Module 8 Tax Law Compliance and Procedures

Question 1

Mary reported an income tax liability of $50,000 (on AGI of $300,000) on her tax return for 2022. This year, Mary expects to have an income tax liability of $60,000. She also has estimated that the amount of income tax withheld from her wages will total $35,000. What minimum amount of estimated tax payments must Mary pay (in equal quarterly installments) for 2023?

A)
$0
B)
$15,000
C)
$19,000
D)
$20,000

Answer 1

c
The required annual payment (since the prior-year AGI is greater than $150,000) is the lesser of:

90% of the current year tax ($60,000 x .90 = $54,000), OR
110% of the tax shown in the preceding year ($50,000 x 1.10 = $55,000)
reduced by the withholding of $35,000.
Thus, $54,000 reduced by the withholding of $35,000 equals $19,000.

LO 8.2.3

Question 2

Primary sources of tax information

A)
consist of periodicals and newsletters.
B)
are opinions, but useful in understanding tax law.
C)
are authoritative sources for use in tax planning.
D)
have no use for a tax planner.

Answer 2

c
The statutory law and its official interpretations, referred to as primary sources, are the legal authorities that set forth the tax consequences for a particular set of facts. Secondary sources of tax information consist mainly of books, periodicals, articles, newsletters, and editorial judgments published by tax services and are unofficial interpretations—mere opinions—which have no legal authority; although, they are an indispensable aid when seeking an understanding of the tax law.

LO 8.1.1

Question 3

Melanie has city income taxes of $800 and state income taxes of $1,000 withheld from her paycheck last year. She deducted these amounts on her income tax return for last year. This year, Melanie received a refund from the state for $200 due to an overpayment of the state tax. What is the proper tax treatment of the refund this year?

A)
Melanie must reduce the amount she deducts for state income taxes in the current year by the $200 refund.
B)
Melanie need not take any action because refunds are not income.
C)
The $1,000 deducted last year must be included as income in the current year.
D)
Melanie must include $200 in her gross income this year.

Answer 3

d
The tax benefit rule or doctrine converts an otherwise nontaxable receipt—in this case, the $200 state income tax refund—into taxable income. Melanie received a tax benefit by deducting the state income taxes the prior year, and any portion refunded to her would be taxable in the year it is received.

LO 8.2.3

Question 4

Disclosing or using client information given to a tax preparer may result in which one of the following maximum penalties?

A)
100% penalty
B)
50% tax penalty
C)
Closure of business
D)
Imprisonment for up to one year

Answer 4

d
Disclosing or otherwise using any client information given to a tax return preparer pursuant to the preparation of a tax return is a crime for which the preparer may be imprisoned for up to one year.

LO 8.2.1

Question 4

If an employer fails to withhold Social Security and federal income taxes from employee paychecks, what is the percentage penalty that is imposed by the IRS?

A)
50%
B)
25%
C)
100%
D)
75%

Answer 4

c
Employers are required to withhold amounts from an employee’s paycheck for Social Security taxes and federal income taxes. If the employer fails to do so or fails to pay such amounts to the IRS, they or any other responsible person will be subject to the 100% penalty, which is simply having to pay 100% of the amount they should have collected, accounted for, and paid; they are not subject to any additional penalty.

LO 8.2.1

Question 5

When the IRS assesses interest on the underpayment of income taxes by a taxpayer, when does the interest begin to be calculated?

A)
From the extended due date of the income tax return
B)
From the day the IRS contacts the taxpayer
C)
From the taxpayer’s tax year ending date
D)
From the original due date of the income tax return

Answer 5

d
Interest on underpayments (or overpayments) runs from the unextended due date of the tax return (i.e., April 15 of any given year if the individual taxpayer has a calendar tax year).

LO 8.2.3

Question 5

Which one of the following is NOT a main source of federal tax revenue?

A)
Individual income taxation
B)
Payroll taxation
C)
Corporate income taxation
D)
Sales taxation

Answer 5

d
The three main sources of federal tax revenue are individual income taxes, corporate income taxes, and payroll taxes; sales taxation is used by states, not the federal government.

LO 8.1.2

Question 5

Last year, Soleyah deducted $21,500 of itemized deductions. In the current year, she received a state income tax refund of $465. The $465 may be taxable income in the current year.

Which of the following tax doctrines may subject the refund to taxation?

A)
Tax benefit rule
B)
Step transaction doctrine
C)
Assignment of income doctrine
D)
Substance over form doctrine

Answer 5

a
This rule converts otherwise nontaxable receipts into taxable income. The most common example is when a taxpayer is reimbursed in a subsequent year for medical expenses paid and deducted in a previous year.

LO 8.1.2

Question 6

Which one of the following provides the least amount of federal revenue from IRS taxation?

A)
Individual income taxes
B)
Estate taxes
C)
Payroll taxes
D)
Corporate income taxes

Answer 6

b
The three main sources of federal tax revenue are individual income taxes, corporate income taxes, and payroll taxes. Individual income tax accounts for approximately 40% of the total tax revenue collected by the federal government. The federal estate tax and gift tax actually compose only a small percentage of annual tax revenues.

LO 8.1.2

Question 6

Which one of the following is a CORRECT hierarchy of authority of sources published by the IRS from most authoritative to least?

A)
Revenue Rulings, Regulations, Announcements
B)
Regulations, Technical Advice Memorandums, Private Letter Ruling
C)
Revenue Procedures, Revenue Rulings, Notices
D)
Regulations, Technical Advice Memorandums, Announcements

Answer 6

d
The hierarchy of sources published by the IRS from most authoritative to least is as follows:

Regulations
Revenue Rulings
Revenue Procedures
Private Letter Rulings
Technical Advice Memorandums
Notices
Announcements
LO 8.1.1

Question 6

Mary filed her 2022 income tax return on April 3, 2023. The IRS has recently determined that she worked a part-time job, but the employer failed to provide Mary with a W-2. Mary honestly did not realize that she was required to report the income because she did not receive a W-2. The IRS has determined that her negligent failure to report the income resulted in an additional income tax liability of $2,000. What is Mary’s tax penalty?

A)
$400
B)
$100
C)
$200
D)
$1,000

Answer 6

a
The negligence penalty is 20% of the deficiency due to the taxpayer’s negligence. For the $2,000 tax deficiency, 20% results in a negligence penalty of $400. It may be argued that the failure to report the income was fraud, but the fact pattern states that the act was merely negligent.

LO 8.2.2

Question 6

Which of the following sources of authority on a tax issue may be relied upon in tax research?

Treasury Regulation
Tax Court opinion
United States Supreme Court opinion
A)
I, II, and III
B)
II and III
C)
I and II
D)
I and III

Answer 6

a
Congress has authorized the Secretary of the Treasury to prescribe and issue all rules and regulations needed for enforcement of the Code. Regulations can be classified into three groups: (1) legislative (Treasury Regulation), (2) interpretive (Tax Court opinion), and (3) procedural (United States Supreme Court opinion).

