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Flashcards in Module 5 Deck (44)
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1

Which of the following entities is NOT allowed to use the cash method of accounting?

A. Partnership that has annual gross receipts of $23 million
B. Solely owned personal service corporation providing medical services
C. C corporation with annual gross receipts of $30 million for the last 3 years
D. Sole proprietor whose annual gross receipts for all prior years exceed $10 million

C.

A C corporation with annual gross receipts of more than $26 million (for any 3-year preceding period) cannot use the cash method of accounting. Partnerships with gross receipts that do not exceed $26 million can use the cash method. With respect to sole proprietors, it makes no difference what amount constitutes annual gross receipts; it is only important whether the receipts are derived from merchandise or services.

2

Fred runs a small corporation that has been in the family for more than 50 years. The business uses the cash basis method of accounting as the average gross receipts have ranged between $3.75 million and $4 million for the last 10 years. Which of the following would affect net income for Fred’s corporation last year?

I. A bonus Fred declared for employees on December 31 of last year but that is not payable until January 2 of the following year
II. Dividends received on December 30 of last year
III. Sales made to customers last year
IV. Interest on a money market account last year but that is not posted by the bank until January 2 of the next year

II , III, & IV

For the cash method of accounting, all income received during the tax year is included in gross income (e.g., dividends, interest, sales). Income received constructively during the year, even though actual receipt is delayed, is includable for the tax year. Bonuses declared but that are not yet payable until the next tax year will not affect the corporation’s net income. The bonuses are an expense that will be included on the corporate tax return in the year paid.

3

During a period of rising prices, Marathon Shoe Company is using the FIFO method of inventory costing. If it converts to LIFO, which of the following statements regarding ABC Company is CORRECT?

A. Its income tax liability will be higher.
B. Its net business income will be lower.
C. Its net business income will be higher.
D. Its earnings per share reported to investors will be increased.

B.

If a business converts from FIFO to LIFO in an inflationary environment, its net business income will be lower, which will result in a reduction of earnings per share to investors.

4

Benjamin and Abby have formed an S corporation for their new business. Benjamin has a tax year ending August 31, and Abby’s ends December 31. The business will have a natural tax year ending December 31. How does this affect Benjamin and Abby?

A. Benjamin must change his tax year to December 31 on his next income tax return.
B. The differing tax years will not affect when Benjamin reports income from the business.
C. Benjamin must report his S corporation income in the same tax year that their business tax year ends.
D. Benjamin and Abby cannot be in business together because their different tax years prevent accurate reporting of their income.

C.

If a partner or S corporation shareholder/owner has a different taxable year than that of the business entity, the owner must report their share of the entity’s income in the same taxable year within which the entity’s taxable or fiscal year ends.

5

Alphonso is contemplating a new business venture that may or may not include other investors. He is speaking to his planner and asking about losses from a business. He wants to be able to take advantage of a loss in some way but is not clear on what happens. His planner starts by explaining that not all business forms can take advantage of an NOL at the entity level. Which of the following entities or individuals is NOT allowed to take advantage of the NOL tax benefit?

A. Taxpayer’s estate
B. Sole proprietorship
C. General partnership
D. Regular or C corporation

C.

A general partnership is not permitted the benefit of the NOL tax provision. A sole proprietor is the same as a self-employed individual who is allowed to make an NOL election. In addition, S corporations are also flow-through entities and the NOL flows through the entity and is taken by the shareholder via the K-1

6

Which of the following features best describe(s) the regular corporation form of business entity?

I. Limited liability
II. Double taxation of profits
III. Regarded as an entity separate from its owners

I, II, & III

All of these features are attributes of a regular corporation.

7

Which of the following taxes potentially apply to a C corporation?

I. Personal service corporation tax
II. Accumulated earnings tax
III. Self-employment tax

I & II

All of the taxes except the self-employment tax are special taxes that potentially apply to a C corporation.

8

On January 15 of last year, Jonathan, a single taxpayer, purchased stock in Spring Corporation (the stock is Section 1244 small business stock) for $20,000. On January 10 of the current year, he sold the stock for $80,000. How should Jonathan treat the gain on his current year tax return?

A. $60,000 of ordinary income
B. $60,000 of long-term capital gains
C. $60,000 of short-term capital gains
D. $50,000 of ordinary income, $10,000 short-term capital gains

C.

