MCQ REVIEW

Question 1

Which of the following defenses is likely to be successful in a suit alleging negligence by a CPA?

Answer 1

Due care

Negligence arises when a CPA breaches a duty of care. A CPA owes a duty to preform work with due care. Thus, if a CPA can prove due care, the CPA cannot be held liable for negligence.

Question 2

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

Answer 2

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

The courts of original jurisdiction for tax cases, i.e., the courts in which a taxpayer would first bring a lawsuit against the IRS, are the Tax Court, the U.S. District Court, and the U.S. Court of Federal Claims.

Question 3

Which of the following penalties is usually imposed against an accountant who, in the course of performing professional services, breaches contract duties owed to a client?

Answer 3

Money damages.

When a CPA breaches a contract for professional services, the client and any third party beneficiary of the contract are entitled to compensatory money damages.

Question 4

A CPA in public practice may not disclose confidential client information regarding auditing services without the client’s consent in response to which of the following situations?

Answer 4

A letter to the client from the IRS.

A CPA is required to disclosed confidential client information if the information is subpoenaed and relevant to a court case. The IRS would have to do more than request the information in a letter. The IRS would have to subpoena the information and show that the information was relevant to an examination (audit).

Question 5

Would the following expense items be reported on Schedule M-1 of the corporation income tax return showing the reconciliation of income per books with income per return?

Answer 5

NO. Interest Incurred
on Loan to Carry
U.S. Obligations

NO. Provision for
State Corporation
Income Tax.

Schedule M-1 of Form 1120 is used to reconcile the differences between book income and taxable income. Because the interest incurred on loans to carry U.S. obligations and the provision for state corporation income tax are treated the same for both book purposes and tax return purposes, no Schedule M-1 adjustment is required. However, if the interest expense were to carry nontaxable municipal obligations, then the interest would not be tax deductible and would be an adjustment on the Schedule M-1 reconciliation.

Question 6

Simmons, an agent for Jensen, has the express authority to sell Jensen’s goods. Simmons also has the express authority to grant discounts of up to 5% of list price. Simmons sold Hemple goods with a list price of $1,000 and granted Hemple a 10% discount. Hemple had not previously dealt with either Simmons or Jensen. Which of the following courses of action may Jensen properly take?

Express authority occurs when an agent is working on behalf of his or her company to act on behalf of a principal. For example, a life insurance agent may have express authority under their company.

Implied Authority: It is created by the conduct and circumstances surrounding the relationship between the principal and the agent. Example: if a principal asks an agent to take his car to the mechanic, the agent has the implied authority to drive that car.

Apparent authority: is the power of an agent to act on behalf of a principal, even though not expressly or impliedly granted.

Answer 6

Seek recovery of $50 from Simmons only.

It would be reasonable for a third party, such as Hemple, to rely on a sales agent’s title and status to believe that the agent has authority to give a 10% discount. Thus, Simmons had apparent authority to grant the discount, and Jensen is bound to the contract with Hemple and cannot recover the extra $50 from Hemple. However, Jenson will be entitled to recover $50 (5% of $1,000) from Simmons because Simmons was disobedient and breached the agency relationship by giving a 10% discount instead of a 5% discount.

Question 7

Which of the following statements is correct regarding a tax return preparer’s penalty for aiding and abetting the understatement of a tax liability?

Aiding and abetting
= refers to helping or encouraging someone to commit a crime, or in some cases, to commit suicide

Answer 7

The penalty applies to a return preparer who knows about and does not prevent the actions of a subordinate who understates the tax liability.

The IRC Section 6701 penalty for aiding and abetting the understatement of a tax liability applies to any person who knows about the actions of a subordinate to understate a tax liability and does not prevent those actions.

Question 8

Tracy, an owner of an S corporation, has beginning basis of $13,000 in stock of the S corporation. During the year, Tracy contributed an additional $4,000 to partially offset the share of the S corporation’s net operating loss, which was $7,000 for this year. At the beginning of the year, Tracy received a $1,000 distribution from the S corporation. What was Tracy’s basis at year-end in the S corporation stock?

Answer 8

$9,000

$13,000 + $4,000 - $7,000 -$1,000 = $9,000

Question 9

Which of the following acts constitute(s) grounds for a tax preparer penalty?

I.

Without the taxpayer’s consent, the tax preparer disclosed taxpayer income tax return information under an order from a state court.

