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Flashcards in REG 8 Deck (167):
1

A shareholder's basis in the stock of an S corporation is increased by the shareholder's pro rata share of income from


Tax-exempt interest

Taxable interest

Income for an S corporation includes taxable and tax-exempt interest. All income of an S corporation is passed through to the shareholder and results in an increase in the shareholder's basis in the stock of the corporation. The shareholder is responsible for any taxes that may or may not apply to the S corporation's income.

2

L Corporation, an S electing corporation, pays single coverage health insurance premiums of $4,000 per year and family coverage premiums of $7,000 per year (the $7,000 includes single and family coverage). SH owns 10 percent of L stock and L pays SH's family coverage under the health insurance plan. What amount of insurance premium is included in SH's gross income?

The entire premium payment must be included in income since SH owns 2% or more of the L's stock. If SH owned less than 2% of the stock, the entire premium payment could be excluded from income..

3

Carson owned 40% of the outstanding stock of a C corporation. During a tax year, the corporation reported $400,000 in taxable income and distributed a total of $70,000 in cash dividends to its shareholders. Carson accurately reported $28,000 in gross income on Carson's individual tax return. If the corporation had been an S corporation and the distributions to the owners had been proportionate, how much income would Carson have reported on Carson's individual return?

The distributive share to Carson would be $400,000 × 40% = $160,000.

4

Bern Corp., an S corporation, had an ordinary loss of $36,500 for the year ended December 31, 2014. At January 1, 2014, Meyer owned 50% of Bern's stock. Meyer held the stock for 40 days in 2014 before selling the entire 50% interest to an unrelated third party. Meyer's basis for the stock was $10,000. Meyer was a full-time employee of Bern until the stock was sold. Meyer's share of Bern's 2014 loss was

Meyer's share of Bern Corp.'s 2014 loss should be Meyer's pro rata share of the corporation's income.
Since Meyer owned 50 percent of Bern Corp. for the first 40 days of Bern Corp.'s tax year, Meyer's portion of the loss would be $2,000 (= 50 percent ownership* (40 days/365 days) * $36,500 ordinary loss). Meyer's share of the corporation's loss is dependent on his/her ownership percentage, It is unaffected by Meyer's being an employee of the corporation.

5

Absent an election to close the books, the allocation of nonseparately stated income or loss for an S corporation shareholder that changed his ownership interest during the year is computed based on which of the following ownership percentages?
A. Ownership percentage at the end of the S corporation year.
B. Ownership percentage computed on a per-share per-day basis.
C. Ownership percentage at the beginning of the S corporation year.
D. Ownership percentage determined as an average of the beginning and ending ownership percentages.

The ownership percentage that a partner has for a given day of the tax year is multiplied by the income allocated to that day to determine allocations.

6

As of January 1, 2014, Kane owned all the 100 issued shares of Manning Corp., a calendar year S corporation. On the 40th day of 2014, Kane sold 25 of the Manning shares to Rodgers. For the year ended December 31, 2014 (a 365-day calendar year), Manning had $73,000 in nonseparately stated income and made no distributions to its shareholders.
What amount of nonseparately stated income from Manning should be reported on Kane's 2014 tax return?

The amount of the nonseparately stated income from Manning Corp. that should be reported on Kane's 2014 tax return should be Kane's pro rata share of the corporation's income.
Since Kane owned 100 percent of Manning and sold a 25 percent share on the 40th day of Manning's tax year, Kane's portion of the income would be calculated with respect to 100 percent ownership for the first 40 days of the corporation's tax year and 75 percent ownership for the remainder of the tax year.

Kane's share of Manning's income from the first 40 days of the corporation's tax year would be $8,000 = 100 percent ownership × (40 days/365 days) × $73,000 in income. Kane's share of the corporation's income for the remainder of the year would be $48,750 = 75 percent ownership × (325 days/365 days) × $73,000 in income).

Hence, the amount of the nonseparately stated income from Manning Corp. that should be reported on Kane's 2014 tax return is $56,750 ? the sum of $8,000 from the first 40 days and $48,750 from the remainder of the tax year.

7

Beck Corp. has been a calendar year S corporation since its inception on January 2, 2006. On January 1, 2014, Lazur and Lyle each owned 50% of the Beck stock, in which their respective tax bases were $12,000 and $9,000. For the year ended December 31, 2014, Beck had $81,000 in ordinary business income and $10,000 in tax-exempt income. Beck made a $51,000 cash distribution to each shareholder on December 31, 2014. What was Lazur's tax basis in Beck after the distribution?

$6,500 is correct. His/her portion of income items of the corporation that are separately computed and passed through to shareholder, including tax-exempt income, increases the stock basis of each S corporation shareholder. Basis is calculated as follows:

Beginning Basis $12,000
Plus 50% profits 40.500(81,000x50%)
Plus 50% exempt 5,000(10,000x50%)
Less distributions (51,000)
Ending Basis $ 6,500

8

Prail Corporation is a C corporation that on February 1, 2014 elected to be taxed as a calendar-year S corporation. On June 15, 2014, Prail sold land with a basis of $100,000 for $200,000 cash. The fair market value of the land on February 1, 2014 was $150,000. Prail had no other income or loss for the year and no carryovers from prior years.
What is Prail's tax?

A C corporation that makes an S election and has unrealized built-in gains in its assets as of the election day must pay a built-in gains tax on this appreciation if it is recognized within the next 10 years.
When Prail makes the S election it has appreciation in the land of $50,000 ($150,000 - $100,000). Since the land was sold within 10 years of the election day, the first $50,000 of gain is taxed to the corporation at the rate of 35%.

Therefore, Prail must pay a tax of $17,500 ($50,000 * 35%).

9

A sole proprietorship incorporated on January 1 and elected S corporation status. The owner contributed the following assets to the S corporation:

Basis Fair market value
Machinery $ 7,000 $ 8,000
Building 11,000 100,000
Cash 1,000 1,000


Two years later, the corporation sold the machinery for $4,000 and the building for $110,000. The machinery had accumulated depreciation of $2,000, and the building had accumulated depreciation of $1,000. What is the built-in gain recognized on the sale?

The built in gains tax applies only when an existing C corporation makes an S corporation election. The built in gains tax does not apply when a sole proprietorship makes an S election, so the correct answer is $0.

10

If an S corporation has no accumulated earnings and profits, the amount distributed to a shareholder
A. Must be returned to the S corporation.
B. Increases the shareholder's basis for the stock.
C. Decreases the shareholder's basis for the stock.
D. Has no effect on the shareholder's basis for the stock.

A distribution from an S corporation that has no accumulated earnings and profits reduces the basis of a shareholder's stock. If the payment exceeds the shareholder's basis in the stock, it is viewed as a payment in exchange for stock.

11

Baker, an individual, owned 100% of Alpha, an S corporation. At the beginning of the year, Baker's basis in Alpha Corp. was $25,000. Alpha realized ordinary income during the year in the amount of $1,000 and a long-term capital loss in the amount of $3,000 for this year. Alpha distributed $30,000 in cash to Baker during the year.
What amount of the $30,000 cash distribution is taxable to Baker?

Calculate basis in an S corporation as follows: The current basis of $25,000 is increased by the $1,000 of income to $26,000, then reduced for the distribution of $30,000 which would reduce the basis to $0 and produce a $4,000 gain. The $3,000 loss is suspended until there is more basis in the future.
If the amount of the distribution exceeds the adjusted basis of the stock, such excess shall be treated as gain from the sale or exchange of property.

12

Sandy is the sole shareholder of Swallow, an S corporation. Sandy's adjusted basis in Swallow stock is $60,000 at the beginning of the year. During the year, Swallow reports the following income items:

Ordinary income $30,000
Tax-exempt income 5,000
Capital gains 10,000


In addition, Swallow makes a nontaxable distribution to Sandy of $20,000 during the year. What is Sandy's adjusted basis in the Swallow stock at the end of the year?

An S corporation shareholder increases her basis in the S corporation stock by her share of the corporation's income (taxable and non-taxable) and expenses (deductible and non-deductible). Distributions also reduce the stock basis. Sandy's basis is reduced to $40,000 for the distribution ($60,000 - $20,000) and is increased for all three income items for an ending basis of $85,000 ($40,000 + $30,000 + $5,000 + $10,000).

13

On July 1, 2014, Vega made a transfer by gift in an amount sufficient to require the filing of a gift tax return. Vega was still alive in 2014.
If Vega did not request an extension of time for filing the 2014 gift tax return, the due date for filing was

A. March 15, 2015.
B. April 15, 2015.
C. June 15, 2015.
D. June 30, 2015.

Individual taxpayers making gifts that are not fully excludable due to the $14,000 annual exclusion for each gift are required to file a gift tax return, Form 709, by the April 15th of the year following the year the gifts were given by the donor. The required filing date differs, if the donor died during the year that the gifts were made.

14

When Jim and Nina became engaged in April 2014, Jim gave Nina a ring that had a fair market value of $50,000. After their wedding in July 2014, Jim gave Nina $75,000 in cash so that Nina could have her own bank account. Both Jim and Nina are U.S. citizens.
What was the amount of Jim's 2014 marital deduction?

For gift tax purposes, a taxpayer may claim a marital deduction for all gifts given to a spouse provided: 1) the taxpayer and the spouse were married at the date of the gift; 2) the spouse is a U.S. citizen; and 3) the property transferred is not a terminable interest.
As Jim and Nina were not married when Jim gave Nina the engagement ring, Jim may not claim the marital deduction for the fair market value of the ring. However, Jim and Nina were married when Jim gave Nina $75,000 in cash so that Nina could have her own bank account. Therefore, Jim may claim a marital deduction of $75,000, attributable to the cash gift.

15

In 2014, Sayers, who is single, gave an outright gift of $50,000 to a friend, Johnson, who needed the money to pay medical expenses.
In filing the 2014 gift tax return, Sayers was entitled to a maximum exclusion of

Gift donors may exclude the first $14,000 of gifts made to each donee for each calendar year from the donor's taxable gifts. Married couples are allowed to elect to treat the gift as made one-half by each spouse.
Sayers is a single taxpayer and, as such, may only exclude the first $14,000 of any gift to a donee. The fact that the gift was to pay medical expenses is irrelevant. Thus, Sayers may exclude $14,000 of the $50,000 gift.

16

The answer to each of the following questions would be relevant in determining whether a tuition payment made on behalf of another individual is excludible for gift tax purposes, EXCEPT:
A. Was the tuition payment made for tuition or for other expenses?
B. Was the qualifying educational organization located in a foreign country?
C. Was the tuition payment made directly to the educational organization?
D. Was the tuition payment made for a family member?

Tuition payments can potentially be excluded from the gift tax if made for any individual. The exclusion is not limited to just family members so this information is not relevant.

17

During the current year, Mann, an unmarried U.S. 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?

Mann can give up to $14,000 to any individual and pay no gift tax since the annual exclusion for the given year is $14,000. There is an unlimited exclusion from the gift tax for education gifts as long as the gift is made directly to the educational institution, as is the case here. Therefore, the $25,000 gift is also not subject to the gift tax.

18

Under the unified rate schedule,
A. Lifetime taxable gifts are taxed on a noncumulative basis.
B. Transfers at death are taxed on a noncumulative basis.
C. Lifetime taxable gifts and transfers at death are taxed on a cumulative basis.
D. The gift tax rates are 5% higher than the estate tax rates.

Under the unified rate schedule, lifetime taxable gifts and transfers at death are taxed on a cumulative basis through reducing the amount of the unified credit by the sum of all amounts credited in preceding periods.

19


Which of the following payments would require the donor to file a gift tax return?

A.
$30,000 to a university for a spouse's tuition.

B.
$40,000 to a university for a cousin's room and board.

C.
$50,000 to a hospital for a parent's medical expenses.

D.
$80,000 to a physician for a friend's surgery.

There is an unlimited exclusion for education gifts if the tuition is paid directly to the educational institution. However, this exclusion is limited to tuition and does not apply to room and board. For 2014, $14,000 of the gifts to the cousin can be excluded from the gift tax, so the remaining $26,000 is subject to the gift tax. A gift tax return must be filed to reflect this transaction.

20

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?


An unlimited exclusion from the gift tax applies for gifts to spouses. Therefore, Suzanne can give the entire $1,000,000 to George and pay no gift tax.

