2012 AICPA Newly Released Questions Flashcards
The Uniform Capitalization Rules of Code Sec. 263A apply to retailers whose average gross receipts for the preceding three years exceed what amount?
a. $1,000,000
b. $2,500,000
c. $5,000,000
d. $10,000,000
Choice “d” is correct. The uniform capitalization rules do not apply to inventory acquired for resale if the taxpayer’s average gross receipts for the preceding three tax years do not exceed $10,000,000.
An individual taxpayer reports the following items for the current year:
Ordinary income from partnership A, operating a movie theater in which the taxpayer materially participates $70,000
Net loss from partnership B, operating an equipment rental business in which the taxpayer does not materially participate (9,000)
Rental income from building rented to a third party 7,000
Short-term capital gain from sale of stock 4,000
What is the taxpayer’s adjusted gross income for the year?
a. $70,000
b. $72,000
c. $74,000
d. $77,000
Choice “c” is correct. Except in the year in which an individual, estate, trust, or closely-held C corporation disposes of an entire interest in a passive activity investment, such taxpayers cannot deduct passive activity expenses and losses against income and gain attributable to non-passive activities. A passive activity is (i) any activity in which such taxpayers do not materially participate and (ii) as a general rule, such taxpayers’ rental real estate investments – regardless of the extent of such taxpayers’ involvement with the rental real estate operations. A limited exception (the “Mom and Pop Exception”) regarding rental real estate activities is available to individuals, but the facts of this question do not provide any information which would entitle the taxpayer to the benefits of this exception.
Hence, the taxpayer can deduct, against the profit from the taxpayer’s $7,000 passive activity rental income from the building rented to a third party, only $7,000 of the $9,000 net loss from partnership B which is operating an equipment rental business in which the taxpayer does not materially participate.
Computation of adjusted gross income for the year:
Ordinary income from partnership A, operating a movie theater in which the taxpayer materially participates $70,000
Rental income from building rented to a third party (a passive activity) 7,000
Net loss from partnership B, operating an equipment rental business in which the taxpayer does not materially participate (per the above rule the taxpayer can deduct only $7,000 of the $9,000 passive activity loss) (7,000)
Short-term capital gain from sale of stock (fully taxable) 4,000
Adjusted gross income for the year $74,000
On February 1, year 1, a taxpayer purchased an option to buy 1,000 shares of XYZ Co. for $200 per share. The taxpayer purchased the option for $50,000, which was to remain in effect for six months. The market declined, and the taxpayer let the option lapse on August 1, year 1. The taxpayer would report which of the following as a capital loss on the year 1 income tax return?
a. $50,000 long term.
b. $50,000 short term.
c. $150,000 long term.
d. $200,000 short term.
Choice “b” is correct. An option held by an investor is a capital asset. A capital asset which is sold or exchanged within one year of acquisition will generate either a short-term capital gain (if the capital asset is sold at a price greater than acquisition cost) or a short-term capital loss (if the capital asset is sold at a price less than the acquisition cost). The cost (or other basis) of worthless stock or securities is treated as a capital loss as if they were sold on the last day of the taxable year in which they became totally worthless. The option’s exercise price is irrelevant with respect to determining loss on account of the lapse of the options.
In this question, the options, which were capital assets purchased for $50,000 on February 1, Year 1, became worthless on the lapse date, August 1, Year 1. Thus, the $50,000 capital loss is treated as having occurred on December 31, Year 1, the last day of the taxable year in which the options became totally worthless. Because, as of December 31, Year 1, the options had not been held for more than a year, the $50,000 capital loss will be reported on the income tax return as a short-term capital loss.
A taxpayer lived in an apartment building and had a two-year lease that began 16 months ago. The taxpayer’s landlord wanted to sell the building and offered the taxpayer $10,000 to vacate the apartment immediately. The taxpayer’s lease on the apartment was a capital asset but had no tax basis. If the taxpayer accepted the landlord’s offer, the gain or loss would be which of the following?
a. An ordinary gain.
b. A short-term capital loss.
c. A long-term capital gain.
d. A short-term capital gain.
Choice “c” is correct. A capital asset which is sold or exchanged more than one year after the date of acquisition will generate either a long-term capital gain (if the capital asset is sold at a price greater than acquisition cost) or a long-term capital loss (if the capital asset is sold at a price less than the acquisition cost). In this question, the lease-hold interest, which is a capital asset, was acquired more than a year ago, and the basis (acquisition cost) in that capital asset is -0-. So, the receipt of $10,000 to vacate the apartment will generate a $10,000 long-term capital gain.
