The Uniform Capitalization Rules of Code Sec. 263A apply to retailers whose average gross receipts for the preceding three years exceed what amount?
- $ 1,000,000
- $ 2,500,000
- $ 5,000,000
The Uniform Capitalization Rules do not apply to small personal property dealers. Small personal property dealers are defined as those with $10 million or less in gross receipts during the preceding three years.
A cash-basis taxpayer should report gross income
- For the year in which income is either actually or constructively received, whether in cash or in property.
- For the year in which income is either actually or constructively received in cash only.
- Only for the year in which income is actually received whether in cash or in property.
- Only for the year in which income is actually received in cash.
For the year in which income is either actually or constructively received, whether in cash or in property.
A cash-basis taxpayer should report gross income for the year in which income is either actually or constructively received, whether in cash or in property.
Fuller was the owner and beneficiary of a $200,000 life insurance policy on a parent. Fuller sold the policy to Decker, for $25,000. Decker paid a total of $40,000 in premiums.
Upon the death of the parent, what amount must Decker include in gross income?
Decker's cost basis is the $25,000 he paid for the policy plus the $40,000 he paid in premiums. $200,000 less $65,000 = $135,000.
To Decker, the policy is an investment. Had it been Fuller, the owner and beneficiary, it would not have been included in income.
Blake, a single individual age 67, had a 2015 adjusted gross income of $60,000 exclusive of social security benefits. Blake received social security benefits of $8,400 and interest of $1,000 on tax-exempt obligations during 2015. What amount of social security benefits is excludable from Blake's 2015 taxable income?
PI = AGI + tax-exempt interest + 50% (SSB)
PI = $60,000 + $1,000 + 50% (8,400) = $65,200.
Since PI ($65,200) exceeds Base Amount 2 ($34,000), then the taxable amount of SSB is the lesser of:
- .85 x SSB ($8,400) = $7,140, or
- .85 x [PI - BA2; $65,200 - $34,000) = $26,520, plus the lesser of
- amount included based on the 50% formula (50% x $8,400) = $4,200, or
- $4,500 (unless married filing joint, then $6,000), which provides $26,520 + $4,200 = $30,720 for part b of the formula.
Thus, the amount included in income is the lower of $7,140 or $30,720, so the amount excluded is $1,260 ($8,400 - $7,140).
Unless the Internal Revenue Service consents to a change of method, the accrual method of tax reporting is mandatory for a sole proprietor when there are:
- Accounts receivable for services rendered
- Year-end merchandise inventories
- Accounts receivable for services rendered NO
- Year-end merchandise inventories YES
Unless the IRS consents to a change of method, taxpayers are to use the accrual method of accounting for purchases and sales if inventories are used.
Accounts receivable for services rendered does not trigger the required use of the accrual method.
This response correctly indicates that accounts receivable for services rendered would not lead to the required use of the accrual method and that the use of inventories would trigger the required use of the accrual method.
In 2014, Brun Corp. properly accrued $10,000 for an income item on the basis of a reasonable estimate. In 2015, Brun determined that the exact amount was $12,000. Which of the following statements is correct?
- Brun is required to file an amended return to report the additional $2,000 of income.
- Brun is required to notify the IRS within 30 days of the determination of the exact amount of the item.
- The $2,000 difference is includible in Brun's 2015 income tax return.
- No further inclusion of income is required as the difference is less than 25% of the original amount reported and the estimate had been made in good faith.
The $2,000 difference is includible in Brun's 2015 income tax return.
Under the accrual method of accounting, income is reported once all events to establish a taxpayer's right to receive the income have occurred and the amount can be determined with reasonable accuracy. If an amount of income has been accrued on the basis of a reasonable estimate with the exact amount to be determined at a later date, any difference between the estimate and exact amount is to be included in income or deducted in the year when the exact amount can be determined.
Which of the following costs are subject to the Uniform Capitalization Rules of Code Sec. 263A for manufactured tangible personal property?
- Off-site storage.
Off-site storage costs must be capitalized as part of the inventory cost for tax purposes.
Costs capitalizable under UNICAP are (in addition to DM, DL and OH:
- Off-site storage costs (onsite = NO)
- Quality control costs
- Utilities, repairs, rent and depreciation
Non-Unicap Costs are:
- Selling, marketing and administrative expenses
Which of the following is correct concerning the LIFO method (as compared to the FIFO method) in a period when prices are rising?
- Deferred tax and cost of goods sold are lower.
- Current tax liability and ending inventory are higher.
- Current tax liability is lower and ending inventory is higher.
- Current tax liability is lower and cost of goods sold is higher.
Current tax liability is lower and cost of goods sold is higher.
If prices are rising and LIFO is used then the cost of inventory, and therefore the total for costs of goods sold, will be higher. If costs of good sold is higher then taxable income will be lower, which also means that the current tax liability will be lower.
In calculating the tax of a corporation for a short period, which of the following processes is correct?
- Divide current-year income by prior-year income, then multiply the result by prior-year tax.
- Compute tax on short-period income, then multiply the result by 12 divided by the number of months in the short period.
- Determine the average taxable income for the past three years, then multiply the result by the number of months in the short period divided by 12.
- Annualize income and calculate the tax on annualized income, then multiply the computed tax by the number of months in the short period divided by 12.
Annualize income and calculate the tax on annualized income, then multiply the computed tax by the number of months in the short period divided by 12.
If a corporation filed a short-year return for 3 month, the income for that period is first multiplied by 4 (12 months/3 months) to annualize the income for 12 months. The corporate tax liability is then computed on this amount for the full 12 months. That amount is the multiplied by 3/12 to prorate for the short tax year.
