Questions Entities

Question 1

Mason’s will created a testamentary trust for the benefit of Mason’s spouse. Mason’s sister and Mason’s spouse were named as co-trustees of the trust. The trust provided for discretionary principal distributions to Mason’s spouse. It also provided that, on the death of Mason’s spouse, any remaining trust property was to be distributed to Mason’s children. Part of the trust property consisted of a very valuable coin collection. After Mason’s death, which of the following statements would be correct?

Answer 1

A.
Mason’s spouse may not be a co-trustee because the spouse is also a beneficiary of the trust.

B.
Mason’s sister may delegate her duties as co-trustee to the spouse and thereby not be liable for the administration of the trust.

C.
Under no circumstances could the spouse purchase the coin collection from the trust without breaching fiduciary duties owed to the trust and Mason’s children.

Correct D.
The co-trustees must use the same degree of skill, judgment, and care in managing the trust assets as reasonably prudent persons would exercise in managing their own affairs.

Question 2

Arno plans to establish a spendthrift trust naming Ford and Sims as life income beneficiaries, Trip as residuary beneficiary, and Bing as trustee. Arno plans to fund the trust with an office building.

Assume that an enforceable trust was formed. Sims has the following personal creditors:

Bank holding a home mortgage note deficiency judgment
Judgment creditor as a result of an automobile accident
To which of these creditors can Bing pay Sims’s share of trust income?

Answer 2

A.
I only

B.
II only

C.
Both I and II

Correct D.
Neither I nor II

A spendthrift trust is created for a beneficiary that is wasteful with money. The trust prevents the beneficiary from selling the funds or property and bars seizure from creditors of the beneficiary.

Bing cannot pay Sims’s share of trust income to either the bank holding a home mortgage note deficiency judgment or the judgment creditor as a result of an automobile accident. This trust is being funded with an office building, making it an express trust of real property; it must be in writing under the statute of frauds.

Question 3

Which of the following is a disadvantage of a revocable trust?

A.
The grantor will be subject to gift taxes on the transfer of property to the trust.

B.
The trust assets are subject to being probated upon the death of the grantor.

C.
The grantor loses power to control the trust funds for federal estate tax purposes.

D.
The trust is included in the gross estate of the grantor.

Answer 3

The correct answer is D.
A revocable trust is set up while the person is alive and means that the person who set up the trust can change their mind. If a revocable trust has a vehicle placed in it, the person can remove the vehicle and terminate 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. Thus, there are no gift taxes on the transfer of property to the trust.

The gross estate includes all property in which the decedent had an interest (including real property outside the United States). It also includes:

certain transfers made during the decedent’s life without an adequate and full consideration in money or money’s worth,
annuities,
the includible portion of joint estates with right of survivorship,
the includible portion of tenancies by the entirety, and
property over which the decedent possessed a general power of appointment.
As a result, a disadvantage of a revocable trust is it is included in the gross estate.

Question 4

When a trust instrument is silent regarding a trustee’s powers, which of the following implied powers does a trustee generally have?

The power to make distributions of principal to income beneficiaries
The power to lease trust property to third parties

A.
Both A and B

B.
Only A

C.
Only B

D.
Neither A nor B

Answer 4

The correct answer is C.
When a trust instrument is silent regarding a trustee’s powers, the trustee has the implied power to lease trust property to third parties, but does not have the implied power to make distributions of principal to income beneficiaries. An implied power is the power a trustee needs to perform such acts as are necessary to achieve the objectives of the trust.

Question 5

Pat created a trust, transferred property to this trust, and retained certain interests. For income tax purposes, Pat was treated as the owner of the trust. Pat has created which of the following types of trusts?

A.
Simple

B.
Grantor

C.
Complex

D.
Pre-need funeral

Answer 5

The correct answer is B.
The trust described here is a grantor trust. The grantor retains interests in the property transferred to the trust.

A simple trust is required to distribute all its income annually. A complex trust is not required to distribute all its income annually.