LO 8.1.1

Question 7

Margo files her tax return 39 days after the due date. Along with the return, she remits a check for $6,000 (the balance of the tax owed). Disregarding any interest element, her combined failure-to-file and failure-to-pay penalties are

A)
$440.
B)
$400.
C)
$600.
D)
$660.

Answer 7

c
The failure-to-file penalty is netted against the failure-to-pay penalty: $60 + ($600 − $60) = $600.

LO 8.2.3

Question 7

Which one of the following statements regarding common tax traps is NOT accurate?

A)
Tax traps may result in the unexpected recognition of income.
B)
A transaction is based solely on its economic form.
C)
Tax traps are of particular concern to owners of closely held businesses.
D)
A transaction must be based on economic reality as well as economic form.

Answer 7

b
A transaction cannot be based solely on form; it must also be based on “economic reality.”

LO 8.2.3

Question 8

If an employer withholds Social Security and federal income taxes from employee paychecks, but fails to pay those amounts to the IRS, what is the percentage penalty that is imposed?

A)
75%
B)
100%
C)
25%
D)
50%

Answer 8

fbbvbbbbbbbbbbb
Employers are required to withhold amounts from an employee’s paycheck for Social Security taxes and federal income taxes. If the employer fails to do so or fails to pay such amounts to the IRS, they or any other responsible person will be subject to the 100% penalty.

LO 8.2.1b

Question 9

Which one of the following is a federal taxation function of the social objective?

A)
Reduction of taxes during a recession to stimulate the economy
B)
Restricting spending through greater taxation
C)
Promoting full employment
D)
Charitable deduction

Answer 9

d
The reduction of taxes in order to stimulate the economy is due to the economic objective, as well as restricting spending and promoting full employment. Social objectives of the federal taxation system include the charitable deduction, excluding life insurance proceeds from taxation, and renovation of a historic home.

LO 8.1.2

Question 9

How much is the penalty for filing a federal income tax return that the IRS deems as frivolous?

A)
$5,000
B)
$50
C)
75% of the underpayment of the tax liability
D)
$500

Answer 9

a
The penalty is $5,000 for each frivolous return filed.

LO 8.2.3

Question 10

Lana filed her 2021 income tax return on April 3, 2022. The IRS has recently determined that she worked a part-time job, but the employer failed to provide Lana with a W-2. Lana honestly did not realize that she was required to report the income, because she did not receive a W-2. The IRS has determined that her negligent failure to report the income resulted in an additional income tax liability of $2,000.

What is Lana’s tax penalty?

A)
$100
B)
$200
C)
$1,000
D)
$400

Answer 10

d
The answer is $400. The negligence penalty is 20% of the deficiency due to the taxpayer’s negligence. For the $2,000 tax deficiency, 20% results in a negligence penalty of $400. It may be argued that the failure to report the income was fraud, but the fact pattern states that the act was merely negligent.

LO 8.2.3

Question 11

Which one of the following is a tax return preparer failure that would initiate a tax penalty from the IRS?

A)
Failure to have the clients sign their return
B)
Failure to maintain a list of all returns prepared for the past 10 years
C)
Failure to keep a copy of all returns prepared for at least the last three years or to maintain a list of returns prepared
D)
Failure to provide a taxpayer with a receipt for their services

Answer 11

c
The following actions would constitute a tax return preparer’s failure and be subject to a tax penalty: failure to provide a taxpayer with a copy of their return, failure to keep a copy of all returns prepared for at least the last three years or to maintain a list of returns prepared, and failure to sign a return as preparer and give their tax identification number on the return.

LO 8.2.1

Question 11

The reduction of taxes in order to stimulate the economy is due to the economic objective, as well as restricting spending and promoting full employment. Social objectives of the federal taxation system include the charitable deduction, excluding life insurance proceeds from taxation, and renovation of a historic home.

LO 8.1.2

Answer 11

a
The negligence penalty is imposed if any part of the underpayment of tax is due to taxpayer neglect or a disregard for the tax rules and regulations, without the intent to defraud. The penalty is 20% of the portion of the underpayment attributable to negligence, which is $1,200 in this case.

LO 8.2.3

Question 11

Which of the following statements is CORRECT?

Targeted program audits make up approximately 25% of each year’s total of returns audited.
The general statute of limitations for audits is three years from the filing date of the return, but six years if 25% of gross income is unreported.
A)
Neither I nor II
B)
II only
C)
I only
D)
Both I and II

Answer 11

d
Targeted program audits make up approximately 25% of each year’s total of returns audited. The general statute of limitations for audits is three years from the filing date of the return (or due date, if later), but six years if 25% of gross income is unreported.

LO 8.2.2

Question 12

Frank is a single taxpayer who failed to report $500 of taxable income during the current tax year. Frank erroneously believed that the $500 was not considered to be income. Frank’s adjusted gross income is $90,000 for the current tax year. Which one of the following penalties is the IRS most likely to impose?

A)
Negligence penalty
B)
Criminal fraud penalty
C)
Civil fraud penalty
D)
Substantial understatement penalty

Answer 12

a
Penalties may be generally categorized as three types: (1) failure-to-file, (2) failure-to-pay penalties (which are automatically assessed by the IRS), and (3) underpayment penalties that are related to some negligence or intentional fault of the taxpayer. There are also underpayment penalties owing to some fault of the taxpayer. The least severe of these is the 90%/100% payment criteria to avoid the estimated tax penalty. However, there are also the following penalties, listed in order of their severity: criminal fraud, civil fraud, negligence, and frivolous return.

LO 8.2.3

Question 13

Chip files a timely tax return but is later required to pay an additional $15,000 in tax. Of this amount, $6,000 is attributable to Chip’s negligence. The negligence penalty will be

A)
$0; there is no penalty because the return was filed timely.
B)
$500; there is a maximum of $500 penalty.
C)
$3,000; a 20% penalty is applied to all tax due.
D)
$1,200; a 20% penalty is applied to the $6,000.

Answer 13

d
A 20% penalty ($6,000 × 0.20 = $1,200) applies to the negligence component.

LO 8.2.3

Question 14

Steve’s tax return for a prior tax year has been audited, and the IRS has assessed a deficiency of $10,000 against him. In addition, he owes interest of $3,000 on the deficiency. The deficiency was due to negligence on Steve’s part. What is the tax penalty that may be imposed on Steve?

A)
$7,500
B)
$5,000
C)
$700
D)
$2,000

Answer 14

d
The negligence penalty is imposed if any part of the underpayment of tax is due to taxpayer neglect or a disregard for the tax rules and regulations, without the intent to defraud. The penalty is 20% of the portion of the underpayment attributable to negligence, which is $2,000 in this case.