Which of the following taxpayers may use the cash basis as its method of accounting for tax purposes?
- Partnership that is designated as a tax shelter.
- Retail store with $2 million in gross receipts.
- An international accounting firm organized as a partnership.
- Office cleaning corporation with average annual income of $8 million.
An international accounting firm organized as a partnership.
Partnerships can use the cash method regardless of the amount of gross receipts as long as none of the partners are C corporations.
Retail store is incorrect. Since a retail store has inventory gross receipts it would need to not exceed $1 million for the cash method to be permitted.
The selection of an accounting method for tax purposes by a newly incorporated C corporation
- Is made on the initial tax return by using the chosen method.
- Is made by filing a request for a private letter ruling from the IRS.
- Must first be approved by the company's board of directors.
- Must be disclosed in the company's organizing documents.
Is made on the initial tax return by using the chosen method.
Accounting methods for a new corporation are made on the initial tax return.
A corporate taxpayer plans to switch from the FIFO method to the LIFO method of valuing inventory. Which of the following statements is accurate regarding the use of the LIFO method?
- In periods of rising prices, the LIFO method results in a lower cost of sales and higher taxable income, when compared to the FIFO method.
- The taxpayer is required to receive permission each year from the Internal Revenue Service to continue the use of the LIFO method.
- The LIFO method can be used for tax purposes even if the FIFO method is used for financial statement purposes.
- Under the LIFO method, the inventory on hand at the end of the year is treated as being composed of the earliest acquired goods.
Under the LIFO method, the inventory on hand at the end of the year is treated as being composed of the earliest acquired goods.
The LIFO method assumes that the inventory items most recently purchased are the ones sold. Thus, the oldest inventory (earliest acquired goods) items are the ones that remain in ending inventory.
Ace Rentals Inc., an accrual-basis taxpayer, reported rent receivable of $35,000 and $25,000 in its 2015 and 2014 balance sheets, respectively. During 2015, Ace received $50,000 in rent payments and $5,000 in nonrefundable rent deposits.
In Ace's 2015 corporate income tax return, what amount should Ace include as rent revenue?
Ace Corp. would report rent revenue of $65,000. Of this amount, $55,000 (the sum of $50,000 in rental payments and $5,000 in nonrefundable rent deposits) would be cash receipts. Ace Corp. is an accrual based taxpayer. Therefore, for tax purposes, income is earned when 1) all the events have occurred to attach the taxpayer's right to receive the income and 2) the amount of income can be determined with reasonable accuracy. With respect to rent receivable, the income must have been earned to record it as a receivable.
Hence, in calculating rent revenue, the $10,000 increase in rent receivable from 2014 to 2015 would have to be added to the corporation's cash receipts.
Lake Corp., an accrual-basis calendar year corporation, had the following 2014 receipts:
- 2015 advanced rental payments where the lease ends in 2015 $125,000
- Lease cancellation payment from a 5-year lease tenant $50,000
Lake had no restrictions on the use of the advanced rental payments and renders no services. What amount of income should Lake report on its 2014 tax return?
For accrual based taxpayers, items generally are included in gross income for the year in which the income is earned. However, for tax purposes, income is earned when 1) all the events have occurred to attach the taxpayer's right to receive the income and 2) the amount of income can be determined with reasonable accuracy. Cash based taxpayers report income when it is actually received or constructively received (i.e., in the taxpayer's control).
Since there are no restrictions on the advance lease payments or the lease cancellation payment and no services need to be rendered, Lake Corp. has a right to receive the advance lease payments and the lease cancellation payments in the current year. The payments also can be determined with reasonable accuracy. Hence, both the advance lease payments and the lease cancellation payments should be reported on Lake Corp.'s tax return.
This response includes both the advance lease payments and the lease cancellation payments in Lake Corp.'s taxable income.
Tom owns a fast-food restaurant which he reports as a sole proprietorship for tax purposes. Which of the following expenses is allowed as a deduction on Tom's Schedule C for the current year?
- Wages of $20 per week to his 14 year-old daughter who cleans the restaurant on Saturdays.
- Speeding ticket of $75 that he incurred while picking up supplies to bring to the restaurant.
- A bribe of $200 to the city inspector charged with inspecting whether restaurants have met all city health requirements.
- State income taxes paid during the year of $1,650.
Wages of $20 per week to his 14 year-old daughter who cleans the restaurant on Saturdays.
It is an ordinary and necessary expense to have the restaurant cleaned and the $20 is reasonable.
Sam has been engaged in an illegal business this year related to electronically stealing funds from individuals' bank accounts. Which of the following items is not deductible on his business tax return for the year?
- Salaries for two individuals that helped him operate the business.
- Rent expense for an office used to operate the illegal business.
- Interest expense on a loan used to purchase equipment for the business.
- The salaries, rent expense, and interest expense are all deductible.
The salaries, rent expense, and interest expense are all deductible.
The ordinary, necessary, and reasonable expenses of operating illegal businesses (other than illegal drug activity) are permitted (as long as the expense itself is not against public policy). Therefore, all of these expenses are deductible against the revenue earned from the activities.
On December 1, 2014, Michaels, a self-employed cash basis taxpayer, borrowed $100,000 to use in her business. The loan was to be repaid on November 30, 2015. Michaels paid the entire interest of $12,000 on December 31, 2014.
What amount of interest was deductible on Michaels' 2015 income tax return?
Cash basis taxpayers report income when cash or property is actually or constructively received. There is no constructive receipt for deductions. Deductions for cash basis taxpayers generally are taken when actually paid. However, for expenses covering 12 months or more, the deduction must be spread over the period for which the expenses apply. Thus, since the loan was to be repaid in 12 months, the deduction for the interest must be spread over the 12 month period.