Question 6

Which of the following situations would cause a resulting trust to be created?

Failure of an express trust
Application of the cy pres doctrine
Fulfillment of the trust purpose
A.	 	
I and II

B.
I and III

C.
II and III

D.
I, II, and III

Answer 6

The correct answer is B.
Failure of an express trust and fulfillment of the trust purpose are the only two situations provided that could cause a resulting trust to be created.

The cy pres doctrine as defined in many legal dictionaries means “as close as possible.” In the world of trusts, the courts use this law when charitable trusts are unable to fulfill a charitable objective. The courts replace the original charity with a comparable charity, but this does not create a new trust.

An express trust is created when funds or property are distributed to a trustee. The trustee holds the funds or property for the recipient. The express trust must generally fulfill the requirements within the legal trust.

A resulting trust is any trust resulting from a decree or judgment of a court. The trusts are created in order to prevent one party from being unjustly enriched.

If the express trust is unreasonable and fails, the courts will create a resulting trust to help with the issue. Also, if there are any funds or property left when a trust purpose has been fulfilled, a resulting trust would be created to apply the rest of the funds or property.

Question 7

Which of the following describes a testamentary trust?

A.
A trust created by a grantor who is still alive at the time the trust is created

B.
A trust that may be amended, altered, or revoked by its grantor at any time, provided the grantor is not mentally incapacitated

C.
A trust created by an individual’s will at or following the date of the grantor’s death

D.
A trust that may not be amended, altered, or revoked by its grantor at any time until the terms or purposes of the trust have been completed

Answer 7

The correct answer is C.

A testamentary trust is created by an individual’s will at or following the date of the grantor’s death.

A trust created by a grantor who is still alive at the time the trust is created is a living (inter vivos) trust. A trust that may be amended, altered, or revoked by its grantor at any time, provided the grantor is not mentally incapacitated, is a revocable trust. A trust that may not be amended, altered, or revoked by its grantor at any time until the terms or purposes of the trust have been completed is an irrevocable trust.

Question 8

Arno plans to establish a spendthrift trust naming Ford and Sims life income beneficiaries, Trip as the residuary beneficiary, and Bing as trustee. Arno plans to fund the trust with an office building. Assume that an enfor­ceable trust was formed. Which of the following will be allocated to trust principal?

A.
Annual property tax: Yes; Monthly mortgage principal payment: Yes

B.
Annual property tax: Yes; Monthly mortgage principal payment: No

Correct C.
Annual property tax: No; Monthly mortgage principal payment: Yes

D.
Annual property tax: No; Monthly mortgage principal payment: No

Answer 8

the answer is C.
The property tax is an annual payment that is typically allocated to the income of a trust. Because the monthly mortgage payment is for the only trust asset, it would be allocated to the principal of the trust.

Question 9

Frost’s will created a testamentary trust naming Hill as life income beneficiary, with the principal to Brown when Hill dies. The trust was silent on allocation of principal and income. The trust’s sole asset was a commercial office building originally valued at $100,000 and having a current market value of $200,000. If the building was sold, which of the following statements would be correct concerning the allocation of the proceeds?

A.
The entire proceeds would be allocated to principal and retained.

B.
The entire proceeds would be allocated to income and distributed to Hill.

C.
One-half of the proceeds would be allocated to principal and one-half to income.

D.
One-half of the proceeds would be allocated to principal and one-half distributed to Brown.

Answer 9

The correct answer is A.

Since the trust’s only asset was the commercial office building and it was sold, then it is reasonable that the entire proceeds from the sale of the office building be allocated to the trust principal.

Question 10

RR Trust had a long-term capital gain of $3,000 (allocated to corpus), taxable interest of $2,000 and nontaxable interest of $2,000. The trustee’s fee was $400. The trust distributed $1,600 to beneficiaries. RR Trust is a simple trust. The trust’s taxable income is:

A.
$0.

B.
$3,000.

C.
$4,000.

D.
$3,700.

Answer 10

The answer is D.