21

Jan, an unmarried individual, gave the following outright gifts in 2014:

Donee Amount Use by Donee
Jones $15,000 Down payment on house
Craig 14,000 College tuition
Kande 5,000 Vacation trip


Jan's 2014 exclusions for gift tax purposes should total

For gift tax purposes, donors may exclude the first $14,000 of gifts to each donee for each calendar year from the amount of taxable gifts.
Hence, Jan could exclude $14,000 of her $15,000 gift to Jones and, similarly, $14,000 of her $14,000 gift to Craig. Jan could exclude her entire $5,000 gift to Kande because the gift was less than $14,000. Therefore, Jan's 2014 exclusions for gift tax purposes should total $33,000.

This response is, therefore, correct.

22

Bell, a cash basis calendar year taxpayer, died on June 1, 2014. In 2014, prior to her death, Bell incurred $2,000 in medical expenses. The executor of the estate paid the medical expenses, which were a claim against the estate, on July 1, 2014.
If the executor files the appropriate waiver, the medical expenses are deductible on

A. The estate tax return.
B. Bell's final income tax return.
C. The estate income tax return.
D. The executor's income tax return.

A decedent's medical expenses paid by the decedent's estate are deductible on the decedent's tax return in the year incurred if:

1) the expenses were paid within a year of the decedent's death;
2) the expenses are not deducted for federal estate tax purposes; and
3) a waiver stating that no estate tax deduction for the expenses was taken by the estate and that the estate waives its right to the deduction.

Bell's estate paid the medical expenses a month after Bell's death, easily within a year. In addition, the appropriate waiver was filed. Thus, assuming that the estate not deducted the expenses for federal estate tax purposes, the medical expenses may be deducted on Bell's final income tax return.

23

H and W are married citizens. All of their real and personal property is owned as tenants by the entirety or as joint tenants with right of survivorship. The gross estate of the first spouse to die:
A. Includes only the property acquired by the deceased spouse.
B. Is governed by federal tax provisions rather than community property laws.
C. Includes one third of all real estate as the dower right of the first spouse to die.
D. Includes half of the value of all the property owned regardless of which spouse furnished the original consideration.

For married individuals, half of the value of jointly owned property is always included in the estate of the first spouse to die.

24

Ordinary and necessary administration expenses of an estate are deductible:
A. Only on the fiduciary income tax return.
B. Only on the estate tax return.
C. On the fiduciary income tax return if the estate tax deduction is waived.
D. On both the fiduciary income tax return and the estate tax return.

Ordinary and necessary administration expenses of an estate are deductible on the fiduciary income tax return if the administrator of the estate waives the deduction on the estate tax return.

25


Under which of the following circumstances is trust property with an independent trustee includible in the grantor's gross estate?

A.
The trust is revocable.

B.
The trust is established for a minor.

C.
The trustee has the power to distribute trust income.

D.
The income beneficiary disclaims the property, which then passes to the remainderman, the grantor's friend.

In general, once a trust is established and the taxpayer has transferred property to the trust, this property will not be included in the taxpayer's gross estate at death unless the taxpayer maintains ownership or control of the property. Since this trust can be revoked, the taxpayer still controls the property so at death the property will be included in his gross estate. Other conditions listed in the problem (trust for a minor, independent trustee can distribute income, disclaimer) do not cause the taxpayer to retain ownership in the property.

26

Which of the following items of property would be included in the gross estate of a decedent who died in 2014?
1.Clothes and jewelry of the decedent.
2.Cash of $400,000 given to decedent's friend in 2012. No gift tax was paid on the transfer.
3.Land purchased by decedent and held as joint tenants with rights of survivor-ship with decedent's brother.

All assets owned by the decedent as of the date of death are included in the gross estate. Even though the land was owned jointly, since it is held with a right of survivorship 100% of the value of the land is included in the estate of the first co-owner to die.
The only exception to this rule is if the other co-owner had paid for a percentage of the land when originally purchased. In that case the percentage purchased by this co-owner would be excluded from the gross estate.

The cash is excluded since it was not owned as of the date of death.

27

The generation-skipping transfer tax is imposed
A. Instead of the gift tax.
B. Instead of the estate tax.
C. As a separate tax in addition to the gift and estate taxes.
D. On transfers of future interest to beneficiaries who are more than one generation above the donor's generation.

As a separate tax in addition to the gift and estate taxes. The generation-skipping transfer tax is a tax imposed on outright or in trust transfers to beneficiaries more than one generation below the generation of the donor. This tax is a flat tax equal to the maximum gift and estate tax rate. The generation-skipping transfer tax is a separate tax imposed in addition to the gift and estate taxes.

28

If the executor of a decedent's estate elects the alternate valuation date and none of the property included in the gross estate has been sold or distributed, the estate assets must be valued as of how many months after the decedent's death?
A. 3
B. 6
C. 9
D. 12

For estate tax purposes, a decedent's gross estate is the all property owned by the decedent at death valued at its fair market value.
However, if the executor of the decedent's estate elects the alternative valuation date, the property is valued six months after the date of the decedent's death or, if earlier, the date the property is distributed or sold.

29

Fred and Amy Kehl, both U.S. citizens, are married. All of their real and personal property is owned by them as tenants by the entirety or as joint tenants with right of survivorship. The gross estate of the first spouse to die
A. Includes 50% of the value of all property owned by the couple, regardless of which spouse furnished the original consideration.
B. Includes only the property that had been acquired with the funds of the deceased spouse.
C. Is governed by the federal statutory provisions relating to jointly held property, rather than by the decedent's interest in community property vested by state law, if the Kehls reside in a community property state.
D. Includes one-third of the value of all real estate owned by the Kehls, as the dower right in the case of the wife or curtsey right in the case of the husband.

For tenants by the entirety and for joint tenants with rights of survivorship created between spouses, 50 percent of the value of the jointly-owned interest is included in the estate of the decedent spouse. Therefore, the gross estate of the first spouse to die includes 50 percent of the value of all property owned by the couple, regardless of which spouse furnished the original consideration.

30

In connection with a "buy-sell" agreement funded by a cross-purchase insurance arrangement, business associate Adam bought a policy on Burr's life to finance the purchase of Burr's interest. Adam, the beneficiary, paid the premiums and retained all incidents of ownership.
On the death of Burr, the insurance proceeds will be

A. Includible in Burr's gross estate, if Burr owns 50% or more of the stock of the corporation.
B. Includible in Burr's gross estate only if Burr had purchased a similar policy on Adam's life at the same time and for the same purpose.
C. Includible in Burr's gross estate, if Adam has the right to veto Burr's power to borrow on the policy that Burr owns on Adam's life.
D. Excludable from Burr's gross estate.

"Buy-sell" agreements are excludable from a decedent's estate provided the agreement:
1) is a bona fide business agreement;
2) is not a device to transfer property to the decedents family for less than full and adequate consideration; and
3) has terms similar to those entered into by persons in arm's length transactions.
As the "buy-sell" in this case meets the requirements for being excludable from the decedent's estate, the insurance proceeds will be excluded from Burr's estate upon Burr's death.

31

The federal estate tax may not be reduced by a credit of
A. Foreign death taxes.
B. Credit for estate tax paid on a prior transfer of the same property within ten years of the death of the decedent.
C. Gift taxes paid on pre-1977 gifts.
D. State death taxes paid.

An estate tax credit is not allowed for death taxes paid to states.

32

Within how many months after the date of a decedent's death is the federal estate tax return (Form 706) due if no extension of time for filing is granted?
A. 9
B. 6
C. 4 1/2
D. 3 1/2

If a decedent's estate exceeds $5,340,000 (2014), the executor of a decedent's estate is required to file Form 706, the federal estate tax return, within nine months of the date of death.

33

Which of the following credits may be offset against the gross estate tax to determine the net estate tax of a U.S. citizen?


Unified credit

Credit for gift taxes paid on gifts made after 1976

Certain credits may be offset against the gross estate tax to determine the net estate tax of a U.S. citizen. These credits are the unified credit, foreign death taxes, prior transfers and gift taxes paid on pre-1977 gifts.
This response correctly indicates that the unified credit may be offset against the gross estate tax to determine the net estate tax of a U.S. citizen and that credits for gift taxes paid for gifts after 1976 may not be used as a credit to offset against the gross estate tax in determining the net estate tax. Note that there is a reduction in the estate tax for the gift taxes paid or payable on post-1976 gifts, but this reduction is not designated as a "credit" by the tax law. It is not a credit because the reduction is computed at the current rates (for the year of death) for post-1976 gifts, NOT the actual amount of gift tax paid in the past.

34

Under the provisions of a decedent's will, the estate's executor made the following cash disbursements:
I. A charitable bequest to the American Red Cross.

II. Payment of the decedent's funeral expenses.

What deduction(s) is(are) allowable in determining the decedent's taxable estate?

Charitable contributions and funeral expenses are deductible from the gross estate.

35

Which one of the following is a valid deduction from a decedent's gross estate?
A. Expenses of administering and settling the estate.
B. State inheritance tax.
C. Income tax paid on income earned and received after the decedent's death.
D. Federal estate tax.

Administration and selling expenses may be claimed either as a deduction from the decedent's gross estate for estate tax purposes or as a deduction from the estate's taxable income for income tax purposes.

36

What is the due date of a federal estate tax return (Form 706), for a taxpayer who died on May 15, year 2, assuming that a request for an extension of time is not filed?
A. September 15, year 2.
B. December 31, year 2.
C. January 31, year 3.
D. February 15, year 3.

February 15, year 3. The due date of the estate tax return is nine months after the date of death.

37

As per the uniform capitalization rules which costs incurred in acquiring property for resale must be capitalized as part of the cost of inventory?

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.

38

How many public company audits per year does a CPA firm that is registered with the Public Company Accounting Oversight Board (PCAOB) have to perform before it receives an annual inspection from the PCAOB?

CPA firms that audit more than 100 issuers must have an annual inspection by the PCAOB.

39

Is The interest on the deficiency deductible as a tax?

The interest on the deficiency is not deductible as a tax.

40

Explain casualty loss

A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. Deductible casualty losses may result from earthquakes, tornadoes, floods, fires, vandalism, auto accident, etc. However, a loss due to the accidental breakage of household articles such as glassware or china under normal conditions is not a casualty loss. Neither is a loss due to damage caused by a family pet.

41

Whe does court refuse to confirm a foreclosure sale?

A judicial foreclosure sale of the debtor’s real property is conducted generally at the direction of a court official (county sheriff) and confirmed by the court. A court will not refuse to confirm a sale merely because a higher price might have been received at a later time. The court will refuse to confirm a sale if the price is so low as to raise a presumption of unfairness or lack of protection for the mortgagor.

42

Which of the following statements is correct under the Federal Fair Labor Standards Act?




Some workers may be included within the minimum wage provisions but exempt from the overtime provisions.



Some workers may be included within the overtime provisions but exempt from the minimum wage provisions.



All workers are required to be included within both the minimum wage provisions and the overtime provisions.



Possible exemptions from the minimum wage provisions and the overtime provisions must be determined by the union contract in effect at the time.

Some workers may be included within the minimum wage provisions but exempt from the overtime provisions.the Federal Fair Labor Standards Act provides that a minimum hourly wage be paid to each covered employee. The act also requires that a wage rate of not less than one and one-half times the regular rate be paid for hours worked beyond forty hours in any given work week except for those employed in agriculture, seasonal employment in recreation, or engaged in the delivery of health care services for the sick.

43

What is the requirement for firm offer to be effective?

in order for a firm offer to be effective, it must be contained in writing signed by a merchant offeror. If the offeree supplies the form which contains a firm offer clause, the merchant offeror must separately sign that clause, otherwise it will be ineffective against the offeror.

44

Income in respect of a cash basis decedent
A. Covers income earned before the taxpayer's death but not collected until after death.
B. Receives a stepped-up basis in the decedent's estate.
C. Must be included in the decedent's final income tax return.
D. Cannot receive capital gain treatment.

Covers income earned before the taxpayer's death but not collected until after death. Income is only included on a cash-basis taxpayer's final income tax return if the taxpayer had actually or constructively received the income before death. After death income with respect to the decedent is reported by the decedent's estate. Thus, income in respect of a cash basis decedent covers income earned before the taxpayer's death but not collected until after death.

45

An executor of a decedent's estate that has only U.S. citizens as beneficiaries is required to file a fiduciary income tax return, if the estate's gross income for the year is at least
A. $400
B. $500
C. $600
D. $1,000

An executor of a decedent's estate that has only U.S. citizens as beneficiaries is required to file a fiduciary income tax return, Form 1041, if the estate has either gross income for the year of at least $600 or taxable income for the year.