LO 8.2.2

Question 14

Which of the following represents the most severe tax penalty that may be imposed? A) Civil fraud B) Negligence C) Criminal fraud D) Frivolous return

Answer 14

c Criminal fraud is tax evasion, which is illegal. If convicted, a taxpayer will be subject to heavy fines, imprisonment, or both. LO 8.2.3

Question 15

Which of the following is the type of audit usually performed for a minor issue? A) Field audit B) Correspondence audit C) Office audit D) None of these types of audits

Answer 15

b A correspondence audit is usually performed through the mail because the disputed tax issue is minor. LO 8.2.2

Question 16

Paul was recently assessed a deficiency of $10,000, along with interest of $2,000, from a prior year's tax return. It has been determined that the deficiency was due to civil fraud. What is the amount of the fraud penalty? A) $6,000 B) $7,500 C) $10,000 D) $2,000

Answer 16

b Civil fraud, essentially, is taxpayer fraud that does not rise to the level of criminal fraud. If imposed, the penalty is 75% of the portion of tax underpayment attributable to fraud. In this case, the fraud penalty is $7,500 (75% of $10,000). The $2,000 from a prior year's return would be separate from the fraud penalty. LO 8.2.3

Question 17

Which one of the following is a taxation function of the economic objective? A) Reduction of taxes to stimulate the economy B) Excluding life insurance proceeds from taxation C) Renovation of a historic home D) Charitable deduction

Answer 17

a The reduction of taxes in order to stimulate the economy is due to the economic objective. Social objectives of the federal taxation system include the charitable deduction, excluding life insurance proceeds from taxation, and renovation of a historic home. LO 8.1.2

Question 17

Lester owns a commercial building that generates substantial rental income. He is concerned about the effect the rental income would have on his federal income tax liability. Lester directs the management company to send the rent checks to his three grandchildren in equal shares. He reasons that including the rental income in the grandchildren's gross income would be beneficial because their tax rate is much lower than his. Which of the following tax law doctrines presents the biggest obstacle to Lester's plan? A) Business purpose doctrine B) Assignment of income doctrine C) Constructive receipt doctrine D) Tax benefit doctrine

Answer 17

b Under the assignment of income doctrine, a taxpayer cannot assign the income he earns to someone else for income tax purposes. The rental income would still be taxable to Lester. LO 8.2.3

Question 17

If a taxpayer deducted medical expenses on a prior year's tax return and receives a reimbursement of the expenses from her insurance company in the following year, which one of the following rules or doctrines might cause the reimbursement to be included in income? A) Constructive receipt doctrine B) Assignment of income doctrine C) Ownership attribution rules D) Tax benefit rule

Answer 17

d The tax benefit rule applies to situations in which a particular tax benefit exists. For instance, if an insurance reimbursement is received for medical expenses, it is generally nontaxable. However, if the reimbursement was received in the year after a medical expense deduction was taken and a tax benefit was received for that deduction, then the reimbursement is converted into taxable income in that subsequent year. LO 8.2.3

Question 18

To be considered a responsible person by the IRS, which one of the following is among important factors? A) Authority to sign checks B) Shareholder of a similar company C) Impressive title D) Not in charge of hiring and firing employees

Answer 18

a The determination of whether someone is a responsible person is a test of facts and circumstances. Some of the questions the IRS usually asks in determining responsibility are as follows: Was the individual an officer or director? Was the individual a shareholder? Was the individual a member of a board of directors? Did the individual have the authority to sign checks? Was the individual responsible for hiring and firing employees? Did the individual have actual authority or merely an impressive title? LO 8.2.1

Question 19

Which of the following statements regarding constructively received income is CORRECT? Income is constructively received in the taxable year in which there is no substantial limitation or restriction on a taxpayer's right to bring the funds under personal control. Constructive receipt occurs only when income is actually received during the taxable year. A) I only B) Neither I nor II C) Both I and II D) II only

Answer 19

a Statement II is incorrect; income may be constructively received in a taxable year even if it is not actually received. LO 8.2.3

Question 20

Which one of the following is a tax return preparer failure that would initiate a tax penalty from the IRS? A) Failure to maintain a list of all returns prepared for the past five years B) Failure to have the clients sign their return C) Failure to provide a taxpayer with a copy of their return D) Failure to keep a copy of all returns prepared for at least the last 10 years

Answer 20

c The following actions would constitute a tax return preparer's failure and be subject to a tax penalty: failure to provide a taxpayer with a copy of their return, failure to keep a copy of all returns prepared for at least the last three years or to maintain a list of returns prepared, and failure to sign a return as preparer and give their tax identification number on the return. LO 8.2.1

Question 20

Which one of the following sources of information provides the most persuasive authority on a tax issue? A) Private Letter Ruling B) Treasury Regulation C) General Counsel Memorandum D) Revenue Ruling

Answer 20

b Treasury regulations carry the full effect of law. The other choices apply only to specific situations and, although helpful, are not as authoritative. LO 8.1.1

Question 21

Which one of the following are IRS statements reflecting the internal management practices of the IRS that affect the rights and duties of taxpayers? A) Revenue Rulings B) Revenue Procedures C) Regulations D) Private Letter Rulings

Answer 21

b Revenue Procedures are statements reflecting the internal management practices of the IRS that affect the rights and duties of taxpayers. Private Letter Rulings are taxpayer guidance from the IRS that apply only to the particular taxpayer(s) asking for the ruling; they are not applicable to all taxpayers. The primary purpose of the regulations is to explain and interpret particular IRS Code sections. LO 8.1.1

Question 22

Which one of the following best describes the tax benefit rule? A) Nontaxable receipts may be converted into taxable income. B) Stock owned by one person may be attributed to another related person who receives the tax benefits of ownership. C) Income is taxed to the tree that grows the fruit, even though the income is assigned to another prior to receipt. D) A solvent taxpayer may have to realize income upon the forgiveness of a debt by a creditor.

Answer 22

a The tax benefit rule provides that a recovery or reimbursement of a previously-deducted item will cause that recovery or reimbursement to be taxable. For instance, if an insurance reimbursement is received for medical expenses, it is generally nontaxable. However, if the reimbursement was received in the year after a medical expense deduction was taken and a tax benefit was received for that deduction, then the reimbursement is converted into taxable income in that subsequent year. LO 8.2.3

Question 22

Which one of the following objectives of the federal taxation system involves the collection of corporate income taxes? A) Social objective B) Revenue raising C) Writing tax code D) Economic objective

Answer 22

b Revenue raising through corporate, individual, and payroll taxes is an important objective of the federal taxation system. The first, and perhaps most important, goal of the economic objective is price stability. JGTRRA and TCJA significantly increased the Section 179 expense limit and the amount of depreciation deductions (bonus depreciation) that may be claimed in the first year in an attempt to stimulate purchases of business assets. LO 8.1.2

Question 23

Which one of the following is NOT a taxation function of the social objective? A) Charitable deduction B) Renovation of a historic home C) Reduction of taxes to stimulate the economy D) Excluding life insurance proceeds from taxation

Answer 23

c Social objectives of the federal taxation system include the charitable deduction, excluding life insurance proceeds from taxation, and renovation of a historic home. The reduction of taxes in order to stimulate the economy is due to the economic objective. LO 8.1.2

Question 24

Ed deducted $6,500 in medical expenses as an itemized deduction on his prior-year tax return. During the current year, he receives a reimbursement from his insurance company of $5,000. Which of the following rules or doctrines may cause the reimbursement to be taxable to Ed? A) Step transaction doctrine B) Assignment of income doctrine C) Tax benefit rule D) Substance over form doctrine