II.

At the taxpayer’s suggestion, the tax preparer deducted the expenses of the taxpayer’s personal domestic help as a business expense on the taxpayer’s individual tax return.

Answer 9

II only.

Question 10

A CPA sued a former client for nonpayment of the final bill. Although happy with the CPA’s performance of services, the client claimed that the CPA is not entitled to the final bill payment because the contract between the client and the CPA failed to meet the Statute of Frauds. The client argues that the contract allowed up to 15 months for the CPA to complete the work, the contract price was well over $5,000, and although the client sent signed checks to the CPA, the client did not sign the contract. Which of the following statements about this situation is correct?

Answer 10

The Statute of Frauds does not apply, allowing enforcement of the contract terms.

Statute of Frauds: a common law concept that requires written contracts for certain agreements to be binding. The statute applies to land sales and most purchases of goods of $500 or more. There are significant exceptions, such as oral contracts where work has already started.

Question 11

An individual taxpayer’s adjusted gross income (AGI) for the current year is $200,000 and AGI for the prior year is $160,000. The taxpayer had federal income tax withholdings from wages throughout the year. In which of the following independent situations could the IRS impose a penalty for failure to pay sufficient estimated tax payments for the current year?

Answer 11

The taxpayer’s current year withholding is 100 percent of the prior year’s tax liability.

An individual taxpayer must pay taxes throughout the tax year, through withholdings and/or quarterly estimated tax payments, of the lesser of (a) 90 percent of the current year’s tax or (b) 100 percent of the prior year’s tax (110 percent if prior year’s AGI is more than $150,000). This question evaluates each situation independently. Here, the taxpayer’s prior year AGI of $160,000 is more than $150,000, so withholding of 100 percent of the prior year’s tax liability is not sufficient to avoid the penalty for failure to pay estimated tax payments.

Question 12

With regard to an agreement for the sale of real estate, the Statute of Frauds:

Answer 12

Does not require that the agreement be signed by all parties.

The Statute of Frauds does not actually require an agreement to be signed by any party; instead, it requires written proof of the material terms of the agreement to be evidenced by a writing signed by the party being sued.

Question 13

The accumulated earnings tax can be imposed:

Answer 13

On regular corporations not classified as personal holding companies.

Question 14

Which of the following acts by a CPA will not result in a CPA incurring an IRS penalty?

Answer 14

Understating a client’s tax liability as a result of an error in calculation.

The IRS does not impose a penalty on a CPA for making an error in calculating a tax return.

Question 15

Under agency law, which of the following sets of categories refer to principals?

Answer 15

Disclosed, partially disclosed, and undisclosed.

Question 16

A taxpayer has just received a 90-day letter from the IRS related to the audit of the taxpayer’s Year 1 federal income tax return. Which of the following is a true statement about the 90-day letter?

Answer 16

The taxpayer has 90 days to either pay the tax deficiency or file a petition with the U.S. Tax Court.

Question 17

Which of the following is considered a corporate equity security?

Answer 17

A share of callable preferred stock

An equity security represents an ownership interest in a corporation. All types of stock are considered equity securities.

Question 18

An S corporation has 30,000 shares of voting common stock and 20,000 shares of non-voting common stock issued and outstanding. The S election can be revoked voluntarily with the consent of the shareholders holding, on the day of the revocation:

Shares of
voting stock

Answer 18

10,000 Shares of
voting stock

16,000 Shares of
nonvoting stock

S corporation status can be revoked if shareholders owning more than 50% of the total number of issued and outstanding shares consent. The specific percentage of voting and nonvoting shareholders is not considered, only the total. Holders of more than 25,000 total shares must approve the revocation. Note that there are many correct answers (any that the total exceeds 25,000 shares). But this is the only answer that is correct out of the choices presented.

Question 19

Alex, Becky, and Cindy are limited partners in a limited partnership. Zack is the general partner. Unless otherwise stated in the partnership agreement, how will profits and losses be distributed?

Answer 19

Proportionally, based on each partner’s contribution to the partnership.

In a limited partnership, profits and losses are divided according to contributions of the partners.

Question 20

A parent corporation owned more than 90% of each class of the outstanding stock issued by a subsidiary corporation and decided to merge that subsidiary into itself. Under the Revised Model Business Corporation Act, which of the following actions must be taken?

Answer 20

The subsidiary corporation’s dissenting stockholders must be given an appraisal remedy.