46

Which of the following is(are) deductible on the fiduciary income tax return for a decedent's estate?
I. Expenses of administering and settling the estate.

II. State inheritance or estate tax.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

I only. The deductions and credits allowed (or disallowed) on the fiduciary return for an estate are similar to those allowed for an individual taxpayer. However, certain deductions and credits differ between estates and individual taxpayers. Most of these differences deal with the nature of an estate. For example, the estate's administration costs and losses during the administration of the estate may be deducted by the estate. An individual taxpayer would not have administration fees. However, note that if administration expenses are deducted on the fiduciary return they cannot also be deducted on the estate tax return (i.e., no double deduction is allowed). There are no differences in the deductibility of taxes by estates and individuals. Thus, several types of state and local taxes may be deducted by an estate, but state inheritance or estate taxes are not deductible for estates nor for individual taxpayers on their respective income tax returns. For example, state and local taxes that are deductible for estates and individual taxpayers include income taxes, personal ad valorem property taxes, and real property taxes. This response correctly indicates that expenses for administering and settling the estate are deductible from an estate's gross income and that state inheritance or estate taxes are not deductible.

47

Lyon, a cash basis taxpayer, died on January 15, 2014. In 2014, the estate executor made the required periodic distribution of $9,000 from estate income to Lyon's sole heir.
The following pertains to the estate's income and disbursements in 2014:

2014 Estate Income
$20,000 Taxable interest
10,000 Net long-term capital gains allocable to corpus
2014 Estate Disbursements

$ 5,000
Administrative expenses attributable to taxable income


For the 2014 calendar year, what was the estate's distributable net income (DNI)?

15'000 To compute distributable net income for an estate, taxable income must be adjusted for: 1.extraordinary dividends and taxable stock dividends;
2.capital gains and losses;
3.nontaxable income;
4.gains excluded from gross income under the 50 percent exclusion for qualified small business gain;
5.the distribution deduction;
6.the personal exemption; and
7.the deduction for estate tax attributable to income in respect to the decedent. Capital gains are excluded from distributable net income if the gains are allocated to corpus and


a. not paid, credited, or required to be distributed to a beneficiary or
b. not paid or set aside for charity.
Since the $10,000 of net long-term capital gains is allocable to corpus and not required to be distributed to the beneficiary, it is excluded from distributable net income in this case. Thus, the estate's distributable net income is $15,000, $20,000 of taxable income less $5,000 of administrative expenses attributable to taxable income.

48

Pat created a trust, transferred property to this trust, and retained certain interests. For income tax purposes, Pat was treated as the owner of the trust. Pat has created which of the following types of trusts?
A. Simple.
B. Grantor.
C. Complex.
D. Pre-need funeral.

Grantor. When the individual creating a trust retains certain interests in the trust, the trust is known as a grantor trust and the income from the trust is taxed to the grantor.

49

Lyon, a cash basis taxpayer, died on January 15, 2014. In 2014, the estate executor made the required periodic distribution of $9,000 from estate income to Lyon's sole heir.
The following pertains to the estate's income and disbursements in 2014:

2014 Estate Income
$20,000 Taxable interest
10,000 Net long-term capital gains allocable to corpus

2014 Estate Disbursements


$ 5,000
Administrative expenses attributable to taxable income


Lyon's executor does not intend to file an extension request for the estate fiduciary income tax return. By what date must the executor file the Form 1041, U.S. Fiduciary Income Tax Return, for the estate's 2014 calendar year?

April 15, 2015. The rules for when estate's Form 1041, U.S. Fiduciary Income Tax Return, are the same as those for individuals. Thus, the return must be filed on or before the 15th day of the fourth month after the close of the taxpayer's tax year. For calendar year taxpayers, the deadline for filing is April 15th. Short period returns must be filed on or before the 15th day of the fourth month after the close of the short period. Since Lyon died in January, the executor must file a short period return on or before the 15th day of the fourth month after the close of the short period. The estate's short period closed at the end of the calendar year, so the estate's Form 1041 must be filed on or before April 15, 2015.

50

Astor, a cash-basis taxpayer, died on February 3. During the year, the estate's executor made a distribution of $12,000 from estate income to Astor's sole heir and adopted a calendar year to determine the estate's taxable income.
The following additional information pertains to the estate's income and disbursements for the year:


Estate income
Taxable interest $65,000
Net long-term capital gains allocable to corpus 5,000
Estate disbursements:
Administrative expenses attributable to taxable income 14,000
Charitable contributions from gross income to a public charity, made under the terms of the will 9,000


For the calendar year, what was the estate's distributable net income (DNI)?

$42,000, is correct as follows:

Taxable interest $65,000
Estate disbursements
Administrative expenses attributable to taxable income (14,000) (2)
Charitable contributions from gross income to a public charity, made under the terms of the will ( 9,000) (1)
Estate's distributable net income (DNI) $42,000

1.An estate qualifies for a deduction for amounts of gross income paid or permanently set aside for qualified charitable organizations. The adjusted gross income limits for individuals do not apply. However, to be deductible by an estate, the contribution must be specifically provided for in the decedent's will. If there is no will, or if the will makes no provision for the payment to a charitable organization, then a deduction will not be allowed even though all of the beneficiaries may agree to the gift. 2.Expenses of administering an estate can be deducted either from the gross estate in figuring the federal estate tax on Form 706 or from the estate's gross income in figuring the estate's income tax on Form 1041. However, these expenses cannot be claimed for both estate tax and income tax purposes.

51

Which of the following fiduciary entities are required to use the calendar year as their taxable period for income tax purposes?


Estates

Trusts(except those that are tax exempt)

Estates may use either the calendar year or a fiscal year for its tax year. Trusts, except those that are tax-exempt, are required to use the calendar year for its tax year. This response correctly indicates that estates are not required to use the calendar year as its tax year and that trusts, except those that are tax-exempt, are required to use the calendar year.

52

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 amount of income recognized by the beneficiaries is the lower of the amount distributed ($150,000) or distributable net income ($120,000). Thus, Kent and Lind will recognize income of $120,000. Since they received total distributions of $150,000, the income recognized is 80% ($120,000/$150,000) of the amount received. Thus, Lind's income is 80% x $90,000, or $72,000.

53

A trust has distributable net income of $14,000 and distributes $20,000 to the sole beneficiary. What amounts are taxable to the trust and to the beneficiary?


Trust

Beneficiary

$14,000 $0
$0 $14,000
$14,000 $20,000
$0 $20,000

DNI is the maximum amount of income taxable to the beneficiaries. Since all of the income was distributed, the beneficiary is taxed on $14,000 and the trust has no taxable income.

54

Ordinary and necessary administration expenses paid by the fiduciary of an estate are deductible
A. Only on the fiduciary income tax return (Form 1041) and never on the federal estate tax return (Form 706).
B. Only on the federal estate tax return and never on the fiduciary income tax return.
C. On the fiduciary income tax return only if the estate tax deduction is waived for these expenses.
D. On both the fiduciary income tax return and on the estate tax return by adding a tax computed on the proportionate rates attributable to both returns.

Ordinary and necessary administration expenses paid by the fiduciary of an estate are deductible either in computing the estate's taxable income for income tax purposes or in computing the decedent's taxable estate for estate tax purposes. For the deduction to be taken for income tax purposes, the estate tax deduction must be waived. This response correctly states that administration expenses are deductible on the fiduciary income tax return only if the estate tax deduction is waived for these expenses.

55

The charitable contribution deduction on an estate's fiduciary income tax return is allowable
A. If the decedent died intestate.
B. To the extent of the same adjusted gross income limitation as that on an individual income tax return.
C. Only if the decedent's will specifically provides for the contribution.
D. Subject to the 2% threshold on miscellaneous itemized deductions.

Only if the decedent's will specifically provides for the contribution. The charitable contribution deduction on an estate's fiduciary income tax return is allowable only if the decedent's will specifically provides for the contribution.

56

The standard deduction for a trust or an estate in the fiduciary income tax return is
A. $0
B. $650
C. $750
D. $800

The standard deduction for a trust or an estate in the fiduciary income tax return is zero.

57

Jay properly created an inter vivos trust naming Kroll as trustee. The trust's sole asset is a fully rented office building. Rental receipts exceed expenditures. The trust instrument is silent about the allocation of items between principal and income.
Among the items to be allocated by Kroll during the year are insurance proceeds received as a result of fire damage to the building and the mortgage interest payments made during the year.

Which of the following items is(are) properly allocable to principal?



Insurance proceeds on building

Current mortgage interest payments

Only extraordinary items are allocated to principal; that is, payments that are made irregularly. Regular payments are allocated to interest.
The insurance proceeds are unusual and were made only once. They are allocated to principal. The interest payments are made at regular intervals and so are allocated to interest. (Y/N)

58

All of the following are administrative sources of the tax law except:
A. Private letter rulings.
B. Technical advice memoranda.
C. Revenue rulings.
D. Committee reports.

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.

59

Which Senate committee considers new tax legislation?
A. Budget.
B. Finance.
C. Appropriations.
D. Rules and Administration.

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

60

In evaluating the hierarchy of authority in tax law, which of the following carries the greatest authoritative value for tax planning of transactions?
A. Internal Revenue Code.
B. IRS regulations.
C. Tax court decisions.
D. IRS agents' reports.

The Internal Revenue Code is the highest tax authority.

61

Which one of the following is not a primary source of the tax law?
A. Internal Revenue Code §351.
B. The Journal of Taxation.
C. Revenue Ruling 97-40.
D. Treasury Regulations §1.721-1(a).

The Journal of Taxation is a leading tax journal which publishes articles that explain how primary sources of the tax law apply to specific fact scenarios.

62

Which of the following is NOT considered a primary authoritative source when conducting tax research?
A. Internal Revenue Code.
B. Tax Court cases.
C. IRS publications.
D. Treasury regulations.

IRS Publications are a secondary source of the tax law.

63

Which of the following type of regulations cannot be cited as authority to support a tax position?
A. Legislative regulations.
B. Interpretive regulations.
C. Procedural regulations.
D. 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.

64

Which of the following courts is not a court of original jurisdiction?
A. United States Tax Court.
B. United States District Court.
C. United States Court of Appeals.
D. United States Court of Federal Claims.

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.

65

A calendar-year taxpayer files an individual tax return for 2013 on March 20, 2014.
The taxpayer neither committed fraud nor omitted amounts in excess of 25% of gross income on the tax return.
What is the latest date that the Internal Revenue Service can assess tax and assert a notice of deficiency?

A. March 20, 2017.
B. March 20, 2016.
C. April 15, 2017.
D. April 15, 2016.

The Internal Revenue Service (IRS) is required to assess taxes within the assessment period. After the end of the assessment period, the IRS usually may not collect taxes. The assessment period begins on the day that the return is considered filed and last for three years after that date. Returns are considered filed on the last day of the filing period, even for returns filed early.
Hence, for a calendar-year taxpayer who filed an individual tax return for 2013 on March 20, 2014, the assessment period will end on April 15, 2017.

66

If a taxpayer receives a 30-day letter from the Internal Revenue Service, the taxpayer:
A. 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.
B. May ignore the letter and take no action.
C. Must pay the tax deficiency or file a petition with the Tax Court within 30 days of the date of the letter.
D. Must pay the tax deficiency and file a petition with the District Court within 30 days of the date of the letter.

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.

67

On April 15, 2014, a married couple filed their joint 2013 calendar-year return showing gross income of $120,000.
Their return had been prepared by a professional tax preparer who mistakenly omitted $45,000 of income, which the preparer in good faith considered to be nontaxable. No information with regard to this omitted income was disclosed on the return or attached statements.

By what date must the Internal Revenue Service assert a notice of deficiency before the statute of limitations expires?

The statute of limitations on asserting a notice of deficiency lasts for three years and begins on the date the return is filed. Returns filed early are viewed as being filed on the due date. If the amount of income omitted is greater than 25 percent of the income reported on the taxpayer's income tax return, the statute of limitations is extended to six years.
The married couple in this case omitted $45,000 of income, which is more than 25 percent of the $120,000 reported on their joint income tax return.

Hence, the statute of limitations on asserting a notice of deficiency in this case would end six years after the due date of the return - April 15, 2020.

68

A corporation's tax year can be reopened after all statutes of limitations have expired if
I. The tax return has a 50% nonfraudulent omission from gross income.