Simple trusts (1) distribute all trust income ($1,600 in this question), (2) do not deduct charitable contributions, and (3) do not distribute trust principal. In addition, a personal exemption is allowed of $300 for a trust that is required to distribute all of its income currently (i.e., simple trusts).

According to IRC Section 265, expenses that are not related to a particular type of income (indirect expenses) must be allocated proportionately between taxable and nontaxable income. The trustee fee allocation is ($2,000 ÷ $4,000) × $400 = $200. The numerator of $2,000 is the nontaxable income and the $4,000 denominator is the total income included in trust accounting income and excludes income allocated to corpus. Also, the denominator includes gross income (if the amount is given), such as gross rental income, and not net rental income.

The same allocation applies to the deduction for distributions to beneficiaries (IRC Section 662). Since the beneficiaries received $1,600, it is assumed that half ($2,000 ÷ $4,000) of the distribution or $800 is from nontaxable income. The trust gets a deduction for the amount that the beneficiaries include in income.

The trust’s taxable income is computed as follows:

 Capital gain           $ 3,000
 Taxable interest         2,000
 Trustee fee (1/2)      -   200
 Distribution (1/2)     -   800
 Exemption              -   300
 Taxable income         $ 3,700
                        =======

Terms

Simple Trust
References

Question 11

Absent specific directions, which of the following parties will ordinarily receive the assets of a terminated trust?

A.
Income beneficiaries

B.
Remaindermen

C.
Grantor

D.
Trustee

Answer 11

The answer is B.

Income beneficiaries receive the income from a trust.

The remaindermen (or principal beneficiaries) receive the assets of a terminated trust. The grantor is the person who established the trust. The trustee is responsible for the management of the trust.

Question 12

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

Year 15 Estate Income
$20,000 Taxable interest
10,000 Net long-term capital gains
allocable to corpus

Year 15 Estate Disbursements
$5,000 Administrative expenses
attributable to taxable income

For the Year 15 calendar year, what was the estate’s distributable net income (DNI)?

A.
$15,000

B.
$20,000

C.
$25,000

D.
$30,000

Answer 12

The answer is A.

The estate’s distributable net income (DNI) is calculated as follows:

Taxable interest $20,000
Less administrative expenses
attributable to taxable income 5,000
DNI $15,000
=======

Distributable net income is an amount that sets the limit on the deduction of a domestic estate or trust for distributions to beneficiaries. The net long-term capital gains of $10,000 allocable to corpus are not part of “DNI.”

Question 13

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

A.
Partnerships

B.
S corporations

C.
Trusts and estates

D.
Not-for-profit organizations

Answer 13

The answer is C.

As pass-through (conduit) entities, both partnerships and S corporations are denied a net operating loss deduction in determination of taxable income. Trusts and estates are allowed a net operating loss deduction under Treasury Regulations. Not-for-profit organizations are generally denied net-operating-loss deductions except in calculating any unrelated business income tax.

IRC Sections 512(b)(6), 703(a)(2)(D), and 1363(b)(2)

Question 14

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

A.
Estates

B.
Trusts (except those that are exempt)

C.
Both estates and trusts (except those that are exempt)

D.
Neither estates nor trusts (except those that are exempt)

Answer 14

The answer is B.

Only three entities are permitted to freely select a fiscal year: C corporations, estates, and tax-exempt entities.

Trusts, partnerships, S corporations, and personal service corporations generally must conform their tax years to the tax years of their owners or a calendar year, unless the entity can establish a business purpose for having a different tax year.

Question 15

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

A.
Trust: $14,000; Beneficiary: $0

B.
Trust: $0; Beneficiary: $14,000

C.
Trust: $14,000; Beneficiary: $20,000

D.
Trust: $0; Beneficiary: $20,000

Answer 15

The correct answer is B.

Distributable net income (DNI) determines the amount and character of the income to be reported by the beneficiaries. In this case, all the DNI was distributed plus an additional $6,000. The DNI is the taxable amount ($14,000). For trusts, whoever gets the money is taxed on it. In this case, the trust kept no money and the beneficiaries received all of the taxable income from the trust.

