Part 2 - Businesses - Unit 3 - Questions

Question 1

Harry, a single person, died in 2023. The executor does not elect the alternate valuation date. Given the following information, determine the value of Harry’s gross estate.

FMV at Date of Death:
CD: $100,000
Mortgage Receivable on Sale of Property: $2,000,000
Painting and Collectibles: $500,000
Income Tax Refunds Due from 2022 Individual Tax Return: $30,000
Household Goods and Personal Effects: $20,000

A. $2,600,000
B. $2,650,000
C. $2,620,000
D. $2,120,000

Answer 1

B. $2,650,000.

• The gross estate is valued at the date of death, unless the alternate valuation method is elected. The gross estate includes all property in which the decedent had an interest (including real property outside the United States). It also includes:

1. Certain transfers made during the decedent’s life without an adequate and full consideration in money or money’s worth;
2. Annuities;
3. The includible portion of joint estates with right of survivorship;
4. The includible portion of tenancies by the entirety;
5. Certain life insurance proceeds (even though payable to beneficiaries other than the estate);
6. Property over which the decedent possessed a general power of appointment;
7. Dower or curtesy (or statutory estate) of the surviving spouse; and
8. Community property to the extent of the decedent’s interest as defined by applicable law.

• Accordingly, all of the above amounts are includible in Harry’s gross estate.
• Therefore, the value of Harry’s gross estate is $2,650,000.

Question 2

A fiduciary representing a dissolving corporation may file a request for prompt assessment of tax. Generally, this request reduces the time allowed for assessment to:

A. 12 months.
B. 18 months.
C. 24 months.
D. 30 months.

Answer 2

B. 18 months.

• Normally, the Internal Revenue Service has 3 years after an income tax return is filed to assess additional tax or to begin court action to collect the tax. However, a personal representative may request a prompt assessment of tax after the return has been filed. This reduces the time for making the assessment to 18 months from the date the written request for prompt assessment was received.
• The fiduciary representing a dissolving corporation, or an administrator of a decedent’s estate, may request a prompt assessment of tax under Internal Revenue Code (IRC) Section 6501(d). This will limit the time to 18 months from the date the fiduciary files the request, but not beyond 3 years from the date the return is filed.

Question 3

Joaquin is a small business owner who maintains a SIMPLE plan for his employees:

1. Jan is a 42-year-old part-timer who has worked for Joaquin in this business since 2017. She works 15 hours per week. She earned $13,500 in 2023.
2. Malik is a 72-year-old seasonal worker who works from September through December. He has worked for Joaquin in this business since 2018 and earned $6,000 in 2023.
3. Monica is 21 years old and works 10 hours per week, all year. She has worked for Joaquin since June 2022 and earned $4,800 in 2023.

Joaquin’s business had net taxable income in 2023 of $62,300. All employees and Joaquin are U.S. citizens and none of them are union members. Which of the individuals listed below can be excluded from coverage under the SIMPLE plan in 2023?

A. Jan
B. Malik
C. Monica
D. Joaquin

Answer 3

C. Monica.

• An employee must be allowed to participate in an employer’s SIMPLE plan if the employee:

1. Received at least $5,000 in compensation from his or her employer during any 2 years prior to the current year, and
2. Is reasonably expected to receive at least $5,000 in compensation during the calendar year for which contributions are made.
   In addition, the term “employee” includes a self-employed individual who received earned income.

• In this problem, Monica has worked only 1 year and has compensation of $4,800, which is less than the threshold amount of $5,000. Hence, Joaquin can exclude Monica from participating in the SIMPLE plan.

Question 4

How must a corporate horse breeder account for breeding fees under Section 447?

A. Use the accrual method of accounting for tax purposes and capitalize the breeding fees and allocate them to the cost basis of offspring.
B. Use the accrual method of accounting for tax purposes and amortize the breeding fees over a 5-year period.
C. Use the accrual method of accounting for tax purposes and depreciate the breeding fees as 3-year property under MACRS.
D. Use the cash method of accounting for tax purposes and expense the breeding fees in the year purchased.

Answer 4

A. Use the accrual method of accounting for tax purposes and capitalize the breeding fees and allocate them to the cost basis of offspring.

• Under an accrual method of accounting, you generally report income in the year earned and deduct or capitalize expenses in the year incurred. The purpose of an accrual method of accounting is to correctly match income and expenses. Certain businesses engaged in farming must use an accrual method of accounting for their farm business and for sales and purchases of inventory items. (Publication 225, page 7)
• IRC Section 447(a) provides the general rule that the accrual method of accounting shall be used in computing taxable income from farming of a corporation engaged in the trade or business of farming, or a partnership engaged in the trade or business of farming, if a corporation is a partner in such partnership. Publication 225, page 7, gives other limitations to the kinds of corporations or other organizations that are required to use accrual accounting. In general, the following businesses are required to use an accrual method of accounting:

1. A corporation that has gross receipts of more than $29 million.
2. A partnership with a corporation as a partner, if that corporation meets the $29 million requirement, or
3. A tax shelter.

• With respect to breeding fees, Publication 225, page 22, provides that a taxpayer can deduct breeding fees as a farm business expense. If, however, the taxpayer uses the accrual method of accounting (as a corporation does), the taxpayer must capitalize breeding fees and allocate them to the cost basis of the calf, foal, etc.

Note: Breeding fees are not discussed in IRC Section 447.

Question 5

In 2020, Thomas Hatch established the TWH Trust. TWH is a revocable trust. Thomas contributed cash, a significant stock portfolio, and tax-exempt bonds to this trust when he established it. In 2023, the TWH Trust had income consisting of $5,000 in taxable interest, $3,000 in ordinary dividends, and $2,000 in tax-exempt interest. Thomas has never relinquished dominion and control of the TWH Trust. What amount of the TWH Trust’s income is taxable to Thomas Hatch in 2023?

A. $10,000
B. $8,000
C. $5,000
D. $0

Answer 5

B. $8,000.

• A trust is a grantor trust if the grantor retains certain powers or ownership benefits. In general, a grantor trust is ignored for tax purposes and all of the income, deductions, etc. are treated as belonging directly to the grantor.
• As a result, all of the income from Thomas’s revocable trust will be taxed to him, regardless of distributions. Thus, Thomas includes $8,000 in income, which is the sum of the taxable interest ($5,000) and ordinary dividends ($3,000).

Question 6

Which of the following is more than the allowable contribution amount to a self-employed retirement plan in 2023?

A. Contribution of $15,000 to a self-employed individual’s own defined contribution Keogh plan. The individual’s net earnings from self-employment (on Schedule C) are $40,000.
B. $18,000 to the SEP-IRA of an employee who earned $100,000 in 2023.
C. $17,000 contribution into a SIMPLE IRA by an employee who earns $30,000.
D. A contribution of $16,000 to an employee’s account in a defined contribution plan. The employee earned $40,000.