II. The corporation prevails in a determination allowing a deduction in an open tax year that was taken erroneously in a closed tax year

II only. A corporation's tax year may be reopened after the statute of limitations has expired if there is a determination for an open year that an earlier treatment was erroneous. The determination must adopt the position of the successful party and be unfavorable for the inconsistent party. The correction must fall under one of the following circumstances: double inclusion or exclusion of an item of income; double allowance or disallowance of a deduction or credit; deduction or inclusions for trusts or estates and beneficiaries; or an item involving basis.
The 50 percent nonfraudulent omission from gross income from a tax return could not lead to the reopening of a corporation's tax year after the statute of limitations because it does involve a determination for an open year. However, a corporation prevailing in a determination allowing a deduction in an open tax year that was taken erroneously in a closed tax year would meet the requirements for reopening its tax year after the expiration of the statute of limitations.

69

Which of the following documents does NOT govern the conduct of a CPA who is engaged in providing tax services?
A. AICPA's Code of Professional Conduct
B. AICPA's Statements on Standards for Tax Services
C. Circular 230
D. Internal Revenue Service Audit Guides

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.

70

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?
A. The taxpayer may NOT amend the tax return for that taxable year.
B. The IRS generally does NOT reopen the examination except in cases involving fraud or other similar misrepresentation.
C. The IRS may NOT reopen the examination.
D. The IRS may NOT examine any other tax return of the corporation for a period of one year.

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.

71

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?
A. $30,000
B. $33,000
C. $45,000
D. $50,000

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.

72

Chris Baker's adjusted gross income on her 2014 tax return was $160,000. The amount covered a 12-month period. For the 2014 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. 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.

73

Keen, a calendar-year taxpayer, reported a gross income of $100,000 on his 2013 income tax return. Inadvertently omitted from gross income was a $20,000 commission that should have been included in 2013.
Keen filed his 2013 return on March 15, 2014.
To collect the tax on the $20,000 omission, the Internal Revenue Service must assert a notice of deficiency no later than

A. March 15, 2017.
B. April 15, 2017.
C. March 15, 2019.
D. April 15, 2019.

The assessment period for the Internal Revenue Service to assess tax is three years from the due date of the income tax return. After the assessment period, the Internal Revenue Service usually will not be able to collect the tax. Returns filed before the due date are treated as being filed on the due date.
When the taxpayer fraudulently avoids tax, the assessment period increases to six years. The fraud penalty is not imposed if the taxpayer acted in good faith and reasonable cause for the underpayment can be shown.

Keen filed his return on March 15, 2014, but it will be treated as being filed on its due date of April 15, 2014. When Keen omitted the $20,000 commission from his income, it was inadvertent and not fraudulent. Thus, the Internal Revenue Service has a three year period from the due date of the income tax return to assess the tax attributable to the commission. Therefore, the notice of deficiency must be asserted by April 15, 2017.

Thus, this response is correct.

74

A tax return preparer may disclose or use tax return information without the taxpayer's consent to
A. Facilitate a supplier's or lender's credit evaluation of the taxpayer.
B. Accommodate the request of a financial institution that needs to determine the amount of taxpayer's debt to it, to be forgiven.
C. Be evaluated by a quality or peer review.
D. Solicit additional nontax business.

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.

75

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?

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

76

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?
A. One year.
B. Two years.
C. Three years.
D. Four years.

2 years
The deadline for filing a claim for refund (on form 1040X) is the later of:
1. Two years from the payment of tax, or
2. Three years from the date the return was filed (or April 15 if filed before the original due date).

77

If an individual paid income tax in 2014 but did not file a 2014 return because his income was insufficient to require the filing of a return, the deadline for filing a refund claim is
A. Two years from the date the tax was paid.
B. Two years from the date a return would have been due.
C. Three years from the date the tax was paid.
D. Three years from the date a return would have been due.

Two years from the date the tax was paid. For a taxpayer to get a refund, a claim for the refund must be filed with the IRS within the refund period. If a taxpayer was required to file a return, the claim for refund must be filed either within three years of the date of filing the return (or the due date if later) or within two years of the date the tax was paid.
However, if no return was required to be filed with the IRS, the claim for refund must be filed within two years from the time the tax was paid.
This response correctly states that an individual not required to file a return has a deadline for filing a refund claim of two years from the date the tax was paid.

78

In which of the following circumstances does the three-year statute of limitations on additional tax assessments apply?
A. A taxpayer willfully attempts to evade tax in filing income tax returns.
B. A taxpayer inadvertently omits from gross income an amount in excess of 25% of the gross income stated on the income tax return.
C. A taxpayer inadvertently overstates deductions equal to 15% of gross income.
D. 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.

79

Bass Corp., a calendar year C corporation, made qualifying 2014 estimated tax deposits based on its actual 2013 tax liability.
On March 15, 2015, Bass filed a timely automatic extension request for its 2014 corporate income tax return. Estimated tax deposits and the extension payment totaled $7,600. This amount was 95% of the total tax shown on Bass' final 2014 corporate income tax return. Bass paid $400 additional tax on the final 2014 corporate income tax return filed before the extended due date. For the 2014 calendar year, Bass was subject to pay

I. Interest on the $400 tax payment made in 2015.

II. A tax delinquency penalty.

I only. Bass Corp. based its estimated payments on its 2013 tax liability, indicating that the corporation used the preceding year method. This method requires that the estimated payments to be equal to the corporation's tax liability during the preceding year. However, interest is required to be paid on any portion of the corporation's tax liability exceeding the amount of the estimated payments.
This response is, therefore, correct in stating that Bass Corp. would be required to pay interest on the $400 tax payment made in 2015. The tax delinquency penalty is imposed if the taxpayer fails to promptly file a tax return with a tax liability. As Bass Corp. filed an automatic extension on the original due date of its return, the corporation qualifies for a six month extension and is not viewed as being filed late.

Hence, this response is correct in implying that Bass Corp. would not be subject to the tax delinquency penalty.

80

A penalty for understated corporate tax liability can be imposed on a tax preparer who fails to
A. Audit the corporate records.
B. Examine business operations.
C. Copy all underlying documents.
D. Make reasonable inquiries when taxpayer information appears incorrect.

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.

81

A civil fraud penalty can be imposed on a corporation that underpays tax by
A. Omitting income as a result of inadequate recordkeeping.
B. Failing to report income it erroneously considered not to be part of corporate profits.
C. Filing an incomplete return with an appended statement, making clear that the return is incomplete.
D. 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 percent of the tax underpayment.
Specific intent to evade taxes could be shown of a corporation that maintained false records and reported fictitious transactions to minimize corporate tax liability.

82

Vee Corp. retained Water, CPA, to prepare its 2014 income tax return. During the engagement, Water discovered that Vee had failed to file its 2011 income tax return.
Water should:

A. Prepare Vee's 2011 income tax return and submit it to the IRS.
B. Advise Vee that the 2011 income tax return has not been filed and recommend that Vee ignore filing its 2011 return since the statute of limitations has passed.
C. Advise the IRS that Vee's 2011 income tax return has not been filed.
D. Consider withdrawing from preparation of Vee's 2013 income tax return until the error is corrected.

Consider withdrawing from preparation of Vee's 2013 income tax return until the error is corrected. A member should inform the taxpayer promptly upon becoming aware of an error in a previously filed return or upon becoming aware of a taxpayer's failure to file a required return. A member should recommend the corrective measures to be taken. If a member is requested to prepare the current year's return and the taxpayer has not taken appropriate action to correct an error in a prior year's return, the member should consider whether to withdraw from preparing the return and whether to continue a professional or employment relationship with the taxpayer.

83

A claim for refund of erroneously paid income taxes, filed by an individual before the statute of limitations expires, must be submitted on Form
A. 1139
B. 1045
C. 1040X
D. 843.

A claim for refund of erroneously paid income taxes, filed by an individual before the statute of limitations expires, must be submitted on Form 1040X, the amended individual income tax return. Form 1040, Form 1040A, and Form 1040-EZ are used to claim refunds for excess withholdings or estimated tax payments.

84

Blink Corp., an accrual basis calendar year corporation, carried back a net operating loss for the tax year ended December 31, 2013. Blink's gross revenues have been under $500,000 since inception. Blink expects to have profits for the tax year ending December 31, 2014.
Which method(s) of estimated tax payment can Blink use for its quarterly payments during the 2014 tax year to avoid underpayment of federal estimated taxes?

I. 100% of the preceding tax year method

II. Annualized income method

II 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.

85

Morgan, a sole practitioner CPA, prepares individual and corporate income tax returns.
What documentation is Morgan required to retain concerning each return prepared?
A. An unrelated party compliance statement.
B. Taxpayer's name and identification number or a copy of the tax return.
C. Workpapers associated with the preparation of each tax return.
D. 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:
(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

86

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.

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.

87

Edge Corp., a calendar year C corporation, had a net operating loss and zero tax liability for its 2013 tax year. To avoid the penalty for underpayment of estimated taxes, Edge could compute its first quarter 2014 estimated income tax payment using the


Annualized income method

Preceding year method

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.
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.

88

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.

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.

89

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?
A. One year.
B. Two years.
C. Three years.
D. 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.

90

Jose has owned stock for eight years that has a basis of $20,000 and fair market value of $100,000. Jose contributes the stock to a qualified charity. Which of the following is a proper tax consequence from this transaction?
A. Jose has recognized gain of $80,000.
B. Jose has a charitable contribution of $100,000.
C. Jose has a charitable contribution of $80,000.
D. Jose has a charitable contribution of $20,000.

Jose has a charitable contribution of $100,000. When long-term capital gain property is contributed to a qualified charity, the fair market value of the property can be deducted as a charitable contribution.

91

Appropriate strategies for reducing the alternative minimum tax include all of the following except:
A. Do not exercise incentive stock options.
B. Make additional charitable contributions.
C. Increase home mortgage interest on primary mortgage.
D. Increase 2% miscellaneous itemized deductions

Increase 2% miscellaneous itemized deductions. 2% miscellaneous itemized deductions are not deductible for AMT purposes so increasing these will not reduce the AMT.

92

Chris is in the 50% tax bracket in Year 1 but Congress has decreased his tax bracket to 30% for Year 2. Which of the following would be an appropriate tax planning strategy for Chris?
A. Defer income until Year 2.
B. Accelerate income into Year 1.
C. Defer deductions until Year 2.
D. Increase his estimated tax payments for Year 1.

Defer income until Year 2. Since his income tax rate is declining, he will save 20% on any income deferred from the 50% tax rate in Year 1 to the 30% tax rate in Year 2.

93

Ms. Planner is in the 25% tax bracket and itemizes on her tax return. She plans to make a charitable contribution of $12,000 to her alma mater this year. The net cost of this contribution to T is:

Her tax savings is $3,000 ($12,000 x 25%) since the contribution is deductible. Therefore, her net cost is $9,000 ($12,000 - $9,000).

94

Orleans has owned land as an investment for five years. His basis in the land is $70,000 and the land's current fair market value is $50,000. Which of the following statements is correct with regard to this land?
A. If Orleans sells the land to his father he can deduct the $20,000 loss in the land.
B. If Orleans gives the property to an unrelated friend he can deduct the $20,000 loss in the land.
C. Orleans should sell the land, recognize the $20,000 capital loss, and then gift the $50,000 cash from the sale to his friend.
D. If the land is sold to an unrelated party, the $20,000 loss cannot be recognized since the land is not depreciable.

Orleans should sell the land, recognize the $20,000 capital loss, and then gift the $50,000 cash from the sale to his friend. If Orleans gives the property to his friend, the $20,000 loss disappears since the friend's loss basis in the land will be its fair market value of $50,000. Therefore, Orleans should sell the land so he can recognize the loss. He can then contribute the cash from the sale to his friend.

95

The rule limiting the allowability of passive activity losses and credits applies to
A. Partnerships.
B. S corporations.
C. Personal service corporations.
D. Widely-held C corporations.

Passive activity limits are applied to the following entities: individuals, estates, trust, personal service corporations and closely-held personal service corporations.

96

For which of the following entities is the owner's basis increased by the owner's share of profits and decreased by the owner's share of losses but is NOT affected by the entity's bank loan increases or decreases?
A. S corporation.
B. C corporation.
C. Partnership.
D. Limited liability company.

S corporation. The owner's basis is increased for her distributive share of profits and losses for S corporations, partnerships, and limited liability companies. However, owner's basis is not affected by the debt of S corporations, while it is for partnerships and limited liability companies.