Question 16

Ordinary and necessary administration expenses paid by the fiduciary of an estate are deductible:

Incorrect A.
only on the fiduciary income tax return (Form 1041) and never on the federal estate tax return (Form 706).

B.
only on the federal estate tax return and never on the fiduciary income tax return.

C.
on the fiduciary income tax return only if the estate tax deduction is waived for these expenses.

D.
on both the fiduciary income tax return and on the estate tax return by adding a tax computed on the proportionate rates attributable to both returns.

Answer 16

The correct answer is C.
Ordinary and necessary administration expenses are deductible on either the fiduciary income tax return (Form 1041) or the federal estate tax return (Form 706) but not both.

In order to deduct the expense on Form 1041, the estate must file a waiver of the death tax deduction on Form 706 and Form 1041.

While the expenses cannot be deducted twice, they can be allocated between the Form 1041 and Form 706.

Question 17

Which of the following is allowed in the calculation of the taxable income of a simple trust?

A.
Exemption

B.
Standard deduction

C.
Brokerage commission for purchase of tax-exempt bonds

D.
Charitable contribution

Answer 17

You are correct, the answer is A.

Estates and trusts are separate taxable entities. A personal exemption of $300 is allowed for a trust that is required to distribute all of its income currently (simple trust). A simple trust has no beneficiaries that are charitable organizations.

Question 18

What is Distributable Net Income (DNI)

Answer 18

Distributable net income is an amount that sets the limit on the deduction of a domestic estate or trust for distributions to beneficiaries. It also sets the maximum amount of the distribution taxable to the beneficiary.

A distribution from estate income that was currently required was made to the estate’s sole beneficiary during its calendar year. The maximum amount of the distribution to be included in the beneficiary’s gross income is limited to the estate’s distributable net income (DNI).

Question 19

Which of the following parties is necessary to create an express trust?

A.
Remainderman: Yes; Successor trustee: Yes

B.
Remainderman: Yes; Successor trustee: No

C.
Remainderman: No; Successor trustee: Yes

D.
Remainderman: No; Successor trustee: No

Answer 19

The correct answer is D.

Neither a remainderman nor a successor trustee is needed to create an express trust. A remainderman refers to the person who gets the remainder of the items in a trust. For example, a trust states A gets the trust, and then B gets the trust. A dies, and therefore B gets the remainder. A successor trustee is the person that takes over a trust when the original trustee becomes incapacitated or dies. Therefore, the trust dies when the beneficiary is incapacitated or dies.

Question 20

For the current year, the AB Trust had DNI of $30,000, fiduciary accounting income of $50,000, and distributed $40,000 to beneficiaries. What amount should the sole beneficiary of the AB Trust report as taxable income from the trust?

A.
$0

B.
$30,000

C.
$40,000

D.
$50,000

Answer 20

The correct answer is B.

Beneficiaries are taxed on their share of the trusts income distributed to them, but not more than their share of DNI of the trust.

Question 21

Gardner, a U.S. citizen and the sole income beneficiary of a simple trust, is entitled to receive current distributions of the trust income. During the year, the trust reported:

Interest income from corporate bonds $5,000
Fiduciary fees allocable to income 750
Net long-term capital gain allocable to corpus 2,000

What amount of the trust income is includible in Gardner’s gross income?

A.
$7,000

B.
$5,000

C.
$4,250

D.
$0

Answer 21

The correct answer is C.

The full amount of a simple trust’s distributable net income (DNI) is includible in the beneficiary’s income for the year whether distributed or not. DNI does not include the net capital gains allocable to corpus. In this case, DNI equals the interest income less the fiduciary fees allocable to income ($5,000 − $750 = $4,250).

IRC Section 652(a)

Question 22

The Simone Trust reported distributable net income of $120,000 for the current year. The trustee is required to distribute $60,000 to Kent and $90,000 to Lind each year. If the trustee distributes these amounts, what amount is includible in Lind’s gross income?