Answer 6

C. $17,000 contribution into a SIMPLE IRA by an employee who earns $30,000.

• Profit sharing plans are one type of Keogh plan that allows a business to contribute up to the lesser of 100% of the compensation or $66,000 for 2023. In this case, $15,000 would be required to be less than $40,000.
• For 2023, a defined contribution plan’s annual contributions and other additions (excluding earnings) to the account of a participant cannot exceed the lesser of 100% of the participant’s compensation (i.e., $40,000 of net earnings) or $66,000 for 2023. In this case, $16,000 is less than $40,000.
• Contributions a taxpayer makes for 2023 to a common-law employee’s SEP-IRA cannot exceed the lesser of 25% of the employee’s compensation (i.e., $25,000, which is 25% of $100,000) or $61,000. Compensation generally does not include the taxpayer’s contributions to the SEP. In this case, $18,000 is less than the $25,000.
• Publication 560, page 15, provides the limits for an employee’s contribution to an employer’s SIMPLE plan. The amount the employee chooses to have contributed to a SIMPLE IRA on his or her behalf cannot be more than and $15,500 for 2023.
• As a result, the $17,000 contribution to the SIMPLE plan by an employee who earns $30,000 is more than the allowable contribution amount of $15,500 for 2023.

Question 7

Based on the following information, what is the total allowable deduction against the decedent’s estate?

Mortgages and notes (receivable) $10,000
Income in respect of a decedent 5,000
Funeral expenses 12,000
Attorney fees 20,000

A. $47,000
B. $32,000
C. $42,000
D. $10,000

Answer 7

B. $32,000.

• An estate will arrive at the tentative taxable estate (Form 706, Part 2, line 3a) by subtracting allowable deductions against its gross estate. A recapitulation of the gross estate and deductions appear as Schedules listed on Form 706, Part 5. The deductions appear on lines 14 through 22 of Form 706, Part 5, and as applicable to this question, the following expenses are permitted as deductions on line 2 of the Tax Computation (Part 2):

1. Funeral expenses and administrative expenses, which include attorney’s fees (Schedule J, Form 706, lines A and B2).
2. Debts of the decedent (Schedule K, Form 706).
3. Mortgages and liens (Schedule K, Form 706).

• Since the mortgages and notes are receivable, they are income items and as such are not deductible items against the decedent’s estate on Schedule K. Therefore, the total allowable deductions against the decedent’s estate are $32,000, which are the funeral expenses and attorney fees. (Form 706 Instructions, pages 33–34).

Question 8

Income in respect of a decedent must not be included in the income of which of the following?

A. The decedent’s final 1040 filing.
B. The decedent’s estate (if received by the estate).
C. The beneficiary’s filing (if the right to income is passed directly to and received by the beneficiary).
D. Any person to whom the estate properly distributes the right to receive it.

Answer 8

A. The decedent’s final 1040 filing.

• The decedent’s income includible on the final return is generally determined as if the person were still alive except that the taxable period is usually shorter because it ends on the date of death. The method of accounting regularly used by the decedent before death also determines the income includible on the final return (Publication 559, page 6).
• Additionally, all income the decedent would have received had death not occurred that was not properly includible on the final return is income in respect of a decedent.
• Publication 559, page 13, states that income in respect of a decedent must be included in the income of one of the following:

1. The decedent’s estate, if the estate receives it;
2. The beneficiary, if the right to income is passed directly to the beneficiary and the beneficiary receives it; or
3. Any person to whom the estate properly distributes the right to receive it.

• Therefore, income in respect of a decedent must not be included in the income of the decedent’s final Form 1040 filing.

Question 9

Ms. Winter owns an apartment complex. She received $5,000 in December 2023 to cover the January rents for tenants who will be on vacation January 15, 2024, when the rent is due. Although she is a cash basis taxpayer for purposes of filing her return, she uses the accrual method of accounting to maintain her books on the rental property. What amount should Ms. Winter report if she uses the accrual method of accounting?

A. $0 in 2023 and $0 in 2024.
B. $0 in 2023 and $5,000 in 2024.
C. $5,000 in 2023 and $0 in 2024.
D. $5,000 in 2023 and $5,000 in 2024.

Answer 9

C. $5,000 in 2023 and $0 in 2024.

• Rental income and expenses are discussed in general in Publication 527. In general, a taxpayer must include in gross income all amounts that are received as rent. Rental income is any payment received for the use or occupation of property.
• In addition to amounts received as normal rent payments, there are other amounts that may be rental income and as such are included in rental income. Advance rent, for example, is any amount received before the period that it covers. These payments are included in rental income in the year received regardless of the period covered or the method of accounting that the taxpayer is using.
• In this problem, the taxpayer includes the $5,000 of advance rent as rental income in the year received (i.e., 2023). It does not matter what period the payment is for or the method of accounting that the taxpayer is using. (See Publication 527, pages 3–4.)

Question 10

Given the following information, determine the value of Sara’s gross estate in 2023:

FMV at Date of Death:
Beneficiary for life of a QTIP trust (Qualified terminal interest property): $10,000,000
Irrevocable trust (Sara was the grantor, but retained no interest in the trust): $1,000,000
Revocable grantor type trust (Sara was the grantor): $500,000

A. $10,500,000.
B. $11,500,000.
C. $11,000,000.
D. $500,000.

Answer 10

A. $10,500,000.

• The gross estate is valued at the date of death, unless the alternate valuation method is elected. The gross estate includes all property in which the decedent had an interest (including real property outside the United States). It also includes:

1. Certain transfers made during the decedent’s life without an adequate and full consideration in money or money’s worth;
2. Annuities;
3. The includible portion of joint estates with right of survivorship;
4. The includible portion of tenancies by the entirety;
5. Certain life insurance proceeds (even though payable to beneficiaries other than the estate);
6. Property over which the decedent possessed a general power of appointment;
7. Dower or curtesy (or statutory estate) of the surviving spouse; and
8. Community property to the extent of the decedent’s interest as defined by applicable law.

• Accordingly, the value of Sara’s gross estate in 2023 is $10.5 million, determined as follows:

QTIP Trust: $10,000,000
Revocable Grantor Trust: $500,000
Gross Estate: $10,500,000.

Question 11

Generally, in determining the taxable income for most taxpayers, Internal Revenue Code (IRC) Section 469 limits the deduction of losses from passive activities to the amount of income derived from all passive activities. Which of the following statements is correct for an estate or trust that has a loss from a passive activity owned by the estate or trust?

A. It can be used to offset portfolio income (interest, dividends, royalties, annuities, etc.) of the estate or trust in determining taxable income.
B. It can offset passive activity losses only against passive activity income in the current year.
C. It can offset passive activity losses only against passive activity income and any passive activity losses or credits that are not allowed in the current year can be carried forward to the next year.
D. It can be used to offset portfolio income of the estate or trust in determining taxable income and any passive activity losses or credits that are not allowed in the current year can be carried forward to the next year.

Answer 11

C. It can offset passive activity losses only against passive activity income and any passive activity losses or credits that are not allowed in the current year can be carried forward to the next year.

• A passive activity is any trade or business activity in which the taxpayer does not materially participate. Rental activities are passive activities regardless of the taxpayer’s participation, unless the taxpayer meets certain eligibility requirements.
• Individuals, estates, and trusts can offset passive activity losses only against passive activity income. Passive activity losses or credits that are not allowed in one tax year can be carried forward to the next year.

