in the waiting room of one of his clients, Monrew slipped in a back door and had the client sign a backdated document. When the government discovered all this, Monrew was indicted for tax fraud in violation of Section 7206. Which of the following is true?

Monrew is probably guilty.

Monrew is probably not guilty, because the client bears the blame here.

Monrew is probably not guilty because his actions, while not praiseworthy, do not violate the statute.

B and C.

Answer 15

Monrew is probably guilty.

Monrew clearly willfully aided in the preparation of a tax-related document that was fraudulently backdated.

Question 16

Louis, the volunteer treasurer of a nonprofit organization and a member of its board of directors, compiles the data and fills out its annual Form 990, Return of Organization Exempt from Income Tax. Under the Internal Revenue Code, Louis is not considered a tax return preparer because:

He is a member of the board of directors.

The return does not contain a claim for a tax refund.

He is not compensated.

Returns for nonprofit organizations are exempt from the preparer rules.

Answer 16

He is not compensated.

People are TRPs if (a) they are paid, (b) to prepare or retain employees to prepare, (c) a substantial portion, (d) of any federal tax return. Because Louis was not paid specifically to prepare the return, he does not satisfy the first requirement to be a TRP.

Question 17

Tax return preparers can be subject to penalties under the Internal Revenue Code for failure to do any of the following except

Sign a tax return as a preparer.

Disclose a conflict of interest.

Provide a client with a copy of the tax return.

Keep a record of Returns prepared.

Answer 17

Disclose a conflict of interest.

The I.R.C. contains no penalty for failing to disclose a conflict of interest when preparing a tax return.

Question 18

Which of the following statements is correct concerning a penalty for a tax return preparer who understates a taxpayer’s liability?

No penalty is imposed if the understatement of tax liability is related to a tax shelter and was properly disclosed, and if there was substantial authority for the position.

If there is a final judicial decision that there was no understatement of liability, the related tax preparer penalty paid earlier is not refundable.

In general, the penalty does not apply unless the understatement of the tax liability is at least $10,000.

No penalty is imposed if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.

Answer 18

No penalty is imposed if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.

Correct! A “reasonable cause” defense exists if the tax return preparer had both “reasonable cause” (an objective standard) for the position taken and acted in “good faith” (a subjective standard).

Question 19

Which agency is responsible for determining the continuing professional education requirements for licensed CPAs?

The Securities and Exchange Commission

The board of accountancy for the state in which the licensed CPA practices

The American Institute of Certified Public Accountants

The National Association of State Boards of Accountancy

Answer 19

The board of accountancy for the state in which the licensed CPA practices

Correct! State boards of accountancy establish CPE requirements.

Question 20

To whom must a CPA pay license fees in order to maintain a CPA license?

The Public Company Accounting Oversight Board

The American Institute of Certified Public Accountants

The state board of accountancy of the CPA’s state of licensure

The state society of certified public accountants of the CPA’s state of licensure

Answer 20

The state board of accountancy of the CPA’s state of licensure

Correct! State boards of accountancy both license CPAs and collect the fees for the CPA license.

Question 21

When an ethics complaint carrying national implications arises, which entity typically handles it?

SEC.

PCAOB.

State CPA society.

AICPA.

Answer 21

AICPA.

The AICPA handles ethical complaints with national implications.

Question 22

What is JEEP?

Joint Energy Equity Program.

Junior Emergency Enforcement Program.

Joint Ethics Enforcement Program.

None of the above.

Answer 22

Joint Ethics Enforcement Program.

JEEP is the Joint Ethics Enforcement Program that divides ethics complaints and investigations between the AICPA and state societies.

Question 23

CPA Smithers has had some professional difficulties. Which of the following is true?

If the state board of accountancy revokes Smithers’ CPA license, s/he will be automatically expulsed from the AICPA.

If the state society of CPAs expulses Smithers, the state board of accountancy will automatically revoke his/her CPA license.

Both A and B.

Neither A nor B.

Answer 23

If the state board of accountancy revokes Smithers’ CPA license, s/he will be automatically expulsed from the AICPA.

If the state agency revokes Smithers’ license, s/he will no longer be a CPA, which is requisite to membership in the state society of CPAs.

Question 24

Which of the following can grant a CPA license?

A state board of accountancy.

The AICPA.

The Securities Exchange Commission.

All of the above.

Answer 24

A state board of accountancy.

Only state boards of accountancy can grant a CPA license.

Question 25

Cherokee wants to know which of the following is a requirement to earn a CPA license:

150 hours of college education.

Passing the CPA examination.

One year of work experience.

All of the above.

Answer 25

All of the above.

All three choices represent a requirement to earn a CPA license.

Question 26

Iola has had a few serious professional problems. Which of the following will probably cause a state board of accountancy to revoke her license or order a lesser punishment?

Failing to complete required continuing professional education.

Failing to pay her own income tax.

Violating professional standards.

All of the above.

Answer 26

All of the above.