In year 1, a taxpayer sold real property for $200,000, receiving $100,000 at closing and $100,000 plus accrued interest at the prime rate in the next year. The buyer also assumed a $50,000 mortgage on the property. The taxpayer’s adjusted basis was $75,000, and the taxpayer incurred $10,000 of selling expenses. If this transaction qualifies for installment sale treatment, what is the gross profit on the sale?
a. $115,000
b. $125,000
c. $165,000
d. $175,000
Choice “c” is correct. Unless the taxpayer elects not to use the installment sales method, the taxpayer generally will recognize gain (but not loss) over the period during which the taxpayer receives cash payments (other than interest income) from the sale of noninventory assets. Note that this method is not available for the sale of stocks and securities traded on an established securities market.
The gross profit will be the amount realized less selling costs less the adjusted basis of the property sold (note: IRS forms require the taxpayer (i) to increase the adjusted basis by the amount of the selling costs and (ii) not reduce the amount realized by the selling costs. This requirement does not change the amount of gain/gross profit.
If the contract requires that payments be made in a subsequent year and if the contract requires little or no interest, the taxpayer may have to reduce the amount realized by the amount of unstated interest. This rule does not apply here because the contract requires that the buyer pay accrued interest at the prime rate in the next year.
Amount realized:
Cash to be received, excluding interest income $200,000
Related debt assumed by the buyer 50,000
Less: selling expenses (10,000)
Amount realized $240,000
Less: Adjusted basis (75,000)
Gain realized/gross profit $165,000
Upon her grandfather’s death, Jordan inherited 10 shares of Universal Corp. stock that had a fair market value of $5,000. Her grandfather acquired the shares in 1995 for $2,500. Four months after her grandfather’s death, Jordan sold all her shares of Universal for $7,500. What was Jordan’s recognized gain in the year of sale?
a. $2,500 long-term capital gain.
b. $2,500 short-term capital gain.
c. $5,000 long-term capital gain.
d. $5,000 short-term capital gain.
Choice “a” is correct. Unless the executor elects the “alternative valuation date” method (not applicable to this question), the basis of property acquired by bequest or by inheritance is the property’s fair market value on the date of the decedent’s death. The decedent’s basis is irrelevant. Additionally, such acquired property is always considered to be “long-term” property, regardless of how long it has been held by the decedent and by the beneficiary or heir.
Calculation of gain realized and recognized:
Amount realized $7,500
Less: Basis (date-of-death fair market value) (5,000)
Long-term capital gain realized and recognized $2,500
Davidson was transferred from Chicago to Atlanta. In connection with the transfer, Davidson incurred the following moving expenses: Moving the household goods $2,000 Temporary living expenses in Atlanta 400 Lodging on the way to Atlanta 100 Meals 40 What amount may Davidson deduct if the employer reimbursed Davidson $2,000 (not included in form W-2) for moving expenses? a. $100 b. $120 c. $500 d. $520
Choice “a” is correct. The moving expense deduction is allowable only for direct moving expenses: (i) travel and along-the-way lodging of the taxpayer and the taxpayer’s family and (ii) transportation, to the new location, of the taxpayer’s household goods and personal effects. Deductible expenses must be reduced by the amount of employer reimbursements not properly included on IRS form W-2. No longer is there a deduction for either (i) temporary living expenses at the new location or (ii) along-the-way meal expenses.
Moving the household goods $ 2,000
Lodging on the way to Atlanta 100
Less: employer reimbursement not included on IRS form W-2 (2,000)
Deduction (adjustment) for (towards) AGI $ 100
Choices “b”, “c”, and “d” are incorrect per the above rule: The $400 temporary living expenses in Atlanta and the $40 meal expense are not deductible.
Which of the following statements is correct regarding the deductibility of an individual’s medical expenses?
a. A medical expense paid by credit card is deductible in the year the credit card bill is paid.
b. A medical expense deduction is allowed for payments made in the current year for medical services received in earlier years.
c. Medical expenses, net of insurance reimbursements, are disregarded in the alternative minimum tax calculation.
d. A medical expense deduction is not allowed for Medicare insurance premiums.
Choice “b” is correct. A medical expense deduction is allowed for payments made in the current year for medical services received in earlier years.
On January 1 of the current year, Locke Corp., an accrual-basis calendar-year C corporation, had $30,000 in accumulated earnings and profits. For the current year, Locke had current earnings and profits of $20,000, and made two $40,000 cash distributions to its shareholders, one in April and one in September. What amount of the distributions is classified as dividend income to Locke’s shareholders?
a. $0
b. $20,000
c. $50,000
d. $80,000
Choice “c” is correct. The general rule is that distributions are taxable dividends to the extent of current earnings and profits (E&P) by year end and to the extent of accumulated E&P as of the distribution date. If both are positive and if distributions exceed the sum of current E&P and accumulated E&P, then the distributions in excess of the sum are treated as a return of capital. In this example, both current E&P and accumulated E&P are positive (the total is $50,000), and total distributions during the year are $80,000; so, $50,000 of the total distributions will be taxable dividends.