Question 12

For 2023, what is the maximum amount that can be contributed on your behalf, assuming that other requirements are met, to a SIMPLE plan if you are over 50 years old?

A. $17,500
B. $15,500
C. $19,000
D. $18,500

Answer 12

C. $19,000.

• Publication 560, page 15, provides the limits for an employee’s contribution to an employer’s SIMPLE plan. The amount the employee chooses to have contributed to a SIMPLE IRA on his or her behalf cannot be more than $15,500 for 2023.
• A SIMPLE IRA plan can permit participants who are age 50 or over at the end of the calendar year to also make catch-up contributions. The catch-up contribution limit for $3,500 for 2023. Salary reduction contributions are not treated as catch-up contributions for 2023 until they exceed $15,500. However, the catch-up contribution a participant can make for a year cannot exceed the lesser of:
  
  • The catch-up contribution limit or
  • The excess of the participant’s compensation over the salary reduction contributions that are not catch-up contributions.
• As a result, the maximum amount that can be contributed on your behalf, assuming that other requirements are met, to a SIMPLE plan if you are over 50 years old is $19,000 for 2023, which is $15,500 for the basic contribution and $3,500 for the catch-up contribution.

Question 13

Bearing is an individual taxpayer who uses the filing status of single. A review of Bearing’s Year 2 records disclosed the following tax information:

Wages: $ 18,000
Taxable interest and qualifying div.: 4,000
Schedule C trucking business NI: 32,000
Rental (loss) from residential property: (35,000)
Limited partnership (loss): 5,000)

Bearing actively participated in the rental property and was a limited partner in the partnership. Bearing had sufficient amounts at risk for the rental property and the partnership. What is Bearing’s Year 2 adjusted gross income?

A. $14,000
B. $19,000
C. $29,000
D. $54,000

Answer 13

C. $29,000.

• Items included in AGI: Wages ($18,000) + Taxable interest and qualified dividends ($4,000) + Schedule C income from business ($32,000) − Maximum allowed deduction for residential rental property ($25,000) = $29,000 AGI.
• The limited partnership loss is not deductible as it is a passive activity. The rental loss may be deducted up to a maximum of $25,000 for a single taxpayer. All other income items are taxable.

Question 14

A trust was required to distribute $10,000 a year to its sole beneficiary out of the trust’s income for the year. In 2023, the distributable net income of the trust was $8,000 and the actual amount distributed was $7,000. How much income must the beneficiary report for 2023?

A. $10,000
B. $8,000
C. $0
D. $7,000

Answer 14

B. $8,000.

• A trust will qualify as a simple trust if:

1. The trust instrument requires that all income must be distributed currently,
2. The trust instrument does not provide that any amounts are to be paid, permanently set aside, or used for charitable purposes, and
3. The trust does not distribute amounts allocated to the corpus of the trust.

• Additionally, the beneficiary of a simple trust must include in his or her gross income the amount of the income required to be distributed currently, whether or not distributed, or if the income required to be distributed currently to all beneficiaries exceeds the distributable net income (DNI), his or her proportionate share of the DNI.
• Given that the trust had $8,000 of distributable net income to distribute, the beneficiary should report income of $8,000, computed as follows:

DNI $8,000
100% Beneficiary x 1.0
To the beneficiary $8,000

Question 15

Where is the income of a grantor trust reported?

A. Grantor’s return regardless of whether a distribution is or is not made from the trust to the grantor.
B. Grantor’s return only if distributions from the trust are made to the grantor.
C. Grantor’s return only if no distributions from the trust are made to the grantor.
D. The income is not reported.

Answer 15

A. Grantor’s return regardless of whether a distribution is or is not made from the trust to the grantor.

• A trust is a grantor trust if the grantor retains certain powers or ownership benefits. In general, a grantor trust is ignored for tax purposes and all of the income, deductions, etc. are treated as belonging directly to the grantor, regardless of distributions. Hence, it is the grantor’s return that reports the income from the grantor’s trust. (Instructions for Form 1041, pages 13–14).
• If the entire trust is a grantor trust, fill in only the entity information of Form 1041. Don’t show any dollar amounts on the form itself; show dollar amounts only on an attachment to the form. Don’t use Schedule K-1 (Form 1041) as the attachment.
• In addition, a grantor trust is a legal trust under applicable state law that is not recognized as a separate taxable entity for income tax purposes because the grantor or other substantial owners have not relinquished complete dominion and control over the trust. (Instructions for Form 1041, page 19)

Question 16

A farmer sold a 3-year-old raised dairy cow for $600. It cost him $75 for shipping and commissions to sell the cow. He reports this sale as follows on his tax return:

A. A loss of $700 on his Schedule F because he believed it cost him $1,300 to raise the dairy cow
B. A Section 1245 gain of $525 reported on Form 4797
C. A gain of $525 reported on Schedule F as ordinary farm income
D. A Section 1231 gain of $525 reported on Form 4797

Answer 16

D. A Section 1231 gain of $525 reported on Form 4797.

• Publication 225, page 10, provides the general rules for sales of business property for farmers. To begin, income from farming reported on Schedule F (Form 1040), which includes amounts received by the taxpayer from cultivating, operating, or managing a farm for gain or profit, either as owner or tenant. This includes income from operating a stock, dairy, poultry, fish, fruit, or truck farm and income from operating a plantation, ranch, range, or orchard. It also includes income from the sale of crop shares if the farmer materially participates in producing the crop.
• Income received from operating a nursery, which specializes in growing ornamental plants, is considered to be income from farming.
• Amounts received from the sale of products raised on the farm for sale (or bought for resale), such as livestock, produce, or grains, are reported on Schedule F.
• However, as provided on page 9 of Publication 225 (under Form 4797 header), sales of livestock held for draft, breeding, sport, or dairy purposes may result in ordinary or capital gains or losses, depending on the circumstances. In either case, a taxpayer should always report these sales on Form 4797 (under Section 1231 gains) instead of Schedule F.
• In this problem, the farmer sold a 3-year-old raised dairy cow, which would fall under the category of income that is not reported on Schedule F but rather on Form 4797. The amount to be reported is $525, which is the difference between the selling price of $600 and the cost of shipping the cow of $75. Apparently, the cow had no adjusted basis to account for. If it did, the adjusted basis would be subtracted from the selling price for purposes of determining profit.

Question 17

The Wilder Trust is a complex trust with a controlling instrument that specifically allocates capital transactions to the corpus of the trust. The instrument goes on to state that $2,000 will be set aside out of gross income for charitable purposes and that $10,000 in income is required to be distributed each year. At the end of 2023, the Wilder Trust had $20,000 in gross income, which included $5,000 in capital gains. If there was no other information to consider, what would the Wilder Trust’s income distribution deduction be for 2023?