Answer 24

c The tax benefit rule converts otherwise nontaxable receipts into taxable income. The most common example is when a taxpayer is reimbursed in a subsequent year for medical expenses paid and deducted in a previous year. LO 8.1.2

Question 25

Which one of the following amendments to the U.S. Constitution established federal taxation in the U.S.? A) Eighteenth Amendment B) Fifteenth Amendment C) Seventeenth Amendment D) Sixteenth Amendment

Answer 25

d In 1913, the required number of states ratified the Sixteenth Amendment, and taxation of income began on March 1 of that year. Since that time, the federal income tax system has played an important role in an individual's investment decisions. LO 8.1.2

Question 26

A revenue ruling is A) a court's general administrative interpretation of the Internal Revenue Code and regulations. B) a judicial interpretation of an Internal Revenue Code provision or a Treasury regulation. C) an administrative interpretation of statutory tax law that is generally related to specific circumstances of fact. D) a judicial interpretation of specific circumstances related to a taxpayer.

Answer 26

c A revenue ruling is an administrative interpretation of statutory tax law that is generally related to specific circumstances of fact. LO 8.1.1

Question 27

Which of the following correctly describes the Targeted Program audit process? A) Matches information documents (e.g., W-2 or 1099 forms) to individual taxpayers' income tax returns B) Computes the norms and averages that are used in the Discriminant Functions System Program C) Voluntary compliance program designed for selected transactions or occupations D) Screens individual tax returns and ranks them in order of auditworthiness

Answer 27

c The IRS uses a targeted programs approach for approximately 25% of all returns audited. Targeted Program audits are not so much a revenue-raising device as they are a voluntary compliance device. When a particular problem area is singled out, the word quickly spreads, and voluntary compliance is greatly increased. LO 8.2.2

Question 28

Which is the best source for obtaining information about the intent of a very recent change in the tax law? A) Tax Court Reports B) Treasury Regulations C) RIA Federal Tax Coordinator D) Congressional Committee Reports

Answer 28

d Congressional Committee Reports indicate the intent of Congress when the law was passed. They may not be cited as precedent, but are especially useful if Regulations are not available. LO 8.1.1

Question 29

Which of the following statements regarding IRS audits is CORRECT? A correspondence audit is usually performed through the mail because the disputed tax issue is minor. The IRS is not required to disclose the criteria it uses in selecting returns for audit. An office audit is usually restricted in scope to a specific item or items and is performed at the IRS office by an office auditor. A field audit is an examination of numerous items and is usually performed on the premises of the taxpayer (such as a business office) by a revenue agent. A) III only B) I and IV C) I, II, III, and IV D) I, III, and IV

Answer 29

d Statements I, III, and IV are correct. Statement II is incorrect. The IRS is required to disclose the criteria it uses in selecting returns for audit and to take steps to protect the confidentiality of personal and financial information. LO 8.2.2

Question 29

Which one of the following is NOT a statute of limitations that restricts or allows the IRS to audit a return? A) Twelve years if 50% of gross income is unreported B) Six years if 25% of gross income is unreported C) No statute of limitations for failure to file or if a fraudulent return is filed D) Three years from the filing date of the return or due date if later

Answer 29

a After the statute of limitations has passed, except in cases of fraud, the IRS cannot audit a return. The statutes to be aware of are as follows: three years from the filing date of the return or due date if later, six years if 25% of gross income is unreported, and no statute of limitations for failure to file or if a fraudulent return is filed. LO 8.2.2

Question 30

John is a bartender who makes a significant amount of his income from tips. During the current year, John intentionally underreported by 20% the amount of tips that he received. Which one of the following penalties, potentially applicable to John, would most likely apply? A) Negligence B) Late payment C) Underpayment of estimated tax D) Civil fraud

Answer 30

d Negligence is the failure to make a reasonable attempt to comply with the provisions of the Code. The penalty for negligence is 20%. Civil fraud is knowing and showing intentional disregard of the Code and Regulations. The penalty for civil fraud is 75% of the amount underreported due to fraud by the taxpayer. Because the failure to report was intentional, the civil fraud penalty should apply. LO 8.2.3

Question 31

Secondary sources of tax information A) are authoritative sources for use in tax planning. B) are opinions, but useful in understanding tax law. C) consist of IRS notices and announcements. D) have no use for a tax planner.

Answer 31

c The statutory law and its official interpretations, referred to as primary sources, are the legal authorities that set forth the tax consequences for a particular set of facts. Secondary sources of tax information consist mainly of books, periodicals, articles, newsletters, and editorial judgments published by tax services and are unofficial interpretations—mere opinions—which have no legal authority; although, they are an indispensable aid when seeking an understanding of the tax law.

Question 31

A client currently is being audited by the IRS, and the agent has proposed a tax deficiency with which the client does not agree. The client has asked a CFP® certificant to research the issue. Which of the following sources is considered to be the most authoritative and, accordingly, would have the highest precedential value in defending the client's position to the IRS? A) Private Letter Ruling B) Treasury Regulations C) Revenue Procedure D) Revenue Ruling

Answer 31

b Treasury Regulations have the full force and effect of law. A Private Letter Ruling is never precedential, and Revenue Rulings and Revenue Procedures are merely administrative interpretations of the statutory tax law, with lower authority than Regulations. LO 8.1.1

Question 31

o be considered a responsible person by the IRS, which one of the following is among the important factors? A) Relative of a board member B) Not in charge of hiring and firing employees C) Shareholder of the company D) No authority to sign checks

Answer 31

c The determination of whether someone is a responsible person is a test of facts and circumstances. Some of the questions the IRS usually asks in determining responsibility are as follows: Was the individual an officer or director? Was the individual a shareholder? Was the individual a member of a board of directors? Did the individual have the authority to sign checks? Was the individual responsible for hiring and firing employees? Did the individual have actual authority or merely an impressive title? LO 8.2.1

Question 32

Which one of the following summarizes code sections in layman's terms, but have only short-term value? A) Private Letter Rulings B) Technical Advice Memoranda C) Notices D) Announcements

Answer 32

d Announcements often summarize code sections in layman's terms or notify taxpayers of impending deadlines; they have only short-term value. Technical Advice Memoranda normally take place during an audit or during the appeals process of the audit; they give both the taxpayer and the revenue agent an opportunity to resolve a dispute over a technical question. Private Letter Rulings are taxpayer guidance from the IRS that apply only to the particular taxpayer(s) asking for the ruling; they are not applicable to all taxpayers. A Notice is a public pronouncement that contains official guidance about regulations or interpretations of the Code. LO 8.1.1

Question 32

Announcements often summarize code sections in layman's terms or notify taxpayers of impending deadlines; they have only short-term value. Technical Advice Memoranda normally take place during an audit or during the appeals process of the audit; they give both the taxpayer and the revenue agent an opportunity to resolve a dispute over a technical question. Private Letter Rulings are taxpayer guidance from the IRS that apply only to the particular taxpayer(s) asking for the ruling; they are not applicable to all taxpayers. A Notice is a public pronouncement that contains official guidance about regulations or interpretations of the Code. LO 8.1.1

Answer 32

b The penalty for failing to file an income tax return is 5% of the amount due for each month, or part thereof, that the return is late, up to a maximum penalty of 25%. Dan has filed his return five full months, and a part of the sixth month, late, which seemingly results in a 30% penalty for late filing (5% per month for six months). However, the maximum failure-to-file penalty is 25% of the amount owed. LO 8.2.3

Question 32

If a court disallows a loss on the sale of an asset because the sale was not bona fide and was made for the sole purpose of realizing a loss, the court is applying A) the clear reflection of income doctrine. B) the step transaction doctrine. C) the assignment of income doctrine. D) the sham transaction doctrine.