Thus, to account for the period of December 1, 2014 to December 31, 2014, Michaels would have deducted $1,000 of the interest on her 2014 income tax return and $11,000 on her 2015 income tax return to account for the period January 1, 2015 to November 30, 2015.
This response is correct.
Mock operates a retail business selling illegal narcotic substances. Which of the following item(s) may Mock deduct in calculating business income?
- Cost of merchandise
- Business expenses other than the cost of merchandise
No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted. However, a deduction is allowed for the cost of merchandise purchased.
Cole earned $3,000 in wages, incurred $1,000 in unreimbursed employee business expenses, paid $400 as interest on a student loan, and contributed $100 to a charity. What is Cole's adjusted gross income?
The unreimbursed employee business expenses and charitable contribution are itemized deductions, so these do not affect the computation of adjusted gross income. AGI equals the $3,000 of wages less student loan interest of $400, or $2,600.
In 2015, Roger, who is single, gave an outright gift of $15,000 to a friend, Matt, who needed the money to pay tuition at an accredited university. In filing his 2015 gift tax return, Roger was entitled to a maximum exclusion of
The first $14,000 of gifts made to a donee during the calendar year (except gifts of future interests) is excluded in determining the amount of the donor’s taxable gifts for 2015. Note that Roger does not qualify for the unlimited exclusion for tuition paid on behalf of a donee, because Roger did not pay the $15,000 as tuition to an educational organization on Matt’s behalf.
For the year ended December 31, 2015, Sanchez had a net operating loss of $100,000. Taxable income for the earlier years, computed without reference to the net operating loss, was as follows:
- 2011 $90,000
- 2012 $80,000
- 2013 $50,000
- 2014 $40,000
If Sanchez makes no special election to waive the net operating loss carryback, what amount of net operating loss will be available to Sanchez for 2016?
The $100,000 NOL would first be carried back to 2013 and offset $50,000 of income. It would then be carried to 2014 and offset $40,000 of income. This would leave $10,000 of NOL ($100,000 - $50,000 - $40,000) to carryforward to 2016.
Deduction for Bad Debts are available for?
- Accrual basis taxpayers
- Cash basis taxpayers
Accrual basis taxpayers ONLY. A cash basis TP does not have basis in the bad debt and thus is not allowed a deduction.
Example...Since Budd reports on the cash basis he did not recognize income when the client was billed. Therefore, he has no basis in the receivable to deduct when it becomes uncollectible.
An individual's losses on transactions entered into for personal purposes are deductible only if
- The losses qualify as casualty or theft losses.
- The losses can be characterized as hobby losses.
- The losses do not exceed $3,000 ($6,000 on a joint return).
- No part of the transactions was entered into for profit.
The losses qualify as casualty or theft losses. An individual's losses on transactions entered into for personal purposes are only deductible if the losses qualify as casualty or theft losses. If the losses originated due to a trade or business, individuals also may deduct losses originating from transactions entered into for profit.
Cobb, an unmarried individual, had an adjusted gross income of $200,000 in 2015 before any IRA deduction, taxable social security benefits, or passive activity losses.
Cobb incurred a loss of $30,000 in 2015 from rental real estate in which he actively participated.
What amount of loss attributable to this rental real estate can be used in 2015 as an offset against income from nonpassive sources?
Passive activity losses normally only may be used to offset passive activity income. Rental activities are considered passive activities, regardless of the level of participation by the taxpayer.
However, a natural person is allowed an allowance for offsetting up to $25,000 of nonpassive income with passive losses resulting from rental activities, provided certain conditions are met. The person must own at least 10 percent of the rental activity and must have actively participated.
Hence, Cobb's $30,000 loss from his rental real estate activities would be considered a passive loss, initially indicating that Cobb would be limited to the $25,000 allowance. However, the $25,000 allowance is reduced by 50 percent of the amount that the taxpayer's adjusted gross income exceeds $100,000. Thus, Cobb's credit must be reduced by $50,000, which exceeds Cobb's $30,000 passive loss.
Therefore, Cobb may not use any of his loss attributable to the rental real estate to offset against income from nonpassive sources.
Barkley owns a vacation cabin that was rented to unrelated parties for 10 days during the year for $2,500. The cabin was used personally by Barkley for 3 months and left vacant for the rest of the year. Expenses for the cabin were as follows:
- Real Estate Taxes $1,000
- Maintenance and Utilities $2,000
How much rental income (loss) is included in Barkley's adjusted gross income?
- $ 500
- $ (500)
Special rules apply to realty that is used for both personal and rental purposes. If the number of rental days is less than 14 then the property is treated as if it was used 100% for personal use. In that case, the rental revenue is ignored (i.e., does not have to be recognized).
The only items that can be deducted are real estate taxes and mortgage and these items must be reported on Schedule A.
Therefore, there is no rental income and no rental expenses.
A review of Bearing's year 2 records disclosed the following tax information:
- Wages $18,000
- Taxable interest and qualifying dividends $4,000
- Schedule C trucking business net income $32,000
- Rental (loss) from residential property $(35,000)
- Limited partnership (loss) $(5,000)
Bearing actively participated in the rental property and was a limited partner in the partnership. Bearing had sufficient amounts at risk for the rental property and the partnership. What is Bearing's year 2 adjusted gross income?