A. $18,000.
B. $13,000.
C. $10,000.
D. $5,000.

Answer 17

C. $10,000.

• A trust or decedent’s estate figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to estates and trusts. However, one major distinction is that a trust or decedent’s estate is allowed an income distribution deduction for distributions to beneficiaries. (Form 1041 Instructions, page 3)
• The income distribution deduction allowable to estates and trusts is limited to its distributable net income (DNI). A trust will arrive at DNI by adding and subtracting applicable amounts against its adjusted total income as figured on Schedule B. (See Schedule B on Form 1041 and the instructions for Form 1041, page 4.)
• More specific to the issue in this question, when calculating the DNI for a complex trust, any amounts allocable to the corpus are disregarded in determining the adjusted total income amount.
• Thus, given that DNI (see calculation below) is more than the amount required to be distributed, the income distribution deduction for 2023 is $10,000, which is the lesser of amount distributed ($10,000) or DNI ($13,000).Gross income $20,000
  Less:
  Charitable contribution (2,000)
  Adjusted total income $18,000
  Less:
  Capital gains (5,000)
  Distributable net income $13,000*
• *This is what the income distribution deduction is limited to. However, no limitation is placed on the deduction because the amount required to be distributed is less than the DNI. See page 4 of the instructions for Form 1041 for more details on this rule.

Question 18

After Mary died on June 30, 2023, her executor identified the following items belonging to her estate:

• Personal residence with a fair market value of $400,000 and an existing mortgage of $100,000
• Certificate of deposit in the amount of $150,000, of which $10,000 was accrued interest payable at maturity on August 1, 2023
• Stock portfolio with a value at date of death of $1 million and a basis of $500,000
• Life insurance policy, with her daughter named as an irrevocable beneficiary, in the amount of $150,000

Assuming that no alternate valuation date is elected, what is the gross value of Mary’s estate?

A. $1,700,000.
B. $1,090,000.
C. $1,550,000.
D. $1,450,000.

Answer 18

C. $1,550,000.

• The gross estate is valued at the date of death, unless the alternate valuation method is elected. The gross estate includes all property in which the decedent had an interest (including real property outside the United States). It also includes (as given on pages 1 and 2 of the Instructions for Form 706):

1. Certain transfers made during the decedent’s life without an adequate and full consideration in money or money’s worth;
2. Annuities;
3. The includible portion of joint estates with right of survivorship;
4. The includible portion of tenancies by the entirety;
5. Certain life insurance proceeds (even though payable to beneficiaries other than the estate);
6. Property over which the decedent possessed a general power of appointment;
7. Dower or curtesy (or statutory estate) of the surviving spouse; and
8. Community property to the extent of the decedent’s interest as defined by applicable law.

• The proceeds of all insurance must be included in the estate on the life of the decedent not receivable by, or for the benefit of, the decedent’s estate if the decedent possessed at death any of the following incidents of ownership, exercisable either alone or in conjunction with any person or entity (Form 706 Instructions, page 27):

1. The right of the insured or estate to its economic benefits
2. The power to change the beneficiary
3. The power to surrender or cancel the policy
4. The power to assign the policy or to revoke an assignment
5. The power to pledge the policy for a loan
6. The power to obtain from the insurer a loan against the surrender value of the policy
7. A reversionary interest if the value of the reversionary interest was more than 5% of the value of the policy immediately before the decedent died

• Accordingly, the life insurance policy with her daughter named as an irrevocable beneficiary does not have the incidents of ownership and is not included, so the gross value of Mary’s estate is $1,550,000, determined as follows:Personal Residence $400,000
  Certificate of Deposit 150,000
  Stocks 1,000,000
  Gross Estate $1,550,000

Question 19

Christopher wants to create a revocable grantor trust that will own all of his stocks and rental properties. Which statement regarding income of the trust is true?

A. Christopher will be taxed only on income that is distributed to him.
B. Christopher will be taxed on all income of the trust, regardless of distributions.
C. State law will determine how much of the trust income is taxable to Christopher.
D. If the rental income is passive, it will not be taxable to him.

Answer 19

B. Christopher will be taxed on all income of the trust, regardless of distributions.

• A trust is a grantor trust if the grantor retains certain powers or ownership benefits. This also can apply to only a portion of a trust. In general, a grantor trust is ignored for tax purposes and all of the income, deductions, etc. are treated as belonging directly to the grantor.
• In addition, the grantor is treated as an owner of any portion of a trust in which he or she has a reversionary interest in either the income or corpus therefrom, if, as of the inception of that portion of the trust, the value of the reversionary interest is more than 5% of the value of that portion. This rule also applies in the case of the owner’s spouse.
• Note: The grantor is treated as holding any power or interest that was held by either the grantor’s spouse at the time that the power or interest was created or who became the grantor’s spouse after the creation of that power or interest.
• As a result, all of the income from Christopher’s revocable grantor trust will be taxed to him, regardless of distributions.

Question 20

Which of the following statements concerning contributions by business entities to their employees’ retirement accounts is correct?

A. Sole proprietors deduct them on Schedule C.
B. Partnerships deduct them on Form 1065.
C. Corporations deduct them on Form 1120 or Form 1120-S.
D. All of the answer choices are correct.

Answer 20

D. All of the answer choices are correct.

• Publication 560, page 16, addresses the issue of where to deduct contributions. In general, a taxpayer deducts the contributions made by the taxpayer for common-law employees on the taxpayer’s tax return. That is to say:
  
  • Sole proprietors deduct them on Schedule C (Form 1040 or 1040-SR), or Schedule F (Form 1040 or 1040-SR) in the case of farming,
  • Partnerships deduct them on Form 1065, and
  • Corporations deduct them on Form 1120 or Form 1120-S.

Question 21

The trustee of a grantor type trust must never:

A. Give all payers of income the name and TIN of the grantor and the address of the trust.
B. File a trust return, completing only the entity information, and attach a statement identifying the grantor to whom the income is taxable.
C. File Forms 1099 with the IRS showing the trust income as paid to the grantor.
D. File a trust return, figuring the tax on all income and deductions of the trust.

Answer 21

D. File a trust return, figuring the tax on all income and deductions of the trust.

• A trust is a grantor trust if the grantor retains certain powers or ownership benefits. In general, a grantor trust is ignored for tax purposes and all of the income, deductions, etc. are treated as belonging directly to the grantor. This also applies to any portion of a trust that is treated as a grantor trust.
• If the entire trust is a grantor trust, the trustee fills in only the entity portion of Form 1041. Therefore, the trustee does not file a trust return, figuring the tax on all income and deductions of the trust.
• If only part of the trust is a grantor type trust, the portion of the income, deductions, etc., that is allocable to the non-grantor part of the trust is reported on Form 1041, under normal reporting rules. The amounts that are allocable directly to the grantor are shown only on an attachment to the form. Schedule K-1 (Form 1041) is not used as attachment. However, Schedule K-1 is used to reflect any income distributed from the portion of the trust that isn’t taxable directly to the grantor or owner.
• The fiduciary must give the grantor (owner) of the trust a copy of the attachment.

Question 22

A paycheck issued after the date of death to a taxpayer for work performed prior to death is considered:

A. Non-taxable income.
B. Income in respect of a decedent.
C. Excess compensation.
D. Deferred income.

Answer 22

B. Income in respect of a decedent.

• The entire amount of wages or other employee compensation earned by the decedent but unpaid at the time of death is income in respect of a decedent. The income isn’t reduced by any amounts withheld by the employer. If the income is $600 or more, the employer should report it in box 3 of Form 1099-NEC.