A.
$0

B.
$60,000

C.
$72,000

D.
$90,000

Answer 22

The correct answer is C.

The Simone Trust is required to distribute $60,000 to Ken and $90,000 to Lind for a total of $150,000 each year. Kent receives 40% of the total distribution ($60,000 ÷ $150,000 = 0.40). Lind receives 60% of the total distribution ($90,000 ÷ $150,000 = 0.60). Since the trust reported distributable net income of $120,000, 60% ($72,000) should be included in Lind’s gross income.

Question 23

A trust in which the beneficiaries are given a future right to trust income or corpus and the $14,000 gift tax exclusion is retained is termed a:

A.
reversionary trust.

B.
Crummey trust.

C.
gift-leaseback.

D.
throwback trust.

Answer 23

The correct answer is B.

A Crummey trust is a “safe harbor” rule that allows the annual gift tax exclusion on gifts to a trust. The gift of a future interest provision does not apply to gifts to a Crummey trust if trust assets go to the beneficiaries on or before age 21. Giving the right to the trust income (generally only up to $14,000 per donee, per year) meets the requirement even though the beneficiaries do not actually withdraw the funds.

Question 24

During the current year, a trust reports the following information:

Dividends $10,000
Interest from corporate bonds 12,000
Tax-exempt interest from state bonds 4,000
Capital gain (allocated to corpus) 2,000
Trustee fee (allocated to corpus) 6,000
What is the trust’s accounting income?

A.
$22,000

B.
$26,000

C.
$28,000

D.
$34,000

Answer 24

The correct answer is B.
The accounting income of a trust is the amount an income beneficiary is entitled to receive from the trust. Accounting income includes both taxable and nontaxable items of income.

Dividends $10,000
Interest from corporate bonds 12,000
Tax-exempt interest from state bonds 4,000
Capital gain allocated to corpus 0
Trustee fee allocated to corpus 0
——-
Trust’s accounting income $26,000
=======

Question 25

Separately stated items vs. separately stated items.

Answer 25

A partnership computes its income and reports only trade or business activity deductions. The ordinary business income for a partnership is computed as:

gross receipts or sales less cost of goods sold plus other partnership income, less
salaries and wages,
repairs and maintenance,
bad debts,
rent,
taxes and licenses,
interest,
depreciation,
retirement plans, and
other deductions.
Certain deductions, however, are not allowed to the partnership. Items that are separately stated on the partnership return and included as separate items on the partners' returns are:

ordinary income or loss from trade or business activities,
net income or loss from rental real estate activities,
net income or loss from other rental activities,
guaranteed payments to partners,
interest income, dividends, and royalties,
gains and losses from sales or exchanges of property described in IRC Section 1231,
dividends (passed through to corporate partners) that are eligible for the dividends-received deduction,
taxes paid or accrued to foreign countries and U.S. possessions, and
other items of income, gain, loss, deduction (e.g., IRC Section 179, charitable contributions), or credit, as provided by regulations. Examples include nonbusiness expenses, intangible drilling and development costs, and soil and water conservation expenses.
The nonseparately stated partnership income or otherwise known as ordinary income from the trade or business is $46,000, which is the difference between the sales income of $100,000 less cost of goods sold of $50,000 and less employee wages of $4,000.

Question 26

PDK, LLC, had three members with equal ownership percentages. PDK elected to be treated as a partnership. For the tax year ending December 31, Year 1, PDK had the following income and expense items:

Revenues                       $120,000
Interest income                   6,000
Gain on sale of securities        8,000
Salaries                         36,000
Guaranteed payments              10,000
Rent expense                     21,000
Depreciation expense             18,000
Charitable contributions          3,000
What would PDK report as nonseparately stated income for Year 1 tax purposes?