Wages, interest, dividends, and Schedule C income are all taxable for a total of $54,000. $25,000 of the rental loss is allowed since Bearing actively participates in the rental real estate activity and his modified AGI does not exceed $100,000. However, the $5,000 passive loss from the partnership cannot reduce other income. Therefore, AGI is $29,000.
Lane, a single taxpayer, received $160,000 in salary, $15,000 in income from an S Corporation in which Lane does not materially participate, and a $35,000 passive loss from a real estate rental activity in which Lane materially participated. Lane's modified adjusted gross income was $165,000. What amount of the real estate rental activity loss was deductible?
Lane has $160,000 in active income, $15,000 of passive income, and $35,000 of passive losses. Note that the exception that allows deduction for up to $25,000 of rental real estate losses does not apply since Lane's modified AGI exceeds $150,000. The passive losses can only be deducted to the extent of passive income, so $15,000 is correct.
50% reduced for over $100k of AGI up to $150k
$0 if > $150k in AGI
The federal estate tax may be reduced by a credit for
- Foreign death taxes.
- Gift taxes on gifts made 2 years before death.
- Income taxes paid in the year of death.
- Intangible property taxes.
Foreign death taxes.
The federal estate tax may be reduced by a credit for foreign death taxes. However, no federal estate tax credit is available for foreign gift taxes, foreign income taxes, or foreign intangible property taxes.
Which of the following types of income would likely be considered "business income" for state income tax purposes?
- Dividends from stock held as long term investments.
- Gain from the sale of land that is not used in the taxpayer's regular business operations.
- Rent received from corporate office space not used in the taxpayer's regular business operations.
- Royalties from the licensing of a song that was produced as part of ordinary business operations.
Royalties from the licensing of a song that was produced as part of ordinary business operations.
Business income is generated from the business's regular operations, or from the sale of property that is an integral part of the business. Therefore, the royalty income could be business income
Woods Corporation's federal taxable income for the current year is $250,000 which includes the following:
- $15,000 of deducted state income taxes
- $25,000 of interest income on United States Treasury Bonds
Woods also had $10,000 of interest from state and local bonds that it owns. Federal depreciation in excess of that allowed for state purposes was $7,000. Woods operates exclusively in State F, which does not tax income earned on federal obligations, taxes all municipal bond interest, and disallows a deduction for state income taxes. What is Wood's state taxable income?
The starting point for computing state taxable income is $250,000 (Fed Tax Income). Adjustments are:
- State income taxes + $15,000
- Municipal interest income + $10,000
- Excess federal depreciation + $ 7,000
- U.S. Treasury interest income - $25,000
- State taxable income $257,000
Machine Corporation buys a business van in State V and pays 6% sales tax. The van is used in State W by Machine. State W has a 9% sales tax. Because of this transaction, State W is likely to impose which of the following taxes on Machine?
- Sales tax.
- Income tax.
- Use tax.
- Franchise tax.
If property is purchased in one state but used in a different state, the state of use is likely to impose a use tax for the use of the property in its jurisdiction.
Which of the following statements is incorrect?
- Foreign currency exchange gains and losses resulting from the normal course of business operations are ordinary.
- Foreign currency exchange gains and losses resulting from investment transactions are capital.
- Foreign currency exchange gains and losses resulting from personal transactions are capital.
- Foreign currency exchange gains and losses resulting from the normal course of business operations are capital.
Foreign currency exchange gains and losses resulting from the normal course of business operations are capital.
Foreign currency exchange gains and losses resulting from the normal course of business operations are ordinary, not capital.
Which one of the following types of income is not U.S. source income?
- Salary earned in the United States.
- Interest income on United States Treasury Bonds.
- Income from the sale of land by a Japanese resident to a taxpayer whose residence is in the United States.
- Rents received from property located in the United States.
Income from the sale of land by a Japanese resident to a taxpayer whose residence is in the United States.
Income from the sale of personalty is determined based on the residence of the seller.
ABC, Inc., has $120,000 U.S. source income, $80,000 of foreign source income, and $25,000 foreign taxes deemed paid. Assume that the U.S. income tax liability before the foreign tax credit is $61,250. ABC's foreign tax credit is?
- - $0 -
$25,000, but not to exceed the foreign tax credit limitation of $80,000/($120,000 + $80,000) x $61,250 = $24,500.
The private foundation status of an exempt organization will terminate if it
- Becomes a public charity.
- Is a foreign corporation.
- Does not distribute all of its net assets to one or more public charities.
- Is governed by a charter that limits the organization's exempt purposes.
Becomes a public charity.
A private foundation is a tax-exempt organization which receives less than one-third of its annual support from its members and the general public. Therefore, public charities that solicit broad public support do not meet this definition.
Hope is a tax-exempt religious organization. Which of the following activities is (are) consistent with Hope's tax-exempt status?
- I. Conducting weekend retreats for business organizations.
- II. Providing traditional burial services that maintain the religious beliefs of its members.
Conducting retreats for business organizations would not be considered an activity related to the tax-exempt purpose of a religious organization so this response is not correct. Providing burial services consistent with its religious beliefs would be related and therefore permissible.
Maple Avenue Assembly, a tax-exempt religious organization, operates an outreach program for the poor in its community. A candidate for the local city council has endorsed Maple's anti-poverty program. Which of the following activities is (are) consistent with Maple's tax-exempt status?
- I. Endorsing the candidate to members.
- II. Collecting contributions from members for the candidate.
Neither I nor II.
Exempt organizations cannot endorse political candidates or provide support to them. Therefore, both of these statements are incorrect.