All listed acts will likely be cause for serious sanction.

Question 27

Which of the following bodies ordinarily would have the authority to suspend or revoke a CPA’s license to practice public accounting?

The SEC.

The AICPA.

A state CPA society.

A state board of accountancy.

Answer 27

A state board of accountancy.

While certain types of punishments may be meted out by the SEC, the AICPA, and state CPA societies, only a state board of accountancy truly has the power to revoke a CPA’s license to practice public accountancy. Nonetheless, the SEC may, for example, prevent an accountant from appearing before it or doing any attest work for a public company.
The AICPA may revoke an accountant’s membership, as may a state CPA society. But only the state board of accountancy may revoke a license to practice.

Question 28

Regarding the standards for substantiation of tax positions, in which of the following answers is the proper standard matched with the appropriate numerical value?

Substantial authority = 20%.

Reasonable basis = 40%.

Substantial authority = 40%.

Reasonable basis = 30%.

Answer 28

Substantial authority = 40%.

Correct! And a “reasonable basis” is 20%.

Question 29

For taxpayers who are trying to get things right when facing difficult tax questions, what two key words should they keep in mind?

Reasonable cause and good faith

Good faith and no fraud

Reasonable cause and attention to detail

Attention to detail and no fraud

Answer 29

Reasonable cause and good faith

Correct! These are the two concepts that can avoid liability.

Question 30

Which of the following is an accurate statement regarding the rules for substantiation of federal income tax positions?

Failure to keep adequate books and records can lead to accuracy-related penalties.

The IRS seldom questions home office deductions.

Taxpayers should retain all tax returns for the previous 10 years.

Charitable tax deductions are encouraged so the IRS does not require them to be substantiated.

Answer 30

Failure to keep adequate books and records can lead to accuracy-related penalties.

Correct! This is a major ground for such penalties.

Question 31

Taxpayer Clegg would certainly like to take a particular deduction that is barred by an IRS regulation. However, after considerable research Clegg’s tax attorney believes that there is a one-third chance that a court would overturn the regulation as invalidly promulgated by the IRS. What should Clegg do?

Take the deduction without disclosure.

Take the deduction, but disclose it.

Not take the deduction.

All of the above.

Answer 31

Take the deduction, but disclose it.

Choice B: Correct! With disclosure, Clegg can avoid an underpayment penalty even if the position is ultimately rejected because there is a reasonable basis (≥ 20% chance of approval) for it.

Question 32

Fitely hired a tax accountant whom his attorney recommended. The accountant, Tilder, recommended that Fitely take a particular tax position that resulted in an understatement of taxes and the IRS is now seeking to penalize Fitely. In order to establish a good faith defense against the 20% understatement penalty, which of the following does Fitely need to establish:

That Tilder was a competent professional.

That Fitely gave Tilder all necessary and accurate information.

That Fitely actually relied in good faith on Tilder’s judgment.

All of the above.

Answer 32

All of the above.

Choice D: Correct! All choices are needed to establish the good faith defense.

Question 33

Which of the following burdens of proof must be met when a disclosed position regarding a particular individual deduction is evaluated to determine whether it was taken in good faith.

≥ 10% chance of being sustained

≥ 20% chance of being sustained

≥ 40% chance of being sustained

> 50% chance of being sustained

Answer 33

≥ 20% chance of being sustained

Choice B: Correct! This “reasonable basis” standard applies to disclosed positions.

Question 34

The disclosure of a tax return position will reduce or eliminate an accuracy-related penalty on the taxpayer in which of the following circumstances?

The position is frivolous.

The position is not properly substantiated.

The position concerns a tax shelter with substantial authority.

The position does not concern a tax shelter and has a reasonable basis.

Answer 34

The position does not concern a tax shelter and has a reasonable basis.

Correct! Only if a position does not involve a tax shelter and has a reasonable basis will it be shielded from penalty by disclosure.

Question 35

Tribble carelessly filed his taxes four months late. He owed $60,000 in taxes. What is his late filing penalty?

$120,000

$60,000

$12,000

$9,500

Answer 35

$12,000

Correct! Tribble owes 5% of $60,000 ($3,000) times 4 (the number of months late), which multiplies out to $12,000.

Question 36

Xina carelessly filed her taxes 10 months late. She owed $100,000 in taxes. What is Xina’s late filing penalty?

$100,000

$75,000

$50,000

$25,000

Answer 36

$25,000

Correct! The late filing penalty is capped at 25% of the amount of taxes owed ($100,000 × 25% = $25,000). Absent the cap, Xina would have owed $50,000.

Question 37

Tera filed her tax return on time but did not pay her taxes until four months after they were due. She owed $20,000. What is her late payment penalty amount?

$400

$600

$4,000

$60,000

Answer 37

$400

Correct! Tera’s fine is 0.5% × 4 × $20,000 = $400.

Question 38

Omar’s correct tax amount is $500,000, but he filed a form reporting that it was only $400,000. There is no claim of fraud. Is this a “substantial understatement” that will subject him to the 20% understatement penalty?