Answer 32

d a sale that is not bona fide and made for the sole purpose of realizing a loss from the transaction would be considered a sham. LO 8.2.3

Question 33

im's 2022 income tax return, which was for a full year, showed an AGI of $185,000 and a tax liability of $35,000. He estimates his 2023 tax to be $40,000 and his total wage withholding to be $10,000. What minimum amount, if any, of estimated tax payments must Jim pay (in equal quarterly installments) for 2023? A) $28,500 B) $0 C) $36,000 D) $26,000

Answer 33

d The safe harbor for avoiding the underpayment penalty is the lesser of 90% of the current year tax liability or 110% of the prior-year tax liability if the prior year's AGI is over $150,000. 90% of the current year tax liability is $36,000; 110% of the prior-year tax liability is $38,500. The smaller of these numbers, reduced by the $10,000 withholding, equals $26,000. LO 8.2.3

Question 33

Maria is a single taxpayer. She is the owner of a car wash, from which she receives a substantial portion of her income in cash. Last year, the car wash had sales of $160,000, but Maria intentionally failed to report $15,000 of the sales that she received in cash. Which of the following penalties is the IRS most likely to apply if it determines that Maria underreported her income? A) Civil fraud penalty B) Willful reckless endangerment penalty C) Accuracy penalty D) Ad valorem penalty

Answer 33

a Maria is attempting to intentionally deceive the IRS, which will likely result in a civil fraud penalty. LO 8.2.1

Question 34

The doctrine of constructive receipt applies A) to large corporations only. B) to S Corporations mainly. C) when accrual accounting methods are utilized. D) when income is credited to a taxpayer's account, or otherwise made available without restriction (the taxpayer could access it during the current tax year).

Answer 34

d The concept of constructive receipt applies to cash accounting by corporations as well as individuals (e.g., dividends from stocks posted by previous year end but not received until beginning of current year). LO 8.2.3

Question 34

Which one of the following often summarize code sections in layman's terms or notify taxpayers of impending deadlines? A) Announcements B) Technical Advice Memoranda C) Private Letter Rulings D) Notices

Answer 34

a Announcements often summarize code sections in layman's terms or notify taxpayers of impending deadlines; they have only short-term value. Technical Advice Memoranda normally take place during an audit or during the appeals process of the audit; they give both the taxpayer and the revenue agent an opportunity to resolve a dispute over a technical question. Private Letter Rulings are taxpayer guidance from the IRS that apply only to the particular taxpayer(s) asking for the ruling; they are not applicable to all taxpayers. A Notice is a public pronouncement that contains official guidance about regulations or interpretations of the Code. LO 8.1.1

Question 35

Bill files his tax return 40 days after the due date. Along with the return, Bill remits a check for $5,000 (the balance of the tax owed). Disregarding the interest element, Bill's combined failure-to-file and failure-to-pay penalties are A) $550. B) $600. C) $500. D) $650.

Answer 35

c Explanation The penalty is determined as follows: Failure-to-pay penalty ½% × 2 (2 months delinquency) $50 Plus: Failure-to-file penalty 5% × $5,000 × 2 (2 months violation) $500 Less: Failure-to-pay penalty ($50) $450 Total penalties $500 LO 8.2.3

Question 35

Wayne and Gil are married taxpayers filing jointly. Wayne is the owner of an upscale restaurant, from which he receives a substantial portion of his income in cash. During the current year, the restaurant had sales of $80,000, but Wayne intentionally failed to report $15,000 of the sales that he received in cash. Which of the following penalties is the IRS most likely to apply if it determines that Wayne underreported his income? A) Underreporting penalty B) Negligence penalty C) Civil fraud penalty D) Substantial understatement penalty

Answer 35

c Wayne is attempting to deliberately deceive the IRS. This is civil fraud—essentially taxpayer fraud that does not rise to the level of criminal fraud. If imposed, the penalty is 75% of the portion of tax underpayment attributable to fraud. LO 8.2.1

Question 35

An EA, CPA, or attorney may represent a client before the IRS. A CFP® certificant is not allowed to do so unless he or she possesses one of the other listed credentials. LO 8.2.2

Answer 35

d There is no doctrine known as the comparative income doctrine. LO 8.2.3

Question 35

Alex's tax return for last year has been audited, and the IRS has assessed a deficiency of $5,000 against him. In addition, he owes interest of $3,000 on the deficiency. The deficiency was due to negligence on Alex's part. What is the tax penalty that may be imposed on Alex? A) $1,000 B) $700 C) $8,000 D) $3,000

Answer 35

a The negligence penalty is imposed if any part of the underpayment of tax is due to taxpayer neglect or a disregard for the tax rules and regulations, without the intent to defraud. The penalty is 20% of the portion of the underpayment attributable to negligence, which is $1,000 in this case. LO 8.2.2

Question 35

Which one of the following is a statute of limitations that restricts the IRS in auditing a return? A) Six years if 25% of gross income is unreported B) Twelve years if 50% of gross income is unreported C) Ten years for failure to file or if a fraudulent return is filed D) Seven years from the filing date of the return or due date if later

Answer 35

a After the statute of limitations has passed, except in cases of fraud, the IRS cannot audit a return. The statutes to be aware of are as follows: three years from the filing date of the return or due date if later, six years if 25% of gross income is unreported, and no statute of limitations for failure to file or if a fraudulent return is filed. LO 8.2.2

Question 35

Which one of the following would normally prompt a decrease in taxation of individuals and corporations according to an economic objective of the federal taxation system? A) Increased inflation B) A period of economic boom C) Reduced inflation D) A period of recession or depression

Answer 35

d During periods of recession or depression, it seems sensible to decrease the amount of taxes paid by individuals and corporations. This should allow people to spend more money, thus increasing demand, creating more jobs, and stimulating the economy. LO 8.1.2

Question 35

Interest on underpayments of federal income tax liabilities runs from the unextended due date of the tax return until paid. cannot be waived by the IRS if the taxpayer is audited and a tax deficiency results. A) I only B) II only C) Both I and II D) Neither I nor II