97

Which of the following is an advantage of forming a limited liability company (LLC) as opposed to a partnership?
A. The entity may avoid taxation.
B. The entity may have any number of owners.
C. The owner may participate in management while limiting personal liability.
D. The entity may make disproportionate allocations and distributions to members.

In an LLC, a member can participate in management and have limited liability. In a partnership, if a partner participates in management she must be a general partner, and general partners have unlimited liability.

98


Which of the following statements concerning S corporations is False?

A. S corporations must be incorporated under state law in the same fashion as C corporations.
B. S corporation shareholders are not liable for the debt of the corporation.
C. An S corporation can issue both voting and non-voting common stock.
D. S corporations are subject to the alternative minimum tax.

This statement is false. Since S corporation income flows directly to the shareholders, the corporation is not subject to the AMT.

99

Lane Inc., an S corporation, pays single coverage health insurance premiums of $4,800 per year and additional premiums of $7,200 per year for family coverage. Mill is a ten percent shareholder-employee in Lane. On Mill's behalf, Lane pays Mill's family coverage under the health insurance plan. What amount of insurance premiums is includible in Mill's gross income?

The cost of health and accident insurance premiums paid on behalf of the greater than 2% S corporation shareholder-employee (hereafter referred to as "shareholder") is deductible by the S corporation and reportable as additional compensation to the shareholder. Note that the problem indicates that "additional" premium for family coverage is $7,200, so this must be added to the $4,800 to get the total premium of $12,000.

100

Which of the following entities may adopt any tax year end?

A C corporation may adopt any tax year-end.

101

Which of the following types of entities is entitled to the net operating loss deduction?

Trusts and estates can carryback or carryforward a net operating loss.

102

Which one of the following is a difference between an S corporation and a partnership?
A. All owners of an S corporation have limited liability but general partners in a partnership have unlimited liability.
B. Income earned by an S corporation does not flow through to shareholders while income earned by a partnership does flow through.
C. S corporation shareholders can have a negative basis while partners can never have a negative basis.
D. Partnerships can be formed in such a manner that gains or losses to the partners as a result of the formation are deferred, but shareholders forming an S corporation must always recognize formation gains and losses.

All owners of an S corporation have limited liability but general partners in a partnership have unlimited liability. Owners of an S corporation have limited liability but general partners in a partnership have unlimited liability.

103

What would be the alternative minimum tax liability for a corporation that is not exempt from the alternative minimum tax and whose tax return reflects the following for 2014?
Alternative minimum taxable income (after exemption) $110,000
AMT foreign tax credit 5,000
Regular federal income tax (net of foreign tax credit) 4,500

This answer is correct. The corporation’s tentative minimum tax ($110,000 × 20%) = $22,000 would be reduced by the $5,000 AMT foreign tax credit and $4,500 of regular federal income tax, resulting in an alternative minimum tax (AMT) liability of $12,500.

104

Boles Corp., an accrual-basis, calendar-year S corporation, has been an S corporation since its inception and is not subject to the uniform capitalization rules. For the current year, Boles recorded the following:

Gross receipts $50,000
Dividend income from investments 5,000
Supplies expense 2,000
Utilities expense 1,500

On Boles' current year S corporation Form 1120-S Schedule K, Shareholders’ Shares of Income, Deductions, Credits, etc., what amount of income should be separately stated from business income?
$50,000
$48,000
$ 5,000
$0

As a pass-through entity, an S corporation’s items must be divided into (1) nonseparately stated income or loss from trade or business activities, and (2) items of income, loss, deduction, and credit the separate treatment of which could affect the tax liability of any shareholder. Boles' gross receipts, supplies expense, and utilities expense are all ordinary income and deduction items and will be netted in arriving at Boles' nonseparately stated business income. In contrast, the $5,000 of dividend income from investments must be separately stated and passed through to shareholders in order to preserve its characteristic as an item of portfolio income.

105

Heath acquired a 50% interest in the Dentists Partnership by contributing property with an adjusted basis of $100,000. Heath would recognize a gain if

I. The fair market value of the contributed property exceeds its adjusted basis.
II. The property is encumbered by a mortgage with a balance of $50,000.
I only.
II only.
Both I and II.
Neither I nor II.

Neither I nor II.
Generally, no gain is recognized when appreciated property is transferred to a partnership in exchange for a partnership interest. However, gain will be recognized if the transferred property is encumbered by a mortgage, and the partnership’s assumption of the mortgage results in a net decrease in the transferor’s individual liabilities that exceeds the basis of the property transferred. Here, the basis of the property transferred is $100,000, and the net decrease in Heath’s individual liabilities is $25,000 (i.e., $50,000 × 50%), so no gain is recognized.

106

Corporations A and B combine in a qualifying reorganization, and form Corporation C, the only surviving corporation. This reorganization is tax-free to the
Shareholders Corporations
Yes Yes
Yes No
No No
No Yes

Corporate reorganizations are generally nontaxable under the theory that they represent a mere change in form since there is an underlying continuity of shareholder interests and a continuity of the business enterprise. In this case, Corporations A and B combined to form Corporation C, the only surviving corporation. This is called a consolidation-a qualifying Type-A corporate reorganization. Assuming no boot is received, no gain or loss is recognized by the Corporation A and B shareholders when they exchange their A and B stock for stock of Corporation C. Similarly, no gain or loss is recognized by Corporations A and B when they transfer their assets to Corporation C pursuant to the plan of corporate reorganization.

107

In general, which of the following debts will be discharged under the voluntary liquidation provisions of the Bankruptcy Code?
Debts incurred after the order for relief but before the debtor receives a discharge in bankruptcy.
Income taxes due as the result of filing a fraudulent return 7 years prior to the filing of the bankruptcy petition.
A debt arising before the filing of the bankruptcy petition due to the debtor’s negligence.
Alimony payments owed to the debtor’s spouse under a separation agreement entered into prior to the filing of the bankruptcy question.

under the voluntary liquidation provisions of the Bankruptcy Code, a debt arising before the filing of the bankruptcy petition due to the debtor’s negligence will be discharged in the proceedings. Note that had the debt been due to the debtor’s willful and intentional torts, it would not be discharged in bankruptcy.

108

What are the filing requirement for LLP and Corp?

Corporations and limited partnerships may only be created pursuant to state statutes. Normally, both the Articles of Incorporation and a Certificate of Limited Partnership must be filed with the Secretary of State.

109

No penalty will be imposed on a corporation for underpayment of estimated tax for a particular year if

No penalty will be imposed on a corporation for underpayment of estimated tax for a particular year if the tax for that year is less than $500.

110

Rachel Mroz, a self-employed taxpayer, reported the following information for 2014:

Income: Dividends from investments $ 300
Net short-term capital gain on sale of investment 1,400
Deductions: Net loss from business (10,000)
Personal exemption (3,950)
Standard deduction (6,200)

What is the amount of Rachel’s net operating loss for 2014 that can be carried back to Rachel’s 2012 taxable year?
$8,300
$10,000
$13,700
$15,800

This answer is correct. A NOL generally represents a loss from the conduct of a trade or business and can be carried back 2 years and forward 20 years to offset income in the carryback and carryforward years. Since a NOL generally represents a business loss, an individual taxpayer’s personal exemptions and an excess of nonbusiness deductions over nonbusiness income cannot be subtracted in computing the NOL. Nonbusiness deductions generally include itemized deductions as well as the standard deduction if the taxpayer does not itemize. In this case, the $6,200 standard deduction offsets the $1,700 of nonbusiness income received in the form of dividends and short-term capital gain, but the excess ($4,500) cannot be included in the NOL computation. Thus the taxpayer’s NOL simply consists of the $10,000 business loss.

111

If a contract for the sale of goods includes a C&F shipping term and the seller has fulfilled all of its obligations, the




Title to the goods will pass to the buyer when the goods are received by the buyer at the place of destination.



Risk of loss will pass to the buyer upon delivery of the goods to the carrier.



Buyer retains the right to inspect the goods prior to making payment.



Seller must obtain an insurance policy at its own expense for the buyer’s benefit.

This answer is correct because the shipping term "C&F" (cost and freight) means that the purchase price includes both the cost of the goods and the cost of delivering the goods to the shipper. Under such agreements, the risk of loss and title to the goods pass when the seller places the goods in the appropriate carrier’s hands.

112

For the current year, Bell Corporation had worldwide taxable income of $675,000 and a tentative United States income tax of $229,500. Bell’s taxable income from business operations in Country A was $300,000, and foreign income taxes paid were $125,000 stated in United States dollars. How much should Bell claim as a credit for foreign income taxes on its United States income tax return for the current year?

$0
$ 42,500
$102,000
$125,000

This answer is correct. The requirement is to determine the amount of foreign tax credit that may be claimed by Bell Corporation. The allowable credit for foreign income taxes is subject to an overall limit of
Foreign TI /Worldwide TI × (US tax)

Thus, the $125,000 of foreign income taxes paid are available as a credit for 2013 to the extent of

$300,000 / $675,000 × ($229,500) = $102,000

113

Insider rule for relatives?

an insider includes a beneficial owner of more than 10% of any class of the issuer’s equity securities. Beneficial ownership includes ownership of securities owned by oneself, securities in a spouse’s name, a minor child’s name, or a relative’s name who shares the same home.

114

Donna Andersen and Dana Marwick formed the Northern Corporation on July 5, 2015. On the same date Andersen paid $90,000 cash to Northern for 900 shares of its common stock. Simultaneously, Marwick received 100 shares of Northern’s common stock for services rendered. How much should Marwick include as taxable income for 2015 and what will be the basis of her stock?

The requirement is to determine the taxable income to Marwick and the basis of her stock. Since services are excluded from the definition of "property," Marwick’s transfer does not fall under the nonrecognition provisions of Sec. 351, but instead is a taxable exchange. As a result, Marwick must report $10,000 of compensation income and her basis for the stock will be $10,000, the amount reported as income.

115

Difference between oral and written stop payment?

Stop payment orders may be oral and are valid for 14 days. Written stop payment orders are valid for 6 months and are renewable.

116

An individual had the following capital gains and losses for the year:


Short-term capital loss $70,000
Long-term gain (unrecaptured Section 1250 at 25%) 56,000
Collectibles gain (28% rate) 10,000
Long-term gain (15% rate) 20,000

What will be the net gain(loss) reported by the individual and at what applicable tax rate(s)?

Gains and losses (including carryovers) within each of the capital asset rate groups are netted to arrive at a net gain or loss for each group. A net loss in any rate group is then applied to reduce the net gain in the highest rate group first. In this case, the net short-term capital loss of $70,000 first offsets the $10,000 of collectibles gain in the 28% group, then offsets the $56,000 of long-term gain in the 25% group, and finally offsets $4,000 of the $20,000 long-term gain in the 15% group. As a result, the individual has a net capital gain of $16,000 which will be taxed at a 15% rate.

117

When is it possible to offer or sell securities to the public using instruments of interstate commerce?

unless a registration statement has been filed with and accepted by the SEC, it is generally unlawful under the 1933 Act to offer or sell securities to the public using instruments of interstate commerce.

118

Nicole Sandler, a public school teacher with adjusted gross income of $20,000, paid the following items during the current year for which she received no reimbursement:


Initiation fee for membership in teachers’ union $300
Dues to teachers’ union 250
Voluntary unemployment benefit fund contributions to union-established fund 85

How much can Nicole claim as allowable miscellaneous deductions on Schedule A of Form 1040?


Both the initiation fee and the union dues are deductible. The voluntary benefit fund contribution is not deductible. Miscellaneous itemized deductions are generally deductible only to the extent that they exceed 2% of AGI. In this case the deductible amount is $150 [$550 − (.02 × $20,000)].

119

Mem Corp., which had earnings and profits of $500,000, made a nonliquidating distribution of property to its stockholders during the current year. This property had an adjusted basis of $10,000 and a fair market value of $15,000 at the date of distribution. The property was subject to a liability of $12,000, which its stockholders assumed. How much gain did Mem have to recognize as a result of this distribution?
$0
$2,000
$5,000
$7,000

If a corporation makes a nonliquidating distribution of appreciated property to a shareholder, the corporation must recognize gain just as if the property were sold at its fair market value. Here, Mem must recognize a gain of $15,000 — $10,000 = $5,000. A liability increases the recognized gain only when the amount of liability exceeds fair market value.