Yes, and his penalty will be $100,000.

Yes, and his penalty will be $20,000.

Yes, and his penalty will be $5,000.

No.

Answer 38

Yes, and his penalty will be $20,000.

Correct! This is a substantial understatement, because Omar’s $100,000 understatement exceeds both 10% of the tax ($50,000) and the $5,000 level. The penalty is 20% of the underpayment of $100,000, or $20,000.

Question 39

ABC Corporation, a Chapter C corporation, had a correct tax amount of $1,000,000 but reported only $800,000. There is no claim of fraud. Is this a “substantial understatement” that will subject ABC to the 20% understatement penalty?

Yes, and its penalty will be $40,000.

Yes, and its penalty will be $20,000.

Yes, and its penalty will be $10,000.

No.

Answer 39

Yes, and its penalty will be $40,000.

Correct! This was a substantial understatement, because the $200,000 amount, while not exceeding $10,000,000, does exceed the lesser amount of 10% of the tax ($100,000) (which, in turn, exceeds $10,000). The penalty will be 20% × $200,000 = $40,000.

Question 40

Slim is considering taking an aggressive tax position on his income tax return. His experienced tax CPA has evaluated the position carefully and determined that there is a one in four chance that it will, if challenged, be sustained. What should Slim do?

Take the position but not disclose it.

Take the position and disclose it.

Not take the position.

All of the choices.

Answer 40

Take the position and disclose it.

Correct! Because this meets the “reasonable basis” test (≥20%), it can be taken if disclosed without courting an understatement penalty.

Question 41

Which of the following type of regulations cannot be cited as authority to support a tax position?

Legislative regulations.

Interpretive regulations.

Procedural regulations.

Proposed regulations.

Answer 41

Proposed regulations.

Proposed regulations do not have the effect of law, but they do provide an indication of the IRS’s view on a tax issue.

Question 42

In evaluating the hierarchy of authority in tax law, which of the following carries the greatest authoritative value for tax planning of transactions?

Internal Revenue Code.

IRS regulations.

Tax court decisions.

IRS agents’ reports.

Answer 42

Internal Revenue Code.

The Internal Revenue Code is the highest tax authority.

Question 43

Which of the following courts is not a court of original jurisdiction?

United States Tax Court.

United States District Court.

United States Court of Appeals.

United States Court of Federal Claims

Answer 43

United States Court of Appeals.

The United States Court of Appeals hears appeals from the U.S. Tax Court and the U.S. District Court. It is not a court of original jurisdiction.

Question 44

All of the following are administrative sources of the tax law except:

Private letter rulings.

Technical advice memoranda.

Revenue rulings.

Committee reports.

Answer 44

Committee reports.

Committee reports are legislative sources of authority which provide insight into the intention of the House Ways & Means Committee, Senate Finance Committee, and Joint Conference Committee.

Question 45

Which of the following is NOT considered a primary authoritative source when conducting tax research?

Internal Revenue Code.

Tax Court cases.

IRS publications.

Treasury regulations.

Answer 45

IRS publications.

IRS Publications are a secondary source of the tax law.

Question 46

Which Senate committee considers new tax legislation?

Budget.

Finance.

Appropriations.

Rules and Administration.

Answer 46

Finance.

Tax legislation in the Senate begins in the Senate Finance Committee.

Question 47

A CPA is researching a tax issue and is attempting to understand the intent of Congress. Which of the following would generally be least useful for that purpose?

Committee Report of the House Ways and Means Committee

A Notice of Proposed Rulemaking

A Senate Finance Committee Report

The Congressional Record

Answer 47

A Notice of Proposed Rulemaking

CORRECT! A notice of proposed rulemaking does not provide information about congressional intent.

Question 48

Which of the following is a list of courts that are referred to as courts of original jurisdiction, or trial courts, for tax matters?

The Tax Court, the U.S. District Court, and the U.S. Court of Federal Claims.

The Tax Court, the U.S. District Court, and the U.S. Bankruptcy Court.

The Tax Court, the U.S. Court of Federal Claims, and the U.S. Court of Appeals.

The U.S. District Court, the U.S. Court of Federal Claims, and the U.S. Court of Appeals.

Answer 48

The Tax Court, the U.S. District Court, and the U.S. Court of Federal Claims.

CORRECT! There are three courts of original jurisdiction: the Tax Court, the U.S. District Court, and the U.S. Court of Federal Claims.

Question 49

A statutory notice of deficiency explains that the taxpayer has 90 days to either pay the deficiency or else to file a

Claim for refund.

Petition with the U.S. Tax Court.

Protest and request a conference with an appeals officer.

Petition with the taxpayer’s U.S. District Court.

Answer 49

Petition with the U.S. Tax Court.