An individual taxpayer earned $10,000 in investment income, $8,000 in noninterest investment expenses, and $5,000 in investment interest expense. How much is the taxpayer allowed to deduct on the current-year’s tax return for investment interest expenses?
a. $0
b. $2,000
c. $3,000
d. $5,000
Choice “b” is correct. The deduction for investment interest expenses is limited to net taxable investment income which is defined as taxable investment income minus all related investment expenses (other than investment interest expense). If the investment expense is an itemized deduction, then only those expenses exceeding 2% of AGI are considered.
Taxable investment income includes: (i) interest and dividends, (ii) rents (if the activity is not a passive activity), (iii) royalties (in excess of related expenses), (iv) net short-term capital gains, and (v) net long-term capital gains if the taxpayer elects not to claim the net capital gains reduced tax rate.
Calculation:
Investment income $10,000
Less: Related investment expenses other than investment interest expenses (8,000)
Net investment income $ 2,000
The taxpayer’s deduction for investment interest expense is $2,000: the lesser of (i) $2,000 net investment income or (ii) $5,000 investment interest expense.
Brenda, employed full time, makes beaded jewelry as a hobby. In year 2, Brenda’s hobby generated $2,000 of sales, and she incurred $3,000 of travel expenses. What is the proper reporting of the income and expenses related to the activity?
a. Sales of $2,000 are reported in gross income, and $2,000 of expenses is reported as an itemized deduction subject to the 2% limitation.
b. Sales of $2,000 are reported in gross income, and $3,000 of expenses is reported as an itemized deduction subject to the 2% limitation.
c. Sales and expenses are netted, and the net loss of $1,000 is reported as an itemized deduction not subject to the 2% limitation.
d. Sales and expenses are netted and deducted for AGI.
Choice “a” is correct. Based upon the facts presented (“Brenda makes jewelry as a hobby . . .”), this activity is not a trade or business activity but is an activity not engaged in for profit. As such, the taxpayer can only deduct as itemized deductions on Schedule A of IRS form 1040 the following: (i) expenses, such as state and local income taxes and property taxes, which would be allowed regardless of whether or not the activity were engaged in for profit and (ii) all other expenses that would be allowed if such activity were engaged in for profit. However, the amount of these “other expenses” cannot exceed gross income reduced by the expenses described in “(i),” above. Furthermore, the allowable “other expenses” are subject to the “2% of AGI” limitation.
Because Brenda had only $2,000 of gross income, the most she can deduct is $2,000 of the $3,000 travel expenses she incurred. Because the travel expenses constitute “all other expenses” (see “(ii),” above), this amount is subject to the “2% of AGI” limitation.
Note that the activity-is-engaged-in-for-profit statutory presumption does not apply. Reason: that presumption applies only if the activity shows a profit for at least three taxable years during the five consecutive taxable year period ending with the year in question (year #2 for this question). Because the facts do not state that during the five year period ending with year 2 Brenda had a profit in at least three of those five years, the presumption is not available to Brenda. If the presumption would have been available to her and if she had had a profit in at least three of the five consecutive, ending with year #2, then the sales and expenses would have been netted and deducted for AGI (and choice “d” would have been correct).
On their joint tax return, Sam and Joann had adjusted gross income (AGI) of $150,000 and claimed the following itemized deductions:
Interest of $15,000 on a $100,000 home equity loan to purchase a motor home
Real estate tax and state income taxes of $18,000
Unreimbursed medical expenses of $15,000 (prior to AGI limitation)
Miscellaneous itemized deductions of $5,000 (prior to AGI limitation)
Based on these deductions, what would be the amount of AMT add-back adjustment in computing alternative minimum taxable income?
a. $21,750
b. $23,750
c. $35,000
d. $38,750
Choice “d” is correct. Per the mnemonic “PANIC TIMME,” for purposes of calculating alterative minimum taxable income, the taxpayer must add back, among other things, the following itemized deductions:
- Taxes reduced by taxable refunds,
- Home mortgage interest when the mortgage loan proceeds were not used to buy, build, or improve the taxpayer’s qualified dwelling (house, condominium, apartment, or mobile home not used on a transient basis),
- Medical expenses not exceeding 10% of AGI, and
- Miscellaneous deductions subject to the 2% of AGI floor.