An organization that operates for the prevention of cruelty to animals will fail to meet the operational test to qualify as an exempt organization if
- The organization engages in insubstantial nonexempt activities
- The organization directly participates in any political campaign
The organization engages in insubstantial nonexempt activities = NO, this is OK
The organization directly participates in any political campaign = YES, this is NOT OK
Engaging in insubstantial nonexempt activities will not cause an exempt organization to lose its exempt status. However, exempt organizations are strictly prohibited from engaging in political campaigns and activities.
Brown transfers property to a trust. A local bank was named trustee. Brown retained no powers over the trust. The trust instrument provides that current income and $6,000 of principal must be distributed annually to the beneficiary. What type of trust was created?
A complex trust is one in which the trustee
- has discretion whether to distribute or accumulate its income,
- may make charitable contributions, and
- may distribute trust principal.
A simple trust is one that
- is required to distribute all of its income each year,
- cannot make charitable contributions, and
- cannot make distributions of trust principal.
Since the trust must distribute $6,000 of principal each year, it is a complex trust. Also note that since Brown retained no powers over the trust, the trust cannot be a grantor trust nor can it be a revocable trust.
When Calvin and Jasmin became engaged in March 2015, Calvin gave Jasmin a ring that had a fair market value of $25,000. After their wedding in October 2015, Calvin gave Jasmin a sports car with a fair market value of $70,000. Both Calvin and Jasmin are US citizens. What is the amount of Calvin’s 2015 gift tax marital deduction?
An unlimited marital deduction is allowed for gift tax purposes for gifts to a donee, who at the time of the gift is the donor’s spouse. Thus, Calvin’s gift of the $70,000 car to Jasmin after their wedding is eligible for the marital deduction, whereas the gift of the $25,000 engagement ring does not qualify because Calvin and Jasmin were not married at the date of the gift.
Raff died in 2015 leaving her entire estate to her only child. Raff’s will gave full discretion to the estate’s executor with regard to distributions of income. For 2015, the estate’s distributable net income (DNI) was $15,000, of which $9,000 was paid to the beneficiary. None of the income was tax-exempt. What amount can be claimed on the estate’s 2015 fiduciary income tax return for the distributions deduction?
An estate’s DNI represents the maximum amount of available distribution deduction, and the maximum amount on which beneficiaries can be taxed. Here, since only $9,000 was distributed to a beneficiary, only $9,000 can be claimed on the estate’s fiduciary income tax return as a distribution deduction, and only $9,000 will be taxed to the beneficiary.
Mr. Chang deposited $50,000 in a joint bank account that he created for himself and his friend’s son, Mohammed. There is a gift to Mohammed when
- Mr. Chang deposits the money into the account.
- Mr. Chang dies.
- Mohammed is notified by Mr. Chang that the account has been created.
- Mohammed draws on the account for his own benefit.
Mohammed draws on the account for his own benefit.
A gift does not occur when Mr. Chang opens the account and deposits money into it. Instead, a completed gift results when the noncontributing tenant (Mohammed) withdraws money from the account for his own benefit.
Which of the following is allowed in the calculation of the taxable income of a simple trust?
- Standard deduction.
- Brokerage commission for purchase of tax-exempt bonds.
- Charitable contribution.
A simple trust is allowed a personal exemption of $300, but is not eligible for a standard deduction. Additionally, a simple trust is not allowed to make charitable contributions, and brokerage commissions for the purchase of tax-exempt bonds would not be deductible because they represent an expense incurred in the production of tax-exempt income.
Simple trust is one that
- is required to distribute all of its income to beneficiaries each year,
- cannot make charitable contributions, and
- makes no distribution of trust corpus (i.e., principal) during the year.
During the current year, a trust reports the following information:
- Dividends $10,000
- Interest from corporate bonds $12,000
- Tax-exempt interest from state bonds $4,000
- Capital gain (allocated to corpus) $2,000
- Trustee fee (allocated to corpus) $6,000
What is the trust’s accounting income?
In fiduciary accounting, all receipts and disbursements are classified as either income or corpus (principal). For example, interest on state bonds may constitute accounting income even though not included in gross income for tax purposes. Other items, for example capital gain, would be included in gross income for tax purposes but may be classified as corpus (principal) for fiduciary accounting purposes. Any items allocated to corpus (principal) are not included in the computation of a trust's accounting income. Here, the trust's accounting income includes the $10,000 of dividends, $12,000 of interest from corporate bonds, and $4,000 of tax-exempt interest from state bonds, but excludes the capital gain and trustee fee which are allocated to corpus (principal).
Alan Curtis, a US citizen, died on March 1, 2015, leaving a gross estate with a fair market value of $5,800,000 at the date of death. Under the terms of Alan’s will, $4 million was bequeathed outright to his widow, free of all estate and inheritance taxes. The remainder of Alan’s estate was left to his mother. Alan made no taxable gifts during his lifetime. Disregarding extensions of time for filing, within how many months after the date of Alan’s death is the federal estate tax return due?
- 2 ½
- 3 ½
The federal estate tax return (Form 706) must be filed and the tax paid within nine months of the decedent’s death, unless an extension of time has been granted.
A complex trust is a trust that
- Must distribute income currently, but is prohibited from distributing principal during the taxable year.
- Invests only in corporate securities and is prohibited from engaging in short-term transactions.
- Permits accumulation of current income, provides for charitable contributions, or distributes principal during the taxable year.
- Is exempt from payment of income tax since the tax is paid by the beneficiaries.
Permits accumulation of current income, provides for charitable contributions, or distributes principal during the taxable year.
Classification of Trusts
- Simple trust is one that (1) is required to distribute all of its income to beneficiaries each year, (2) cannot make charitable contributions, and (3) makes no distribution of trust corpus (i.e., principal) during the year.