Correct! The statutory notice of deficiency is also known as 90-day letter. It is significant in that this is the time that the taxpayer has to file a petition with the Tax Court. If the petition is not filed in a timely manner, the taxpayer’s only judicial recourse is through a U.S. District Court or a U.S. Claims Court, both of which require the deficiency to be paid before the judicial process can begin.

Question 50

If a taxpayer receives a 30-day letter from the Internal Revenue Service, the taxpayer:

Must pay the tax deficiency or respond to the issues raised through written correspondence to the IRS within 30 days of the date of the letter.

May ignore the letter and take no action.

Must pay the tax deficiency or file a petition with the Tax Court within 30 days of the date of the letter.

Must pay the tax deficiency and file a petition with the District Court within 30 days of the date of the letter.

Answer 50

May ignore the letter and take no action.

The taxpayer is not required to respond to a 30-day letter, although if there is no response the IRS will follow with a 90-day letter.

Question 51

Which of the following documents does NOT govern the conduct of a CPA who is engaged in providing tax services?

AICPA’s Code of Professional Conduct

AICPA’s Statements on Standards for Tax Services

Circular 230

Internal Revenue Service Audit Guides

Answer 51

Internal Revenue Service Audit Guides

IRS Audit Guides provide guidance to revenue agents who are conducting audits but they do not govern the conduct of CPAs engaged in providing tax services.

Question 52

An IRS agent has just completed an examination of a corporation and issued a “no change” report. Which of the following statements about that situation is correct?

The taxpayer may not amend the tax return for that taxable year.

The IRS generally does not reopen the examination except in cases involving fraud or other similar misrepresentation.

The IRS may not reopen the examination.

The IRS may not examine any other tax return of the corporation for a period of one year.

Answer 52

The IRS generally does not reopen the examination except in cases involving fraud or other similar misrepresentation.

After a “no change” report the IRS cannot reopen the examination unless the corporation has committed fraud.

Question 53

A C corporation had a federal income tax liability of $40,000 for each of the last five years, each covering a 12-month period. The tax for the current year is $48,000. What is the lowest amount that must have been paid as estimated taxes for the current year so that no penalty for underpayment is applicable?

$40,000

$44,000

$48,000

$52,800

Answer 53

$40,000

Correct! To avoid an underpayment penalty, the corporation can pay the lower of 100% of the prior year’s tax liability ($40,000) or 100% of the current year’s tax liability ($48,000).

Question 54

A taxpayer filed his income tax return after the due date but neglected to file an extension form. The return indicated a tax liability of $50,000 and taxes withheld of $45,000.
On what amount would the penalties for late filing and late payment be computed?

$0

$5,000

$45,000

$50,000

Answer 54

$5,000

The late filing and late payment penalty is based upon the balance due. $50,000 owed less $45,000 withheld = $5,000 net due.

Question 55

A tax return preparer may disclose or use tax return information without the taxpayer’s consent to

Facilitate a supplier’s or lender’s credit evaluation of the taxpayer.

Accommodate the request of a financial institution that needs to determine the amount of taxpayer’s debt to it, to be forgiven.

Be evaluated by a quality or peer review.

Solicit additional nontax business.

Answer 55

Be evaluated by a quality or peer review.

Disclosure or use of the information on a tax return can only be done with the written consent of the taxpayer. Absent the taxpayer’s written consent, disclosure or use of the taxpayer’s tax return information by a tax preparer makes the preparer subject to a penalty for knowingly or recklessly disclosing tax return information.
However, there are exceptions to the penalty. Specifically, tax preparers may disclose or use information on a tax return if the disclosure is (1) for quality or peer reviews; (2) for use in preparing state and local taxes and/or in declaring estimated taxes;(3) under code; and (4) under the order of a court of law.
Thus, disclosing information for a peer review is an allowable exception to the penalty for knowingly or recklessly disclosing tax return information.

Question 56

Which, if any, of the following could result in penalties against an income tax return preparer?
I. Knowing or reckless disclosure or use of tax information obtained in preparing a return.
II. A willful attempt to understate any client’s tax liability on a return or claim for refund.

Neither I nor II.

I only.

II only.

Both I and II.

Answer 56

Both I and II.

Disclosure or use of the information on a tax return can only be done with the written consent of the taxpayer. Absent the taxpayer’s written consent, disclosure or use of the taxpayer’s tax return information by a tax preparer makes the preparer subject to a penalty for knowingly or recklessly disclosing corporate tax information. Penalties also may be imposed on income tax preparers that willfully attempt to understate the tax liability on a return or refund claim.
This response indicates penalties may be imposed against preparers that knowingly or recklessly disclose or use tax information obtained in preparing a return or willfully attempt to understate any client’s tax liability on a return or claim for refund. Thus, it is correct.

Question 57

An accuracy-related penalty applies to the portion of tax underpayment attributable to
I. Negligence or a disregard of the tax rules or regulations.
II. Any substantial understatement of income tax.

I only.

II only.

Both I and II.

Neither I nor II.

Answer 57

Both I and II.