In a short form merger (one between a parent and a subsidiary 90% of which is owned by the parent), the subsidiary’s shareholders have a right to dissent and take advantage of the appraisal remedy.

Question 21

On reaching majority, a minor may ratify a contract in any of the following ways, except by:

Answer 21

Affirming, in writing, some of the terms of the contract.

The term “ratification” refers to the process by which a minor by his/her action or “inaction” legally accepts an entire contract after he/she reaches the age of majority. Accepting some of the terms is not “ratification.”

Question 22

Under the Secured Transactions Article of the UCC, which of the following security agreements does not need to be in writing to be enforceable?

Answer 22

A security agreement where the collateral is in the possession of the secured party.

Attachment of a security interest requires: (i) value given by the creditor, (ii) the debtor’s having rights in the collateral, and (iii) an agreement to create the security interest evidenced either by a written security agreement describing the collateral and authenticated (e.g., signed) by the debtor or by the creditor’s taking possession of the collateral. When a creditor takes possession, no written security agreement is required.

Question 23

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

Answer 23

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

Under the majority position an accountant is liable for negligence only to third parties whom the accountant knows or should foresee will be relying on the accountant’s work.

Question 24

Under the parol evidence rule, oral evidence will be excluded if it relates to:

Answer 24

A contemporaneous oral agreement relating to a term in the contract.

The parol evidence rule generally bars evidence of prior or contemporaneous oral statements offered to vary the terms of a fully integrated written contract. Oral evidence is permissible when the contract is incomplete, ambiguous, invalid, or subject to a condition precedent, or when modification is made after the original contract is written. A contemporaneous oral agreement will be excluded.

Question 25

When a taxpayer needs guidance with a specific tax issue related to a proposed transaction, the taxpayer can ask the IRS for:

Answer 25

A private letter ruling.

A private letter ruling (PLR) is the IRS’s interpretation of the federal tax law as it applies to a specific taxpayer situation. A PLR is issued by the IRS in response to a taxpayer’s request for guidance as to the federal tax consequences of a proposed transaction. It is binding for that specific taxpayer and transaction, but may not be relied on as precedent by other taxpayers or the IRS.

Question 26

Robbe, a cash-basis single taxpayer, reported $50,000 of adjusted gross income last year and claimed itemized deductions of $13,550, which included $5,500 of state income taxes paid last year. Robbe’s itemized deduction amount exceeded the standard deduction available to single taxpayers for last year by $1,150. In the current year, Robbe received a $1,500 state tax refund relating to the prior year. What is the proper treatment of the state tax refund?

Answer 26

Include $1,150 in income in the current year.

Under the tax benefit rule, an itemized deduction recovered in a subsequent year is included in income in the year recovered. In this situation, the taxpayer only received a tax benefit of $1,150, the amount by which total itemized deductions exceeded the standard deduction in the prior year. Therefore only $1,150 of the $1,500 state tax refund is included in taxable income for the current year.

Question 27

On May 25, Fresno sold Bronson, a minor, a used computer. On June 1, Bronson reached the age of majority. On June 10, Fresno wanted to rescind the sale. Fresno offered to return Bronson’s money and demanded that Bronson return the computer. Bronson refused, claiming that a binding contract existed. Bronson’s refusal is:

Disaffirm: to refuse, to annul, contradict

Answer 27

Justified, because Fresno must perform under the contract regardless of Bronson’s minority.

In this problem, Fresno was an adult and Bronson was a minor at the time of contracting. The common law gives minors the right to disaffirm a contract anytime while a minor or within a reasonable time after becoming an adult. Only the minor has the right to disaffirm. The adult may not disaffirm the contract.

Question 28

In the current tax year, Blake Smith provided more than half of the support for his cousin, niece, and a close family friend. Blake lives alone and sends a monthly support check to each person. None of the individuals whom Blake supports has any income or files a tax return. All three individuals are U.S. citizens. Which of the three people that Blake supports can he claim as a dependent on his tax return?

Answer 28

Niece

The niece meets the SUPORT test for qualifying relative status. The cousin and family friend do not meet the “R” (relative) or “T” (taxpayer lives with individual) tests. All three people whom Blake supports fail the residency test for a qualifying child.