- Complex trust is any trust other than a simple trust.
Don and Linda Grant, US citizens, were married for the entire 2015 calendar year. In 2015, Don gave a $60,000 cash gift to his sister. The Grants made no other gifts in 2015. They each signed a timely election to treat the $60,000 gift as one made by each spouse. Disregarding the unified credit and estate tax consequences, what amount of the 2015 gift is taxable to the Grants for gift tax purposes?
Don and Linda (his spouse) elected to split the gift made to Don’s sister, so each is treated as making a gift of $30,000. Since both Don and Linda would be eligible for a $14,000 exclusion, each will have made a taxable gift of $30,000 — $14,000 exclusion = $16,000. Thus, the Grants’ total taxable gift is $32,000 ($16,000 × 2).
Roberts, a cash-basis calendar-year taxpayer, died on October 31, 2015. In 2015, prior to his death, Roberts incurred $18,000 in medical expenses. The executor of the estate paid the medical expenses, which were a claim against the estate, on December 3, 2015. If the executor files the appropriate waiver, the medical expenses are deductible on
- The executor’s income tax return.
- The estate income tax return.
- Roberts’ final income tax return.
- The estate tax return.
Roberts’ final income tax return.
The executor may elect to treat medical expenses paid by the decedent’s estate for the decedent’s medical care as paid by the decedent at the time the medical services were provided. To qualify for this election, the medical expenses must be paid within the 1-year period after the decedent’s death, and the executor must attach a waiver to the decedent’s Form 1040 indicating that the expenses will not be claimed as a deduction on the decedent’s estate tax return. Here, since Roberts died during 2014, and the medical services were paid for by Roberts’ estate during 2014, the medical expenses are deductible on Roberts’ final income tax return for 2014, provided that the executor attaches the appropriate waiver.
The Simone Trust reported distributable net income of $120,000 for the current year. The trustee is required to distribute $60,000 to Kent and $90,000 to Lind each year. If the trustee distributes these amounts, what amount is includible in Lind’s gross income?
The maximum amount that is taxable to trust beneficiaries is limited to a trust’s distributable net income (DNI). When distributions to multiple beneficiaries exceed DNI, the trust’s DNI must be prorated to the distributions to determine the portion of each distribution that must be included in gross income Here, since the distributions to Kent and Lind totaled $150,000, the portion of Lind’s $90,000 distribution that must be included in gross income equals ($90,000/$150,000) × $120,000 DNI = $72,000.
Which of the following is an attribute of a complex trust?
- It distributes income to more than one beneficiary.
- It has a grantor that is not an individual.
- It has a beneficiary that is not an individual.
- It distributes corpus.
It distributes corpus.
A complex trust is one in which the trustee
- has the discretion whether to distribute or accumulate income,
- may make charitable contributions, and
- may distribute trust corpus.
The number and type of income beneficiaries and the type of grantor have no effect on a trust’s classification as a complex trust.
Michael and JeMeace (brother and sister) own unimproved land that they hold in joint tenancy with rights of survivorship. The land cost $40,000 of which Michael paid $30,000 and JeMeace paid $10,000. JeMeace died during 2013 when the land was worth $280,000. What amount should be included in JeMeace’s gross estate with respect to the land?
In general, the gross estate includes the fair market value of all property in which the decedent had an ownership interest at time of death. In the case of property held in joint tenancy that was acquired by purchase by other than spouses, the decedent’s estate must include the fair market value of the property multiplied by the percentage of total cost furnished by the decedent. In the present case, JeMeace furnished $10,000/$40,000 = 1/4 of the cost of the land. Therefore, JeMeace’s estate should include 1/4 × $280,000 = $70,000 with respect to the land.
Which of the following payments would require the donor to file a gift tax return?
- $30,000 to a university for a spouse’s tuition.
- $40,000 to a university for a cousin’s room and board.
- $50,000 to a hospital for a parent’s medical expenses.
- $80,000 to a physician for a friend’s surgery.
$40,000 to a university for a cousin’s room and board.
Generally, a gift tax return must be filed by a donor if the donor makes a taxable gift (e.g., a gift of a future interest, or a gift of a present interest that exceeds the amount of annual exclusion [$14,000 for 2015]). In determining the amount of taxable gifts, there is an unlimited exclusion that is available for amounts paid on behalf of a donee to an educational organization for tuition, as well as for amounts paid on behalf of a donee to medical care providers for medical services. Thus, the $30,000 to a university for a spouse’s tuition, $50,000 to a hospital for a parent’s medical expenses and $80,000 to a physician for a friend’s surgery would be fully excluded and would not require the filing of a gift tax return. In contrast, the gift of $40,000 to a university for a cousin’s room and board would require the donor to file a gift tax return. That is because the $40,000 payment is a gift of a present interest in excess of the annual exclusion, and does not qualify for the unlimited exclusion because it is not a payment of tuition.
During the current year, Mann, an unmarried US citizen, made a $5,000 cash gift to an only child and also paid $25,000 in tuition expenses directly to a grandchild’s university on the grandchild’s behalf. Mann made no other lifetime transfers. Assume that the gift tax annual exclusion is $14,000. For gift tax purposes, what was Mann’s taxable gift?
The first $14,000 of gifts of a present interest made to a donee during a calendar year are excluded in determining the amount of a donor’s taxable gifts. As a result, the $5,000 cash gift to a child does not result in a taxable gift. Additionally, there is an unlimited exclusion for tuition or medical expenses paid on behalf of a donee. Thus, the $25,000 tuition paid directly to the grandchild’s university is fully excluded and does not result in a taxable gift.