Question 23

Adams owns a second residence that is used for both personal and rental purposes. During Year 1, Adams used the second residence for 50 days and rented the residence for 200 days. Which of the following statements is correct?

A. Depreciation may not be deducted on the property under any circumstances.
B. A rental loss may be deducted if rental-related expenses exceed rental income.
C. Utilities and maintenance on the property must be divided between personal and rental use.
D. All mortgage interest and taxes on the property will be deducted to determine the property’s net income or loss.

Answer 23

C. Utilities and maintenance on the property must be divided between personal and rental use.

• Since Adams made rental use of the property more than 14 days or 10% of the total rented days, he must allocate the total expenses between the rental use and personal use based on the number of days used for each purpose.

Question 24

Which of the following statements is correct concerning a grantor type trust?

A. It is a legal entity under applicable state law.
B. Since the grantor has not relinquished complete control over the trust, it is not recognized as a separate taxable entity for income tax purposes.
C. All of the income and deductions are treated as belonging directly to the grantor of a grantor trust (not the trust).
D. All of the answer choices are correct.

Answer 24

D. All of the answer choices are correct.

• A trust is a grantor trust if the grantor retains certain powers or ownership benefits. In general, a grantor trust is ignored for tax purposes and all of the income, deductions, etc. are treated as belonging directly to the grantor (not the trust). This also applies to any portion of a trust that is treated as a grantor trust (Instructions for Form 1041, pages 13–14).
• In addition, a grantor type trust is a legal trust under applicable state law that is not recognized as a separate taxable entity for income tax purposes because the grantor has not relinquished complete dominion and control over the trust (Instructions for Form 1041, pages 18–19).

Question 25

Which of the following statements is correct about spouses that elect to split gifts?

A. The election applies to all gifts made in the current tax year.
B. The election applies to all gifts made in future tax years until the election is revoked.
C. The election applies to all gifts made in the current tax year even if the couple is granted a divorce.
D. All of the answer choices are correct.

Answer 25

A. The election applies to all gifts made in the current tax year.

• While a married couple may not file a joint gift tax return, the IRS permits spouses to split gifts under certain conditions. If both spouses agree, all gifts during the calendar year will be considered as made one-half by each spouse if:

1. Both spouses were married to one another at the time of the gift,
2. Divorced or widowed after the gift, the spouse did not remarry during the rest of the calendar year,
3. Neither of the spouses was a nonresident alien at the time of the gift, and
4. A spouse was not given a general power of appointment over the property interest transferred.

• Note: If spouses agree to split their gifts, they should file both of their individual gift tax returns in the same envelope to help the IRS process the returns and to avoid correspondence from the IRS; but do not attach the gift tax returns to the Form 1040.

Question 26

All of the following statements are correct, except:

A. A qualified plan does not include a 401(k) plan.
B. A defined contribution plan can be either a profit-sharing plan or a money purchase pension plan.
C. A defined contribution plan provides an individual account for each participant in the plan.
D. A defined contribution plan provides benefits to a participant largely based on the amount contributed to that participant’s account.

Answer 26

A. A qualified plan does not include a 401(k) plan.

• Publication 560, page 18, states, in part, that a defined contribution plan provides an individual account for each participant in the plan. It provides benefits to a participant largely based on the amount contributed to that participant’s account.
• A defined contribution plan can be either a profit-sharing plan OR a money purchase pension plan.
• An employer’s qualified plan (see Publication 560, page 24) can include a cash or deferred arrangement under which participants can choose to have the employer contribute part of their before-tax compensation to the plan rather than receive the compensation in cash. A plan with this type of arrangement is popularly known as a “401(k) plan.”

Question 27

Where should income be reported when received by an individual from rental (not including self-rentals) of an office building and where no significant services are provided to the tenant?

A. Other income on Form 1040.
B. Income on Schedule E, Supplemental Income and Loss.
C. Income on Schedule C, Profit or Loss From Business.
D. Income on Schedule D, Capital Gains and Losses.

Answer 27

B. Income on Schedule E, Supplemental Income and Loss.

• Publication 527, page 12, states that when a taxpayer rents buildings, rooms, or apartments, and provide basic services such as heat and light, trash collection, etc., the taxpayer normally reports the rental income and expenses in Part I of Schedule E (Form 1040).
• If, on the other hand, the taxpayer provides substantial services that are primarily for the tenant’s convenience, such as regular cleaning, changing linen, or maid service, the taxpayer reports the rental income and expenses on Schedule C (Form 1040), Profit or Loss From Business, or Schedule C-EZ, Net Profit From Business.
• Substantial services do not include the furnishing of heat and light, cleaning of public areas, trash collection, etc. For more information on this issue, look at Publication 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ).

Question 28

Which of the following is not a disqualified person for purposes of determining whether a prohibited transaction has been entered into under the qualified retirement plan rules?

A. A plan fiduciary who deposits contributions into his or her own account and uses the funds to pay personal business expenses
B. A 70-year-old individual who receives a distribution of the full value of his retirement account from a plan established by a business that he owns.
C. A fiduciary that invests the plan’s assets in FGH partnership. FGH deposits 10% of the plan’s assets into the fiduciary’s own account.
D. An employee who provides services to the plan.

Answer 28

B. A 70-year-old individual who receives a distribution of the full value of his retirement account from a plan established by a business that he owns.

• Prohibited transactions are transactions between the plan and a disqualified person that are prohibited by law. If a taxpayer is a disqualified person who takes part in a prohibited transaction, the taxpayer must pay a tax. Prohibited transactions generally include the following transactions (Publication 560, page 31):
  
  • A transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person
  • Any act of a fiduciary by which he or she deals with plan income or assets in his or her own interest
  • The receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a transaction that involves plan income or assets
  • Any of the following acts between the plan and a disqualified person: selling, exchanging, or leasing property; lending money or extending credit; or furnishing goods, services, or facilities
• A list of disqualified persons for determining prohibited transactions is found on page 31 of Publication 560. A partial listing of disqualified persons includes:
  
  • A fiduciary of the plan,
  • A person providing services to the plan,
  • An employer, any of whose employees are covered by the plan, and
  • An employee organization, any of whose members are covered by the plan.
• A prohibited transaction does not take place if the taxpayer is a disqualified person and receives any benefit to which the taxpayer is entitled as a plan participant or beneficiary. However, the benefit must be figured and paid under the same terms as for all other participants and beneficiaries.
• In this case, the 70-year-old owner and plan participant would not be a disqualified person for determining whether a prohibited transaction has been entered into, because the owner is receiving the benefits that he or she is entitled to as the plan participant.

Question 29

The Morrison Trust requires that all trust income be distributed at least annually. There are no provisions for charitable contributions. To be treated as a simple trust, what must also be true?

A. Trust income can consist of interest and dividends only.
B. There were no other distributions of corpus in the current year.
C. All beneficiaries must be U.S. citizens or resident aliens.
D. All of the answer choices are correct.