120

Sack Company has been doing business as a partnership, but the owners decided to incorporate Sack in Delaware. Sack has branch offices in Delaware and Pennsylvania. Which of the following is correct?
Sack must also incorporate in Pennsylvania because it has branch offices there.
Sack is a foreign corporation in Pennsylvania.
Sack is a domestic corporation in Pennsylvania.
Sack is a de facto corporation in Pennsylvania.

Since Sack is doing business in a state other than where it was incorporated, it is termed a foreign corporation in Pennsylvania.

121

Haplow engaged Turnbow as his attorney when threatened by several creditors with a bankruptcy proceeding. Haplow’s assets consisted of $85,000 and his debts were $125,000. A petition was subsequently filed and was uncontested. Several of the creditors are concerned that the suspected large legal fees charged by Turnbow will diminish the size of the distributable estate. What are the rules of limitation which apply to such fees?
None, since it is within the attorney-client privileged relationship.
The fee is presumptively valid as long as arrived at in an arm’s-length negotiation.
Turnbow must file with the court a statement of compensation paid or agreed to for review as to its reasonableness.
The trustee must approve the fee.

according to the Rules of Bankruptcy Procedure, it is necessary to file a proof of claims against the debtor’s estate. The filing must be timely (within a 6-month period) or the claim will be barred. A claim that is filed on time is given prima facie validity and is approved unless there is an objection by one of the creditors. The filing would include a statement of compensation paid or agreed.

122

Karr transferred a negotiable instrument payable to his order to Watson for value. Karr did not endorse the instrument. As a result of the transfer, Watson
Obtains such rights as the transferor had in all cases.
Can become a holder only if the instrument is endorsed and delivered at the same time.
Is presumed to be the owner of the instrument since he gave value.
Is entitled to an unqualified endorsement by Karr.

Is entitled to an unqualified endorsement by Karr.
This answer is correct. Any transfer for value of an order instrument gives the transferee (Watson) the right to obtain an unqualified endorsement from the transferor (Karr).

123

Which one of the following statements concerning traditional IRAs for individuals under the age of 50 is not correct for 2014?
If neither the taxpayer nor the taxpayer’s spouse is an active participant in an employer-sponsored retirement plan or a Keogh plan, there is no phase-out of IRA deductions.
Total IRA contributions are subject to the $5,500 or 100% of compensation limit.
A taxpayer whose AGI is not above the applicable phase-out range can make a $500 deductible contribution regardless of the proportional phaseout rule.
A taxpayer who is partially or totally prevented from making deductible IRA contributions can make nondeductible IRA contributions.

A taxpayer whose AGI is not above the applicable phaseout range can make a $200 (not $500) deductible contribution regardless of the proportional phase-out rule. This $200 minimum applies separately to taxpayer and taxpayer’s spouse.

124

On August 1, Neptune Fisheries contracted in writing with West Markets to deliver to West 3,000 pounds of lobsters at $4.00 a pound. Delivery of the lobsters was due October 1 with payment due November 1. On August 4, Neptune entered into a contract with Deep Sea Lobster Farms which provided as follows: "Neptune Fisheries assigns all the rights under the contract with West Markets dated August 1 to Deep Sea Lobster Farms." The best interpretation of the August 4 contract would be that it was
Only an assignment of rights by Neptune.
Only a delegation of duties by Neptune.
An assignment of rights and a delegation of duties by Neptune.
An unenforceable third-party beneficiary contract.

An assignment of a contractual agreement is taken to mean both the assignment of the rights of the contract as well as the delegation of the duties of the contract. In this case, Neptune has assigned the contract to Deep Sea Lobster.

125

On August 1, Titan wrote a personal check that was drawn on First Plymouth Bank and made payable to Brass. Brass, on August 2, presented the check to First Plymouth Bank for payment, which was refused. Who had primary liability on this check?

First Plymouth on August 1 but not on August 2.
First Plymouth on August 2 but not on August 1.
Titan on August 2 but not August 1.
No one on August 1 or August 2.

No one on August 1 or August 2.
First Plymouth Bank does not have primary liability unless it accepts (certifies) the check. This is true because although the drawer, Titan, has ordered First Plymouth Bank to pay this check, the bank is not obligated to the payee, Brass, to follow that order.

126

Julie, who is single, had the following items of income and deduction included on her 2014 Form 1040 income tax return:
Salary $40,000
Net capital loss deduction 3,000
Itemized deduction (all attributable to a personal casualty loss when a tornado destroyed her vacation home) 45,000
Personal exemption 3,950
What is the amount of Julie’s net operating loss for 2014?
$5,000
$8,000
$11,700
$45,000

Julie’s personal casualty loss of $45,000 incurred as a result of the tornado damage to her vacation home is allowed as a deduction in the computation of her NOL and is subtracted from her salary income of $40,000, to arrive at a NOL of $5,000. In the computation of a NOL, no deduction is allowed for personal and dependency exemptions, and no deduction is allowed for a net capital loss.

127

The rule limiting the deductibility of passive activity losses and credits applies to
Partnerships
S corporations
Personal service corporations
Widely held C corporations

Personal service corporations This answer is correct. The passive activity limitations apply to individuals, estates, trusts, closely held C corporations, and personal service corporations. Application of the passive activity loss limitations to personal service corporations is intended to prevent taxpayers from sheltering personal service income by creating personal service corporations and acquiring passive activity losses at the corporate level. A personal service corporation is a corporation (1) whose principal activity is the performance of personal services and (2) such services are substantially performed by owner-employees. Since passive activity income, losses, and credits from partnerships and S corporations flow through to be reported on the tax returns of the owners of such entities, the passive activity limitations are applied at the partner and shareholder level, rather than to partnerships and S corporations themselves.

128

Which type of job is considered nonexempt with respect to minimum wage and overtime pay provisions of the Fair Labor Standards Act?
Factory line workers
Professionals
Managers
Outside salespersons

Factory line workers. This answer is correct because factory line workers are entitled to minimum wages and overtime pay.

129

On April 1, 2015, Crowe and Greene formed Apex Corporation. The same day Crowe paid $150,000 for 500 shares of Apex common stock, and Greene transferred land and building to Apex in exchange for 500 shares of common stock. The land and building had an adjusted basis to Greene of $120,000, a fair market value of $200,000, and was subject to a mortgage of $60,000 on April 1, 2015. The mortgage was assumed by Apex. Apex had no other shares of stock outstanding on April 1, 2015. The basis of the land and building to Apex on April 1, 2015, is
$ 60,000
$120,000
$140,000
$150,000

This answer is correct. The land and building were transferred by Greene in a nontaxable Sec. 351 transfer to a controlled corporation. The basis of the land and building to Apex would be the same as Greene’s adjusted basis, increased by any gain recognized by Greene. Since Greene did not receive any boot, no gain was recognized by him. Apex’s basis for the land and building is $120,000.

130

Bill McDonald, a cash-basis taxpayer, is the owner of a house with two identical apartments. He resides in one apartment and rents the other apartment to a tenant under a 5-year lease dated March 1, 2012, and expiring on February 28, 2017. The tenant made timely monthly rental payments of $500 for the months of January through November 2014. Rents for December 2014 and January 2015 were paid by the tenant on January 5, 2015. The following additional information for 2014 was available:


Fuel and utilities $3,600
Depreciation of building 3,000
Maintenance and repairs (rental apartment) 400
Insurance on building 600
What amount should McDonald report as net rental income for 2014?

$2,200
$2,000
$1,700
$1,500

This answer is correct. Since McDonald is a cash-basis taxpayer, his rental income consists of the 11 payments received. Since he resides in one apartment, only 50% of the expenses relating to both apartments can be allocated to the rental unit.
Rents (11 × $500) $5,500
Less:
Fuel and utilities (50% × $3,600) (1,800)
Depreciation (50% × $3,000) (1,500)
Repairs to rental unit (400)
Insurance (50% × $600) (300)
Net rental income $1,500

131

Which one of the following statements concerning Roth IRAs is correct?

A distribution from a Roth IRA is treated as first made from contributions (return of capital).
The maximum contribution to a Roth IRA is limited to $5,000, for 2014.
An individual cannot make contributions to a Roth IRA and a traditional IRA during the same tax year.
A contribution to a Roth IRA must be made by the due date for filing the individual’s tax return for the year (including extensions).

A distribution from a Roth IRA is treated as first made from contributions (return of capital). This answer is correct. A distribution from a Roth IRA is treated as first made from contributions, and to that extent, will be a nontaxable return of capital. An individual, under age 50, can make a contribution to both a traditional IRA and a Roth IRA for the same tax year as long as the total amounts contributed do not exceed an overall maximum of $5,500. Contributions to a Roth IRA must be made by the due date for filing the individual’s tax return for the year (not including extensions).

132

Which one of the following statements concerning the lifetime learning credit is correct?
The credit is claimed on a per student basis.
The credit may be claimed for an unlimited number of years.
The credit is 20% of the first $5,000 of qualified tuition and related expenses per year.
Tuition incurred for graduate courses does not qualify for the credit.

This answer is correct. The lifetime learning credit provides a credit of 20% of up to $10,000 of tuition and fees paid by a taxpayer for one or more students for graduate and undergraduate courses at an eligible educational institution. The credit may be claimed for an unlimited number of years, is available on a per taxpayer basis, and covers tuition and fees paid for the taxpayer, spouse, and dependents.

133

Kneenober Corp., an accrual-basis calendar-year C corporation, liquidated in during the current year. In cancellation of all their Kneenober stock, each Kneenober shareholder received a liquidating distribution of $5,000 cash and land with a tax basis of $4,000 and a fair market value of $8,750. Before the distribution, each shareholder’s tax basis in Kneenober stock was $7,000. What amount of gain should each Kneenober shareholder recognize on the liquidating distribution?
$0
$1,750
$2,000
$6,750

This answer is correct. The requirement is to determine the amount of gain that each Kneenober Corp. shareholder should recognize as a result of a liquidating distribution from Kneenober. Amounts received by shareholders in complete liquidation of a corporation are treated as received in exchange for stock, generally resulting in capital gain or loss because the stock was held as an investment. Here the amount realized by each shareholder consists of $5,000 cash plus the $8,750 FMV of the land, for a total of $13,750. Since each shareholder’s stock basis was $7,000, each shareholder has a gain of $13,750 — $7,000 = $6,750.

134

Which of the following is allowed in the calculation of the taxable income of a simple trust?
Exemption.
Standard deduction.
Brokerage commission for purchase of tax-exempt bonds.
Charitable contribution.

Exemption. This answer is correct. 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.

135

Frank Lyon was held up and robbed of $800 cash in June 2014. One month later, Frank had $2,000 cash stolen from him by his housekeeper. Frank’s adjusted gross income for 2014 was $10,000. How much was deductible by Frank for theft losses in 2014?
$ 900
$1,600
$1,700
$1,800

This answer is correct. Nonbusiness theft losses are deductible to the extent that each loss is in excess of $100, and the taxpayer’s net nonbusiness casualty and theft losses exceed 10% of AGI. Thus, Frank can deduct $1,600 [($800 − $100) + ($2,000 − $100) − (10% × $10,000)].

136

A corporation that has both preferred and common stock has a deficit in accumulated earnings and profits at the beginning of the year. The current earnings and profits are $25,000. The corporation makes a dividend distribution of $20,000 to the preferred shareholders and $10,000 to the common shareholders. How will the preferred and common shareholders report these distributions?
Preferred—$20,000 dividend income; common—$10,000 dividend income.
Preferred—$20,000 dividend income; common—$5,000 dividend income, $5,000 return of capital.
Preferred—$15,000 dividend income; common—$10,000 dividend income.
Preferred—$20,000 return of capital; common—$10,000 return of capital.

This answer is the correct answer. The requirement is to determine how the $20,000 distributed to preferred shareholders and $10,000 distributed to common shareholders should be treated when a corporation has a deficit in accumulated earnings and profits and has only $25,000 of current earnings and profits (CEP). When current earnings and profits are less than the total amount distributed to preferred and common shareholders, current earnings and profits must first be allocated to distributions to preferred shareholders, with only the remainder available to tax distributions to common shareholders. Here, the $25,000 of current earnings and profits are first allocated to the distribution to preferred shareholders making all $20,000 taxable as a dividend. That leaves only $5,000 of earnings and profits to be allocated to the $10,000 distribution to common shareholders, making $5,000 taxable as a dividend and the remaining $5,000 of distribution a nontaxable return of stock basis.