Answer 35

c Both statements are correct. Interest on underpayments (or overpayments) runs from the unextended due date of the tax return (i.e., April 15 of any given year). The rate of interest is set by statute and is the same rate that will be paid by the IRS on overpayments (refunds) to noncorporate taxpayers. Interest assessments cannot be waived by the IRS if the taxpayer is audited and a tax deficiency results. LO 8.2.2

Question 36

Which one of the following is primarily used to explain and interpret particular IRS Code sections? A) Revenue Rulings B) Revenue Procedures C) Private Letter Rulings D) Regulations

Answer 36

d The primary purpose of the regulations is to explain and interpret particular IRS Code sections. Private Letter Rulings are taxpayer guidance from the IRS that apply only to the particular taxpayer(s) asking for the ruling; they are not applicable to all taxpayers. LO 8.1.1

Question 36

Which one of the following objectives of the federal taxation system would include the addition of bonus depreciation to the tax code? A) Economic objective B) Writing tax code C) Revenue raising D) Social objective

Answer 36

d As a social objective, JGTRRA and TCJA significantly increased the Section 179 expense limit and the amount of depreciation deductions (bonus depreciation) that may be claimed in the first year in an attempt to stimulate purchases of business assets. The first, and perhaps most important, goal of the economic objective is price stability. Revenue raising through corporate, individual, and payroll taxes is an important objective of the federal taxation system. LO 8.1.2

Question 37

Which of the following credentials permit an individual to appear before the IRS on behalf of a client? Enrolled agent (EA) Certified Public Accountant (CPA) Attorney Certified Financial Planner certificant A) I, II, and III B) II and IV C) I, III, and IV D) I and II

Answer 37

a An EA, CPA, or attorney may represent a client before the IRS. A CFP® certificant is not allowed to do so unless he or she possesses one of the other listed credentials. LO 8.2.2

Question 37

Which one of the following is NOT a main source of federal tax revenue? A) Private company taxation B) Individual income taxation C) Corporate income taxation D) Payroll taxation

Answer 37

a The three main sources of federal tax revenue are individual income taxes, corporate income taxes, and payroll taxes; private company taxation is not a main source of federal tax revenue. LO 8.1.2

Question 37

Which of the following is NOT an example of the constructive receipt of income in 2023 for these cash basis taxpayers? On New Year's Eve 2023, Bart saw a client at lunch in a restaurant who told him that he would call his staff and tell them that if Bart dropped by his office before the end of the day, they could write a check for the $10,000 invoice the client owed Bart. If not, the client would write and mail a check to Bart on January 2, 2024. Bart was unable to go to his client's office before the end of the day. On January 13, 2024, Kayla received a statement from her bank advising that $290 was credited to her savings account on December 31, 2023, as interest income. Kayla did not know the interest amount until she received her bank statement. A) Both I and II B) I only C) II only D) Neither I nor II

Answer 37

b The check has not yet been written by Bart's client and would not be written in 2023 unless Bart was able to go to the client's office before the end of the day. Interest earned on a savings account in 2023 is income to the account owner in 2023. LO 8.2.3

Question 38

Which of the following sources of information would be the most authoritative when conducting research on an income tax issue? A) Treasury Regulation B) Revenue Procedure C) Technical Advice Memorandum D) CPA’s opinion letter

Answer 38

a The Treasury Regulations have the full force and effect of law, unlike the other listed options. LO 8.1.1

Question 39

Which one of the following best describes the assignment of income doctrine? A) A complex transaction may be collapsed and treated as taking place in one transaction. B) The substance of a transaction and not merely its form governs its tax consequences. C) Items may be reallocated among taxpayers to clearly reflect income. D) Income is taxed to the tree that grows the fruit, even though assigned to another prior to receipt.

Answer 39

d The assignment of income doctrine prevents taxpayers from assigning to another the income from property that the taxpayer owns. The doctrine is also known as the fruit and tree doctrine. LO 8.2.3

Question 39

Which of the following is a requirement for the IRS to assure protection of taxpayer rights? The IRS must disclose the criteria it uses in selecting returns for audit. The IRS must take steps to protect the confidentiality of personal and financial information. The IRS must follow due process when imposing tax levies. The IRS must provide clear explanations in any tax notices or inquiries. A) IV only B) I, II, III, and IV C) III only D) II and IV

Answer 39

b All of these are requirements the IRS must follow to assure taxpayer rights. LO 8.2.2

Question 40

Which one of the following is a CORRECT hierarchy of authority of sources published by the IRS from least authoritative to most? A) Revenue Procedures, Revenue Rulings, Notices B) Technical Advice Memorandums, Private Letter Rulings, Revenue Rulings C) Regulations, Technical Advice Memorandums, Private Letter Rulings D) Technical Advice Memorandums, Announcements, Revenue Procedures

Answer 40

b The hierarchy of sources published by the IRS from most authoritative to least is as follows: Regulations Revenue Rulings Revenue Procedures Private Letter Rulings Technical Advice Memorandums Notices Announcements LO 8.1.1

Question 40

A taxpayer currently is being audited by the IRS, and the agent has proposed a tax deficiency with which the taxpayer does not agree. The client has asked you to research the issue. Which one of the following sources is considered to be the most authoritative and, accordingly, would have the highest precedential value in defending the taxpayer's position to the IRS? A) Private Letter Ruling B) Treasury Regulations C) Revenue Ruling D) Revenue Procedure

Answer 40

b Treasury Regulations have the full force and effect of law. A Private Letter Ruling is never precedential, and Revenue Rulings and Revenue Procedures are merely administrative interpretations of the statutory tax law with lower authority than Regulations. LO 8.1.1

Question 41

Which one of the following is a tax return preparer failure that would initiate a tax penalty from the IRS? A) Failure to maintain a list of all returns prepared for the past five years B) Failure to provide a taxpayer with a receipt for their services C) Failure to keep a copy of all returns prepared for at least the last 10 years D) Failure to sign a return as preparer and give their tax identification number on the return

Answer 41

d The following actions would constitute a tax return preparer's failure subject to a tax penalty: failure to provide a taxpayer with a copy of their return, failure to keep a copy of all returns prepared for at least the last three years or to maintain a list of returns prepared, and failure to sign a return as preparer and give their tax identification number on the return. LO 8.2.1

Question 42

Which one of the following is a publication of specific taxpayer guidance from the IRS? A) Regulations B) Private Letter Rulings C) Revenue Procedures D) Revenue Rulings

Answer 42

b Private Letter Rulings are taxpayer guidance from the IRS that apply only to the particular taxpayer(s) asking for the ruling; they are not applicable to all taxpayers. The primary purpose of the regulations is to explain and interpret particular IRS Code sections. LO 8.1.1

Question 43

Which of the following parties may be subject to IRS penalties? A) Individual taxpayer only B) Both the individual taxpayer and the tax preparer C) Tax preparer only D) The individual taxpayer when the tax preparer has closed their business

Answer 43

b Both clients and tax professionals alike may be held accountable for tax reporting errors. Financial planners should also be aware that a tax return preparer might be subject to certain penalties. These penalties include failure to provide a taxpayer with a copy of their return, failure to keep a copy of all returns prepared for at least the last three years or to maintain a list of returns prepared, and failure to sign a return as preparer and give their tax identification number on the return. LO 8.2.1