Answer 29

B. There were no other distributions of corpus in the current year.

• A trust will qualify as a simple trust if:
  
  • The trust instrument requires that all income must be distributed currently,
  • The trust instrument does not provide that any amounts are to be paid, permanently set aside, or used for charitable purposes, and
  • The trust does not distribute amounts allocated to the corpus of the trust.
• Given that the Morrison Trust requires all trust income to be distributed currently, and there are no provisions for charitable contributions, the only other requirement for the trust to be deemed a simple trust is that it does not distribute amounts allocated to the corpus.

Question 30

In 2023, Exeter Trust had taxable interest of $2,000, capital gains of $6,000, and a fiduciary fee of $1,000. The trust instrument allocates capital gains to income. At the end of 2023, the fiduciary retains $3,000 and distributes $4,000. What is the distributable net income (DNI) of Exeter Trust for 2023?

A. $4,000.
B. $4,375.
C. $7,000.
D. $7,375.

Answer 30

C. $7,000.

• A trust or decedent’s estate figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to estates and trusts. However, one major distinction is that a trust or decedent’s estate is allowed an income distribution deduction for distributions to beneficiaries. (Instructions for Form 1041, page 3)
• The income distribution deduction allowable to estates and trusts is limited to its distributable net income (DNI). A trust will arrive at DNI by adding and subtracting applicable amounts against its adjusted total income as figured on Schedule B. (See Schedule B on Form 1041 and the Instructions for Form 1041, page 4.)
• More specific to the issue in this question, when calculating the DNI for a simple trust, any amounts allocable to the corpus are disregarded in determining the adjusted total income amount. However, the capital gains are allocated to income.
• Thus, based on the information provided in the above question, the distributable net income is $7,000, calculated as follows:Interest Income $2,000
  Capital Gains (allocate to income) 6,000
  Less:
  Fiduciary Fee (1,000)
  Distributable Net Income $7,000

Question 31

All of the following are true regarding Income in Respect of a Decedent (IRD) EXCEPT:

A. IRD is income the decedent would have received had death not occurred that wasn’t properly included in the decedent’s final return.
B. The character of the IRD remains the same as it would have been to the decedent had they not passed.
C. If an individual receives IRD and includes it on their return, they are not allowed a deduction for the estate tax attributable to the item of IRD as reported on Form 706.
D. IRD must be included as income on either the decedent’s estate return, if the estate receives it, or the beneficiary, if the right to income is passed directly to the beneficiary and the beneficiary receives it, or any person to whom the estate properly distributes the right to receive it.

Answer 31

C. If an individual receives IRD and includes it on their return, they are not allowed a deduction for the estate tax attributable to the item of IRD as reported on Form 706.

• The decedents income includible on the final return is generally determined as if the person were still alive except that the taxable period is usually shorter because it ends on the date of death. The method of accounting regularly used by the decedent before death also determines the income includible on the final return. (Publication 559, page 5)
• Pursuant to Publication 559, page 10, income in respect of a decedent must be included in the income of one of the following.
  
  • The decedent’s estate, if the estate receives it.
    - The beneficiary, if the right to income is passed directly to the beneficiary and the beneficiary receives it.
  • Any person to whom the estate properly distributes the right to receive it.
• Finally, if a person is required to include income in respect of a decedent in their gross income and an estate tax return (Form 706) was filed for the decedent, you may be able to claim a deduction for the estate tax paid on that income.

Question 32

Ms. Smith, a cash method taxpayer, died on September 30, 2023. Subsequent to her death, but prior to December 31, 2023, her beneficiary received:

$1,500 in rental income,
$20,000 in proceeds from a life insurance policy, and
$6,000 in dividend declared on September 27, 2023.

What amount is considered income in respect of a decedent?

A. $1,500.
B. $7,500.
C. $3,000.
D. $27,500.

Answer 32

B. $7,500.

• The decedent’s income includible on the final return is generally determined as if the person were still alive except that the taxable period is usually shorter because it ends on the date of death. The method of accounting regularly used by the decedent before death also determines the income includible on the final return.
• Additionally, if the decedent accounted for income under the cash method, only those items actually or constructively received before death are included in the final return.
• Generally, if the decedent receives accelerated death benefits either on his or her life or on the life of another person, those benefits are not included in the decedent’s income.
• Therefore, the amount of income in respect of a decedent is $7,500, computed as follows:

                                                  Received
                                                 After Death Rental Income                                  $1,500 Dividend                                              6,000 Income in Respect of Decedent    $7,500

Question 33

All of the following are reporting requirements of a qualified retirement plan subject to ERISA except:

A. Submit Form 5500, Annual Return/Report of Employee Benefit Plan.
B. Information on certain contributions, conversions, and distributions to retirement plans reported on Form 8606.
C. Distributions from the plan are reported on Form 1099-R.
D. Participants must receive period statements of their retirement benefits.

Answer 33

B. Information on certain contributions, conversions, and distributions to retirement plans reported on Form 8606.

• Form 5500 Instructions, page 2 provides that all pension benefit plans covered by ERISA must file an annual return/report except as provided in this section. The return/report must be filed whether or not the plan is “tax-qualified,” benefits no longer accrue, contributions were not made this plan year, or contributions are no longer made. Pension benefit plans required to file include both defined benefit plans and defined contribution plans.
• Form 1099-R is filed for each person to whom a company made a designated distribution or are treated as having made a distribution of $10 or more from profit-sharing or retirement plans, any individual retirement arrangements (IRAs), annuities, pensions, insurance contracts, survivor income benefit plans, permanent and total disability payments under life insurance contracts, charitable gift annuities, etc. (Form 1099-R Instructions, page 1)
• The DOL report and disclosure guide for employee benefit plans provide on page 2 that a summary annual report is required to participants and pension plan beneficiaries receiving benefits within 9 months after end of plan year or 2 months after due date for filing Form 5500.

Question 34

The decedent died on June 30, 2023. The decedent used the cash method of accounting, and a calendar year-end. What total amount of the following is includible in the decedent’s final return (Form 1040)?

Taxable interest (earned equally all year): $2,000
Dividends (declared on June 15, 2023, and received on July 10, 2023): $500
Final wages (received July 10, 2023): 2,500
Total: $5,000

A. $1,000.
B. $2,500.
C. $4,000.
D. $3,500.

Answer 34

A. $1,000.

• The decedent’s includible income on the final return is generally determined as if the person were still alive except that the taxable period is usually shorter because it ends on the date of death. The method of accounting regularly used by the decedent before death also determines the income includible on the final return.
• Accordingly, if the decedent accounted for income under the cash method, only those items actually or constructively received before death are included in the final return.
• A dividend is considered constructively received if it was available for use by the decedent without restrictions, which is not the case for this decedent.
• Therefore, the total amount of income that is includible in the decedent’s final return is $1,000, which is one-half of the taxable interest earned equally all year.