The gain of $60,000 is classified as a short-term capital gain. Section 1244 small business stock rules apply only to losses (and not gains) on Section 1244 stock. Because Jonathan held the stock for less than 5 years, he would not qualify for the favorable tax treatment provided under Section 1202 for gains on qualified small business stock (QSBS).

9

Which of the following describes the sole proprietorship form of conducting business?

A. The business’s success or failure depends exclusively on the owner.
B. The businessowner must file legal documents with the state government to form the business.
C. The businessowner has creditor protection against personal liability for business debts.
D. The businessowner usually has no difficulty raising capital from third-party lenders.

A.

A sole proprietorship is a business that is controlled and operated by only one individual. Therefore, the success or failure of the business depends exclusively on the owner.

10

All of the following may be described as a strength of the general partnership form of business EXCEPT

A. ease of formation.
B. ease of management.
C. joint and several liability.
D. special allocation of income and loss.

C.

General partners have joint and several (personal) liability for the acts of the partnership and of the other partners. This is a weakness of the form, not a strength.

11

When is a corporation likely to elect S corporation status?

A. Personal liability of the owners is not an issue.
B. A loss is anticipated at the start of the business.
C. There is a desire to issue preferred stock to shareholders.
D. There is an intention to borrow money from a bank in the corporate name.

B.

One of the reasons a corporation elects S corporation status is to afford the pass-through of losses to shareholders. Preferred stock is not permitted to be issued by an S corporation, and the shareholder does not get the tax (basis) benefit of money borrowed from a bank in the corporate name. S corporation shareholders (like all corporate shareholders) have limited liability for corporate obligations.

12

Which of the following taxes might an S corporation be required to pay?

I. Excess net passive income tax
II. LIFO recapture tax
III. Built-in gains tax
IV. Personal holding company (PHC) tax

A. I only B. I and III C. I, II, and III D. II, III, and IV

I, II, & III

The excess net passive income tax, LIFO recapture tax, and built-in gains tax may be paid at the S corporation level. The PHC tax is only applicable to regular or C corporations

13

A one-member LLC may elect to be taxed as any of the following EXCEPT

A. an S corporation.
B. a sole proprietorship.
C. a regular corporation.
D. a general partnership.

D.

A one-member LLC may not elect to be taxed as a general partnership because that form is available only to LLCs with two or more members. Any of the other taxation forms are permitted

14

Takashi is a successful CPA and is interested in combining his practice with Josef, another CPA with a thriving practice. As is prudent, both are concerned about being held liable for the acts of the other and want to combine practices in the most tax-efficient manner possible. Which of the following business forms should they adopt?

A. Limited partnership
B. General partnership
C. Regular corporation
D. Limited liability partnership (LLP)

D.

Given Takashi’s and Josef’s objectives, an LLP is most appropriate. This form would restrict (at least partially) the liability of both partners for the acts of the other, while still permitting partnership tax advantages. A limited partnership is only for passive investors, and a general partnership would involve joint and several liability for partnership acts. Finally, a regular corporation is not appropriate because the business would likely constitute a personal service corporation (PSC). This could potentially result in “double taxation” because their income could be taxed at the entity level and then again at the shareholder level when dividends are distributed.

15

Sarah and her sister, Hannah, are interested in forming a business together. They are primarily concerned about the following:

- Whether they will have limited liability protection
- Whether the business will have losses for the next three years
- Whether the business will continue in the event that one of the sisters dies

After considering each of these concerns, which of the following business forms should they adopt?

A. C corporation
B. S corporation
C. General partnership
D. Limited partnership

B.

An S corporation will allow losses to flow through to the sisters, continue in the event that one sister should die, and still enjoy the limited liability protection of a regular corporation. An LLC taxed as a general partnership would also be viable if it was provided as a choice.

16

Brian has the following income for 2020:

-Net Schedule C income: $60,000
-Dividends and interest: $5,000
-Partnership K-1 income: $10,000
-S corporation K-1 income: $20,000

What is Brian’s total self-employment tax for 2020 (round up to nearest dollar)?

$9,891

Brian’s self-employment income is $70,000 (do not include the K-1 distributions from the S corporation or the dividends and interest). Therefore, $70,000 multiplied by (0.9235 × 0.1530) or (0.1413) = $9,891.