Question 44

What is the amount and character of the penalty for an employer who fails to withhold Social Security and federal income taxes from employee paychecks? A) 50%, and the responsible party needs to pay back what is owed plus a 50% penalty B) 100%, but the responsible party needs only to pay back what is owed with no additional penalty C) 50%, but the responsible party needs only to pay back 50% of what is owed with no additional penalty D) 100%, and the responsible party needs to pay back what is owed plus a 100% penalty

Answer 44

b Employers are required to withhold amounts from an employee's paycheck for Social Security taxes and federal income taxes. If the employer fails to do so or fails to pay such amounts to the IRS, they or any other responsible person will be subject to the 100% penalty, which is simply having to pay 100% of the amount they should have collected, accounted for, and paid; they are not subject to any additional penalty. LO 8.2.1

Question 45

Which one of the following is NOT a group of the IRS Regulations? A) Legislative B) Procedural C) Interpretive D) Implementative

Answer 45

d Regulations can be classified into three groups: (1) legislative, (2) interpretive, and (3) procedural. LO 8.1.1

Question 45

Which one of the following is an application of the administrative powers of the Internal Revenue Service and not of the powers of Congress? Regulations Revenue Rulings A) I only B) Neither I nor II C) II only D) Both I and II

Answer 45

c Regulations are a direct extension of the lawmaking powers of Congress, whereas revenue rulings are an application of the administrative powers of the Internal Revenue Service. LO 8.1.1

Question 46

To be considered a responsible person by the IRS, which one of the following is among the important factors? A) Shareholder of a similar company B) Impressive title C) No authority to sign checks D) In charge of hiring and firing employees

Answer 46

d The determination of whether someone is a responsible person is a test of facts and circumstances. Some of the questions the IRS usually asks in determining responsibility are as follows: Was the individual an officer or director? Was the individual a shareholder? Was the individual a member of a board of directors? Did the individual have the authority to sign checks? Was the individual responsible for hiring and firing employees? Did the individual have actual authority or merely an impressive title? LO 8.2.1

Question 46

Which one of the following is advice from the National Office of the IRS requests that can give both the taxpayer and a revenue agent an opportunity to resolve a dispute? A) Private Letter Rulings B) Technical Advice Memoranda C) Notice D) Announcement

Answer 46

b Technical Advice Memoranda normally take place during an audit or during the appeals process of the audit; they give both the taxpayer and the revenue agent an opportunity to resolve a dispute over a technical question. Private Letter Rulings are taxpayer guidance from the IRS that apply only to the particular taxpayer(s) asking for the ruling; they are not applicable to all taxpayers. A Notice is a public pronouncement that contains official guidance about regulations or interpretations of the Code. Announcements often summarize code sections in layman's terms, or notify taxpayers of impending deadlines; they have only short-term value. LO 8.1.1

Question 47

Which one of the following is NOT a type of tax audit performed by the IRS? A) A home audit B) A field audit C) An office audit D) A correspondence audit

Answer 47

a The three types of tax audit performed by the IRS are as follows: a correspondence audit, which is usually performed through the mail because the disputed tax issue is minor; an office audit, which is usually restricted in scope to a specific item or items and is performed at the IRS office by an office auditor; and a field audit, which is an examination of numerous items and is usually performed on the premises of the taxpayer (such as a business office) by a revenue agent. LO 8.2.2

Question 47

Which of the following is a public pronouncement that contains official guidance about regulations or interpretations of the Internal Revenue Code (IRC)? A) Notice B) Revenue Ruling C) Private Letter Ruling D) Revenue Procedure

Answer 47

a A notice is a public pronouncement that contains official guidance about regulations or interpretations of the Code. The guidance is often substantial but again, ultimately it only points to higher regulations. Notices in and of themselves do not carry the weight of law. LO 8.1.1

Question 48

Which one of the following types of audits is conducted on a random basis? A) National Research Program audit B) Discriminant Functions System Program audit C) Targeted Program audit D) Document Matching Program audit

Answer 48

a Explanation The National Research Program audit is the only random audit that the IRS conducts. The NRP is, in effect, the replacement for the old Taxpayer Compliance Measurement Program audit. The Discriminant Functions System Program (DIF) compares the information on each return to a set of norms, weighs each item, and ranks the return for audit-worthiness. The Document Matching Program allows the IRS to detect discrepancies between the amounts reported on a tax return and the amounts shown on information documents (e.g., W–2 forms, 1099 forms). Under the Targeted Program Audit, the IRS "targets" particular taxpayers in particular situations. LO 8.2.2

Question 48

Which one of the following is NOT a goal of the federal income tax system? A) Monetary policy B) Economic growth C) Inflation control D) Price stability

Answer 48

a The Federal Reserve System controls monetary policy. Income tax policy is used to influence all of the other goals. LO 8.1.2

Question 49

Which one of the following is NOT a main source of federal tax revenue? A) Corporate income taxation B) Payroll taxation C) Taxation of taxpayers living abroad D) Individual income taxation

Answer 49

c The three main sources of federal tax revenue are individual income taxes, corporate income taxes, and payroll taxes; taxation of taxpayers living abroad is not a main source of federal tax revenue. LO 8.1.2

Question 50

Which one of the following is a statute of limitations that restricts the IRS in auditing a return? A) Ten years for failure to file or if a fraudulent return is filed B) Twelve years if 50% of gross income is unreported C) Seven years from the filing date of the return or due date, if later D) Six years if 25% of gross income is unreported

Answer 50

d After the statute of limitations has passed, except in cases of fraud, the IRS cannot audit a return. The statutes to be aware of are as follows: three years from the filing date of the return or due date if later, six years if 25% of gross income is unreported, and no statute of limitations for failure to file or if a fraudulent return is filed. LO 8.2.2

Question 51

If an individual taxpayer files an Extension Form 4868 on a timely basis in 2023, the 2022 federal income tax return is due (ignoring weekends or holidays), at the latest, by A) July 15, 2023. B) October 15, 2023. C) April 15, 2023. D) August 15, 2023

Answer 51

b The Form 4868 provides an automatic six-month extension of time to file the Form 1040. The return would be due April 15 without regard to extensions. With the six-month extension, the due date is October 15. LO 8.2.2

Question 51

Which one of the following objectives of the federal taxation system would include keeping prices stable? A) Revenue raising B) Social objective C) Writing tax code D) Economic objective

Answer 51

d The first, and perhaps most important, goal of the economic objective is price stability. As a social objective, JGTRRA and TCJA significantly increased the Section 179 expense limit and the amount of depreciation deductions (bonus depreciation) that may be claimed in the first year in an attempt to stimulate purchases of business assets. Revenue raising through corporate, individual, and payroll taxes is an important objective of the federal taxation system. LO 8.1.2