Question 35

Farmer Judy is a calendar year taxpayer who uses the cash method of accounting. She normally sells 200 head of sheep a year. Because of a drought, she sold 250 head of sheep in 2023. Farmer Judy realized $50,000 from the sale. The affected area was declared a disaster area eligible for federal assistance on March 12, 2023. How much, if any, income can Farmer Judy postpone to 2024?

A. $10,000.
B. $50,000.
C. $12,500.
D. $0, since only sales because of flooding qualify for postponement.

Answer 35

A. $10,000.

• Publication 225, page 11, provides a special provision for farmers that sell or exchange more livestock, including poultry, than the farmer normally would in a year because of a drought, flood, or other weather-related condition. That is, the farmer may be able to postpone reporting the gain from the additional animals until the next year. The farmer/taxpayer must meet all the following conditions to qualify:
  
  • The taxpayer’s principal trade or business is farming.
  • The taxpayer uses the cash method of accounting.
  • The taxpayer can show that, under his or her usual business practices, he or she would not have sold or exchanged the additional animals this year except for the weather-related condition.
  • The weather-related condition caused an area to be designated as eligible for assistance by the federal government.
• One should realize that sales or exchanges made before an area became eligible for federal assistance qualify if the weather-related condition that caused the sale or exchange also caused the area to be designated as eligible for federal assistance. The designation can be made by the president, the Department of Agriculture (or any of its agencies), or by other federal departments or agencies.
• Farmer Judy appears to qualify for postponing the proceeds received from the sale of the additional head of sheep in 2023 until 2024. Thus, she can postpone $10,000, which is the amount attributable to the added sales ((50 head of sheep ÷ 250 head of sheep) × $50,000).
• Farmer Judy determines this amount by dividing the total income realized from the sale of all livestock in the class during the tax year ($50,000) by the total number of such livestock sold during the same tax year (250 head of sheep). She does not include any postponed gain in this part of the formula. Then, Judy multiplies the quotient she just determined by the excess number of such livestock sold solely because of weather-related conditions (50 head of sheep).

Question 36

When reporting rental income, an individual taxpayer must use which accounting method?

A. Cash basis.
B. Cash basis or accrual basis.
C. Accrual basis.
D. Hybrid.

Answer 36

B. Cash basis or accrual basis.

• A taxpayer has the choice of accounting methods when reporting rental income. A cash-basis taxpayer can select accrual basis for their rental activities.
• The one exception to this rule is prepaid rent. Regardless of which methodology chosen, prepaid rent must be recognized when received.

Question 37

Which of the following statements is correct about crop insurance and disaster payments?

A. The insurance proceeds can be deferred only if the farmer can show that the income from the crops would normally be reported in a tax year following the year of damage.
B. An accrual basis taxpayer can elect to include crop insurance proceeds in income for the tax year following the tax year in which the crops were damaged.
C. Insurance proceeds received in the tax year following the tax year in which the crops were destroyed can be deferred until the tax year following receipt of the proceeds.
D. A separate election to defer the inclusion of crop disaster payments must be made for each damaged crop of the trade or business.

Answer 37

A. The insurance proceeds can be deferred only if the farmer can show that the income from the crops would normally be reported in a tax year following the year of damage.

• Publication 225, pages 12–13, provides, in part, that a taxpayer farmer must include in income any crop insurance proceeds received as the result of crop damage, or reduction of crop revenue, or both in the year received.
• However, Publication 225, pages 12–13, provides a special rule for choosing to postpone reporting until the following year. A taxpayer can postpone reporting crop insurance proceeds as income until the year following the year the damage occurred if the taxpayer meets all of the following conditions:
  
  • The taxpayer uses the cash method of accounting,
  • The taxpayer receives the crop insurance proceeds in the same tax year the crops are damaged, and
  • The taxpayer can show that under his or her normal business practice the taxpayer would have included income from the damaged crops in any tax year following the year the damage occurred.
• Deferral isn’t permitted for proceeds received from revenue insurance policies.
• To postpone reporting crop insurance proceeds received in 2023, report the amount received on line 6a of Schedule F (Form 1040), but do not include it as a taxable amount on line 6b. Check the box on line 6c and attach a statement to the tax return. The statement must include the taxpayer’s name and address and other information that can be found on pages 12–13 of Publication 225.

Question 38

Trust B has distributable net income of $60,000, which includes $5,000 of tax-exempt income. The trustee distributed $75,000 to the trust’s sole beneficiary. What amount will be shown as the distribution deduction on the trust’s Form 1041?

A. $55,000.
B. $60,000.
C. $70,000.
D. $75,000.

Answer 38

A. $55,000.

• A trust or decedent’s estate figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to estates and trusts. However, one major distinction is that a trust or decedent’s estate is allowed an income distribution deduction for distributions to beneficiaries (Form 1041 Instructions, page 4).
• The income distribution deduction allowable to estates and trusts for amounts paid, credited, or required to be distributed to beneficiaries is limited to its distributable net income (DNI). (See Form 1041 Instructions, page 4, and Schedule B on Form 1041.)
• Therefore, Trust B will be able to deduct $55,000 as an income distribution deduction, determined as follows:

DNI: $60,000 Line 7, Schedule B, Form 1041
Less:
Tax-exempt interest: $(5,000) Line 2, Schedule B, Form 1041
Tentative income distribution: $55,000 Line 14, Schedule B, Form 1041 deduction
Amount distributed: $75,000 Line 11, Schedule B, Form 1041
Less:
Tax-exempt income: $(5,000) Line 12, Schedule B, Form 1041
Tentative income distribution: $70,000 Line 13, Schedule B, Form 1041 deduction
Income distribution deduction (lesser of line 13 or 14, and limited to DNI): $55,000 Line 15, Schedule B, Form 1041

Question 39

The John Q estate fiscal tax year runs from April 1, 2022, to March 31, 2023. The estate made distributions to beneficiaries on December 12, 2022, and March 15, 2023. Assuming that the estate has taxable income, in what year will its beneficiaries be required to report taxable distributions?

A. 2022.
B. 2023.
C. Both 2022 and 2023.
D. Neither 2022 nor 2023.

Answer 39

B. 2023.

• Generally, taxable distributions from an estate should be included on a beneficiary’s tax return in the year it was received. However, if the beneficiary’s tax year is different from the estate’s tax year, the taxable distribution must be reported on the beneficiary’s return for the tax year in which the last day of the estate’s tax year falls.

EXAMPLE: For example, if the tax year of the estate is a fiscal year ending on June 30, 2023, and the beneficiary’s tax year is the calendar year, the beneficiary will include in gross income for the tax year ending December 31, 2023, his or her share of the estate’s distributable net income distributed or required to be distributed during the fiscal year ending the previous June 30. (Publication 559, page 23)

• As a result, the beneficiaries of John Q estate must report the distributions received in 2023, the tax year in which the last day of the estate’s tax year falls, March 31, 2023.

Question 40

Which of the following is true regarding Income in Respect of a Decedent (IRD)?