The accuracy-related penalty applies to any portion of an understatement if tax on a tax return is due to negligence or to substantial income tax understatements, income tax valuation misstatements, estate or gift tax understatements, or pension liability overstatements.

Question 58

Chris Baker’s adjusted gross income on her 2018 tax return was $160,000. The amount covered a 12-month period. For the 2019 tax year, Baker may avoid the penalty for the underpayment of estimated tax if the timely estimated tax payments equal the required annual amount of
I. 90% of the tax on the return for the current year paid in four equal installments.
II. 100% of prior year’s tax liability paid in four equal installments.

I only.

II only.

Both I and II.

Neither I nor II.

Answer 58

I only.

The required annual amount is usually the lower of 90% of the tax shown on the taxpayer’s current year return or 100% of the tax shown on the taxpayer’s prior year return. If the taxpayer’s adjusted gross income exceeded $150,000 in the prior year and the taxpayer elects to base his/her required annual amount on the prior year, then the taxpayer would have to use 110% of the prior year’s return.
Thus, Baker must base his required annual amount on 90% of the current year’s tax liability or, since his adjusted gross income exceeded $150,000, 110% of the prior year’s liability.

Question 59

A civil fraud penalty can be imposed on a corporation that underpays tax by

Omitting income as a result of inadequate recordkeeping.

Failing to report income it erroneously considered not to be part of corporate profits.

Filing an incomplete return with an appended statement, making clear that the return is incomplete.

Maintaining false records and reporting fictitious transactions to minimize corporate tax liability.

Answer 59

Maintaining false records and reporting fictitious transactions to minimize corporate tax liability.

A civil fraud penalty can be imposed on a taxpayer if the Internal Revenue Service (IRS) is able to show by a preponderance of evidence that the taxpayer had specific intent to evade a tax. After the IRS originally shows that fraudulent actions by the taxpayer have occurred, the taxpayer must prove that any tax underpayment was not attributable to fraudulent behavior. The civil fraud penalty amounts to 75% of the tax underpayment.

Question 60

Edge Corp., a calendar-year C corporation, had a net operating loss and zero tax liability for its 2019 tax year. To avoid the penalty for underpayment of estimated taxes, Edge could compute its first-quarter 2020 estimated income tax payment using the

Annualized income method
Preceding-year method

Yes
Yes

Yes
No

No
Yes

No
No

Answer 60

Yes
No

Corporations owing $500 or more in income tax for the tax year are required to make estimated tax payments or be subject to an interest penalty. The payments must be equal to the lesser of 100% of the tax liability for the current year (i.e., the annualized income method) or the preceding year (i.e., the preceding-year method). The payments cannot be based on the preceding year if: (1) the corporation did not file a return showing a tax liability for that year (e.g., the corporation experienced a net operating loss); (2) the preceding year was less than 12 months; or (3) the corporation had taxable income of over $1,000,000.
This response correctly indicates that the Edge Corp. could use the annualized income method for calculating its estimated tax payments. Firms can always use the annualized income method to calculate their estimated tax payments because there are no restrictions on the use of the method. In addition, this response correctly indicates that Edge Corp. could not use the preceding year’s tax liability as a basis for calculating its current-year estimated tax payments. Edge Corp. cannot use the preceding year’s tax liability because the corporation experienced a net operating loss during that year and, as a result, there was no tax liability.

Question 61

A penalty for understated corporate tax liability can be imposed on a tax preparer who fails to

Audit the corporate records.

Examine business operations.

Copy all underlying documents.

Make reasonable inquiries when taxpayer information appears incorrect.

Answer 61

Make reasonable inquiries when taxpayer information appears incorrect.

Tax preparers are subject to civil penalty for each tax return or claim if: (1) any understatement of tax liability is based on an unrealistic position; (2) the preparer was aware of or should have been aware of the unrealistic position; and (3) the unrealistic position was not disclosed as required. Tax preparers are not required to examine or review documents or other evidence to independently verify a taxpayer’s information. However, preparers are required to make reasonable inquiries if the taxpayer’s information appears to be incorrect or incomplete.

Question 62

Morgan, a sole practitioner CPA, prepares individual and corporate income tax returns.

What documentation is Morgan required to retain concerning each return prepared?

An unrelated party compliance statement.

Taxpayer’s name and identification number or a copy of the tax return.

Workpapers associated with the preparation of each tax return.

A power of attorney.

Answer 62

Taxpayer’s name and identification number or a copy of the tax return.

Other assessable penalties with respect to the preparation of income tax returns for other persons include:
(a) Failure to furnish copy to taxpayer; (b) Failure to furnish identifying number; (c) Failure to retain copy or list; (d) Failure to file correct information returns; (e) Negotiation of check

Question 63

An individual taxpayer’s tax return included the following:

Regular tax before tax credits
$5,000
Current-year estimated tax payments
6,000
Amount paid with current-year extension
1,000
Federal income tax withheld
1,000

What amount, if any, is the taxpayer’s overpayment?