Question 52

Which of the following statements describes the constructive receipt doctrine? Darrell was issued notification in December of this year that his bonus for the current year would be $10,000 and the check would be issued in January next year. Martha was notified that a check would be issued to her on December 31 for royalties on her song used in a local commercial; the check was available for pick up that day. A) Both I and II B) II only C) I only D) Neither I nor II

Answer 52

b Darrell was only notified in December of the amount of the bonus that would be paid. No check was issued and the funds were not available until January of the following year. The check to Martha constitutes constructive receipt, whether or not she picks up the check in December. LO 8.2.3

Question 52

Which one of the following is NOT a federal taxation function of the economic objective? A) Reduction of taxes during a recession to stimulate the economy B) Restricting spending through greater taxation C) Charitable deduction D) Promoting full employment

Answer 52

c The reduction of taxes in order to stimulate the economy is due to the economic objective, as are restricting spending and promoting full employment. Social objectives of the federal taxation system include the charitable deduction, excluding life insurance proceeds from taxation, and renovation of a historic home. LO 8.1.2

Question 52

For a taxpayer with an AGI in excess of $150,000 for the prior tax year ($75,000 if married filing separately), the estimated tax penalty safe harbor is A) 90% of the prior year’s tax liability or 110% of the current year’s tax liability. B) 90% of the current year’s tax liability or 110% of the prior year’s tax liability. C) 120% of the prior year’s tax liability or 80% of the current year’s tax liability.

Answer 52

b The safe harbor is 90% of the current year's tax liability or 110% of the prior year's tax liability if the taxpayer's prior-year AGI exceeded $150,000. LO 8.2.3

Question 53

Which one of the following provides the greatest federal revenue from IRS taxation? A) Gift taxes B) Corporate income taxes C) Individual income taxes D) Estate taxes

Answer 53

c Explanation The three main sources of federal tax revenue are individual income taxes, corporate income taxes, and payroll taxes. Individual income tax accounts for approximately 40% of the total tax revenue collected by the federal government. The federal estate tax and gift tax actually compose only a small percentage of annual tax revenues. LO 8.1.2

Question 54

John has had a very good year and has over $600,000 of taxable income, including a sizable amount of capital gains. He's thinking of selling a large block of stock to a neighbor at a price significantly below market value solely to recognize the loss. If a court disallows the loss on the sale of the stock because the sale was not bona fide and was made for the sole purpose of realizing a loss, which doctrine is being applied? A) Assignment of income doctrine B) Clear reflection of income doctrine C) Step transaction doctrine D) Sham transaction doctrine

Answer 54

d A sale that is not bona fide and made for the sole purpose of realizing a loss from the transaction would be considered a sham transaction. LO 8.2.3

Question 55

Bill's 2022 income tax return, which was for a full year, showed an AGI of $140,000 and an income tax liability of $32,100. He estimates his 2023 income tax to be $38,000 and his total wage withholding to be $5,000. What minimum amount of estimated tax payments must Bill pay for 2023? A) $34,200 B) $27,100 C) $32,100 D) $41,800

Answer 55

b The safe harbor for avoiding the underpayment penalty is the lesser of 90% of the current year tax liability or 100% of the prior year tax liability (110% if the prior year's AGI was over $150,000). 100% of the prior year tax liability is $32,100. 90% of the current year tax liability of $38,000 is $34,200. The smaller of these numbers, reduced by the $5,000 withholding, equals $27,100. To avoid penalties, the estimated tax should be paid to the tax authorities in quarterly installments. LO 8.2.3

Question 55

Frank, a taxi driver, inadvertently fails to report approximately $1,200 of his tips received during the tax year. If the IRS imposes a penalty due to the underreported income, it would most likely impose a penalty equal to A) 20% of the deficiency. B) 75% of the deficiency. C) 20% of the deficiency plus 50% of the interest. D) 50% of the deficiency.

Answer 55

a Explanation The negligence penalty is likely to be imposed, due to the failure to make a reasonable effort to comply with the requirements of the Code. This carries a penalty of 20% of the deficiency. LO 8.2.3

Question 56

In 2023, Jim had an AGI of $160,000. What percentage of prior-year income tax must be paid by Jim in 2023 to avoid the imposition of a penalty for underpayment of estimated tax? A) 100% B) 80% C) 110% D) 90%

Answer 56

c The common exception for avoiding estimated tax penalties generally is 90% of the current year's tax or 100% of the prior year's tax. However, if the prior year's AGI exceeds $150,000, then the requirement is 90% of the current year tax or 110% of the prior year's tax liability. LO 8.2.3

Question 57

Brandon failed to file a federal income tax return for last year's tax liability by April 15 of the current year. He filed his tax return October 30 of the current year and remitted the tax that was due. Which of the following statements is CORRECT? Brandon will owe interest to the IRS on the unpaid tax liability that runs from April 15 of the current year until the tax liability is paid in full. Because he took so long to file, the 90%/100% payment criteria does not apply. Brandon will be assessed the failure-to-file penalty. Depending on the facts and circumstances surrounding the return filed, Brandon could be assessed a negligence penalty. A) I, II, III, and IV B) I only C) III and IV D) I, III, and IV

Answer 57

d Statement II is incorrect. The 90%/100% underpayment criteria will still apply even though Brandon did not file in a timely manner. All of the other statements are correct. LO 8.2.3

Question 57

Gil owns a portfolio of income-producing real estate. Gil retains ownership of the real estate but directs that the rental income be paid to his son, Kevin. The income is paid directly to Kevin, who reports it as part of his taxable income. Gil does not report the income on his tax return. With which one of the following potential tax traps should Gil be most concerned? A) Constructive receipt B) Assignment of income C) Ownership attribution rules D) Substance over form

Answer 57

The fact that Gil retains ownership of the property and merely assigns the income to someone else is a potential tax trap for him. The assignment of income doctrine serves to tax the person who actually owns the property producing the income. The income cannot merely be assigned to another in order to generate tax advantages. LO 8.2.3

Question 58

All of the following are tax avoidance techniques except A) investing in tax-free municipal bonds. B) owning, rather than renting, a residence to benefit from claiming a home mortgage interest deduction. C) investing in zero-coupon U.S. Treasury bonds. D) utilizing tax credits such as qualifying child care expenses.

Answer 58

c Taxes must be paid on accrued interest on zero-coupon Treasury bonds even though no cash income is received. The other choices are legitimate tax avoidance techniques. LO 8.2.3

Question 58

Fred runs a small business that has been in the family for over 50 years. The business has always used the cash basis method of accounting. Which of the following would be considered income to Fred last year? A bonus he declared for himself on December 31 of last year that is not payable until January 2 of the following year Dividends received on December 30 of last year Salary received during last year Interest on his money market account last year, but not posted until January 2 of the next year A) I and II B) I, II, and III C) II, III, and IV D) II and III

Answer 58

c For the cash method of accounting, all income actually received during the tax year is included in gross income (e.g., dividends, interest, wages). Income received constructively during the year, even though actual receipt is delayed, is includible for the tax year. Bonuses declared but not yet payable until the next tax year are not includible for the prior tax year because there was no constructive receipt. LO 8.2.3