A. The character of the IRD changes once the decedent passes away.
B. IRD is income the decedent would have received had death not occurred and was properly included in the decedent’s final return.
C. If an individual receives IRD and includes it on their return, they are not allowed a deduction for the estate tax attributable to the item of IRD as reported on Form 706.
D. IRD must be included as income by either the decedent’s estate, if the estate receives it, or the beneficiary, if the right to income is passed directly to the beneficiary and the beneficiary receives it, or any person to whom the estate properly distributes the right to receive it.

Answer 40

D. IRD must be included as income by either the decedent’s estate, if the estate receives it, or the beneficiary, if the right to income is passed directly to the beneficiary and the beneficiary receives it, or any person to whom the estate properly distributes the right to receive it.

• IRD is all income the decedent would have received had death not occurred that was NOT properly includible on the final return. IRD must be included in one of the following:
  
  • The estate
  • The beneficiary or
  • Any person whom the estate properly distributes the right to receive it
• Publication 559, page 14, provides that the character of income received in respect of a decent remains the same as it would have been to the decent if the decedent were alive.
• The correct answer is that the IRD must be included as income by either the decedent’s estate, if the estate receives it, or the beneficiary, if the right to income is passed directly to the beneficiary and the beneficiary receives it, or any person to who the estate properly distributes the right to receive it.

Question 41

Which of the following statements is correct?

A. If an exempt organization’s gross receipts are normally $50,000 or less, it must file Form 990-N.
B. Political organizations are not required to file Form 990-N.
C. Form 990 is filed by the 15th day of the 5th month after the organization’s accounting period ends.
D. All of the responses are correct.

Answer 41

D. All of the responses are correct.

• If an exempt organization’s gross receipts are normally $50,000 or less, it must submit Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to File Form 990 or 990-EZ, unless the organization chooses not to file Form 990 or 990-EZ. (Instructions for Form 990, page 3)
• A tax-exempt political organization must file Form 990 or 990-EZ if it had $25,000 or more in gross receipts during its tax year, even if its gross receipts are normally $50,000 or less, unless it meets one of the exceptions. (Instructions for Form 990, page 3)
• A qualified state or local political organization must file Form 990 or 990-EZ only if it has gross receipts of $100,000 or more. (Instructions for Form 990, page 3)
• As stated above, political organizations are required to file Form 990 or 990-EZ if it had $25,000 or more in gross receipts during its tax year, unless it meets one of the exceptions for certain political organizations under Section B; they are not required to submit Form 990-N.
• Form 990 is required to be filed by the 15th day of the 5th month after the organization’s accounting period ends. This is true for all Form 990s. (Instructions for Form 990, page 6)

Question 42

John Smith died on March 30, 2023. From January 1, 2023, to March 30, 2023, $2,000 in medical bills had been paid by John. The following additional medical bills were received and paid by the executor out of John’s estate:

From March 31, 2023, to December 31, 2023, in the amount of $5,000
From January 1, 2024, to March 30, 2024, in the amount of $5,000
From March 31, 2024, to April 6, 2024, in the amount of $3,000

The executor of John’s estate may elect to deduct what amount of the medical expenses (subject to percentage limitations) on John’s final income tax return, Form 1040, if deductions are itemized?

A. $2,000.
B. $7,000.
C. $12,000.
D. $15,000.

Answer 42

C. $12,000.

• The decedent’s includible income on the final return is generally determined as if the person were still alive except that the taxable period is usually shorter because it ends on the date of death. The method of accounting regularly used by the decedent before death also determines the income includible on the final return.
• Accordingly, if the decedent accounted for income under the cash method, only those items actually or constructively received before death are included in the final return (Publication 559, page 6).
• In addition, the rules for deductions allowed to an individual also apply to the decedent’s final income tax return, such as the standard deduction and unused net operating loss carryovers from prior years. Additionally, if the decedent’s medical expenses are paid out of the estate during the 1-year period beginning with the day after death, an election can be made to treat all, or part, of the expenses as paid by the decedent at the time they were incurred.
• Thus, in preparing John’s final Form 1040, the executor of John’s estate may elect to deduct $12,000 ($5,000 + $5,000 + $2,000) of medical expenses. The $3,000 paid after March 30, 2024, is beyond the 1-year period and, as such, it is not deductible.

Question 43

The Large Trust is a simple trust. Bert Little is the sole beneficiary of the trust. Capital gains are allocable to corpus. Based on the following information, what is the trust’s distribution deduction?

Interest $1,700
Dividend 300
Capital gains 2,000
Fiduciary fee 1,000

A. $1,000
B. $1,500
C. $2,000
D. $3,000

Answer 43

A. $1,000

• A trust or decedent’s estate figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to estates and trusts. However, one major distinction is that a trust or decedent’s estate is allowed an income distribution deduction for distributions to beneficiaries.
• The income distribution deduction allowable to estates and trusts is limited to its distributable net income (DNI). A trust will arrive at DNI by adding and subtracting applicable amounts against its adjusted total income. (See Schedule B on Form 1041.)
• More specific to the issue in this question, when calculating the DNI for a simple trust, any amounts allocable to the corpus are disregarded in determining the adjusted total income amount.
• Thus, based on the information provided in the above question, the Large Trust’s distribution deduction is $1,000, calculated as follows:Interest Income $1,700
  Ordinary Dividends 300
  Less:
  Fiduciary Fee (1,000)
  Distributable Net Income $1,000Distribution Deduction $1,000, which is limited to DNI

Question 44

The JLB Trust is a simple trust. Alan is the sole beneficiary of the trust. Capital gains are allocable to corpus. Based on the following information, what is the trust’s distribution deduction?

Interest $1,700
Dividends 300
Capital gains 2,000
Fiduciary fee 1,000

A. $1,000.
B. $1,500.
C. $2,000.
D. $3,000.

Answer 44

A. $1,000.

• A trust or decedent’s estate figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to estates and trusts. However, one major distinction is that a trust or decedent’s estate is allowed an income distribution deduction for distributions to beneficiaries.
• The income distribution deduction allowable to estates and trusts is limited to its distributable net income (DNI). A trust will arrive at DNI by adding and subtracting applicable amounts against its adjusted total income as figured on Schedule B. (See the instructions for Form 1041, pages 3 and 4; and Schedule B on Form 1041.)
• More specific to the issue in this question, when calculating the DNI for a simple trust, any amounts allocable to the corpus are disregarded in determining the adjusted total income amount.
• The distributable net income is $1,000, which is the interest income of $1,700 plus the ordinary dividends of $300 less the fiduciary fees of $1,000. Thus, the JLB Trust’s distribution deduction is limited to the DNI or $1,000 in this case.

Question 45

The Bordman Trust, an ongoing trust, was created in 2010. It has net operating loss in 2023. Which of the following statements is true regarding the trustee’s choices for claiming the loss?

A. Carry the NOL back to 2010.
B. Carry the NOL forward.
C. Waive the 2-year carryback period and pass the NOL through to beneficiaries.
D. Waive the 2-year carryback period and carry the NOL forward.

Answer 45

B. Carry the NOL forward.

• Generally, an NOL can only be carried forward to subsequent years and cannot be carried back. The 2-year carryback period only applies to the portion of an NOL attributable to a farming loss.
• Thus, the trustee of the Bordman Trust can only carry the NOL forward to subsequent years.