$0

$1,000

$2,000

$3,000

Answer 63

$3,000

Correct! The taxpayer’s tax liability before credits is $5,000. The taxpayer has three sources of tax payments for the year: (1) FIT withheld ($1,000), (2) estimated payments ($6,000), and (3) amount paid with extension ($1,000). These payments total $8,000, which is $3,000 more than the tax liability of $5,000.

Question 64

A company engaged a CPA to perform the annual audit of its financial statements. The audit failed to reveal an embezzlement scheme by one of the employees. Which of the following statements best describes the CPA’s potential liability for this failure?

The CPA’s adherence to generally accepted auditing standards (GAAS) may prevent liability.

The CPA will not be liable if care and skill of an ordinary reasonable person was exercised.

The CPA may be liable for punitive damages if due care was not exercised.

The CPA is liable for any embezzlement losses that occurred before the scheme should have been detected.

Answer 64

The CPA’s adherence to generally accepted auditing standards (GAAS) may prevent liability.

If a CPA adhered to GAAS, he or she acted according to professional standards and likely was not careless so as to create negligence-based liability.

Question 65

When performing an audit, a CPA

Must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances.

Must strictly adhere to generally accepted accounting principles.

Is strictly liable for failing to discover client fraud.

Is not liable unless the CPA commits gross negligence or intentionally disregards generally accepted auditing standards.

Answer 65

Must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances.

The standard that CPAs are held to is one of due care. They need not perform perfect work in every audit to live up to this standard. They must simply act as a reasonably prudent CPA would in the same circumstances.

Question 66

CPA Crane agreed to audit Banner Co. The audit did not go well, especially because Crane did not audit Banner’s subsidiary, which created various problems for Banner. Banner sued Crane for breach of contract, because Crane allegedly did not comply with the engagement letter. Which of the following might Crane successfully raise in defense?

Evidence that Banner did not provide Crane with all the records needed to successfully complete the audit.

A provision in the engagement letter that provided that Crane would audit Banner, but not its subsidiaries.

A provision in the engagement letter that provided that Crane would not be liable for any errors it made in the audit.

A and B.

Answer 66

A and B.

Because choices A and B are both right, this is the best answer.

Question 67

A CPA who has agreed to prepare a corporation’s taxes and to provide tax advice will generally be liable for breaching:

Promises made in the written engagement letter.

Promises made orally.

A and B.

None of the above.

Answer 67

A and B.

Because both A and B are accurate choices, this is the best answer.

Question 68

Bosco Corporation had a very complicated tax situation. It hired CPA Arnold to prepare its corporate income tax return. Arnold made an error that caused Bosco to overpay its taxes by $3,000. The payment could have been avoided had Arnold advised Bosco to structure a particular transaction in a slightly different way. Bosco paid $233,000 rather than the $230,000 that it might have paid. Upset with Arnold’s error, Bosco refused to pay the $20,000 fee specified in the engagement letter on grounds that Arnold had breached the contract by giving inaccurate advice. Which of the following is true regarding Arnold’s fee?

Because he breached the contract by giving defective advice, Arnold cannot recover his fee.

Because he substantially performed the contract, Arnold will recover his fee minus the damages his breach caused Bosco ($20,000 - $3,000 = $17,000).

A and B.

None of the above.

Answer 68

Because he substantially performed the contract, Arnold will recover his fee minus the damages his breach caused Bosco ($20,000 - $3,000 = $17,000).

Arnold must pay for the damage that his error caused. He should recover $17,000 for his fee.

Question 69

Under the position taken by a majority of the courts, to which third parties will an accountant who negligently prepares a client’s financial report be liable?

Only those third parties in privity of contract with the accountant.

All third parties who relied on the report and sustained injury.

Any foreseen or known third party who relied on the report.

Any third party whose reliance on the report was reasonably foreseeable.

Answer 69

Any foreseen or known third party who relied on the report.

Although the AICPA lists this as the correct answer, it is poorly worded. The majority view is the Restatement “limited class” approach, which generally allows recovery by third parties where the CPA had prior knowledge of the existence of a limited class of potential users (but not necessarily of their individual identities) and of the general purpose of their use of the audit. Prior knowledge is the key, so mere foresee ability is not enough, although this answer implies the contrary.

Question 70

Mix and Associates, CPAs, issued an unqualified opinion on the financial statements of Glass Corp. for the year ended December 31, 2005.

It was determined later that Glass’s treasurer had embezzled $300,000 from Glass during 2005. Glass sued Mix because of Mix’s failure to discover the embezzlement. Mix was unaware of the embezzlement.
Which of the following is Mix’s best defense?

The audit was performed in accordance with GAAS.

The treasurer was Glass’s agent and, therefore, Glass was responsible for preventing the embezzlement.

The financial statements were presented in conformity with GAAP.

Mix had no actual knowledge of the embezzlement.

Answer 70

The audit was performed in accordance with GAAS.