A.
$30,000

B.
$35,000

C.
$43,000

D.
$51,000

Answer 26

The correct answer is B.
PDK would report $35,000 as nonseparately stated income for Year 1, calculated as follows:

Revenues $120,000
Less: Salaries (36,000)
Less: Guaranteed payments (10,000)
Less: Rent expense (21,000)
Less: Depreciation expense (18,000)
———
Nonseparately stated income $ 35,000
=========
Any income, losses, deductions, or credits that might affect the tax liability of a member in a different manner depending on any other factors in their particular tax situation must be separately stated on the tax return. In this problem, the separately stated items include gain on sale of securities and charitable contributions.

Guaranteed payments to partners are included with the nonseparately stated items.

Question 27

Which one of the following statements regarding a partnership’s tax year is correct?

A.
A partnership formed on July 1 is required to adopt a tax year ending on June 30.

B.
A partnership may elect to have a tax year other than the generally required tax year, if the deferral period for the tax year elected does not exceed three months.

Incorrect C.
A “valid business purpose” can no longer be claimed as a reason for adoption of a tax year other than the generally required tax year.

D.
Within 30 days after a partnership has established a tax year, a form must be filed with the IRS as notification of the tax year adopted.

Answer 27

The correct answer is B.
Generally, a partnership cannot have a tax year other than its “majority interest taxable year” (IRC Section 706(b)). This means that the partnership year-end must be the same year-end that partners having over 50% interest in partnership profits and capital have. Usually this is a calendar year-end, since most individuals (partners) have a calendar reporting tax year. (IRC Section 706(b); Regulation Section 1.706-1)

A partnership may elect to have a tax year other than the generally required tax year if the deferral period for the tax year elected does not exceed three months. This is known as a “Section 444 election.” This election is made by filing Form 8716. (IRC Section 444(b)(1))

The partnership can elect any tax year if it can establish a business purpose for doing so. (IRC Section 706(b)(1)(C))

The IRS is generally not notified of a year-end adoption. Permission from IRS is required only in cases when the change from one accounting period to another is required. (Regulation Sections 1.441-1(c) and 1.441-1(e))

Question 28

The individual partner rather than the partnership makes which of the following elections?

A.
Election to amortize organizational costs

B.
Nonrecognition treatment for involuntary conversion gains

C.
IRC 179 deductions for tangible personal property

D.
Whether to take a deduction or credit for taxes paid to foreign countries

Answer 28

The correct answer is D.
There are many income and expense items where the partnership must decide on the accounting treatment, especially where there are choices in the treatment of each item. These include the amortization of organization costs, treatment of involuntary conversions, and the option of Section 179 expensing of equipment. The choice of choosing the credit or the use of a deduction for foreign taxes is left to the individual partner.

Question 29

The YZ partnership had the following income items during the year.

Income from operations $10,000
Section 1231 gain 7,000
Dividend income 6,000
Recovery of bad debt previously written off 1,000
What amount should be reported as ordinary income by the partnership for the year?

A.
$10,000

B.
$11,000

C.
$17,000

D.
$24,000

Answer 29

The correct answer is A.
A partnership must report separately any item that could receive special treatment at the partner level. Separately stated items include capital gains and losses, Section 1231 items, investment income and expenses, and items subject to the tax benefit rule.

The recovery of bad debt previously written off of $1,000 is an item subject to the tax benefit rule and is specifically listed as a separately stated item in Regulation Section 1.702-1. Therefore, the bad debt would not be included as ordinary income.

Question 30

Freeman, a single individual, reported the following income in the current year:

Guaranteed payment from services rendered to a partnership: $50,000
Ordinary income from an S corporation: $20,000
What amount of Freeman’s income is subject to self-employment tax?

A.
$0

B.
$20,000

C.
$50,000

D.
$70,000

Answer 30

The correct answer is C.
Only the $50,000 guaranteed payment paid to Freeman is subject to self-employment tax.

Guaranteed payments for services performed by a partner are subject to self-employment tax at the partner level.

A shareholder will report his share of the ordinary income from an S corporation whether it is distributed or not, and this income is not subject to self-employment tax at the shareholder level.