- Annual exclusion—of up to $14,000 per donee is allowed for gifts of present interests (not future interests). A present interest is an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property. A future interest includes reversions, remainders, and other interests that are limited to commence in use, possession, or enjoyment at some future date or time.
- Gift-splitting—a gift by either spouse to a third party may be treated as made one-half by each, if both spouses consent to election. Gift-splitting has the advantage of using the other spouse’s annual exclusion and unified transfer tax credit.
Which of the following types of entities is entitled to the net operating loss (NOL) deduction?
- S corporations.
- Trusts and estates.
- Not-for-profit organizations.
Trusts and estates.
Trusts and estates may have an NOL that can be carried back and carried forward and used as a deduction. Furthermore, for the year in which a trust or estate terminates, any remaining unused NOL passes through to the beneficiaries who succeed to the assets of the trust or estate.
Partnerships and S corporations are pass-through entities whose expenses and losses pass through to be reported on the tax returns filed by their owners.
This answer may also be correct since some not-for-profit organizations may conduct an unrelated business and be subject to tax on unrelated business taxable income. If the unrelated business of a not-for-profit results in an NOL, the NOL can be carried back and forward and used as a deduction against unrelated business income in other years.
Under which of the following circumstances is trust property with an independent trustee includible in the grantor’s gross estate?
- The trust is revocable.
- The trust is established for a minor.
- The trustee has the power to distribute trust income.
- The income beneficiary disclaims the property, which then passes to the remainderman, the grantor’s friend.
The trust is revocable.
A decedent’s gross estate generally includes all property in which the decedent had an ownership interest at time of death, including the value of revocable transfers, as well as all transfers over which the decedent had, at the time of death, the power to change the enjoyment of what was transferred by altering, amending, revoking, or terminating an interest. Thus, a decedent’s gross estate would include the value of a revocable trust at its date-of-death or alternate valuation date value.
Don and Linda Grant, US citizens, were married for the entire 2010 calendar year. In 2010, Don gave a $60,000 cash gift to his sister. The Grants made no other gifts in 2010. They each signed a timely election to treat the $60,000 gift as one made by each spouse. Disregarding the unified credit and estate tax consequences, what amount of the 2010 gift is taxable to the Grants for gift tax purposes?
Don and Linda (his spouse) elected to split the gift made to Don’s sister, so each is treated as making a gift of $30,000. Since both Don and Linda would be eligible for a $13,000 exclusion, each will have made a taxable gift of $30,000 − $13,000 exclusion = $17,000. Thus, the Grants’ total taxable gift is $34,000 ($17,000 × 2).
George and Suzanne have been married for 40 years. Suzanne inherited $1,000,000 from her mother. Assume that the annual gift tax exclusion is $14,000. What amount of the $1,000,000 can Suzanne give to George without incurring a gift tax liability?
In computing the gift tax, there is an unlimited marital deduction that applies to gifts to a taxpayer’s spouse after first subtracting the annual exclusion. Thus, the $1 million gift to the spouse is fully offset by an annual exclusion and marital deduction and does not result in a taxable gift.
- Educational and medical exclusion—an unlimited exclusion is available for amounts paid on behalf of a donee (1) as tuition to an educational organization, or (2) to a health care provider for medical care of donee.
- Political gifts—an unlimited exclusion is available for the transfer of money or other property to a political organization.
- Charitable gifts—(net of annual exclusion) are deductible without limitation.
- Marital deduction—is allowed without limitation for gifts to a donor’s spouse
Under the unified transfer tax rate schedule for 2015, which of the following is not correct?
- Lifetime taxable gifts are taxed on a cumulative basis.
- Transfers at death are taxed on a cumulative basis.
- The unified rate schedule applies different rates for the gift tax and the estate tax.
- The unified transfer tax is reduced by the unified transfer tax credit.
The unified rate schedule applies different rates for the gift tax and the estate tax.
The unified transfer tax rate schedule applies the same tax rates on a cumulative basis to both life and death transfers. For example, during a person’s lifetime, a tax is first computed on cumulative lifetime taxable gifts, then is reduced by the tax on taxable gifts made in prior years in order to tax the current year’s gifts at applicable marginal rates.
Smith and Jones, both US citizens, died in 2015. Neither made any lifetime taxable gifts. At the dates of death, Smith’s gross estate was $4,800,000, and Jones’ gross estate was $5,600,000. A federal estate tax return must be filed for
- Smith - NO
- Jones - YES
For 2015, an executor must file a federal estate tax return (Form 706) if the gross estate of a decedent exceeds $5.43 million. If a decedent made lifetime taxable gifts such that the decedent’s tax credit was used to offset gift tax, the $5.43 million exemption amount must be reduced by the exemption equivalent of the unified credit that was used. Since neither Smith nor Jones made any lifetime taxable gifts, the filing requirement that applies to their estates is $5.43 million. Therefore, a federal estate tax return must be filed for Jones because his gross estate was $5,600,000, while no federal estate tax return need be filed for Smith since his gross estate was $4,800,000.
Mackenzie is the grantor of a trust over which Mackenzie has retained a discretionary power to receive income. Kelly, Mackenzie’s child, receives all taxable income from the trust unless Mackenzie exercises the discretionary power. To whom is the income earned by the trust taxable?
- To the trust to the extent it remains in the trust.
- To Mackenzie because he has retained a discretionary power.
- To Kelly as the beneficiary of the trust.
- To Kelly and Mackenzie in proportion to the distributions paid to them from the trust.
To Mackenzie because he has retained a discretionary power.