To defend such a case, a CPA must show not that she acted perfectly, but that she acted as a reasonable CPA in the circumstances. By showing that she conformed with GAAS, she makes a strong argument that she acted reasonably.

Question 71

An accounting firm was hired by a company to perform an audit. The company needed the audit report in order to obtain a loan from a bank. The bank lent $500,000 to the company based on the auditor’s report. Fifteen months later, the company declared bankruptcy and was unable to repay the loan. The bank discovered that the accounting firm failed to discover a material overstatement of assets of the company.
Which of the following statements is correct regarding a suit by the bank against the accounting firm? The bank

Cannot sue the accounting firm because of the statute of limitations.

Can sue the accounting firm for the loss of the loan because of negligence.

Cannot sue the accounting firm because there was no privity of contact.

Can sue the accounting firm for the loss of the loan because of the rule of privilege.

Answer 71

Can sue the accounting firm for the loss of the loan because of negligence.

If we assume that the accounting firm was negligent, as this answer does, then the focus turns to whether or not a third party such as the bank is entitled to sue. It would be helpful to know what the law of this jurisdiction is, what the engagement letter provided, and what the accounting firm knew about the bank. Assuming that the AICPA is presuming application of the most common rule - the Restatement “limited class” approach - and assuming further that the accounting firm knew that its client was going to use the report to obtain a loan from a bank - then this is clearly a correct answer.

Question 72

The best defense a CPA can assert in a suit brought against the CPA for common law fraud based on the CPA’s unqualified opinion on materially false financial statements is

Due diligence.

Lack of scienter.

Contributory negligence on the client’s part.

A disclaimer contained in the engagement letter.

Answer 72

Lack of scienter.

Correct! The essence of fraud is generally bad intent (scienter).

Question 73

Phillips, CPA, was engaged by Veda, Inc. to audit Veda’s financial statements. Phillips was told that the financial statements and the audit report were to be shown to Ryan, a potential investor. As a result of the audit, Phillips issued an audit report containing an unqualified opinion on Veda’s financial statements. Ryan, after seeing the financial statements and audit report made a substantial investment in Veda shares. Although Phillips exercised reasonable care in performing the audit, inaccuracies in the financial statements were later discovered causing Veda share prices to fall. Ryan claimed that had Ryan known of the inaccuracies, Ryan would not have purchased the shares. Will Ryan succeed in a suit against Phillips for negligence?

Yes, because Ryan is a third-party beneficiary of the contractual relationship between Veda and Phillips.

Yes, because Ryan relied on Phillips’s unqualified opinion.

No, because Phillips owed no duty to Ryan.

No, because Phillips exercised reasonable care in performing the audit.

Answer 73

No, because Phillips exercised reasonable care in performing the audit.

Correct! Phillips owed Ryan a duty of care, but did not breach it. Phillips exercised reasonable care in performing the audit. Therefore, Phillips did not act negligently and is not liable to Ryan. Perfection is not the standard of care for auditors.

Question 74

A husband prepared his own tax return as married filing separately. His wife hired a CPA to prepare her tax return as married filing separately and asked the CPA not to disclose the information to anyone. The CPA was not retained by the husband for any tax work. The husband believed that his wife’s tax return was negligently prepared and that he was financially harmed. He hired an attorney, without his wife’s consent, to pursue a negligence claim against the CPA. The CPA hired an attorney to defend against the negligence claim. To which party, if any, may the CPA disclose the wife’s tax return information without the wife’s consent?

The husband, for the evaluation of the negligence claim

The CPA’s attorney, for the evaluation of the negligence claim

The husband’s attorney, for the evaluation of the negligence claim

No one, because all disclosures must be made with the wife’s consent

Answer 74

The CPA’s attorney, for the evaluation of the negligence claim

Correct! Tax accountants owe their clients a duty of confidentiality, but it is only fair that the CPA be able to defend himself or herself in the malpractice lawsuit by the husband. Doing this typically will require disclosure of important documents to the CPA’s attorney.

Question 75

Salina wants to know which of the following is true regarding recognition of an accountant-client testimonial privilege:

Federal courts recognize such a privilege under their rules of evidence and procedure.

Congress has refused to recognize such a privilege for tax professionals.

Approximately 15 state legislatures have recognized an accountant-client testimonial privilege that applies in their states’ courts.

Congress in federal cases involving the Securities Exchange Commission has recognized such a privilege.

Answer 75

Approximately 15 state legislatures have recognized an accountant-client testimonial privilege that applies in their states’ courts.

You answered correctly! This is true, though the privilege would not apply in federal courts located in those states.

Question 76

Girard gave tax advice to Frontenac Corporation. The Department of Justice and IRS are now investigating certain tax shelter transactions that Frontenac Corp. entered into. Girard is resisting their requests for information by citing the tax practitioner’s privilege of §7525 of the I.R.C. To which of the following would that privilege be inapplicable?

Criminal proceedings.