17

Courtney, a self-employed taxpayer, is interested in taking a home office deduction for this year and provides you with the following information:

Gross income from the business: $15,000
Business supplies and expenses: $10,000
Utilities and property insurance allocated to office use: $1,000
Allocated mortgage interest and real estate taxes: $600
Depreciation expenses on the office: $6,000
Percentage use of home as office: 20%

Assuming Courtney meets the qualifying tests permitting her to claim the home office deduction, what is the allowable amount of her loss, if any?

$0

Courtney is limited to the amount of gross income from the business as an allowable home office deduction. Because of the ordering rules for the deductions for a home office, Courtney must deduct the following: $10,000 supplies + $600 mortgage interest and taxes + $1,000 allocated utilities + $3,400 of the depreciation expense = $15,000 (same amount as her gross income). The excess amount of depreciation expense of $2,600 may be carried forward to a future year (ordering rule). Courtney’s loss is $0 because all income is fully offset by allowable expenses. She cannot create a loss with the deduction.

18

Using the same facts as in the previous question for Courtney’s expenses, and assuming she otherwise qualifies to claim the home office deduction, what is her home office deduction using the simplified method? Courtney uses 400 square feet of her home for her home office.

A. $0 B. $1,500 C. $2,000 D. $3,100

B.

Courtney may take the maximum home office deduction under the simplified method of $1,500. Even though she uses 400 square feet of her home for the office, the method allows only a maximum of 300 square feet. Because Courtney’s net income before the home office deduction is $5,000, she may deduct the maximum of $1,500 because it does not create a loss. Using the simplified method does not create the maximum deduction for the taxpayer but is an easier method to calculate the expense. Also, note that if there is no depreciation deducted on the home office, there is no depreciation recapture when the home is sold, which can also be a consideration for a taxpayer.

19

Alison pursues a hobby of selling antique furniture in her spare time. During the year, she sold furniture for $3,000 and incurred expenses as follows:

-Cost of goods sold: $2,000
-Office supplies: $1,200
-Loan interest: $800
-Advertising: $750

Assuming that the activity constitutes a hobby, and that Alison cannot itemize her deductions this year, how should she report income and expenses on her tax return?

A. Include $3,000 in income and deduct $4,750 for AGI.
B. Ignore both income and expenses because the activity is a hobby.
C. Include $1,000 in income and deduct nothing.
D. Include $3,000 in income and deduct interest of $800 for AGI.

C.

Under hobby loss rules, consumer interest is not deductible. Advertising and office supplies cannot be deducted for a hobby. Under current rules, the taxpayer may report hobby income minus cost of goods sold: $3,000 – $2,000 = $1,000.

20

Which of the following forms of business would file a Schedule C to report the income or loss from the business?

A) Limited partnership
B) S corporation
C) C corporation
D) Sole proprietorship

D.

The sole proprietorship is the business that files a Schedule C with the individual's Form 1040. The limited partnership files a Form 1065, and the C corporation files a Form 1120. The S corporation files an 1120-S.

Note that a single-member LLC would also file a Schedule C, as it would be treated as a disregarded entity for income tax purposes.

21

STUDY NOTE: Self Employment Tax Calculation

To calculate the self-employment tax in 2021 where net income from self-employment is below the taxable wage base, use the following steps:

Step 1: Calculate self-employment income.

Step 2: Subtract 7.65% or multiply by 0.9235 (1 − 0.0765).

Step 3: Multiply the resulting product by 15.3%.

22

Which one of the following employee benefits is NOT currently deductible by a C corporation?

A) Health and accident insurance
B) Group legal services
C) Group term life insurance of $100,000
D) Qualified employee discounts

D.

Items that are currently deductible by a C corporation would include group term life insurance, group legal services, and health and accident insurance. Qualified employee discounts do not generate a deduction for the corporation—the discount merely results in less sales revenue being brought into the organization.

23

Caroline has the following items of income to report in 2021:

-Salary of $65,000 from an S corporation for which Caroline is a 10% shareholder
-Her share of the net income from the same S corporation of $95,000 as reported on Schedule K-1
-Schedule C net income of $15,000 from a small side business she owns

How much of her income in 2021 will be subject to self-employment taxes?

$15,000

Taxes are withheld from Caroline's salary at the S corporation in the same manner as any other employee of the S corporation. Income reported on the Schedule K-1 to shareholders of an S corporation is not considered self-employment income. Only the income from the small side business reported on Schedule C is subject to self-employment taxes.