Question 29

Heather, Erika, and Shelby are members in HES, a partnership. Heather works 40 hours per week and Erika and Shelby work 20 hours per week. Heather contributed $30,000 to the partnership and Erika and Shelby contributed $60,000 each. Erika and Shelby have each originated 45% of the partnership’s business and Heather has originated the other 10%.

If HES were a general partnership, who controls management?

Answer 29

Heather, Erika, and Shelby equally.

Absent an agreement to the contrary, partners have equal management authority.

Question 30

According to Treasury Circular 230, which of the following rules related to the prompt disposition of pending matters before the IRS applies to CPAs?

Answer 30

Practitioners may not unreasonably delay the prompt disposition of matters pending before the IRS.

Treasury Circular 230 Section 10.23 provides that a practitioner may not unreasonably delay the prompt disposition of any matter before the Internal Revenue Service (IRS). CPAs are practitioners subject to the Circular 230 duties and restrictions related to practice before the IRS.

Question 31

A corporate stockholder is entitled to which of the following rights?

Answer 31

Approve dissolution.

A stockholder has the right of approval over fundamental corporate changes such as dissolution.

The board of directors have discretion to declare dividends. Corporate stockholders do not have an absolute right to annual dividends.

Question 32

Where the parties have entered into a written contract intended as the final expression of their agreement, which of the following agreements will be admitted into evidence because they are not prohibited by the parol evidence rule?

Answer 32

YES. Subsequent
oral
agreements

NO. Prior
written
agreements

The parol evidence rule prohibits introduction of prior written statements to vary the terms of a fully integrated contract, but it does not bar the introduction of subsequent oral or written agreements.

Question 33

Jefferson’s investment income consisted of $2,000 in interest from a U.S. Treasury bond and $1,000 interest from a municipal bond. Jefferson also paid $4,000 in investment interest expense. Assuming that Jefferson itemizes, what amount can Jefferson deduct for investment interest expense?

Answer 33

$2,000

The itemized deduction for investment interest expense is limited to net taxable investment income. The $1,000 interest from a municipal bond is nontaxable. The taxpayer’s taxable investment income consists of the $2,000 taxable interest from a U.S. Treasury bond. Therefore the taxpayer’s investment interest expense deduction is limited to $2,000.

Question 34

Thorp was a purchasing agent for Ogden, a sole proprietor, and had the express authority to place purchase orders with Ogden’s suppliers. Thorp placed an order with Datz, Inc. on Ogden’s behalf after Ogden was declared incompetent in a judicial proceeding. Thorp was aware of Ogden’s incapacity. Which of the following statements is correct concerning Ogden’s liability to Datz?

Answer 34

Ogden will not be liable because Thorp’s agency ended when Ogden was declared incompetent.

An agency is terminated by operation of law upon the incapacity of the principal; no notice is needed.

Question 35

Chatham Corporation is a defendant in a lawsuit by the IRS. Which of the following statements is correct with respect to the various defenses that might be available to Chatham to avoid or reduce civil and criminal penalties that might otherwise be imposed on it?

Answer 35

The more-likely-than-not standard involves a position that has a more than 50 percent chance of succeeding.

The more-likely-than-not standard involves a position that has a more than 50 percent chance of succeeding.

Question 36

Max, a 19-year-old single taxpayer, works part time and goes to school part time. Maxʹs adjusted gross income (AGI) for the current year is $30,000. He made a $3,000 contribution to a Roth individual retirement account (IRA). Which of the following is a true statement about Maxʹs retirement savings contribution credit for the current year?

Answer 36

The credit is only available for $2,000 of Maxʹs contributions to a Roth IRA.

Only $2,000 of Maxʹs $3,000 Roth IRA contribution is eligible for the credit. The retirement savings contribution credit is a nonrefundable credit for contributions of up to $2,000 to either a traditional or Roth IRA by an eligible taxpayer.

Max is an eligible taxpayer because he is at least 18 years old by the end of the year, he is not a full-time student, and he is not a dependent of another taxpayer.

Question 37

Under the Revised Model Business Corporation Act, a merger of two public corporations usually requires all of the following, except:

Answer 37

Receipt of voting stock by all stockholders of the original corporations.

A merger can be effected by giving some parties cash or property; not everyone need receive voting shares.

Question 38

Which of the following is not necessary to create an express partnership?

Answer 38

Execution of a written partnership agreement.

A written partnership agreement, while certainly desirable, is not usually necessary to form a valid partnership; partnership agreements are not normally subject to the statute of frauds.