Written advice in connection with promotion of a tax shelter.

A and B.

None of the above.

Answer 76

A and B.

Because §7525 applies to neither criminal proceedings nor written advice in connection with tax shelters, this is the best answer.

Question 77

Lakin is a CPA whose client, Sublette, is being sued by a state government in state court for evasion of state income taxes. Sublette does not want Lakin to testify against him regarding information that Sublette communicated to Lakin. Which of the following is true in a state with a statutory version of the accountant-client testimonial privilege?

Only Lakin can invoke the testimonial privilege.

Sublette can invoke the privilege as to parts of the communications he had with Lakin, while asking Lakin to testify as to other parts.

If the suit was in federal court, the state privilege would not apply even though the communication took place in the state.

A and B.

Answer 77

If the suit was in federal court, the state privilege would not apply even though the communication took place in the state.

State privilege statutes apply only in the state courts in the particular state, not in federal court.

Question 78

Which of the following are recognized exceptions that allow disclosure of confidential information?

An enforceable subpoena has been served on the CPA.

An ethical examination is being conducted regarding the CPA’s conduct.

A peer review is occurring.

All of the above.

Answer 78

All of the above.

A, B, and C all list recognized exceptions to the confidentiality obligation.

Question 79

Trego is a CPA. Under which of the following circumstances would it be permissible for Trego to share confidential client information?

He has been hospitalized on April 14 and needs to share information with his partner, Tandy, who will complete a client’s tax return before the April 15 deadline.

A client has filed a complaint with the State Board of Accountancy about Trego’s work, and he needs to show the Board confidential information to prove that he acted professionally throughout the engagement.

None of the above.

A and B.

Answer 79

A and B.

Two recognized exceptions to the confidentiality requirement are disclosure to other firm members on a need-to-know basis and disclosure during an ethics examination.

Question 80

Powhattan was surprised to learn how much income his tax client, Absurdco, Inc., was making. He thought that Absurdco’s competitors might be interested in the information, so he sold it to one of them. When Absurdco found this out, it started investigating what consequences it might visit upon Powhattan. Which of the following is true?

Powhattan may lose his CPA license.

Powhattan may be sued civilly by the IRS.

Powhattan may be prosecuted criminally by the Department of Justice.

All of the above.

Answer 80

All of the above.

All of the first three choices are potential consequences of breach of the duty of confidentiality.

Question 81

Colby is the managing partner of a small accounting firm. He has heard of the Generally Accepted Privacy Principles (GAPP) and wants to know what his responsibilities are regarding client information. Among others, Colby’s firm must:

Provide its clients notice of its privacy policies and procedures.

Collect information only in compliance with its policies and procedures.

Provide clients with access to their personal information for review and update.

All of the above.

Answer 81

All of the above.

All of the first three choices reflect requirements of GAPP and, therefore, this is the best answer.

Question 82

Jetmore was surprised to learn how much income his tax client, Quantilco, Inc., was making. He thought that Quantilco’s competitors might be interested in the information, so he sold it to one of them. When Quantilco found this out, it started investigating what consequences it might visit upon Jetmore. Which of the following is true?

He may be sued civilly by the IRS.

He may be prosecuted criminally by the Department of Justice.

A and B.

None of the above.

Answer 82

A and B.

Both of the first two choices are potential consequences of breach of the duty of confidentiality when it involves taxpayer information.

Question 83

In which of the following situations is there a violation of client confidentiality under the AICPA Code of Professional Conduct?

A member discloses confidential client information to a court in connection with arbitration proceedings relating to the client.

A member discloses confidential client information to a professional liability insurance carrier after learning of a potential claim against the member.

A member whose practice is primarily bankruptcy discloses a client’s name.

A member uses a records retention agency to store clients’ records that contain confidential client information.

Answer 83

A member whose practice is primarily bankruptcy discloses a client’s name.

It is certainly possible that a client would not want it known that s/he was considering filing for bankruptcy. Therefore, members who practice in that area must be sensitive to that fact.

Question 84

Which of the following is a correct statement about the circumstances under which a CPA firm may or may not disclose the names of its clients without the clients’ express permission?

A CPA firm may disclose this information if the practice is limited to bankruptcy matters, so that prospective clients with similar concerns will be able to contact current clients.

A CPA firm may disclose this information if the practice is limited to performing asset valuations in anticipation of mergers and acquisitions.

A CPA firm may disclose this information unless disclosure would suggest that the client may be experiencing financial difficulties.

A CPA firm may not disclose this information because the identity of its clients is confidential information.

Answer 84

A CPA firm may disclose this information unless disclosure would suggest that the client may be experiencing financial difficulties.

Generally, the mere name of clients is not confidential information. Therefore, unless the accountant knows (or has reason to know, given the circumstances) that the client wishes to keep its identity as a client confidential, this information may be disclosed. An accountant would have reason to know there was a problem if disclosure of the client’s name informed the world that the client was experiencing financial difficulties.