137

Jerry and Ann Parsell paid the following expenses during 2014:
Interest on automobile loan $1,500
Interest on bank loan (loan proceeds were used to purchase municipal bonds) 5,000
Interest on home mortgage for period January 1 to June 29, 2014 1,800
Penalty payment for prepayment of home mortgage on June 29, 2014 1,200
What is the maximum amount that the Parsells can utilize as interest expense in calculating itemized deductions for 2014?
$3,000
$3,150
$3,650
$4,500

This answer is correct. Interest paid on debt incurred to purchase tax exempt obligations is nondeductible. Similarly, interest on the automobile loan is considered personal interest and not deductible. The $1,800 interest on the home mortgage and the home mortgage prepayment penalty of $1,200 are qualified residence interest and will give the Parsells a total interest deduction of $3,000.

138

Don and Cynthia Wallace filed a joint return for 2014 in which they reported adjusted gross income of $35,000. During 2014 they made the following contributions to qualified organizations:
Land held 3 years (stated at fair market value) donated to church for new building site $22,000
Cash contributions to church 300
Cash contributions to the local community college 200
Assuming that the Wallaces did not elect to reduce the deductible amount of the land contribution by the property’s appreciation in value, how much can they claim as a deduction for charitable contributions in 2014?

$10,800
$11,000
$17,500
$22,500

Since the cash gifts of $300 to church and $200 to the community college are only subject to the 50% of AGI limitation, they are fully deductible. The deduction for the gift of land is limited to 30% of AGI (30% ITAX-007 $35,000 = $10,500) because the land is appreciated capital gain property. Therefore, the total deduction for charitable contributions is $11,000.

139

Jans, an individual, owns 80% and 100% of the total value and voting power of A and B Corps., respectively, which in turn own the following (both value and voting power):
Ownership
Property A Corp. B Corp.
C Corp. 80% --
D Corp. -- 100%
All companies are C corporations except B Corp., which had elected S status since inception. Which of the following statements is correct with respect to the companies’ ability to file a consolidated return?
A, C, and D may file as a group.
A and C may not file as a group, and B and D may not file as a group.
A and C may file as a group, and B and D may file as a group.
A and C may file as a group, but B and D may not file as a group.

The requirement is to determine which corporations can file a consolidated tax return. An affiliated group of corporations may elect to file a consolidated tax return instead of filing separately. An affiliated group is one or more chains of includible corporations connected through stock ownership, with a common parent corporation owning at least 80% of the voting power and total value of stock in at least one other includible corporation. Here, A Corp. owns 80% of C Corp., so A and C may elect to file a consolidated tax return. Although B Corp. owns 100% of D Corp., B and D are not allowed to file a consolidated tax return because B Corp. is an S corporation. A Corp. and B Corp. are a brother-sister controlled group (because they are more than 50%-owned by an individual), but are not an affiliated group since they do not own stock in each other.

140

During the current year Alfred Allen sustained a serious injury in the course of his employment. As a result of this injury, Allen received the following amounts during the same year:
Workers’ compensation $2,400
Reimbursement from employer’s accident and health plan for medical expenses paid by Allen 1,800
Damages for personal physical injuries 8,000
How much of the above amounts should Allen include in his gross income for the current year?
$12,200
$8,000
$1,800
$0

All three amounts that Allen received as a result of his injury are excluded from gross income. Benefits received as workers’ compensation and compensation for damages for personal physical injuries are always excluded from gross income. Amounts received from an employer’s accident and health plan as reimbursement for medical expenses are excluded provided the medical expenses were not previously deducted as itemized deductions.

141

A CPA firm performs a negligent audit of financial statements included in an initial public offering of stock (Form S-1) filed with the SEC. An investor who loses money as a result of purchasing the stock will likely have a case to recover damages under
Common law.
The Securities Act of 1933.
The Securities Exchange Act of 1934.
The Racketeer Influenced and Corrupt Organization Act.

The Securities Act of 1933 applies to initial public offerings of stock by issuer companies.

142

A calendar-year individual filed an income tax return on April 1. This return can be amended no later than
Four months and 15 days after the end of the calendar year.
Ten months and 15 days after the end of the calendar year.
Three years, three months, and 15 days after the end of the calendar year.
Three years after the return was filed.

An individual taxpayer must file an amended return within three years from the date a return was filed, or two years from the date of payment of tax, whichever is later. If a return is filed before its due date, it is treated as filed on its due date. Thus, an individual's calendar-year return filed on April 1 is treated as filed on April 15. As a result, the last date an amended return can be filed would be three years, three months, and 15 days after the end of the calendar year (e.g., April 15, 2018, for a 2014 calendar-year return).

143

What is the maximum amount of adjusted gross income that a taxpayer may have for 2014 and still qualify to roll over the balance from a traditional individual retirement account (IRA) into a Roth IRA?
$150,000
$100,000
$ 75,000
A rollover to a Roth IRA is not subject to an adjusted gross income limitation.

For tax years beginning after December 31, 2009, the adjusted gross income and filing status limitations have been eliminated for rollovers from a traditional IRA to a Roth IRA. Even high income taxpayers can convert a traditional IRA to a Roth IRA.

144

Gilda Bach is a cash-basis self-employed consultant. For the year 2014, she determined that her net income from self-employment was $80,000. In reviewing her books you determine that the following items were included as business expenses in arriving at the net income of $80,000:
Salary drawn by Gilda Bach $20,000
Estimated federal income taxes paid 6,000
Malpractice insurance premiums 4,000
Cost of attending professional seminar 1,000
Based upon the above information, what should Gilda Bach report as her self-employment income for 2014?
$ 91,000
$105,000
$106,000
$110,000

This answer is correct. The $20,000 salary drawn by Gilda is not deductible since she is not an employee. Also, federal income taxes are not deductible. Malpractice insurance premiums and professional seminar expenses are deductible. Therefore, Gilda’s self-employment income is computed by adding back the nondeductible expenses to her previously computed income of $80,000.
Previously computed income $ 80,000
Gilda’s salary 20,000
Federal income tax 6,000
$106,000

145

Fil and Breed are 50% partners in F&B Cars, a used-car dealership. F&B maintains an average used-car inventory worth $150,000. On January 5, National Bank obtained a $30,000 judgment against Fil and Fil’s child on a loan that Fil had cosigned and on which Fil’s child had defaulted. National sued F&B to be allowed to attach $30,000 worth of cars as part of Fil’s interest in F&B’s inventory. Will National prevail in its suit?
No, because the judgment was not against the partnership.
No, because attachment of the cars would dissolve the partnership by operation of law.
Yes, because National had a valid judgment against Fil.
Yes, because Fil's interest in the partnership inventory is an asset owned by Fil.

No, because the judgment was not against the partnership. This answer is correct because a partnership is a legal entity separate and apart from its owners.

146

David Waldman, a calendar-year taxpayer, was employed and resided in Philadelphia. On February 1, 2015, Waldman was permanently transferred to Dallas by his employer. Waldman worked for 20 weeks before being laid off for other than willful misconduct. In 2015 Waldman incurred and paid the following unreimbursed expenses in connection with his move:
Cost of moving household furnishings and personal effects $ 1,500
Lodging expenses while moving 500
Penalty for breaking the lease on his Philadelphia apartment 600
What amount can Waldman deduct in 2015 for moving expenses?
$0
$1,026
$2,000
$2,600

Direct moving expenses are deductible if closely related to the start of work at a new location and a distance (i.e., new job must be at least 50 miles further from former residence than old job) and time (i.e., employed at least 39 weeks out of 12 months following move) tests are met. However, the time test does not have to be met in case of death, taxpayer’s job at new location ends because of disability, or taxpayer is laid off for other than willful misconduct. Since the distance test is met and the time test is not met due to the taxpayer being laid off for other than willful misconduct, Waldman’s cost of moving household furnishings and personal effects ($1,500) and cost of lodging and travel expenses while moving ($500) are deductible. The penalty for breaking the lease is an indirect moving expense and is not deductible.

147

Smith and James were partners in S and J Partnership. The partnership agreement stated that all profits and losses were allocated 60% to Smith and 40% to James. The partners decided to terminate and wind up the partnership. The following was the balance sheet for S and J on the day of the windup:
Cash $40,000
Accounts receivable 12,000
Property and equipment 38,000
Total assets $90,000
Accounts payable $24,000
Smith, capital 30,000
James, capital 36,000
Total liabilities and capital $90,000
Of the total accounts receivable, $10,000 was collected and the remainder was written off as bad debt. All liabilities of S and J were paid by the partnership. The property and equipment are sold for $32,000. Under the Uniform Partnership Act, what amount of cash was distributed to Smith?

Smith would receive the amount in his capital account adjusted for the losses on the sale of assets, or $25,200 {$30,000 − [60% × ($2,000 loss on receivables + $6,000 loss on property and equipment)]}.

148

Rockford Corp., a calendar-year taxpayer, purchased used furniture and fixtures for use in its business and placed the property in service on December 1, 2014. The furniture and fixtures cost $112,000 and represented Rockford’s only acquisition of depreciable property during the year. Rockford did not make any special elections with regard to depreciation and did not elect to expense any part of the cost of the property under Sec. 179. What is the amount of Rockford Corp.’s depreciation deduction for the furniture and fixtures under the Modified Accelerated Cost Recovery System (MACRS) for 2014?
$ 4,000
$ 8,000
$16,000
$32,000

The furniture and fixtures qualify as 7-year property and under MACRS will be depreciated using the 200% declining balance method. Regular MACRS depreciation would be computed under which a half-year convention normally applies to the year of acquisition. However, the mid-quarter convention must be used if more than 40% of all personal property is placed in service during the last quarter of the taxpayer’s taxable year. Since this was Rockford’s only acquisition of personal property and the property was placed in service during the last quarter of Rockford’s calendar year, the mid-quarter convention must be used. Under this convention, property is treated as placed in service during the middle of the quarter in which placed in service. Since the furniture and fixtures were placed in service in December the amount of allowable MACRS depreciation is limited to ($112,000) × 2/7 × 1/8 = $4,000.

149

Ed and Ann Ross were divorced in January 2014. In accordance with the divorce decree, Ed transferred the title in their home to Ann in 2014. The home, which had a fair market value of $150,000, was subject to a $50,000 mortgage that had 20 more years to run. Monthly mortgage payments amount to $1,000. Under the terms of settlement, Ed is obligated to make the mortgage payments on the home for the full remaining 20-year term of the indebtedness, regardless of how long Ann lives. Ed made 12 mortgage payments in 2014. What amount is taxable as alimony in Ann’s 2014 return?
$0
$ 12,000
$100,000
$112,000

In order to be treated as alimony, a payment must be made in cash and be received by, or on behalf of, the payee spouse. Furthermore, cash payments must be required to terminate upon the death of the payee spouse to be treated as alimony. In this case, the transfer of title in the home to Ann is not a cash payment and cannot be treated as alimony. Although the mortgage payments are cash payments made on behalf of Ann, the payments are not treated as alimony because they will be made throughout the full 20-year mortgage period and will not terminate in the event of Ann’s death.

150

In order to be a holder of a bearer negotiable instrument, the transferee must
Give value for the instrument.
Have physical possession of the instrument.
Take the instrument before receipt of notice of a defense.
Take in good faith.

in order for someone in possession of a negotiable instrument to qualify as a holder, it is necessary that he receive the instrument through proper negotiation. Proper negotiation of bearer paper requires nothing more than the mere delivery of the instrument to the holder. Thus, in order to qualify as a holder of bearer paper, the transferee need only have physical possession of the instrument.

151

Beta, a C corporation, reported the following items of income and expenses for the year:
Gross income from operations $600,000
Dividend income from a 30% owned domestic corporation 100,000
Operating expenses 400,000
What is Beta’s taxable income for the year?

$200,000
$220,000
$230,000
$300,000

This answer is correct. The requirement is to determine the amount of Beta’s taxable income.
The $100,000 of dividend income received by Beta from a 30%-owned domestic corporation would be eligible for an 80% dividends-received deduction. Thus Beta’s taxable income would beGross income from operations $600,000
Dividends 100,000
Operating expenses (400,000)
TI before DRD $300,000
DRD (80,000)
Taxable income $220,000

152

Dombres is considering purchasing Blackacre. The title search revealed that the property was willed by Adams jointly to his children, Donald and Martha. The language contained in the will is unclear as to whether a joint tenancy or a tenancy in common was intended. Donald is dead and Martha has agreed to convey her entire interest by quitclaim deed to Dombres. The purchase price is equal to the full fair market price of the property. Dombres is not interested in anything less than the entire title to the tract. Under the circumstances, which of the following is correct

There is a statutory preference which favors the finding of a joint tenancy.
Whether the will created a joint tenancy or a tenancy in common is irrelevant since Martha is the only survivor.
Dombres will not obtain title to the entire tract of land by Martha’s conveyance.
There is no way or means whereby Dombres may obtain a clear title under the circumstances.