When the grantor of a trust retains substantial control over the trust, such as the power to revoke the trust or a discretionary power to have trust income distributed to the grantor or grantor's spouse, the income from the trust will be taxed to the grantor. In this case, because Mackenzie retained a discretionary power to receive the trust's income, all of the trust's income will be taxed to Mackenzie even though the income is retained by the trust or distributed to the trust's beneficiary (Kelly).
Mosh, a sole proprietor, uses the cash method of accounting. At the beginning of the current year, accounts receivable were $25,000. During the year, Mosh collected $100,000 from customers. At the end of the year, accounts receivable were $15,000. What was Mosh’s gross taxable income for the current year?
Under the cash method, income is recognized when it is actually or constructively received, whether in cash or in property. Here, Mosh’s gross taxable income for the current year would include the $100,000 cash collected from customers. Mosh’s accounts receivable at the beginning and end of the year are not relevant.
Under the uniform capitalization rules applicable to taxpayers with property acquired for resale, which of the following costs should be capitalized with respect to inventory if no exceptions have been met?
- Repackaging costs
- Off-site storage costs
BOTH should be capitalized.
The uniform capitalization rules generally require that all costs incurred in acquiring property for resale must be capitalized as part of the cost of inventory. The costs that must be capitalized include the costs of purchasing, handling, processing, repackaging and assembly, as well as the costs of off-site storage.
An off-site storage facility is one that is not physically attached to, nor an integral part of, a retail sales facility.
Quail, Inc. manufactures consumer products and sells them to distributors. Quail advertises its products to increase sales and enhance the value of its trade name. What is the appropriate tax treatment of the advertising costs?
- Amortize the costs over 15 years.
- Amortize the costs over 36 months.
- Amortize the costs over 60 months.
- Deduct the costs currently as ordinary and necessary business expenses.
Deduct the costs currently as ordinary and necessary business expenses.
Advertising costs are deductible as an ordinary and necessary business expense if they are reasonable in amount and bear a reasonable relation to the business. Deductible expenses may be for the purpose of gaining immediate sales or developing goodwill. Advertising costs are deductible even though the advertising program is expected to result in benefits extending over a period of years.
An individual taxpayer agreed to a finding of fraud on an income tax return filed two years ago. What is the maximum time limitation, if any, after which the IRS may NOT assess any additional taxes against the taxpayer for this tax return?
- One year.
- Two years.
- Three years.
- There is NO time limitation.
There is NO time limitation.
The IRS is not prevented from assessing any additional taxes at any time in the future because a taxpayer has agreed to a fraud finding.
In which of the following circumstances does the three-year statute of limitations on additional tax assessments apply?
- A taxpayer willfully attempts to evade tax in filing income tax returns.
- A taxpayer inadvertently omits from gross income an amount in excess of 25% of the gross income stated on the income tax return.
- A taxpayer inadvertently overstates deductions equal to 15% of gross income.
- The IRS files a substitute income tax return when it learns that a taxpayer failed to file a return.
A taxpayer inadvertently overstates deductions equal to 15% of gross income.
No special rules apply in this situation so the general three-year rule applies.
Sam's year 2 taxable income was $175,000 with a corresponding tax liability of $30,000. For year 3, Sam expects taxable income of $250,000 and a tax liability of $50,000. In order to avoid a penalty for underpayment of estimated tax, what is the minimum amount of year 3 estimated tax payments that Sam can make?
No penalty is imposed if the tax payments during the year are at least 90% of current year taxes or 100% of last year's taxes. If the taxpayer's AGI exceeds $150,000, then tax payments during the year must be at least 110% of last year's taxes. $30,000 x 110% = $33,000.
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.
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
- for quality or peer reviews;
- for use in preparing state and local taxes and/or in declaring estimated taxes;
- under code; and
- 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.
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.
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:
- Failure to furnish copy to taxpayer
- Failure to furnish identifying number
- Failure to retain copy or list
- Failure to file correct information returns.-
- Negotiation of check
Blink Corp., an accrual basis calendar year corporation, carried back a net operating loss for the tax year ended December 31, 2014 Blink's gross revenues have been under $500,000 since inception. Blink expects to have profits for the tax year ending December 31, 2015.
Which method(s) of estimated tax payment can Blink use for its quarterly payments during the 2015 tax year to avoid underpayment of federal estimated taxes?
- 100% of the preceding tax year method
- Annualized income method
Annualized Income Method ONLY.
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 percent 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.
Hence, Blink Corp. could not use the preceding year method for calculating its estimated tax payments because it sustained a net operating loss for that year. Blink Corp. must use the annualized income method.
This response correctly states that Blink Corp. could use only the annualized method.
Chris Baker's adjusted gross income on her 2015 tax return was $160,000. The amount covered a 12-month period. For the 2015 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
- 90% of the tax on the return for the current year paid in four equal installments.
- 100% of prior year's tax liability paid in four equal installments.
A. I only.
The required annual amount is usually the lower of 90 percent of the tax shown on the taxpayer's current year return or 100 percent 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 percent of the prior year's return.
Thus, Baker must base his required annual amount on 90 percent of the current year's tax liability or, since his adjusted gross income exceeded $150,000, 110 percent of the prior year's liability.
An individual paid taxes 27 months ago, but did not file a tax return for that year. Now the individual wants to file a claim for refund of federal income taxes that were paid at that time. The individual must file the claim for refund within which of the following time periods after those taxes were paid?
- One year.
- Two years.
- Three years.
- Four years.
The deadline for filing a claim for refund (on form 1040X) is the later of:
- Two years from the payment of tax, or
- Three years from the date the return was filed (or April 15 if filed before the original due date).