The “PANIC TIMME” add-back is as follows:
Taxes . . . . . . .$18,000
Home mortgage interest not used to buy, build, or improve a qualified dwelling (the motor home is not a qualified dwelling) . . . . . . . 15,000
Medical expenses in excess of 7.5% AGI but not in excess of 10% of AGI . . . . . 3,750
Deductible miscellaneous expenses in excess of 2% of AGI . . . . . . .2,000
Total “PANIC TIMME” add-back . . . . . . . . $38,750
Gem Corp. purchased all the assets of a sole proprietorship, including the following intangible assets: Goodwill $50,000 Covenant not to compete 13,000 For tax purposes, what amount of these purchased intangible assets should Gem amortize over the specific statutory cost recovery periods? a. $63,000 b. $50,000 c. $13,000 d. $0
Choice “a” is correct. Post-August 10, 1993, acquisitions of goodwill, covenants not-to-compete, franchises, trademarks, and trade names must be amortized on a straight-line basis over a fifteen-year period (180 months) beginning with the month of acquisition. So, both the $50,000 acquisition of the goodwill and the $13,000 acquisition of the covenant not-to-compete – for a total cost of $63,000 – are amortized over the fifteen-year period statutory cost recovery period.
For year 2, Quest Corp., an accrual-basis calendar-year C corporation, had an $8,000 unexpired charitable contribution carryover from year 1. Quest’s year 2 taxable income before the deduction for charitable contributions was $200,000. On December 12, year 2, Quest’s board of directors authorized a $15,000 cash contribution to a qualified charity, which was made on January 6, year 3. What is the maximum allowable deduction that Quest may take as a charitable contribution on its year 2 income tax return?
a. $23,000
b. $20,000
c. $15,000
d. $8,000
Choice “b” is correct. C corporations are allowed a maximum charitable contribution deduction of 10% of taxable income computed before the following deductions:
• Any charitable contribution,
• The dividend received deduction,
• Any net operating loss carryback,
• Any net capital loss carryback, and
• The U.S. production activities deduction.
Accrued charitable contributions not paid by the end of the year are deductible in the year of accrual if (i) the board of directors authorizes the contribution during the tax year and (ii) the accrual-basis corporation pays the accrued amount by the fifteenth day of the third month (generally 2½ months) following the end of the tax year.
Any amount in excess of the “10% limitation” may be carried forward for five years.
In this question, the corporation has: (i) an $8,000 unexpired charitable contribution carryover from the previous year, (ii) -0- charitable contributions paid during the current year, and (iii) a $15,000 contribution which the board of directors authorized by the end of the year and which the corporation paid by the fifteenth day of the third month following the end of the tax year. Hence, the deduction before application of the “10% limit” is $23,000: $8,000 + 0 + $15,000. However, the taxable income before the five deductions listed above is $200,000. So, the deduction is limited to $20,000: the lesser of (i) the $23,000 amount before application of the “10% limit” or (ii) $20,000 which is 10% of the $200,000 taxable income before the five deductions listed above.
Nichol Corp. gave gifts to 15 individuals who were customers of the business. The gifts were not in the nature of advertising. The market values of the gifts were as follows: 5 gifts @ $15 each 9 gifts @ $30 each 1 gift @ $100 What amount is deductible as business gifts? a. $0 b. $75 c. $325 d. $445
Choice “c” is correct. Business gifts are deductible up to a maximum deduction of $25 per recipient per year.
Computation:
5 x lesser of (i) $15 value of each gift or (ii) $25 maximum per recipient per year $ 75
9 x lesser of (i) $30 value of each gift or (ii) $25 maximum per recipient per year $225
1 x lesser of (i) $100 value of the gift or (ii) $25 maximum per recipient per year $ 25
Amount deductible for business gifts $325
In the current year, Fitz, a single taxpayer, sustained a $48,000 loss on Code Sec. 1244 stock in JJJ Corp., a qualifying small business corporation, and a $20,000 loss on Code Sec. 1244 stock in MMM Corp., another qualifying small business corporation. What is the maximum amount of loss that Fitz can deduct for the current year?
a. $50,000 capital loss.
b. $68,000 capital loss.
c. $18,000 ordinary loss and $50,000 capital loss.
d. $50,000 ordinary loss and $18,000 capital loss.
Choice “d” is correct. The stock in each corporation is a capital asset. The general rule is that a loss on the sale or exchange of a capital asset will be a capital loss (either a short-term capital loss or a long-term capital loss – depending upon the holding period). However, a special rule applies to “section 1244 small business stock): when a corporation’s stock is sold or becomes worthless, an original stockholder can be treated as having an ordinary loss (fully deductible), instead of a capital loss, up to $50,000 ($100,000 if married filing jointly) for the year. Any loss(es) in excess of this amount is (are) a capital loss.
In this question the taxpayer, who is not married, during the year has $68,000 of losses from the sale of section 1244 small business stock. As such, the taxpayer will treat as an ordinary loss $50,000 of the total loss; the taxpayer will treat as a capital loss the remaining $18,000 of the total loss.