When the deed is unclear as to whether a joint tenancy or tenancy in common was intended, there is a statutory presumption in favor of tenancy in common. Thus, Donald and Martha were tenants in common, and when Donald died, his interest passed to his heirs. Thus, if Dombres wanted to obtain the entire title, he would have to purchase the interest of Donald’s heirs, as well as Martha’s interest.

153

A general business credit in excess of the limitation amount is carried
Forward indefinitely.
Back 2 years and forward up to 20 years, at the taxpayer’s election.
Back 1 year and forward 20 years.
Forward up to a maximum of 20 years, but they cannot be carried back.

A general business credit in excess of the limitation amount is carried back 1 year and forward 20 years.

154

Nancy is asserting rights as a third-party donee beneficiary on a contract made by Johnson and Harding. In order to prevail, Nancy must prove that
The contract specifically named her as the beneficiary.
She gave consideration for the donative promise.
She is related by blood or marriage to the promisee.
The terms of the contract and surrounding circumstances manifest a clear intent to benefit her.

The terms of the contract and surrounding circumstances manifest a clear intent to benefit her. This answer is correct because in the third-party donee beneficiary contract, the donee beneficiary can assert rights to the contract if the beneficiary can prove that the terms of the contract and surrounding circumstances manifest a clear intent to benefit her.

155

Hedge Holding Corporation has 20 unrelated stockholders, each of whom owns 100 shares of Hedge stock. For the year ended December 31, 2014, Hedge’s gross income consisted of the following:
Dividends from domestic taxable corporations $20,000
Interest earned on US Treasury notes 12,000
Net rental income 6,000
Deductible expenses for 2014 totaled $8,000. Hedge paid no dividends during 2014. Hedge’s liability for personal holding company tax for 2014 will be based on undistributed personal holding company income of
$0
$ 7,000
$13,000
$30,000

0. This answer is correct. Hedge does not meet the "stock ownership test" that is required to be classified as a personal holding company. The stock ownership test requires that more than 50% of the outstanding stock must be owned directly or indirectly by five or fewer individuals. Hedge has 20 equal unrelated shareholders. Thus, Hedge is not classified as a personal holding company, and therefore, has no undistributed PHC income.

156

Iris Jones, a widow, had adjusted gross income of $35,000 for the current year. In order for her to be gainfully employed, she incurred and paid the following expenses for her 5-year-old son Jason:
Period Payee Amount per month
January-June Day-care center $150
January-December Babysitter 100
September-December First grade school 200
What amount of her employment-related expenses is eligible for the child care tax credit for for the current year?

$1,200
$2,000
$2,100
$2,300

This answer is correct. Iris incurred a total of $2,100 of child and dependent care expenses.
Day-care (6 months × $150) $ 900
Babysitter (12 months × $100) 1,200
$2,100
Day-care expenses are allowable if incurred so that the taxpayer can be gainfully employed. Expenses for attending first grade and thereafter are not allowed. The maximum amount of expenses on which the credit can be taken for one child or dependent is $3,000 ($6,000 for more than one).

157

For the current year, Shady Corporation had net income per books of $2,000,000. Included in the determination of net income were the following items:
Interest income on municipal bonds $60,000
Damages received from settlement of patent infringement lawsuit 125,000
Interest paid on loan to purchase municipal bonds 22,000
Provision for federal income tax 796,000
What should Shady report as its taxable income for the current year?

$2,633,000
$2,671,000
$2,736,000
$2,758,000

This answer is correct. The requirement is to compute Shady’s taxable income given book income of $2,000,000 and items included in the computation of book income. Book income must be adjusted for the tax-exempt interest (net of related expenses) and the provision for federal income tax:





Book income $2,000,000
Municipal bond interest (60,000)

Nondeductible interest expense
(to produce tax-exempt interest income)
22,000
Provision for federal income tax 796,000
Taxable income $2,758,000


The damages received for patent infringement that were included in book income are similarly included in taxable income, so no adjustment is necessary.

158

Wilson, CPA, uses a commercial tax software package to prepare clients’ individual income tax returns. Upon reviewing a client’s computer-generated year 1 itemized deductions, Wilson discovers that the schedule’s deductible investment interest expense is less than the amount paid by the taxpayer and the amount that Wilson entered into the computer. After analyzing the entire tax return, Wilson determines that the computer-generated investment interest expense deduction is correct. Why is the computer-generated investment interest expense deduction correct?

I. The client’s investment interest expense exceeds net investment income.
II. The client’s qualified residence interest expense reduces the deductible amount of investment interest expense.
I only.
II only.
Both I and II.
Neither I nor II.

I only. This answer is correct. The deduction for an individual’s investment interest expense is limited to the individual’s net investment income. As a result, a computer-generated deduction for investment interest expense would be less than the amount entered into the computer if the individual’s net investment income was less than the amount of investment interest expense that was entered. Net investment income includes such income as interest and short-term capital gains, less any related investment expenses. An individual’s deduction for qualified residence interest has no effect on the deduction of investment interest expense.

159

Harold Brodsky is an electrician employed by a contracting firm. His adjusted gross income is $25,000. During the current year he incurred and paid the following expenses:
Use of personal auto for company business (reimbursed by employer for $200) $300
Specialized work clothes 550
Union dues 600
Cost of income tax preparation 150
Preparation of will 100
If Brodsky were to itemize his personal deductions, what amount should he claim as a deduction for miscellaneous itemized deductions?
$ 800
$ 900
$1,500
$1,700

This answer is correct. The cost of uniforms not adaptable to general use (specialized work clothes), union dues, unreimbursed auto expenses, and the cost of income tax preparation are all miscellaneous itemized deductions. The preparation of a will is personal in nature, and is not deductible.
Unreimbursed auto expense $100
Specialized work clothes 550
Union dues 600
Cost of income tax preparation 150
$1,400
Less (2% × $25,000) 500
Allowable deduction $ 900

160

Dole, the sole owner of Enson Corp., transferred a building to Enson. The building had an adjusted tax basis of $35,000 and a fair market value of $100,000. In exchange for the building, Dole received $40,000 cash and Enson common stock with a fair market value of $60,000. What amount of gain did Dole recognize?
$0
$ 5,000
$40,000
$65,000

The requirement is to determine the amount of gain recognized by Dole on the transfer of a building with a basis of $35,000 to his solely owned corporation in exchange for $40,000 cash and stock with a value of $60,000. No gain or loss is recognized if property is transferred to a corporation solely in exchange for stock if the transferor is in control of the corporation immediately after the exchange. If consideration other than stock is received, a realized gain must be recognized to the extent of the boot received. Here, Dole realized a gain of ($40,000 + $60,000 stock) — $35,000 basis = $65,000 on the transfer of the building, and must recognize the gain to the extent of the $40,000 of cash received.

161

Poole, 45 years old and unmarried, is in the 15% tax bracket. He had 2014 adjusted gross income of $30,000. The following information applies to Poole:
Medical expenses $9,450
Standard deduction 6,200
Personal exemption 3,950
Poole wishes to minimize his income tax. What is Poole’s 2014 total income tax?

$4,500
$3,098
$2,940
$2,693

This answer is correct. To determine Poole's taxable income, his adjusted gross income must be reduced by the greater of his itemized deductions or a standard deduction, and a personal exemption. Since Poole's medical expenses of $9,450 are deductible to the extent in excess of 10% of his AGI of $30,000, his itemized deductions of $6,450 exceed his available standard deduction of $6,200. Poole's tax computation is as follows:
Adjusted gross income $30,000
Less:
Itemized deductions $6,450
Personal exemption 3,950 10,050
Taxable income $19,600
Tax rate × 15%
Income tax $ 2,940

162

Tim and Nicole Wendler were divorced in 2013. Under the terms of their divorce decree, Tim paid alimony to Nicole at the rate of $60,000 in 2013, $25,000 in 2014, and nothing in 2015. What amount of alimony recapture must be included in Tim's gross income for 2015?
$0
$10,000
$35,000
$47,500

$47,500. This answer is correct. Alimony recapture may occur if alimony payments sharply decline in the second and third years that payments are made. The payor must report the recaptured alimony as gross income in the third year, and the payee is allowed a deduction for the same amount. Recapture for the second year occurs to the extent that the alimony paid in the second year ($25,000) exceeds the third year alimony by more than $15,000 ($0 + $15,000), or $10,000. Recapture for the first year occurs to the extent that the alimony paid in the first year ($60,000) exceeds the average alimony paid in the second year (reduced by the recapture for that year) and third year by more than $15,000. In this case, recapture for the first year amounts to $37,500, computed as follows:

First year payment $60,000
Second year payment $15,000
Third year payment $ 0
$15,000
÷ 2 (7,500) Average of second and third year payments
(15,000) Threshold
$37,500 Recapture for first year

163

Cooma Corporation’s book income before income taxes for the year ended December 31, 2014, was $260,000. The company began business during March 2014 and organizational costs of $130,500 were expensed when incurred during 2014 for financial statement purposes. For tax purposes these costs are being written off over the minimum allowable period. For the year ended December 31, 2014, Cooma’s taxable income was
$260,000
$368,750
$383,250
$390,500

A corporation’s organizational expenditures can be deducted ratably over the 180-month period beginning with the month in which the corporation begins business. Here, the $130,500 of organizational expenditures expensed per books must be added back to the $260,000 of book income, and then the proper tax amortization deducted ($130,500 × 10/180 = $7,250), resulting in taxable income of $383,250.

164

A self-employed taxpayer had gross income of $57,000. The taxpayer paid self-employment tax of $8,000, health insurance of $6,000, and $5,000 of alimony. The taxpayer also contributed $2,000 to a traditional IRA. What is the taxpayer’s adjusted gross income for 2014?
$55,000
$50,000
$46,000
$40,000

The self-employed taxpayer’s gross income of $57,000 would be reduced by a deduction for 50% of self-employment taxes paid (50% × $8,000 = $4,000), a deduction for 100% of health insurance premiums ($6,000), alimony paid to a former spouse ($5,000), and the $2,000 contributed to a traditional IRA, resulting in AGI of $40,000.

165

Danielson invested $2,000,000 in DEC, a qualified small business corporation. Six years later, Danielson sold all of the DEC stock for $16,000,000 and purchased an office building with the proceeds. Danielson had not previously excluded any gain on the sale of small business stock. What is Danielson’s taxable gain after the exclusion if he sold the stock in 2014?
$0
$6,000,000
$7,000,000
$9,000,000

A noncorporate taxpayer can generally exclude 50% of the capital gain resulting from the sale of qualified small business stock held more than five years. The amount of excludible gain is subject to a cumulative limit of the greater of $10 million, or 10 times the investor's stock basis. Here, the sale for $16,000,000 of qualified stock that was acquired for $2,000,000 results in a gain of $14,000,000. Since the $14,000,000 gain does not exceed 10 times Danielson's stock basis, 50% of the gain can be excluded. resulting in a taxable gain after exclusion of $7,000,000.

166

Allison sold a building for $600,000. Allison received a down payment of $120,000 as well as annual principal payments of $120,000 for each of the subsequent four years. Allison purchased the building for $500,000 and claimed depreciation of $80,000. What amount of gain should Allison report in the year of sale using the installment method?
$180,000
$120,000
$ 54,000
$ 36,000

Under the installment method, gain from the sale is prorated and recognized over the years in which payments are received. The amount of gain recognized for a tax year is calculated by multiplying the payment received in that year by the gross profit ratio. The gross profit ratio is equal to the gross profit divided by the payments that are to be received from the sale. Here, property with a basis of $500,000 − $80,000 = $420,000 was sold for $600,000, resulting in a gross profit of $180,000. Since only $120,000 of the $600,000 selling price was received in the year of sale, the amount of gain to be reported under the installment method for the year of sale would be $120,000 × ($180,000/$600,000) = $36,000.

167

Under the Private Securities Litigation Reform Act, the defendants have what type of liability?

Proportionate to their degree of fault for unknowing conduct.
Joint and several liability for unknowing conduct.
Equal shares of liability.
Strict liability for unknowing or knowing conduct.

The Reform Act changes the rule on joint and several liability so that each defendant is liable for his/her proportionate degree of fault for unknowing conduct.