24

Miguel, a shareholder in ABC Corporation, received a cash distribution from the corporation in the amount of $22,000. The corporation had $8,000 of accumulated earnings and profits and $5,000 and current earnings and profits. Miguel had basis in the stock of $6,000. Which one of the following correctly identifies the proper treatment of the distribution from the corporation?

A) $13,000 ordinary dividend; $6,000 return of capital; $3,000 capital gain
B) $7,000 ordinary dividend; $6,000 return of capital; $9,000 capital gain
C) $13,000 ordinary dividend; $6,000 capital gain; $3,000 return of capital
D) $5,000 ordinary dividend; $6,000 return of capital; $11,000 capital gain

A.

The distribution from a corporation is determined in a three-step manner. To the extent of current and accumulated earnings and profits, the distribution is an ordinary dividend, subject to short-term capital gain rates. Next, the distribution is treated as a nontaxable return of capital until the basis in the stock is exhausted. Any distribution after that is considered long-term capital gain.

25

Your client's share of general partnership net income is $100,000 in 2021, with a distributive share of S corporation income of $20,000. What is your client's self-employment tax, if any, for 2021? Round your answer to the nearest dollar.

$14,130

The distributive share of income from an S corporation is not subject to the self-employment tax.

Actual earnings $100,000
Less: 7.65% (7,650)
Net earnings from self-employment: $92,350
SE tax rate: x 15.3%
Self-employment tax $14,129.55
Rounded $14,130

26

Bill, an engineer, is contemplating forming an S corporation for his practice. He will be the sole employee of the corporation. Which of the following statements accurately describe the income tax consequences of such an arrangement?

I. All of the flow-through of net income from his S corporation is subject to the self-employment tax.
II. Bill must draw a reasonable salary as an employee of the S corporation.
III. The net income of the corporation will be taxed at Bill's individual tax rate.
IV. The net income of the corporation will be subject to a flat 21% tax rate.

II & III

The S corporation income will flow through to Bill and be taxed at his marginal rate. The flow-through is not subject to the self-employment tax. However, Bill must receive reasonable wages or salary, or the IRS will reclassify part of the net income as salary and impose penalties.

27

Which of the following is CORRECT regarding the LIFO method of accounting for inventory?

A) During periods of increasing inventory prices, higher taxable income will result.
B) During periods of increasing inventory prices, lower taxable income will result.
C) During periods of declining inventory prices, lower taxable income will result.
D) During periods of declining inventory prices, the cost of goods sold (COGS) will be higher.

B.

Under the LIFO method, when prices are increasing, COGS will be higher; thus, taxable income will be lower.

28

Which of the following is subject to the self-employment tax?

I. Net income from rental of personalty
II. Net income from the rental of realty
III. $350 net income from a sole proprietorship
IV. Flow-through of income from an S corporation

I only

Net income from the rental of realty and flow-through S corporation income are both excluded from the self-employment tax. Less than $400 of self-employment income is not subject to the self-employment tax.

29

Jim is a single taxpayer. During the current year, he sold Section 1244 stock for $40,000. Jim had held the stock for three years. His basis in the stock was $130,000. What is the tax result from the sale of the stock?

A) Jim has an ordinary loss of $50,000 this year and a carryforward of ordinary loss of $40,000.
B) Jim has a long-term capital loss of $100,000.
C) Jim has an ordinary loss of $100,000.
D) Jim has an ordinary loss of $50,000 and a long-term capital loss of $40,000.

D.

The loss on the sale, exchange, or worthlessness of Section 1244 stock may be treated as an ordinary loss up to $100,000 annually on a joint return or $50,000 annually on any other return. Thus, as a single taxpayer, Jim has a $50,000 ordinary loss. Any excess loss is a capital loss—short- or long-term depending on the holding period.

30

MNO Corporation has the following items of income and expense:

-Taxable income: $330,000
-Federal income tax: $100,000
-Dividends paid in current year: $20,000
-Accumulated earnings and profits at the end of the preceding tax year: $60,000

Assume MNO is not a service corporation and cannot establish a valid business purpose for its excess accumulations.

What is the amount of accumulated earnings tax payable?

$4,000

The accumulated earnings tax rate of 20% applied to the accumulated taxable income of $20,000 equals $4,000. The taxable income is reduced by the income tax and dividends paid, and further reduced by the $190,000 accumulated earnings tax credit ($250,000 accumulation limit less the $60,000 accumulated earnings and profits). The 20% rate is tied to the highest tax rate that may apply to qualified dividends.